TRALAC - Trade Law Centre

Africa: Export zones to boost Africa's manufacturing industry

Saturday, 15 May 2010

Source: Trade Invest Africa

Export processing zones (EPZs) have mushroomed across Africa. Their logic is to attract export-oriented manufacturing investment to boost economies. EPZs, although they create controversy in certain circles, have been highl successful in Asia, central and Latin American countries. Is the attempt by Africa to follow suit bearing fruits?

African states, from Egypt in the north to Zambia in the south, have embraced export processing zones (EPZ) as a strategy to attract foreign investment. Also known as special economic zones, industrial development zones or free trade zones, the EPZ aims to attract export-oriented manufacturing investment by setting aside enclaves where investors receive a wide range of incentives and developed infrastructure.

They have been very successful in Asia. Industrialisation in countries such as China, Taiwan, Hong Kong and Singapore was propelled by implementing policies that promoted the creation of special investment and export processing zones.

China, for instance, established - between 1979 and 1988 - five major special economic zones (SEZs), and opened a further 14 coastal cities to investors. The strategy helped to attract foreign direct investment into industry and increased manufactured exports, ultimately creating GDP growth and employment.

While most nations were developing the foundations of an export-based economy which focused on the development of a manufacturing sector, Africa stagnated, relying on the export of raw materials.

But the trend is gradually changing with countries adopting strategies and policies that will improve their standing on the world economic stage.

The establishment of EPZs is one such strategy. A sweeping wave of EPZ legislation in the early 1990s enabled over 20 countries to establish zones which offer exemption from normal tax codes, custom, duty and labour restrictions. These exemptions have allowed businesses to flourish.

Tax exemptions include:

Kenya provides EPZ investors with a 10-year tax holiday

Egypt offers entities operating in free zones a life-long exemption from all taxes

Mauritius' EPZs offer a flat 15% corporate tax rate and dividends tax free for 20 years

Cameroon's zones give investors 100% tax exemption for 10 years, followed by a 15% tax and free repatriation of profits. Investors also have "flexible labour laws", and an exemption from the standard wage classification scheme.

South Africa's industrial development zones (IDZ) offer direct links to an international port or airport, good infrastructure, a zero rate of VAT on supplies bought locally, latest ICT, and duty free importation of production-related raw materials and inputs.

Nigeria, Ghana, Tanzania, Uganda, Zambia, Morocco, Senegal, Tunisia, Namibia, Mozambique and the Ivory Coast offer similar incentives packages.

However, attempts in Africa to follow on the successes of Asia in developing free trade zones for kick-starting industry and diversifying the economic base have seen less success. A number of factors including inadequate infrastructure and entrepreneurial capacity, institutional challenges, political aspects, and even investor ignorance, have made the implementation of most EPZs sluggish.

Ron Sandrey, a research associate at the Trade Law Centre (Tralac) (Ed: Tralac funds this AGOA.info web portal) says the concept can work in Africa, but must be implemented under the correct circumstances.

'With the right enabling environment the effects of SEZs can be positive and stimulate greater foreign exchange earnings, while promoting strong backward and forward linkages within national economies and regions.'

Sudir Chuckun, an advisor at NEPAD Planning and Coordinating Agency (NPCA), concurs: 'EPZ's should be part of a country's economic strategy and not the basis of strategy. Africa will first need to address internal challenges; otherwise we can not emulate Asia's success.'

For sceptics who doubt the likely success of the African EPZ strategy, its proponents have a two-word answer: Mauritius and Madagascar.

Mauritius has successfully relied on EPZs to fuel its development since 1970. The country has turned the entire island into an EPZ, offering EPZ status and benefits to exporters. The EPZ sector grew rapidly through the production and assembling of apparel, watches and jewellery. Since 1993, Mauritius adopted an explicit policy of promoting more technologically advanced production in the zones.

Mauritius, like the Asian giants, pursued an export-oriented strategy at a time when other nations were looking inward.

Will the global recovery renew interest in EPZs?

Recent data from Kenya's Export Processing Zones Authority (EPZA) shows the number of foreign firms applying to set up in the export processing zones has risen to 12 since August 2009, double the annual average of six in the previous years. EPZA estimates the new applications could add Sh2 billion to the value of Kenya's EPZ exports, which stood at Sh31.3 billion in 2008.

Acting EPZA chief executive Joseph Kosure attributes the increased investor interest in the EPZs to the ongoing global recovery, and also the marketing that Kenya enjoyed when it hosted the African growth and opportunities act (AGOA) conference in 2009. EPZA has received hundreds of enquiries from local and foreign investors since the Agoa conference.

