Institutional determinants and FDI in East Africa

1

Institutional Determinants and FDI in East Africa

The Case of Kenya and Tanzania

Abstract

Multiple studies have shown the importance of institutional determinants on foreign direct

investment (FDI). FDI numbers in East Africa have risen the past years, which can partly be explained by institutional determinants in the region. This qualitative thesis examines the effect of institutional determinants on FDI in Kenya and Tanzania. By conducting a total of 12 interviews in both countries, this thesis shows in-depth results about the relationship between institutional determinants and FDI. Results show that corruption, political instability, political and economic freedom, government policy and human capital all have different effects on FDI in Kenya and Tanzania for various reasons.

Steven Maas Thesis MSc International Management

10247335 1st _{Supervisor: E. Dirksen MSc.}

2 Index

1. Introduction 3

2. Theory 4

- 2.1 Institutions 4

- 2.2 Institutional Determinants of FDI 5

- 2.3 Corruption 6

- 2.4 Political Instability 8

- 2.5 Political and Economic Freedom 8

- 2.6 Government Policy 10

3. Method 12

4. Results 14

- 4.1 Corruption 14

o 4.1.1 Policy of Foreign Organizations 16

- 4.2 Political Instability 17

o 4.2.1 Elections 19

o 4.2.2 Terrorism 20

- 4.3 Political and Economic Freedom 21

o 4.3.1 Democracy 22

o 4.3.2 Economic Freedom 23

- 4.4 Government Policy 24

o 4.4.1 The Role of the President 25

o 4.4.2 Taxes and Regulations 27

o 4.4.3 Decentralization of Power and FDI 30

- 4.5 Human Capital 32

5. Conclusion 34

6. Discussion 36

- 6.1 Suggestions 37

3 1 Introduction

The East-African region, consisting of Kenya, Rwanda, Tanzania and Uganda, is considered to be a high potential region and has recorded the highest share of Foreign Direct Investment (FDI) across the African continent and is projected to be the continents leading region on economic development (African Economic Outlook, 2015; EY, 2016). While this region has suffered in the past twenty years from civil wars, corruption scandals and bad government policy, all four countries are going through different sorts of development on institutional level and FDI, which is argued to be one of the major components for economic growth and development (Borensztein, De Gregorio & Lee, 1998). The attractiveness of the East African region in terms of FDI inflows is supported by the following numbers (African Economic Outlook, 2016). FDI inflows in Kenya has grown from 115 million US dollars in 2009 to 989 million dollars in 2014. Furthermore, FDI inflows in Tanzania has grown from 953 million dollars in 2009 to 2142 million dollars in 2014. Rwanda and Uganda show the same type of growth in FDI inflows between 2009 and 2014: from 119 million dollars to 268 million dollars (Rwanda) and from 842 million dollars to 1147 million dollars (Uganda). Even though these growth figures cannot be compared with upcoming countries such as China and India, the East African region goes through a period of stable economic growth and FDI inflows, which makes it the region within Africa with the highest potential.

While a part of this FDI number is the result of macroeconomic determinants and interests in natural resources, institutional determinants are also of importance to the growth of FDI in these countries. Institutional determinants are connected to certain institutions, such as the government, the judicial system and the educational system. Multiple studies show the importance of institutional determinants on FDI (Asiedu, 2002; Asiedu, 2006; Blonigen, 2005). However, most of the current scientific literature focusses on the mathematical or statistical relationship between different institutional determinants and FDI. These studies show that there actually exists a statistical

relationship between institutional determinants and FDI, but lack an in-depth analysis of underlying motives and reasons for this relationship. Obviously, it is necessary at first to show the actual relationship between variables. However, without further in-depth explanations the relationship between variables remains superficial and without an understanding of underlying motives. Next to the lack of in-depth studies on this subject, the East African region remains insufficiently examined on the subject of FDI, while FDI is an important factor for economic growth and stability in the region. The importance of examining FDI in the East Africa region lies in the potential to attract larger number of FDI as a result from extensive research on this subject. In order to fill this gap in the current scientific literature, this thesis tries to answer the following question:

4 “How do institutional determinants affect the development of FDI in Kenya and Tanzania?”

In order to examine the East African region, Kenya and Tanzania are examined on multiple

institutional determinants and their influence on FDI. Both countries differ on FDI levels, but also on political and social level, which makes it interesting to look at the different aspects. Uganda is not taken into account in this thesis, as their FDI level and development is not sufficient to examine. Furthermore, Rwanda and Uganda are not taken into account in this thesis, as respondents and contacts in both countries are not reachable, partly because of a lack of freedom of speech in the countries.

2 Theory

In the theory section, all important concepts, ideas and relationships between variables in the current literature are explained. At first, the basic ideas of institutions are described. After that, the institutional determinants of FDI and their relationship towards FDI are explained.

2.1 Institutions

Institutional determinants are an important predictor of the development of foreign direct investment, as mentioned in the introduction. However, the concept of institutions is

comprehensive, and needs extensive explanation. According to North (1990), institutions can be described as the rules of the game in a society that shape human interaction. How the game is played, is defined by these rules of the game, which can be both formal (e.g. legislation) and informal (e.g. codes of behavior). The major role of institutions is to reduce uncertainty within a society by setting up a stable environment for human interaction. This stability does not imply that institutions cannot change. In fact, codes of behavior, codes of conduct, legislation, norms and values, and contracts between individuals are able to influence the evolution of institutions (North, 1990). According to Scott (2013, p. 56), “institutions comprise regulative, normative and cultural-cognitive elements that, together with associated activities and resources, provide stability and meaning to social life.” Next to symbolic systems, such as rules and norms, institutions cover associated behavior.

Another perception of institutions is that institutions are formed by three elements or pillars: regulative systems, normative systems and cultural-cognitive systems. The regulative pillar is

associated with legislation, rule-setting and sanctioning activities. The normative pillar includes values and norms. The basis of compliance of the normative pillar is social obligation: the society expects one to behave in a certain way. The third pillar, cultural-cognitive systems, is associated with both societal and organizational culture. The term “belief” is central in this system, which is based on a shared understanding and taken-for-grantedness (Scott, 2013). As multiple studies show,

5 institutions are an important predictor of foreign direct investment (Blonigen, 2005; Busse &

Hefeker, 2007). However, the concept of institutions is too comprehensive to use as a single determinant for foreign direct investment. The institutional level consists of different variables, which all have different effects on foreign direct investment. The most important institutional determinants are described in other parts of the theory section.

