FDI and Export Performance of the Mauritian Manufacturing Sector. Vinaye Dey Ancharaz. November Abstract

Transcription

1 FDI and Export Performance of the Mauritian Manufacturing Sector by Vinaye Dey Ancharaz Department of Economics and Statistics, Faculty of Social Studies and Humanities, University of Mauritius, Réduit, Mauritius November 2003 Abstract Foreign direct investment (FDI), especially in the export-processing zone, has played a pivotal role in industrialization and export diversification in Mauritius. This paper examines the impact of FDI on the country s export performance and export competitiveness. It argues that, while FDI has been instrumental is export development, it has not had much of an impact on export competitiveness per se. The paper concludes with a discussion of the strategic reorientation of FDI policy aimed at attracting larger amounts of FDI in emerging sectors of the economy, as well as in clothing and textiles.

2 Introduction Like most developing countries, Mauritius participates actively in the global competition for foreign direct investment (FDI). However, by all standards regional or international Mauritius has attracted relatively small FDI inflows since the inauguration of a more permissive investment framework back in the early 1970s. Nevertheless, FDI especially in the export-processing zone has played a critical role in industrial diversification, employment creation, export development and growth. It helped the economy emerge from agricultural dependence and backwardness to a modern, dynamic and technologically advanced economy with higher per capita incomes and greater equity. More importantly, perhaps, the EPZ will be hailed as a catalyst in the process of emancipation of women in the country since it permitted women with few alternative employment opportunities to enter the formal labor market and to contribute to the economic development of Mauritius. FDI was particularly crucial in the early stages of export development, contributing largely to the take-off of the EPZ. Subsequently, however, domestic investment caught up, and even surpassed, FDI in the zone, thus limiting the latter s impact. This is a positive occurrence that illustrates the country s capacity to learn and adapt foreign technology to the local context. Furthermore, the Mauritian experience suggests that domestic and foreign investments have complemented each other in sustaining the EPZ s growth momentum. Despite the diminished role of FDI, government policy remains centered on promoting foreign investment, especially in the priority sectors of the economy. This reflects the continuing importance of FDI as a generator of employment and income, as a vehicle for technology transfer, and as a platform for building a vertically integrated textile and apparel industry. Consequently, in the face of emerging challenges in the export sector (rising costs, vanishing trade preferences, ad stiffer global competition), government has taken measures to enhance the attractiveness of the FDI regime.

3 The paper surveys the recent trends in FDI in Mauritius and discusses the factors behind the dismal FDI performance recent years (Section 2). Some of these same factors (in particular, high labor costs and declining productivity) have led some local firms to relocate their low-value, labor-intensive processes in nearby Madagascar and Mozambique. Thus, Mauritius has now joined the league of outward investors. Outward FDI from Mauritius is likely to gather momentum as domestic competitiveness is further eroded and as firms try to exploit new opportunities to export (for example, under AGOA). The paper also surveys this phenomenon. Section 3 investigates the impact of FDI on export performance and export competitiveness. Section 4 concludes by taking a strategic perspective on FDI policy and discussing how Mauritius can re-engineer its investment regime to attract significant amounts of development-oriented FDI. 2. FDI in Mauritius: Trends and Determinants Mauritius adopted an official, more liberal, FDI policy with the establishment of the export-processing zone in The government sought to attract FDI in the zone by offering investors a wide range of fiscal incentives including duty-free imports of machinery, raw materials and other inputs, substantial tax holidays, subsidized power rates and factory space, free unlimited repatriation of profits and dividends, and access to credit on preferential terms, which some (for example, World Bank, 1989) have qualified as overgenerous. The incentives contained in the EPZ Act combined with the availability of relatively cheap semi-skilled labor and very flexible labor laws to spur a steady wave of investment into the export sector. On the external front, the preferential access of Mauritius s clothing exports into the then-e.e.c. under the Lomé Convention and the yet unexploited potential to export to the United States were probably instrumental in attracting foreign investors from Hong Kong who had bumped up against MFA quota ceilings. 1 While the initial stimulus to EPZ activity came from foreign investors, local participation quickly 1 The Lome Convention, signed in 1972, allows duty-free and quota-free access of Mauritian exports to the EU. Mauritius was not a member of the MFA. Nevertheless, exports of certain items of clothing were (and still are) subject to quotas in the United States and Canada. These quotas were underutilized in the early 1970s, thus allowing significant room for exports to North America.

