Alison K. Mitchell
The role of foreign direct investment in the economic growth of developing countries inevitably varies to a considerable extent from one economy to another, depending on both domestic and external circumstances. A country with natural resources requiring large-scale capital investment for their exploitation, such as minerals, especially petroleum, is most likely to be heavily dependent on foreign investment, at least until a substantial flow of exports can be established. However, of the 38 developing countries in Africa that are members of the International Monetary Fund and the World Bank, probably not more than 12 could be classified in this group, including a few whose mineral resources are of relatively minor importance (though it should be noted that many new discoveries have taken place in the past few years and more may be expected). Foreign investment is also usually necessary for the development of large-scale hydroelectric power projects such as have been undertaken or envisaged in a few African countries. Outside investment may also play an important part in setting up new industries, such as tourism, where the investor’s background of experience in other countries may be as useful as his funds, or in improving existing industries, such as food processing, through the use of foreign techniques and equipment.
Where the Role is Less Clear
Beyond this, however, the role of foreign investment becomes much less clear. For most African countries export earnings come mainly from agricultural and forestry products, and they depend less on initial capital than on programs to encourage efficient production as well as suitable distribution and marketing arrangements. Although official foreign or international assistance may be helpful in such situations, private foreign investment may or may not be of use. From the standpoint of investor’s profits there is usually less incentive to put funds into agriculture than into extractive industries: world demand for the agricultural commodities that can be produced in Africa, such as cocoa, coffee, and bananas, tends to rise with population and income but not to expand much more rapidly than that, unlike the demand for many mineral products, so that profit prospects may not be as enticing. At the same time investment in agriculture is inherently risky because of crop fluctuations. Moreover, investment in agriculture is more likely to be profitable where a project can be on a large scale, but in a number of African countries plantation cultivation is frowned upon by the government as a relic of colonialism. Agricultural commodities are often readily available from a number of competing sources, and since they are renewable they are less subject than minerals to the desire to control supplies, which is often a feature of investment in natural resources. While there is a continuing need for infrastructure investments in most developing countries, such projects do not easily attract private foreign capital.
Commenting on the outlook for direct investment in Africa, Professor G.K. Helleiner has written,1 “There just does not seem to be much prospect of significant increases in direct private investment in Africa in the near future.” The reasons given for this assessment include the failure of some governments to implement conventional recommendations regarding such things as tax incentives, risk insurance, joint ventures, project-preparing institutions, local training facilities, and local participation, and, in addition, the sheer absence of sufficiently profitable opportunities in the countries concerned under prevailing conditions.
In trade and services there is often little difficulty in attracting foreign enterprises from one developing country to another, especially where the language and institutional structure are broadly similar; indeed, a number of African countries have recently adopted policies designed to limit the spread of foreign businesses and to reserve these activities as far as possible to their own nationals. This trend may well intensify in the future. It is in secondary manufacturing that foreign investment is apt to pose complex problems. Virtually all developing countries are striving to foster growth in this area, and foreign investment—funds, machinery, and management—is very much desired. But most of the new nations are anxious that such investment should fit in with their own development plans. A variety of legislative measures have been introduced in African countries for the double purpose of promoting and controlling inflows of foreign direct investment.
Other Influences on Investors
Of course, foreign investors are influenced by a great many considerations besides investment laws per se. Profit prospects must be encouraging. Two other major incentives to foreign investment in general are usually considered to be the desire to ensure supplies of industrial materials and the desire to preserve and extend markets. As already suggested, the second of these is probably more important than the first in relation to Africa. Markets must be readily accessible whether within or outside the country receiving the investment. For large international firms, new projects must fit into existing networks of materials, components, and final products, with suitable links in the form of transportation and other marketing facilities. The network may also be political and financial, where there are long-standing ties with particular countries. The country where the investment is to be made should be politically stable and as free as possible from restrictions on international trade and payments. Regulations regarding prices and wages may act as disincentives to foreign investment, as may employment regulations. Financial conditions should be favorable, and capital funds readily transferable. The tax structure should be reasonable and equitable, and should compare favorably with that prevailing in alternative locations. Tariff protection may provide an incentive for certain kinds of investment. Apart from these general economic considerations, a government may make special arrangements for particular enterprises that it wishes to bring into the country.
