- Laura Wallace
- Published Date:
- January 1999
Many African countries have embarked on broad-based reforms to attract foreign investment, but investors are not responding. What is the problem? Harris Mule illustrates an exceptional case where an array of economic and regulatory reforms initiated in the 1990s have not triggered the expected growth in Kenya. It puts into perspective a country where the rate of growth is falling, implying that the level of investment in the economy is also falling.
I do not believe, however, that Kenya’s reform efforts are misdirected. Kenya is in a state of transition and there is a time lag to shift from an economic regime where everything has been controlled to a new regime based on market forces. Indeed, there is conclusive evidence that the market works, but it takes time to create the conditions for the market to work effectively.
What is important is that Kenya is getting its economic fundamentals right and making the country market friendly. I believe that if the reforms are maintained, it will be much easier for Kenya to integrate into the regional and world markets—and to attract foreign investment—thus enjoying an edge over other counties that have not initiated reforms.
Thus, from the Kenyan experience, we can say that macroeconomic stability prior to reform is essential and that economic and regulatory reforms are not, by themselves, sufficient for growth; policymakers must also strengthen institutional developments. As Florian Alburo pointed out, it is essential to abolish bureaucratic barriers prior to letting in foreign direct investment, as the Philippines did.
So what barriers need to be abolished? This is what I will focus on in my comments today. In particular, what other measures or strategies should be pursued by African countries wishing to attract investment? And what lessons can we draw from Africa?
To address these questions it is useful to ask why investors are not coming to Africa. With the exception of very few countries, investors have the impression that:
Africa’s infrastructure—human, physical, and financial—is generally less developed than that of other regions, including a lack of efficient banking and financial institutions;
there are higher risks of investing in Africa than elsewhere—risks due to the political and economic environments and risks associated with the quality of the legal and regulatory framework intended to support private initiatives; and
Africa’s overall institutional framework is weak, undercutting even well drafted laws and regulations.
Let me address these three concerns, individually.
So what can Africa do to attract investors? Based on the experience of Mauritius—which embarked on gradual liberalization policies in the mid-1980s—a critical prerequisite of foreign direct investment is the existence of an efficient public sector and a prosperous private sector that can ensure growth and development. Investors look for countries where growth is positive and where companies are profitable. Obviously, poor economic performance deters investment. Investors tend to follow growth, not to lead it.
To entice investors, the government and the private sector should delimit their respective roles to minimize competition for scarce resources, giving priority to the private sector. The government should initiate actions for the building up of institutions in support of greater resource mobilization for the private sector. The creation of stock exchanges and leasing facilities will greatly enhance the industrialization process. The government should also establish a framework for a partnership with the private sector, giving the various players (such as industry) the opportunity to express their views on the policy thrust. National policy and decision making should be a matter of shared responsibility and trust.
If the government follows this route, it will enjoy the support of a wide spectrum of the population, and there will be a national consensus on the development strategy to be pursued. No economic reform is successful if there is no consensus—that is, if the general population that has to be a party to the reform objectives feels it has nothing to gain, it will not show any interest.
The government actually has an essential role to play in the development of the private sector. It should not only act as a facilitator and catalyst in the process of economic development but also provide the logistical and financial support in the form of infrastructure, training, tax and other incentives; and, of course, ensure political stability, efficiency, and credibility of its institutions, leaving the private sector to invest in the economy and to create employment opportunities.
The government should disengage itself from areas where it cannot produce the best results. It should consider privatizing state concerns—without, however, creating other forms of monopolies—limiting its intervention only to areas that are of strategic importance, and leaving resources to the private sector.
Working with the private sector, the government should identify new growth sectors that are compatible with the expectations of the investors. It can consider setting up industrial zones and provide support to domestic small-scale industry. Government also has an extremely important public relations role to play—developing market access through international relations and friendly ties with all trading blocs, and, of course, increasing markets through base regional groupings.
The image of seriousness and credibility that the government projects to the outside world is critical in attracting investment. Foreign investors will invest in a country not because the private sector advertises that opportunities exist, but because the government clearly demonstrates that such opportunities exist and commits itself to private sector participation.
