Sustainable Growth: Leveraging Tax Policy in Africa
| Author | Josh Tetrick |
| Pages | 06 |
Page 26
Generating significant investment returns will solve the world’s biggest needs. Specifically, a nexus exists between the growth of frontier markets in Africa and the world’s most confounding challenges. The majority of foreign direct investment (FDI), whether deployed by multinationals, venture capitalists, private equity, or other investment vehicles, will be diverted from least-developed economies because of risks, both real and imagined. FDI in low-carbon, clean-energy infrastructure can promote sustainable development while achieving high rates of return for investors.
Tax policies, can stimulate investments for sustainable livelihoods; foreign companies might select where to establish a presence based on tax incentives. A targeted approach that draws FDI into low-carbon emitting technologies offers promise for a new energy future for the developing world and a healthier global environment for the planet.
Many African nations are revising their corporate tax policies to try to attract FDI into clean-energy and related sectors. This brief will highlight a regional, global, ecological, and social problem and provide political and financial recommendations.
As mainstream emerging markets move to become high-income economies, it makes sense to look at countries that are still in an embryonic stage of development.1 The Standard & Poor’s Frontier Markets index returned an annualized 37 percent return over the past five years and provide a low-correlation with returns of emerging and developing economies.2 Investors and host governments need a radical paradigm shift to capture these opportunities. Domestic political leaders should establish bold incentive policies to attract FDI. Investors should cultivate an investment approach that embraces the nexus between the need and the market.
The investment community and political leaders must move past the limits of either vibrant growth or sustainable development. A mindset that considers a broader array of elements, while embracing the tension between opposing ideas to create new alternatives that take advantage of many possible solutions, forms the backbone of this investment and policy overview. The transition to a low-carbon economy, water scarcity, resource degradation, and related sustainability issues will increasingly provide much of the shape and direction of the social, economic, and political landscape. The path of least resistance, both in terms of technological feasibility, cost, and expertise, is the continued use of coal resources, the destruction of forested areas, and the production of energy from other high carbon-emitting generation facilities. Unless a low-carbon energy infrastructure is put in place today, high carbon-emitting energy sources will continue to account for around 80 percent of energy consumed in 2030.
“Let us choose to unite the power of markets with the authority of universal ideas.”
Kofi Annan
The world’s poorest countries, especially those in sub-Saharan Africa, have attracted little FDI. In 2004, sub-Saharan African nations attracted only $13 billion, mostly in the extractive and commodity sectors.3 Examining the numbers after removing the oil-producing countries (Chad, Nigeria, Congo, Sudan, Angola, Equatorial Guinea, and Gabon), FDI for all of Africa totaled only $4 billion.4 This meager $4 billion representsPage 27 less than 1 percent of the world’s FDI, despite the fact that Africa contains over 10 percent of the world’s population.5
Frontier markets in Africa are undermined by a dearth of liquidity, volatility and political instability, abject poverty, hyper-inflations, crime, poor regulation, and endemic corruption. These qualities create both subjective negative perceptions and objective financial risks. As a result, instead of the world’s poorest countries receiving the bulk of FDI, the middle-income countries attract the most FDI. For example, in 2004, Brazil’s FDI totaled more than $18 billion—almost double that of the entire continent of Africa.6 A basic foundation- —political stability, guarantees against expropriation, and reasonably stable currency—must be in place before the vast majority of foreign investors will consider investing in developing countries (extractive sectors are the exception). FDI does enter some conflict zones—notably, in the diamond and oil industries—but it mainly goes into more stable areas. Investors also look to reliable power, electricity, and access to clean water, health care facilities, roads, communications, and airports.7 Finally, potential foreign investors will look to ease of entry through ports and to clear and stable tax laws.8
Opportunities in clean energy investment are immense, but Africa, the continent with the largest number of frontier markets, has a history of cynicism towards foreign investment and linkages with the global economy. The continent’s colonial past has significantly and understandably affected its view of foreign entities. Outsiders may still be equated with exploitation in the minds of citizens. A number of international economists and notable non-governmental organizations (NGOs) also express criticism of FDI. One such criticism is that international firms—such as Firestone in Liberia—with their vast resources, encroach on and eventually squeeze out local firms that have no real chance of competing.9 A number of domestic rubber plantations in Liberia have been unable to compete with the breadth of Firestone’s financial and physical resources. International firms are often charged by NGOs with exploiting local labor, or not tapping into local labor and local suppliers.10 These criticisms apply in the Liberian context, as Firestone Liberia has routinely been sanctioned by local and international environmental NGOs for local water contamination and illegal deforestation. Finally, critics of FDI’s role in promoting development note the potentially destabilizing effect on domestic currencies when outflows occur and emphasize that multinational companies exist to make a profit, a motive that often diverges from the developmental needs of the host country.11 Reluctance to accept FDI has led some African countries to construct domestic barriers to foreign capital.12 These barriers include: national interventions, such as the expropriation of foreign investment; Africanization, in which ownership is seized by local government from foreign owners; explicit preference and special treatment of domestic investors; and legal obstacles, such as the reservation of certain sectors for domestic enterprises (e.g., Liberia investment law currently reserves 26 sectors for domestic firms), the restriction of foreign ownership, and the imposition of local employment requirements on foreign firms.13 Countries may also have indirect barriers to FDI, including: bureaucratic obstacles, delays in customs or visa approval, unclear regulatory standards, a corrupt legal system, or unstable infrastructure.14 While problems with infrastructure and the legal system are not intentional, bureaucratic obstacles may be the state’s attempt to impede foreign operation.15
Policy and investment experts estimate $100 billion must flow into developing economies by 2030 to meet the challenges of sustainable development.
However, not all African countries are resistant to foreign investment; in fact, Uganda, Tanzania, Angola, Ghana, and Kenya have all seen significant increases in FDI due to active promotion and FDI facilitation.16 A World Bank study revealed that, despite the difficult environments in which foreign enter-Page 28prises operate (i.e., environments high in macroeconomic instability, corruption, crime, and/or technological unreliability), foreign firms are more productive and make a greater contribution to local development than domestic firms.17 The World Bank study also showed that foreign firms employ more workers than local firms, report more revenue to the government for tax purposes, invest more into local infrastructure, are more likely to have formal training programs for their employees, and are more likely to provide medical care or medical insurance to their workers than local firms.18 The recent research indicates that FDI increases productivity through investments into both physical capital (e.g., infrastructure, internet connectivity, technology resources, roads, bridges) and human capital (e.g., education, training).19 It leads to increased employment, the transfer of new technologies, and the infusion of new and innovative management and leadership practices.20 These study results undermine a number of the common criticisms of FDI and directly disprove others.
Since the 1970s, when FDI inflows totaled less than $1 billion per year, FDI in Africa has increased to $9 billion per year in 2000.21 However, Africa’s share of both the total world and developing-country FDI has decreased since the 1970s and FDI remains concentrated in a few select countries.22 In the past ten years, Nigeria, South Africa, and Angola were the recipients of 55 percent of Africa’s total FDI.23 Over the same period, the twenty-four African countries that were the lowest recipients accounted for less than 5 percent of the continent’s FDI.24 Recent World Bank and UNCTAD (United Nations Conference on Trade and Devel opment) findings indicate that FDI builds a foundation for solid economic growth.25 Importantly, it has the potential to vastly increase the export productivity of local enterprises through linkages with international firms.26 Economic models produced by William Davidson Fellows at the...
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