Tax incentives are of limited value when foreign investors are motivated
by the desire to access domestic markets or natural resources. PHOTO |
FILE
According to the 2017 World Investment Report published
by the United Nations Conference on Trade and Development, more foreign
investment capital flows to developed markets relative to developing
markets.
In 2000, $5.8 trillion in foreign capital
flowed to developed markets, $4 trillion more than what flowed to
developing markets. Today, this gap has widened. This year, $17 trillion
flowed to developed markets, $8 trillion more than what flowed to
developing markets.
Clearly, for developing markets,
attracting this foreign investment capital requires a rethink of their
capital mobilisation approach. To understand this better, we need an
illustration.
Uganda is a developing country that has
not succeeded in its efforts to be sub-Saharan Africa’s preferred
foreign direct investment destination. Despite a slew of incentives to
foreign investors — like open-ended tax exemptions — the country’s stock
of FDI has declined by 40 per cent over the past six years.
Last
year, the country attracted $541 million in foreign capital — a paltry
0.6 per cent of what the Netherlands, a developed market, attracted. The
country’s leadership is of the view that to turn around Uganda’s FDI
prospects, more tax holidays should be offered to foreign investors.
In
August 2016, at the Bank of Uganda’s celebrations to mark 50 years in
existence, President Yoweri Museveni remarked that: “…You find that we
have high corporation tax of 30 per cent. My economists say we only tax
you when you make profits. That is very good, but if you didn’t tax me,
wouldn’t I transform more. And how about the one who taxes less, is he
not going to attract more investors than you who is taxing more?”
Capital movement
The
president’s approach, as well as the country’s focus on tax incentives
as a way of attracting FDI, ignores two established aspects of capital
movement in Uganda and in developing markets.
One, tax
incentives are not a deal-breaker for investors in Uganda. According to
an Investor Motivation Survey conducted by the Investment Climate
Department of the World Bank Group in 2012, over 92 per cent of
investors in Uganda who were enjoying tax incentives then would have
still invested their capital even without these incentives.
Two,
tax incentives are of limited value when investors are motivated by the
desire to obtain access to domestic markets or natural resources.
Reinvigorating
Uganda’s FDI prospects is still a possibility, but the following
question must be answered: Why do foreign investors deploy capital in
developing markets?
In their work titled Multinational Enterprises and the Global Economy,
professors John Dunning of the University of Reading in the UK and
Savianna Lundin of Maastricht University in the Netherlands proposed a
framework that differentiates between the various motivations of FDI.
According to them, foreign investors are generally motivated by four
desires:
- Access to natural resources in the host country. For example, Barrick Gold Corporation’s investment in Tanzania’s Bulyanhulu goldmine in July 2001.
- Access to the host country’s market. For example, McKinsey and Company’s investment in opening a local office in Nairobi in August 2014.
- Acquiring strategic assets of firms in the host country — such as IBM’s acquisition of the German technology company IRIS Analytics in January 2016.
- Saving costs through higher production efficiency such as Bombardier Aerospace’s investment in setting up of a manufacturing facility for its learjet 85 aircraft in Queretaro, Mexico, in October 2010.
Policy interventions
In
developing markets, however, close to 90 per cent of foreign
investments are predominantly motivated by the desire to access the host
country’s domestic market, according to the World Bank Group’s 2017
Global Competitiveness Survey, in which over 700 business executives of
multinational enterprises with investments in developing markets were
interviewed.
With such a credible statistic, Uganda’s
leadership should ask: What policy interventions are best suited to
attract market-seeking investors?
According to the
same survey, market-seeking FDI are most responsive to, in descending
order, political stability; a clear legal and regulatory environment;
market size; macroeconomic stability; availability of talent and skilled
labour; and the presence of physical infrastructure.
If
we are really committed to attracting FDI, we now know where to focus.
For long time now, we have prioritised tax incentives with disappointing
results. It is time to change course.
Victor Tumwenturaho is a structured finance analyst. E-mail: vnturaho@gmail.com
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