THE IMPACT ON FOREIGN DIRECT INVESTMENT OF FISCAL INCENTIVES IN MAURITIUS

Abstract

In a world where an increasing number of governments compete hard to attract foreign investors and Foreign Direct Investment (FDI), fiscal incentives have become a global phenomenon. Mauritius is increasingly aware of the role of FDI as an engine of growth and has progressively sought ways to attract larger volumes of FDI flows to the economy.

Government has used tax incentives and other forms of fiscal incentives ranging from tax holidays, low corporate tax, import duty exemptions and zero rated Value Added Tax (VAT) to investment allowances, tax credits, accelerated depreciation, no registration duty and other forms of tax exemptions to attract foreign investors to Mauritius. This trend has strengthened over the years.

This dissertation seeks to identify whether fiscal incentives have been key determinants leading to the inflow of foreign direct investment to Mauritius and investigate the impact of the different incentive policies.

The overall findings suggest that fiscal incentives have an impact on foreign investors and FDI. A large proportion of the foreign direct investors would not have come to Mauritius if lower or no incentives would have been offered. Thus ‘free rider’ investors have benefited.

Recommendations are made on how to create a more conducive environment for foreign direct investment whilst focusing less on fiscal incentives. There is no doubt that tax incentives are costly and represent potential loss of revenues for the government.

Chapter 1:  Introduction

This chapter illustrates the background and purpose of the dissertation as well as the research questions. To conclude this introduction chapter, the outline of the study is presented.

1.1 Background

Foreign Direct Investment (FDI)[1] is one of the most important forms of international capital flows. According to UNCTAD World Investment Report 2005, FDI has been growing steadily in importance, relative to other forms of international investment, for the last 30 years and has accounted for about three quarters of total International Capital Flows from 1998 to 2004. Particularly for developing countries, FDI has been the most important source of foreign investment and an important source of technological spillovers.

The increasing mobility of international firms and the gradual elimination of barriers to global capital flows have stimulated competition among governments for FDI and often through tax or fiscal incentives.

Over the past few decades, Mauritius has used tax incentives and other forms of fiscal incentives ranging from tax holidays, import duty exemptions and zero rated Value Added Tax (VAT) to investment allowances, tax credits, accelerated depreciation, no registration duty on acquisition of immovable property and exemptions on land conversion taxes to attract foreign investors. This trend appears to have strengthened over the years seeing at the number of qualifying activities benefiting from incentives under the Investment Promotion Act.

This dissertation will analyse the use of fiscal incentives in attracting foreign investors and FDI and its impact thereon. It is an attempt to explore some of the key issues about the extensive use of fiscal incentives in Mauritius. Have tax policies affected the location of FDI? Do tax policies have some effect on the location decisions of foreign investors? Is there a risk that government is “racing to the bottom” with competitive tax incentives?

Tax incentives represent foregone revenue to the government. There is no doubt that tax incentives are costly. The question in such case is whether the new investment would have come to Mauritius if government had offered lower incentives or none at all. The central hypothesis thus revolves around this question.

At first glance the impact on foreign direct investment of tax incentives appears ambiguous. Over the past few decades, numerous surveys of international investors have shown that tax incentives are not the most influential factor for multinationals in selecting investment locations (Morisset, 2003). More important are such factors as basic infrastructure, political stability, the cost of doing business and availability of labour. Surveys have confirmed that tax incentives are a poor instrument for compensating for negative factors in a country’s investment climate.

But that does not mean that tax incentives have no effect on foreign direct investment. Ireland’s tax incentives have been recognized as key in attracting international investors over the past two decades. In recent years there has been growing evidence that tax rates and incentives influence the location decisions of companies within regional economic groupings, such as the European Union, North American Free Trade Area, and Association of Southeast Asian Nations (Brewer, T and Young, 1997). Similarly, in the United States incentives can play a decisive role in the final location decisions of foreign companies once the choices are narrowed down to a handful of sites with similar characteristics (Ernst & Young, 1994).

1.2    Research Problem

These new findings have reenergized the debate about the effectiveness of fiscal incentives. The debate about the impact of tax incentives on FDI is far from over. So far the benefits appear uncertain, while the costs are large. Old questions will lead to new answers and new questions will arise.

Have tax incentives attracted foreign investment to Mauritius? What kind of incentives is likely to have the greatest impact on the investment location decisions of foreign companies? And what kind of investment is likely to be the most sensitive to tax changes? Which of the location factors have greater impact on FDI?

1.3    Outline of the study

This dissertation consists of six chapters. It starts with the introduction, followed by describing the investment policy in Mauritius. Chapter 3, the theoretical chapter, presents various theories and models used in order to answer our main problem and research questions followed by methodology describing how the investigation was conducted. The empirical findings are demonstrated in the next chapter, where research questions are discussed. Finally, the chapter covering conclusions and recommendations will end the dissertation.

Chapter 2: Investment policy in Mauritius

This chapter is concerned with the policy and regulatory framework of foreign direct investment. It has three main objectives. The first is to provide an overview of the foreign investment trends in Mauritius. The second is to review the policy and regulatory framework of FDI and its standards of treatment and finally to review the investment incentives and identify sources thereof.

2.1           Background

Like most developing countries, Mauritius participates actively in the global competition for foreign direct investment. FDI has played a critical role in the industrial diversification, employment creation, export development and growth. It helped the country emerge from agricultural dependence and backwardness to a modern, dynamic and technologically advanced economy with higher per capita incomes and greater equity (UNCTAD, 2001).

Mauritius has been transformed from a poor, state dominated and a mono-crop economy, entirely dependent on sugar, into a private sector led upper-middle income country, built around four pillars namely sugar, tourism, economic processing zones (EPZ) and services, particularly in financial services, offshore and Freeport enterprises. Information and Communication Technology (ICT) has now been added as the fifth pillar of development. The country has successfully sustained its economic growth over the past 20 years, with GDP per capita rising to US$ 4,500 in 2004.

In the 1990s, Mauritius entered the league of outward investors, as firms began to establish operations in lower-wage sites in the region. The “flying geese” pattern, visible in Asia and Latin America, is finally in the making in Africa, with tiny Mauritius as the hub.

The government policy remains centered on promoting foreign investment. According to the Statement by Hon. Ramakrishna Sithanen, Deputy Prime Minister and Minister of Finance and Economic Development at the National Assembly on 30 August 2005 on Setting the Stage for Robust Growth, “the only route to more robust growth is more investment. The growth equation is brutally simple.  No investment; no growth.” This reflects the continuing importance of both domestic and foreign direct investment as a generator of employment and income, as a vehicle for technology transfer and a means for higher economic growth.

Consequently, in the face of emerging challenges and competition for foreign direct investment, government has taken measures to enhance the attractiveness of the FDI regime through tax incentives and other forms of fiscal and regulatory incentives ranging from tax holidays and import duty exemptions to investment allowances, tax credits and rebates on land conversion and land transfer tax.

2.2           Investment trends

2.2.1       FDI inflows

Foreign direct investment into Mauritius is not significant in quantitative terms. According to the Bank of Mauritius, annual FDI inflows averaged US$ 10 million during 1980-1990 and US$ 38 million in the period 1990-1999.  In 2000, FDI soared to US$ 276 million (as shown in the tables below) as a result of the part-privatisation of Mauritius Telecom.

 

Sector	1990	1991	1992	1993	1994	1995	1996	1997	1998
EPZ	18,133	8,275	13,030	5,198	2,268	13,764	2,588	–	1,126
Tourism	10,208	4,328	513	8,588	7,135	3,933	1,776	950	3,128
Banking	–	3,246	193	–	–	–	2,790	53,302	4,879
Telecommunications	–	–	–	–	–	–	–	–	–
Other	12,559	3,055	1,027	1,525	10,509	562	26,230	1,045	3,044
Total (USD)	40,900	18,905	14,763	15,311	19,912	18,258	33,384	55,297	12,177

Table 1: FDI by Sector in USD, 1990-1998 (Bank of Mauritius)

 

Sector	1999	2000	2001	2002	2003	2004
EPZ	11,928	305	103	1,368	2,760	9,019
Tourism	1,074	381	–	3,338	3,691	4,400
Banking	8,549	–	20,598	10,547	46,627	11,273
Telecommunications	–	274,438	–	–	–	1,382
Other	27,873	1,638	11,432	17,422	17,382	39,238
Total (USD)	49,423	276,762	32,133	32,675	70,461	65,311

Table 2: FDI by Sector in USD, 1999-2004 (Bank of Mauritius)

By and large, though, FDI flows have been relatively small. In fact, when comparing Mauritius to other countries in Africa in terms of FDI as a share of GDP, Mauritius fares worse than Nigeria and Seychelles (figure 1). Furthermore, net FDI inflows over the past half-decade represent somewhat less than 5% of all investment. Investment in Mauritius, in as much as it contributed to the Mauritian miracle, seems to have been a locally based phenomenon.

 

(a) Sectoral distribution

 The manufacturing sector has attracted an important share of FDI in the early 1990s, and much of it was concentrated in the Export Processing Zone[2]. However, this sector as a percentage of total FDI inflow now represents a smaller share with declining inflows in knitwear and garments manufacture. According to the Bank of Mauritius published figures, the decline is most prominent in garments and textiles, which together account for 72.8 per cent of cumulative FDI in manufacturing. FDI in other manufacturing sub-sectors is marginal: electric and electronic components account for only 1.3 per cent of total FDI, and the high skilled sector, watches and clocks, 0.8 per cent. Recent FDI in the EPZ sector has been investment in Spinning plants and seafood.

FDI in services has expanded. Banking accounts for a quarter of all new FDI, due to a single deal: an investment of $45.9 million in 1997 by the South African bank, Nedcor, in the State Bank of Mauritius. Other services attracting FDI include tourism (which has received a steady inflow of FDI in hotels since 1983), construction, retail trade and leisure.

 (b) Sources of FDI

The predominant investments in Mauritius are from France and South Africa amongst other countries as shown in the figure 3 below. France is currently the largest source of FDI as a result of France Telecom’s investment in Mauritius Telecom. South Africa is the second largest source of FDI because of the Nedcor investment in the State Bank of Mauritius.

2.3           Policy and operational framework for FDI

Transparent, stable and predictable conditions for long term investment encourage higher flows of FDI by reducing investor perceptions of risk (Ferrarini, 2003). Alternatively put, lack of transparency creates uncertainty about the existing legal regime. According to the European Commission’s proposal for a multilateral investment framework to WGTI, the EC notes that:

“the non-discriminatory treatment of international investment is a necessary condition for the development of a level playing field for FDI worldwide, which would improve the allocation of capital and minimise distortions, releasing additional resources. Moreover, all countries have realised that in order to attract foreign investors they need to provide, as a pre-condition, a predictable, transparent and non-discriminatory regulatory framework, beyond macroeconomic and political stability, infrastructure, labour skills, etc”

Hence, the emphasis is on the importance of having clear rules on the admission of foreign investors. Some host-country governments usually keep a certain control on the entry of foreign investors in order to preserve national development goals, security, and the protection of the environment, safety and public morals.

