Foreign Direct Investment and Manufacturing Sector in Sierra Leone: A Vector Auto-Regression Analysis Approach

Abstract

This study assesses the short-term and long-term impact of Foreign Direct Investment (FDI) on the manufacturing sector output in Sierra Leone using time series from 1970 to 2018. In order to assess the impact of FDI together with some explanatory variables such as inflation, movement of exchange rates, external debt and exports; the Vector Auto Regression (VAR) method was applied. It first tests for unit root using both the Augmented Dickey-fuller (ADF) and the Philip Perron (PP) tests. The results from the granger causality test imply that the foreign direct investment (FDI) greatly influences the manufacturing output (MQ, which also implies that, an increase in FDI will result to increase in MQ. There is also significant relationship between MQ, inflation and exchange rate (ER). Additionally, there is no directional relationship between external debt (DET) and export (XPT) with MQ. This implies that MQ cannot granger cause DET and XPT individually but it can granger cause them all in totality. The study also employed the Johansen cointegration method in order to derive the long-run relationship of the variables. The results from the empirical findings identified that there is positive relationship between the FDI and the manufacturing sector, while inflation and export reported a negative relationship with FDI. The error correction model (ECM) was also used to test for the short run relationship of the variables and reported that exchange rate and FDI availability are the main determinants of manufacturing sector output in Sierra Leone. The study did not find external debt, export and inflation to be significant with the manufacturing sector output in the short run. The study concluded that it is important for the Sierra Leone government to take into account the paramount role of FDI and also improve the business environment by creating an investment destination that is safe and friendly. This required government to formulate policies that are bias free and create a business environment that can inspire investors greatly. This calls for government to strengthen the implementation of reforms which will improve the country’s gross domestic product (GDP), while embarking on severe infrastructural development and curbing inflation via strengthening monetary policy.