4 caught up with and surpassed the degree of foreign equity in the zone. The domesticowned capital stock in the EPZ as of 2000 is estimated to be more than five times larger than the foreign-owned capital stock. With a rather modest start, the EPZ evolved over the years into a dynamic export platform with considerable job creation potential. This process was however erratic, reflecting the influence of unpredictable and volatile FDI flows (Figure 1). It is possible to analyze the evolution of the EPZ in terms of four distinct, identifiable stages. The period may be dubbed the take-off phase. The EPZ had just been launched, and during this period, it was still in its infancy, struggling to get a foothold in the industrial landscape of the country. In this, the pioneering firms most of which were local were aided by the sugar boom of , which provided the foreign exchange for import of raw materials and machinery. By 1977, 86 firms were operating in the zone, employing 17,474 workers, about 80% of which were female. Figure 1: FDI Flows in the Mauritian EPZ, (Rs. million) Year The period was one of stagnation. Its causes were a dramatic combination of internal and external factors. On the internal front, the mismanagement of the sugar boom led to soaring public sector deficits, resulting in rising labor costs, a real appreciation of the rupee, and ultimately an erosion of export competitiveness.

5 Concurrently, this phase was punctuated by strikes in the port in the build-up to the 1982 elections, which, among other things, cut off supplies of imported raw materials and machinery to EPZ firms. The uncertain political climate also deterred potential foreign investors. Externally, the Mauritian EPZ bore the brunt of the recession in its major export markets in the wake of the 1979 oil crisis. The third phase covered the period the EPZ boom years. Employment rose sharply as new units set up in increasing numbers in the zone. Most of these firms were multinationals, which were relocating to Mauritius to take advantage of a substantially improved set of incentives offered by the government. At the same time, institutional support for the EPZ was consolidated with the setting up of the Mauritius Export Development and Investment Authority (MEDIA) whose mandate is well summarized by its name. Economic recovery in the industrialized countries gave a further boost the EPZ. After six years of rapid growth in EPZ activity, the pendulum swung back again, ushering in a protracted period of recession in the zone. This phase began in 1989 and continues to the present day. FDI flows during this period exhibited a general downward trend, with sporadic spurts, notably in 1992, 1995 and Total EPZ employment, which stood at a record high of 90,861 in 1991, declined steadily over the next half-decade, and although this trend was partly reversed during , employment in 2000 was lower than its level in Analysis of the sectoral distribution of FDI flows reveals that export-oriented FDI in the manufacturing sector has witnessed a secular decline in favor of the emerging services sector (led by banking and tourism). Manufacturing FDI accounted for a mere 8 percent of total FDI flows in 1998, down from 36 percent in The decline is most prominent in textiles and wearing apparel, which together make up more than threequarters of cumulative FDI in manufacturing. FDI in other sub-sectors within the EPZ has been marginal. This shows that Mauritius has had little success in diversifying its manufacturing base.

6 Moreover, the analysis indicates that traditional manufactured exports, which once pulled in significant FDI flows, have lost their magnetic power as the initial favorable conditions gradually faded out. In a sense, therefore, the EPZ has been a victim of its own success. On the domestic front, labor shortages have driven wages up while labor productivity has lagged behind. The effect of rising labor costs (see Figure 2) has been compounded by the inability of many EPZ enterprises to adopt more capital-intensive and technologically superior production methods. Externally, the dismantling of the Multi-Fiber Arrangement by 2004 will erode the preferential access to the U.S. and E.U. markets that Mauritian exporters have traditionally enjoyed, exposing them to acute competition from lower-cost producers of textiles and garments. The appendix includes an econometric investigation of the determinants of export-oriented FDI in Mauritius. Figure 2: Labor Productivity and Unit Labor Cost Indices in the EPZ (1982=100) Year Labor Productivity Index Unit Labor Cost Index Some firms are responding to the changing investment climate by diversifying away from basic knitted and woven shirts, trousers, jeans and fully-fashioned knitwear to items of higher added value. Others are moving their operations offshore. As Table 1 shows, there has been a steady outflow of direct investment in manufacturing, and countries like Madagascar and Zimbabwe have been the major beneficiaries. Thus, Mauritius is yet another victim of the flying geese pattern of FDI. On the positive side, however,

