ATTRACTING FDI: BEST PRACTICE IN INVESTMENT INCENTIVES Krista Tuomi American University 2012
Overview of Presenta/on 1. Reasons for the increase in investment incen:ves 2. Why incen:ves are problema:c 3. Types of incen:ves 4. Regional trends in incen:ve policy 5. Snapshot of Zambia and its neighbours 6. Case studies: Singapore, Rwanda, Tanzania, Costa Rica, Mozambique 7. Sugges:ons
Why the desire for Investment Incen:ves? poten:al benefits of FDI are substan:al: - technology transfer - employment gains - skills upgrading - growth incen:ves or legisla:ve measures aimed at s:mula:ng investment are seen as necessary to compete with other countries, and to signal government commitment to an open investment environment desire for incen:ves can also arise from agency problems and the compara:ve ease of enac:ng them
Why are incen:ves problema:c? in most instances governments overes:mate the benefits and underes:mate the oyen hidden costs although research has found posi:ve paybacks from investment promo%on, the research on fiscal incen%ves is mixed in par:cular, redundancy ra:os (the number of firms who would have invested without an investment) are high e.g. FIAS es:mates for Vietnam, Thailand, Mozambique and Jordan are 85%, 81%, 78% and 70% respec:vely.
despite this, many governments feel that not offering incen:ves could put them at a disadvantage it is therefore important that any associated distor:ons and costs related to these tools are minimized this paper will assist in this goal through an analysis of best prac:ce in the area of investment incen:ves it will focus on developing countries, especially those in Africa, as their circumstances are different to those of developed countries
Types of Incen:ves 1. low general corporate tax rate which abracts a wide base 2. tax havens and export processing zones (EPZs) 3. tax holidays and tax exemp:ons 4. transfers such as government grants, subsidized credit, subsidized services, government equity par:cipa:on and preferen:al insurance and foreign exchange rates 5. targeted measures such as investment allowances and accelerated deprecia:on
Interes:ng regional trends from UNCTAD surveys Asia and Pacific: 78% intensified their investment targe:ng efforts, 39% had increased incen:ves and 61% had increased liberaliza:on La:n America: addi:onal incen:ves are the least preferred method of investment promo:on. Instead, 62% had intensified their investment targe:ng efforts Africa: made greater use of incen:ves and less use of targe:ng methods Central and Eastern Europe: favored targe:ng and liberaliza:on over incen:ves as a means to abract FDI
The Zambian Situa:on The Zambian government recognizes the importance of a good investment climate and has taken many posi:ve steps to crea:ng one: - - - - - abolished exchange controls allows free repatria:on of earnings and repayments Financial Sector Development Plan 2012 budget that priori:zes lowering cost of credit, accelera:ng business licensing and inves:ng in voca:onal and technical educa:on wants to re- assess the incen:ve policy to make it more cost effec:ve and beneficial for Zambia
Most current Zambian incen/ves date back to the Investment Act of 1993 (amended in 1996) and include: ini:al cost and wear and tear allowances for buildings (manufacturing, mining, hotels) 50% wear and tear allowance for machinery (farming, tourism and manufacturing ) customs exemp:on for mining and agriculture equipment custom duty is 15% on intermediate goods and 25% on finished goods smaller sector specific fiscal incen:ves exist for mining, manufacturing, agriculture, tourism and energy firms that list on the Lusaka Stock Exchange are subject to a reduced corporate tax rate of 33%, do not have to pay Capital Gains Tax and there are no restric:ons on foreign ownership or shareholder levels
Sample of neighbouring country incen/ves Burundi Kenya Rwanda Uganda Tanzania Tax Rate 35% 37.5% 30% 30% 30% CGT 35% suspended 30% 30% 30% Reduc:ons/ exemp:ons 10 year holiday for some firms 10 year tax holiday in EPZ 0% tax rate in EPZ 10 year tax holiday for exporters 10 year tax holiday in EPZ/ SEZ 10% reduc:on for employing >100 locals 20-40% exemp:on for newly listed companies 2-7% deduc:ons for employing locals 50-75% ini:al allowance for plant/ machinery 25% rate for newly listed companies 100% allowance for large qualifying investment 40% investment allowance in Kigali and 50% outside 50% ini:al allowance for plant and machinery
Costs of incen:ves 1. redundancy and foregone tax revenue (oyen understate true cost since even those investors who were swayed by incen:ves receive more than would have been necessary to convince them to invest) 2. discre:onary deterrent to investors and transparency issues 3. tax incen:ves tend to abract highly mobile firms and discriminate against smaller firms 4. create distor:ons as firms try to shiy produc:on to low- tax areas or engage in transfer pricing
5. tax holidays discriminate against start- ups 6. equipment incen:ves can create distor:ons between different capital classes and weaken financial ra:os 7. prisoner s dilemma type situa:on winner s curse 8. opportunity cost: funds used/revenues lost might have been used for produc:vity- enhancing human capital forma:on and infrastructure all these costs highlight the importance of well designed policy!
