Foreign Direct Investment in South Africa

Johannesburg City Centre PanoramaJohannesburg City Centre Panorama

The fall of the morally repugnant Apartheid regime allowed a democratic and unified South Africa to rejoin the international community. This led to the undertaking of rapid liberalization policies that allowed for significant and sustained increases in foreign direct investment (FDI) into Africa’s most industrialized economy. To put this point into perspective (see figure 1 below), South Africa’s overall FDI inflows increased from $374 million in 1994 to around $1,5 billion in 2015. This article then, aims to apply international relations theory on FDI flows in order summarize and understand the underlying reasons for the increase seen within South Africa. This will be done by elaborating specifically on democratization, the rise multinational companies (MNC’s) and Bilateral Investment Treaty (BIT’s) and finally South Africa’s relative bargaining power position. A common thread throughout the article will be its application of these international theories in order to explain the observed trends in South Africa. More specifically, these theories will be used in order to provide the author with a robust framework to think about the country’s recent decision to terminate a lot of it’s BIT’s. This will be done with a specific focus on bargaining power and domestic distributional challenges. Finally, this article will conclude by attempting to formulate a position aimed at sustaining FDI in lieu of the cancelling of certain BIT’s order to ensure that it fosters economic growth in South Africa going forward.

Figure 1:Screen Shot 2017-10-21 at 10.35.05 PM

The period between 1970 and 2000 saw countries increasingly liberalizing their economies. This process included the liberalization of FDI to a point where it has become the largest source of global capital flows. A starting point then, would be to understand what is meant by FDI, is aptly defined as, “the international flow of firm-specific capital such as proprietary production techniques, managerial and organizational practices, and trademarked brands”. One of the important theories have been used to explain this pertinent trend has been subsequent increase in democratization around the globe. Democracy promotes FDI as it gives politicians an incentive to enact labour friendly policies. The reason for this is that expanded political participation allows more citizens to be actively involved in policy dialogue and formation. Notwithstanding, citizens and more specifically labour, prefer unrestricted FDI flows because it raises the demand for labour. This leads to a 10 to 30 percent increase in wages for non-skilled labour in foreign owned manufacturing firms. Alternatively, local owners of capital would be against an inflow of foreign firms because they will battle to compete with these firms and MNC’s. That is, in general, local firms have higher production costs which affects their market share, stock prices and productivity levels due to a low level of spillovers that occur. Applying this theory to the South African case, confirms the theories thesis surrounding democracy and FDI. Before South Africa became a fully fledged constitutional democracy, net FDI flows averaged $52 million. That said, after the democratic process, it averaged $3.2 billion. Moreover, labour and more specifically the Congress of South African Trade Union (COSATU) represents the largest segment of the South African government’s voter base and would be in favour of increased investment. Indeed, South Africa’s transition to democracy, like many other political transitions, was a double transition: from authoritarianism to democracy, and from a controlled economy to a market system more in line with the exigencies of globalization. Notwithstanding, upon democratization, labour was part of the mass movement towards “negotiated liberalization” that would allow for inclusive economic growth, and employment in line with the aforementioned arguments.

The liberalization practices amongst stakeholders within South Africa was one of the main underlying factors driving FDI investment into the country. The second driver of increased FDI was the excessive amount of BIT’s that were signed by the South African government and the increased number of MNC’s from other countries looking to invest. Bilateral Investment Treaties (BITs) represent an indirect international legal mechanism for the regulation between host countries and MNCs. Put another way, BITs are treaty agreements between two countries: a host to MNCs within a developing country and a home to MNCs in a developed country. In essence, these treaties provide a series of protections, including the provision for international arbitration of disputes through the International Center for Settlement of Investment Disputes (ICSID). Theory suggests that developed countries would negotiate these treaties because they reduce the ambiguity of a host country’s obligations in order to protect their investments. That is, they would explicitly involve South Africa’s government as a treaty party with which they could pursue damages against the government through arbitration. The rise in prominence of BIT’s after democratization makes sense in lieu of the endemic political risk within South Africa at the time. Moreover, any rational investor would need and seek international arbritration and recourse should these risks materialize. Finally, it makes sense why South Africa would initially sign these treaties in order to foster investment that promotes economic growth in order to overcome the structural challenges inherited from the Apartheid regime.

