Foreign direct investment and its role in alleviating poverty: A Tanzanian perspective

Abstract

The impact of Foreign Direct Investment [FDI] and major macroeconomic variables such as government spending, unemployment, inflation, and exchange rate on poverty in Tanzania over the period 1993-2023 is investigated in this study. It is based on three structural theories: Production Cycle, where FDI grows with the life cycle of products, leading to technological development and product development, and results in poverty eradication via employment and market expansion; Internalisation, in which multi-national corporations internalise the market to reduce transaction costs which leads to technology transfer and increases efficiency and poverty reduction; and Vernon’s Production Cycle and Market Imperfection Theories, where firm-specific advantages in imperfect markets cause FDI to increase competition and employment and help to reduce poverty. The data used in this study were extracted from reliable sources, including the World Bank and the Tanzania National Bureau of Statistics, and they cover annual time series. The explanatory variables examined consist of poverty headcount ratio, FDI inflows, government spending, unemployment rate, CPI, and real exchange rate. The inclusion criteria provided reliable, consistent data over 30 years, while the exclusion criteria removed incomplete data sets, which could have been affected by differences in methodology. The ARDL model was employed to generate short-run and long-run relationship and dynamic analysis, which was validated in the model through the robust diagnostic tests such as CUSSUM test for stability, Breusch-pagan test for heteroskedasticity, and Breusch Godfrey statistic for autocorrelation. The results show that FDI has significant effects on reducing poverty in the short and long run. One percent increase in FDI is negatively and significantly related to poverty in the long run, with an impact of 0.437 per cent and a short-run impact of 0.034 per cent, suggesting that FDI promotes job creation, technology diffusion, and economic activities, particularly in agriculture. Inflation, on the other hand, has a twofold effect, increasing poverty in the long run as a result of weakening purchasing power (a 1% increase in inflation is associated with a 0.437% increase in poverty). Ironically, in the short term, inflation leads to a slight reduction in poverty, perhaps due to temporary gains in wages and specific sector dynamics. Government spending is not an effective tool for addressing poverty. The long-term impacts are weakly positive (coefficient=0.152) and the short-term are slightly negative (-0.087), which means that long-run efficiencies are questioned regarding the assignment of resources to education and health, which are more directly associated with poverty. Unemployment has a strange relationship with poverty, decreasing in significance in the long run (although it is still significant with a negative effect of -0.193), perhaps indicating difficulty in measuring the large unregistered labour market in Tanzania and its immediate impact is -0.045. Poverty is relatively insensitive to exchange rate adjustments, showing a long-run impact of -0.098, which is a small number. This marginal effectiveness might reflect the counteracting influences of export-led growth and more expensive imports. The study also reveals the persistent structural presence of poverty (long-term and short-term lagged poverty rates -0.612, and 0.387 as the coefficients) which provides evidence of deep-rooted economic poverty alleviation downward pressures. Policy implications include investing in human capital and increasing Tanzania’s absorptive capacity for FDI by enhancing institutions and strengthening labour-intensive (e.g. agriculture, manufacturing, and textiles) sectors, managing monetary policy to reduce negative inflation, and enhancing the targeting and efficiency of public spending on social infrastructure, healthcare, and education.