Private Sector and Infrastructure 'ONAL :* .M/i4rch 2002 Findings reports on ongoing operational, economic, and sector work carried out by the World Bank and its member governments in the Africa Region. It is published periodically by the WORLD BANK Knowledge and Leaming Center on behalf of the Region. The views expressed in Findings are those of the author/s and should not be attributed to the World Bank Group. Madagascar: Incentives and IV A D z Obstacles to Trade Lessons from manufacturing case sudies 2 3 9 7~"" 4~ since the mid- 1980s the Mala- uting to a faster overall growth rate gasy government has pursued with a much broader base. Despite fiscal and administrative re- the dramatic growth of recent form along with economic and fi- years, EPZs also face constraints, nancial liberalization. These efforts and there is considerable room for have contributed to steady GDP improvement. Firm-level studies growth rates since 1995, averaging allow for deciphering the impedi- 4.1 percent between 1997 and ments and challenges faced by 1999. Manufacturing has been these disparate groups. Madagas- * w [ keeping pace with GDP, its share car must address these issues to hovering around 12 percent. Firms improve productivity and competi- W W located in Export Processing Zones tiveness both inside and outside (EPZs) have experienced tremen- EPZs, as trade barriers fall around - dous growth, (19 percent a year the world and the country becomes - _ between 1995 and 1999), but their more integrated into the global production still represents a rela- economy. - S tively small share of value added. Most of the growth in the Malagasy Export Processing Zones economy has occurred in transpor- * tation, construction, and other As part of the government of non-tradable sectors. By contrast, Madagascar's active promotion of * the development of import-substi- exports since the early 1990s, it tuting (IS) firms has been consid- developed Export Processing Zones erably slower. In the past, IS firms (EPZs) to attract foreign direct in- -became accustomed to producing vestment (FDI). Investors from for the domestic market under the China, France, Hong Kong, India, _ protection of high import barriers. Malaysia and Mauritius and oth- _ These companies are stagnating as ers responded. In 1999, entrepre- they find themselves unprepared for neurs invested about FMG 328 bil- * - t the stiff competition from imports lion, (around $US 51 million) in unleashed by recent liberalization. textile firms, while investment in The present market structure has agro-processing amounted to FMG U created distortions, pulling re- 58 billion (around $US 9 million). sources into the EPZs (and to some Wood processing and data process- extent, the non-tradable sector) ing firms invested FMG 39 billion T O 3 from the rest of the economy. Given and FMG 20 billion respectively, the right environment, all segments (for example of one zone in 2000 of the economy can thrive, contrib- see Table 1). Table I Industrial Free Zone (Agglomeration of Tana and Antsirabe), 2000 Division Production in billions Value added in billions Average value added FMG (% of total) FMG (% of total) in billions FMG Textile manufacture 690.7(50.3) 122.6(32.4) 3 Manufacture of articles 546.1(39.8) 213.3(56.3) 4.5 of clothing, making and dyeing of fur Manufacture of leather and shoes 11.2(0.8) 3.9(1) 0.8 Wood manufacture(except furniture) 15.2(1.1) 3.1(0.8) 0.6 Manufacture of precision medical 25.2(1.8) 10.8(0.6) 3.6 instruments and optics and clocks Furniture manufacturing 52.8(3.8) 12.7(3.6) 2.1 Others 32.4(2.4) 12.3(2.1) 1.8 Total 1373.6(100) 378.7(100) 3.3 The Malagasy government offers advantage. Whether the industry Common law sector several incentives to firms located will continue to prosper after the in EPZs including a grace period on removal of quotas under the Multi- The Common Law sector consists corporate taxes for the first 2-15 Fiber Agreement and the phase-in of those firms operating outside of years of operations; exemption from of local content rules under the EPZs - import substituting firms customs duties and taxes on im- United States' Africa Growth and (IS) and the non-tradables sector. ported equipment; taxation of divi- Opportunity Act, depends on its Most of the recent growth in Mala- dends at only 10 percent; and 99- ability to improve competitiveness gasy economy has come from non- year leases for investment in land. vis-a-vis other major exporters in- tradables sectors, including con- There is a VAT of 20 percent on cluding India, Bangladesh and the struction, transport, beverages and imported inputs supposedly re- Caribbean Basin and East Asian