This aforementioned theories explains why MNC’s would want to sign BIT’s with the newly democratic South Africa after 1994. That said, it doesn’t fully explain why South Africa has been able to terminate some of these treaties and yet still remain an attractive investment destination. This is where understanding bargaining power becomes paramount. The extent to which South Africa can influence the behavior of multinational corporations depends on its potential and actual bargaining power. Potential power depends on; the level of the host government’s expertise; the degree of competition among multinationals; the type of direct foreign investment; and the degree or extent of prevailing economic uncertainty. Actual power refers to the ability and willingness of host governments to exercise their bargaining power to extract more favorable terms from MNCs. The level to which a country can exert their actual power depends on domestic politics, international relations with various MNC’s host nations and the threat of economic coercion through retaliation. In this instance, the author could credibly argue that South Africa has a lot of potential bargaining power. That is, it has the most robust talent pool in Africa that is provided by its competitive tertiary education system in which 8 of the top ten universites are South African. Moreover, the country has been considered as the gateway and entry point for lucrative investment into the rest of Africa. This has drastically increased the level of competition for FDI within South Africa. That is, a disproportionate number of the countries companies were Mergers and acquisitions and partnerships on the continent. Finally, the democratic dispensation has drastically reduced the level of political instability within South Africa that existed within the country before and immediately after 1994. This implies that the country has a large amount of potential power relative to the other African FDI competitors. Therefore, in order to understand South Africa’s recent policy towards BIT’s it is important to elaborate on its actual power and ability to exercise its will. More specifically, the author will focus on domestic politics and the subsequent economic retaliation/coercion induced by developed economies through the ICSID process.

In order to understand South Africa’s actual power in being able to negotiate FDI terms, it will be important to elaborate on domestic policy shifts and contrast this with retaliation from BIT signatories within various MNC host countries. Since the beginning of the democratic regime, the South African economy has experienced the largest period of uninterupted economic growth. During this period, the country recorded an average of 3% real economic growth and increased its per capita income from $3650 to $6498 in 2014. That said, the economic effects of increased globalization and investments have led to a steady decrease in manufacturing and mining as a source of the country’s GDP and employment base. In essence, these flows have helped create a highly competitive and sophisticated financial and services sector to the detriment of manufacturing and low skilled employment . This has lead to South Africa having an unemployment rate of around 27% along with being considered amongst the most unequal societies in the world according to its gini coefficient. The main cause of this inequality can be direclty analyzed when comparing the wealth of black South Africans relative to the rest of the population. To this extent, the government enacted domestic policy of affirmative action and Broad Based Black Economic Empowerment (BBBEE) in order to directly increase the number of black owners of capital and land in line with the expectations of the labour unions and a rising black working class. Although this may have been prudent domestic policy, international investors from Luxembourg and Italy duly brought a claim against South Africa under the ICSID facility rules. They argued that South Africa’s local provisions of affirmative action and BBBEE expropriated their mineral rights and went against the BIT that was signed between the countries. This was due to the percentage of local ownership that is required when conducting business within the country. The affected parties subsequently settled the case in 2010 which prompted a bruised South Africa to review the array of BIT’s that it undertook immediately after Apartheid. The conclusion was to terminate the first generation BIT’s in 2012 . Thereafter, the government took steps to codify and clarify typical BIT provisions and include them within doemstic law and outside of the realm of BIT’s. This was done to strengthen investor protection but within a domestic context . It is clear to see here that domestic politics lead to a change in policy from South Africa. In essence, their ability to terminate certain BIT’s and remain an investment proposition proves that in fact, South Africa has a lot of leverage when bargaining relative to other developing economies. Moreover, that the country has enough bargaining power to dictate terms outside of the auspices of BIT’s.

In conclusion, this article presented international relations theory and applied it to South Africa. This article found that theory accurately predicted the affect of democratization, BIT’s and an increase in MNC’s in increasing South Africa’s levels of investment and economic growth. Moreover, this article also also argued that South Africa bargaining power has subsequently increased in the last 23 years after Apartheid. This was evident when the country was able to terminate some of its BITs with European countries and yet still remain a viable destination for international investors. This allows the government to continue to focus on redressing the structural issues inherrited by the abhorrent Apartheid regime through FDI investment. That said, it is not the panacea to all of the current issues the country faces in the long run. The countries attractiveness to investors largely depends on its ability to provide returns and a stable domestic political environment. My concern regarding the countries ability to remain an attractive environment revolves largely around its ability to eradicate the high levels of inefficiencies currently endemic to the public sector. That said, it remains to be seen whether the country’s leaders, civil society and the private sector will still be able to assist us in providing a stable environment in order to ensure that we overcome the high levels of unemployment and inequality it currently faces.

About the Author

Carlos Baeta
Proudly South African. Masters student at Fordham University in New York. Entrepreneur, young leader, coffee addict and an avid Liverpool fan. Let's change the world.

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