U.S. State Department Geographic Bureaus: Africa Bureau

U.S. DEPARTMENT OF STATE
95/02/27 SPEECH: REGINA BROWN ON AFRICA TRADE
BUREAU OF AFRICAN AFFIARS

REMARKS BY
REGINA C. BROWN
DEPUTY ASSISTANT SECRETARY OF STATE
FOR AFRICAN AFFAIRS

AFRICA TRADE AND INVESTMENT CONFERENCE 1995
THE NEWEST EMERGING MARKETS

PRESIDENTIAL AWARDS DINNER
MONDAY, FEBRUARY 27

IMPROVING AFRICAN INVESTMENT PROSPECTS
THROUGH POLICY REFORM

Your excellency El Hadj Omar Bongo, President of Gabon, Your Excellency Paulin Obame Nguema, Prime Minister of Gabon, Your Excellency Leon Kengo wa Dondo, Prime Minister of Zaire, Your Excellency Salim Salim, Secretary General of the Organization of African Unity, it is a pleasure to be at the Presidential Awards Dinner. I thank Ambassador Cohen for asking me to address you tonight on improving African investment prospects through policy reform.

A vibrant, growing private sector is crucial for improving economic growth in Africa and the standard of living for each nation's citizens. The World Bank estimates that about 350 million new jobs will be needed in Sub-Saharan Africa within a generation. Outgoing Bank President Lewis Preston has said that only the private sector--free to allocate resources and respond to market signals--can create jobs and income on this scale. Moreover, the private sector can best provide Africa with much-needed access to investment, know-how and technology.

Creating an enabling environment for private sector led growth is a key challenge facing African governments today as both economic and political institutions become more open.

As governments review and amend existing policies in both arenas, the needs and concerns of private investors--both domestic and foreign--are important to keep in the forefront. A country cannot encourage foreign investment without first creating an environment where its own nationals will want to invest. Furthermore, in encouraging domestic investment, governments should not overlook the economic value of the informal sector, and small and medium enterprises, many of these run by women. Africa's decision-makers need to address specific needs of women and smaller firms and not simply focus on large companies making large investments.

Ghana/Korea Example

To illustrate the importance of an enabling environment, I would like to contrast the cases of Ghana and South Korea. In 1962, per capita incomes in both countries were virtually identical at $490 (in 1980 U.S. dollars). About two-thirds of the labor force in both countries was in agriculture. Twenty years later, the average Korean enjoyed an income five times that of the average Ghanaian. Why? The most striking comparisons are level and type of exports, and level of private sector credit. In South Korea, exports in 1982 represented 39 percent of GDP, and 90 percent of exports were manufactured goods. Private sector credit was 49 percent of GDP. By contrast, exports accounted for only 2 percent of GDP in Ghana in 1982, and most of these were commodities. Private sector credit was only 2 percent of GDP. A World Bank study on private enterprise in Africa concludes that the level of private sector credit and a policy environment conducive to enterprise and initiative contributes to economic growth and increased income. Ghana undertook economic reforms in 1983 that started to create the conducive environment for private sector investment, and the results have been positive.

Historical Perspective

Ghana is not alone. Improving the investment climate is not a new concept in most African countries. During the 1980's many African nations adopted policies, provided incentives, and improved regulatory frameworks to attract Foreign Direct Investment as part of their economic reform efforts. Between 1982 and 1987, about half of all African countries either introduced or amended their investment codes with an eye to attracting more investment, largely foreign. Even countries that have traditionally been seen as more open to investment, such as Kenya and Zimbabwe, have revised their investment codes and overall regulatory frameworks to attract more investment. Countries which had been hostile to investment--Ethiopia, Guinea, and Mozambique--now offer a range of incentives and guarantees to investors. In addition, more and more African countries permit and have set up investment promotion agencies and have opened the so-called "one-stop shop" investment centers to assist companies in getting through the regulatory process of establishing a business.

