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Using The Evaluation Framework Economics Essay

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The possession of an ownership advantage gives a firm the opportunity to sell goods overseas but it fails to explain why this is carried out through production in the foreign market rather than exporting to the foreign market. As a result, there is the need for an evaluation framework.

LEARNING OBJECTIVES

By the end of this Unit, you should be able to understand and grasp the following:

the importance of an evaluation framework;

the 4 criteria of the evaluation framework;

assess the contribution of MNEs in a foreign country by using the Evaluation Framework.

THE EVALUATION FRAMEWORK

The contribution of MNEs to the development of the host nation, more particularly developing countries or LDCs has been the subject of much debate over the years. Whilst it is generally accepted that MNEs do contribute by way of technology transfer, skills diffusion and by bringing much needed finance capital, nevertheless criticisms abound as to the negative impact of MNEs in that they are viewed as exploiting the local labour force, they transfer outdated technology, and they strip the LDCs of much needed resources.

However, MNEs were and still remain a very important ingredient of growth, especially for developing countries. This is why it is crucial for a host country's government that it should be able to assess FDI in a policy context. The latter process is usually done by way of an Evaluation Framework. An evaluation framework usually encompasses 4 criteria.

3.3 Efficiency of Resource Allocation

Efficiency of resource allocation relates to the extent to which there exist complementarities between of economic interests between the multinationals and the host countries. In a similar vein, it highlights the following: under what conditions do the operations of the TNC in a host country contribute to the world economic welfare that could not be achieved before?

However, the presence of MNEs in host countries is often prompted by government-induced imperfections including protection from imports. Such a situation mainly occurred when countries were adopting an import substitution industrialization strategy.

Adopting an import-substitution strategy entailed a high level of protection, via tariffs, import restriction measures and quotas, which discriminated against exports via explicit and implicit tax of export activities and an overvalued foreign exchange rate. Also, the government used investment license, differential taxes, tax holidays, exemptions and remissions to influence resource allocation between industries and sectors.

The proponents of IS strategy firmly believed that they would be able to meet the domestic demand for manufacturing products; provide employment opportunities for skilled labour; ease pressure on the balance of payment and strengthen the long term productive capacity of the economy by importing the production technology via foreign firms [1] and by using the "infant" industry argument.

Under such an era of protectionism [2] , MNEs were mainly regarded as being of a "market-seeking [3] " nature. Firms set up plant within foreign nations in order to supply their national markets in the most profitable way possible. The key location advantages (in Dunning's terminology) which determined these market-seeking investments were the cross-border transport and communication costs; artificial barriers (import restrictions) to trade in goods and services; the size, income per capita and the expected growth of the local market. Though cost considerations were deemed important and even decisive in certain marginal markets, an efficiency-seeking motivation was deemed to be of a very secondary nature (Pearce, 1999).

However, the overwhelming consensus is that IS was a failure [4] . IS strategy has turned out to be self-defeating since it has resulted in huge increases in imports of equipment and inputs while transfer pricing constituted a severe drain on foreign exchange. Also, IS granted excessive protection to industries producing inefficiently non-essential goods for high-income elite. Furthermore, fiscal credit and exchange rate policies, coupled with subsidies on imports of capital goods, made it possible and advantageous to entrepreneurs to rely on high capital intensive equipment produced abroad and technology unsuited to the factor proportions prevailing in less developed countries.

As a result, a new orthodoxy emerged in the late 60's and early 70's which stressed the role of exports of labour intensive manufactures as an engine of growth. This represented a return to the static theory of comparative advantage with trade based upon different factor proportions prevailing in various countries which meant that the pendulum turned full swing for development policy in LDCs from import substitution to manufactured exports.

Export oriented strategy not only encourages free trade [5] , but also the free movement of capital, labour, enterprises and an open system of communication. It also entailed more efficient allocation of resources with firms competing internationally [6] based on their relative comparative advantages. These considerations, coupled with the emergence of trade blocks, were factors motivating changes in the strategic orientation of MNEs.

MNEs underwent a complete restructuring of their global and regional supply profiles. This entailed locating [7] manufacturing operations in only a few countries but exporting for a wider market. Each subsidiary were opened to a fully competitive market situation which permitted the realisation of economies of scale and the attainment of optimal efficiency in production (Pearce, 1999). The "where" to produce clearly gained in prominence during such an era which led to MNEs redistributing their unchanged ownership advantages in order to create an international network of subsidiaries [8] which optimised their supply of established range of products. Thus, investments undertaken by MNEs were mainly of an efficiency-seeking nature.

However, one should not underestimate the crucial role played by the government during that period. It was not only the choice of trade strategy but also the appropriate role of government policy which was at the heart of the development issue. For example, export-oriented growth and appropriate macroeconomic policies [9] were mutually of economic development in the NICs. The integration of NICs into world and regional economies was essential for their long-term growth. This required less government intervention and greater reliance on private initiatives and market forces. It provided an environment conducive to foreign investment and domestic entrepreneurship. The Government was expected to actively promote economic growth and use its resources to direct and support the private industry.

It was the pursuit of such appropriate policies by these developing countries' governments permitted shifts in their pattern of international specialisation in response to the changing structure of their comparative advantage at different levels of industrial development. As a result, the efficiency of resource allocation improved, the rates of growth accelerated, with benefits accruing to all concerned.

DISTRIBUTION

Distribution relates to the extent to which the gains arising from the MNEs operations are distributed between the partners. The host country would demand a fair share of the benefits created by the investment. However, the identification of a fair distribution is very difficult since it is almost impossible to price correctly some contribution such as technology diffusion and managerial expertise which are intangible in nature.

In addition, the issue of distribution is even more contentious especially when profits of the multinationals are due less to the efficiency of resource allocation and more to market distortions or imperfections created and sustained in the first place by the government to attract these foreign firms. Also, the distribution of such rent is influenced by the relative bargaining strength of the multinationals and the host governments in the light of factors such as tax concessions, tariff protection and labour training.