2.2 Institutional Determinants of FDI

Foreign Direct Investment (FDI) is an investment made by an organization or individual in a certain country, while based in another country (Helpman, Melitz & Yeaple, 2003). Total FDI inflows of a specific country is often described as the total amount invested in that specific country by foreign firms and organizations. FDI is considered to be better for economic growth and development of a certain country than other capital flows (Walsh & Yu, 2010). This idea is supported by Alguacil, Cuadros & Orts (2011), who argue that capital flows, and especially FDI, are one of the key

components of globalization and international integration of developing countries. Furthermore, FDI provides the needed capital for investment, and brings with it managerial skills, employment and technology, which accelerates the growth and development of a country (Asiedu, 2002). It is often argued that FDI in Africa is largely driven by natural resources and market size, which seems to be consistent with Angola, Nigeria and South-Africa; the largest receivers of FDI in Africa. In contrast to these beliefs, Asiedu (2006) shows that other determinants may have a large impact on the

development of FDI in Africa. Corruption, taxes and regulation, political instability and policy uncertainty, which are all considered to be institutional determinants, are found to constrain FDI in Sub-Saharan Africa (SSA). This is supported by Kinoshita & Campos (2003), who find that institutions and agglomeration economies are the most important determinants of FDI in transition economies, overruling the importance of (macro) economic determinants. Blonigen (2005) argues that the quality of institutions can be of great importance to the development of FDI, particularly in less-developed regions in the world, for several reasons. First, poor institutions may lead to poor

infrastructure (i.e. public goods), resulting in an expected decline of profitability and FDI in a certain market. Second, poor legal protection of assets increases the chance of expropriation of a firms’ assets. This makes investments less likely in that specific country. At last, poor quality of institutions (e.g. corruption) increases the cost of doing business, which decreases FDI activity. As mentioned in the introduction, there are multiple determinants of FDI. These determinants can roughly be divided into two groups of determinants: macroeconomic determinants (e.g. exchange rates) and

institutional determinants (e.g. corruption). Asiedu (2006) provides an overview with institutional determinants of FDI in Sub Saharan countries, based on four independently conducted surveys. The first survey, conducted by the World Bank in 1999/2000, covers 413 foreign firms in Sub Saharan

6 Africa. The second survey, conducted by the World Bank in 1996/1997, covers 540 foreign firms in Sub Saharan Africa. The third survey, conducted by the United Nations Conference on Trade and Development (UNCTAD), covers 63 transnational corporations active in Sub Saharan Africa. The fourth survey, conducted by the Centre for Research into Economics and Finance in Southern Africa (CREFSA), covers 81 transnational corporation active in Southern Africa. Table 1 shows the

institutional determinants of FDI in Sub Saharan African countries and the frequency of those determinants being mentioned in all four survey as an important determinant of FDI.

Table 1: Constraints of FDI in Sub-Saharan countries - Corruption (4)

- FDI regulation (3) - Political instability (2) - Policy uncertainty (2) - Taxes and regulation (3)

Institutional constraints mentioned in four surveys conducted by the World Bank, UNCTAD and CREFSA. Table 1 shows the most frequent institutional constraints for FDI in Sub Saharan Africa. (Asiedu, 2006)

“FDI regulation” and “taxes and regulation” are both part of the legislative institutions within a country, but are also part of the government policy of a country. The determinant “policy uncertainty” can be a part of both government policy and political instability. To make clear

distinctions between the major institutional determinants, the three determinants mentioned above are considered to be a part of government policy. Furthermore, political and economic freedom are mentioned as important determinants of FDI in the current scientific literature. In order to make clear distinctions between the determinants, the following determinants are described in the theory: 1) corruption, 2) political instability, 3) political and economic freedom and 4) government policy. 2.3 Corruption

Corruption is a term widely known, but misunderstood at the same time. ‘Corrupt’ and ‘illicit’ are almost interchangeably used for describing a transaction, while not all illegal transactions are corrupt, just as not all instances of corruption or bribery are illegal. Furthermore, a distinction must be made between ‘immoral’ and ‘corrupt’ transactions, which are often used as synonyms. The consequences of corruption are not clear as well. Corruption in the forms of smuggling and black

7 marketeering may actually improve welfare, which extends to the efficiency of transactions, while others argue that corruption limits the efficiency of transactions (Bardhan, 1997). To create clarity in the concept of corruption, this thesis follows the explanation of Cuervo-Cazurra (2006) on

corruption, who states that corruption is the abuse of public power for private gain. Following the disagreeing opinions about the effects of corruption on the efficiency of transactions, the current literature does not provide a clear direction for the effects of corruption on FDI. Leff (1964) states that economic development will be higher as a result of bureaucratic

corruption. Following this view on corruption, Egger & Winner (2005) argue that corruption has to be seen as a stimulus for FDI, as high levels of corruption result in higher FDI, because corruption accelerates the ease of doing business. Furthermore, Barassi & Zhou (2012) agree on this theory, as they argue that corruption can function as a “helping-hand” in transactions. It is said that there are two different views on corruption. First, corruption can be seen as a “helping-hand”, especially for multinational enterprises (MNEs) operating in developing countries. This view suggests that corruption may speed up certain transactions and thus, increase the ease of doing business, which results in a higher attractiveness of the country to foreign investors. The other view on corruption, seen as a “grabbing-hand”, suggests that corruption increases the costs of doing business, which is likely to result in a decrease of FDI (Barassi & Zhou, 2012).

Habib & Zurawicki (2002), however, argue that investors are likely to avoid corruption, because investors consider it to be wrong. Besides, corruption can create operational inefficiencies, resulting in a decrease of FDI. In accordance with this view, Cuervo-Cazurra (2008) argues that corruption results in lower FDI, but that the type of corruption, rather than the level of corruption, affects the level of FDI in transition economies. Furthermore, Cuervo-Cazurra (2006) states that corruption results in lower FDI for countries that have signed a contract of the Organization for Economic Operation and Development Convention on Combating Bribery of Foreign Public Officials in International Business. Kenya and Tanzania, however, have not signed this agreement, as both countries are not members of the OECD. Following the conflicting statements on the relationship between corruption and FDI, the following propositions are made.