However, during the early 1990's investment flows into Africa have stagnated while those to other developing regions, notably Asia and Latin America, have increased. Africa's share of investment flows declined to 6 percent by 1992 down from 12.9 percent in 1981. Moreover, 70 per cent of investment flows into Africa in the early 1990's were concentrated in oil-exporting countries, mainly Nigeria.

Reasons for Low Levels of Investment

Why have investment flows to Africa been weak compared to other developing countries? The UN's World Investment Report lists several reasons:

1)Africa has few location-specific advantages.

2)Privatization programs have been limited in contrast to other regions.

3)Civil conflicts continue to plague some countries, (Liberia, Rwanda, Somalia, Sudan); others are just emerging after years of struggle, for example Ethiopia, Eritrea, Chad, Mozambique, and Uganda.

4)Domestic markets tend to be relatively small, and there is limited opportunity to export to neighboring countries in many cases.

5)Poor and deteriorating physical infrastructure and lack of telecommunications and financial infrastructure inhibit investment.

6)Relatively slow progress in introducing market- and private sector-oriented reforms discourage FDI.

7)A high level of indebtedness can lead to chronic foreign exchange shortages that threaten repatriation of profits.

8)A lack of or low level of skills and access to technology further hinders investment.

U.S. Concerns

Many U.S. companies interested in investing in Africa cite similar reasons for low levels of investment in the continent. Political stability ranks at the top of the list for most investors. This is closely related to legal predictability. An investor is most interested in doing business, knowing clearly the cost of doing business, and not having to worry about politics. A country with a transparent legal system under which an investor can be aware of all relevant laws and regulations and be assured of their enforcement encourages investment--both domestic and foreign. The bottom line is that investors want an environment where contracts and the rule of law are respected. Furthermore, investors expect good governance. This means: 1) decentralized political activity, 2) accountable and responsible government, and 3) respect for human rights, including a free press that permits a free and open exchange of ideas.

Corruption

Furthermore, U.S. businesspeople explain that the inability to know or plan exactly what will happen to an investment because of 1) corruption, 2) unstable currencies, and 3) poor infrastructure, including the provision of basic services, such as electricity,and honest police protection, creates an environment which is not conducive for conducting business. From a business perspective, corruption is a wild card in determining the cost of doing business; it creates uncertainty rather than predictability and distracts an entrepreneur from his/her key goal: producing to generate a profit. All told, corruption discourages prospective investors from abroad and limits those at home.

Unstable currencies

The second issue, that of unstable currencies, is best addressed in the context of economic reform efforts and getting the prices right. Governments must adopt internationally realistic exchange and interest rates, and noninflationary monetary policies. They must eliminate price controls, labor market rigidities, and artificial restraints on internal investment and competition. In short, sound fiscal and monetary policies, and an open trading system are the basis of a healthy macroeconomic environment attractive to private business.

Infrastructure

Thirdly, to attract investment, countries must improve basic physical infrastructure: roads, ports, railroads, and power generation. Equally, if not more important, are improvements in telecommunications and financial infrastructure. Business depends more and more on an ability to communicate quickly with firms around the world. Mauritius, an African country successful in attracting investment, recognized this early on and updated and expanded its telecommunications network. AT&T is working to improve Africa-wide telecommunications through its Africa One project, which will bring Africa into the 21st century.

Financial sector reforms, supported by noninflationary monetary policy and fiscal restraint, are essential to increasing investment, especially in encouraging growth of the domestic private sector, a large percentage of which is small and medium enterprises. Shortages of investment funds and working capital are particularly critical for the latter. In some cases financial market regulations reduce domestic savings deposits. Excessive government borrowing, often to support parastatal losses, crowds out the private sector, and heavy taxes squeeze corporate profits and entrepreneurial income.

