Chapter

Chapter 6 Competitiveness and Foreign Direct Investment in Africa

Author(s):
International Monetary Fund
Published Date:
August 2001
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What Are Competitiveness Rankings?

The term “competitiveness” causes many academics some discomfort, piques the attention of policymakers and assumes near-mantra status in much of the private sector1. The competitiveness index rankings that this chapter discusses were designed as a tool for businesses and governments, a spur to reform and a signal of success rather than a strict academic exercise. The index subordinates market size, natural-resource endowments and other characteristics of business interest to economic growth, which represents a better estimate of the medium-term health of national economies. Survey results and empirical data both show that the most important factor in propelling economic growth, attracting foreign direct investment in the long term or allowing the healthy increase of domestic firms is a stable, well-managed economy. The work described here, conducted originally for the 1998 Africa Competitiveness Report, measures the competitiveness of 23 African countries based on estimates for their medium-term economic growth, controlling for levels of initial income (Table 6.1).

Table 6.1.African Competitiveness Index
RankCountryScaleRankCountryScale
1Mauritius0.8713Kenya-0.15
2Tunisia0.7914Uganda-0.16
3Botswana0.5415Burkina Faso-0.21
4Namibia0.4316Tanzania-0.24
5Morocco0.4017Ethiopia-0.25
6Egypt0.3818Mozambique-0.32
7South Africa0.3419Cameroon-0.38
8Swaziland0.2220Zimbabwe-0.40
9Ghana0.0921Malawi-0.43
10Lesotho0.0622Nigeria-0.48
11Côte d’lvoire-0.0923Angola-0.79
12Zambia-0.09a
Source: Africa Competitiveness Report, 1998.Note:

Before rounding scale numbers, Zambia scores slightly behind Côte d’lvoire.

Source: Africa Competitiveness Report, 1998.Note:

Before rounding scale numbers, Zambia scores slightly behind Côte d’lvoire.

The index methodology has attracted considerable attention and debate among those familiar with the rankings. Given these concerns, it is worth detailing the justification for the methodology as well as the variables contained in the index, their sources, and the weighting each received.

The methodology used in the Africa competitiveness rankings is the index used for several years by the Harvard Institute for International Development (HIID) and the World Economic Forum (WEF) to calculate global competitiveness rankings. Comparisons of the competitiveness rankings with subsequent economic performance have confirmed the general reliability of the methodology, because the index has done a good job predicting future economic growth during several years of global rankings. Other rankings of African countries that measure components of economic health, such as those of Institutional Investor, the Index of Economic Freedom and Transparency International, have shown a high degree of correlation with the competitiveness index. For these reasons, as well as the strength of the theoretical base in the economic-growth literature upon which the methodology is based, the competitiveness rankings are useful and defensible, and plans are to continue to use the index as currently defined and calculated.

The overall index is an average of six sub-indices, which in turn combine hard data collected from African governments and international organisations, and the results of an Executive Survey of African businesses conducted in preparation for the Competitiveness Report. The six sub-indices listed below were selected on the basis of a thorough analysis of factors with a demonstrated effect on economic growth.

  • Openness. This sub-index measures the degree to which government policies open each country to international trade. It looks at such indicators as exchange-rate policy, barriers to imports, average tariff rates, and similar items.

  • Government. This variable looks at government consumption rates, budget deficits, and national tax policies, as well as businesses’ perceptions of the extent of state involvement in the private sector, government competence, and taxes.

  • Finance includes firms’ access to financing, the maturity of the banking sector and corporate attitudes towards taxation.

  • Infrastructure. This sub-index covers the extent and quality of roads, railways, ports, and air travel. It also looks at telecommunications infrastructures and access to computers. The quality of utilities, such as water and electricity supply, is also included.

  • Labour examines the characteristics of the workforce relevant to economic growth. What are national education rates? Is health care adequate? From business perspectives, does government over-regulate workplace conditions?

  • Institutions. The only one based entirely on survey data, this sub-index includes subjects such as crime rates and the effectiveness of police forces, the quality of legal institutions and other rule-of-law issues. Political and policy stability are key components.