Case Studies case study analysis is one the best exercises to do prior to policy design useful to look at the good and the bad of each program, focusing on the good that is replicable for this paper, five countries/ projects have been chosen: - Singapore - Rwanda - Special Economic Zones in Tanzania - Intel in Costa Rica - Mozal in Mozambique
Singapore like Zambia, Singapore had an ini:al low base and was far from large markets 1961: established an autonomous government agency, the Economic Development Board, advised by an interna:onal advisory board of execu:ves of foreign firms experimented with tax holidays and reduced taxes, reforming the program over the years removing joint venture requirements, allowing the hire of foreign workers and encouraging long term supply contracts with local firms
Outcome Some missteps but broadly successful Lessons? Replicable success factors: proac:ve one- stop investment agency consistent pro- FDI stance realiza:on of the importance of linkages and a suppor:ve macro- economic environment flexibility in dealing with ini:al skill shortages constant review of programs
Rwanda the Rwandan Development Board was established in 2008 to fast track development projects and facilitate new investment. provides permanent residence and access to land for investors who deposit $500,000 in a commercial bank in Rwanda for more than 6 months. no statutory limits on foreign ownership ins:tuted a specialized commercial courts with the help of foreign judges to clear a backlog of cases
ini:al capital investment of $250,000 qualifies the investor for incen:ves such as: - - - 40% investment allowance on assets deductable training and research expenses discounts for exports, hiring of locals and loca:on in FTZ Outcome moved from posi:on 143 to 58 in the Ease of Doing Business index annual growth rate of 8.8% ayer reforms BUT es:mates of the cost of incen:ves are high: ~4% of GDP (versus 2.8% for Tanzania, 1% for Kenya and 0.4% for Uganda (IPAR))
Lessons? too great a focus on tax incen:ves and too lible on business promo:on no transparency and no regular calcula:on of the amount foregone through exemp:ons it is important to review programs and reform those that are not cost effec:ve beber way to meet the country s development objec:ves would be to: lower the corporate tax rate to 25%, set up a comprehensive claw- back scheme for exporters/importers, and improve administra:on of the Rwandan Revenue Authority (UNCTAD, FAIS)
Tanzania: A Study of Special Economic Zones ins:tuted an Export Processing Zone (EPZ) in 2002 2006 established a further Special Export Zone incen:ve package included: exemp:on from forex restric:ons, exemp:on from corporate tax for 10 years, exemp:on from all local government taxes, and remission of customs duty Outcome EPZ underperformed: by 2008 had only led to an increase of 6522 jobs and 1.7% exports 2008-2009: $451 million cost, 6,4% of GDP (Domincian)
Lessons? two conflic:ng zones created problems investors need to know that zone board has the authority to solve problems special zones are only abrac:ve if have strong links to markets or large cost/scale advantages (Tanzania entered too late India and China already had established networks) success also depends on clear and consistent policy based on solid research (compara:ve advantage assessments, benchmarking, investor input), modera:on of labour demands and targeted marke:ng campaign Tanzania has, however, been successful in linking voca:onal training programs to zone needs
Costa Rica: the Intel Case excellent case study in how a small country can abract large scale investment through careful research, government dedica:on and a willingness to tailor the investment climate worked with Intel and other investors to determine their needs although it had fairly high exemp:ons (100% of export and du:es and tax holiday for 8 years for profits on exported goods), other factors considered more important in its success:
- studied local industry upgrade programs in other countries before ins:tu:ng programs to develop local suppliers and broaden the manufacturing base (e.g. to medical supply devices) able to weather recessionary global condi:ons - post- investment care program established commibee to channel feedback from exis:ng investors reinvestments equaled half of total FDI flows! - investment climate reform: allowed private investors to par:cipate in public tenders, streamlined customs procedures, and created one- year skill cer:ficate program specifically designed for Intel and related industry
Mozambique: the Mozal case during the 1990s the government began reform process aimed at abrac:ng investment: infrastructure provision, fast- tracking of visas and customs, fiscal concessions and the priva:za:on of ports, customs and power u:li:es ins:tuted an Industrial Free Zone (85% had to be exported) that offered allowances for equipment upgrades, training, regula:on on labour unions, exemp:ons from customs and a ten year 60% corporate tax reduc:on this facilitated the large scale Mozal smelter project, which was built in record- breaking :me, and enabled Mozal to become one of the world lowest- cost aluminium producers
despite this success Mozal has underperformed in some areas, notably linkages with local suppliers not surprising given the lack of capacity among local firms both government and investors are taking numerous steps to address this however working together to iden:fy poten:al contractors and educate them about the tender process, contract fulfillment, cost reduc:on, financial management, accoun:ng and procurement mentors with experience in various areas also make regular visits to local contractors
Sugges:ons for Best Prac:ce Incen:ve Policy ideal incen:ve scheme: complement to welcoming investment climate, transparent, stable, cost- effec:ve cost- effec:ve when targeted toward anchor investment (that abract more FDI) or FDI with substan:al technology spillovers (through measures such as tax- exempt technology development funds and tax credits for R&D expenditures) informa:on provision to poten:al investors should be proac:ve and preferably conducted by a single autonomous investment promo:on agency who consults regularly with business
incen:ves should not be based on neighbouring country policies to avoid the winners curse cost- effec:ve to focus on sequen:al investment in current firms appointment of a business ombudsman to handle investor concerns and offer recourse to a neutral dispute seblement mechanism incen:ves should be rules- based and are open to all investors regardless of na:onality or industry discre:onary programs deter FDI
the costs and achievements of schemes should be regularly reviewed and published. investment tax credits are preferable to tax holidays, since they target investment directly and enhance transparency by requiring the filing of tax returns Zambia has already made important strides toward becoming a business friendly investment des:na:on. By con:nuing to improve its general investment climate and by reforming some aspects of its current incen:ve policy, it should be able to accelerate broad- based growth in the near future