2.3.1       Permissive framework

Mauritius pursues a very liberal policy in respect of investment and investors can invest in all sectors of the economy. The Board of Investment, a corporate body established under the Investment Promotion Act 2000, is the body responsible to approve investment projects and issue an investment certificate to person who intends to invest in a qualifying activity[3] and is applying for investment incentive.

Table 3 depicts the current situation following an assessment by UNCTAD of the permissive framework. Mauritius currently has a low growth permissive framework that falls well below best practice standards of openness and transparency (UNCTAD, 2001). As shown by the shaded area, Mauritius is presently positioned as a “low-growth” regime. Though significant actions have been made to speeding up the procedures through the ‘declared framework’ for ICT projects.

The high growth permissive framework is one in which a confident middle-income country welcomes FDI in all sectors. Admission of new FDI is a process of registration rather than screening. It recognizes that FDI can contribute capital, skills, technology, and market development throughout the economy and moreover, that competition with established producers, while sometimes painful, improves the overall competitiveness of the economy. The provision of goods and services to business is immediately opened up.

2.3.2       The regulatory environment

The legal authority for the screening of proposed FDI rests in the Investment Promotion Act 2000 and purports to approve investors (local and foreign) for investment in qualifying activities. This legislation consolidates the existing regulatory and supervisory frameworks while simultaneously putting into place a unified investment promotion and facilitation strategy with the creation of the Board of Investment to consolidate these functions in a single apex body with the exception of the offshore financial sector[4].

The following enactments fall under the Investment Promotion Act 2000:

1. The Industrial Expansion Act 1993
2. The Hotel Management (incentives) Act 1982
3. The Health Development Certificate Act 1992
4. The Export Service Zones Act
5. The Investment Promotion (Regional Headquarters Scheme) Regulations 2001
6. The Investment Promotion (Regional Development Scheme) Regulations 2001
7. The Investment Promotion (Integrated Resort Scheme) Regulations 2002
8. The Investment Promotion (Permanent Resident Scheme) Regulations 2002
9. The Investment Promotion (SAPES) Regulations 2002
10. The Investment Promotion (ICT Scheme) Regulations 20021
11. The Freeport Act 2004

2.3.3       Investment approval process

The Board of Investment screens all investment applications for approval and requires feasibility studies and other evidence of the viability of a project before allowing the setting up of new investment. Pursuant to section 15(1) of the Investment Promotion Act 2000, where the Board approves an application, it issues to the person who intends to invest in a qualifying activity an investment certificate. The investment certificate is considered to be an award for fiscal incentives for qualifying projects and the elimination of hurdles and delays by BOI for the implementation of projects. Approving any investment often involves the grant of a list of fiscal incentives and non-fiscal incentives including duty and concessions to the promoter. Where projects fall in the enactments of the IPA 2000, the trend is towards automatic, rule-based and across the board concessions.

There is established for the purpose of appraising and examining projects at the level of the Board of Investment technical committees. The appraisal process for FDI can be grouped into 3 categories:

• Projects requiring investment certificates,
• Projects under the declared framework for investment certificates,
• Investment requiring no investment certificates.

A).       Projects requiring investment certificates

An investor wishing to benefit from the incentives of the different schemes needs to submit an application accompanied by a detailed feasibility study to the BOI. The latter therefore receives, processes and approves all applications for investing in Mauritius. It also assists investors in obtaining the necessary secondary permits and clearances from relevant authorities thus ensuring a speedy implementation of their investment project.

All applications are subject to an appraisal process by technical committees to enable members to channel the views of their respective Ministry/organisation on a given project.

B).       Projects under the declared framework for investment certificates

 There exists in the permissive system the framework for declared projects where a list of predefined activities is automatically eligible for an investment certificate and incentives attached therewith. The declared framework is limited at present for export-oriented projects involving less complex issues that do not have distortionary impact on the local market.

D).       Investment requiring no investment certificates

Foreign investment to Mauritius in the existing plethora of promoted schemes where no investment certificates are required include (1) the acquisition of immovable property by non citizens who want to acquire property for residence under the Integrated Resort Scheme[5] and (2) investment by non citizen in the Permanent Resident Investment Fund (PRIF) under the Permanent Resident Scheme[6].  Applicants require approval from the Board of Investment prior investment in villa under the IRS or in the PRIF to benefit from resident status under IRS and permanent residence status in the Republic of Mauritius under PRS.

2.4           Specific standards of treatment and protection

In the absence of a foreign investment law, there are none of the usual provisions in Mauritius law governing specific standards of treatment in relation to matters such as national treatment, non-discrimination, funds repatriation and access to international arbitration.

Foreign investors must rely on the good track record of foreign investor treatment established by Mauritius and where applicable, on an investment treaty to obtain the standard protections. Mauritius has entered bilateral investment treaties (BITs) with 29 countries and a further 6 await signing or ratification. Mauritius has been energetic in extending its investment and tax treaty network as shown in the comparison with other small island states.

These treaties have standard provisions in relation to the key areas of specific standards of treatment and include inter alia:

 National treatment: the Mauritius BITs guarantee fair and equitable treatment to foreign investors but not necessarily national treatment.

• Non-discrimination: the Mauritius BITs extend most-favoured-nation treatment to investors with the usual exclusions for regional agreements and double tax treaties.
• Funds repatriation: in 1994, Mauritius suspended application of the Exchange Control Act. No exchange controls of any kind now apply. The Mauritius BITs provide for the free transfer in convertible currency of capital and returns including profits, fees and royalties.
• Expropriation: the Mauritius BITs provide that expropriation will only take place for public purposes, in accordance with due process and will result in prompt, adequate and effective compensation.
• International arbitration: the Mauritius BITs provide a foreign investor in dispute with the State a choice of local judicial hearing or international arbitration. Mauritius joined the International Centre for the Settlement of Investment Disputes in 1969.

2.5           General standards of treatment

2.5.1       Taxation

The key business taxes in Mauritius are corporate income tax, import duties, value-added tax (VAT), registration duty, land conversion tax and land transfer tax. A modern platform of business taxation with substantial reforms has been developed over the past 15 years. The statutes governing the Mauritian taxation system include:

• The Income Tax Act;
• The Value Added Tax Act;
• The Sugar Industry Efficiency Act;
• The Registration Act;
• The Land (Duties and Taxes) Act;

The normal corporate tax rate is 25 per cent with tax incentives companies qualifying for reduced rates in the 0-15 per cent range. Any loss incurred by a tax incentive company during the period of exemption of its net income is available for carry forward and set-off against its net income derived in the following 5 income years. Holders of an Investment Certificate may opt to claim annual allowance in respect of capital expenditure. Some schemes provide for tax credit by way of deduction from income tax otherwise payable for the income year.

The value added tax is at the rate of 15 per cent.

Import duties vary from zero on capital goods, raw materials and foodstuffs to 60 per cent on non-basic consumer goods.

Registration duty of up to 10 per cent of the value of land and improvements is applied on transfer of title. A land transfer tax of 10 per cent is levied if the property interest is transferred within 5 years; reduced to 5 per cent if the transfer is made after 5 years. The high rate of these taxes appears to be designed to collect economic rents from land scarcity and to curb speculation. Also, a tax of 4.4 per cent is applied to the rent and other charges paid by lessees of land.

2.5.2       Foreign exchange arrangements

Mauritius has no official foreign exchange controls of any kind, since the suspension of the Exchange Control Act in July 1994. A greater role is assigned to market forces in determining the exchange rate in Mauritius. It is the Bank of Mauritius, which is the central bank, monitors and analyses, on a daily basis, the movements of the exchange rate of the Mauritian rupee against major international currencies, including the US dollar and the Euro, and intervenes from time to time in the foreign exchange market.

The Bank of Mauritius interventions in the foreign exchange market are not aimed at offsetting underlying market pressures, but rather at smoothing out seasonal and unwarranted short-term fluctuations in the exchange value of the rupee. The exchange rate policy generally reflects the macroeconomic fundamentals of the country.

2.5.3       Employment of non-citizens

Non-citizen personnel are required to have a work permit to and a residence permit to take employment in Mauritius. For key positions, each employee receives initial work and residence permit for one year and subsequently for three-year periods.

2.5.4       Competition Policy

Presently, the competition policy in Mauritius revolves around 5 Acts of parliament, although mention has to be made of the new rules relating to the requirement of fair competition in the area of intellectual property. These include:

• The Fair Trading Act
• The Consumer Protection Act
• The Consumer Protection (Price and Supplies Control Act)
• The Protection against Unfair Practices (Industrial Property Rights) Act
• The Competition Act

2.5.5       Protection of intellectual property

Mauritius has a modern copyright law and is in the process of finalizing a best practice law on industrial property e.g. patents, trademarks and industrial designs. The intellectual property regime is consistent with WTO requirements.

2.5.6       Corporate governance

Referring to the Second Reading of the Companies Bill 2001 in the National Assembly, one of the express aims of the legislator in formulating the Companies Act 2001 was to devise a system offering a simple and cheap method of incorporation as well as the flexibility to cope with diverse corporate structures. A company under the present settings can either be incorporated or a foreign company can be registered at the registrar of companies. The core aspect of the new Companies Act provides for the domestic framework for the incorporation, internal management and winding up of all companies, that is, birth, life and death of a company. Companies have the obligations to comply with International Accounting Standards.

The Companies Act provides for a more effective, efficient, responsive, user and investor-friendly legislative framework for the corporate sector. It also aligns the legal provisions governing domestic companies with those companies known as offshore or international companies. The provisions of the Act incorporate international best practices and promote accountability, openness and fair-trading. It recognizes the productivity benefits of information technology and makes provision for electronic means of record and communication. The Act thus provides modern vehicles for domestic and international investors in and from Mauritius in confidence.

2.7           Investment incentives

2.7.1       Background

The provision of incentives, primarily fiscal, has been one of the foundations of investment promotion in Mauritius. Incentives are extensive. With the establishment of the export-processing zone in 1970, 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 holiday, subsidized power rates and factory space, free unlimited repatriation of profits and dividends and access to credit on preferential terms which the World Bank (1989) qualified as “overgenerous”.