Aims of Investment Codes
Although investment codes are broadly intended to encourage desirable foreign investments while allowing governments to supervise and control the inflow in the light of their own criteria, the particular aims of such legislation may vary, as may the instruments chosen for the pursuit of these aims. Thus incentives may be offered primarily for investments that will stimulate exports or for those that will reduce dependence on imports. Particular industries may be assigned priority: in Africa, emphasis is often placed on agricultural processing for export. In other instances particular industries may be closed to foreign participation. Questions of ownership and control assume more importance in some countries than in others.
The techniques chosen usually include exemptions from import duties for machinery, equipment, and necessary materials. Such exemptions may be partial or total, and may apply either permanently or for a limited number of years. Tax concessions are also a feature of most investment codes: these may take the form of “tax holidays” for specified periods, special depreciation allowances or preferential treatment in relation to income, property, excise, sales, or turnover taxes. Investment allowances in the form of direct cash grants are also used in some countries. Sites and local services may be provided on favorable terms. Special incentives are often offered for the reinvestment of earnings. Enterprises locating in particular areas may be guaranteed protection from competition; more generally, tariff protection may be offered. Usually there are specific guarantees for the repatriation of capital imported for approved investments, as well as guarantees for the transfer of certain amounts of current income.
Broadly speaking, investment laws may be divided into three groups: those which place no restrictions at all on foreign investment, those which lay down fixed regulations so that a potential investor knows in advance exactly what his position will be, and those which operate on an ad hoc basis, where potential projects are scrutinized individually and conditions are determined by negotiation with administrative authorities. The last group includes some where the status of an investment even when approved is not fixed, but remains subject to review either after a fixed interval or at the discretion of the authorities.
Clearly, from the standpoint of the investor the most desirable situation is the one without restrictions of any kind. If regulations are fixed in advance, apply for a suitably long period, and are accompanied by incentives or concessions of one kind or another, the investor may be willing to accept some limitations. However, an investment code that operates entirely on the basis of administrative discretion is almost certain to inhibit foreign investment. In a country with valuable mineral resources where investors feel reasonably certain of a high rate of return on their capital, they may not be deterred by the uncertainties of a discretionary investment code. In most African countries, however, profit prospects are apt to be somewhat uncertain in any event, and investors may well be influenced by investment legislation which operates on an arbitrary basis. Presumably the more arbitrary the procedure, the more discouraging it is to potential investors. Apart from the basic decisions, which cannot be known in advance under such a regime, further problems may arise when the approval procedure involves long delays, or where the administration is weak, inefficient, or possibly corrupt.
French Franc Area Countries
Of the 38 developing African countries that are members of the Fund and the Bank, 26 have investment codes. All of these have been introduced within the past decade, often following closely on the achievement of independence. The detailed provisions of the codes vary, but the general arrangements can be classified in a number of distinct groups. The largest group is composed of the French Franc Area countries,2 where there is considerable uniformity of investment legislation, although provisions are not exactly the same in all these countries. In none of them, however, do controls apply to France, or to other countries considered by France to be in the French Franc Area. Foreign direct investments from outside this group of countries must be declared to the appropriate Minister either before or as they are undertaken. The Minister then has two months in which, he may request postponement of a particular project. Liquidation of foreign direct investments must also be reported to the Minister. Usually foreign participation is defined as direct investment only when it exceeds 20 per cent of the capital of a company whose shares are quoted on a stock exchange.
Within the French Franc Area group, the investment codes of Cameroon, the Central African Republic, Chad, Congo (Brazzaville), and Gabon are similar. The laws provide that industrial, tourist, agricultural, and mining enterprises (whether foreign or domestic) may be granted reduced duties and taxes on imports of specified equipment. Certain enterprises may also receive exemption from direct taxes on specified income. Three or four categories of preferential treatment are established, in accordance with which fiscal and other privileges are granted for firms investing either in new enterprises or in the expansion of existing enterprises, in most sectors of the economy apart from the commerical sector.