In this light, it may be argued that there is a direct relationship between the bargaining strength of the host country and its level of industrialization such that, the lower the industrialization level, the weaker its bargaining power. Finally, host nations are unable to extract their fair share of benefits because imperfections in the market for factors of production in which the multinationals are strong permits them to earn monopoly rent on these factors.

SOVEREIGNTY

Sovereignty relates to the ways in which the multinational may compromise the economic independence of host nations in either the short or long term. It highlights how the behaviour of multinationals may compromise the effectiveness of certain aspects of the host countries' policies.

For example, the intra-group transfer of rent, via transfer pricing practices, may undermine the autonomy of the host countries in areas such as fiscal policy, monetary policy, trade policy and its attempt to control and organize the structure of industries.

SELF RELIANCE

Self-reliance relates to the ways in which the operations of the multinational may undermine the viability or independence of local firms or enhance their potential. The self-reliance issue also crops up during the investigations of the impact of multinationals on the industrial structure of the host nations; for e.g. the level of concentration and/or modes of operations.

It is also concerned with whether the operations of multinationals in the host nations may either enhance or hold back the availability of particular types of skills for local enterprises since there are claims that multinationals remunerate better their employees than local enterprises.

However, there is no reason as to why the relationship between local enterprises and multinationals should be a competitive one. They may in fact complement each other rather than act as rivals. For e.g. multinationals may have recourse to indigenous forms for their supply of inputs and this may lead to significant benefits for the indigenous firms by way of improved technology, better quality control procedures and diffusion of skills.

EXERCISES

1. MAURITIUS CASE STUDY

Mauritius is unique in having had a wealthy class of sugar plantation owners who were actively seeking to diversify their investments in the first years of independence. They have experimented with horticultural and industrial exports, as well as with tourist facilities, for many years. It took the arrival of Hong Kong and Taiwan textile firms to get industrialization going, however. And South African hotel chains first brought the tourist facilities up to world class standards. Why couldn't they do it alone? The key missing ingredient was the much vaunted keystone of the "new economy:" knowledge. Mauritian investors lacked the depth and breadth of knowledge needed to create viable industry and tourism on their own.

The overseas Chinese and South African investors brought in-depth knowledge of how to run an efficient firm. They also had intimate knowledge of customers and their preferences, as well of what the competition was offering. They were able to train the Mauritian workforce, interspersing production lines with faster Chinese workers and more flexible Indian ones to bring up productivity. Domestic investors, whether the sugar barons or more locals of more modest and ethnically diverse origins, unanimously reported that they were not squeezed out by foreign investment. On the contrary, they worked with, learned from, and in many cases bought out foreign investors.

Ethnicity has been handled delicately in Mauritius, in surprising contrast to analysts' predictions at independence. The few dozen Franco-Mauritian sugar barons who controlled the economy at independence in 1970 faced the classic South African nightmare of being washed into the sea. The majority of the electorate comprised landless descendants of cane-cutters brought in from the Indian subcontinent as contract labor. Yet Mauritians found a stable accommodation, in both politics and the economy. The constitution explicitly recognizes ethnic minorities, providing for 10 percent of parliamentary seats to go to "also rans" from ethnic minorities that would otherwise not be represented. The tiny new polity attained in two decades an economic transition from monocrop Sugar Island to a balanced economy in which textiles, tourism and sugar are the pillars.

New forays are being made into business services, information technology and other diverse export products. Indo-Mauritians are still minimally represented as entrepreneurs, though they dominate the civil service. Sino-Mauritians, hitherto concentrated in smallscale commerce, enhanced their status through association with Hong Kong and Taiwan industrialists whose knowhow and investment initiated the textile sector. Economic tensions are worked out in annual tripartite negotiations between labor, government and employers, most of whom are Franco-Mauritians. Sound institutions have played a critical role in the process. The rule of law has prevailed consistently. The sturdy financial sector, led by Mauritius State Bank since 1828, provides investment capital to both domestic and foreign investors. The British tradition schools graduate fully bilingual, often tri- and quadrilingual students, whom employers find a great asset in the new global economy.

Foreign And Local Investment In Mauritius

Mauritius was chosen as a case study because it has a reputation as a country in which foreign investment has played a critical and unanticipated role in industrialization, driven largely by good policies. The case study bore this out, but added great complexity to the portrait. Ethnicity was a complicating factor that could have derailed growth, and sound institutions played as important a role as policies in its success.

An Overview of Investment Policy and Performance in Mauritius

In the 1960s as independence from Britain approached, James Meade and Burton Benedict published several studies that foresaw a bleak economic and political future for Mauritius.11 Meade proposed strategies to improve the standard of living while taking into consideration projected continuing rapid population growth (then over 3% per year). He foresaw pressures of population growth on economic resources on this small volcanic isle and suggested several mitigating strategies, including increasing productivity, encouraging emigration and family planning. Burton Benedict challenged Meade's proposed solutions, asserting that even if Meade's suggestions on ways to increase productivity were followed, this would not produce results strong enough to counter the population growth problem.

To the Malthusian logic in these first analyses, Benedict added concern over the future political stability of Mauritius. He analyzed the 1953 and 1962 censuses and documented the impact of ethnic, religious, caste and linguistic fragmentation on local politics-from the national level to the squabbles over a repair contract for a small town road. He began with the observation that Mauritians rarely identified themselves and others as Mauritians. In 1962 people from the Indian subcontinent were the majority, but did not comprise a single ethnic group. 50.5 percent of the population was Hindu and 16.2 percent Muslim Chinese comprised 3.4 percent of the population, and the "General Population," mainly Creoles and Franco-Mauritians constituted 29.9 percent. Although Africans had been brought to Mauritius in slavery, African languages and ethnic groups had melded into a mixed population speaking the Creole French patois that gradually became a lingua franca of the Island. The Indo-Mauritian population was 63 percent Hindu Sanatan and 19 percent Muslim Hanafi. There were generally endogamous minority sects of both major religions (the largest of which were Arya Samaj and Ahmadiyya), as well as Indian Christians. Castes had consolidated into a bipolar mode.