7 outward investment has allowed local firms to relocate low value-adding operations to nearby countries to take advantage of cheap labor in their struggle to remain competitive. At a more fundamental level, this strategy makes it possible for Mauritius to re-engineer and harness dynamic comparative advantages in emerging sectors such as IT, banking and other services. Table 1: Direct Investment Abroad by Sector, (Rs. million) Tourism n.a. n.a. 3 n.a Banking n.a. n.a. n.a. n.a Manufacturing Other Total The African Growth and Opportunity Act (AGOA) can provide some relief by opening up new markets if Mauritius could satisfy the stringent rules-of-origin regarding thirdcountry fabric. These rules require that garments exported to the U.S. under the Act be made from materials coming from eligible countries or from the U.S. itself. Since Mauritius imports the bulk of its raw materials from Asia, the extent to which local exporters can benefit from the AGOA provisions will depend critically on the country s ability to seek out alternative, low-cost, sources of supplies from within Sub-Saharan Africa. AGOA has had a long-awaited impact on the textile and clothing industry. It has attracted massive foreign investments in spinning mills that purport to produce and supply textiles and yarn for garment making. FDI in textile manufacturing is likely to continue as Mauritius seeks to develop a vertically integrated, and hence more competitive, clothing industry. Regional trading arrangements hold some additional promise for Mauritian exporters and foreign investors who wish to use the domestic zone as an export platform. For instance, the SADC Trade Protocol aims at integrating textile and clothing production within the region by encouraging the use of textiles manufactured in the Community in clothing

8 production. To that end, the Protocol provides tariff concessions intra-sadc textiles trade. 3. FDI, Export Performance and Export Competitiveness FDI has played a pivotal role in the structural transformation of the Mauritian economy from a mono-crop economy to one based on a dynamic manufacturing industry and a fledging services sector over a relatively short period of time. In 1970, agriculture accounted for about 16 percent of GDP and one-third of total employment. By 2000, agriculture s share of GDP had declined to a 5.6 percent; the sector represented a mere 11.5 percent of total employment. Concurrently, the manufacturing sector has expanded to become an important pillar of the economy. This sector accounted for 21.6 percent of GDP and 29.4 percent of employment in Although this impressive record is attributed to a confluence of favorable conditions, FDI arguably kick-started the prolonged phase of industrial growth by bringing to Mauritius technology, know-how, and much-needed capital and entrepreneurship. Perhaps FDI s role was most critical in achieving export success in manufactures. The EPZ, driven by FDI flows in its initial phase, helped the economy diversify its export base, and move dramatically away from quasi-total dependence on sugar. Thus, primary products made up less than one-quarter of merchandise exports in 2000, while manufactures (mainly EPZ products) represented over 70 percent of exports. Manufactured export growth has remained high averaging more than 10 percent during the period , even when other export sectors (sugar and non-epz manufactures) witnessed a slowdown in Figure 3 shows the evolution of EPZ exports along with investment domestic and foreign in the zone. It is clear that the behavior of manufactured exports closely followed FDI flows over the period under analysis. FDI, in turn, complemented domestic investment. Indeed, the latter has emerged as the main form of investment in the zone, maintaining a steady flow in the face of cyclical movements in FDI over much of the 1990s.

9 Evolution of Key EPZ Indicators, (log scale) Year Exports Domestic Investment FDI Mauritius export performance has been strong and sustainable, especially in the highly competitive market for made-up garments. Mauritius has consistently outperformed other countries both keen competitors and emerging exporters in the expanding segment of the clothing market. It has gained significant market share and established a dynamic comparative advantage in the sector. This comparative advantage can be gauged by the revealed comparative advantage (RCA) index. The RCA index shows the importance of a country s export of a particular product relative to its overall export performance. It is measured by the ratio of product j s share in country i s exports to the product s share in world exports. An RCA index greater than 1 in a given product group suggests that the country s export share in that product is higher than the world s. The

10 country is therefore revealed to have a comparative advantage in the product. Table 2 below presents RCA indices for Mauritius vis-à-vis its main competitors. Table 2: Revealed Comparative Advantage (RCA) Indices, selected countries, Country Bangladesh China Hong Kong China/Hong Kong Macao China/Macao India Indonesia Mauritius Mexico Nepal Pakistan Sri Lanka Thailand Vietnam Source: Computed using data from UNIDO (2000) Cursory analysis of the indices suggests that Mauritius has effectively maintained its comparative advantage over a period of nearly two decades, even as lower-cost producers of clothing and textiles emerged. Its immediate competitors appear to be Bangladesh and China. However, before interpreting the RCA of Mauritius as a cause for celebration, it should be borne in mind that the RCA is an outcome-based measure of competitive