Proposition 1A: A decreased level of corruption in Kenya and Tanzania does not lead to higher levels of FDI inflows, as corruption can function as a “helping hand”

Proposition 1B: A decreased level of corruption in Kenya and Tanzania leads to higher levels of FDI inflows, as foreign investors try to avoid corruption, considering it to be wrong and damaging their image.

8 2.4 Political instability

Asiedu (2006) argues that political instability is one of the major institutional determinants on the growth of FDI within a certain country. According to Alesina & Perotti (1996), political instability can be viewed in two ways: 1) executive instability and 2) social unrest and political violence, whereas executive instability is the instability at the top of governmental institutions. Alesina, Özler, Roubini & Swagel (1996) define political instability in the first approach as “the propensity of a change in the executive power, either by constitutional or unconstitutional means” (p.191). High propensity to change in executive power is associated with policy uncertainty. Whether one uses the first or second approach depends on their subject of research. This thesis focusses on the second approach of political instability as this approach is mostly used by governments and companies. The current literature does not provide a clear answer to the question whether or not political instability leads to an increase or decrease of FDI inflows in a specific country. However, Li (2006) examines how political violence might influence FDI inflows. Forward-looking firms are likely to incorporate the probability of political violence in their choices of investment location. A desirable investment location at first may become undesirable through the anticipated events of political violence. This suggests that political violence can make a certain investment location less attractive. Furthermore, Rivoli & Salorio (1996) argue that political violence-induced policy changes tend to be exogenous to investment. This also applies to events such as civil wars and terrorist attacks. These unforeseen events are likely to negatively influence the investment decision and amount of foreign MNEs (Li, 2006). As a result of the arguments of multiple studies, the following proposition is made about political instability:

Proposition 2: A decreased level of political instability, as means of political violence and social unrest, leads to higher levels of FDI inflows in Kenya and Tanzania, because investors are risk-avoiding. 2.5 Political and Economic Freedom

Political freedom, in the form of a democracy, is often seen as the perfect foundation for a stable economic environment. Data of the Worldbank (2017) shows, however, that democracy and FDI are not always complementary to each other. For example, China and Singapore are amongst the highest FDI receivers, while both countries score low on the democracy index. Yang (2007) argues that democracies are not significantly associated with FDI and thus, being a democracy does not attract higher levels of FDI. Indeed, democratic institutions may hinder FDI inflows, by limiting monopolistic or oligopolistic behaviors of MNEs (Li & Resnick, 2003). On the other hand, democratic institutions reduce risks and transaction costs. This implies that democratic institutions actually promote FDI inflows, as foreign organizations are risk-avoiding. Following this view, Jensen (2003) argues that

9 democratic political institutions leads to higher levels of FDI inflows. When compared to

authoritarian governments, democratic governments attract around 70 percent more FDI as a percentage of GDP. The reason why democratic political institutions are able to attract higher levels of FDI, is because of their increased credibility. From an international perspective, democracies are seen as more credible compared to authoritarian regimes (Jensen, 2003; Jensen, 2008; Li & Resnick, 2003). As Clague, Keefer, Knack & Olson (1996) suggest, long-lasting democracies are able to provide contract enforcement and secure property rights protection, supporting the credibility of the

country. However, there are not any long-lasting democracies in developing countries. This suggests that this does not apply to most of the East-African countries. Asiedu & Lien (2011) find that

democracies do attract higher FDI levels, but only if the value of minerals and oil in total exports is less that a certain critical value. Radelet (2010), however, argues that a shift towards democracy may lead to improved governance. Subsequently, improved governance within a country can result in less corruption, effective government policies and institutions, and improved rule of law. These three consequences possibly have a positive impact on the FDI in that country. Following the theory, there are two different propositions for the relation between democracy and FDI:

Proposition 3A: Democratic political institutions in Kenya and Tanzania do no lead to higher levels of FDI inflows compared to authoritarian political institutions, as only long-lasting democracies are able to provide contract enforcement and secure property rights protection.

Proposition 3B: A shift towards democracy in Kenya and Tanzania leads to higher levels of FDI inflows, because of less corruption, a more effective government policy and improved rule of law.

Recently, Mathur & Singh (2013) find that political freedom, such as in a democracy, is not as important in making decision as economic freedom. Indeed, democratic countries may receive even less FDI if economic freedom is not guaranteed. According to Gwartney, Lawson & Norton (2008), the cornerstones of economic freedom are voluntary exchange, personal choice, freedom to compete with other enterprises and security of privately owned property. Economic freedom in a host country promotes FDI as greater economic freedom activities attract a larger presence of foreign

organizations (Azman-Saini, Baharumshah & Law, 2010). More evidence for this relationship is found in Latin America (Bengoa & Sanchez-Robles, 2003), East-Asia (Quazi, 2007), and developing countries in general (Kapuria-Foreman, 2007).

Proposition 3C: A high level of economic freedom leads to higher levels of FDI inflows in Kenya and Tanzania, as economic freedom attracts the presence of foreign investors.

10 2.6 Government policy

As mentioned earlier in the theory section, the term “government policy” is a comprehensive concept, consisting of multiple variables, such as a host country’s economic openness towards foreign firms, policy stability and the legislative network of a country, taxes and regulations for instance. A part of a governments’ policy has to do with decentralization and privatization. While decentralization can be seen as a process of redistributing governmental functions and power towards local authority instead of central authority (Prud’homme, 1995), privatization can be seen as the transfer of public or governmental ownership of property towards a privately owned entity. As Prud'homme (1995) argues, decentralization is a process with a lot of disadvantages, especially in countries with a low level of political freedom. This view is largely supported by Smoke (2003), who argues that decentralization only can succeed in African countries if local governments are

experienced. The current literature, however, does not provide evidence for a relationship between decentralization of governmental functions and the level of FDI inflows. This is also the case for privatization of government entities. Therefore, both privatization and decentralization are not used as determinants for FDI in this thesis.

