By Riccardo Crescenzi (LSE) and Nicola Limodio (Bocconi University)
Chinese foreign direct investment in Ethiopia has transformed the local economy with winners and losers among domestic firms. Firms competing in the same sector as the new foreign entrant have been depleted and competitors have been adversely affected. Conversely, suppliers to foreign firms have expanded. Overall the host economy has benefitted from significant and persistently positive long-term effects.
China’s evolution into a manufacturing giant has generated highly heterogeneous impacts across sectors, firms and places in both developed and developing countries. Part of the ‘China Shock’ on the world economy has materialised through trade in both advanced and emerging economies. More recently, the ‘China Shock’ has started to unfold beyond the traditional trade channels to involve outward FDI, for example through the Belt and Road Initiative. In this context, a special role has been played by African countries.
In terms of value (both flows and stocks) Africa still accounts for a relatively small share of total global Chinese outward FDI. However, these investment projects have attracted significant attention due to their increasing sectoral and geographical diversification beyond natural resource seeking, as well as for their economic and geo-political implications.
The lively debate on the effects of Chinese FDI presents a wide spectrum of views. Some analysts and commentators have highlighted the growth-enhancing potential of Chinese investment, based on a generally positive view of global investment flows towards less advanced economies. In contrast, more critical views have offered a neo-colonialist interpretation of Chinese FDI, highlighting the geo-political strings attached to fresh Chinese capital injections (in particular where institutions are weak and regulatory frameworks often absent). Tensions between the USA and China have further polarised views on Chinese FDI in Africa, making it difficult to scrutinise opportunities and treats in a balanced evidence-based manner.
In a recent study we have explored the impact of Chinese FDI in Ethiopia, which constitutes a large manufacturing hub in Africa and where China is heavily investing both to serve the local market and to export to other African countries and beyond. China is currently the largest investing country in Ethiopia – accounting for 30.74% of all greenfield FDI projects between 2013 and 2020 – followed by the USA (21.45%) and the UK (4.58%) (BvD data). The diversification and upgrading of Chinese FDI has also progressed at a remarkable pace with new manufacturing projects consistently outnumbering natural resources projects since the mid-2000s. This evolution is well-aligned with the emphasis of Ethiopia’s Growth and Transformation Plan (GTP II) on making the country a manufacturing hub and its sustained process of growth-promoting structural transformation. Ethiopia is therefore an ideal case study to analyse the impacts of the evolving nature of Chinese economic presence in Africa.
In order to shed new light on the impact of this distinctive form of FDI, we leveraged and combined a variety of data sources: the universe of FDI investment recorded in Ethiopia, the census of medium and large manufacturing firms, as well as an innovative night lights panel of Ethiopian districts in order to shed light on local impacts beyond the boundaries of individual firms. In order to identify the causal impact of FDI inflows on local firms and economic activity we leveraged a natural experiment in the allocation of Chinese FDI to Ethiopian sectors and districts offered by the unique structure of Chinese export taxes, due to the non-neutrality of its value-added tax (VAT).
This analysis produces two main findings.
First, the increase in Chinese FDI generates mixed effects on the host economies. On the one hand, firms competing in the same sector and district shrink their operations (production, employment and investment) and lower their prices, in line with a competition shock induced by FDI. On the other hand, firms operating in the local upstream and downstream sectors expand their sales, investment and inputs, as the demand for their products and the quality of their inputs increases. Firms facing Chinese FDI in sectors which are upstream to their operations benefit from cheaper, higher-quality inputs, which lower their costs and/or increase their productivity allowing for higher employment levels and total investment. At the same time, although to a lesser extent, domestic firms interacting with Chinese subsidiaries in downstream sectors benefit from the possibility to supply more efficient buyers (both new foreign subsidiaries and surviving more efficient domestic firms) through imitation, learning and knowledge spillovers. This leads to higher total employment and sale prices.
Second, we estimate the wider economic impacts of Chinese FDI beyond the effects on domestic firms by using satellite night lights data over a 20-year horizon. The analysis of this innovative data source, developed through machine learning, makes it possible to explore how Chinese FDI impact the entire economy of their host districts, generating returns in terms of total local output proxied at such a fine-grained spatial scale by the intensity of artificial lights during the night. The results show that the positive and negative firm-level impacts of FDI – highlighted by the firm-level analysis – offset each other in the short-run, resulting in a well-estimated instantaneous zero effect of Chinese FDI on local economic activity. However, the positive effects outweigh the negative ones in the medium-run, with an overall positive, significant and persistent impact on local growth after 6-12 years.
Figure 1 plots the evolution of positive effects over time.
The chart shows the coefficients of five separate IV regressions in which the natural logarithm of night light brightness at time t + k is regressed over the natural logarithm of Chinese FDI at time t, which is instrumented using a weighted sum of the export tax in sector s at time t-1 interacted with the district exposure to the specific sector. Standard errors are clustered at district level.
Overall, these findings cast some doubts on the fierce and often-times ideological debate around Chinese presence in Africa. We show that the effects of Chinese FDI are highly heterogeneous, but overall positive in the medium run. This empirical contribution offers grounds for a fruitful, evidence-based discussion, and subsequent refinement of guidance surrounding optimal trade and investment policies.
At a time when international development budgets are being cut in the UK and across advanced economies it is crucial to look at all possible sources of economic growth and recovery for Africa. The poisonous rhetoric of the ‘Chinese Virus’ risks to overshadow an important avenue for development that, instead, needs to be better understood and supported within appropriate regulatory frameworks. The unprecedented challenges of the post-Covid world economy call for fresh approach to economic opportunities based on solid evidence and free from ideology.
The Impact of Chinese FDI in Africa: Evidence from Ethiopia by Riccardo Crescenzi and Nicola Limodio is currently under review at a top US academic journal and is available as a Discussion Paper by both the LSE Institute of Global Affairs (IGA) and the Department of Geography and Environment.
This post represents the views of the authors and not those of the GILD blog, nor the LSE.
The authors are part of the ERC GILD (Global Investments and Local Development) Team at the LSE
Riccardo Crescenzi is a Professor of Economic Geography at the London School of Economics.