2.7.2       The legal and administrative framework of investment incentives

• The Development Incentives Act 1974

The first legislation stipulating measures and incentive programme, the Development Incentives Act of 1974[7], was introduced to encourage import substitution in the manufacturing sector. Mauritius abandoned the strategically indefensible idea of promoting protected manufacturing for the tiny local market in favour of the new opportunities for export-oriented textile industry.

• The Investment Promotion Act (IPA)

The IPA regroups all the incentives. The Board of Investment may determine the list of incentives for the qualifying activities under the second schedule of the IPA2000.

• The Industrial Expansion Act

The second generation of industry incentives was introduced with the Industrial Expansion Act of 1993. This Act establishes the export processing zones (EPZ), strategic local enterprises, modernization and expansion enterprises, industrial building enterprises, pioneer status enterprises and small and medium enterprises and the list of incentives thereof.

• The Income Tax Act (ITA)

The taxation of resident Mauritian companies is governed by the Income Tax Act 1995. Mauritius has a global system of taxation as opposed to a schedular system. Under this system, income from all sources is added up and the appropriate tax rate or rates are applied after reckoning all allowable deductions and exemptions.

• The Financial Services Promotion Act

A round of incentives to promote domestic capital markets and financial services was also introduced in the 1990s. These included incentives for companies to list on the stock exchange and for investors to buy listed securities.

• The Freeport Act

The Freeport Act 2004 is the legislation governing the Freeport sector in Mauritius. The list of authorized Freeport activities is defined in the second schedule to the Act. The incentives provided to Freeport companies include inter alia, zero percent corporate tax, Value Added Tax (VAT) at zero rate on supplies, duty free imports on equipment and reduced port handling charges. These incentives have statutory power.

2.7.3       Incentives (other than for offshore business)

The incentives provided to investors, both fiscal and non-fiscal, are grouped in different incentive schemes. The industrial development in Mauritius so far has been supported by a number of schemes, enabling investors to benefit from incentives and other support services provided by Government. The incentive schemes are classified by sector of activities, namely manufacturing (including agriculture) and services (including ICT and tourism). All investment schemes, with the exception of those falling under Financial Services Promotion Agency have been consolidated under a single organisation with the setting up of the Board of Investment. However, the number of schemes has increased over the years in an effort to develop new areas activities and sectors. There are at present 9 different schemes that are managed by the BOI under the First Schedule of IPA 2000, besides 12 other areas of activity which are eligible for an Investment Certificate under the Second Schedule of Investment Promotion Act 2000.

The different schemes can be classified in two main blocks, namely:

1. Projects related to the production of goods and services; and,
2. Infrastructural projects

These projects can be further sub-divided by:

1. Activities, either Manufacturing (M) or Services (S);
2. Markets, either Local (L) or Export-oriented (X).

Activities can thus be either Manufacturing of any product in any sector or any type Services offered. These two broad activities can also target one of the two markets mentioned above. The matrix can therefore be summarised as follows:

	Local, L	Export-oriented, X
Manufacturing, M	ML	MX
Services, S	SL	SX

Companies that would fit this matrix will thus be either:

1. ML – Manufacturing companies targeting the local market, or
2. MX – Manufacturing export-oriented companies, or
3. SL – Providers of services targeting the local market, or
4. SX – Providers of export-oriented services.

Existing schemes would therefore be grouped in the matrix as follows:

	Local, L	Export-oriented, X
Manufacturing, M	·  PSEC ·  SLEC ·  MEC   M L	·  EEC ·  Spinning   M X
Services, S	·  HMSC ·  ICT ·  Health Development ·  PSEC         S L	·  ESZ ·  ICT ·  RHQ ·  RDS         S X

Manufacturing Companies producing for the local market

Pioneer Status Enterprise Scheme	Strategic Local Enterprise Scheme	Modernisation and Expansion Scheme
Corporate tax of 15%
Tax free dividends
No customs duty on scheduled equipment or raw materials		No customs duty on production equipment
·       Free repatriation of profits, dividends and capital		·       Income Tax credit of 10% (spread over 3 years) of investment in new plant and machinery, provided at least Rs. 10 million are spent within two years of date of issue of certificate. This is in addition to existing capital allowances, which amount to 125% of capital expenditures; ·       An additional allowance of 30% over the normal initial allowance of 50% on investment made on anti-pollution machinery or plant

Table 4: Manufacturing Companies producing for the local market

Export-oriented Manufacturing Companies

Modernisation and Expansion Scheme	Export Enterprise Scheme (EEC)	Spinning
Tax free dividends
	Duty-free import of raw materials and equipment
	No VAT on raw materials and equipment
	No capital gains tax
	Free repatriation of profits, dividends and capital
	50 % relief on personal income tax for 2 expatriate staff (limit of four years for EPZ)
	60% remission of customs duties on buses of 15-25 seats used for the transport of workers
Corporate tax of 15%		A ten-year tax holiday for spinning companies starting operation before 30 June 2006
	Concessionary registration fee for the purchase of land and buildings by new industrial enterprises	5% registration duty on purchase of land and buildings for industrial purposes
		·       Unrelieved loss can be carried forward; ·       Special investment tax credit; ·       Unrelieved special tax credit may be carried forward; ·       Land at very concessionary rates; ·       Possibility of equity participation up to a maximum of Rs 100 mn in the share capital of spinning units by the National Equity Fund. ·       Duty remission on construction materials; ·       Concessionary Electricity rates; ·       Duty remission on the import of two cars (maximum duty remission of Rs 500,000 per car) provided the initial investment exceeds Rs 50 million or the project creates at least 200 jobs for Mauritian workers.

Table 5: Export-oriented Manufacturing Companies

Service Providers targeting the local market

ICT Scheme	Health Development Certificate	Pioneer Status Enterprise Scheme	Hotel Management Scheme
Tax holiday up to 2012 and a 15% corporate tax thereafter. For call centres or back office operations, the company can opt for a uniform corporate tax of 5%	15% corporate tax
		Tax free dividends	Tax free dividends for 10 years
		Free repatriation of profits, dividends and capital
Duty-free import of equipment
·       Accelerated depreciation allowances for ICT equipment ·       50% relief on personal income tax for a specified number of foreign IT specialists per company; ·       Duty-free import of personal belongings of expatriates excluding vehicles; ·       Fast track processing of visa, work and residence permits for expatriates; ·       Electricity tariffs at industrial rates instead of commercial rates; Duty free import of two cars (maximum duty remission of Rs 500,000 per car) provided that the initial investment exceeds Rs. 50M or the project creates at least 200 jobs for Mauritian workers.	·       No VAT on equipment		·       Term loans and overdraft at preferential rates

Table 6:  Service Providers targeting the local market

Export-oriented Service Providers

ICT Scheme	Regional Headquarters Scheme (RHQ)	Export Service Zone Scheme	Regional Development Scheme
Tax holiday up to 2012 and a 15% corporate tax thereafter. For call centres or back office operations, the company can opt for a uniform corporate tax of 5%	10-year tax holiday on foreign-sourced income, provided the company derives at least 80% of its income from outside Mauritius	15% corporate tax
50% relief on personal income tax for a specified number of foreign IT specialists per company	Concessionary personal income tax for 2 expatriates and non-resident Mauritian employees for the first 4 years of employment
Duty-free import of a maximum of 2 cars
Duty-free import of personal belongings of expatriates excluding vehicles
Duty-free import of equipment
	Tax-free dividends
	Duty-free import of office furniture
·       Accelerated depreciation allowances for ICT equipment in the form of investment allowance of 50% plus annual allowance of the total investment over 3 years (i.e 33 1/3 annually); ·       Fast track processing of visa, work and residence permits for expatriates; ·       Electricity tariffs at industrial rates instead of commercial rates;			·       Investment allowance of 25% is allowed

Table 7: Export-oriented Service Providers

 The table below provides the sources of these incentives.