The hard data variables come largely from World Bank sources, in particular the 1997 African Development Indicators, the African Development Bank’s Africa in Figures, and the US Central Intelligence Agency’s Country Factbooks. Other sources include the International Monetary Fund, the United Nations and individual countries. For most countries, resident experts check the data to ensure their general accuracy. Even with such measures, however, the reliability of data for parts of Africa varies widely.

WEF and HIID collaborate to conduct surveys of the business communities in the 24 countries covered in the Africa Competitiveness Report. In partnership with local business organisations and economic institutes, as well as individual consultants, WEF and HIID have received responses from more than 650 companies working in Africa. This sample consists primarily of medium-sized to large businesses, 80 per cent locally owned, which produce largely for domestic markets.

The response rate varied across countries, with most providing between 25 and 55 completed surveys. Sample sizes were unusually small in Angola, Swaziland and Lesotho. Two of these economies are themselves quite small, so the small number of responses is not surprising. Because the data that were collected matched relatively well with other sources of information, the survey responses were included in the overall index.

The competitiveness results show that small, dynamic, stable economies with solid export bases perform best. The top finishers, Mauritius, Tunisia, and Botswana, all are reliably well managed economies and have been so over time. They all have significant export interest, and all have a history of sustained, respectable economic growth.

Mauritius moved from a multi-cultural, mono-crop economy at independence 30 years ago to become one of Africa’s richest countries, with current average per capita annual income at just under $3 700. Annual growth rates averaging 6 per cent explain much of the turnaround, aided in part by one of Africa’s few export-processing zones, through which nearly 90 per cent of the country’s trade flows.

At an average of 4.5 per cent this decade, growth in Tunisia has been less dramatic than in some other top finishers, but it has been consistently good. Moreover, with real GDP at just under $14 billion, Tunisia’s economy is more than four times as large as either Mauritius or Botswana.

Botswana, another of Africa’s success stories, was one of the world’s 20 poorest countries at independence 30 years ago, but is now a solid member of the World Bank’s group of middle-income countries, with Africa’s fourth-highest per capita GDP. A diversified and carefully managed mining sector has driven nearly two decades of 8 per cent growth.

The countries that have done well have largely avoided the extreme economic and political turmoil that trapped many places in Africa during the 1970s and 1980s. The middle performers, as a rule, are reforming but still recovering from a long period of poor performance. Whether burdened by socialist economic systems, such as Tanzania’s under previous leadership, or outright civil war, as in Ethiopia, even policy-smart economies take time to rebuild. The classification of well known reforming countries, such as Ghana and Uganda, as “middle performers” may surprise many, but it should be recalled that in both countries, even after a decade of overall stability, real per capita GDP is just recovering its 1970 level.

Those middle performers not in the recovery stage often have relative stability but sporadic reform policies. Kenya, for example, has since 1993 had periods of reform interspersed with faltering government commitment to liberalisation, characterised by the economic unrest surrounding the electoral activity of 1997. Zambia has started and stopped reform several times since the early 1990s.

The poorly performing countries are largely those that have suffered recent political turmoil, such as the lengthy civil wars in Angola and Mozambique or the military dictatorship in Nigeria, or that have yet to commit themselves to market-oriented economies. Some, such as Malawi, are new reformers facing particularly difficult geographical, demographic, or environmental situations, which make achieving immediate fast growth and competitiveness more challenging.

The competitiveness index shows a strong geographic bunching of the more competitive economies. North Africa scores well, as do the island state of Mauritius and countries in the Southern African Customs Union (Botswana, Lesotho, Namibia, South Africa, and Swaziland). This is consistent with recent research, which emphasises the correlation between geography and economic growth. Without suggesting “geographical determinism”, it is clear that geography plays one important role among many in economic performance. Geographical features are not included in the variables used to calculate the competitiveness index.

Increasing Competitiveness through Increasing Growth

Once African countries decide that fast growth is a national priority, where should their leaders begin to reform? Research by HIID and others shows that policy variables are the most important factors in promoting or restraining growth. Particularly important are openness to trade, high national saving rates, and smoothly functioning government institutions. Geographical location, natural-resource endowments and demographic patterns also emerge as important factors in economic growth.