This means getting the word out to the world on what is being done in the country, and also, getting the word out to the people to obtain their consensus and support. Of course, if the public sector is to be efficient, governmental rules and procedures must be adapted as lessons are learned.
Legal and Regulatory Reform
Let me now turn to my second point, creating an appropriate legal and regulatory framework. Investors feel that there is excessive use of legislation to regulate business activity. What worries them most is the low degree of certainty and predictability about how existing laws and rules are applied. Investors also feel that there is often a great disparity between what the law says and how it is implemented in day-to-day practice. Moreover, some new laws that have been enacted to support investment conflict in substance with other applicable laws.
In some countries, liberalization has been accompanied by decree, but not followed by appropriate legislative steps, creating an atmosphere of uncertainty for investors. Investors believe that there are too many impediments to identifying and exploiting opportunities because of the lack of information facilities, and they believe that they have to go through long and winding procedures—involving several entities within the government that may have different perceptions and concurrent approval power—to get a project approved. Not surprisingly, this puts them off altogether.
Indeed, in the absence of an adequate framework with clear transparent legislation, various interpretations of the law become possible, leaving investors with the impression that the possibility of obtaining authorization to invest or to benefit from incentives announced by the government depends largely on the discretion of certain officials. In other words, that some sort of extra effort may be necessary to get a project through.
Thus, it is vital that the government establish an efficient, credible legal framework with clear and transparent legislation—a necessary condition for attracting foreign investment. Investors must be reassured about the quality of the legal framework and the capacity and seriousness of the government to enforce the laws and contractual obligations.
Key elements include an efficient, transparent judicial system; arbitration courts with proper enforcement facilities that can settle disputes quickly; and the absence of political intervention in the outcome of proceedings. If the court system is weak, it dramatically weakens investors’ confidence.
The legal framework and laws supporting investment, domestic and foreign, must define, in clear terms, the responsibility and obligation of the parties—who does what and which ministry or agency has the authority to implement the government’s policy decisions. This includes passing laws that define in a clear, unequivocal manner the responsibilities of the agencies involved. Such clarity is crucial for investors, who need to know who has the authority to approve investments and issue licenses—not to mention the scope of that authority.
The legal infrastructure must take into consideration all aspects that are important to the potential investor. Investors searching to invest in a country need to know how the government addresses legal issues such as formation of business, enforcement of contracts, private ownership, transfer of property, security arrangements, taxes, repatriation of profits, and foreign exchange dealings. All of these should be clearly and unequivocally defined in the laws.
Accounting and financial reporting must match international standards. And in drafting the laws, one important consideration is to reexamine other existing sectoral laws—banking laws, tax laws, and so on—to harmonize them with the general trend of liberalization policies so that they do not conflict with one another. In formulating private sector policy, domestic and foreign, care should be taken not to go beyond protecting the general public interest to protecting private interests.
For countries that do not have a well-defined legal system, it may be more efficient to have a specific law for foreign investment that addresses most of the legal issues, including approvals and tax treatment. It is helpful for investors to find, in a single comprehensive document, the main legal provisions related to foreign direct investment and incentives provided by the government, thus leaving little room for interpretation and discretion. This will reduce opportunities for corrupt activities and ensure that the investment liberalization schemes are operated with fairness and consistency. What is more important, it sends clear, positive signals to potential investors that the governments welcome foreign investment. And it is very important that such legislation be in place prior to undertaking foreign investment campaigns in order to reduce delays and to avoid frustration. Of course, any changes in the law should be immediately communicated to the institutions responsible for implementing them.
The third point I would like to talk about is the reform of institutions. Laws governing foreign investment, however well drafted, are not, alone, sufficient to attract or to regulate investment. It is imperative that an overall institutional framework for business activities be set up. It is the efficiency of implementing policy decisions that will determine the attractiveness of the country to investors at large and, consequently, the rhythm of industrialization.
Because foreign participation requires approvals, permits, and licenses from several ministries, several of which may hold differing perceptions of a given project, it is desirable for the government to streamline administrative procedures so that investors only need to deal with one government office to obtain and renew approvals. Consideration can also be given to the issue of automatic approval and clearances in some cases.