An economy based on openness to trade is one aspect of government policy and is likely to be an important determinant of FDI, as a closed economy and/or protectionism decrease the ease of doing business and thus, does not encourage foreign investors to invest in a certain country. Trade openness of the economy is often described as the ease of moving capital in and out of a country by investors. Kindiero & Shitiga (2006) find that increased openness to trade in African countries has a positive impact on FDI inflows in those countries, which is largely supported in the current literature (Morisset, 2000; Chakrabarti, 2001; Onyeiwu & Shrestha, 2004) Contra wise, countries with a high degree of control and restrictions on trade discourage FDI inflows.

Proposition 4A: Increased openness to trade leads to higher levels of FDI inflows in East-African countries, because investors are encouraged to invest as a result of the ease of doing business When looking at the legislative network of institutions and their effect on FDI, a distinction has to be made between taxes and other regulations, such as regulations on workforce and employment. As Blonigen (2005) suggests, taxes can be of great importance to the level of FDI inflows. Obviously, high corporate taxes are likely to discourage MNE activity and thus FDI, as MNEs often try to avoid high tax rates in certain countries. Evidence from the Unites States of America, however, shows the opposite. Both Hartman (1985) and Morisset & Pirnia (2000) suggest that FDI inflows may not be sensitive to the tax policy of a host country, while Swenson (1994) argues that increased taxes of a country leads to higher FDI inflows. While these findings are associated to corporate tax rates,

11 evidence from Central and East European countries show that lowering the income taxes by the government result in larger FDI activity in that specific region (Bellak & Leibrecht, 2009; Bellak, Leibrecht & Damijan, 2009). Furthermore, Bénassy-Quéré, Fontagné & Lahrèche-Révil (2005) find that countries with lower tax rates fail to attract significant FDI, while higher taxes tend to discourage FDI inflows. This same perspective is supported by Cassou (1997), who argues that there is a

significant effect of tax policy on foreign direct investment, but lacks a clear distinction of these effects are positive or negative. Because the theory does not provide a clear direction for the relationship between tax policy and FDI, the following proposition is made:

Proposition 4B: Tax policy of the government in East-African countries does not necessarily influence FDI inflows in a positive way, nor does it in a negative way.

The last aspect of government policy addressed in this thesis, is the legislative network of a country and the relation towards FDI inflows. Leibrecht & Scharler (2009) argue that employment protection legislation does not lead to significant higher FDI inflows. Dewit, Görg & Montagna (2009) find, however, high level employment of protection legislation discourages FDI inflows. This same view is supported by Olney (2013), who argues that a reduction in employment protection legislation results in higher FDI inflows. The reasoning behind these findings is that a low level of employment

protection legislation leads to low labor costs per unit. By lowering these labor costs per unit, countries are able to compete with other low labor countries, which attracts MNEs and thus, FDI. Proposition 4C: A low level of employment protection legislation results in a higher level of FDI inflows, as countries are able to compete internationally through low labor costs

In order to summarize all of the propositions and their manner of subject, the following table provides an overview:

12 Table 2: Overview of propositions towards FDI in Eastern Africa

Determinant/determinant Influence Reasoning Corruption

- Corruption (1A)

- Corruption (1B)

+ -

“Helping-hand” principle increases the ease of doing business

Investors avoid corruption, considering it to be wrong

Political Instability:

- Political violence and social unrest (2)

- Risk avoidance of investors

Political / economic freedom - Democracy (3A) - Democracy (3B) - Economic freedom (3C) 0 + +

Democracy only leads to high levels of FDI if those countries are long-lasting democracies

Democracy leads to high levels of FDI, because of less corruption, improved rule of law and a more effective government policy

Economic freedom attracts MNEs and thus, FDI Government policy

- Openness to trade (4A)

- Tax policy (4B) - Employment protection (4C) + 0 -

Investors are attracted trough lower transaction costs and ease of doing business

No effect, because of no clear evidence in the current literature

Countries are able to compete internationally through low labor costs, attracting foreign organizations

3 Method

This thesis follows a qualitative inductive approach and conducts data through the use of multiple interviews (Gephart, 2004). The aim of this research is to provide extensive support for the institutional determinants of FDI found by Asiedu (2006) and Blonigen (2005), amongst others, by looking for underlying motives and reasons with respect to these institutional determinants. The unit of analysis consists of 12 interviews from East-African based employees and experts in the area of institutional determinants, FDI development and change. Within these 12 interviews, MNEs,

13 government institutions, foreign NGOs and foreign small and medium-sized enterprises (SMEs) are examined in order to obtain information from multiple angles. All organizations have the same interest, which is to invest or attract investments in Kenya and/or Tanzania. Kenya and Tanzania differ from each other on areas such as corruption level and FDI growth. Therefore, it is necessary to conduct at least 5 interviews per country. Obviously, no conclusions can be made if the results are based on only one interview per country. For that reason, 12 organizations are interviewed, of which 7 organizations are active in both countries; 3 organizations are only active in Tanzania, and 2 organizations are only active in Kenya. Furthermore, companies within this sample are operating in different industries and sectors: oil and gas, logistics, agricultural, tourism and investments. This increases the variety of enterprises, which leads to more information compared to only one specific sector. The interviews in this thesis are semi-structured in order to obtain as much new information as possible. Each interview is analyzed in order to obtain information that can be used in following interviews.

The interviews contain open questions on all institutional determinants of FDI, following the theory of Asiedu (2006) and Blonigen (2005), among others. These are: corruption, political

instability, political and economic freedom and government policy. Next to the existing institutional determinants, participants are asked which determinants may be of importance as well. If other important institutional determinants are discovered in the interviews, these are used in following interviews. The interviews last between thirty minutes and ninety minutes, which is sufficient to obtain in-depth information that is needed.

All interviews are recorded and transcribed. In cases when the participants answer in Dutch, the recordings are accurately translated before coding. Before the interviews, all participants are asked if the interview can be recorded. Furthermore, the anonymity of all participants are guaranteed, as some questions require sensitive answers concerning the determinants. After the transcription of the interviews, the interviews are coded following the process of coding (Burnard, 1991). First, each transcript is excluded from so called dross, which are needless and irrelevant parts of the interview. Secondly, each transcript is coded following the process of open coding, which means that codes are assigned to each relevant part of the interview. Thirdly, by the use of axial coding, all codes of the transcripts are compared to each other in order to form groups of codes. Some of these groups are already labeled, as the institutional determinants provide a guideline for axial coding. However, not every group of codes can be assigned to one of the institutional

determinants of the research. For that reason, the remaining codes are grouped and named in a different way compared to the institutional determinants. After this process, all transcripts are coded, which results in multiple different labels for each group of codes.

