Economic growth in South Africa: weaving together industrialization and foreign direct investment

South Africa's economic trajectory is markedly different from that of other African countries, characterized by its advanced industrial base and technological capabilities. As the most industrialized and technologically advanced economy in Africa, South Africa boasts a rich endowment of natural resources, a relatively well-developed infrastructure, and a diversified economic base. Yet, despite these advantages, the country faces persistent challenges that hinder sustainable growth, including high unemployment, inequality, and structural inefficiencies (Enaifoghe et al., 2021). The legacy of apartheid-era policies has left an imprint on its economic fabric, contributing to entrenched disparities that continue to shape policy priorities today (Muyambi and Ahiaku, 2025).

South Africa's recent economic performance has been characterized by sluggish growth, averaging around 1.5%–2% annually since 2010 (Hausmann et al., 2022). This growth rate remains inadequate to address the country's pressing socio-economic issues, such as unemployment exceeding 30%, widespread poverty, and income inequality (Hlongwane and Daw, 2021). Structural constraints – such as skills shortages, infrastructural deficits, and regulatory challenges – persist despite efforts to stimulate industrial development and attract foreign investment (Francis and Webster, 2019). Moreover, South Africa's geopolitical positioning, regional integration within the Southern African Development Community (SADC), and its role as a gateway to Africa amplify the importance of understanding its unique developmental context.

The strategic importance of South Africa in Africa's economic landscape makes it an ideal case for examining the interaction between industrialization and foreign direct investment (FDI). The country's industrial sector, particularly manufacturing, has historically been a key driver of economic growth and employment, contributing approximately 13%–15% to the national GDP (Sichoongwe, 2024). However, this sector has experienced a decline due to global competition, policy shifts, and infrastructural challenges, reflecting broader shifts in global economic dynamics. Simultaneously, South Africa remains a major recipient of FDI, especially in the mining, manufacturing and services sectors, motivated by its resource wealth, market size, and relatively stable financial systems (Matekenya and Moyo, 2023; Muzuva et al., 2024).

Furthermore, South Africa's unique socio-economic landscape necessitates a thorough exploration of how industrialization and FDI interact amid its ongoing structural challenges. The country's experience offers valuable insights into the complexities faced by emerging economies striving to leverage foreign investment and industrial capacity to overcome structural barriers. As the most advanced economy in Africa, South Africa's developmental pathways and policy responses can serve as a reference point for other resource-dependent and developing nations seeking to harness the benefits of FDI and industrialization.

The aim of this study was to empirically investigate the interconnected effects of industrialization and FDI on South Africa's economic growth, addressing a significant gap in the literature. It advances the existing literature by empirically quantifying the interactive and synergistic effects of industrialization and foreign direct investment (FDI) on South Africa's long-term economic growth. Unlike prior research, which typically has examined these variables in isolation or as separate determinants, this research uniquely models their interdependent relationship, highlighting how the two factors mutually reinforce each other to promote growth.

In addition, the study provides context-specific evidence that emphasizes the importance of integrated policy efforts to harness the combined effects of industrialization and FDI, thereby fostering sustainable development in South Africa. By focusing on South Africa's distinctive context – its history, socio-economic challenges, and regional influence – this research provides insights that are both contextually relevant and broadly applicable to similar emerging markets.

The primary research question guiding this study is:

What are the interdependent effects of industrialization and foreign direct investment (FDI) on economic growth in South Africa?

The organization of the rest of the paper is as follows: The next section presents a summary of the literature that is currently available. The third section details the methodology. Section four discusses the findings, and the final section wraps up the paper with conclusions.

This section examines economic growth in South Africa, focusing on the interplay between industrialization and foreign direct investment (FDI). Rostow's stages of economic growth highlight the country's transition from reliance on natural resources to a diversified economy, emphasizing the role of FDI in enhancing productivity and fostering technological innovation.

Rostow's stages of economic growth outline five phases of economic evolution: “traditional society”, “preconditions for take-off”, “take-off”, “drive to maturity” and “age of high mass consumption” (Thaha and Karunia Galib, 2022). In South Africa, this model illustrates the connection between industrialization and FDI. Since 1994, the country has progressed towards the “take-off” stage by attracting FDI and diversifying its economy, leading to enhanced productivity and job creation (Balbi et al., 2019). However, socio-economic inequalities and infrastructure deficits persist, necessitating the alignment of industrialization strategies with FDI policies for sustainable growth (Liu et al., 2022).