The policies and responsibilities of such a one-stop shop should be coordinated in advance to ensure speedy decisions, and the team of people representing the various ministries should have relevant competencies and authority.
At the level of customs and excises, bureaucratic procedures should be streamlined, so that delivery of inputs can be effected in time. In the absence of an efficient administrative system, reforms to attract investment may be negated. The government should consider establishing an arbitration court for commercial disputes, and set up agencies at home and abroad to provide assistance to identify market outlets and joint venture partners.
In conclusion, I wish to point out that Africa needs to take concerted action on many fronts. It has to improve infrastructure (physical, human, and financial), formulate an appropriate legal and regulatory framework, and create and maintain institutions for upgrading human capital, as most foreign investors are interested in countries where they can produce to international standards of quality and price to sustain comparative advantage. In essence, therefore, Africa would benefit greatly by adopting a global approach to investment.
Iain T. Christie
It is an honor and a pleasure for me to be with you today to discuss Africa’s adjusting to the challenges of globalization. Rather than make a speech that would repeat many of the excellent points already made, let me build on some of the points from the two earlier presentations, with a view to provoking some debate. I would also like to refer to the points Motomichi Ikawa made in his opening speech, relating to agriculture and regional integration.
Let me start with the proposition that Africa’s current relatively high growth rates, coupled with the low investment rate, are not sustainable. There has been a return to growth as macroeconomic stability has been established. Indeed, with substantial underutilized capacity in some economies, growth has taken place relatively quickly, but we are going to reach a ceiling soon. Investment levels will have to rise to over 20 percent from 16–17 percent if growth is to be maintained. This is not as high as the Asian countries that have been cited, but nonetheless much higher than current levels.
The World Bank Group is doing its part to promote trade and investment by helping governments make the transition from public to private finance. The recently approved partial risk guarantee is one item. We are looking at a short-term trade guarantee for those wartorn countries where a mechanism to kick start private investment is needed and, in agriculture, we are looking at an agricultural input guarantee instrument. More broadly, we are implementing a World Bank Group strategy for private sector development in Africa that draws on the resources of all members of the Group, including the International Bank for Reconstruction and Development, IDA, International Finance Corporation, Multilateral Investment Guarantee Agency, Foreign Investment Advisory Service, and their agencies.
Most would now agree that macroeconomic reform is an essential, but not sufficient condition to ensure a supply response. Florian Alburo reminds us of a very difficult situation: how are we going to make choices, and how are we going to prioritize? It is often clear what the choices and the priorities are, but somehow, when push comes to shove, we prefer to cut programs across-the-board, rather than eliminate some.
Related to choice, of course, is the question of transition. How do economies make the transition from one environment to another? Many small countries in Africa have switched from a closed economy to an open economy rather quickly under adjustment. In the resulting small open economies, many small- and medium-sized firms have had difficulty competing, and, in fact, many have failed. For those firms that are uneconomical, this is inevitable. But one worries about the losses incurred by those firms that failed but would have survived had the transition been more gradual.
I would like to stress the importance of a policy dialogue with all stakeholders. Too often in Africa, the private sector looks at the government as the problem, and the government looks at the private sector as the problem. That gap must be bridged effectively. We tend to think that agreement with the government is all that is required for a policy framework to work. But it has been proven over and over again in Africa that “stroke of the pen” reform does not work. There must be more public/private debate of policy options. Until the private sector comments on policies, and until their point of view is taken into account in adapting policies, it will be very difficult for policy reform to succeed.
Alburo talked about privatization, and, indeed, this is one of the ways of addressing the high service costs that many African economies face. It is not privatization for its own sake. Rather, privatization implies an environment where competitive firms are able to deliver goods and services efficiently, in terms of timeliness, value, and cost. Typical cases are electricity, water, and telecommunications, where regulation is particularly important, as many privatized utilities remain as monopolies. For example, in Africa, telecommunications markets are typically small and operate under monopolistic conditions, but have very high revenue per line. The world trend is just the opposite—it is for opening the telecommunications sector to competition, increasing market penetration, with reduced revenues per line. In the Central African Republic, revenue per line is $1,800, while in the United States it is in the order of $800. Privatization has to be looked at in a broader context than the transaction itself, to include market structure and the policy environment. In fact, it is much more important to introduce competition (by bringing in a cellular operator in telecommunications, for example) than it is to simply privatize the national carrier.