tobacco. Import-penetration ratios funded within one month upon countries. in recent years have on the whole proof of exports, thereby prevent- Continued high growth rates in increased, suggesting that the weak ing leakage of goods into the do- EPZs require a stable and favorable growth of IS firms is likely due to mestic market. Implementation of regulatory environment as well as import competition, (Table 2). IS this VAT drawback scheme has substantial improvements in the firms producing for the local mar- been difficult and is an area of on- provision of infrastructure and ket have been protected by formal going concern. public services. For example, the and informal barriers to entry in In the past several years, garment growth of information technology the past and have not yet fully re- and textile firms have been flock- firms is currently limited by the structured to face competition from ing to Antananarivo and Antsirabe, lack of bandwidth. Madagascar's imports. Consequently, resources where most EPZs are located. These low labor costs for literate, French- have been flowing out of traditional firms currently account for almost speaking workers has encouraged IS industries toward non- 90 percent of the value of EPZ pro- the establishment of firms that de- tradeables that do not have to com- duction in these cities. Encouraged sign web sites and Internet appli- pete against imports. by the effective implementation of cations, perform data entry and Malagasy IS firms face a substan- the EPZ legislation, firms have provide Internet content for tially more difficult business envi- taken advantage of some of the low- Francophone countries. High com- ronment than do EPZ firms. Un- est labor costs in the world and munications costs force firms to like firms in EPZs, they receive few preferential access to the US and make large shipments of data via tax incentives or duty exemptions EU markets. But most companies courier imposing high transporta- and therefore, find themselves have not yet made irreversible in- tion costs and slow shipment turn- shouldering a disproportionate vestments and they can easily move around times. share of the economy's fiscal bur- if Madagascar loses its competitive den. Moreover, they bear the brunt Table 2 Import-penetration ratios, 'competing' sectors (in %) Branches 1995 1996 1997 1998 1999 Food 31.7 22.2 27.0 21.4 25.6 Beverage and tobacco 30.5 12.4 23.5 25.3 17.1 Textile & clothing 4.0 5.1 8.7 7.8 5.7 Wood 3.2 5.9 4.7 8.2 7.4 Paper & printing 32.1 30.5 39.1 44.3 49.4 Leather goods 8.0 7.1 25.1 28.3 27.4 Electrical equipment 6.1 3.5 4.8 4.0 6.9 Metal products 80.9 67.5 71.8 75.7 71.0 Chemicals 26.5 20.8 33.2 27.8 30.4 Energy Construction material 38.7 20.9 20.1 29.5 24.2 Transportation equipment 23.6 15.4 28.7 23.9 30.5 Mining 10.9 10.6 12.4 13.1 9.9 Sources: IMF (2000); INSTAT; Ministbre du Commerce; authors' calculations. Finance and banking of government regulations and ad- Infrastructure Finance is cited as a major prob- ministrative procedures. Currently, electric power appears lem by almost all firms surveyed. Among other concerns of IS to be adequate in the capital. How- As difficult at it is to get short- term firms, one of the most frequently ever, firms report that voltage fluc- money, long-term finance is even cited is the quality, availability, and tuations and outages are increas- harder. Credit is restricted because high price of local inputs. In addi- ing and that they plan to buy banks find it difficult to obtain re- tion, the aging capital stock in most standby generating plants in the liable information on borrowers or firms means dependence on out- near future. Outside of to accurately assess their credit- dated and inflexible technology and Antananarivo, the electricity infra- worthiness. More important, the frequent production breakdowns. structure is far worse. The run- judicial system is weak and inef- The small size and fragmentation down inland transportation infra- fective, making it extremely diffi- of Madagascar's market is also a structure affects particularly the cult and costly for creditors to ob- frequently-cited explanatory factor companies serving the domestic tain recourse when a borrower de- for the weak price competitiveness market. High shipping costs and faults on a loan. Moreover, land of local products vis-a-vis imports. inadequate air freight capacity sig- tenure laws make it impossible for Firm-level interviews suggest that nificantly raise the general cost of foreign banks to take title to land, substantial barriers to regional international business. The high rendering it almost worthless as market access persist in spite of cost of physical