Scheme	Legislation	Incentives	Relevant legal provisions
Export Processing	Industrial Expansion Act (Part III)	Reduced Corporate Tax at 15%	S.1, 1st Schedule (part 4) – ITA 1995
		Duty remission on scheduled equipment and materials	Section 17 – IEA 1993
		Tax Free Dividend	S.1 – Part III – 2nd Schedule – ITA 1995
		No Capital Gains Tax	S44A(4)(a)(ii) – ITA 1995
		Free repatriation of profits, dividends and capital
		60% remission of Customs duties on buses of 15-25 seats used for the transport of workers	Concession A35 – Customs Tariff Act
		Concessionary registration fee for the purchase of land buildings by new industrial enterprises	S.3(5)(a) – Registration Duty Act 2003
		50% relief on personal income tax for 2 expatriates staff for a peiod of 4 years	S.13, Part II, 2nd  Schedule – ITA 1995
		VAT Remission	Section 51 –  VAT Act
Pioneer Status Enterprise	Industrial Expansion Act (VII)	Reduced Corporate Tax @ 15%	S.5, 1st Schedule (part 4) – ITA 1995
		Exemption from Customs duty on scheduled equipment or raw materials	Section 34 – IEA 1993
		Tax Free Dividend	S.1 – Part III – 2nd Schedule – ITA 1995
		Free repatriation of profits, dividends and capital	Policy
Strategic Local Enterprise	Industrial Expansion Act (IV)	Reduced Corporate Tax @ 15%	S.2, 1st Schedule (part 4) – ITA 1995
		Tax Free Dividend	S.1 – Part III – 2nd Schedule – ITA 1995
Modernization and Expansion	Industrial Expansion Act (V)	Reduced Corporate Tax @ 15%	S.3, 1st Schedule (part 4) – ITA 1995
		No Customs duty on production equipment	S.26 – IEA 1993
		Income Tax Credit of 10%(spread over 3 years) of investment in new plant and machinery, provided @ least Rs 10m are spent within 2 years of date of issue of certificate. This is in addition to the existing capital allowances, which amount to 125% of capital expenditure	S.70 – ITA 1995
		An additional allowance of 30% over the normal initial allowance of 50% on investment made on anti-pollution machinery	Income Tax Act
Spinning	Investment Promotion Act (2nd Schedule)	A 10 year tax holiday for spinning companies starting operation before 30 June 2006	S.33, Part I, 2ND Schedule – ITA 1995
		Any unrelieved loss (after deduction of profits) incurred by a spinning company during the period of exemption shall be available for carry forward under Section 59 of the Income Tax Act	S.33, Part I, 2nd Schedule – ITA 1995
		Investors subscribing at least 20% to the share capital of a spinning company, or over Rs 60M (whichever is the higher), will be granted a special investment tax credit. They may opt to deduct from their tax payable, 15% of the amount so invested per annum over 4 years or 10% over 6 years. the tax credit will be made available to the investing company right from the year the investment is made and not in the subsequent year as is usually the case	S69A  – ITA 1995
		Any unrelieved special tax credit may be carried forward for a period of five consecutive years following the year the investment is made. The deduction allowed in respect of the special tax credit shall be withdrawn if the spinning company has not started operations by 30 June 2006	S69A  – ITA 1995
		Land at very concessionary rate	Policy
		5% registration duty on purchase of land and buildings for industrial purposes	Registration Act
		Possibility of equity participation up to a maximum of Rs 100 m in the share  capital of spinning units by National Equity Fund	National Equity Fund set up by the Government
		Duty remission on construction materials	Policy
		No Customs duty and VAT on raw materials and equipment	Policy
		No tax on dividends	S.1 – Part III – 2nd Schedule – ITA 1995
		Free repatriation of profits, dividends and capital	Policy
		60% remission of Customs duties on the purchase of buses of 15-25 seats used for the transportation of workers	Policy
		50% relief on personal income tax for two expatriate staff	S14 – Part II, 2nd schedule – ITA 1995
		Concessionary electricity rates	CEB Tariff
		Duty remission on the import of two cars (maximum duty remission of Rs 500 000 per car) provided the initial investment exceeds Rs 50M or the project creates at least 200 jobs for Mauritian workers	Policy Decision
Hotel Management Scheme	Hotel Management (Incentives) Act	Reduced Corporate Tax @ 15%	S.9, 1st Schedule (part 4) – ITA 1995
		Tax free dividends for ten years	S.1 – Part III – 2nd Schedule – ITA 1995
		Free repatriation of profits, dividends and capital, subject to original investment being received “A” status from the Bank of Mauritius
		Term loans and overdraft at preferential rates
Hotels and leisure projects	2nd Schedule – IPA 2000	Incentives can be in the form of reduced corporate tax, exemption on equipment and raw materials, preferential loan rates and reduced tariffs foe electricity and water.	Package of incentives dependent on project
ICT Scheme	Investment Promotion (ICT Scheme) Regulations 2002	Tax holiday up to 2008 and a 15% corporate tax thereafter. For call centres or back office operations, the company may opt for a uniform corporate tax of 5%	S.29 -2nd Schedule (Part I) – ITA 1995
		Duty Free import of equipment	Exemption E47 – Customs Tariff Act
		Accelerated depreciation allowances for ICT equipment in the form of investment allowance of 50% plus annual allowance of the total investment over 3 years (i.e 33 1/3 annually)	S.64A – ITA 1995
		50% relief on personal income tax for a specified number of foreign IT specialists per company	S.18 – 2nd Schedule (Part II) – ITA 1995
		Duty Free import of personal belongings of expatriates excluding vehicles
		Fast track processing of visa, work and residence permits for expatriates
		Electricity tariffs at industrial rates instead of commercial rates	CEB Tariff
		Duty free import of two cars (maximum duty remission of Rs 500 000 per car) provided that the initial investment exceeds Rs 50M or the project creates at least 200 jobs for Mauritian workers.	Policy Decision
Regional Headquarters Scheme	The Investment Promotion (Regional Headquarters) Regulations 2001	10-year tax holiday on foreign-sourced income,provided the company derives at least 80% of its income from outside Mauritius	S.22 – Part II – 2nd Schedule – ITA 1995
				Tax Free dividends	S.1 – Part III – 2nd Schedule – ITA 1995
		Duty-free import of office furniture, equipment and personal belongings of expatriate employees, excluding vehicles	Exemption E35 – Customs Tariff Act
				Duty-free import of a maximum of 2 cars for expatriate staff
		Concessionary personal income tax for 2 expatriates and non-resident Mauritian employees for the first 4 years of employment	S.13 – Part II – 2nd Schedule – ITA 1995
				Health Development Certificate (Polyclinic)	The Health Development Certificate Act	15% corporate tax	Income Tax Act First Schedule Part IV (14)- List of Tax Incentives Companies
						Approved medical equipment and accessories to be imported for the purpose of the polyclinics are exempted from the payment of duty and value-added tax	S.12 – Health Development Certificate Act
		Regional Development Scheme	IPA 2000 & Investment Promotion(Regional Development Scheme)Regulations 2001					15% corporate tax	S.28 – Part IV – 2nd Schedule – ITA 1995
								Investment is deemed to be capital expenditure
Investment allowance of 25% is allowed	ITA 1995 – Section 25 (1), Section 64 &Section 64A
Industrial Building Enterprise Scheme	Industrial Expansion Act – (Part VI)	15% corporate tax	S.4 – Part IV – First Schedule – ITA 1995
		No tax on dividends	S.1 – Part III – 2nd Schedule – ITA 1995
		50% exemption on the normal registration for land purchase	Section 3(5) – Registration Duty Act
		The disapplication of the Landlord and Tenant Act	Industrial Expansion Act Part IV section 31-Derogation

Table 8: Incentives and sources thereof

2.7.4       Incentives to develop offshore and freeport

Recognising that it has to diversify its economic base, Mauritius has developed strategies to position itself as provider of services to non-residents and as a base for investors in the sub-region. Two channels having growth potential that have been considered include:

• Offshore business and financial services;
• Freeport (transshipment and re-export);

1. A) Offshore business and financial services

The nineties saw Mauritius develop as an international business and financial centre. It allowed offshore banking in 1988 and offshore business services in 1992. In 1989, Mauritius launched its International Financial Services Centre by introducing legislation allowing international banks to establish offshore units. Mauritius opted for offshore status in 1992-93. The main incentives provided to Global Business Companies[8] include:

• No withholding tax the remittance of branch profits;
• No capital gains tax in Mauritius except on property development gains;
• No limit on the carry forward of tax losses;
• 100% accelerated depreciation rate in the first year for aircraft companies;
• Investment tax credit of 10% for capital expenditure;
• Dividends paid are tax exempt;
• No withholding tax on interest, royalties and dividends;
• Royalties paid to a non-resident are tax exempt;
• No estate duty, inheritance, wealth or gift taxes;
• No registration duties, levy;
• Zero-rated VAT for global business transactions;
• Duty convention of the equipment;
• Furniture or motor vehicles.

 

B) Freeport (transshipment and re-export)

In a bid to diversify the local economy, the Government devised a strategy to consolidate the services sector.  Established in 1992, the Mauritius Freeport, a duty-free zone, was created to position Mauritius as a regional logistics, distribution and marketing hub. The main incentives provided to Freeport operators include:

• Corporate tax incentives with no tax on companies involved into trading activities.
• Dividends derived from business operations are not taxable;
• Free repatriation of profits without exchange control;
• Reduction of 50% on income tax for expatriates;
• Goods; raw materials; and equipment imported into the Freeport Zones are exempted from duties and value-added tax;
• Reduced port handling charges for goods imported and then re-exported;
• Company ownership can be 100% foreign;
• Sales on the domestic market allowed up to 20% of turnover;
• One-stop shop for work & residence permits processing;
• Banking operations through offshore banks;
• Capital financing from Development Bank of Mauritius at preferential rate

2.7.5       Double taxation treaties

Mauritius has energetically expanded its double taxation treaty network over this decade. There are now 29 treaties in effect and a further 14 are under either negotiation or awaiting signature or ratification. Importantly, all but 4 of the treaties in effect have tax-sparing provisions that enable foreign investors from the relevant home countries to effectively retain the benefit of Mauritius corporate tax incentives. Treaties with France, Germany, and Italy do not contain this benefit.

2.8           Conclusion

In this chapter, FDI flows, initially in the export processing zone, but also in other sectors (such as banking and tourism) which have put Mauritius firmly on the path of industrial diversification has been highlighted. The government which sees a wider role for Mauritius has taken important measures to reposition Mauritius as an attractive FDI destination. The incentive regime appealing or not has been further enhanced with the introduction of the Permanent Residence Scheme and SAPES. The Board of Investment was created in 2000 to promote and facilitate investment, foreign and local, by consolidating in one body the power to approve applications for investment. Mentioned was also made to the significant steps taken to boost FDI inflows. It has signed bilateral investment treaties and double taxation agreements with a number of countries, including some of Mauritius’ investors.

The following chapter shall deal with a review of the main literatures that deal with the subject of this study.

Chapter 3: Literature Review

In understanding foreign direct investment (FDI) flows, it is important to recognise the fundamental motivation for a firm or Multinational Corporation (MNC)[9] when investing in another country, rather than exporting its products to that country or selling licenses to the foreign country’s firms to perform the business on its behalf.

The purpose of this chapter is to review the existing body of knowledge about foreign direct investment and the studies on investment incentives to attract FDI. It attempts to present a summary of the relevant theories, hypotheses and schools of thought that contribute to the understanding and fundamental motivation of FDI flows. A study of these theories will assist in the study and it will support arguments to be used in empirical estimation and discussion.

3.1           Main concepts and definitions

3.1.1       Foreign Direct Investment

Foreign direct investment (FDI) is defined as an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or affiliate enterprise of foreign affiliate).[10]

As per UNCTAD World Investment Report 2005, FDI implies that the investor exerts a significant degree of influence on the management of the enterprise resident in other economy. Such investment involves both the initial transaction between the two entities and all subsequent transactions between them and among foreign affiliates, both incorporated and unincorporated. FDI may be undertaken by individuals as well as business entities (UNCTAD, 2005).

According to Krugman and Obstfeld (1997), foreign direct investment is international capital flows in which a firm in one country creates or expands a subsidiary in another. It involves not only a transfer of resources but also the acquisition of control. That is, the subsidiary does not simply have a financial obligation to the parent company; it is part of the same organizational structure.

According to the International Monetary Fund, “FDI refers to investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. The most important characteristic, which distinguishes it from foreign portfolio investment, is that it is undertaken with the intention of exercising control over an enterprise”.

Flows of FDI comprise capital provided (either directly or through other related enterprise) by a foreign direct investor to an FDI enterprise, or capital received from an FDI enterprise by a foreign direct investor.

The above ideas, even though not identical, show the clear conventional definition that foreign direct investment is putting money or other resources with the intention to produce goods or services in a foreign country and to control that business to a certain degree. Foreign portfolio investment is not foreign direct investment because there is no intention of producing goods or services but the desire to speculate with the shares they have bought.

3.1.2       Foreign direct investor

According to the OECD benchmark definition for FDI (1996), a foreign direct investor is an individual, an incorporated or unincorporated public or private enterprise, a government, a group of related individuals, or a group of related incorporated and/or unincorporated enterprises which has a direct investment enterprise – that is, a subsidiary, associate or branch – operating in a country other than the country or countries of residence of the foreign direct investor or investors.