They had no corporate organization, but were generally endogamous. Chinese were nearly evenly split between Christians and Buddhists. Indo-Mauritians were further split by language, which sometimes had ethnic connotations. Hindi was the mother tongue of 36 percent of the total population and Urdu of 13.5 percent. Smaller Tamil and Telugu groups rarely intermarried with other Hindus. The "General population" of metisse, Franco-Mauritians and others was 96 percent Roman Catholic. The Franco-Mauritian families, are mostly descendants of French nobility who fled there during the French Revolution. The British gained control of the island during the Napoleonic wars andgoverned it until 1968, but the French families dominated the domestic society and economy.

For the dependency theorists of the 60s, Mauritius was an archetypical monocrop colonial economy. It depended on sugar for 99 percent of exports and one third of GDP. Cane fields occupied 90 percent of arable land. Of that, 55 percent was owned by 25 Franco-Mauritian families, often dubbed sugar barons. The remaining 45 percent of sugar estates were owned by 84,000 small farmers, predominantly of Indian origin. Almost no food was produced on the island. The majority who would dominate numerically in a democratic Mauritius was a land-poor population of former indentured laborers on sugar plantations from the Indian subcontinent. Until recently they had been considered transients, not counted as members of the population.

Benedict's complex analysis of the ethnic situation did little to lift the prevailing pessimism about Mauritius' future. The colonial government commissioned Meade to head an appointed commission to produce an economic strategy. The Meade Report was to strongly influence the government in creating its initial import substitution industrialization policy. The key recommendations in the Meade Report included tariff protection for certain local industries, a decrease of corporate tax from 40 to 30 percent, tax holidays for five of the first eight years of a company, priority of capital expenditure for projects leading to productive employment and the abolition of tariffs on importation of machine tools and equipment. These policies already focused on investment promotion, a policy which successive Mauritian governments have consistently favored. Even as early as 1960, investment in Mauritius reached 30% of GDP, a figure only recently achieved by the most successful economies in East Asia and largely unheard of in the developing world.

At this time, however, neither the new government of Mauritius, nor others in the developing world, had recognized the connection between investment policy and the larger political and economic context. A number of trends of the first government, which was dominated by the Mauritian Labour Party from independence in 1968 until 1982, limited the effectiveness of investment promotion incentives. One concern of foreign investors was political stability. There had been some communal violence just before independence, and the new Hindu dominated government maintained a fragile truce with minorities, including Muslim, Chinese and Franco-Mauritians. Other concerns centered around macroeconomic policies. Currency controls and protective tariffs designed to nurture import substitution industries [for the tiny national market], raised energy and transaction costs and times for potential exporters. The involvement of government in labor/ management negotiations and the creation of state corporations in key sectors led investors to take a wait and see attitude toward government. And the fledgling transport and telecommunications infrastructure was barely adequate.

The idea of creating an export promotion zone (EPZ) was added to the policy mix in 1970, only two years after independence. It was inspired by the success of Taiwan. Within a year the EPZ legislation was passed. In a stroke of brilliance, industrial leaders and policy-makers realized that Mauritius, being a small island with readily controlled access, could declare the whole island an EPZ-it did not need to have a fenced area. This allowed investors to build in dispersed locations, to facilitate transport for their workers and/or their products. Only a few foreign investors took advantage of the EPZ law in the 1970s, however.

Mauritius' isolated location in the Indian Ocean, its currency controls and uncertain political situation reportedly influenced the first investors to limit their commitments. What became the flagship textile firm, for example, was set up initially to do only the manufacturing - marketing and management were based in Japan and Hong Kong respectively.

By the end of the 1970s Mauritius was experiencing many of the same problems that other African countries had with state corporations, protective tariffs, and currency controls. With no petroleum resources, it had been hit hard by OPEC's escalation of oil prices and the global economic distortions that ensued. Government was running unsustainable annual deficits, the balance of trade was negative, industry was stagnant, and foreign exchange rationing slowed down all transactions. A devastating cyclone catalyzed a change in direction and in government. An alliance of former opposition parties, the Mauritian Militant Movement (MMM) and Mauritian Socialist Party (PSM), won the 1982 elections, changing the dominant party position for the first time since electoral politics was introduced in 1947.

The new government scrapped the mixed strategy of the 1970s, liberalized the currency, retreated from subsidizing state corporations, and put its full efforts into voluntary structural adjustment and promoting export-led growth. In retrospect, a recent government report sees that decision as an inevitable logical consequence of Mauritius' geographic situation. The report, Mauritius at Crossroads (1995) explains that as a small island, physically limited by lack of arable land and relying solely on sugar for foreign exchange, "Mauritius was condemned to turn to an aggressive export strategy. However, it was not until the early 80s that foreign investment actually took off. And, it appears, partly as a consequence so too did domestic investment take off.

Today, according to Mauritius at Crossroads, every Mauritian is taught the concept "Export or Die." This philosophy has led to the development of a sound business environment which is friendly to investors, both local and foreign, and which offers an attractive investment incentives package to compensate for the lack of resources and the no-longer inexpensive labor force. The older generation of industrial and government leaders also stresses that Mauritians have learned to make a virtue of their ethnic diversity. The switch to an export-led strategy came at a time of crisis. The ill-paid labor force was still predominantly of Indian origin, as was the government, whereas the industrial sector was led by Franco-Mauritians, Hong Kong/Taiwan investors and a few Sino-Mauritians.

