The Causality Effect between Institutional Factors and Foreign Direct Investment (FDI) Inflows in Tanzania

Abstract

The study examined effect of institutional factors on foreign direct investment (FDI) inflows in Tanzania between 1996 and 2015. The study used time series data for the period 1996 – 2015, data for FDI inflows was drawn from the Bank of Tanzania (BOT), available at (w.w.w.bot-tz.org) and data for institutional variables was drawn from the World Bank Worldwide Governance Indicators (www.govindicators.org).  Augmented Dickey Fuller test and Phillip Perron (PP) was employed to test whether each data in series was integrated and has a unit root, thereby testing the stationarity. Johansen test of cointegration was used to evaluate long and short run relationship existing among the variables. Granger- Causality Test was used to test whether one time series variable data was useful in forecasting the behavior of another variable. The results demonstrate that regulatory (RQ), rule of law (RL), government effectiveness (GE), voice and accountability (VA) do not granger cause FDI and FDI do not granger -cause those variables. On the other hand, political stability and absence of violence (PSV) and control of corruption (CC) granger- cause FDI inflows in Tanzania. The two variables demonstrated high predictive power for FDI inflows in the country. However, the relationship was unidirectional. Structural break test revealed that there was a stable contribution among the variables over time as such there was positive relationship between variables. Based on this finding this study recommends that Tanzania should address any unfavorable component related with rule of law, government effectiveness among others which constraint FDI inflows in order to optimize the benefits of FDI inflows in Tanzania.