Kenya's EPZ investors, like their counterparts operating in African countries which are signatories to the AGOA act, have benefited immensely from the Act that offers preferential, duty-free access to the US market for more than 6000 goods and services from Africa.

61% of companies in Kenya's 35 EPZ's are from China, UK, USA, Netherlands, Qatar, Taiwan and India. They offer downstream linkages by buying a wide range of local raw materials and goods, thereby promoting domestic businesses. Only 14% of the companies are fully owned by Kenyans.

Minimal local ownership in Africa's EPZs has been a big issue with domestic investors complaining some governments invest too much in the development of free trade zones and forsake to create infrastructure and more jobs for the same amount of money to benefit businesses outside the special zones.

'The idea is to strike a balance between infrastructure development in FTZ with a commensurate upgrade and maintenance for areas outside the zones.

FTZ infrastructure plans should be integrated within the broader regional and national infrastructure master plans in order to complement the overall need and goal for infrastructure development,' says James Chakwizira, senior researcher in the built infrastructure department of the Council for Scientific and Industrial Research (CSIR).

Nigeria is serious about enticing domestic investors to set up in its free trade zones. Ananda Sivaram, the managing director of the Lagos Free Trade Zone Company, says domestic investors could avoid the bureaucratic bottlenecks associated with getting approvals from various government ministries and agencies if they invested in a free trade zone, where decent infrastructure exists.

'The biggest challenge facing developing economies today is that of infrastructure and Nigeria is not an exception. Investors are looking for production cost reduction, safety and security of their investment as well as good return on investment in their bid to break even and compete favourably in the international market. Nigeria's free zones will facilitate this.'

The Jebel Ali Free Trade Zone in the United Arab Emirates was key to that country's successful diversification of the economy from the oil sector. Nigeria, in a bid to boost its manufacturing capacity, followed suit and developed about 20 free trade zones (only 11 are functioning), most of them situated in ports so access to regional and international markets is maximised.

Now the focus of federal and state governments is increasingly on areas where every kind of infrastructural support is put in place to support manufacturers. A wide range of tax holidays, customs incentives and other special concessions apply to investors operating in the FTZs, especially if they use locally sourced raw materials and export the end product.

Ten years after they were born, South Africa's five industrial development zones continue to attract investment. Although the country is a favourite investment destination, many investors have kept away from the IDZs due to the government's refusal to back down on labour regulations.

A 2008 paper on the Coega IDZ authored by Vanessa Tang says South Africa could easily outshine Mauritius because of its good infrastructure and existence of some incentives Mauritius did not offer. Tang opines South Africa will have to build a good brand reputation to match Mauritius in order to attract IDZ investors. The paper advocates for an IDZ policy that promotes economies of scale and innovation. Local businesses neighbouring the IDZ's have been the biggest beneficiaries of the infrastructure development in the zones.

Lower taxes, lower wages?

While incentive packages and infrastructure networks have acted to pull investors to EPZs, the chief attraction has been cheap labour.

'Particularly of concern in terms of negative effects has been the "race to the bottom" theory. Neighbouring countries lower their standards in terms of labour regulations and investment laws to compete for special economic zones investment,' says Sandrey.

A report he co-authored with Hannah Edinger for the African Development Bank warns competition to attract Chinese SEZ investment could threaten development of countries, including the deterioration of labour standards, progress towards regional integration and cooperation initiatives.

China has invested heavily in Africa's special economic zones, as well as the manufacturing sector, relocating factory work from Asia to start-up projects in Zambia, Nigeria, Mauritius and Ethiopia in export processing zones.

EPZs growing the manufacturing and services sectors

Until recently, very little diamond polishing and cutting has been based in Africa, although it is home to five of the top seven global diamond producers.

Botswana, the world's largest producer of diamonds, was determined to get more cash for its bling and insisted on the development of a local processing industry as a pre-condition for awarding mining licences. Over 10 manufacturing factories are now in operation. The country is competing with processors in India, and has added a good percentage to the value of its exports.

Botswana's budding diamond processing industry is one example of efforts across Africa to boost the manufacturing industry. Pockets of success include Kenya's horticulture and Lesotho's garments industry.

Implementing policies and reforms to attract foreign direct investment into manufacturing industries can be complex to establish throughout a whole country. Sub-Saharan Africa, unable to fully develop its infrastructure, has focused on creating EPZs where every kind of infrastructural support is put in place to support manufacturers.

The result has been a burgeoning manufacturing industry, made profitable by a huge domestic market and a growing export market.