Industrialization generally represents a pivotal shift from an agriculture-based economy towards one that emphasizes the large-scale production of both finished and semi-finished goods. This process includes the mass manufacturing of specialized components within global value chains (Yuni et al., 2023). The resulting increase in the quantity and diversity of manufactured products stimulates job creation and enhances the collective well-being of the population. During periods of economic expansion, the industrial sector acts as a primary engine of growth due to its substantial potential for productivity improvements. When supported by appropriate policies, this sector can significantly accelerate economic recovery, transforming a slow rebound into robust growth (Ndiaya and Lv, 2018). Moreover, industries often signal economic progress, as the marginal revenue products of labour in these sectors typically surpass those in agriculture (Ibitoye et al., 2022).

The link between economic growth and FDI has been a prominent topic of discourse among scholars, economists and policymakers, particularly concerning developing nations (Simionescu, 2016). FDI is essential in economies with underdeveloped financial markets, as it fosters the creation of business opportunities, generates employment, and enhances individual income levels. The easing of trade restrictions has brought about a notable increase in FDI inflows, thereby contributing positively to the growth trajectory of developing nations (Khan et al., 2023). FDI facilitates the transfer of both tangible and intangible assets, such as technology, innovative product designs, and management know-how. The positive influence of FDI on economic growth is assured through its associated spillover effects and improvements in productivity (Simionescu, 2016).

In conclusion, the interplay between industrialization and FDI generates a synergistic effect that can unlock substantial economic potential, particularly in developing countries. By leveraging the strengths of both sectors, countries are better positioned to achieve sustained economic growth and enhance the well-being of their populations.

The relationship between foreign direct investment (FDI) and economic growth has long been the focus of empirical studies, producing varied and sometimes contradictory results. Many researchers argue that FDI fosters economic development by introducing capital, transferring technology and creating jobs, which can boost productivity and enhance the competitiveness of host economies (Chizema, 2025). In Africa, for instance, FDI has significantly driven growth, particularly when supported by well-functioning financial markets that efficiently allocate foreign capital (Makalima et al., 2024). Cross-country analyses further identify key mediators – such as labour force size, trade openness and economic freedom – that affect how effectively FDI translates into growth (Dalaseng et al., 2022).

The role of human capital in this dynamic is particularly crucial for developing economies. FDI can aid technological transfer and skills development, but these benefits depend heavily on a country's absorptive capacity and technological readiness (Rajab and Zouheir, 2024). In Vietnam, early FDI inflows spurred growth, yet excessive FDI has sometimes displaced domestic investment or led to inefficiencies (Guo et al., 2024). Sector-specific studies show that FDI tends to boost productivity most in export-oriented industries, aligning with broader development goals (Mabeta et al., 2025; Pečarić et al., 2021).

However, FDI does not uniformly yield positive outcomes. In certain European low- and middle-income countries, FDI has had negative or negligible effects, sometimes crowding out domestic firms or misallocating resources (Jusaj and Zogaj, 2024). In Asia, Rao et al. (2023) observed that, while foreign aid might deter investment, FDI remains crucial for long-term growth. Similarly, in Pakistan, FDI was associated with reduced unemployment, but effects on labour markets were mixed (Arslan and Zaman, 2014).

Sectoral variation further complicates the FDI-growth link. Elheddad et al. (2021) noted that certain sectors benefit more from FDI than others. Hayat (2018) found that, while FDI generally promotes growth, heavy investments in natural resources often produce diminishing returns. In relation to Sudan, Sirag et al. (2018) highlighted that the financial sector played a more pivotal role than FDI in driving growth. These differences underscore the importance of domestic factors, such as sectoral composition, policy environment and institutional quality, in shaping the impact of FDI (Fazaalloh, 2024).

Industrialization, closely tied to economic growth, is widely recognized as transformative, particularly in developing economies. It reallocates resources to more productive sectors, enhances employment, and spurs innovation. Manufacturing has shown a strong correlation with growth, especially in economies transitioning away from agriculture (Aquilas et al., 2024; Pinto et al., 2025). Urbanization, often driven by industrial growth, generates hubs for innovation and employment, but can also exacerbate environmental and social issues (Jacobs et al., 2023; Yu et al., 2024).