The surveys show that the business community in much of Africa concurs with the importance of government policy. Foreign-owned firms listed political and policy stability as the most important factors affecting where they invest and as among the most critical in determining their investment’s eventual success. Domestic businesses tied policy instability with high inflation as a key barrier to business, ranking just behind taxes, infrastructure, and access to financing. Because many questions contained in the survey are virtually identical to those in the Global Competitiveness Report, one can compare results from Africa with those from a wide variety of other countries.

Openness

Openness to trade is usually the best place for governments to begin if their goal is to promote fast growth. During 1970–90, much of Africa stayed effectively closed to trade, except for natural-resource exports and the imports they financed. It was very difficult under existing regulations for new export sectors to arise. Even today, after several years of trade liberalisation, considerable room remains for further trade-policy liberalisation.

Survey results confirm both the importance of openness and the need to do more. Openness to trade in both goods and information is generally perceived as low in Africa compared with the rest of the world, although clearly improving in recent years. A series of survey questions looked at factors such as tariffs and quotas, import barriers and national export positions more generally.

When asked whether the levels of tariffs and quotas “significantly raise the cost of acquiring foreign materials and equipment for your firm”, most companies in Africa responded “yes”. A question of almost identical wording included in the Global Competitiveness Report shows that much of the rest of the world says “no”. This result holds not just for industrial economies but for all. Table 6.2 provides a more precise breakdown.

Table 6.2.Responses to the Question: The level of import tariffs and quotas in your country significantly raises the cost of acquiring foreign materials and equipment for your firm(1 = strongly agree, 7 = strongly disagree)
Global RankCountryMean ResponseGlobal RankCountryMean Response
1Denmark6.4744Hungary3.96
2Hong Kong-China6.4645Peru3.88
3Finland6.4046India3.81
4Spain6.29Kenya3.72
17Austria5.6847Poland3.62
Tunisia5.67Egypt3.38
18Norway5.53Côte d’lvoire3.35
21Argentina5.4448Colombia3.28
22Mexico5.44Namibia3.25
24Philippines5.33Malawi3.10
25Czech Republic5.3249Vietnam3.04
29Malaysia5.18Zimbabwe3.00
30Turkey5.05Uganda3.00
31Indonesia4.9450Russia2.83
32Brazil4.72Cameroon2.81
33Thailand4.69Zambia2.80
34Chile4.67Ethiopia2.78
40Slovakia4.45Nigeria2.66
Ghana4.4052Ukrainea2.61
Botswana4.39Tanzania2.57
Morocco4.33Burkina Faso2.54
South Africa4.15Mozambique2.43
43Iceland4.00
Sources: Global Competitiveness Report, 1997, for global rank, and Africa Competitiveness Report for mean response.Note:

Bottom-ranked country in Global Competitiveness Report, 1997.

Sources: Global Competitiveness Report, 1997, for global rank, and Africa Competitiveness Report for mean response.Note:

Bottom-ranked country in Global Competitiveness Report, 1997.

Similar results hold true for questions on hidden import barriers and exchange-rate volatility and misalignment. African countries generally have much lower means than countries elsewhere. Africa’s responses do show results similar to those of the world more generally for the availability of foreign exchange at reasonable rates, which has improved in the past five years.

Trade regulations can be very quickly improved; the necessary changes require only a series of government decisions. The survey results amply indicate progress—both anticipated and experienced—towards more open economies in Africa. Among the trends of optimism and anticipated improvement, trade openness ranks alongside telecommunications as having progressed the fastest in the past five years. Recent lowering of trade barriers, through tariff reductions and other means, is well documented throughout the continent. The surveys show that businesses both expect and want this trend to continue.

Strength of Institutions

Africa’s governmental and judicial institutions got a mixed view in the surveys—better than conventional wisdom assumes, but generally lower than needed for sustained high growth. The data show, for example, that the extent of corruption varies widely within Africa. Some countries show minimal incidence while others show very high levels. On the whole, Africa is not an outlier on this score compared with other parts of the developing world, although this masks a wide range of performance.

