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Where red tape wraps: Foreign Direct Investment, South Africa and the costs of administrative barriers

Where red tape wraps: Foreign Direct Investment, South Africa and the costs of administrative barriers _______________________ Matthew MacDevette. Structure. Section 1 – Why red tape matters

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Where red tape wraps: Foreign Direct Investment, South Africa and the costs of administrative barriers

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  1. Where red tape wraps: Foreign Direct Investment, South Africa and the costs of administrative barriers _______________________ Matthew MacDevette

  2. Structure • Section 1 – Why red tape matters • Section 2 – Econometric testing: disaggregating red tape and measuring its effect on FDI • Section 3 – South Africa and red tape

  3. Section 1Why red tape matters

  4. What is red tape? • Synonymous with ‘administrative barriers’ • The filling in and submission of forms and reports • Consultation with government departments • Compliance with tax laws • Adherence to specific business practice criteria (regarding hiring and firing, for example) • Various forms of licensing and registration • The acquisition of permits • And all manner of torturous bureaucratic nonsense

  5. Examples of obstacles • Uganda – Registrar’s office forgets to sacrifice to stationery God, experiences papyrus shortage • Ghana – Form famine! Loitering locals loan to lost applicants • Namibia – Eco-feminists condemn company registration, opt for CC instead • Elsewhere…

  6. The costs - Business • Study by Brunetti et al (1997) spanning 69 countries and 3600 firms • Industrial countries – 3 categories of red tape above access to financing • South Asia, SE Asia, Middle East and North Africa – tax regulation above access to financing • Central and Eastern Europe – tax regulation above inflation, access to financing and corruption • Leff (1964) and Huntington (1968) on corruption and economic growth

  7. The costs - Community • The poor have no option of expediting processes or circumventing them through bribes • Frye (2007) • Mass mismanagement of social grants in SA • In one rural area, 166 children died of malnutrition in 2001 • Costs of litigation against state amounted to R134 million

  8. The costs - Community • KhabeloThibedi– In 2005, held a Home Affairs official hostage for 6 hours in Johannesburg: “I am sick and tired. I am hurt because I don’t have anything to do. I am sitting at home. I wrote my matric [the national school-leaving examination] in 2003. I can’t find a job, I can’t go to school, I can’t do anything. I have lost opportunities of finding jobs. I could have worked at ABSA [a bank]. I could have worked at Nedbank. I could have worked at the South African army” (Frye, 2007: 722)

  9. The costs - FDI • Mlambo(2005), Nonnembergand Mendonca (2004) and Asiedu (2004) – key determinant of FDI • Nunnenkamp - as globalization has progressed, the relative importance of ease of doing business has increased. ‘Administrative bottlenecks’ highly significant for FDI in developing countries (2002). • Busseand Groizard (2008) - more regulated countries less able to take advantage of benefits of multinational investment • A.T. Kearney’s 1999 survey (1000 companies) - regulatory environment among the top 5 most important factors for FDI, alongside market size and political and macroeconomic stability

  10. The costs - FDI • Additional licenses can stall investment process, especially when assessment of risks is dependent on government action • Automotives industry - Delays in decision-making regarding MIDP have made international parent companies (BMW, Nissan and Ford) noncommittal • Need for local knowledge discourages 100% FDI • Low rates of realisation of new investment • Ghana – fewer than 20% of firms proceed to implementation • Excessive informational demands • Up-front screening of investments

  11. Rhetoric vs. Reality • Though many states may have done away with formal red tape and have loudly opened themselves up to the world, in many cases the actual experience of investors has not changed • Emery and Spence (2000) - “[though] the restrictive policies may have changed, the institutions that implemented them still exist and the procedures they spawned persist or even proliferate”

  12. Section 2Disaggregating red tape

  13. Defining the problem • Despite a massive increase in net private capital flows, dominated by FDI, in developing countries during the 1990s ($41 billion in 1990 to $301 billion in 2004), Africa’s share of this windfall has been meagre • Considering the case of South Africa, within the Southern African Development Community the country ranked 4th from bottom (above only Madagascar, Malawi and Zimbabwe) in terms of relative share of FDI in GDP in the period 2000-2004 (Mlambo, 2005: 559) • 1990 to 2008 - although there have been considerable improvements in the country’s share of total African FDI stocks, increases have not been consistent – this share even took a dip in 2008

  14. The gap • Theory and survey-related evidence strong, but not so with econometric evidence • Most authors clump administrative barriers in with general indices of institutions or socio-political risk • Wheeler and Mody (1992) and Singh and Jun (1995), for example • Busse and Groizard (2008) recognise gap, but concentrate on capitalising on gains from existent FDI

  15. Benchmark model Foreign Direct Investment = α + βAdministrative Barriers + δControls + ε

  16. FDI • Stock measure (millions of $US) • We define Foreign Direct Investment (FDI) generally as partnership in or ownership of an enterprise by a non-national, ownership of a minimum of voting rights in an organisation or, alternatively, effective control via management or royalty agreements (Fedderke and Romm, 2004: 3-4).

