Africa must prepare better for foreign divestment

In the wake of COVID-19, a strategy to understand and reverse this growing trend is urgently needed.

Published on 20 October 2020 in ISS Today

By

Kouassi Yeboua
Senior Researcher, African Futures and Innovation, ISS Pretoria

Foreign divestment is steadily becoming more pronounced and requires greater attention from policymakers, especially in Africa. The term refers to sales or liquidations of foreign affiliates by multinational enterprises in a host economy.

Divestment is the opposite of foreign direct investment and is increasingly coming to the fore as many firms react to geopolitical uncertainties such as Brexit and competition between China and the United States (US). Their aim is to minimise the risk of disruptions of global value chains that straddle borders with much of manufacturing occurring in Asia.

Little information and data are available about this phenomenon despite its importance. This makes it difficult to get a clear picture of trends in foreign divestments in developing countries in general and Africa in particular.

A 2019 study by Ernst & Young found that about 84% of surveyed firms were planning to divest at least some of their operations within the next two years, which is a global average of 85% American, 82% Asia-Pacific, and 84% of Europe, Middle East and Africa.

Little is known about foreign divestment trends in developing countries and Africa in particular

And according to the United Nations Conference on Trade and Development (UNCTAD), the investment stocks held by the US in Africa, the largest foreign investor on the continent, declined by 15% in 2018 due to divestments.

International divestment can affect the performance of the divested firms as well as the domestic economy. For example a recent study by the Organisation for Economic Co-operation and Development (OECD) examined 62 000 foreign-owned affiliates from 41 OECD and G20 countries. It revealed that divested foreign affiliates experience on average 28% lower sales, 24% lower value added and 13% lower employment compared to firms that remain under foreign ownership.

The impact of liquidations or business closures would no doubt be even more severe in the domestic economy. This means that increasing foreign divestments may undermine growth and employment prospects in the economies in which they occur.

COVID-19 is likely to intensify international divestments. Measures taken around the world to limit the spread of the pandemic have caused major disruptions in the global value chains. This may lead some multinationals to insulate themselves from future shocks by shortening their supply chains. Others may opt for a diversification of their supplier networks to reduce vulnerability to location-specific shocks.

African countries’ efforts to attract foreign direct investment have not had much success

The pandemic will probably also increase corporate debt levels that were already rising before the crisis. The financial distress of parent companies may trigger the sales or liquidations of some affiliates located in other economies. As COVID-19 has accelerated digitalisation of businesses, some multinationals may also reduce and consolidate their geographic presence and, in the process, reduce foreign investment.

Foreign firms are important sources of employment and trade for host economies. Beyond their direct contribution to growth, their presence may be associated with other benefits such as technology transfer when they establish buyer-supplier relations with domestic firms. A decision to leave the host economy would have multiple negative effects.

African countries’ efforts to attract foreign investment as a boost to development and industrialisation have not had much success. The continent is still marginalised in the current financial globalisation, with barely 5% of global foreign direct investment flows.

COVID-19 hit at a time when such flows to Africa were already declining. According to UNCTAD’s World Investment Report 2020, Africa experienced a 10% drop in 2019. Projections are that foreign direct investment will contract further by between 25% and 40% in 2020 due to the economic fallout of the pandemic. This downward trend is set to continue for some time in the future, says UNCTAD’s director of Investment and Enterprise, James Zhan.

Beyond contributing to growth, foreign firms bring other benefits such as technology transfer

Today, foreign investors are not in Africa only for resource extraction; they’re diversifying into services and manufacturing which create more links with domestic firms and local entrepreneurs. A decline in foreign direct investment combined with increased foreign divestment would undermine economic transformation and industrialisation on the continent.

As soon as the COVID-19 health emergency is overcome, African countries should redouble their efforts to retain and attract foreign direct investment. This will be key to accelerating economic recovery and meeting the UN Sustainable Development Goals.

In contrast to foreign investment inflows, not much is known about the forces shaping foreign divestments. Factors such as political instability and unfavourable legal and regulatory environments probably play a role which means investment climate policies matter for attracting and retaining foreign direct investment.

However, retention and attraction may not necessarily be two sides of the same coin as investment and divestment decisions could be based on different factors. Policymakers in Africa need to systematically consider the risk of foreign divestment in their policy design. The focus should be on improving political stability, the efficiency of the labour market, reducing corruption and improving the regulatory environment. Regional trade integration under the African Continental Free Trade Area agreement is also key.

The push towards diversification of value chains away from China may benefit Africa as companies seek to position themselves closer to the next large consumer market. Africa must seize this opportunity by winning investors’ confidence through good policymaking.

Kouassi Yeboua, Researcher, African Futures and Innovation, ISS Pretoria

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