14 4 Results

First, all of the participants were asked which institutional determinants they perceive as important to the development of FDI in Kenya and/or Tanzania, dependent on their operating country. Most participants appoint government policy as the most important determinant. Furthermore,

corruption, and political instability are mentioned as important determinants as well. These results confirm studies mentioned in the theory by Asiedu (2006) and Blonigen (2005), among others. However, the results of the participants differ per country. For that reason, each of the institutional determinants is elaborated, in some cases per country, in order to show the different effects of these determinants on the development of FDI. All of the statements are supported by quotes from

different participants of different organizations. 4.1 Corruption

Corruption is one of the major institutional determinants for development of FDI in East Africa. Multiple studies have shown the significance of corruption on FDI levels in all sorts of regions. In general, participants state that the level of corruption in both Kenya and Tanzania is very high. This is in line with the results of the Corruption Perception Index of 2016 (Transparency International, 2016). Their report states that Tanzania is ranked as 116th _{out of 176 countries, while Kenya is ranked} as 145th_{. Following the current scientific literature, there are multiple theories about the effect of} corruption on FDI. Participants argue that, especially in Kenya, corruption is integrated in all

processes and that foreign companies participate in corruption, because it will speed up the process of doing business. However, the participants find it difficult to explain what the origin of most corruption in Kenya is.

- “Corruption is integrated in the process and just a part of doing business. Obviously, it is clear that paying bribes will speed up the process, that’s in Kenya. In Tanzania, this is much vaguer. It hasn’t become easier the past couple of 18 months.” (D)

- “To be honest, I tend to say that Kenya’s model is more like the first theory, the helping hand theory. Organizations paying people to speed up the process and getting things done much faster. But you can never deny the fact that this comes along with a person getting better of it.” (D)

- “The process of doing business is slowed down without paying bribes. If you participate in corruption in Kenya, it will speed up the process.” (G)

-

15 are lots of examples that foreign companies investing in Kenya, because they can bribe certain people and organizations, which makes it a lot easier to do business.” (J)

-

(E)

from. Certain countries are not as strict on things like paying bribes. I think it depends if you’re in one of the countries who are a bit looser. You may see it as a helping hand and to make things easier, or even to give an advantage.” (A)

- “In terms of what is the source of the corruption? It’s hard to say, I’ve heard about of all levels where city locals, city council guys are checking licenses every month instead of once in a year. Obviously looking for something. But I also heard about very high levels, if it’s a very large investment, that senior people are expecting something. It’s very hard to put your finger on where it’s coming from. You cannot say this specific Ministry or that institution.” (A) - “But to start from the beginning, corruption is expensive for doing business, so it scares off

investors.” (G)

- “Corruption affect investments and doing business in two ways. First, corruption raises the price of doing business and investments, because you need to pay extra for certain extras or services. And the second thing, it causes a bad image for both country and organization, which is very important.” (G)

In contrast to the case of Kenya, the origins of corruption in Tanzania is clear. Participants agree that the level of corruption at government institutions is very high in Tanzania. Civil servants and other government representatives expect bribes. Especially small foreign organizations suffer from corruption on government level, because they lack the resources to take a stance against it, while larger organizations do have these resources.

-

- “Corruption was paralyzing the whole society and it is making normal business impossible. Wherever you do business in Tanzania or wherever you invest in the region, you always have to deal with corruption.” (F)

- “…for large companies, it is much easier to deal with it than for small businesses. I mean, they can have a strong policy on their taxes and ethics. But as a small business, you’re much more vulnerable to corruption.” (F)

16 - “…that judiciary system is placed on number two of the corruption list. As long as you can

bribe the judge, especially as a foreigner, you cannot accept any contract or agreement, as the paper where it is written on is worth more than the actual agreement.” (F)

- “Especially in Tanzania, civil servants make up a large part of corruption on government level. I think that this is especially disastrous for small foreign organizations.” (J)

- “It depends on how straight the investors are. If they are not willing to pay bribes, they will find it very hard to do business in Tanzania. Without corruption, it will increase the speed of doing business as “things” are clear and straightforward and it becomes more pleasant to do business.” (L)

4.1.1 Policy of Foreign Organizations

In the previous section, it becomes clear that small foreign organizations are probably involved in corruption in Kenya and Tanzania, because it may speed up the process of doing business. Besides, small foreign organizations lack the resources to fight against it. However, participants of larger foreign organizations state that their organizations are strict and explicit against corruption. The image of these large organizations is of great importance and they try to avoid corruption in order to maintain their image. For that reason, most of these organizations have strict policies on corruption, both in Kenya and Tanzania. Another solution for corruption is to work with local communities. Instead of paying civil servants, foreign organizations can contribute to the community with local projects, in order to speed up the process, while avoiding corruption and maintaining a good image.

- “I think that there are two ways of dealing with corruption. You can say, there is a high level of corruption, so we do not invest or do business in that region or country. That’s fine, but that means loss of potential business. And for private organizations, that’s the right option. The second thing you need to do when handling corruption, is to have locals in your team. Those people know the culture and are much more familiar with corruption in their country. They know when people want to get money, they know when it’s wrong. So, you need those people in order to manage the policy of the company.” (C)

- “You can try to handle the corruption in a certain country, and that means that you have to stand straight at all times. And your company policy has to be that every person does not pay bribes. Everybody has to stay to the same policy. Like a sort of core values to deal with corruption. Otherwise, your organization may be getting into corruption, which is dangerous for the organization and its image.” (C)

17 - “If we look at corruption, it is something within our power. Corruption can be handled in

order to maintain your good image. There is control of course and corruption is something you can mitigate.” (C)

- “If they want something, you can speed up the process of doing business and improve your business relations with the local community by doing something back for the community. But not giving any money.” (K)

- “The same thing for the government. Instead of giving civil servants money, you can offer them to work on something with them.” (K)

Foreign organizations have different opinions about corruption in Kenya and Tanzania. Looking at Kenya, participants state that engaging in corruption is beneficial for doing business, while increasing the costs of doing business, as it speeds up the process, which is in line with proposition 1A.