3.2           Theoretical Concept of Foreign Direct Investment

3.2.1       Historical development of theories on foreign direct investment

International capital movements have been taking place among Western countries and their colonies for several centuries, although on a somewhat significant scale only after the Industrial Revolution in Western Europe in early 1800s. Dunning (2002) mentions that in the first half of the period 1900 to 2000, most mainstream theories focussed only on explaining particular types of FDI in a positivistic manner (rather than using integrated approaches). Their units of analysis differed – some schools of thought were concerned with the behaviour of the firm or groups of firms (micro analysis) and other schools were concerned with the behaviour of countries (macro oriented).

According to Dunning (2002), the second half of the period, 1900 to 2000, saw the introduction of more holistic theories or paradigms of FDI. More attention was given by trade economists to incorporating variables of foreign-owned production into their models.

3.2.2       Theories of industrial organisation

3.2.2.1              Hymer’s contribution

Hymer (1976) was the first to systematically analyse issues related to the advantages of TNCs, market imperfections and control in foreign markets with the successful competition between domestic producers and foreign firms. Hymer’s thesis (1976) incorporated two explanations of what he called ‘international operations’. One emphasised the possession of advantages by firms and the other removal of conflict between them. Both explanations for control rely exclusively on market failure.

So far as the advantage explanation is concerned, Hymer argued that whilst the possession of an advantage is a sufficient condition for international operations, it is not a necessary one. In the absence of some sort of failure in the market for advantage, there will be no gains from controlling the firm wishing to ‘buy’ the advantage and, hence, international operations will not take place.

Hymer observed that “if a firm of one country possesses an advantage over firms of all other countries in a certain line of activity that does not necessarily mean that the firm will have its own enterprises in foreign countries.” In particular, it would be necessary to explain why a firm would choose to use the advantage itself instead of licensing it. His answer was that “decentralised decision making – free market – is defective when there are certain types of interactions between the firms; that is if each firm’s behaviour noticeable affects the other firms”. Thus, the main reason for preferring FDI was that the market for the advantage was typically one where there were only a few buyers of the advantage in foreign countries.

The removal of conflict reason for control also relied on market failure. Hymer pointed out that enterprises are frequently connected to each other through markets across boundaries. They compete by selling in the same markets or one firm may sell to another. In such a situation profits may be increased if one firm controls all the enterprises rather than having separate firms in each country. In other words, it is profitable to substitute centralised decision-making for decentralised decision-making. Whether this takes place will depend on whether markets are perfect. In particular, if there is duopolistic or oligopolistic interdependence between firms involved in horizontal relationships, some form of collision will increase joint profits, and once again integration or merger is possibly the most effective form of collusion. However, if there are many firms, or if entry is easy, then there is not much point in trying to control the market and international operations will not take place.

Hymer theory has also been criticised. Dunning criticised Hymer for over-emphasising structural market imperfections at the expense of transaction costs. Oman (2000) argue that Hymer’s concept of advantage is too narrow; it focuses only on proprietary assets that are tradable and, as a consequence, fails to provide an adequate explanation of a firm’s ability to operate in foreign countries. He further adds that Hymer implicitly views the firm as arising only in response to market failure.

3.2.2.2              Caves’ Contribution

Caves (1971, 1974, 1996) and Kindleberger (1984) further extended the industrial organization theory of FDI. Their theories emphasize the behaviour of firms that deviate from perfect competition as the determinants of FDI. According to their perspective, multinational companies (MNCs) face disadvantages imposed by both geographic and cultural distance in comparison to domestic firms. In order for a firm to undertake FDI in a foreign country, it must possess some special ownership advantage over potential domestic competitors. Technological superiority or possession of some intangible, rent-yielding assets such as management skills and brands are believed to provide such advantages.

Compared to portfolio investment, which only involves the cross-border flow of capital, FDI entails a cross-border transfer of a variety of resources, including process and product technology, managerial skills, marketing and distribution know how, and human capital. Viewed this way, FDI involves a transfer of intangible assets such as technological skills across nations. Neglect of the technological aspect can lead to a serious underestimation of the role of foreign-owned capital in the recipient country. However, early theorists neither calculated the benefits and costs of technology transfers, nor explicitly analyzed their impact on a host country through spillover effects.

3.2.3       Theories of the firm

The main question addressed under this school of thought on FDI is as to why firms expand their territorial boundaries outside their home countries. The mainstream theories include:

1. The product life cycle theory
2. Transaction cost theory

3.2.3.1              The product life cycle theory

This hypothesis offers an explanation for both FDI and international trade and focuses on different stages that a product goes through. Vernon proposed the product life cycle theory in the mid 1960s. Vernon argued that in many cases the establishment of facilities abroad, to produce a product for consumption in that market or for export to other markets, is often undertaken by the same firm or firms that pioneered the product in their home market.

Vernon’s view is that firms undertake FDI at particular stages in the life cycle of a product they have pioneered. They invest in other advanced countries when local demand in those countries grows large enough to support local production. They subsequently shift production to developing countries when product standardisation and market saturation give rise to price competition and cost pressures.

There is merit to Vernon’s theory; firms do invest in a foreign country when demand in that country will support local production, and they do invest in low-cost countries when cost pressures become intense. Vernon’s theory fails to explain, however, why it is profitable for a firm to undertake FDI at such times, rather than licensing a foreign firm to produce its product. Just because demand in a foreign country is large enough to support local production, does not necessarily mean that local production is the most profitable option. It may still be more profitable to produce at home and export to that country.

3.2.3.2              Transaction cost theory

Transaction cost can be defined as the sum of information, enforcement and bargaining costs associated with a market transaction (Hennart, 1991).

Transactions cost theory focuses on the problem of organising interdependencies between individuals. These individuals can generate rents by pooling together different or similar capabilities. Transaction cost theory argues that firms arise when they are the most efficient institution to organise these interdependencies. Likewise, MNEs thrive when they are more efficient than markets and contract in arguing interdependencies between agents located in different countries. For example, firm A may have established a distribution system and a manufacturing capacity in its own country, but may be looking for foreign licenses to manufacture and distribute complementary products; while on the other hand a foreign manufacturer may have already developed such a product and can sell its technology to firm A at very low marginal cost. However, such cooperation, when would be profitable to both parties, will not automatically take place. Both parties must be aware of the potential gains of cooperating, they must be able to agree on a price for technology and they must prevent protracted bargaining from eating all the potential gains for cooperation. Because economic agents suffer from cognitive limitations and because at least some of them are opportunistic, organising this cooperation will incur positive information, enforcement and bargaining costs. These are called transactions costs.

3.2.4       Theories of Trade

International trade theory has been used to provide an explanation for foreign direct investment decisions. One must trace the origins of international trade beginning with comparative advantage theory, which views trade from the standpoint of perfect competition, to the new classical theories that focus on imperfect markets.  The debates that are raised in these theories touch on many issues, however, central to the underlying theme in all of these theories are the issues of efficiency and equity as they impact both the home and host countries. The theories that have commonly been used to explain why corporations engage in international trade and the entry mode leading to FDI include:

1. Comparative advantage theory
2. Factor proportional theory of capital movements
3. Imperfect market theory
4. Product life-cycle theory

3.2.4.1              Comparative advantage theory

Comparative advantage theory, developed by David Ricardo, explains what happens when one country can produce all products at an absolute advantage, but still engages in trade with another country.  What occurs is specialization by countries, which promotes more efficiency in their production processes.  Specialization can also lead to the absence of production in other products.  In order to obtain essential products not produced in the home country, it is important to establish trade with other countries.  This is the classical argument of comparative advantage (Hill, 1998).  From this we can begin to understand the basis of foreign market penetration.

3.2.4.2              Factor proportional theory of capital movements

Ricardo argued that trade patterns among countries are explained by the factor endowments of the respective countries. This initial theory was expanded and sophisticated by the Swedish economists Heckscher and Ohlin in the so-called Heckscher/Ohlin theorem. This theorem argues that differences in comparative advantages among nations are explained by different relative costs of the separate factors of production. Thus, countries will tend to export those products using large portions of their abundant factors and import those that depend upon their scarce factors of production.

International trade economics did not provide an explicit explanation of FDI and MNCs. However, some economists (E.g. Meade or Kojima) suggested that the logic of international trade economics could be employed to explain flows of capital among nations. This interpretation of the Hecksher-Ohlin model is called the ‘factor proportional theory of capital movements’ and provides a framework for understanding certain causes and consequences of TNC movement of resources. According to this interpretation, factors would move whenever the marginal product of the factor in one country exceeds the marginal cost in another by more than the costs of movement. In other words, the location of specific operations would be determined by the traditional tenets of comparative advantages making allowance various frictions such as transport costs or government policies.

3.2.4.3              Imperfect market theory

If markets were perfect, factors of production would be extremely mobile and would transfer freely from country to country.  But the real world is not perfect, and countries differ in the resources that are available for the production of goods.  Imperfect Market Theory discusses the conditions where factors of production are somewhat immobile.  There are costs and most often restrictions related to the transfer or labour and other resources used in production.  Heckscher and Ohlin, two Swedish economists developed the theory which stated that differences in a countries endowments of labour relative to their endowments of land or capital, were used to explain the differences in factor costs.  For example, if labour were abundant in relation to land and capital, labour costs would be low and land and capital costs would be high.  If labour costs were high the reverse would be true.  This scenario suggests that countries need to excel in the production and export of products that were in excess, leading to less expensive production factors.  These imperfections in the market often allow MNC’s to capitalize on a foreign country’s resources, which create opportunities for foreign direct investment.

3.2.4.4              Product life-cycle theory

Raymond Vernon developed the Product Life Cycle (PLC) Theory to explain world trade in manufactured products based on the life cycle of the product.  In general, the PLC theory states that the production location for many products moves from one country to another depending upon the stage in the product’s life cycle.  There are four stages in the life cycle: introduction, growth, maturity and decline.   The key assumption underlying this theory is that the location of production will shift internationally depending on the stage of the cycle.  It is in the introduction stage that the PLC theory is most commonly associated with classical international trade theory.  Since information about markets and competition is more readily available at home, it is more common for a firm to establish itself in its home country.   But as Vernon’s theory progresses through the other stages of the PLC, it begins to take on a more neo-classical dimension as discussed in the earlier section.