Several interviewees described the moment as if they had looked at one another, then at the surrounding hundreds of miles of ocean, and decided that they would sink or swim together. For the export strategy, Mauritius needed to reach out to Hong Kong and Taiwan textile magnates, who had the capital and skills to organize a competitive industry. Franco-Mauritian local capital and know-how, and contacts were needed to open up European markets. A cooperative, trainable labor force was needed to attract investors. And government needed to be fully committed to its investor-friendly strategy. Mauritius had hard-working bilingual predominantly male labor force. They were skilled in farming, not industrial work. Most analysts doubted that Hindu or Muslim women would ever come out of the home and into the workplace. Within six or seven years, Mauritius had full employment, and industrial workers were mainly women.

Policies were the main, but not the only factor in investment decisions. Promoting investment has been on the top of the government's industrial agenda throughout the different development phases, but the understanding of what works for investors, for government and for the society as a whole, has evolved continuously. The first clearly defined policy came in 1961, as the colonial government began to prepare for an independent Mauritius, with the Industrial Development Tax Relief Act. The Export Processing Zone took effect in 1971, as one of the first acts of the newly independent government. Support services for exporters were given a fillip in 1981 with the Export Service Zones Act.

In 1985, the Mauritius Export Development and Investment Authority (MEDIA) was established as the executive arm of the Ministry of Industry. Its main responsibilities are to attract investment, promote exports and manage industrial estates. Investors clearly weighed these incentives against the inconveniences created by location, lack of local food and fuel supplies and small market size. The only major policy disincentive for foreign investors is that they are not allowed to own land. Government has compensated by providing fully equipped industrial sites for lease. Hotel investors generally partner with a local landowner. In the 1980s Mauritius offered inexpensive labor, but within a decade the development of the textile and hotel sectors had brought wages to a middle level, by world standards. From the late 1980s through early 1990s, Mauritius experienced full employment. Rising wages have gradually priced the textile industry out of its mass-production T-shirt lines, and forced both government and industry to rethink development strategies.

The Industrial Expansion Act of 1993 was a partial response to this dilemma. Through it Mauritius confirmed its commitment to permanent zero tax rates for exporters, and added a bundle of new-targeted incentive programs, providing for high technology investors, offshore financial services and freeport services. The full range of incentive programs Mauritius which were offered is shown in Table 6.1. To increase confidence in the industrial sector in general, corporate tax for manufacturers who do not qualify for the EPZ zerorate was cut from 35 to 15 percent.

Table 3.1: Manufacturing - Fiscal Incentives

INCENTIVE SCHEMES

QUALIFYING ACTIVITIES INCENTIVES

Export Enterprise

(EPZ)

·€ All manufactured goods for exports

·€ Produce of deep sea fishing (Including fresh or frozen fish)

·€ Printing and publishing as well as associated operations

·€ IT activities

·€ Agro Industries

·€ No customs duty, or sales tax on raw materials and equipment

·€ No corporate tax

·€ No tax on dividends

·€ No capital gains tax

·€ Free repatriation of profits, dividends and capital

·€ 60% remission of customs duties on buses of 15-25 seats used for the transport of workers.

·€ Exemption from payment of half the normal registration fee on land and buildings by new

enterprises.

·€ Relief on personal income tax for 2 expatriate staff

Pioneer Status Enterprise

·€ Activities involving technology and skills above average existing in Mauritius and likely to

enhance industrial and technological development.

·€ Applicant companies may come under one of three broad categories:

(a) new technology,

(b) support industries and

(c) service industries.

·€ No customs duty, or sales tax on scheduled equipment or materials.

·€ 15% corporate tax

·€ No tax on dividends

·€ Free repatriation of profits, dividends and capital

Strategic Local Enterprise

·€ Local industry manufacturing for the local market and engaged in an activity likely to promote

and enhance the economic, industrial and technological development of Mauritius.

·€ 15% corporate tax

·€ No tax on dividends

Modernization and Expansion Enterprise

·€ Two broad categories:

·€ Investment in productive machinery and equipment, such as automation equipment and

processes and computer applications to industrial design, manufacture and maintenance

CAD/CAM)

·€ Investment in anti-pollution and environment protection technology to be made within 2 years

of date of issue of certificate.

·€ No customs duty on production equipment

·€ Income tax credit of 10% (spread over 3 years) of investment in new plant and machinery,

provided at least Rs 10 million are spent and this occurs within two years of date of issue of

certificate. (This is in addition to existing capital allowances which amount to 125%of capital

expenditures.)

·€ Enterprises incurring expenditure on anti-pollution machinery or plant benefit from a further

incentive, i.e. an initial allowance of 80% instead of the normal 50%

Industrial Building Enterprise

Construction for letting purposes of industrial buildings or levels thereof, provided floor space is

at least 1000 square meters. Special conditions:

The applicant can only be a company intending to erect an industrial building to be let to the holder of a certificate (other than an industrial building enterprise certificate) issued under this Act or to an enterprise engaged in the manufacture or processing of goods or materials except the

milling of sugar.

·€ 15% corporate tax

·€ No tax on dividends

·€ Registration dues for land purchase: 50% exemption

·€ There is also a non-fiscal incentive, namely the disapplication of the Landlord and Tenant Act,

i.e. rent control

Source: Destination Mauritius, Mauritius Export Development and Investment Authority (MEDIA).

Table 3.2: Services - Fiscal Incentives

INCENTIVE SCHEME QUALIFYING ACTIVITIES INCENTIVES

Offshore Business

Conduct of business with non-residents and in currencies other than the Mauritian Rupee. Activities include: offshore banking, offshore insurance, offshore funds management, international financial services, operational Headquarters, international consultancy services, shipping and ship management, aircraft financing and leasing, international licensing and franchising, international data processing and other information technology services, offshore pension funds, international trading and assets management, international employment services ·€ No tax on profits

·€ Free repatriation of profits

·€ Complete freedom from exchange control

·€ Concessionary personal income tax for expatriate staff

·€ Complete exemption from taxes on imported office equipment

·€ Complete exemption from import duties on cars and household equipment for two expatriate

staff per company

·€ No withholding tax on interest payable on deposits raised from non-residents by offshore banks

·€ No withholding tax on dividends and benefits payable by offshore entities, no estate duty or

inheritance tax is payable on the inheritance of share in an offshore entity, no capital gain tax.