11 advantage, and, as such, it does not isolate the effect of trade preferences from cost-based relative advantages. As Table 3 shows, Mauritius ranks far low in cost competitiveness relative to its competitors, implying that its high RCA is mainly the result of preferential market access, which conferred an unfair advantage to Mauritius over other exporting countries that did not benefit from the same preferences. Table 3: Labor Costs in the Apparel Industry (US$ per hour), 1996 Country Cost Poland 2.10 South Africa 1.26 Mauritius 1.02 Philippines 0.62 Bangladesh 0.31 Russia 0.58 Sri Lanka 0.41 India 0.36 Kenya 0.30 Madagascar 0.29 China 0.28 Source: Werner International (1996) It thus appears that FDI, while contributing in important ways to export development, has had limited impact on export competitiveness as such. The fact that the bulk of EPZ exports today comes from domestic firms bears testimony to the ability of local investors to learn from, and adapt the technology of, foreign firms. This transfer of technology and know-how occurred early in the evolution of the EPZ, allowing Mauritius to develop a home-grown industrial culture that today permeates the entire economy. In particular, FDI has provided managerial skills and training of local personnel in the services (tourism) sector. On the downside, FDI did not help diversify the EPZ either in terms of markets or products. After more than 30 years of existence, the zone remains heavily concentrated in wearing apparel, exporting virtually all of its output to the US and the EU. Certainly, the Mauritian EPZ has moved up-market over time, carving for itself a niche in high value-added products. However, zone enterprises have not successfully diversified away

12 from wearing apparel, thus limiting the scope of technology transfer and spillovers to the wider economy. Thus, while Mauritius may be a reference in EPZ success, it pales in comparison to industrialized economies like Malaysia, Taiwan and Hong Kong, which started out much like Mauritius, but rapidly moved out of clothing into more technologically intensive sectors such as electronics and assembly. Why has this horizontal diversification not taken place in Mauritius? Part of the answer lies in trade preferences. It seems that foreign investors set up export platforms in Mauritius only to exploit new opportunities to penetrate the US and EU markets when their operations elsewhere had bumped up against MFA quotas or faced other trade barriers. This hypothesis can explain the drying up of FDI flows in recent years as well as the wave of closures of foreign units. While the deteriorating competitive environment is surely to blame, vanishing trade preferences arguably remain the main culprit. 4. Conclusion FDI has a fair claim in Mauritius impressive economic record over the past two decades. FDI flows, initially in the export-processing zone, but also in other sectors (such as tourism) have contributed to a technological shift, putting Mauritius firmly on the path of industrial diversification and durable growth. This paper argues that, while Mauritius has received modest amounts of FDI, these flows were nevertheless crucial in imparting know-how to domestic firms and in implanting an industrial culture. However, although FDI contributed to export growth, it has fallen short of promoting export competitiveness. Mauritius exports remain heavily concentrated both in products (clothing) and markets (US and EU). In the face of rising production costs and dwindling market potential with the withering away of trade preferences Mauritius is confronting a dramatic decline in FDI flows. This calls for a strategic perspective on FDI policy aimed at averting the recent trend and at reinvigorating FDI in key sectors of the economy. The government, which sees a wider role for Mauritius as a Hong Kong or Singapore of Africa a centre for sourcing products from reliable and quality-conscious suppliers is taking important measures to reposition Mauritius as an attractive FDI destination. The incentive regime already very appealing has been further enhanced with the