The first category, “A,” applies to enterprises and markets limited to the territory of the country concerned. Benefits consist of duty-free entry for capital goods and raw materials needed for manufacturing and processing, and are granted for periods of up to 10 years. Category “B” applies to enterprises whose activities and markets extend into the territory of two or more states of the Central African Customs and Economic Union. The benefits are those of Category “A,” and in addition an exemption for 5 years from taxes on industrial and commercial profits as well as from various other taxes and fees. Category “C” provides the most favorable treatment and is reserved for enterprises considered to be of prime importance to the country’s economic development. A company classified in Category “C” may conclude an “establishment agreement” with the government under which special conditions are agreed regarding the operations of the company and the nature and extent of tax concessions. For firms of particular significance to the national economy, fiscal charges may be stabilized under the agreement, which is normally valid for 25 years. The agreement also defines the legal, economic, and financial guarantees which are granted to the company, including the assurance of stable conditions regarding financial transfers and the marketing of goods.
The investment code of Dahomey also established three preferential categories, A, B, and C, for enterprises deemed to be of value for national development. Category “A” includes small and medium-sized investments and provides exemptions for up to 5 years from import duties and taxes on materials necessary for production. Category “B” includes larger projects and provides a maximum period of 8 years during which the enterprise receives the benefits of Category “A” as well as a 5-year exemption from taxes on industrial and commercial profits and from certain other taxes. Category “C” is intended for very large enterprises and is granted for up to 25 years.
In Mauritania and Upper Volta the investment codes provide for two kinds of preferential treatment. That of Upper Volta is similar to those already discussed, while the country also has an assistance fund for new industries. In Mauritania the first category, the “priority regime” applies to investments amounting to at least CFAF 75 million 3 within 2 years, providing employment for at least 20 people. The benefits include exemption for a specified number of years from duties on imports of certain materials and from taxes on specified income. The second or “long-term fiscal stability regime” gives certain firms of exceptional importance for national development, making minimum investments of CFAF 1 billion within 5 years, special benefits, mainly stable taxes, for up to 25 years.
In Ivory Coast, the Malagasy Republic, Senegal, and Togo the investment codes, stated in more general terms, provide a range of benefits for approved new enterprises. In Ivory Coast and Togo such enterprises are granted “priority status.” The Ivory Coast investment code provides for a range of tax and customs duty benefits as well as other special privileges. In Togo the enterprise must have its head office in the country and must invest at least CFAF 20 million. Under the founding agreement, tax rates may then be guaranteed over a number of years. In the Malagasy Republic, an enterprise of special importance for the economy may be granted an “order of approval” entitling it to tax and duty advantages, supplementary import allocations, and protection against competing imports through quotas. In some cases exceptional preferences may be granted beyond these provisions, but only with parliamentary approval. In Senegal an investor who is prepared to put at least CFAF 500 million over 5 years into a project conforming to the National Development Plan may negotiate a “founding agreement” with the Government that commits him to carry out a specified program in return for legal, financial, and other assurances, including stability of taxes. In addition, a firm proposing a project that either involves a minimum investment of CFAF 40 million in 3 years or creates at least 40 permanent jobs for Senegalese workers may also be designated a priority enterprise eligible for tax privileges.
Mali’s investment code grants privileged status to foreign investment of special interest to the economy and compatible with the Economic Plan. Each foreign investment is assessed individually under this arrangement; the privileges granted are mainly tax concessions. In some instances enterprises become the property of the government after a negotiated period.
In the Maghreb countries of North Africa there is no uniformity of investment laws. In Tunisia all nonresident investment requires prior approval in order to secure a guarantee for transfers of the capital or current earnings. In Morocco foreign investment must be approved and may be granted various tax and customs tariff benefits, as well as investment bonuses similar to those granted to domestic investors. In Algeria the investment code is more complex. Foreign investments of more than DA 500,0004 in the industrial or tourist sector may be granted tax facilities, and investments of more than DA 5 million may be given exclusive rights in a specified geographic area. The financial advantages granted depend on the sector and region, the amount of invested capital, and the number of jobs created. Approved investments are usually protected against nationalization unless this becomes essential for the economic development of the country, in which case provision is made for compensation. The law provides for total or partial exemption from taxes on profits not exceeding 20 per cent of the investment capital for up to 5 years, from taxes related to the acquisition of property and from land taxes for up to 10 years. In addition, reductions may be granted on turnover taxes on invested equipment, and guarantees may be provided for access to short-term bank credits.
Provisions in Other Countries
The investment code of Burundi is based on “priority status” for investments meeting specified conditions regarding amounts and economic importance. The privileges granted are mainly exemptions from import duties and from taxes on investment income during a period of 5 years. Taxes on profits or real estate may be reduced or suspended. Enterprises granted priority status may obtain protection against foreign competition and priority in the allocation of government contracts. Companies undertaking investments of special significance for Burundi’s development may be granted fiscal stability.
