Memorandum submitted by Christian Aid
INTRODUCTION
"Poor people are the private sector, they
are the farmers and small businesses that we are trying to help."
Hilary Benn, "Growth and poverty reduction",
speech to the New Economics Foundation, 19 January 2006
1. Christian Aid welcomes the International
Development Select Committee's enquiry into the key subject of
private-sector development in developing countries. We strongly
agree with Hilary Benn's recent words about the importance of
the private sector, and the need to create "more and better
jobs" if we are serious about eradicating poverty.
2. Christian Aid's experience in more than
50 developing countries has always underlined the crucial nature
of private-sector development to any country's development strategy,
and our lobbying and campaigning work on trade has sought to help
create an environment where a strong, pro-poor private sector
can exist. A thriving domestic private sector has been a key factor
in all countries that have experienced rapid rates of poverty
reduction over the last 50 years.
3. However, there is a worrying tendency
in policy debates to reduce discussions about the private sector
to a series of policy proposals aimed at attracting foreign direct
investment (FDI). This submission will argue that attracting FDI
is not the only, or even the most important, government action
to develop the private sector. If FDI is not handled carefully,
it can, as we have seen, have serious costs for developing countries.
4. Successful development is more often
associated with a strong domestic private sector, but this is
often underplayed in current discussions. Our submission focuses
on ways the UK can work with developing countries to maximise
the benefits of FDI, as well as encouraging the domestic private
sector in those countries to play its part in poverty reduction.
MOZAMBIQUE AND
BOLIVIA—TWO
STORIES OF
PRIVATE-SECTOR
DEVELOPMENT
5. The story of investment in the sugar
sector in Mozambique shows some of the benefits that investment
can deliver, and particularly how the right government policy
can ensure that these benefits go directly to poor people. The
sector has attracted US$350 million in investment, mainly from
South African and Mauritian companies. Currently there are more
than 20,000 people directly employed in the sugar mills, with
wages guaranteed by the government's minimum wage policy. The
impact on the local economies from increased demand for goods
and services has been striking. This is particularly important,
as sugar factories tend to be located in rural areas which have
suffered the most from weak markets and lack of business opportunities.
Mozambique also earns nearly US$30 million a year from sugar exports.
6. As well as its wages policy, which ensures
poor people get some of the benefits of increased sugar production,
the government was prepared to intervene to compensate for international
distortions in the sugar market.
7. A variable tariff on sugar imports protects
local producers from unfair competition in domestic markets with
subsidised producers in Europe. This was one of the factors attracting
investment in Mozambique's sugar sector. When the IMF threatened
to insist that the Mozambican government remove this tariff, investors
joined with the government in lobbying the IMF to allow it to
remain. One investor described the threat of removal as the "sword
of Damocles" hanging over their heads, and asked, "What
do you do? Do you turn to them [the factory workers] and say,
sorry, because of the IMF there are no more jobs?"[22]
8. In Bolivia the story is significantly
different, raising the question whether investment has brought
any substantial benefits to the local population. Bolivia is the
poorest country in Latin America, yet is sitting on gas and oil
reserves worth billions. In 1996 the national gas and oil industry
was privatised under heavy pressure from the IMF.[23]
The government negotiated a deal with a consortium of companies
from the US and Europe, offering them generous financial incentives
to invest. The state oil and gas company, Bolivian Fiscal Petroleum
Resources (YPFB), was sold off for US$835 million.[24]
9. The companies paid very little tax on
the value of the gas and oil extracted at the wellhead, only 18%
of the market price for the new reserves (which represented 95%
of Bolivia's reserves) and 25% on the rest. The government hoped
these low rates would increase investment in gas and thereby boost
production. However, while production did increase dramatically,
Bolivia's earnings barely rose. The companies involved, including
British Gas, BP and others, continued to enjoy healthy profits,
while rapidly depleting Bolivia's main non-renewable resource.