Freeport Transshipment and re-export trade, e.g. warehousing and storage, bulk breaking, sorting, grading, cleaning, mixing, packing and repacking, minor processing and simple assembly ·€ No corporate tax

·€ Complete exemption from payment customs duty and sales tax on:

all machinery, equipment and materials imported into a Freeport zone for exclusive use in

the freeport

all goods destined for re-export, access to offshore banking facilities, warehousing and storage fees at preferential rates

Export Service Zone Export oriented service companies, such as accountancy, law, medicine, international marketing, quality testing, pre-shipment services, civil engineering, management consultancy, re-insurance, entrepot trade, transshipment

·€ 15% Corporate tax

·€ Exemption from payment of income tax on dividends

·€ No customs duty on office equipment

Source: Destination Mauritius, Mauritius Export Development and Investment Authority (MEDIA).

Table 3.3: Others - Investment Incentives

INCENTIVE SCHEME INCENTIVES

Agricultural Development

Certificate

·€ 15% corporate tax

·€ Exemption from payment of income tax on dividends

·€ Free repatriation of capital, profits and dividends

·€ Exemption from payment of customs duty on machinery and equipment

·€ Exemption from payment of 50% of the normal registration fee on land and buildings purchased

by the new enterprise.

Hotel Management

Incentives

·€ 15% corporate tax

·€ Tax free dividends for 10 years

·€ Free repatriation of profit, dividends and capital subject to original investment being received

"A" status from the Bank of Mauritius

·€ Term loans and overdraft at preferential rates

Hotel Development

·€ 5% corporate tax

·€ Tax free dividends for 10 years

·€ Exemption of customs duty on importation of equipment as per approved list

·€ Free repatriation of profit, dividends and capital subject to original investment being received

"A" status

·€ Term loans and overdraft at preferential rates

Source: Destination Mauritius, Mauritius Export Development and Investment Authority (MEDIA).

Factors in Investor's Decisions

Negatives

Four main factors initially tended to detract from Mauritius as an investment location: its size, isolation, lack of natural resources, and uncertain sociopolitical future. Mauritius is an isolated speck in the Indian Ocean. The nearest country, Madagascar, is some 500 miles to the West. Sri Lanka is 2000 miles in the East. The great distances from potential markets for its products tend to add to its transport costs, whether by sea or air. The island is of volcanic origin and has no mineral deposits of any commercial value. The soils are shallow and poor in phosphates, and farming without fertilizers is impossible. The one natural resource Mauritius has been able to develop is its beaches. It has over 95 tourist hotels.

With independence in 1968, Mauritius inherited a fierce problem of unemployment and landlessness. The population skills were limited mainly to sugar plantation work. Moreover, a population of barely 700,000 constitutes a very small domestic market. The policies favoring import substitution industries clearly was based on political pressures and nationalism. Neither theories nor realities of international competition were well understood.

Furthermore, dependence of the economy on sugar, for 99 percent of exports and 70 percent of employment, meant that the economy was extremely vulnerable to fluctuations in world sugar prices and natural disasters like cyclone, drought and diseases. With such a hostile beginning for investment, what factors then led to the choice of Mauritius as an investment location to foreign investors? How did local investors get started? What were the catalysts behind the investment boom in Mauritius?

Positives

Foreign investment was not a factor in the early years of independence. Local investment grew strongly from 1972 through 1978. Foreign investment only began to be recorded as a separate phenomenon in 1976. The registry of firms and oral interviews suggest that it was negligible until one year earlier. Domestic investment thus clearly led the investment boom in Mauritius, making it an exception to the global pattern. There was a brief three years of foreign investment from 1975 through 1977, a period when local investment also continued to grow. The first Hong Kong textile firm pioneered with the EPZ legal framework, but it struggled in the early years and inspired little imitation.

In the late 1970s and early 1980s came a series of economic, political and climatic crises that caused an abrupt falling off in new investment, both foreign and local. Sugar prices were down on the world market, the country was experiencing political tensions, and a major cyclone destroyed both the sugar crop and much of the island's infrastructure. The crisis of 1979-81 proved a turning point for Mauritius' economy, a time of rethinking that led to a renewed national consensus and common economic strategy.

The turn around came with the announcement of an appropriate structural adjustment strategy by the government. Unlike structural adjustment programs imposed elsewhere on unwilling and/or uncomprehending governments, Mauritians seem to have devised its own strategy and united behind it. The new policy stance grew out of a dynamic civic leadership on the part of local investors and government. Investors explained why the EPZ law was not sufficient to overcome the constraints, and worked together with government to plan a more liberal, more dynamic future.

By then the socio-political situation appeared more stable. Tripartite labor negotiations, held annually then as now, provide a forum in which all parties come to understand the economic dynamics affecting them and to reach a consensus on development strategy. When the government changed hands through peaceful elections in 1982 and the new government appeared even more committed to a market economy, foreign investors took note.

In the early 1980s, after more than a decade of misguided attempts at industrialization, it became clear that the limited size of the domestic market meant that an import substitution strategy could not be viable. The government opted for an outward-oriented strategy leading to export-led growth. Ironically, the EPZ legislation had been in effect from 1970, but only became a factor in Mauritius' development from 1983 on, when all parties agreed to try to make it work. Once the strategic planning and policy dialogue processes were established, they became a tradition. Three successive pillars have contributed to investment, the Export Processing Zone (EPZ), tourism and financial/business services. The EPZ was the main focus from 1983 through 1993, tourism from 1990 to the present, and financial/business services only in the past few years.