Bureaucratic Hurdles

Despite improvements in the macroeconomic environment and positive changes in investment codes, in many African countries, bureaucratic obstacles discourage private sector investment. The famous study by Hernando de Soto in The Other Path cites the example of Peru. When De Soto's Institute for Liberty and Democracy attempted to register an imaginary factory, the process took 289 days, required the full-time labor of the group assigned, as well as $1,231, which represented the equivalent minimum wage earnings for one month of 32 people. A recent article in the Financial Times indicates that this tale holds true in Kenya today. Market Integration and Reforming Trade Regimes

U.S. investors also cite the relatively small market size of most African countries as a constraint on investment. With the exception of Nigeria and South Africa, few African countries possess the market size that will draw foreign investment in value-added industrial sectors. To attract more investors (foreign and domestic), Africa must look to the creation of larger markets through regional integration. Today only 5-10 percent of Africa's trade is with Africa. African countries can work bilaterally and through existing regional organizations to eliminate barriers, tariff and non-tariff, to cross-border trade, and to integrate transport and communications systems. Import licenses and complicated customs procedures also inhibit trade and hinder efforts toward creating larger regional markets. International donors, including the World Bank, IMF, and African Development Bank, have encouraged and supported regional integration efforts. The fundamental responsibility, however, rests with Africa's decision-makers.

Free Trade Zones

Free Trade Zones, or Export Processing Zones (EPZ's), are popular with some foreign investors, and Mauritius has been successful in using these to its advantage, particularly in developing its textile and apparel industry. However, a World Bank study of Export Processing Zones as a tool of economic development indicated that links from the zones to the local economy often are disappointing. EPZ's are most useful for exposing local labor and management to international competition, and the quality expected on the world market. In Africa, EPZ's also can be useful in initial stages of diversification away from commodity exports. Although EPZ's have some advantages, particularly in Africa, they are no substitute for a liberal economic environment conducive to export-oriented development.

Export Promotion and Diversification

Sound macroeconomic policies and correct prices, however, are not enough to boost growth through investment and exports. Ghana's example illustrates the need for export promotion and diversification programs. Although Ghana had adopted enabling macroeconomic policies, exports did not grow as much as hoped, particularly non-traditional exports, such as clothing. Such exports totalled $1 million in 1983, at the start of Ghana's economic reforms, and grew to $60 million in 1990, an impressive figure, but not enough to offset declines in traditional commodity exports. Ghana now actively promotes non-traditional exports, and we expect increased growth. For example, a new juice plant, built by a Ghanaian, has reached full capacity in one year and is both producing for the local market, and exporting, by air, to the Middle East. The Ghana example shows that domestic investors in particular need to be supported through: 1) export finance, 2) market information, 3) access to technology, 4) tariff reform, and 5) elimination of cumbersome administrative regulations.

Investing in Human Resources

Human resource development cannot be ignored when looking at policy reform. Lack of or a low level of skills in the labor force is one reason for a low level of investment in Africa. Without specific skills taught in conjunction with a sound basic education, the African workforce will have difficulty in accessing technology and know-how essential for Africa's economies to compete in the world, to attract private investment, and to support growth and competition. Beyond job training, health and nutrition of the citizens of African countries also are important in attracting investment and achieving development. A World Bank study on sustainable growth in Africa cites two priorities for human resources: 1) improve the quality and relevance of education at every level, and 2) redirect public resources toward basic education and health care. With these priorities met, Africa's workforce and entrepreneurs can be ready to take advantage of the enabling environment for investment.

Domestic Investment Small and Medium Enterprises

The policy reforms I have described to create an environment conducive for investment hold true for domestic as well as foreign investors. Indeed, growing numbers of private entrepreneurs are essential to future economic growth. Most domestic investment will come from small and medium enterprises (SME's). SME's play a key role in the transition from agricultural to industrial economies. For example, in Japan, where small enterprises have always been important as subcontractors to large firms, over half of manufacturing output in 1960 originated from firms with fewer than 100 employees. One-third of all the workers in Japan were employed by them. This was at the start of Japan's rise to a world economic power. In the U.S. today, 100 percent of new job creation comes from the small business sector. Large companies are downsizing.