The point has been made that publicly provided infrastructure has a high cost in Africa. We must rely more on the private sector to provide both the management and capital. In some countries, perhaps Côte d’Ivoire is the first among them, there has been a transition to private sector participation in infrastructure (power generation, water supply, and telecommunications). Over 20 countries are following that lead, including Cameroon and Kenya, where not only small companies are being privatized (or liquidated), but also big utilities and agribusinesses (rubber, palm oil, and bananas).
Legal and Regulatory Reforms
I would now like to address the legal and regulatory environment. There are perfectly sound laws on the books in many African countries, but they are not supported by the institutional underpinnings that make things work better. I would cite the example of agriculture in Uganda. Much has been done on extension services, yields, and agronomy; little has been done on the institutional side to ensure that agricultural policy can actually work. The supply chain and logistics system of inputs and outputs is inefficiently managed, lacks the flexibility to adapt to change, and private providers are scarce. So while research and extension are very important, attention to institutional reform is equally so—to make sure that there is choice in the marketplace. There are still many public sector institutions, such as coffee boards or tea boards, that are inefficient—too many public intermediaries where the private sector might be more efficient.
One case that has worked quite well is trade and fiscal reform in Central Africa. Following trade and fiscal reform, Gabon made every effort through training and technical assistance to ensure that the value-added tax and common external tariff both worked. Without this institutional effort, the policy reform would have been much less likely to succeed. Similarly, as has been pointed out, once the economy in Mauritius was liberalized, a key element to ensure success was the institutional reforms made to support economic policy reform.
Another case that was quite illuminating was maritime transport in West Africa, where there was huge institutional resistance to change. Yet, as soon as the system was liberalized, and the institutional underpinnings were put in place, maritime transport costs in West Africa came down rapidly. Most products are about 20 percent cheaper than they were before liberalization.
With macroeconomic reform well launched in Africa, more time needs to be spent on those regulatory reforms that affect firms. Two main areas are: setting up rules of the game, including dispute resolution; and helping firms to be more competitive. Judicial systems are often weak in Africa and court systems are fraught with delays and inefficiencies; I will come back to that in the regional context. In the interim, many businesses and business organizations put the emphasis on interim solutions such as arbitration courts and ways of enforcing contracts that do not require going to the formal judicial system.
Much more needs to be done to help firms become more competitive—to increase productivity—starting with a stable macroeconomic environment. Modern business laws are part of the equation, as are clear rules for competition and regulation. This includes equitable taxation systems and transparent investment procedures; labor laws that do not severely impede a firm’s ability to hire and fire as business fluctuates; and access to technology and human resource development. It is also important that firms communicate with each other, through business and professional organizations, which can provide a means of acquiring knowledge and training. Such measures are central to achieving sustainable growth in Africa today.
Motomichi Ikawa referred to regional integration in his opening remarks. The World Bank is supporting the Second Tokyo International Conference on African Development through the Global Coalition for Africa. The West African Economic and Monetary Union, and the Central African Customs and Economic Union, are expressions of a common interest for regional trade and investment—which are outward looking—as a stepping stone to globalization. Regional competition, regional markets, and regional support systems are all vital. The reform of the legal environment in West and Central Africa under the Organization for the Harmonization of Business Law in Africa provides countries an opportunity to leapfrog years of deficient judicial environments and move to a more modern framework.
Similarly, there are many opportunities for harmonization and cooperation in East and Southern Africa. The East African Community is looking at, among other things, harmonizing capital markets, the banking system, and infrastructure. Given the small size of many capital markets in Africa, this regional approach is a very important way of reaching out to the world economy.
Lastly, I would like to refer to the efforts of the West African Enterprise Network, a network of young independent businessmen and women that has really helped improve the dialogue between the public and private sectors on trade and mobilized investment for the region. Similar organizations are currently being set up for East and Southern Africa.