In Guinea all capital transfers require authorization. The investment code protects foreign investment in industry and mining from nationalization and provides for preferential tax and customs treatment. Small and medium-sized enterprises with investments of at least GF 150 million5 over 3 years may receive 7-year to 10-year exemptions, while 25-year exemptions are provided for long-term investments of particular importance to the economy. The actual conditions applying to each foreign investment are subject to negotiation.
In Ghana the Capital Investment Act gives special benefits to investments contributing to the development and utilization of productive capacity, the reduction of import requirements, the attainment of a high level of employment, or the acquisition of technical skills by Ghanaians. The benefits include tax holidays, initial capital allowances, and protection from expropriation. All outgoing capital transfers must be approved. In Ethiopia special concessions to foreign investment may include 5-year tax exemption and duty exemptions for merchandise imports. However, all receipts of capital in foreign exchange must be surrendered. In Liberia, where there are no exchange controls, new investments may be granted 5-year to 10-year tax exemptions and tariff exemptions on construction materials, raw materials, and capital goods to be used in manufacturing. Tariff protection may also be granted by the legislature.
Libya is different from other African countries in the overriding importance of its petroleum industry; foreign investment is largely concentrated in this sector and is governed by special petroleum legislation. Beyond this, approved status may be granted to projects considered to contribute to the economic development of the country; such status guarantees the transfer of capital and profits. Real estate in Libya may be sold only to Libyans. A similar prohibition applies in the Democratic Republic of Congo where, in addition, capital may not be transferred abroad. In Somalia, the investment laws are patterned after those of Italy which provide two categories, “productive” enterprises and others. The privileges granted are mainly in the form of rights regarding transfers of capital and income.
Nigeria and Sierra Leone do not restrict investment from the sterling area, but other investments must be approved in order to ensure transfers of capital. Sierra Leone grants concessions on income tax and customs duties to companies undertaking industrial or agricultural activities needed for economic development. The Sudan and The Gambia require approval of any foreign investment to ensure capital repatriation.
In Kenya, Tanzania, and Uganda “approved” status is also necessary to ensure repatriation of capital. Such approval is usually given freely. In these countries, however, the emphasis of the investment code has been somewhat different: investments in certain specified kinds of production require approval under the East African Licensing Ordinance.
Countries with neutral investment arrangements include Malawi and Zambia, where there are neither restrictions nor incentives for foreign investment.
Results of Legislation
This brief description of investment codes suggests the variety and complexity of the arrangements prevailing in African countries and gives some indication of the considerations which have led the governments to adopt their investment codes. The results of the legislation are much more difficult to judge. To begin with, although statistical information about these countries is improving rapidly, it does not yet permit satisfactory assessment of the role of foreign investment on a comparative basis in relation to total investment or to gross national product.
Moreover, the nature of foreign investment itself has been changing. In the past, before the African states became independent, the pattern of such investment was strongly influenced by the old colonial relationships. In some instances, the traditional links have continued to be important, while in others they have been largely discarded. In the early years of independence, capital formation in many of the African countries has been carried out to some extent through foreign or international assistance of various kinds, and private foreign investment has not yet been able to develop very far.
As time goes on, the scope of foreign investment in Africa is likely to expand, and the forms of investment legislation will assume correspondingly greater importance. At present many of the African investment codes do not meet the criteria put forth earlier in this article: where conditions for foreign investment are fixed in advance, incentives are usually accompanied by limitations of various kinds, and in too many instances the conditions applicable to a particular investment depend on the results of negotiation ad hoc. However, this legislation is experimental. One out of three of the investment codes has already been revised at least once since its first introduction. Such willingness to experiment is promising, and as economic development proceeds, further improvements can be expected.
G.K. Helleiner, “New Forms of Foreign Investment in Africa,”The Journal of Modern African Studies, Vol. 6, No. 1 (May 1968).
Cameroon, Central African Republic, Chad, Congo (Brazzaville), Dahomey, Gabon, Ivory Coast, Malagasy Republic, Mali, Mauritania, Niger, Senegal, Togo, and Upper Volta.
CFAF 277.710 = US$1.
Official parity corresponds to DA 4.93706=US$1.
GF 246.853 = US$1.