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Africa’s economic integration offers prospects for UK investors

Written by Dirk Willem te Velde

Image credit:Skylines in Addis Ababa, Ethiopia. Simon Davis/DFID (CC BY 2.0) Image license:CC BY 2.0

The UK government is organising the Africa Investment Conference this week, bringing together a range of UK and African policy-makers and businesses to increase investor interest in Africa. Growth in the stock of UK foreign direct investment (FDI) in the 2010s has been slow, and less strong relative to other FDI in Africa. Recent political momentum behind the African Continental Free Trade Area (AfCFTA) could help to transform African economies and make Africa more attractive for investors, which can in turn support Africa’s economic transformation.

Here I take a look at how different types of provisions in AfCFTA could support investors and provide tentative estimates that suggest a deeply integrated Africa, through a well-implemented AfCFTA, could lead to an increase in the stock of UK FDI by as much as 25% (or £12.5 billion) over time.

UK FDI in Africa

The UK is a major investor in Africa, responsible for £50.6 billion stock of FDI in 2019. However, while the stock of UK FDI was 10% of all FDI in 1992, this share decreased to less than 7% in 2019. Compared to other investors, UK FDI is concentrated more in natural resources and financial services. There appear to be opportunities for UK investors. Since 1992, the returns (net earnings after tax) expressed as a percentage of the stock of UK FDI in Africa have been consistently double the returns estimated for the world as a whole (it was 12.1% in Africa in 2019, and 6.1% for the world as a whole).

Trade and investment provisions in the AfCFTA

The AfCFTA has been signed by 54 out of 55 AU members and ratified by more than 40 countries. It covers 1.2 billion people with a market size of $2.5 trillion. The AfCFTA has two main phases of negotiations. Phase one is organised around three protocols: the Protocol on Trade in Goods; the Protocol on Trade in Services; and the Protocol on Rules and Procedures on the Settlement of Disputes. Phase two issues include Investment, Competition Policy, Intellectual Property Rights (IPRs) and Digital Trade, including e-commerce. There are also discussions on protocols on Women and Youth.

Links between regional integration and FDI

African integration and the provisions in the AfCFTA can make Africa more attractive for African and external investors. In general, FDI is attracted by a range of factors including:

  • General and specific host country economic conditions, including market size and growth; good-quality and appropriate infrastructure and skills; and natural resources;
  • General and specific host country policies, institutions, administrative procedures and governance;
  • International rules and activities (multilateral, bilateral and regional) and home country policies (e.g. directed credit and investment guarantees).

The AfCFTA will affect these determinants of FDI. For example, it is expected to raise African incomes which in turn will drive more market-seeking local and foreign investment. External investors will also be more interested in investing in a more integrated (and less fragmented) Africa through stronger trade provisions because investors can serve the region more easily from one location in the region and export to the rest (the so-called market size effect), or they can access (regional) inputs and export finished products more easily (which is relevant for “efficiency-seeking” investors). Further, provisions governing investment (e.g. investment protection, investment facilitation, dispute settlement) may also provide incentives to investors, both those that are part of the region and external investors.

There is an empirical literature on the impact of regional membership on attracting inward FDI, with suggestions that membership of a region can increase inward FDI by more than 50%.

Importantly, evidence also suggests that the type or scope of regional provisions matters. One study suggests that membership of a region as such is not significantly related to inward FDI, but, crucially, when a country is a member of a region with a sufficient number and level of trade and investment provisions (describing e.g. the treatment of foreign firms, or significant reduction in tariff and non-tariff barriers), this will help attract more inward FDI. The stricter and more comprehensive the rules, the more comfortable investors (though the effect is unlikely to be as strong as the effect of incomes, skills and infrastructure on FDI).

Possible implications of AfCFTA for UK FDI

Here are three ways the AfCFTA could increase UK FDI and tentatively provide quantitative estimates (providing insights into orders of magnitude).

Increased incomes

Higher incomes often lead to more FDI, especially investors that want to use a growing consumer base. The World Bank (2020) estimates that AfCFTA can raise African incomes by between 0.2% (tariff liberalisation only), 2.4% (tariff and non-tariff barrier liberalisation) and 7% (trade facilitation included). We tentatively estimate that when deep integration would raise incomes by 7%, this would increase the stock of UK FDI by 5% (7% times 0.7, with 0.7 being the estimated elasticity of UK FDI with respect to GDP based on previous research). A change of 5% in the stock of UK FDI is equivalent to £2.5 billion.

AfCFTA trade provisions

Eliminating trade barriers will help to attract inward FDI by increasing effective market size. The average tariff is 13% for Africa as a whole and there are also significant non-tariff barriers amongst African countries. Previous analysis of UK FDI suggests that UK FDI has an elasticity to trade provisions (measured on a score between 0 and 3) of 0.43. African RECs already have some trade provisions, so AfCFTA may increase the score by one point (an increase of a third), which means a 0.33*43% increase in the stock of FDI, or an increase of £7.2 billion.

AfCFTA investment provisions

A more transparent framework governing intra-African FDI can also make Africa attractive to UK investors. Previous analysis on regional investment provisions suggests that UK FDI has an elasticity with respect to the depth of investment provisions (measured on a scale from 0 to 3) of 0.17. African RECs already have some investment provisions, so AfCFTA may increase the score by a third which could mean a 0.33*17% increase in the stock of FDI, or an increase of £2.9 billion.

In conclusion, deeper regional integration through the AfCFTA could lead to a boost of £12.5 billion (adding the above effects), or a 25% increase, in the stock of UK FDI and would take many years to materialise. We should emphasise the tentative nature of such estimates and attach more value to qualitative insights on the type of effects rather than the actual quantitative estimate.

Private sector investors are likely to take a long view of African integration. Many provisions will take many years to negotiate and implement. However, it is important to stress that progress in the AfCFTA generally as well as implementation of specific trade and investment provisions matter for investor interest. The precise effects for individual investors may depend on specific measures, such as trade facilitation measures, sustainable investment facilitation measures, or provisions relating to digital trade. A major objective of the AfCFTA is to transform African economies and one of the ways in which this might be done is through attracting quality FDI. There is a busy agenda ahead.