In Africa, too, SME's predominate in productive activities. According to the IFC, small firms (less than 50 employees) account for 85 percent of manufacturing employment in Ghana, 86 percent in Nigeria, and 96 percent in Sierra Leone. In other countries, such as Tanzania and Kenya, the figure is lower but nevertheless significant at around 60 percent. With the rapid rate of population growth in most of Africa, SME's labor intensity is expected to continue to provide the best chance of employment generation. The challenge for African nations is to remove existing constraints to SME's. Many of these constraints will fall away as governments adopt sound fiscal and monetary policies and eliminate trade barriers. However, governments must be alert to large company biases in investment incentives, such as tax and trade concessions. In addition, African nations need to promote SME's through easing access to credit, providing business training for future entrepreneurs, and providing market information, particularly for export markets.

Informal Sector

The challenge for African nations is to create an infrastructure to help the informal economy become part of the formal economy so that the informal vendor of avocados on the street can become the small enterprise of tomorrow, earning greater income and employing more people. This transformation from informal to formal has been successfully accomplished through credit programs for microenterprises. For example, in a loan program set up by Save the Children in the Gambia, one woman borrowed a small sum of money (around $30) to start her own trading business. One year later she has a small storage area well-stocked with goods and provides her family with economic security.

Women

This example also illustrates the value to including if not targetting women in efforts to boost small enterprises. In fact, more micro-loan programs today target women rather than men, partly because women have better loan repayment records. Moreover, women make up a large percentage of the informal sector in Africa. World Bank economists estimate that petty trading by women accounts for 30 to 50 percent of GDP in some countries. African countries can reap employment benefits by assisting women in turning petty trading operations into small and medium enterprises. For example, in the U.S., the 11 million employees of women-owned businesses total more than the number employed by the Fortune 500 companies.

Private/Public Sector Dialogue

Finally, in looking at investment policies, it is important for Africa's leaders to listen to the concerns of their own, however nascent, private sector and to let reform come from the bottom up and not only from the top down. There must be continued communication and dialogue between the private and public sectors. In Ghana there is a Private Sector Round Table which meets periodically with government to make the views of the private sector known. Partnership is the key word. Governments should be alert to general biases against smaller firms in tax policy, labor laws and access to credit. The U.S. is committed to the importance of private sector access to credit. Last October President Clinton announced the creation of the Southern Africa Enterprise Fund to address the issue of access to credit and capital to help create and expand small indigenous businesses in that region. The African Development Bank also created a private sector arm a few years ago to address this issue, and was instrumental in the creation of the African Business Round Table.

Conclusion

In sum, to grow and to improve the standard of living of the average African, African governments must work with their citizens to create an environment that encourages investment--both small- and large-scale--of their own nationals. A country that fosters private investment at home will also attract investors from abroad. Many of you already know that one key to improving investment prospects is to adopt sound macroeconomic policies that send appropriate signals to the market. Equally if not more important is a transparent, predictable legal system, free from corruption and undue influence that demonstrates respect for contracts and the rule of law. Tax and other investment incentives are fine such as they are but elimination of the "petites blockages", the little obstacles, cumbersome regulations and unwelcoming attitude to private investors, will do more to increase investment levels than any tax holiday. An open trading system and increased regional market integration will bring in foreign investors and stimulate local producers, particularly in manufacture of non-traditional exports. Look at the informal sector and the needs of its entrepreneurs and bring them into the formal economy. Remove constraints of small and medium enterprises, which, like the informal sector, create the lion's share of new jobs. Give the domestic investor access to credit, market information and training. Let everyone know the rules of the game, and give clear, enthusiastic signals that the government is committed to sector-led growth. Finally, support women, educate them and provide them with access to credit. They are often an untapped source of economic growth. I hope you will take my ideas and suggestions, consider them and work together--public officials and private businesspeople--in a dynamic partnership to develop your own enabling environment for investment, the catalyst of economic growth. Africa's future will depend on it. Thank you.

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