  17. Administrative barriers • Subset of the Economic Freedom of the World index – Regulation of Credit, Labour and Business • Credit – foreign bank license denial rates, private sector share of credit, interest rate controls, degree of private ownership of banks • Labour market regulation – hiring and firing regulations, mandated cost of worker dismissal, minimum wage, freedom of firms to set own wages • Business regulation – price controls, perception of admin. requirements, bribes, tax compliance, starting a business

  18. Controls • Market size (GDP in millions of 2007 $US) • Fedderkeand Romm(2004), Mlambo(2005), Nonnembergand Mendonca(2004), Nunnemkamp (2002), Lim (2001) • Infrastructure – proxied by Gross Fixed Capital Formation (% GDP) and telephone and mobile lines per 100 people • Asiedu (2004), Fedderke and Romm (2004), Nunnenkamp(2002) • Education – enrollment in secondary school (% gross) • Nunnenkamp (2002) • Trade openness – exports and imports (% of GDP) • Fedderke and Romm (2004), Mlambo (2005), Asiedu (2004), Lim (2001), Nunnenkamp (2002)

  19. Controls • Legal System and Property Rights – EFW’s Legal Structure and Security of Property Rights • Nonnembergand Mendonca (2004),Fedderke and Romm (2001), Cho (2003), Dunning and Zhang (2007) • Macroeconomic stability – proxied by inflation rate • Lim (2001;), Cho (2003), Asiedu (2004), Nonnemberg and Mendonca (2004)

  20. Data and Problems • All data, but for those EFW variables already mentioned and FDI, sourced from World Development Indicators database • Sample size 158 when combining WDI and EFW, but reduced to 83 after correcting for missing observations • Problem not remedied by seeking other sources – UNICEF and Doing Business, for example • Similar problems experienced by Busse and Groizard – sample reduced from 175 to 84

  21. Robust Regression

  22. Dummy Regressions

  23. Results • Individual red tape measures don’t seem to matter for FDI, with the exception of tax compliance costs • Perhaps reasonable to assume that they matter only within the context of broader regulatory quality • It may also be that the true costs of red tape are only known once investment has already been made – chimes well with our previous observations • Tax a logical exception to this rule – Firms may reasonably be expected to devote more time and effort to investigating tax regulations than, say, whether or not there will be forms available at the registrar’s office

  24. Section 3South Africa’s red tape burden

  25. 2004 SBP Survey • 1794 businesses across South Africa • ‘State interference, regulations’ 2nd most important concern for business growth, below only ‘weakness in the economy/demand’. Ranked above crime, skills constraints and labour problems • When asked how firms would avoid regulatory compliance costs • Most firms thought it impossible • Next top responses: reducing employment and limiting size

  26. 2004 SBP Survey • An important finding was that regulatory compliance costs were particularly dire for small businesses

  27. 2004 SBP Survey - Conclusions • Excessive regulation in SA imposes a cost of 6.52 percent of GDP – disproportionate burden on small businesses • Estimated compliance costs in 2004 amounted to R78.9 billion • Without abolishing any necessary regulations, it is their contention that SA could be spared R40 billion per year

  28. South Africa vs. The World • South Africa ranks 34th overall, according to the Doing Business 2010 rankings • 2nd place in access to credit, 10th in protecting investors and 23rd in paying taxes • But: • starting a business (67), • dealing with construction permits (52) • registering property (90) • enforcing contracts (85) • closing a business (76) • employing workers (102) • trading across borders (a shocking 148)

  29. South Africa vs. Competitors

  30. South Africa vs. Competitors

  31. Red tape in SA - Conclusions • Does very well in access to credit, payment of taxes and protecting investors • However, even in relation to other developing nations, there is vast room for improvement in registering property, enforcing contracts and closing businesses • Moreover, its alarmingly poor performance in trading across borders deserves urgent attention • MOST ALARMINGLY, since the previous period SA fell in virtually all variables, dropping 22 places in the category of starting a business

  32. Conclusions • Red tape may not matter for attracting FDI, but it certainly matters for reaping its benefits • In South Africa, there is evidence to suggest that red tape reforms will boost domestic business activity, especially in the SMME sector • While policy should not view the alleviation of administrative barriers alone as a way to attract FDI, easing trade across borders in particular and red tape reform in general can form an integral part of more comprehensive efforts to improve the country’s investment climate

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