Corruption is only one of several variables that measure the overall quality of institutions. When questioned about market dominance by a few companies (all questions are on a 7-point scale; higher is better), Africa’s average response was 3; for 20 developing economies in the Global Competitiveness Report, it was 3.28. Responses to questions on the quality of rule of law scored similarly. On the effectiveness of national legal systems in enforcing contracts, African countries responded slightly more confidently, at 4.4, than did the group of 20 other developing economies (4.2). On the effectiveness of the police force in providing security, Africa scored 3.65, just below the average of the others, at 3.75. Moreover, business respondents do not anticipate major changes in policy in coming years. This includes responses from countries such as Angola, Ethiopia and Mozambique, which have recently emerged from conflict.

While strengthening appropriate institutions in Africa is clearly important and should be a focus of attention from governments that desire fast growth, the data suggest that a large number of African countries lie well within the range of institutional quality in developing economies. Still, Africa’s official institutions need considerable improvement. If not a source of slow growth, institutions in Africa are not yet a propelling force towards prosperity.

Geography and Health

Other factors affect growth but are more difficult to overcome through proper policies. Africa as a whole faces several geographical difficulties, though their extent varies widely. As is well known, the interior suffers from very high transport costs to Africa’s ports. No major navigable rivers exist to carry ocean-going trade from the interior all the way to or from the sea—in contrast, say, to the Mississippi, the Saint Lawrence Seaway, or the Rhine. Many African countries, 15 out of 53, are landlocked, adding to the high costs of transport. Not only must trade pass a considerable distance over land, but it must also cross political borders.

Almost 90 per cent of Africa sits in the tropics, which brings a distinctive set of challenges and difficulties. Tropical agriculture often has very low productivity, because of such variables as poor soils, torrential rains, unstable weather patterns, pests and veterinary disease. Fortunately, highly productive tropical economies, such as Hong Kong-China, Malaysia and Singapore, have proven that manufactures can thrive in the tropics if economic policy is supportive.

Health is another growth-related factor, regarding which Africa faces particular challenges. Unfortunately, effective health care continues to elude many African countries, lowering the quality of life and playing a part in slowing economic growth. The continent-wide average life expectancy at birth is 54 years, considerably below most other regions in the world, due in part to a huge burden of infectious disease. To some extent, this results from Africa’s low income levels; as income increases, disease rates will almost surely decline. At the same time, many of these diseases are related to the continent’s special tropical ecology and climatic conditions.

AIDS continues to plague some parts of Southern Africa and the areas surrounding the Great Lakes, and it is present to some degree in most sub-Saharan countries. Drug-resistant strains of many existing infectious diseases, such as cholera, dysentery and pneumonia, further complicate health care delivery. In part, more investment in public-health surveillance and improved interventions are appropriate responses. More research on new and re-emerging diseases is critical for the future health of the continent.

Competitiveness and Foreign Investment

The global surge in foreign direct investment (FDI) in the past decade has largely bypassed Africa (Table 6.3). In 1996, total inflows of FDI world-wide stood at just over $349 billion, of which the United States was the largest recipient. Africa’s share was just under $5 billion, or 1.4 per cent. While overall levels of investment in Africa increased by 5.3 per cent in 1996, its share of developing-country flows more than halved, from 11 per cent to 5 per cent from 1986 to 1990. Worse still, the investment that does arrive is unevenly distributed. A disproportionate share goes to North Africa or oil-exporting countries such as Nigeria (Table 6.4). Indeed, half of all inflows to Africa from 1990 to 1995 went to Nigeria and Egypt.

