Domestic risks to Africa’s growth: Navigating local content regulation and taxation

Editor's note:

On October 7, 2016, the Brookings Africa Growth Initiative hosted its second biannual roundtable examining the risks, trends and opportunities in relation to Doing Business in Africa. This session focused on local content regulation and taxation. For more on the roundtable, see here.

Sub-Saharan Africa is currently experiencing its slowest growth pace since 1994. The International Monetary Fund predicts that this year the continent will grow at a rate of 1.4 percent, down from 3.6 in 2015. Africa’s economic powerhouses—Nigeria and South Africa—are seeing their lowest growth rates in years. Nigeria is predicted to experience a 1.7 percent decrease, while South Africa’s growth rate will lie at 0.1 percent. The decline in Africa’s GDP growth is a reflection of the challenging global macroeconomic climate. Amid the slump in commodity prices, policymakers have urged African countries to diversify their economies and trigger structural transformation. In order to do so, African countries must attract foreign capital.

Striking the right balance

The quest to attract foreign investors brings about the issues of local content regulation and taxation. Today, African countries have to strike the right balance between two tough, but not necessarily contradictory, choices: designing incentives to attract foreign capital vs. strengthening domestic revenue mobilization and developing local content. If designed too rigidly, local content regulations can drive away investors or substantially raise the cost of doing business. Conversely, if loose or nonexistent, local content regulation can hinder countries’ structural transformation, as governments would fail to utilize the country’s local resources, transfer much needed skills and technology, and develop nascent domestic industries. Similarly, poorly designed tax regulation can reduce a country’s attractiveness to foreign investment. However, African countries need to raise their domestic revenues in order to achieve sustainable and inclusive growth. In addition, they need to limit revenue losses from illicit financial activities.

Local content is crucial in getting new and existing businesses to contribute to a host country’s economy.

Local content is crucial in getting new and existing businesses to contribute to a host country’s economy. The use of local content can help in boosting job creation, thus creating a virtuous circle. This potential benefit has not escaped the attention of African policymakers. For instance, in its 2002 Investment Proclamation, the Ethiopian government introduced local content requirements in the manufacturing industries and imposed limits in the employment of foreign staffers. A company applying for an investment permit should provide a time schedule for the replacement of foreign employees by Ethiopian employees in addition to a training program allowing such replacement to occur. However, managerial positions are exempt from this rule. In contrast, Angola requires that oil companies have a workforce that is 70 percent Angolan, a requirement companies have difficulties meeting due to the existing skills gap. More recently, the Rwandan government has also incorporated “local content” requirements in its guidelines for energy investment.

Too strict local content rules can, however, hinder its potential benefits. In some countries, the early stage of local content regulations has been too ambitious partly because of insufficient domestic capacity to meet stringent targets. Currently, a number of projects have been reportedly put on hold due to strict local content regulations. As a result, the new generation of local content regulation has been less demanding. One key issue is that there are few studies of the net benefits of local content regulation in African countries.

The contrasting priorities of foreign actors

In today’s world, foreign investment is highly coveted. With the rise of capital mobility, corporations have a choice in where they wish to invest. With that in mind, strict regulations may sway investors away from investing in a host country. In addition, the development of new local content regulations can be rather challenging. When corporations enter a country under a certain set of rules, a change in said rules—i.e., the development of local content regulations and the implementation of stricter tax regulations—can have a signaling effect to other corporations, stating that the government in question is likely to change its regulatory framework without much notice. A number of cases illustrate how topical the debate is: The South African mobile company MTN was recently fined $5.2 billion by the Nigerian Communication Commission for failing to register up 5.2 million SIM cards. The rule, instituted in 2010 was not strictly enforced by the previous administration. Last year’s administration change in Nigeria brought about stricter enforcement of rules and regulations, which in turn led to the fine. Recently, the Chadian government imposed a $74 billion fine on ExxonMobil for failure to pay taxes. The fine is about seven times Chad’s GDP.

In today’s world, corporate social responsibility (CSR) is becoming increasingly important and seeking ways to support local employment and the development of domestic industries should be a key part of multinational’s CSR strategy.

While some might argue that corporations are accountable to only three groups—employees, shareholders/owners, and customers—others might disagree and state that corporations are accountable to a myriad of actors, including their host countries in their quest for sustainable and inclusive growth. As noted in the recent debate on sustainable development, some corporate choices that appear to be costly in the short-term (for example investing in renewable energy) are not when a longer-term horizon is considered. In the long run, moral responsibility can serve a great self-service interest for multinational corporations. In today’s world, corporate social responsibility (CSR) is becoming increasingly important and seeking ways to support local employment and the development of domestic industries should be a key part of multinational’s CSR strategy.

Today, a few months after the Panama Papers scandal, we see the emergence of a new mindset, coupled with increased integrity, where companies are told to pay their “fair share.” Through base erosion and profit shifting (BEPS), multinationals can deprive developing countries of much-needed domestic resources. Paying taxes is another key pillar of CSR. While some might argue that corporations do not have the moral responsibility to pay taxes, others will state that tax avoidance, while legal, is certainly illicit.

Another challenge to the development of local content regulation in Africa is the mismatch in the priorities of foreign government. United States government agencies face strict regulations when it comes the projects they are allowed to support, meaning that some local content regulations can even make it difficult for U.S. companies to get U.S. government support or protection to invest in Africa. The U.S. government agency the Overseas Private Investment Corporation (OPIC) in its handbook states the following:

By statute, and consistent with overall U.S. government policy, OPIC does not participate in projects subject to performance requirements that would substantially reduce the potential U.S. trade benefits of the investment. Of particular concern are “trade related” performance requirements covering local content and maximum import and minimum export levels where the effect is to reduce U.S. trade benefits that would otherwise accrue.

Moving forward

In conclusion, corporate taxation will remain critical for domestic revenue mobilization and local content regulation, when implemented adequately, can be a great tool for developing the domestic economy of African countries as well as promoting local workforce development. Conversely, if too strictly implemented, local content regulation can drive away investment. The successful implementation of local content regulation requires greater collaboration between local government and corporations. On one hand, governments must strengthen institutions in order for regulation to be designed for the ultimate goal of sustainable and inclusive growth, on the other corporations should incorporate sustainable development in their African strategies.