The industrialization-growth relationship, however, is complex and non-linear. In China's Yangtze Delta, for instance, the effects of industrial clustering vary across development stages, suggesting benefits may wane or evolve over time (Lin et al., 2021; Shen and Pan, 2024). Sectoral differences also matter; equipment manufacturing may have high productivity but is sensitive to demand shifts, requiring targeted policy support (Zhang et al., 2025). The rise of Industry 4.0 – encompassing automation and AI – has boosted industrial productivity, but also introduced challenges like job displacement and the need for reskilling (Alhammadi et al., 2024; Li, 2024).

Empirical findings on the effects of industrialization are similarly mixed. In Tonga, Yangailo and Chambani (2023) found strong positive impacts from industrialization between 2000 and 2021. In Pakistan, Qaiser (2020) confirmed a long-run relationship between manufacturing and economic growth. However, Shabana et al. (2019) found no causal link in their study, citing environmental degradation and urbanization as complicating factors. In Tanzania, manufacturing has been key to structural transformation, supported by both FDI and domestic credit (Lugina et al., 2022). Tunisia's experience also shows that industrialization can drive inclusive growth, although it faces persistent economic challenges (Olfa, 2024).

It is worth noting that the dynamics linking FDI, industrial development and economic expansion are intricate. While FDI can stimulate short-term growth and industrial development, its long-term benefits remain uncertain. In some cases, foreign investment has failed to translate into productive growth and has even harmed domestic industries when not managed properly (Dinh et al., 2019; Sahu, 2021). Manufacturing remains central to employment and exports, yet both foreign and domestic investments have at times coincided with declines in value-added manufacturing, pointing to structural weaknesses (Nwani et al., 2023). These trends suggest the need for stronger policy frameworks to align investment with national development goals.

The effectiveness of FDI and industrialization in driving sustainable growth depends heavily on sectoral strategy. Cross-country evidence from Africa and Asia indicates that sector-specific FDI can lead to varied results – sometimes even stalling growth due to misallocated resources or environmental harm (Mebrek et al., 2025).

In conclusion, although extensive research affirms the significance of FDI and industrialization as drivers of economic growth, the empirical evidence remains mixed and highly context-dependent. For South Africa, understanding the intricate interaction between FDI and industrialization is paramount for devising strategies that harness their synergistic potential for sustainable development. Despite the breadth of the existing scholarly work, there remains a notable gap in comprehensively exploring how these elements interact within the country's unique economic landscape, underscoring the need for further research to inform effective policymaking.

The theoretical model presented in Figure 1 delineates the intricate dynamics between industrialization and FDI as principal determinants of economic growth. Central to the model is economic growth, identified as the primary variable of interest, which is bordered by the key drivers facilitating this growth.

To the left, industrialization is depicted as a direct contributor to economic growth. It does this through several mechanisms. It creates jobs, especially in manufacturing, thereby improving income levels and reducing poverty. It also promotes technology transfer, boosting productivity and innovation, often via FDI and trade. In addition, industrialization fosters the development of skills, enhancing overall competitiveness. It drives economic transformation by shifting the focus from agriculture to higher productivity manufacturing sectors, which sustains growth. Moreover, growth in manufacturing stimulates demand for related sectors like trade, finance and transportation, creating a positive economic ripple effect. Overall, industrialization acts as a catalyst for structural and sustained economic development.

On the right side of the model, FDI is depicted as a vital catalyst that significantly enhances economic expansion. It promotes economic growth through key mechanisms. It transfers advanced technology and managerial expertise from developed to developing countries, boosting productivity when supported by a strong financial system. FDI also provides vital capital for infrastructure and industrial investments, addressing limited domestic savings. The presence of foreign firms fosters competition, encouraging local companies to improve efficiency. In addition, FDI creates jobs, increasing household incomes and demand. Overall, FDI drives growth by enhancing infrastructure, productivity, competitiveness and income levels in the host economy.

