The Impact of Foreign Capital on Institutional Quality: An Empirical Study of Chinese Finances of Loans and Foreign Direct Investments in Africa

Abstract: The African continent has since long had slow economic growth, with large infrastructural gaps compared to the Western World. This has resulted in large inflows of foreign capital to the African economies. With China becoming an increasingly important investor in Africa, the interest to understand the impact that the China-Africa relationship has on the African countries has increased. Previous research has mostly focused on areas such as the impact of FDI on economic growth and social welfare, as well as FDI's impact on institutional quality and local corruption. However, to our knowledge, no study has looked at the difference between Chinese FDI and loans in how they impact institutional quality in the host country, which is the purpose of this study, to provide guidance for policymakers. This area is important to study further as institutional quality has been found to be an important factor for long-run sustainable economic growth. Also, it is interesting to study China as a separate source of capital, as it is scoring low on measures for transparency, governance, and freedom indices. Through a fixed-effects model with lagged variables for net flows of FDI and loans, the results suggest a nonsignificant impact of FDI and a positive and significant impact of loans on institutional quality. Compared to world data, which is nonsignificant, the impact of Chinese capital is similar but of a larger magnitude, which indicates that Chinese capital follows the general trends but influences institutional quality to a larger extent.