Table 6.3.Foreign Direct Investment Inflow by Region, 1996
Millions of DollarsShare of World Total (%)
Inflows349 227100.0
Industrial Economies208 22660.0
Western Europe105 37930.2
North America91 91026.2
Other Industrial Economies11 5363.3
Central and Eastern Europe12 2613.5
Developing Countries128 74136.9
Asia84 28324.1
Latin America and the Caribbean38 56311.0
Africa4 9491.4
Other Developing Economies9460.3
Source: UN, World Investment Report, 1997.
Source: UN, World Investment Report, 1997.
Table 6.4.Foreign Direct Investment Inflows to Africa, 1996
Shares (%) ofShares (%) of
CountryMillions of

Dollars
Africa TotalWorld TotalCountryMillions of

Dollars
Africa TotalWorld Total
Total4 949100.01.4Morocco4008.10.1
Angola2905.90.0Mozambique290.60.0
Botswana230.50.0Namibia521.00.0
Burkina Faso30.10.0Nigeria1 72034.80.4
Cameroon350.70.0Senegal531.10.0
Côte d’lvoire210.40.0South Africa3306.70.0
Egypt74015.00.2Swaziland671.40.0
Ethiopia50.10.0Tanzania1903.80.0
Ghana2555.10.0Tunisia3707.50.1
Kenya370.70.0Uganda1352.70.0
Lesotho170.30.0Zambia581.20.0
Malawi170.30.0Zimbabwe470.90.0
Mauritius210.40.0
Source: UN, World Investment Report, 1997
Source: UN, World Investment Report, 1997

The problem is not simply one of low returns in Africa. In fact, the foreign investment that has been undertaken has yielded rather high returns, according to the recent measures of the World Investment Report. Foreigners are not yet seizing investment opportunities in Africa, for several reasons: market responses have not yet caught up with recent African economic and political reforms; these reforms remain incomplete, so investors remain on the sidelines; and there is simply a lack in world markets of information about the African economies.

What do foreign-owned firms currently operating in Africa say are the most important factors in determining their level of investment and in conducting business once that investment is made? The Executive Survey revealed that the greatest concern, by a considerable margin, is stability—both political and for specific economic policies. Next comes the tax system, followed by infrastructure. The survey also clearly documents the deleterious effect of corruption on foreign businesses in places where it is widespread.

Questions about political and policy stability appeared in several parts of the survey, to test for accuracy of response. The results were consistent. More than 75 per cent of the respondents claimed political stability to be “very important” and the remainder considered it “important” (Figure 6.1). Three-quarters of them reported significant cost to businesses resulting from policy uncertainty. Just over 60 per cent ranked policy instability as a “very important” variable affecting business (Figure 6.2).

Figure 6.1.The Importance of Political Stability

Source: J. Sachs and S. Sievers, Africa Competitiveness Report, Worldlink, London, 1998.

Figure 6.2.The Importance of Predictability and Reliability of Government Policies, Regulations and Laws

Source: J. Sachs and S. Sievers, Africa Competitiveness Report, Worldlink, London, 1998.

Why do firms insist strongly and consistently on stability? They certainly should expect some uncertainty in dynamic emerging markets. Nevertheless, a chief goal of business planning lies in minimising risk. Rapid, unanticipated changes in the regulatory environment greatly increase risk and squeeze firms’ margins, making companies reluctant to invest.

What are the implications for policymakers? Although domestic firms may have fewer options to move elsewhere, foreign firms decide from among a range of alternatives in choosing the best locations for their investments. One key role of government, then, is to create and maintain a stable business climate for domestic and foreign investors alike. Policymaking throughout Africa has had a reputation for sudden reversals and an unpredictable regulatory environment. A mercurial, high-risk environment invites short-term speculators with ephemeral investments, not the sensible, forward-looking investors who would contribute most to long-term growth.

Taxes

As in many places, high taxes are a frustration for businesses in Africa. “Tax regulation and/or high rates” tops the list of grievances for companies overall, and ranks second for companies with foreign ownership. On a related question, 32 per cent of respondents say that tax evasion is a problem. Taxes do decline in significance in answers to more general questions that probe foreign companies’ primary criteria when making investment decisions.

Should policymakers adjust their tax strategies to attract and sustain FDI? The answer is almost surely yes. In some sectors, such as export processing of apparel, leather goods and electronics components, the international environment for FDI is so competitive that tax incentives (e.g. tax holidays) almost always form part of the overall package of policies to attract FDI. Other sectors, such as mining, have widely accepted international norms for royalties and corporate income taxes. In addition to broadly based tax systems with low marginal tax rates and fair administration of taxation, most countries will need some differentiation of their tax codes to attract and maintain FDI in the best ways.