However, participants also argue that corruption in Tanzania has a negative effect on their business and investments, which does not support proposition 1A. While small businesses lack the resources to fight against corruption, large companies do have these resources. Larger foreign companies implement strict rules and policies on corruption. Furthermore, large companies need to have these policies against corruption, in order to maintain their image. Being involved in corruption scandals may damage a companies’ image. This, however, does not support proposition 1B. A decreased level of corruption does not necessarily lead to an increase of FDI, as most large foreign organizations already deal with the extent of corruption, by implementing strict rules and policies. The results show that there is support for proposition 1A in Kenya, but not in Tanzania. Besides, there is no support for proposition 1B.

4.2 Political Instability

Political instability is another important institutional determinant for the development of FDI in Eastern Africa. Following the literature, political instability is used in this thesis as the concept of political violence and social unrest. Opinions about the influence of political instability on FDI vary between participants. Some argue that political instability is important for their decision to invest in both countries, because safety of employees is one of the most important things to foreign

organizations. The following quotes support this statement:

- “But political instability is a whole other thing. That’s something that’s not within the power or control of the organization. The safety of our own employees is one of the most important things for us if we do business in a foreign country. And sure, there are times that will cost a little bit more money and effort to guarantee that, security for example. But that’s very important to us.” (C)

18 - “People will get desperate. And that’s something you do not want to happen when you do

business in a foreign country. Because when a lot of people get desperate or angry or something, it can become very negative. Riots for example. Or in the worst case a civil war. And if that happens, we as an organization do not want to do anything with that. So, political stability is very important to us.” (C)

- “Political instability is very important to our decision to invest in a certain region, because when it’s becoming dangerous, we get out.” (C)

- “Besides, we don’t want to put our own people in uncertain or dangerous situations, because of our support. So, from that point of view, political stability is very important to us and to our decision to invest in that region.” (I)

However, other participants argue that political instability is not of great importance to their

investment decisions. One of the reasons is that Tanzania is argued to be politically stable, especially when compared to other countries in the East African region. The following quotes support the statement that Tanzania is politically stable and that investments do not suffer from political instability:

- “Because of the stable political environment, we do not notice any problems with our projects” (B)

- “On a structural level, I do not think that political instability has any impact on our investments.” (B)

- “Well, technically there is not really any political instability in Tanzania.” (F)

- “There is no significant political unrest or political violence in Tanzania, or within the region I’m active in, so that’s very positive for doing business and investments.” (F)

- “If you look at the second component, social unrest. This is the same. There is no significant social unrest in my region, so this is also very positive for doing business.” (F)

-

- “

Looking at Kenya, participants admit that there is a higher level of political instability compared to Tanzania, but that it does not have a large effect on FDI within Kenya. One of the reasons is that

19 organizations focusing on investing in Kenya, are used to this political instability. Therefore, the participants argue that the effect of political instability is small.

- “I would say it does not affect FDI as much as people would expect.” (A)

- “But I do not think that organizations will pull back all of their employees in times of elections, maybe foreign government institutions such as Embassies, but not the private sector. It is more likely that employees from the private sector will be send on holiday or something like that. But the companies I work with, they will not leave at all, simply because of the fact that they just can’t. And they don’t want to.” (D)

- “But what I would like to add, is the fact that people and organizations in Kenya are used to this volatility and that the private sector will recover very fast from this.” (D)

- “Of course, it is not completely stable. In the sense of, the coming 10 years are going to be like this. There are elections on the program this year, at the county level. And they expect that it will be quiet elections, although that’s never sure in Kenya.” (E)

Besides, participants argue that there are two major components that lead to the high political instability, elections and terrorism.

4.2.1 Elections

The role of elections within the political instability is significant and is originating in the elections of 2007/2008. Post-election violence and social unrest caused a political and economic crisis in Kenya. This crisis is one of the main reasons for foreign investors to be careful in years of elections in Kenya. This is shown by the fact that FDI numbers drop in years with elections. Foreign investors are

concerned for ethnic violence, the continuity of the government and a hostile economic environment.

- “Elections have a very big impact on FDI in Kenya.” (G)

-

(J)

- “The elections are always much contested. We have an election coming up next year. What happens is that FDI slows down. In an election year the whole economy goes down and investments slow down. Because there is a concern about the continuity of the government. In 2007 and 2008 it was very violent.” (A)

20 - “Around elections, the economic environment is very hostile and uncertain. For that reason,

our investments are stopped for that moment. We do not provide any investments in that period.” (I)

-

- “After the elections in Kenya, the market and the private sector will recover very fast. But that’s a very clear trend in Kenya. If you look at the years of elections, you will see a decrease of the FDI number. Investors will react on certain insecurity when it comes to elections. So, in the year of the election the FDI number drops, but the private sector recovers and the FDI number will go up again.” (G)

- “For example, due to post election violence in Kenya’s recent history, trucking companies stop transporting any goods a month prior to elections. This affects not only our operations and staff in Kenya, but also landlocked countries such as Uganda, South Sudan, Rwanda and Burundi.” (K)

4.2.2 Terrorism

The other component of political instability in Kenya, terrorism, originates in attacks from the Somalian terror group Al-Shabaab. Since 2011 this group has performed multiple attacks, especially in cities as Nairobi and Mombasa, and close to the Somalian border in the north of Kenya. Even though these attacks do have an impact on daily life and the local retail sector, participants argue that FDI does not suffer from these terrorist attacks, except for the tourist sector. The tourist sector is one of the largest economic sectors of Kenya and is the second-largest economic sector of FDI. The following quotes argue that terrorism does not have a large impact on FDI in other sectors, except for the tourist sector.

- “Most of terrorism has happened outside of Nairobi, or in the regions and closest to Somalia out of the country side. It’s a bit lawless out there. If you’re someone working in Nairobi or Mombasa, it’s not something you even consider. It does actually have a big impact on tourism. The government tells their employees that you cannot go to Kenya. It tends to hit tourism quite hard. But FDI for all sectors, those are decisions that may take 1 or 2 years. And building a factory, which may take 5 years. That is not something you change your mind over, because of one terrorist incident.” (A)

- “Even when the reputation was at its worst, you did not see FDI in general go down, you see tourism go down. FDI in general are slow moving long-term decisions, which are not

21 - “The attack on the Westgate Mall in Nairobi was something with a lot of impact on people.