and electronic com- collateral. preferential agreements. munications between Madagascar At the end of September 2000, and the rest of the world affects all more than half of all domestic credit Cross-cutting issues sectors of the economy. The lack of was swallowed by the public sec- bandwidth keeps the cost of con- tor, 'crowding-out' private invest- The survey of representative indus- nectivity high, effectively capping ment. As a tight oligopoly protected tries identified a variety of factors the size of the IT sector. Hopefully, by barriers to entry, the banking that affect productivity in all indus- telecommunications costs will come sector enjoys rents which it is not tries and, taken together, dramati- down as the market is deregulated. ready to dissipate: high intermedia- cally reduce competitiveness. Already, the introduction of mobile tion margins, very profitable opera- phone licenses have helped lower tions on the foreign-exchange mar- the cost of voice communications. ket and high transactions fees. Training and education Also, companies interviewed have * Replace direct state intervention A factor common to all firms is the noted that it has become increas- in agro-industrial transformation dearth of trained workers, espe- ingly difficult to obtain expatriate industries with a policy of incen- cially skilled middle-level manag- work permits and permission for tives for private investment in ers and technicians. Basic educa- overtime from the Ministry of La- agriculture; and tion appears to be declining and the bor in a timely manner. * Rehabilitate the highway infra- few industrial training institutions structure and what remains of that do exist appear to be suffering Recommendations the railway network. from neglect. Decreasing gradua- * Lower protection (perhaps a tion rates are compounded by a . X r To get beyond the current 'foot- decline in the quality of education. maximu rte do 20 perc to loose' FDI, the regulatory frame- Another important void in the edu- berougtd to aruniform work must be improved. Suggested cation system is the lack of train- cent)sto steps include: ing in English, the world's main Lower and more uniform taxa- * Delegate the level of decision- business language. tion in order to improve collec- making authority needed to ob- tion,in oratestain EPZ status; Business environment tion rates; Streamline company registration * Collect border taxes more regu- Despite the success of the EPZ sys- larly, at current rates, on final procedures including obtaining tem, government bureaucracy is products; work permit visas for foreigners, still a burden and imposes high and those for environmental com- costs on business, especially com- * Lighten the fiscal burden on im- pliance; panies producing for the domestic ported inputs; Reduce the length of time (cur- market. High taxes, the capricious * Encourage entry into the bank- rently 4 to 6 months) to obtain enforcement of laws and regula- ing system and improve trans- EPZ status to the 21 days speci- tions as well as corruption have parency of the regulatory frame- fied by law, and adopt a new law made it difficult for these firms to work; that will make it easier to obtain restructure to meet the challenge * Adopt a competition law that does EPZ status; of import competition. not give excessive power to the . Take full cognizance of the fact Customs and the import/export administration and implements that well-functioning property regime continue to be burdensome. checks and balances' in order to rights are a sine qua non for long- Corruption and inefficiency have prevent the privatization of key term development. resulted in high costs and slow infrastructure sectors from sub- shipping turnaround times. IS stituting a private-sector mo- firms complain that the customs nopoly for a public-sector mo- agency does not consistently en- nopoly; force tariff duties, putting them at * Develop more effective competi- a disadvantage. Taxes are not tion policy, based on stable rules much of a concern for EPZ firms rather than discretionary powers, This article was written by Oliver because most of them are currently in sectors where ententes are Cadot and John Nasir, the latter operating within a five year tax present; being a member of the Regional holiday. But firms producing for the * Improve incentives for productive Program on Enterprise Develop- domestic market, (especially the investment so as to compensate ment (RPED). For more informa- larger, more conspicuous firms), the high cost and unavailability tion, please contact suffer many tax audits, inspections of investment credit; Jnasir@worldbank.org and other forms of harassment.