The directional arrows within the model depict the nature of influence between the variables, namely industrialization and FDI. This mutual influence produces a synergistic effect that substantially promotes economic growth, structural transformation and long-term development. In essence, the dynamic interplay between industrialization and FDI establishes a reinforcing cycle that augments a nation's economic capacity, competitiveness and resilience, thereby facilitating sustained and inclusive growth.

The study utilizes data from the World Bank Development Indicators, covering the period from 1994 to 2024. The choice of this timeframe is primarily due to its focus on the post-apartheid era, which is particularly relevant for understanding current patterns of economic growth in South Africa driven by industrialization and FDI. By concentrating on the period from 1994, the analysis aims to accurately capture the impacts of structural reforms, policy changes, and South Africa's integration into the global economy following the end of apartheid. This period also includes significant socio-economic transformations and various policy initiatives aimed at liberalizing the economy and boosting its competitiveness on the international stage.

This study employs economic growth as the dependent variable, with key independent variables including foreign direct investment (FDI), FDI stock (FDIS), and industrialization. Industrialization is proxied by two complementary indicators, namely industry value added (IVA) and industry jobs as a share of total employment (IJTE), capturing the contribution of the industrial sector to output and employment, respectively. To capture the dynamic interplay between industrialization and FDI, interaction terms such as IVA × FDI, IVA × FDIS, IJTE × FDI and IJTE × FDIS are included in the analysis. The study also controls for factors like agriculture value added, urbanization, inflation, tax revenue and trade openness, which are important determinants of economic growth (see Table 1).

This study utilizes the autoregressive distributed lag (ARDL) bound test methodology, which offers several advantages. First, it accommodates datasets with different integration orders, including I(0) and I(1) (Chandio et al., 2019). Second, the ARDL method analyses relationships among variables in both the short and long term (Shrestha and Bhatta, 2018). Third, it is suitable for limited sample sizes, allowing simultaneous estimation of long- and short-term parameters (Pokhrel and Khadka, 2019). Finally, the ARDL approach effectively addresses endogeneity concerns, capturing interactions between dependent and independent variables, unlike the Engle-Granger and Johansen methods (Ramirez, 2024).

In the step-by-step process of conducting the ARDL bounds test, the initial phase involved specifying the model by identifying the dependent and independent variables that were theoretically justified and relevant to the study. Following this, the order of integration of each variable was checked using a unit root test, such as the augmented Dickey-Fuller (ADF) tests. The ARDL bounds test could also be applied, regardless of whether the variables were I(0) or I(1), but it was essential that none of the variables were I(2).

Next, the optimal lag length was determined using criteria like the Akaike information criterion (AIC) or the Bayesian information criterion (BIC), ensuring that the model was appropriately specified. The ARDL model was then estimated by including the selected lags of both the dependent and independent variables, regressing the dependent variable on its own lags and those of the independent variables. Following Khan et al. (2023), the ARDL model was formulated as:

In this formulation, $yt$ represents the dependent variable, $xt$ the independent variables, $Δ$ denotes the difference operator, p and q are the optimal lag lengths determined by criteria like AIC or BIC, $ϕ1$ and $ϕ2$ are the long-run coefficients, and $εt$ is the error term.

Subsequently, the bounds test for cointegration was performed by calculating the F-statistic for the joint significance of the lagged levels of the variables. The computed F-statistic was then compared to the critical bounds provided by Pesaran et al. (2001). In this case, the test indicated that the F-statistic exceeded the upper bound, leading to the rejection of the null hypothesis of no cointegration. This result confirmed that a long-run equilibrium relationship existed among the variables, and cointegration was established.

Once cointegration was established, the long-run coefficients were estimated by regressing the dependent variable on the lagged levels of the independent variables within the ARDL framework:

To capture the short-run dynamics and the speed of adjustment toward the long-run equilibrium, an error correction model (ECM) was formulated. The ECM incorporated the error correction term derived from the long-run relationship, providing insights into the short-term adjustments. The ECM is formulated as:

where $λ$ denotes the coefficient linked to the error correction term, and $ECt−1$ represents the lagged error correction term. A negative coefficient indicates a converging process to the equilibrium path.

Before using the bounds-testing approach, it was necessary to check the stationarity of the variables, ensuring each is classified as either I(0) or I(1), and not I(2). The augmented Dickey-Fuller (ADF) test was employed to assess stationarity, with the results summarized in Table 2. The findings showed that some variables were stationary at their original level (I(0)), while others, which required first differencing, became stationary after being differenced once (I(1)).