Unlike the example of Mozambique, where the ration of jobs to
investment is high, in total only 8,737 people were employed in
the sector.[25]
In addition, despite having very low local production costs,[26]
Bolivians were paying US$1.60 per gallon for petrol, almost as
much as US consumers.
10. These two stories show that investment,
and private-sector development in general, can be an important
part of a strategy to reduce poverty, but can also damage a country's
prospects if managed badly. Attempts to attract FDI at any cost
will not necessarily lead to the kind of investment and private-sector
activity that benefit poor people.
GETTING INVESTMENT
POLICY RIGHT
"The single most important thing a developing
country can do to benefit from the trade and investment opportunities
thrown up by globalisation is to get their investment climate
right."
Hilary Benn, "Growth and poverty reduction",
speech to New Economics Foundation, 19 January 2006
"The idea that FDI responds to rather than
creates success has met with resistance and the notion that it
may carry costs as well as benefits almost completely ignored."
Incentives to attract investment
11. In many countries, attracting investment
has become the sum total of industrial policy. Under the original
Washington consensus and its subsequent variations, foreign investment
is regarded as the central engine for economic growth. Foreign
companies can provide innovation and stimulate domestic economies
through technology and skills transfer, as well as providing a
crucial source of jobs and additional foreign exchange. The implication
of Washington consensus policies is that governments simply need
to put in place policies that attract these companies, and the
market will do the rest.
12. Given the insistence of key donors such
as the US, the IMF and the World Bank on the Washington consensus
approach, attracting FDI is now at the top of the economic policy
agenda for most developing countries. For years developing countries
have been told that to get more FDI they have to liberalise their
investment regimes and deregulate.
13. In the global competition for FDI, the
majority of countries have now opened up most of their economies
to foreign investors. This has been accompanied by a number of
measures to actively attract FDI, usually involving incentives
such as subsidies, cheap land, tax holidays and breaks, and exemptions
from regulations, including environmental and labour standards.
Between 1991 and 2002, 95% of changes to investment regimes globally
were designed to attract FDI.[27]
14. These incentives may be an expensive
mistake according to research by the global consulting firm McKinsey.
It concludes that incentives are often ineffective, and argues
that while FDI brings significant benefits, such as employment
and technology, "popular incentives, such as tax holidays,
subsidised financing or free land, serve only to detract value
from those investments that would likely be made in any case."[28]
15. Setting low tax rates or offering tax
holidays in order to attract investors effectively robs poor countries
of vital capital. Subsidies and tax competition, as well as the
existence of tax havens, all drain money which should be available
for public finances and may significantly harm prospects for economic
growth.
Investment and government revenue
16. Developing-country governments believe
that FDI brings significant benefits—so much so that they
are prepared to pay a hefty price in the form of subsidies to
attract it. But on closer inspection, many of these benefits are
illusory and outweighed by the costs.
17. One of the key assumed benefits of FDI
is its ability to generate revenues through taxation. However,
tax competition between countries means that, in an effort to
attract investment, developing countries have been forced to dramatically
lower their corporate tax rates, detracting from the value of
the investment. As the Bolivian example shows, offering tax incentives
is often likely to carry an immediate opportunity cost in terms
of lost government revenue, and "could be considered equivalent
to a (hidden) subsidy that developing countries are providing
to TNCs."[29]
18. Capital flight, facilitated by the existence
of offshore tax havens, also drains the benefits of FDI. For example,
embezzlement and the transfer of illicit funds from Africa amounted
to an estimated US$400 billion, US$100 billion of which came from
Nigeria alone.[30]
By closing down offshore tax havens, the UK could dramatically
slow the flow of money from countries such as Nigeria.
Investment and the local economy—the case
of extractives
19. A fundamental expectation of FDI is
that it will have a positive impact on the host economy. For example,
stimulating the domestic private sector by creating jobs, buying
inputs, and giving less-developed economies access to technological
know-how and skills. However, evidence shows that these benefits
cannot be guaranteed.