Infrastructure

Firms indicate strong feelings about infrastructure’s importance in their business decisions and operations; it ranks high on the list of complaints for all businesses (Figure 6.3), and third for foreign-owned firms. Two survey questions help particularly in identifying the infrastructure problems of most concern to firms. The first asks companies which forms of transportation they use more frequently, and the second asks about the conditions of roads, railways and so on, and their impact on competitiveness. Firms overwhelmingly say that roads are most important, followed by airports.

Figure 6.3.The Impact of Inadequate Supply of Infrastructure on Business

(All Firms)

Source: J. Sachs and S. Sievers, Africa Competitiveness Report, Worldlink, London, 1998.

Improving infrastructure to the satisfaction of many foreign businesses is often extremely expensive. Countries with poor infrastructure and limited budgets should consider two things: first, raising capital from the private sector through some form of concessions or privatisation of existing infrastructure; and, second, prioritising spending by thinking more carefully about the kinds of multinational companies the nation can and should attract, and shaping infrastructure improvements accordingly. Coastal economies, for example, may have great potential for the establishment or enlargement of export-processing zones linked to port facilities. If so, improvements in the physical and administrative operation of ports can be a crucial spur to export-led growth.

Corruption

Corruption is the fourth major concern of foreign businesses. How large a concern? This varies widely from country to country, but it was extremely prominent in the survey responses from Cameroon, Nigeria, Mozambique and Kenya. Table 6.5 shows a country-by-country breakdown of the responses to a survey question on corruption.

Table 6.5.Responses to the Question: In your country, irregular, additional payments connected with import and export permits, business licences, exchange controls, tax assessments, police protection, or loan applications are(1 = required for effective business, 7 = rare in the business community)
CountryMeanCountryMean
Cameroon2.33Ghana4.18
Nigeria2.45Malawi4.21
Kenya2.95Zimbabwe4.31
Egypt3.33Zambia4.40
Uganda3.42Mauritius4.66
Tanzania3.43Namibia5.00
Côte d’lvoire3.45South Africa5.31
Ethiopia3.67Tunisia5.62
Burkina Faso4.00Botswana6.28
Source: Global Competitiveness Report, 1998.
Source: Global Competitiveness Report, 1998.

Considerable recent economic research has demonstrated that corruption is a barrier to FDI and economic growth. Governments that ignore it do so at serious peril to their economies and to the attractiveness of their countries as hosts for FDI. The challenge of good governance is difficult under any circumstances. If the cost of not addressing problems of governance is sufficiently great, as this survey suggests is the case for a number of countries, then firm commitments to transparency and the rule of law are worth the political cost to national leadership.

What Must Africa Do?

The final question of the survey asked respondents which areas posed the most serious problems for doing business. After the familiar complaints about tax regulations and financing, businesses operating in Africa list infrastructure, inflation and corruption as their most serious obstacles. For foreign-owned companies alone, the list varies only slightly, with low education levels replacing financing. An earlier question posed exclusively to firms actively engaged in FDI asked them to rate the factors that affected their decision to invest. Political stability and predictable, reliable policies and laws finish first and second, followed closely by infrastructure and the ability to repatriate capital. These results hold both for companies primarily engaged in exporting and those dependent on imported inputs.

The message to African policymakers is clear: the things that businesses—foreign and domestic, producing for domestic or export markets—say are their most serious constraints lie within the control of African governments. Get the fundamentals right, and businesses already working in the country will be able to grow. If that occurs, and if the attitudes of those currently investing from abroad are any indication of broader sentiment, the country will also attract new capital. For the believer in a market economy, this is a powerful message. Control inflation by resisting the temptation to resort to deficit financing. Improve infrastructure through privatisation, equity share sales, and other ways of attracting capital without increasing national debt. Allow goods and capital to flow freely across national borders. Control corruption. Most important, keep credibility in government reform through consistent, reliable policy stability.

Note

This chapter draws heavily on the work of Jeffrey Sachs and Sara Sievers first published in the 1998 Africa Competitiveness Report. Permission for publication has been granted by WorldLink, publishers of the report.

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