13 introduction of the Permanent Residence Scheme, which offers the possibility of Mauritian nationality to any foreign investor who commits at least $500,000 either in a business or in an approved investment fund. The Board of Investment (BOI) was created in 2000 to promote and facilitate investment, foreign and local, by consolidating in one body the power to approve applications for investment. Furthermore, the government has signaled a keen interest in monitoring the EPZ situation by setting up the Textiles Emergency Support Team a high-level team of stakeholders and policymakers that reflect on the challenges confronting the EPZ and propose remedial measures. Mauritius continues to seek opportunities for promoting vertical shifts in the current industrial structure of manufacturing. In parallel, there is need for a horizontal shift into emerging, high-value, technologically intensive, services (such as financial services and IT). The country is moving aggressively into IT with the construction of a cyber city due to be operational in To that end, the government is actively seeking foreign investment and strategic partners in the field of information and communication technology. Regional integration promises to expand domestic markets and open up new opportunities for Mauritius. The country s strategy is to position itself as a provider of services to the region in offshore business and financial services, free port and outward FDI. Competitive pressures are forcing local firms to relocate their labor-intensive, lowvalue operations to countries in the region. Madagascar and Mozambique, among others, have been major recipients of Mauritian FDI outflows. This trend is likely to be accentuated by the return of political stability to Madagascar and by the opening up of the US market under AGOA. Mauritius is enhancing its regional role by participating fully in preferential trading arrangements and by providing other countries in the region with know-how in manufacturing, marketing and technology. Hence, Mauritius is taking significant steps to boost FDI inflows in sectors of strategic interest. It has signed bilateral investment treaties and double taxation agreements with a number of countries, including some of Mauritius major investors. The government is

14 emphasizing technological upgrading and productivity improvement in an attempt to regain its declining share of efficiency-seeking FDI in textiles and garments. FDI policy is currently favoring investment in textile mills so as promote a vertically integrated clothing industry that satisfies the rules of origin for export to the US. References Alter, R. (1991). Lessons from the Export Processing Zone in Mauritius. Finance and Development, 1991 (December), 7-9. Ancharaz, V.D. (Forthcoming). The Determinants of Foreign Direct Investment in a Comparative Perspective: Is there a Bias Against Sub-Saharan Africa? University of Mauritius Research Journal. UNCTAD. (2001). Investment Policy Review: Mauritius. United Nations, New York. UNIDO. (2000). International Yearbook of Industrial Statistics. United Nations, New York. World Bank. (1992). Mauritius: Expanding Horizons. The World Bank, Washington, DC. World Bank Mauritius: Managing Success. The World Bank, Washington, DC.

15 APPENDIX An Econometric Investigation of the Determinants of Export-Oriented FDI in Mauritius We use the following reduced-form equation to examine the factors that have had a significant effect (positive or negative) on FDI flows to the Mauritian EPZ. The specification of the equation and the choice of variables are inspired by the extensive empirical literature on FDI. The equation is however adjusted to reflect the exportoriented nature of FDI in the EPZ. fdi * t = φ 0 + φ1wt + φ2rt + φ3rert 1 + φ4kt 1 + φ5tl84 where fdi is the logarithm of foreign direct investment in the EPZ, w is the logarithm of daily average wages in the EPZ, r* is a measure of foreign interest rate, rer is the logarithm of the real exchange rate, k is the domestic capital stock in the zone and TL84 is a dummy variable capturing the period of trade liberalization in Mauritius, which began in a significant way in Domestic wages and the foreign interest rate determine the cost of labor and of capital, respectively. It is therefore expected that these variables will have a negative effect on FDI flows. Since FDI in the EPZ is export-oriented, a real appreciation of the rupee will make exports less competitive and reduce the return on foreign investment. The ensuing adverse effect on FDI is assumed to occur with a one-year lag. Further, we assume that higher domestic capital participation increases agglomeration effects, thereby attracting larger FDI flows into the zone. The dummy variable is included to determine whether trade liberalization in Mauritius enhanced the FDI regime and induced larger investment flows. The equation was estimated by the ordinary least squares (OLS) method, after testing for stationarity of the time series, using data for the period The results are reported below (t-statistics in parentheses):

16 fdit = wt rt rert kt 1 + * (-2.62) (-7.90) (-3.52) (2.54) (6.20) (6.71) 2.449TL84 All the variables are statistically significant and conform to a priori expectations. In particular, the trade liberalization dummy is positive and highly significant, suggesting that the 1984 trade reforms had a beneficial impact on FDI flows into the EPZ. The results further show that labor costs are an important determinant of FDI; thus, rising wages in Mauritius are a major deterrent to FDI. We argued above that, since FDI in the EPZ is export-oriented, a real depreciation of the exchange rate, which boosts export competitiveness, should increase FDI. The empirical findings confirm this hypothesis. Finally, the positive sign on the domestic capital stock variable indicates that FDI and domestic investment in the zone complement each other, resulting in significant agglomeration economies.