The estimated long-run and short-run coefficients from the ARDL model, presented in Table 3 below, provide evidence of both the individual and interactive effects of foreign direct investment (FDI) and industrialization on economic growth in South Africa.

In the long run, foreign direct investment (FDI) – measured through net inflows as a share of GDP and total accumulated FDI stock – has a positive and statistically significant effect on South Africa's economic growth. A 1% increase in FDI net inflows is associated with an estimated 2.2% point rise in long-term growth, while a 1% increase in FDI stock corresponds to a 1.5% point gain. These findings underscore the multifaceted role that FDI plays in promoting economic growth, aligning with the broader economic literature, such as that of Fazaalloh (2024) and Liang et al. (2021). Such insights not only highlight the importance of fostering a favourable environment for attracting FDI, but also suggest that policymakers should consider implementing strategies that facilitate the effective integration of foreign investments into the local economy to maximize the potential benefits.

Furthermore, the results show that both interaction terms – industry value added with FDI and with FDI stock – have a significant positive impact on long-term economic growth. At the 1% level of significance, the interaction between industry value added and FDI suggests that the growth effects of FDI are substantially amplified when directed toward the productive industrial sector. Specifically, a 1% increase in this interaction corresponds to approximately a 3.2% point rise in long-term output, while a 1% increase in the interaction between industry value added and FDI stock is associated with a 3.4% point increase in economic growth. These findings highlight the pivotal role of foreign direct investment in promoting industrial activity, facilitating technological diffusion and improving managerial efficiency, all of which contribute to sustainable economic growth. They underscore the importance of integrated policy measures that simultaneously foster industrial development and attract foreign investment. Such coordinated strategies can maximize the synergistic effects between industrialization and FDI, thereby enhancing long-term economic resilience and growth.

Similarly, the interaction between industrial employment and foreign direct investment (FDI) – measured through variables such as industry jobs and FDI, as well as industry jobs and FDI stock – exerts a positive and statistically significant effect on economic growth. The positive coefficients suggest a synergistic relationship: as noted by Antonietti and Mondolo (2023) and Ibarra-Olivo et al. (2024), FDI tends to be more effective in fostering growth within economies possessing a sizable industrial workforce, while industrial employment itself enhances growth prospects when complemented by FDI inflows. A 1% increase in the interaction term between industrial jobs and FDI is associated with an approximate 3.0% point boost in long-term growth. Similarly, a 1% increase in the interaction between industrial jobs and FDI stock results in an estimated 4.3% point increase in growth. These findings underscore the critical importance of integrating a skilled and substantial industrial labour force with targeted FDI attraction strategies. Such a coordinated approach can amplify productivity and output, emphasizing the need for policies that simultaneously stimulate industrial employment and facilitate foreign investment. Harnessing this synergistic potential is essential for fostering sustainable and inclusive economic growth in South Africa.

In the short run, both foreign direct investment (FDI) net inflows and FDI stock significantly influence economic growth. A 1% increase in FDI inflows raises economic growth by 2.5% points, while a 1% rise in FDI stock boosts it by 3.1 points. FDI inflows represent fresh capital that enhances productive sectors, generates jobs, and facilitates technology and expertise transfer – contributing to immediate growth. Likewise, FDI stock reflects the embedded presence of foreign firms, which expands production capacity, stimulates competition, and improves efficiency in domestic markets. The short-run significance of both FDI indicators highlights their complementary roles: inflows bring new resources, while stock represents sustained economic integration. These findings support earlier studies by Nguyen (2022) and Elimam and Alattas (2025), emphasizing the role of FDI in accelerating technology transfer, capital deepening, and overall economic development.

Industry value added also exerts a substantial short-run impact on economic growth. Specifically, a 1% increase in industry value added is associated with a 1.5% point rise in economic growth. This highlights the immediate impact of industrialization on boosting productivity, generating employment, and increasing income, which in turn stimulate consumption and investment. These short-term effects underscore the role of industrial output in driving economic activity, consistent with the findings of Elfaki et al. (2021) and Khan et al. (2023).