3.2.5       Theories of FDI

 3.2.5.1            Eclectic approach

The most common starting point in the literature of FDI for discussing firms’ choice of direct investment relative to other entry modes in a foreign market, is Dunning’s OLI framework (Dunning 1977, 1981). According to Dunning, FDi emerges because of ownership (O), locational (L), and internalization (I) advantages. He argues that these three conditions must be adhered to if a firm is to engage in FDI:

• First, to be competitive in a foreign environment, a firm needs some ownership advantage, in the form of a unique production process, a patented good, or access to more intangible assets like reputation, trademarks and management systems. This competitive advantage may be used to penetrate foreign markets in different ways.
• For a firm to choose FDI, rather than, say, exports, there must also exist some location advantage in the foreign country. Location advantages may come in different forms; firms aiming at reducing costs may be attracted by low wages, firms wishing to expand its international market share may be attracted by a large home market, and so on.
• Finally, given that the firm has decided to produce abroad, it can choose between various contractual arrangements, including licensing agreements and strategic partnerships. The theory therefore predicts that there must exists some internalization advantages making ownership preferable to more arms-length contracts. These advantages typically include a greater control over technology and reduced transaction costs.

3.2.5.2            Integrative approach

The Integrative Schools (Wilhelms, 1998) attempts to transform categorical thinking on FDI by analysing it from the perspectives of host countries as well as investors. It integrates the lines of thought of both the dependency and modernisation concepts that are applicable to FDI analysis.

3.3           Motives for Foreign Direct Investment

Any attempt to design policy prescriptions that result in an increase in foreign direct investment needs to be based on an understanding of what motivates investors to make investments in foreign countries (Lall, 2000). Rational investors are likely to base decisions on where to invest on the quality of the investment opportunity, the anticipated returns and the ease with which the investment can take place, adjusted for the foreseeable and unforeseeable risks that will prevent such returns from being realized (Lall, 2000). Policies aimed at increasing the level of foreign direct investment need to attempt to market opportunities and raise the potential returns, while reducing obstacles and risks associated with such investments.

The assessment of the potential returns to the investment opportunity is likely to take into account a range of factors, including the size of the market; expectations of growth in aggregate demand; strategic gains in market share (on a national/regional basis); expected changes/ volatility in interest rates and exchange rates; which may affect financial costs and export earning; the cost and availability of inputs; and the level of protection from foreign competition.

Dunning (1997) classifies motives for direct investment as primarily resource-seeking; market-seeking; efficiency-seeking; or strategic-asset-seeking. These motives are:

• Resource-seeking investment

Resource-seeking investment is usually directly tied to the presence of natural resources or their processing. This is generally seen as locationally-fixed investment, although processing activities may be more mobile than extraction activities.

• Market-seeking investment

Market-seeking investment seeks to access individual or regional markets. Market seekers produce in foreign markets either to satisfy local demand or to export to markets other than their home market.

• Efficiency-seeking or cost-reducing investment

Efficiency-seeking or cost-reducing investment is undertaken by MNCs to provide more favourable cost bases for their operations. Efficiency-seeking FDI tends to be located in countries with skilled, disciplined workforces and good technological and physical infrastructure.

• Strategic-asset and capability-seeking investment

Strategic-asset and capability-seeking investment aims at protecting or advancing the global competitive advantages of the MNC. These kinds of investments tend to be locationally specific.

3.4           Determinants of Foreign Direct Investment

When investors want to invest in another country, they have reasons to push their business from their country. The government of the host country has reasons to pull that firm to their country as well.

Figure 4: Figure 4: Push – pull diagram of foreign direct investment

(Source: FDI in Asia, Faculty of Economics publications, Krirk University, Bangkok, Thailand)

3.4.1       Push forces

These forces, from public and business, push investors to invest in foreign countries. For the public, they want to reduce foreign currencies if they have large amounts of them from foreign trade and service surplus, Japan for example, or from other causes. Why? Because the large amount of foreign currencies will be changed to domestic currency and people will have extraordinary buying power; demand will be more than supply causing inflation in the country. No country desires inflation. So Japan has to push some of their businessmen to invest abroad.

3.4.2       Pull forces

The pull forces are the benefit that the country hopes to enjoy from the FDI. FDI plays important role in economic growth. Because it brings new investment, up to date technology, more employment, links with developed-country markets and enormous new export opportunities, host countries develop strategies to pull the investment.

3.5           Importance of Foreign Direct Investment to host countries

The table below outlines eight main types of benefits acquired by FDI. It presents the type of benefit, means by which the benefit is received and source of benefit. It also states whether the incentives normally used to extract the benefit are linked to certain performance requirements or they are net incentives aimed at increasing country competitiveness in the eyes of multinational companies.

Type of benefit	Means by which the benefit is received	Source of benefit	Performance requirements/competition
Growth and employment	Greater domestic production by MNEs: access to worldwide markets and capital	MNEs’ intangible assets: brand, financial reputation, etc	Competition
Technololical spillovers	Technology transfer from foreign to domestic firms	MNEs’ superior technology	Competition
Knowledge spillovers	Transfer of knowledge, organizational skills and other assets	MNEs’ intangible assets	Competition
Sectoral and regional development	Stimulation of investment in certain sectors or regions	MNEs sectoral and regional flexibility	Performance requirements
Social development	MNEs’ contributions to government’s social programs	Conservation, environmental protection, and improvement of working conditions capabilities	Performance requirements
Technological development	MNEs contributions to research and innovation	MNEs research and innovation capabilities	Performance requirements
Export promotion	Greater exports by MNEs: access to worldwide markets	MNEs intangible assets: Brand, reputation	Performance requirements

Table 9: Benefits from FDI

 

3.6           Government incentive policies and FDI

Governments try to attract multinational companies and enhance associated spillovers and reap the benefits from FDI. Fiscal incentives have become a global phenomenon (Morriset, 2003) from tax holidays and import duty concessions to investment allowances and accelerated depreciation. According to Morriset, this trend has strengthened since the early 1990s.

3.6.1       Definition of different investment incentives and classification thereof

There are many different types and classifications on investment incentive. Brewer & Young (1997) distinguish between three types.

Firstly, a range of “fiscal Incentives” exist, including:

1. Tax holidays,
2. Investment allowances,
3. Income tax reductions,
4. Import and export duty exemptions,
5. Deductions from social security contributions,
6. Investment and reinvestment allowances,
7. Accelerated depreciation.
8. Exemption from payment of Value Added Tax

Nearly 85% of countries studied in an UNCTAD survey have such fiscal incentives (UNCTAD, 1999). As fiscal incentives represent foregone revenue rather than direct costs, they are most extensively used in developing countries.

Secondly, “Financial Incentives” exist such as:

1. Direct subsidies to cover part of capital, production or marketing costs,
2. Government credit,
3. Equity participation,
4. Insurance at preferable rates,
5. Guaranteed export credits.

Due to the direct costs of such financial incentives they are most commonly used in developed countries.

Thirdly, “Other Incentives” exist that may extend to:

1. Low-cost infrastructure,
2. Low-cost services,
3. Market preferences including access to government contracts,
4. Protection from imports, granting of monopoly rights and preferential treatment on foreign exchange

If these incentives incur direct costs on the host they are less likely to be used in developing countries.

The most common fiscal incentives found in developing countries according to Deloitte & Touche (UNCTAD, 1999) are:

1. Tax holidays (full or partial) and rate reductions;
2. Tax credits (e.g research and development credits);
3. Accelerated or multiple deductions for capital expenditures and other significant costs (e.g training costs);
4. Customs duty reduction;
5. Value-added tax (VAT) reductions and
6. Tax-free profit remittances.

3.6.2       Theoretical foundations

A significant number of studies in this area have been conducted over the last 30 years. This section classifies three major types of research in this area: studies based on theory, quantitative data and interviews/questionnaires.

3.6.2.1            Theoretical Foundations

Studies carried out on the issue provide the theoretical framework on how incentives are likely to attract FDI.

Morisset (2003) believes that incentive systems are “relatively inefficient”, and that most of the investments allegedly induced by incentives should have been attracted “at lower cost”. Incentive systems incur both administrative expenses on host country governments and relatively high information costs on the investor.

Linking incentives to disincentives, such as ownership and control restrictions, local content, export orientation, limitations on royalties, fees, as well as banning production in certain sectors, represent a policy of “what is given with the right hand is taken with the left”. Furthermore, making grants contingent upon performance causes additional uncertainty beyond the normal commercial risk encountered, since performance is highly dependent on market supply and demand conditions.

Azhar and Sharif (1974) suggest that a very important factor for foreign investors is neither the size of the grants nor the length of tax holidays, but confidence in the government’s implementation of incentive policies, as shown by previous experience. This might well explain why some governments grant incentives that at first sight look unnecessary, especially when a change of government occurs, or a change in government policy towards foreign investors is initiated. This is especially true for developing countries. In their study of tax holidays, Azhar and Sharif (1974) divided investment projects into two types: those profitable both in the presence and in the absence of a holiday, and those profitable in the case of a tax holiday only. Theoretically, the latter should be more sensitive to fiscal incentives; however, in practice, as it turns out, it is unlikely that firms will invest in projects where profitability is dependent solely on incentive packages.

Milward and Hosbach (1989) discuss whether incentives have changed the pattern of the American automobile industry. They point to the difficulty of determining how a location decision is made. This problem has attracted a plethora of studies that have used sophisticated econometric and survey techniques, as well as computerised methods, in an attempt to arrive at a satisfactory conclusion. The central limitation surrounding these methodologies stems from their being effective only if applied to quantifiable data such as transportation costs, land availability, labour productivity, and the cost of land and construction. Some researchers (e.g. Yoshida, 1987) claim, however, that qualitative and subjective factors are just as important explanatory factors. Among those “quality-of-life” factors cited are the state and local industrial climate, the educational system, the cost of living, housing, and the environment. Labour unionisation has become an issue just as controversial in its impact on investor’s behaviour as incentive policies. Milward and Hosbach (1989) also refer to the contradictory results of several studies that focussed on the competition among different U.S. states to analyse the basis of investment location decisions. Some suggested that regional incentives were a major factor driving investment in the automobile industry from the “Frost belt” to the southern states such as Tennessee and Kentucky. Other studies flatly rejected this finding and argue that incentives had not been a significant factor.

Guisinger (1992) suggests that given the great diversity of incentive (for example, Brazil uses 117 different kinds), it is very easy to get lost in the maize and to forget exactly what sort of incentive is being examined. He also points out that contradictory findings of different studies, as to the effectiveness of incentives, stem from the ambiguity of language and definitions used by the authors, rather than from spurious data or slipshod methodology. It sometimes happens, Guisinger argues, that those authors who try to prove the ineffectiveness of incentives use various kinds of persuasion techniques like “quoting authorities” or “question-begging”, and everyone refers to the “irrationality of policymakers”. He points out that in some studies, incentives are referred to as a factor of no major importance, but that few people explicitly state that incentives are of little or no importance. In another study, published in 1985, he points to the so-called “zero-sum game”, or “prisoner’s dilemma” effect of competition for FDI. As a matter of fact, governments who increase incentives are inevitably followed by their competitors, though any unilateral action aimed at tightening policies towards FDI is not likely to be followed, and the country becomes significantly worse off. As Guisinger points out, this is why incentives have been increasing so persistently since the late 1970s.