Except for the tourist sector, I think this attack hasn’t been of much influence on the private sector, and not at all on the agrarian sector of Kenya in the long term. But it did have a lot of impact on the tourist sector, which is very important to Kenya.” (D)

- “If you look at the tourist sector, that sector is very short-term minded. If there is a terrorist attack right now, people decide with a week or within days to cancel their trip. So that can escalate very quickly. The agrarian sector is a different story. They suffer much less from terrorist attacks.” (D)

- “… then there is the agrarian sector, which is very important to Kenya. And it is a sector with a lot of foreign investments. But terrorism doesn’t have a big impact on this sector, because it is mostly long-termed.” (G)

Even though some participants argue that political instability in general does not affect FDI in both countries, multiple participants argue that political instability does affect their decision to invest in a certain region, because of risk avoidance for their employees in terms of security. Furthermore, there are two major components of political instability in Kenya that actually do have an impact on FDI. First, elections in Kenya have a large impact on FDI numbers in the year of the election, because of the concern for political and ethnic violence, continuity of the government and a hostile economic environment. Second, terrorism does not have any impact in general on FDI numbers in Kenya. However, the tourist sector, which is the second-largest FDI sector in Kenya, does suffer from terrorism in the short-term. In the case of Tanzania, participants argue that there is no significant political instability and thus, FDI does not suffer from it. Following the statements of the participants, proposition 2 is supported and states that political instability does have a negative effect on FDI, especially in Kenya, because of risk avoidance from foreign investors in years of elections and in times of terrorist attacks.

4.3 Political and Economic Freedom

Political and economic freedom are other determinants for the development of FDI, according to the current scientific literature. However, democracy may be only positive for FDI, if the country can be labeled as a long-lasting democracy. Participants were asked to what extent they perceive Kenya and/or Tanzania as a democracy, and how this type of democracy affects FDI. Secondly, participants were asked to what extent they perceive Kenya and/or Tanzania as economic free, and how this (lack of) economic freedom influences foreign investments.

22 4.3.1 Democracy

In general, participants are critical about the extent of democracy in both countries and how important its effect on FDI is. Multiple participants argue that democracy does not influence FDI at all, especially when the democratic system is not governed well.

- “When we look at East Africa, so I mean Kenya, Rwanda, Tanzania and Uganda, when we compare them. All of those countries are in different stages and differ on developments and democracy. And the question is, if there is a linear causal relationship between democracy and the performance of countries on foreign investments and entrepreneurship, I highly doubt that.” (D)

- “If the democratic system is not governed well, because of corruption or other aspects, there is no benefit of a democratic system for investments in Kenya or Tanzania.” (G)

- “If the policy functions well and the country is politically stable, but it is a dictatorship, it can be positive for the number of foreign investments. And at the other side, a country with a democracy, but with a bad policy, will not receive high FDI per se.” (G)

Another important aspect is that participants argue that a non-democratic system could be evenly beneficial to FDI, as long as the system is governed with strong economic politics. Besides, it is argued that trade openness and economic freedom for the private sector is more important for FDI than the democratic level of a country.

- “Predictable processes, predictable payments and predictable production process and markets are of great importance to foreign investors and entrepreneurs. And if all those determinants work in a development phase, which is not fully democratic, there’s nothing wrong with it.” (D)

- “As long as there is a strong political vision on the economy and foreign investors, the extent of democracy does not matter. Even a semi-democracy or authoritarian system may be positive for foreign investors, as long as there is trade openness and economic freedom for the private sector. (G)

- “… that the ease of doing business and economic freedom to foreign investors is much more important for foreign investments than a badly governed democracy.” (D)

- “So, yes, democracy can be important. But other factors, such as a good economic policy by the government and political stability are much more important for attracting FDI.” (G) Furthermore, participants are especially critical on the democracy of Tanzania. The fact that Tanzania has only been a multiparty democracy since 1992 and the fact that the current democracy does not function, results in a critical vision on the democracy of Tanzania towards foreign investments.

23 - “…you can talk about democracy in Tanzania, and officially, Tanzania is a democracy. But the

democracy as you may call it, is very young in Tanzania. We have a multiparty system since 1992, which is just over 20 years. That is not a very long term for a democracy, and it does not have any impact on foreign investments.” (F)

- “If you look at the current president (resp. Magufuli), who is constantly implementing things at fast pace, but without any announcements. I mean, I do not think that most of the things he introduces are positive for foreign investments.” (F)

- “The current democracy as it exists in Tanzania, is functioning contra-productive and is a threat to foreign investments.” (F)

- “I don’t mind the extent of democracy, if the government makes it harder for me to do business in Tanzania.” (K)

4.3.2 Economic Freedom

As mentioned in the previous section, economic freedom is more important than the democratic system of both countries. However, participants were not able to elaborate on economic freedom extensively. When comparing Kenya and Tanzania, Kenya seems to have a larger private sector, with more opportunities. Starting up an entity is one of the main issues of economic freedom, especially in Tanzania. When comparing Tanzania to other countries in Sub Saharan Africa, Tanzania is placed 14th _{out of 48 countries. The moderate score of Tanzania is mostly the result of difficulties in trading} across borders, registering property, starting a business and protecting minority investors (Doing Business Index, 2017). The following quotes partly support this in the case of Tanzania:

- “If you look at economic freedom, there is little economic freedom, especially for foreign investors. That can be seen in the current number of certain institutions as well. Tanzania doesn’t score very high on this subject. But this little economic freedom is very negative for doing business. This is withholding further and new investments.” (H)

-

-

(H)

-

(H)

- “All business dependent in-or export is highly frustrated. So, there is no open trade.” (F) - “Economic freedom is very limited and affects FDI strongly. Especially property rights (for

24 However, Kenya is placed 5th _{out of 48 countries from Sub Saharan Africa, according to the World} Bank. Especially determinants as getting electricity, getting credit, trading across borders and enforcing contracts contribute to their successful private sector (Doing Business Index, 2017). Even though the participants could not explain in detail how they perceive economic freedom and ease of doing business in Kenya, the following quotes partly support the good rating of economic freedom in Kenya by the World Bank.