Once the new policies were clear and a peaceful national consensus was established, foreign investment came in a strong spurt from 1983 to 1990. Investors from Hong Kong and Taiwan brought know how essential for the development of the textile/garment industry. Local investors, mainly Franco-Mauritian with some Sino-Mauritians, welcomed them and openly sought to learn from them. While local investors had surplus capital to invest, they did not have the know-how to establish manufacturing industries such as textiles. They took advantage of the opportunity to learn from the foreign investors, and within a few years, they ended up buying out most of the foreign owners.

Foreign Investors

The 'Pull Factors'

The success of Mauritius in attracting foreign investment in the mid-1980s rested on creating the right economic and social climate by emphasizing the following factors:

·€ Political stability and policy consistency

Governments in Mauritius have changed several times since independence, without violence and without changes in investment policies. The long-term strategy, the overall vision and economic policies have become increasingly stable and pro-investor. Investment incentives have gone from favorable to even more favorable.

·€ Sound Institutions

Sound institutions have been shown to be the one factor that can outweigh the negative influence of ethnic diversity on economic policies and economic growth. (Easterly and Levine 1996) Mauritius inherited a unique set of sound legal, financial and educational institutions at independence and has resisted the institutional deterioration experienced in most African countries. Mauritian institutions had French underpinning with a British superstructure. Napoleonic Code, for example, was overlaid with British common law and courts.

The unique constitution provides for ethnic and geographic balance in Parliament. Single member districts elect 62 of the 70 seats. This system favors local accommodation between representatives and their constituents of all ethnic origins, unlike the polarizing proportional representation system. In addition, the Mauritian constitution provides for up to eight seats to be awarded to ethnic minority candidates who place "next best," if their group is not otherwise represented in Parliament.

A French patois is the lingua franca and formal French is taught in the schools, but the main language of instruction is English. At independence there was 70 percent literacy, generally in both English and French. Hindi, Urdu, Tamil, Tulugu, and several Chinese languages are spoken. Written literacy in these languages is less widespread, but the availability of native speakers of investors' own languages has made a wide range of investors feel comfortable in Mauritius. In the early years, basic literacy was sufficient. Today factory owners are pressuring the government to provide higher quality, bettertargeted vocational and technical education.

A single bank served the island at independence, but it was a sound one, providing a range of financial services since 1828. Investors trusted their funds to it, and sometimes also benefited from local credit. Financial services today are comparable to the level in South Africa, a vastly larger economy. A wide range of supporting services including commercial, development and investment banks, insurance companies, auditing, accounting and consulting firms has developed to serve the new industrial economy.

Mauritians use credit cards freely, whereas many African businesspeople lack access to credit cards. Automatic teller machines outside major banks provide cash and accept deposits after hours. These facilities reduce transaction costs, which is greatly appreciated by investors. Economic development literature also emphasizes the importance of respect for private property rights and an efficient and honest bureaucracy. On this score Mauritius gets mixed results. There has been no history of expropriation and no evidence that investors had been required to give a percentage of their business to government officials, as happened in other African countries. On the other hand, two or three cases were found where major investments were abandoned at a loss by the original foreign investors. It was beyond the scope of this paper to investigate all of the reasons, but there clearly were some quite disappointed investors.

Business integrity can also be considered an institutional factor. Mauritian firms regularly publish audited accounts. This contributed to the trust necessary for government to allow an island-wide EPZ, and for banks to sustain the credit system. This basis for mutual trust is an important missing element in many business communities in Africa. While the high rate of literacy provides a skilled labor pool for the civil service, surveys ranking the government on a number of indices indicate important shortcomings in overall effectiveness. The 1998 African Competitiveness Report for the World Economic Forum provides the most recent survey data, which is summarized for key countries in Table 6.4. (See Annex)

·€ Cheap, trainable labor force

In the early years, that is, before the investment boom, there was massive unemployment. Labor was therefore cheap compared to places like Hong Kong and Taiwan where the 1980s wave of investors in Mauritius originated. The adaptation was not simple, as Mauritians were initially slow in assembly line work and unreliable in their attendance. Factory owners use many combinations of carrot and stick to enhance their productivity. Some are trying team approaches to production. Several factories reported that they intersperse along the assembly line experienced Chinese workers, whose output is often three times the Mauritian average. They also bring in Indian workers with multiple task skills to fill in for absentees in different spots each day. After a few years, production reached an acceptable level of both productivity and quality in most factories. Several succumbed, however, during the early years. In those who survived, skilled contract Chinese and Indian laborers are still an important stimulus to productivity. With a literacy rate of over 90 percent and most of the labor force having at least attended primary school, Mauritian workers could be trained relatively easily, especially as most of the techniques of production in sectors being targeted (textiles) were simple and labor-intensive. The firms benefited greatly from sales and office staff who were fluent in both Asian and European languages. Much credit goes to the good quality schools, in which students learn both English and French in addition to their mother tongues.

·€ Good economic management

After 1980, the government created a sound macroeconomic environment through judicious blending of policies. Inflation was kept at a low level and monetary policy was geared towards promoting a savings culture. The Rupee is convertible and the exchange rate against other currencies has devalued only slowly.

·€ Infrastructure

The Mauritius Government invested heavily in infrastructure. This involved the overhauling of the road network, the airport, extension of the telecommunications, electricity and water network. Fully operational industrial estates provided sites and services for lease, to minimize investors' start-up costs. Mauritius Telecom has been one of the last to be privatized, so there is little competition in the sector. Nevertheless, it has consistently modernized and reduced costs of service.

·€ Preferential market access

Mauritius has preferential access to the European market through the Lomé Convention and Sugar Protocol and to the US through the Multi-fiber agreement. It also has a sugar quota with the United States. During the 1980 and early 1990s it joined the so-called "frontline states" surrounding South Africa in ignoring sanctions, for the sake of its own economic survival. This proved a boom, as South Africa became a major trading partner and source of tourists. Membership in regional economic cooperation groupings such as SADC is an advantage on which Mauritius is counting for the next phase of development.