In addition, trade openness significantly influences short-term economic growth. The analysis reveals that a 1% increase in trade openness is associated with a 2.4% point increase in economic growth. This underscores the immediate benefits of integrating into global markets, such as increased access to foreign capital, technology transfer, and enhanced competitiveness. The rationale behind this is that, in the short term, openness to international trade can stimulate demand, diversify the economy and foster innovation, thereby accelerating economic expansion. These findings align with prior studies (Esaku, 2021; Raghutla, 2020), which also identified a positive relationship between trade openness and economic growth in the short run.

Lastly, the ECM term of −0.5365 supports the economic theory of mean reversion, which posits that variables deviating from their long-term trends will tend to return to those trends. A negative ECM indicates that any increases or decreases pushing economic growth away from its long-term trend will ultimately be reversed. Furthermore, the significance of the ECM term suggests that a long-run relationship exists.

The stability check for this study utilized the cumulative sum of squares (CUSUMSQ) approach, which assesses the stability of parameters within the applied econometric model. This method ensures that the results remain robust over the examined period, confirming that the variable relationship is consistent. This analytical framework reinforces the credibility of the findings. The outcomes are presented in Figure 2, where the straight lines represent the critical limits, set at the 5% level of significance. The CUSUM graph indicates that the model specified in this study is stable, as it lies between the critical bounds.

To ensure the robustness of the results, a range of diagnostic, stability and sensitivity analyses were conducted. Post-estimation diagnostics included tests for model specification errors, heteroskedasticity and serial correlation. The results confirmed that the model was correctly specified, exhibited homoscedastic errors, and was free from autocorrelation, thereby enhancing the credibility of the estimates. Furthermore, the stability of the model parameters over time was evaluated using the CUSUM of squares (CUSUMSQ) test, which confirmed that the parameters remained stable throughout the sample period. In addition to these checks, sensitivity analyses was performed by varying the model specifications, including the inclusion/exclusion of selected control variables. The consistency of the results across these different specifications further supports the robustness of the findings.

This study explored the dynamic relationship between industrialization, foreign direct investment (FDI) and economic growth in South Africa from 1994 to 2024. Recognizing South Africa's rich resource base and industrial potential, the research investigated how these factors collectively influence growth. Initially, stationarity tests revealed that variables were either I(0) or I(1), indicating they were stationary at level or after differencing. The ARDL bounds test confirmed a long-term cointegration among the variables. The empirical findings demonstrated that both FDI inflows and industrial value added positively influenced economic growth, with their interaction further amplifying this effect. The results highlight that policies promoting industrial development alongside FDI attraction can create a self-reinforcing cycle of growth. In addition, trade openness and industrial employment contribute to short-term growth, emphasizing the importance of integrated policies that foster diversification, technological transfer, and competitiveness to sustain inclusive economic development.

The study outlines the subsequent policy recommendations: First, policymakers should design and implement cohesive strategies that integrate industrialization and foreign direct investment (FDI) as intertwined elements, rather than separate entities. This approach should include incentives for foreign investors to engage with local industries through partnerships, joint ventures and technology transfer arrangements. Second, to attract more FDI and enhance the effectiveness of industrialization efforts, policymakers need to focus on funding initiatives in critical infrastructure and skills development. Third, promoting sustainable industrial practices is essential, as the relationship between industrialization and economic growth must emphasize sustainability. Implementing policies that encourage sustainable manufacturing practices can attract both domestic and international investors who value corporate social responsibility. Fourth, policymakers should strengthen trade agreements by engaging in and negotiating favourable bilateral and multilateral trade agreements that expand market access and protect national interests, thereby fostering an environment conducive to increased trade. Lastly, policymakers should promote investments in high-tech industries to foster innovation that drives economic growth.

This study relies solely on data obtained from the World Bank Development Indicators, which may not capture critical, sector-specific variations within South Africa's economy. Such limitations constrain a comprehensive understanding of the country's heterogeneous economic landscape. Furthermore, the analysis does not account for significant external shocks – such as economic crises or the COVID-19 pandemic – that could have affected the findings. In additional, external factors, including global economic trends and technological advancements, are not considered, despite their potential influence on the relationship between industrialization and foreign direct investment (FDI). Future research should integrate sector-level data and examine external macroeconomic and technological factors to enhance the robustness of the findings.

Data are available on request from the author.