In response to the contradictory findings reported in the various studies, some researchers have tried to segment both FDI and incentives, in order to match them to each other and establish the circumstances under which different types of incentives do or do not work. For example, Buckley (1989) suggests that FDI must be segmented in three groups on the basis of the underlying strategic motivation governing it: market- seeking, raw material- seeking and cost reduction- seeking. The first category includes those investors who aim at maintaining market share in a certain country and are less likely to be influenced by incentives. Guisinger (1985) identifies three types of FDI: those oriented towards supplying the domestic market, the common (regional) market, and the worldwide market. He suggests that the first type is more likely to be influenced by offers of import protection measures such as tariffs, quotas and implicit barriers, while the second and third types would probably respond to commodity protection (provision of cash grants, tax holidays, and cheap or free assets). Some researchers claim that throughout the 1980s and 90s, more and more FDI became export- oriented as a result of the export promotion policies pursued by developing countries and increased global sourcing. Woodward and Rolfe (1993), for example, argue that globalisation is driving manufacturers in labour- intensive industries towards low- wage countries, where the cost of producing intermediate goods may drop substantially. Coyne (1995) proposes a “matrix approach” to FDI where strategic motivation is combined with the size (large or small) and timing (original or secondary) of an investment.

3.6.2.2            Quantitative Analysis of FDI Data

Almost all the articles based on statistical analysis are concerned with a comparative analysis of the relative importance of various country characteristics when multinational enterprises make decisions about FDI locations.

A study by the Overseas Development Institute (1997) examined patterns of FDI flows into Low-Income Countries. It concluded that the impact of incentives on FDI location decisions is very marginal, and such factors as GDP size and growth, the openness of the economy, labour costs and productivity, infrastructure, the enforcement of laws and political risk are much more important determinants than government incentives. The absence of a sound infrastructure and skilled labour is blamed for being a major deterrent to FDI in regions like Sub-Saharan Africa.

Root and Ahmed (1978) divided developing countries into three categories based on data from 1966 to 1970: “unattractive” from the point of view of foreign direct investors (those with FDI per capita inflow of less than $1), “moderately attractive”, and “highly attractive”. It was found that relative incentive policies are not a good discriminator among the three groups. Some countries with highly liberal incentive policies (as well as restriction policies) fell into the “unattractive” group. Root and Ahmed argue, that because of the complexities of incentive laws, many companies forego incentives even if they qualify for them. It is obvious, too, that incentives tend to be mutually offsetting, that is, if one country offers them, other countries usually follow. Nevertheless, the authors maintain that it is unclear, whether a country would remain in the same group if its incentive programs were abolished. Most of the countries with very stringent policies towards FDI fell into the “unattractive” category. The implications for FDI policy in developing countries are as follows. As long as tax incentives, local content requirements, and limitations on foreign personnel have failed to distinguish the three groups of countries, then major changes in policies towards investors are unlikely to change the investment climate in the country.

Lim (1983) studied the incentive policies of 27 less developed countries and FDI flows into these countries from 1965 until 1973. He tried to find a correlation between per capita inflow of FDI into a county and the country’s Incentive Generosity (IG), as expressed in tax holidays, modified tax holidays (those dependent on the level of an investment), and cost lowering incentives like grants. As a result, the regression coefficient for IG came out with a negative sign and, most surprisingly, it was statistically significant at the 95% level of confidence. This means that hyper generosity was seen as a signal of a country’s bad economic performance. Lim argues that countries with small endowments of natural resources and slow economic growth lack FDI, and because of this, governments in these countries, often erroneously, offer enormous tax concessions (to counter competition from neighbouring countries), which only results in huge losses of government revenue.

Using both company and country data from the U.S. Department of Commerce, Rolfe and Woodward (1993) analysed 187 investments made in the Caribbean basin. The method they used was a simple regression of the number of FDI projects on quantitative country data. Qualitative characteristics were converted into continuous or dummy variables. Their results not only fail to corroborate the findings in the studies mentioned previously, but in fact contradict them. It was found, for example, that the length of tax holidays and the existence of free trade zones were significant for export-oriented (cost- reduction) FDI in the region. This can be explained by similarities among the countries surveyed in terms of what cost reduction investors look for: labour/raw material costs, political stability, and proximity to markets.

3.6.2.3            Questioning Investors

Studies that are based upon the results of interviewing the investors, represent a somewhat different approach to the effectiveness of incentives. Instead of examining data, the researchers’ primary goal was to get in touch with decision makers themselves in an attempt to find out which factors were critical in arriving at their decision. All the surveys seem to have been completed very thoroughly from a methodological prospective. Samples were sufficiently large and respondents were spread among sectors and countries.

Barlow and Wender (1955) conducted a survey of 247 U.S. foreign investors, and Robinson (1961) surveyed 205 companies with FDI in 67 countries. Both conclude that investors are mainly driven by maintaining market share, whereas political stability, and a favourable attitude towards investors are far more important explanatory factors than incentives. As opposed to restrictions, which can seriously affect the strategies of multinational firms, incentives can only make “an already attractive country more attractive”, and, frequently, are not even considered by companies in Net Present Value calculations, especially when they are contingent upon the project’s performance. The decision to invest is usually made prior to the incentive offer based on either the market characteristics of the country, or production cost and resource availability.

The Group of Thirty (1984) asked almost 100 major U.S., U.K., Japanese and other corporations to indicate in order of relative importance six main influences on their investment locations. (No specific investments were targeted, however). Then for every factor, the percentage of respondents who ranked it among the “top three” was calculated. Incentives, or “Inducements offered by the host country”, were ranked after such factors as “Access to the host country’s domestic market”, “Access to markets in the host country’s region”, “Avoidance of existing or anticipated tariff and non-tariff barriers”, “Integration with existing investment”, “Slower growth of home market”, and “Access to raw materials”. Surprisingly, however, they were ranked more important than “Integration with other companies’ investment”, “Comparative labour and material cost advantages”, and “Shifts of political and social stability”, notwithstanding the fact that these factors are likely to be crucial, at least in theory, for some cost- reduction FDI. If we take into consideration the fact that of those factors ranked as being most important, all except two special cases (raw materials and integration with existing affiliates) are not associated with cost reduction, then incentives really are ranked amongst the top three factors considered by cost-reduction investors.

In a more recent study by Coyne (1995), 72 U.S. and U.K. foreign direct investors operating in the Caribbean region, were asked to indicate the “relative and absolute importance” of particular factors in their company’s original location decision. The purpose of the study was to verify whether different motivations for FDI and their strength influence the effectiveness of packages designed to attract FDI. Significant differences among different “segments” of FDI were found. For example, it was found that small and large cost reduction investors respond differently to the same investment attraction packages, while for market-seeking investors, the size of the project makes no difference.

Azhar and Sharif (1974) conducted interviews with representatives of firms with FDI experience in Pakistan about their industrial and location decisions. Eighty-three projects were discussed. It turned out, that decisions in about seventy percent of the investments were mainly influenced by industrial factors such as the availability of market facilities, transportation, electricity and power, technical expertise, skilled labour, and proximity to urban areas. Only in eight cases were tax holidays mentioned, and none of the holidays had affected the profitability of a project, since only highly profitable projects had been approved. The availability of some kind of experience in areas of potential FDI turned out to be of major importance. At the same time, Azhar and Sharif note that in Pakistan, most investments are directed to large metropolitan areas like Karachi and Lahor, where the government provides all the necessary facilities, skilled labour is readily available, and where most investors have previous experience. As the major competition for FDI in low-income countries stems from “privileged” areas, which have been the recipients of particular government largesse and attention, it is unlikely that availability of infrastructure is a very good discriminator among these “special” zones. Therefore, the significance of tax holidays, which can be equivalent to large subsidies given the high profitability of the projects referred to earlier, and especially their length, may have decreased.

Chapter 4: Research Methodology

This chapter aims at explaining the research methodology that has been used to study the “paradox of incentives” as to whether they helped to attract foreign direct investment in Mauritius. It explains how the study was organised. It begins with a description of the research approach and strategy followed by an explanation of the types of research strategy adopted and the scheme of the data collection. It discusses the quality of the research and finalises this chapter describing the hypotheses formulated for the study.

4.1 The Research approach

Research methodology refers to the procedural framework within which the research is conducted. Burns (2000) defines research as a “systematic investigation to find answers to a problem”. Besides being systematic, it is also methodical and helps to increase knowledge on a specific area.

There are two types of research, namely the quantitative and the qualitative. In this research, quantitative research approach has been used.

• Quantitative Research

Edem and Lawal (1997) purport that quantitative research is a system of subjecting data or information to empirical analysis in order to assist a manager or researcher in reaching a decision.  It seeks to establish facts, make predictions and test hypotheses.

The main types of approaches to quantitative research are:

1. a) Descriptive or survey research;
2. b) Correlation research;
3. c) Causal-comparative research also called ex post facto research;
4. d) Experimental research.

• Qualitative Research

Qualitative research is characterized by the non-numerical data such as observations, interviews, and other more discursive sources of information.  The focus is more on a “real life” experience. It provides evidence of a real life context and people’s “lived experience”.  It is primarily concerned with getting a subjective “feel” for the research topic, not a numerical, statistically predictable measure.

Merriam (1998) states that in contrast to quantitative research which seeks to find evidence which supports or does not support an existing hypothesis, “qualitative designs allow the hypotheses to emerge from patterns of recurring events”.

Yin (1994) supports the view that qualitative data are useful when one needs to supplement, validate, explain, illuminate, or reinterpret quantitative data gathered from the same setting.

A comparison between quantitative and qualitative research is illustrated in Table 10.

	Quantitative	Qualitative
Data	Measurement with numbers	Examine meaning of words
Setting	Impersonal, controlled	Personalised, interactive
Relationship with theory	Tests existing theory	Theory emerges
Process and procedure	Highly structured	Unstructured

Table 10: Comparison of Quantitative and Qualitative research

4.2 Formulation of the research problem

‘A problem well defined is half solved’ an old saying goes.  The objectives of this project are to:

1. Identify whether fiscal incentives have been key determinants leading to the inflow of foreign direct investment to Mauritius;
2. To investigate the impact of different incentive policies and to examine as to whether foreign controlled companies in Mauritius considered incentives in their decision about where to locate their investments;
3. To assess the level of contribution and importance of the location factors in bringing foreign direct investment to Mauritius.
4. To determine decision making process of foreign investors to Mauritius and their consideration to incentives thereon.