·€ Investment incentives and promotions

Hong Kong investors described actively surveying potential investment sites. Most were eliminated after considering the above factors. When the final selection time came, investment incentives determined their choice of Mauritius from among the last two or three candidates.

·€ The people

The multi-ethnic, multilingual nature of Mauritian society has been an asset in providing a welcoming and friendly investment environment to foreigners. In particular, the Mauritians of Indian and Chinese origin have provided an environment which is 'home-like' to investors especially from India, Hong Kong, China and Taiwan. They feel safe, accepted and can trust the people around them while in Mauritius.

·€ Strategic use of its location

Mauritius has turned its lonely island location into a "gateway to Africa" in its promotional literature. Its first success came in attracting South African stopover flights and tourism during the sanctions period, when South Africans had nowhere else to go between home and Europe. For the textile industry, Mauritius' location was an acceptable halfway between headquarters in Asia and markets in Europe, although without strong push factors, it is doubtful that they would have sought it out. More recently Mauritius' offshore banking arrangements have targeted investors from India and Europe interested in the advantages offered by bilateral double-taxation treaties. Mauritian policy-makers believe that it can attract a significant volume of shipping by encouraging ships with containers full of Asian goods to stop and repackage mixed shipments for different African countries. This is a new concept and new facility, currently operating well below capacity.

6.2.3.2 The 'Push Factors'

Mauritius' success is due in no small measure to alertness and ability to respond to external global events. This capacity for quick response is the newest new thing in strategic planning. Having indigenous leaders with close ties to Asia and Europe allowed Mauritius to understand and integrate lessons from the trends in each before the age of instant cheap global communications. The key events for Mauritians were the British decision to hand over Hong Kong to China and the international Multifiber Agreement, which together sent Hong Kong industrialists searching for new havens for capital and textile industry production.

·€ The Sino-British agreement over Hong Kong

When in 1985 Prime Minister Margaret Thatcher signed an agreement to end British rule over Hong Kong in 1999, and relinquish it to communist China, Hong Kong capitalists felt insecure. There was an atmosphere of uncertainty over what would befall Hong Kong after its handover. Business people in Hong Kong were looking to diversify, if not relocate.

·€ The Multifiber Agreement

In the early 1980s, the multifibre agreement was signed and US further tightened its quota of textiles from Hong Kong and Taiwan. The overseas Chinese textile barons saw an opportunity to take advantage of the Mauritius unfulfilled US quota and the preferential textile market access to European market. Hong Kong and Indian investors reported studying alternative investment locations, such as Madagascar and Sri Lanka which were also providing EPZ facilities. Madagascar had inadequate infrastructure and a poorly educated population, while Sri Lanka was riddled with insecurity due to the Tamil Tigers rebellion. Madagascar was considered unsafe and had unfavorable government policies towards investment. Mauritius offered a safe enclave with the people of the same cultures and way of life.

·€ High labor cost in Hong Kong

By the mid-1980s the maturing textile industry in Hong Kong and Taiwan was seeing wage pressure. In Mauritius, with its high unemployment, they hoped to find cheap labor that might be as efficient as that in Asia.

6.2.4 Local Investors

The factors that attracted foreign investors were equally import to local investors. However, local investors had additional considerations that served to catalyze their new investments in the 1980s. Among these, were the following:

·€ Need to diversify

A number of sugar barons had capital available for investment in the 1980s, and they knew better than anyone the concentrated risks of a monocrop economy. Moreover, new sugar investment was precluded by lack of land. They tried many non-traditional agricultural exports, such as cut flowers grown in ecological microclimates. Once shown the way by foreigners, however, they started reinvesting the sugar profits in textiles, and later tourism and other types of light industry.

·€ EPZ scheme and government incentives

Local investors seem to have been more motivated by the EPZ advantages than foreigners, perhaps because their economic activities were rooted in Mauritius. They could quickly calculate that having a significant-and possibly fluid-portion of their assets in tax-free corporations should be good business.

·€ Local bank lending

Banks played an important role in bringing up local investors by providing them loans at attractive rates. The State Bank of Mauritius, founded in 1828, was the mainstay of investment banking in Mauritius, although in recent years a half-dozen new banks have entered the scene. Local investors could finance up to 80 percent of their investment. Foreign investors could finance 50 to 60 percent locally. Interest rates at the time of the field research in October 1997 were 9-10 percent on long-term loans.

·€ Local population linkages with Europe, India and China

Local investors could access the required technology, entrepreneurial skills, start-up capital and markets through linkages with Europe (France and Britain) and Asia.

·€ The potential in tourist industry

The Mauritians either working in hotel industries previously owned by foreign firms or wanting to break away from the monocrop culture identified tourism as a potential sector with growth prospects. Because of the land laws and local political influence, they had an edge over foreigners in acquiring plots along the beaches. The sugar barons, in the drive to diversify, started investing in the hotel industry.

·€ Historical factors

Many Mauritians credit the grit of immigrants for the national success. Immigrants in general develop a strong instinct to survive and have a spirit of adventure. Immigrants generally leave the motherland with the hope and determination of a better life. They arrive in a new land with all energies mobilized for survival, as there is little social safety net. Therefore the spirit of excelling is inherent in their lives. The fact that no group can claim territorial rights also helps blunt the edge of ethnic sentiments.

6.3 Linkages between Foreign and Local Investment

6.3.1 Linkages between Foreign and Local Partners

Local and foreign investors have been present from the start in both main sectors of economic diversification in Mauritius, industrialization and tourism. In most areas of both industrialization and tourism, local investors preceded foreign in the first efforts, but the real boom began when foreigners took the lead. Foreign investors had the technical manufacturing knowledge, factory management know-how and market contacts needed to succeed. Local investors were interested from the start, however. They brought land, management capability and capital to the table.

