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FDI and Financial Market Development in Africa

Isaac Otchere, Carleton University, Canada, Pierre Yourougou, Syracuse University, USA and Issouf Soumare Administration Laval University, Canada

The development literature on the relationship between foreign direct investment (FDI), financial market development (FMD) and economic growth focuses mainly on two aspects: the relationship between FDI and economic growth and the role played by FMD in that linkage. The literature is almost silent on the relationship and causality direction between FDI and FMD. Although it has been established that FDI contributes more to growth in countries with more developed financial market, it is not clear how FDI and FMD interact with each other. The aim of this paper is to fill this gap in the African context. Particularly, in Africa, where stock markets experience low liquidity and are less transparent, FDI can be an impetus for financial market reforms and serve as a mechanism to improve the transparency and the depth of the financial markets. Also, well-functioning financial markets can help channel foreign investments more efficiently into productive sectors, and therefore create more value for investors, hence making the country more attractive to FDI. In short, both FDI and FMD will impact each other simultaneously, which is confirmed by our findings. We also find that FDI contributes to economic growth in Africa after controlling for endogeneity between FDI, FMD and economic growth.