Discussion Paper No. 153 of 2013 on The Effect of Regional Integration on Net Inward Foreign Direct Investment Flow in East African Countries

Abstract

This study investigates the effect of regional integration on Foreign Direct Investment (FDI) flow in EAC countries. It is based on a working hypothesis that links integration to FDI. The model used was a variant of one used by Jaumotte, where the variables identified as determinants of FDI were regressed alongside variables used to measure location advantage and a dummy representing integration. Feasible Generalized Least Squares was used to examine the relationship between FDI and variables identified by other studies to be determinants of FDI. The EAC integration was found to have no overall impact on FDI flow into the region. The degree of political risk and financial stability were positive and significant. A country whose degree of political risk was relatively high in the region was likely to lose potential investment to countries that appeared more politically stable. The study recommends that Kenya and other EAC countries institute political reforms to accompany, stability be maintained in the real exchange rate market, and political reforms be instituted to improve the country’s ratings in terms of the degree of political risk.