Similarly in tourism, there were some locally owned hotels early on. The real growth spurt, however, came when Sun International, then a South African based chain, brought international standards of architecture, services and entertainment to the business. They were a minority partner, Mauritian sugar interests having provided the majority of the capital and access to the land, but Sun managed the first luxury hotels. Local hotels quickly began innovating themselves, raising the overall quality in the sector. Today the most recent and most luxurious hotels are Mauritian owned and managed.

The EPZ law was passed shortly after independence, but many of the first industries catered to import substitution for the local market. At the end of the first decade there were only 100 EPZ firms. The import substitution industries were a good industrial apprenticeship for local investors, as the mass-market products produced required relatively simple manufacturing techniques, and quality was not at a premium in a protected market. Foreign investors were slow to decide on Mauritius in the first decade after independence, because its now renowned political and social stability was considered uncertain at the time. None knew whether the Hindu majority would nationalize land and industries or let the Franco-Mauritians and Sino-Mauritians continue to dominate the economy.

As exports industries began to expand in more complex and competitive industries from 1983 on, both local and foreign investors recognized that there was strong synergy between their enterprises. Kin and ethnic networks played an important role in forging viable partnerships. Hong Kong manufacturers came looking for a safe haven for capital and quota-free access to markets. They knew the machinery, the factory organization, the worker training needs, and the customers' tastes. In fact they arrived with orders in hand. The first big firms, however, lacked sufficient confidence in Mauritius' social stability to transfer all of its operations here.

Purely local investors welcomed the foreign investors instead of seeing them as competition. Many local garment firms got their start doing commission work (cut, make up and trim) on shirt orders too big for a foreign factory to handle. They hired away skilled labor and managers from the foreign companies when they could. Buyers who came to deal with the foreign-owned firms stopped by to see what other factories were producing. Thus local firms acquired new customers.

The Fragile Early Years

Floreal Knitwear, one of the Island's current flagship firms, was established by Oriental Pacific Export (Hong Kong) in 1971 to do only manufacturing. Marketing was supposed to be handled by a Japanese firm. When that arrangement failed, Oriental Pacific sold out three years later rather than set up local marketing operations. Their successors believe that it was mainly because Mauritius was then experiencing a period of political tension, and that the investors feared for its future stability. In retrospect, they misjudged the political situation. The local firm created by the sugar interests which bought out Oriental Pacific has gone on to become a local and regional conglomerate.

Joint ventures were one means of collaboration, particularly at first. Today they are not the most common. Less than half of current foreign firms are joint ventures. Joint ventures are voluntary on both sides, and joint venture local partners always bring capital to the table. This is a major difference between obligatory joint venture schemes that have been tried, with little success, elsewhere in Africa. Often, in the latter, the capital subscribed by the African partner was a fiction-either lent him by the foreign partner or exacted as a political favor. Mauritius seems to have largely avoided this type of joint venture.

In the hotel sector similar relationships apply, although Mauritian investors have a strong advantage in their access to prime land. The sale of land to non-Mauritians is prohibited by law. Foreigners can overcome this by creating a local firm, which then has the right to buy land. In practice, however, most of the prime land for both tourism and industry is held by Mauritians. In the hotel sector one finds several hotels owned 80 to 100 percent by Mauritians but managed by foreign firms. There are also 100 percent foreign owned hotels, but they are not many and they report difficulty buying land.

6.3.2 Outsourcing/Jobbing

Many local firms reported that they got their start working on a contract basis for big foreign firms. When large firms have a rush order larger than they can handle, they commission smaller locally owned ones to cut, make and trim the pieces. The smaller firms reported that this is how they learned which models were selling and the quality of work that was required. The big firms would come work with them to ensure that the work was completed correctly. That way both they and their labor force received additional training.

6.3.3 Global Sourcing

The multiple ethnic linkages on the island created an instant international sourcing network before the age of globalization. The MEDIA spokesperson considers that Mauritius' garment industry has a major advantage over South Africa's much larger sector in this respect. South Africa's garment and textile industries are vertically integrated, which ties garment makers to high-cost mediocre quality fabrics in a limited range of styles.

In Mauritius, most of the local garment industry is knitwear rather than woven cloth. Knitwear involves several less steps than woven, as the fabric and garment are made in an integrated operation. Many knitting firms do their own spinning, getting their raw cotton mainly from India. Others source their yarn from India. Raw wool comes mainly from Australia and New Zealand, but specialty wools come from the UK. Dyes for both cotton and wool come mainly from Germany. Mauritian firms were able to compare global sources early on, and they quickly diversified whenever price/quality ratios change. In this area as well, local firms reported being glad to be able to learn from the bigger foreign firms.

There is some vertical integration in Mauritian textiles and garments, but it is at the high quality end and clearly mutually beneficial. Two ultramodern Mauritian textile firms produce shirting for garment makers supplying Marks and Spencers (UK) and other upscale firms. Both were created by garment makers working with top-end retailers seeking to integrate their operations upstream to ensure quality and availability. All of the woven cloth is sold to local garment makers, and demand exceeds capacity.

6.3.4 Training and Technical Assistance

Firms are conscious of the fact that they benefit from one another's efforts to train the workforce and from shared technical assistance. Technical assistants sent by a buyer to work with a large firm will sometimes also work with their smaller outsourcers. And all firms compete to recruit qualified personnel. Initially the Hong Kong firms provided much of the workforce training. At first they brought in line managers and most of a line of workers from Hong Kong workers to show the Mauritians the needed skills.

In the hotel sector, training has involved far less direct foreign technical assistance. The managers of Mauritian hotels, however, reported on the job experience working under foreign managers at local hotels.

6.3.5 Labor Force

In the early 1980s Mauritius was fifteen years into independence and still had 23-25 percent unemployment. Its one big advantage was that over 90 percent of adults were iterate, and most secondary school graduates spoke both French and English. When the second wave of Hong Kong investors began to arrive in large numbers in 1984, they set up text


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