title: Essays on foreign direct investment, tax avoidance and institutions
Creators: name: Chiyaba, Grivas Shimonde
Publisher: name: University of Reading
Year: 2024

description: This thesis presents three essays, each exploring various dimensions relating to foreign direct investment (FDI), tax avoidance, natural resources, and institutions. Using Zambia as a case study, the first essay examines the response of the three components of FDI flows to macroeconomic variables within firms. It also investigates the determinants of FDI flows. The second essay explores the use of tax avoidance instruments by large multinational enterprises (MNEs), using a case study of a European headquartered MNE manufacturing in Zambia. The final essay investigates whether natural resources and FDI tend to erode or support the development of national institutions. The components and determinants of FDI within firms: A case study of Zambia This chapter investigates the response of the components of FDI flows to macroeconomic variables within firms. Using a new firm-level database constructed from anonymised confidential data held by the Bank of Zambia covering the period from 2008–2017, I find positive and significant effects of the copper price on FDI inflows. This supports the theory that high commodity prices tend to stimulate investment. I also find a negative relationship between FDI flows and exchange rate appreciation. The effect is insignificant, but it aligns with the theory. The evidence shows varying results when I consider the individual components of FDI. I find that the relationship between equity capital and copper price is negative. The evidence also indicates a negative relationship between equity capital and exchange rate appreciation. In contrast, the evidence shows a positive relationship between reinvested earnings and the copper price. This suggests that firms reinvest profits to finance their operations when the copper price increases. However, the estimated effect of the exchange rate appreciation on reinvested earnings is negative. Also, evidence shows a significant positive relationship between intra-firm debt and copper price, while the impact of the exchange rate depreciation on intra-firm debt is positive. These findings provide new empirical evidence on the response of components of FDI to macroeconomic variables, which could be helpful for future investment policy formulation in developing countries. For instance, the results suggest that policymakers whose primary objectives include attracting more FDI should be aware that reinvestment and intra-firm debt are sensitive to exchange rate movements. Tax avoidance by multinationals: A case study of the Zambian manufacturing sector This chapter investigates the use of tax avoidance instruments by large MNEs, using a case study of a European headquartered MNE manufacturing in Zambia. This detailed study synthesises information from multiple sources, and is believed to be the first of its kind in the literature. Theory identifies three key tax avoidance mechanisms: transfer pricing, mis-pricing of internal loans, and overcharging for internal management services. Transfer pricing can reduce ad valorem tariffs as well as taxes; internal loans are easy to administer; while internal management services are already used for a variety of purposes. All three mechanisms are used by the case study firm. By using multiple mechanisms an MNE can minimize the risk of detection; furthermore, should one mechanism be disabled by tax authorities, others can be substituted for it. The case study firm is regarded as a good corporate citizen by host governments, because of its philanthropic support for hospitals and schools, but the loss of income to high-tax host economies through tax avoidance far outweighs the value to them of its philanthropic activities. Future research should investigate how far these conclusions generalise to other firms, industries and countries. Do natural resources and FDI tend to erode or support the development of national institutions? This chapter explores the effects of natural resources and FDI inflows on the quality of national institutions, also known as “the rules of the game”. Using a panel dataset of 69 developing countries over the period 1970–2015, we find negative and significant effects of natural resource use or extraction on the development of national institutions. We focus on legal and property rights, but these findings also apply to the quality of some other national institutions. Our results align with a theory that abundant natural resources lead to weakened institutions because of the potential for firms to secure monopoly rents. Further, we find that the effects of FDI inflows on institutional development are not robust to controlling for natural resource rents. This suggests that the latter tend to erode institutions regardless of whether those resources are exploited alongside increased foreign investment into the local economy.