20. The impact of foreign investment on
local economies and companies generally depends upon the characteristics
of the capital coming in, and on the government policies that
influence private-sector activity. The case of the extractives
sector in Africa—a sector that dominates FDI in the continent—illustrate
some of the pitfalls of relying on investment to deliver growth
and poverty reduction.
21. While the overall flows of FDI to Africa
have been decreasing over the last 30 years (2% of total global
flows 2002-04, compared with four per cent in the 1970s), the
majority of this is concentrated in the extractive sector. Twenty-four
African countries classified by the World Bank as mineral or oil
dependent have received almost three-quarters of the investment
in developing countries over the last two decades.
22. In addition, the demand for natural
resources, such as minerals and oil, is expected to grow, given
the rise of new economic giants China, Brazil, India and Russia,
and their increasing energy needs. However, many of the countries
richest in oil and minerals are also still the world's poorest—for
example, Nigeria, Chad, the Democratic Republic of Congo (DRC),
Sudan and Angola.
23. For countries such as these, investment
in natural-resource extraction has not brought poverty reduction.
Instead they have been afflicted with a "resource curse"
in which mineral dependence has been shown to slow and even reduce
economic growth.[31]
The incidence of poverty has been increasing for a number of mineral-dependent
exporters in sub-Saharan Africa (SSA),[32]
as has the tendency of FDI to crowd out local investment.[33]
24. Investment in natural resources tends
to be concentrated in enclaves. This can limit the wider benefits
to the local economy, with very little sharing of technology,
a good deal of imported technology, and few local jobs being generated.
Mineral wealth can also distort economies by attracting the lion's
share of support and investment, stifling economic diversification
and making it almost impossible for basic manufacturing industries
to develop.
25. Natural-resource extraction can also
bring direct costs to poor people. In many cases the extraction
of minerals such as oil and diamonds has been responsible for
sustaining conflicts (for example Angola, the DRC, Sierra Leone,
Sudan). These industries are also often associated with environmental
degradation, which bears heavily on poor people. In Nigeria, Shell,
one of the worst offenders, is associated with oil spills and
gas flaring, as well as local conflicts around oil fields.
26. Attempts to resolve these problems have
often had little or no success, a reflection of the lack of international
controls of the behaviour of multinational companies. For example,
in 2002 the UN presented a dossier listing 85 companies investing
in the DRC, 18 of which were UK-based, accused of perpetuating
the conflict. The majority of these companies are based in OECD
countries where governments are obliged to adopt OECD guidelines
for multinational enterprises, Voluntary standards such as these
have so far failed to significantly curtail corporate malpractice.
Such costs could be avoided by regulation.
27. The high returns on investments in resource
extraction make Africa appear a desirable destination for capital.
However, the potential negative affect of foreign investment must
be sufficiently factored into any approach to attract FDI, so
that poor people can benefit.
TRADE POLICY,
INDUSTRIAL POLICY
AND PRIVATE-SECTOR
DEVELOPMENT
28. As with investment policy, until recently
a relatively simplistic attitude to trade policy and private-sector
development has prevailed in the poorest countries, largely due
to the influence of the IMF and the World Bank. In too many countries,
attempts to develop the domestic private sector have been undermined
by trade policies that amounted to little more than a programme
of across-the-board liberalisation.
29. Rather than encourage the domestic private
sector, these policies have often caused serious problems for
established companies, and stopped governments from providing
the right environment to develop new businesses. In other countries,
successful private-sector development has been associated with
a more interventionist approach to trade policy, as in the example
of Mozambique's sugar sector.
Deindustrialisation
30. A combination of trade liberalisation,
increasing competition for local firms, withdrawal of state supports,
and privatisation programmes that did not lead to new resources
or technology transfer have been disastrous for the domestic private
sector in developing countries. For example, in SSA between 1980
and 1990, manufacturing output's contribution to GDP dropped sharply
before reaching a level in the 1990s below that reached in 1960.[34]
31. In Zambia this process led to a fall
in manufacturing employment of 40% in five years; in Ghana this
figure fell by more than half. Both countries were enthusiastic
liberalisers—a strategy that was a failure as far as domestic
private-sector development was concerned.