- “I would say that Kenya is more what they called ‘business minded’. Probably also more transparent in terms of financing, the needed licenses and where you can get them, and the process. And that there is actually progress in obtaining these licenses.” (D)

- “…especially the Dutch flower sector in Kenya. They have some very clear advantages, like tax holidays, certain privileges and they are watched less from the government perspectives” (J)

- “The extent of economic freedom in Kenya is positive for foreign organizations that may decide to invest in Kenya.” (D)

- “…tax rates are very low in the first two or three years of starting a business, to give your organization a boost. And after those years, the tax rate will increase. This is very positive for the private sector, also for foreign organizations interested in investing in Kenya. And there are certain special economic zones, which are important. People know that those zones are a good environment to start a business or to do investments.” (G)

According to the quotes and statements above, participants are very critical on the effect of a democratic system in both countries. A democratic system is not beneficial for foreign investments if economic politics are not governed rightfully. Participants even argue that a non-or semi-democratic system can be more beneficial for foreign investments, if there is trade openness and economic freedom towards foreign organizations. The results show that there is no evidence to support both proposition 3A and 3B. Furthermore, one can say that Tanzania lacks economic freedom, which is negative for foreign investors. The difficulty to start a business and to register property are the main reasons for this negative effect on foreign investors. When looking at Kenya, the political system offers more economic freedom, especially when it comes to enforcing contracts, licenses and trading across borders. Even though the participants do not explain the importance of economic freedom extensively, proposition 3C, which states that economic freedom attracts FDI, is supported. 4.4. Government Policy

Almost all participants state that government policy is the most important institutional determinant for the development of FDI in Kenya and Tanzania. However, there are multiple components of

25 government policy such as tax policy, trade openness, the role of President John Magufuli of

Tanzania and decentralization of power and FDI. Participants do not elaborate extensively on the role of the government in Kenya and their policy, just as participants do not elaborate on the role of trade openness within Kenya. In contrast to the liberal direction of the Kenyan government policy,

Tanzania has followed a socialist direction since its independence. Participants state that this aspect of government policy is important to the current state of the investment climate and the attitude of the country towards foreign investors. The socialist behavior of both government and citizens has a negative impact on foreign investors.

-

-

- “In a certain way, this has absolutely something to do with the fact that Tanzania is a socialist nation since independency, because of the government policy. That concept, the way of working and not just being individualist, but much more with the community and family. I really do think that this concept has its origin in the government policy to create a socialist nation. And if capitalism was introduced a long time ago, I probably think that the people in Tanzania would behave differently on the subject of doing business and making money.” (B) 4.4.1 The Role of the President

Most participants answer extensively on the subject of government policy in Tanzania. The current president, John Magufuli of the CCM political party (Chama Cha Mapinduzi), has become the leader of Tanzania in 2015 and since, he follows a different political direction than previous presidents of Tanzania. The main thing that the participants appoint, is his so called “hostile” behavior towards foreign organizations, foreign investors and foreign employees. The following quotes support the negative attitude of Magufuli and his government towards foreign organizations and employees:

- “…the government has a policy which focusses on closing the borders for in-and export and is in that sense blocking FDI.” (F)

- “Currently, Tanzania seems to very open to attract FDI since the new regime, but perhaps it will turn around again when the government is declining. At least, I hope so.” (L)

26 - “All business dependent in-or export is highly frustrated. So, there is no open trade.” (F) - “He (resp. Magufuli) decides everything around here. And that’s not always to the benefits of

foreign investors. He does have a good policy against corruption in Tanzania, because there is a large extent of corruption in this country. But his negative attitude toward working permits of foreigners has a negative effect on foreign organizations.” (H)

- “Foreign investors are limited to their working permits and they need to form a plan, which is focused on the transfer to the Tanzanian citizens.” (H)

- “It is very hard to convince foreign investors to do business here, but also to stay here, because the government is so unpredictable.” (H)

-

(H)

employees and foreign investments.” (J)

Furthermore, president Magufuli shifts towards a more authoritarian policy, in which (foreign) advisors are neglected. The president creates more autonomy for himself, while he lacks the knowledge and capabilities to organize a growing private sector without help of (foreign) advisors.

-

-

(H)

- “And the current situations, especially at the economic level, Magufuli just doesn’t have enough knowledge. As a president, a lack of knowledge isn’t necessary very bad, but if that’s the case, you need a good team of advisors around you.” (H)

- “They (resp. the government) don’t have the expertise to fix everything and to create a good investment climate, and they don’t have the financial resources.” (H)

- “Another thing, he (resp. Magufuli) brings on very bad advice. Certainly not by diplomatic people from foreign Embassies, which is dangerous for the attitude towards foreign investors and foreign employees.” (H)

- “I think that Magufuli fits perfectly in the current time of big leaders. They don’t take on any advice and don’t listen to anybody.” (J)

27 However, president Magufuli does implement a strict policy against corruption within the private sector and government institutions. Participants seem to be positive about this development, because most of the participants believe that a decrease in corruption will lead to higher foreign investments.

- “The port of Dar Es Salam, the harbor, cleaned up their selves from corruption. Because they were afraid that Magufuli would came in and clean the whole place up and punish the persons responsible, so they did it themselves.” (H)

-

(J)

- “He (resp. Magufuli) does take corruption within government institutions very seriously. That’s a positive development within Tanzania, because it will improve the attitude of foreigners towards corruption in that country.” (J)

4.4.2 Taxes and Regulations

Taxes and regulations, as a part of a government policy, seems of great importance to foreign investors, especially in Tanzania. In general, the participants argue that it is important to always follow the regulations of a specific country. However, tax rates do not affect foreign investors’ decisions to invest in a certain region or country.

- “Well, I always say that you need to hold on to the local regulations of that country. That’s the most important thing. Always do that. I mean, regulation and taxes in that country does not necessarily influence our decision to invest in a project. It’s something we deal with, just like corruption.” (C)

- “So, if a certain country has a very high corporate tax, that’s fine with us, although we find it much better if a country has a low corporate tax of course. But that’s not something that influence our decision making.” (C)

- “Corporate tax rates of Kenya and Tanzania did not affect our investment decision.” (K) Instead of looking at (corporate) tax rates, the randomness of regulation and taxes is more important to foreign investors. Also, the participants state that the current system of taxation and the

collections of taxes need to be improved and enlarged in both countries.

- “But something that is a little bit strange, is how the regulation is so random. Especially when it comes to foreign companies.” (C)