Domestic risks to Africa’s growth:
Navigating local content regulation and taxation
Editor’s note: Improved economic and political governance, together with a favorable global external environment, have set the foundation for Africa’s recent and much-heralded economic growth story. However, these features, although they point to opportunities, do not alone provide a sufficient basis for the type of sustainable and comprehensive development the region badly need. In too many cases, governments and businesses working in Africa encounter daunting economic, political, and social risks that reduce their ability to make long-term investment decisions and implement development policies. The Brookings Africa Growth Initiative (AGI) addresses this need through a private roundtable series that convenes high-level professionals from both the public and private sector for regular working group sessions to identify, manage, and mitigate the biggest risks to economic development in Africa. In addition to risks, the sessions will also seek to identify key trends in the continent in order to come up with practical and implementable policy recommendations to leverage existing and potential opportunities in the continent.
The World Bank’s annual Doing Business Report continues to cite sub-Saharan Africa’s progress as impressive, with the region accounting for almost one-third of the regulatory reforms making it easier to do business. Countries like Rwanda, Senegal, and Benin have become often-quoted examples when it comes to reforming their regulatory processes. Then again, six of the bottom 10 countries are in sub-Saharan Africa. The region ranks low in government effectiveness and continues to struggle with the enforcement of the rule of law. Clearly, many of the regions’ impediments to doing business are sometimes created or exacerbated by African governments. Instead of being a facilitator to trade and business, then, government ends up being a bottleneck.
Two specific aspects—local content regulation and taxation—continue to be hindrances to both entrepreneurs and foreign investors. African governments, with good reason, are increasingly seeking to build local capacity and ensure a transfer of skills and technology from global firms to local firms; however, overregulation sometimes places undue burden on foreign companies, especially when domestic capacity is limited. African governments have also embarked, again with good reason, on an agenda to increase domestic resource mobilization and reduce illicit financial flows in order to meet their sustainable development goals. But such efforts can create complexities in legal interpretation and enforcement, and poorly thought out tax policies close businesses or chase them away.
In this roundtable, participants discussed African policymakers’ goals regarding local content regulation and taxation, the related specific hurdles to investment, and how domestic and outside actors, such as businesses, the United States, and the multilaterals, best inform policies that work for all.
The following takeaway messages emerged from the discussion:
- African governments consider local content regulation and taxation as key instruments to reach sustainable and inclusive growth. In order to exploit the region’s enormous potential, African countries need to create jobs, invest significantly in infrastructure, diversify their economies, and adapt to the effects of climate change while mitigating its effects. Local content regulation can help transfer much-needed skills and knowledge while taxation is the main instrument to raise domestic revenues.
- Investors value balanced, consistent, and predictable regulation. Several of the participants from the private sector emphasized that predictable regulatory behavior in the short and long term is a vital consideration when considering investing in Africa. In the aim to attract foreign capital, they recommended that African countries improve confidence and avoid changing the existing rules once investments are made, as it sends a negative signal to the corporations considering entering their markets and deters future investments. Balance and consistency are two additional key qualities that are sought by investors.
- In today’s globalizing world, there is a need to create an improved business model and create a stable business environment. Corporations have a wide range of options when picking an investment destination. In order to makes their investment environment attractive, African nations must boost investors’ confidence, largely by enacting stable policies and consistently recognizing the rule of law. Similarly, strong institutions are a key prerequisite to developing successful local content regulations.
- Corporate tax should be part of an overall tax policy. Increasing African countries’ tax effort and improving the income taxation process can allow African countries to better design their corporate tax policy. However, as one policymaker noted, local citizens argue that the tax revenue lost to tax breaks could help bridge the infrastructure gap as well as develop the country’s health and education systems. Then again, some participants stressed that it is crucial for African governments to broaden their domestic tax base and efficiently use tax revenues.
- When considering implementing local content regulation, local policymakers must strike a balance between the constraints that investors face and the expectations of their constituents. While it is desirable to boost local employment and develop the domestic economy, corporations face important constraints in complying with regulation. As many participants noted, often complying with local content requirements is difficult when countries do not have sufficient capacity. Poor infrastructure, limited domestic value chains, underdeveloped human capital, and unreliable access to electricity are factors that have contributed to corporations’ inability to source productive input from local content.
- Other participants noted that, when established correctly, local content can serve as a very useful tool to develop domestic capacity, by improving workforce development, boosting domestic industry, and promoting structural transformation. However, local content regulations must be established “the right way,”—i.e., strict enough to develop the local economy but loose enough to avoid chasing corporations away—in order to simultaneously please both the governments and corporations.
- The implementation of local content regulation can in turn pose a challenge when seeking funding from foreign governments. For instance, United States government agencies such as the Overseas Private Investment Corporation (OPIC) are sometimes unable to support projects that require the use of local content above a certain threshold.
- Illicit financial flows are a key hindrance to the development of African countries. As one participant pointed out, the domestic elite and multinational corporations contribute to this problem by shifting their profits to tax havens. Another participant added that the African continent has a very unique opportunity where tax revenue can play a key role in the continent’s development trajectory.