32. In most cases, these policies were imposed
as the condition for receiving aid and loans from the international
community. It is clear that the wrong policies can be disastrous
for private-sector development. What constitute the right policies
to foster growth in this area is highly controversial, and the
answer will inevitably vary from country to country. However,
strong local companies will almost certainly not develop without
some form of infant industry protection, currently denied to many
developing countries.
Successful private-sector development
33. A number of countries have been successful
in developing indigenous private-sector enterprises with positive
impacts for their poorer populations. Every decade has had its
star performers. In the 1970s, east Asian countries showed that
active governments could deliberately encourage the development
of local firms, and build up a private sector that could compete
internationally. Taiwan, for example, used rates of protection
of up to 55% together with policies to encourage linkages between
firms, technological upgrading and export promotion. Other countries,
such as South Korea and Malaysia, adopted different but equally
interventionist policies to boost domestic companies with equal
success.
34. In the 1980s, as the rest of Africa
liberalised under structural adjustment regimes, Mauritius was
almost alone in the continent in retaining significant levels
of protection, and providing strategic industrial policy for domestic
firms. By the 1990s, its industry was almost twice as protected
as that of the rest of Africa. Local producers were treated preferentially
to foreign producers, and certain sectors were targeted for particularly
favourable treatment. The result was a growth rate per head of
4.2% in the 1980s and 1990s, and an increase in life expectancy
of ten years. The domestic private sector has been key in developing
Mauritius' economy—around half of the equity in firms producing
for export is owned by Mauritian nationals.
35. In all these cases, governments, directly
or indirectly, sought to influence and encourage private-sector
development, and to ensure that poor people were able to benefit
from resulting growth.
36. Other examples, such as the cases of
the extractive industries described above, show that, as far as
poverty reduction is concerned, attention to the type and quality
of private-sector development is more important than emphasising
volumes of investment or rates of growth.
WHAT'S
NEEDED?
37. The development of the private sector
is fundamental to successful growth and poverty reduction in developing
countries. However, it is clear that, if private- sector development
is to have positive outcomes for poor people, governments must
design appropriate incentives for new investors and existing companies.
Yet the trend in recent years has been for international institutions
and agreements to constrain national governments' ability to make
appropriate policies, and to push a model of liberalised investment.
38. FDI has an important role to play in
development and the alleviation of poverty. However, in order
to ensure that poor people can participate in a growing economy
and not get left behind, a clear policy framework of government
intervention is needed. Developing countries must be allowed to
design and develop targeted industrial policies that will nurture
the growth of a competitive domestic private sector.
39. Crucially, all measures to promote FDI
must be in line with the objectives of sustainable development;
FDI should not be pursued at any cost. Sensible investment policy
will carefully and seriously weigh up costs and benefits.
RECOMMENDATIONS
40. The World Bank, the IMF, the regional
development banks and bilateral donors must drop economic policy
conditionality. The UK government has already committed itself
to doing so in relation to UK bilateral aid. It must now ensure
that other donors do the same.
41. The UK government must push for trade
and investment agreements that grant developing countries the
flexibility to design and implement appropriate investment and
industrial policies. This will ensure that private sector development
supports national development goals.
42. Regulation is needed to address the
negative impacts of capital flight and tax competition in order
to maximise revenue generation from investment. The UK government
must support measures to end banking secrecy, which would help
eliminate tax havens and capital flight. It must also support
the introduction of an international minimum rate on tax.
43. The UK government must support the development
of stronger legal frameworks for corporate accountability to ensure
standards relating to TNC activities overseas are upheld. It cannot
rely on the good will of companies, nor on the voluntary standards
of the OECD guidelines for multinationals to address the issue.[35]
February 2006
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