4.3 Literature Review

The literature review examined research studies and provided a better understanding of the study by taking into account the findings produced by the researchers. The literature provided an insight of different aspects surrounding the economics of FDI and helped to understand the terminology and in the formulation of appropriate hypotheses for the research.

4.4 Developing the Research Hypotheses

Impact of incentives on FDI

The fiscal incentives are significant determinant of foreign direct investment in Mauritius. The extent to which fiscal incentives is valued by foreign direct investors provides an indication as to whether tax policies affected location of FDI. The hypotheses developed therefore are:

 

H1            Fiscal Incentives have more impact on FDI than the cost of doing business

H1a          Fiscal incentives have less impact on FDI than the cost of doing business

 H2            Fiscal Incentives have more impact on FDI than labour needs

H2b          Fiscal incentives have less impact on FDI than labour needs

 H3            Fiscal Incentives have more impact on FDI than infrastructure

H3c          Fiscal incentives have less impact on FDI than infrastructure

 H4            Fiscal Incentives have more impact on FDI than ease of doing business

H4d          Fiscal incentives have less impact on FDI than ease of doing business

4.5 Research design

The research design is the “overall plan for relating the conceptual research problem to relevant and practicable empirical research on gathering the information needed to answer the research problem under scrutiny”. [Ghauri P, 1995]

Therefore research design is a logical task undertaken to ensure that the evidence collected enables the researcher to answer questions or to test theories as unambiguously as possible.

• Data collection method

Primary data collection method was used. Descriptive research was selected for the purpose of the study in which a sample survey was carried out. With the primary objective of the study being to determine the contribution of incentives to making Mauritius an attractive base for foreign investment in Mauritius, a quantitative approach was thus selected. This approach was chosen as it would provide useful insights and understand the rationale behind the existence the various incentive schemes in Mauritius.

• Sample design

4.5.2.1                 Define the population

The targeted population for the survey was the 212 foreign companies issued with an Investment Certificate by the Board of Investment as at April 2006 from April 2001 and the sampling frame were those 182 operational for calendar year 2005.

4.5.2.2                 Selection of sampling method

For this study, a stratified random sampling method was used. A stratified random sampling is used when the population is split into distinguishable layers.  With foreign investors operating in various incentives schemes as demonstrated in chapter 2, the sample frame was stratified into various investment certificates issued. Separate random samples were then taken from each of the segments and put together to form the sample from the population.

4.5.2.3                 The Sample size

The selection of the sample size was determined through stratified random sampling followed by systematic sampling.  A total of 65 companies participated in the survey representing 30 % of the population.

Sector	Sampling Frame	Sample Size
Biomedical (Healthcare)	4	1
Tourism and Hotel	17	6
BPO-ITES	89	30
IRS & Proprety Development	2	2
Education	3	1
Manufacturing (Non Textile)	35	13
Freeport	13	6
Seafood	1	0
Power Industry	2	1
Textile, Clothing Fashion Design and Accessories	16	6
Grand Total	182	65

Table 11: Sampling frame

4.5.2.4                 Survey Method

This survey was collected by firstly sending online questionnaire to all the respondents by email.  This method was used because the respondents were foreigners and may not be in Mauritius. Main advantage of this method is that a response is received on delivery of the mail. Contacts were established with the 3 respondents who called from abroad in areas which needed more clarification to them. This method also reduced the time for data collection.

A deadline of four weeks was provided to the respondents for completion and submission of the questionnaire.  A response rate of 46% has been received. Reminders were sent to the respondents who had not yet sent the questionnaires at the due date. Non-citizens respondents who were resident in Mauritius were also contacted by telephone and were requested to complete the questionnaires and send it back to the researcher. Further time lags of four days were allocated to them. Two of the respondents preferred to send the questionnaire by fax to the researcher.

4.5.2.5                 Questionnaire design

The questionnaire was designed in line with the key determinants identified for the cross border movements of capital in the literature review. Each question was specific and addressed one issue. The questionnaire was a self-administered one.

Pre-testing of the questionnaire was conducted. A draft questionnaire was commented on by a number of colleagues and the project supervisor. A pilot survey was conducted with a draft questionnaire that was completed by three foreign business people. Through these processes, the format of the questionnaire was finalized to ensure that the questionnaire was user-friendly and removed any ambiguities before emailing to all the respondents.

4.6 Analysis of data

The questionnaires were referenced to facilitate easy retrieval of data collected. They were input and analyzed in the Sphinx Survey software. The data were also extracted from the software and exported to Microsoft Excel for analysis.

The questions which required to be ranked were extracted and a weighted average was used to determine the ascending order of the criteria that were ranked.

4.7 Hypothesis testing

For the chosen test, a paired-samples t-test was used. The variables used were measured on a five point Likert scale. Parameters were established by the notation: No impact (0), Low impact (20), Medium Impact (50), High Impact (80), Very high impact (100). The t-Test: Paired Two Sample for Means, using an alpha value of 0.05 was conducted to evaluate the impact on FDI. The null hypothesis is rejected if the test value of t is greater than the critical value.

4.8 Limitations of the survey

Accessibility to the chief executive officers or decision makers was definitely a limitation of the survey. The fact that most of the foreign controlled companies have either their headquarters located abroad or the decisions makers are travelling abroad have affected the response rate. If the decision makers would have been resident in Mauritius, some more respondents would have answered the questionnaire.

From the above, time constraints was definitely a limitation to the survey research. Some questionnaires were received after the time limits and could not be included in the study.

Chapter 5: Data Analysis and Findings

In this chapter, the findings of the survey are presented. The analysis is carried out in three levels. The first level begins with the description of the findings of the data collected for the area under study. The second level comprises of an in-depth analysis of the results followed by the third level, which comprises of the hypothesis testing.

5.1 Survey Results and Findings

5.1.1       Analysis of survey respondents

The main focus of section A of the questionnaire was on understanding the dynamics in terms of sectors, investor origins, fields of activity, size, entry mode and investment. The analysis of the respondents in this section includes:

1. Number of respondents per sector
2. Main business sectors represented
3. Respondents’ country of origin
4. Mode of entry
5. Company size (by investment value and employment)
6. Distribution of respondents by position within company

5.1.1.1             Distribution of respondents by sector

The analysis was performed on 8 sectors. As mentioned earlier, the selection of companies was based on the activity sector for which these companies have been issued with an Investment Certificate under the Investment Promotion Act 2000.

The largest group among the respondent population was companies operating in the Sector “BPO-ITES” with about 30% (table 12) of the respondent population followed by manufacturing and Freeport with 20% each. It is important to note that these proportions do not represent the distribution of FDI among the different sectors.

Table 12: Response by Business Sector

5.1.1.2             Origin of respondents

The survey was directed to foreign investors. The largest group consisted of European investors (40%) and Asian investors (33.3%) as charted in figure 5. 16.7 % came from East Asian countries.

Figure 5: Location of headquarter

Analysing the investors’ origin by sector in more detail, it appears from figure 6 that:

• European investors are the main investors in BPO-ITES sector.
• East Asian investors are strongly present in the non-textile manufacturing sector.
• Asian investors are particularly strong in the Freeport trade.

Figure 6: Location of headquarter by business sector

5.1.1.3             Entry mode

Firms expanding abroad can choose between different market entry options. The main options available to a foreign investor are setting up a greenfield investment, joint venture or acquiring a local company.

Greenfield investments are the preferred entry mode for foreign companies. 56.7% entered Mauritius as a greenfield investment project. Approximately 36.7% of investment entered through a joint venture with a local company (figure7).

Greenfield entry was the dominant entry mode in all sectors as shown in figure 8 except manufacturing and health care. It is interesting to note that 36.4% of investment in the non-textile manufacturing sector is in the form of joint venture.

5.1.1.4             Size of existing investment

The largest group of respondents falls in the total current investment value category of less than 5 million (44.4 % of respondents). 23.3 % of the respondents indicated a total value of current investment of MUR 20 million or more.

Again some of the distributions in size can be attributed to the distribution of sectors. Some sectors show a relatively high share of smaller size companies in terms of investment value, in particular the in Freeport and BPO-ITES. It is obvious that investment in the IRS & Property Development sector falls in the current investment category of more that MUR 20 million as depicted in the table 14.

Table values are the total of percentages established on 30 observations.

Companies were grouped into six employment categories. Table 15 below provides the number of employees employed by the foreign investors.

No of Employees	N° cit.	Percent
<50	21	70.00%
50-100	4	13.30%
101-150	0	0.00%
151-200	2	6.70%
201-250	0	0.00%
>250	3	10.00%
TOTAL OBS.	30	100%

Table 15: Number of employees

Overall, only 10% of the respondent population fell into the category of large companies (250+ employees). Over two-third of foreign companies had fewer than 50 employees. Sectors with more that 250 employees included 2 non textile-manufacturing companies and 1 BPO-ITES company.

5.1.1.5             Distribution of respondents by position within company

Since this was primarily a survey to understand incentives impact on foreign investors, it was considered very important to ensure that the highest possible data quality be returned. The questionnaires had to be obtained from the most senior managers possible in each company. The views and experiences of the principal decision makers were essential. The survey was very successful in this respect. More than 75% of respondents were either Chief Executive Officer or Director. Figure 10 sets out the distribution of the positions of respondents for the survey.

5.1.2       Pre-investment location findings

In this part of the analysis, key findings are reported on information of important location factors in country selection and the information support required for the foreign investors in their pre-investment phase. The first part analyses the extent to which information is easily made available to investors in their location decision-making process. The kind of information that are made aware to potential investors of investment opportunities will affect the decision making process of investors. Results of this section will be particularly useful for understanding the selection factors and the awareness of incentives in influencing location decision to Mauritius.

The second part examines the perceived risks of the respondents’ investment plans prior their movement to Mauritius.

5.1.2.1             Site selection timeline

Survey respondents were asked about what has been the average time to select Mauritius as their international location site for business. According to FIAS, international location decision starts with gathering of information. Information about the location helps to take timely and rationale decision.

40% of the respondents estimated that it took them less than 6 months to select Mauritius as an international site (figure 11). It is also worth noting from the response of the 3 foreign investors that they have taken more than 3 years deciding on the most appropriate international location.

Figure 11: Average time to select Mauritius as international location site for business

Starting a business is a leap of faith even in the best of circumstances. The decision to invest in an alien country is a daring step, a decision to be taken on rationale facts and sound business indicators. The availability of information thus determines the time taken to process all the information and make the location decision.

5.1.2.2             Location information availability

The survey’s second area of inquiry focused on the types of information that are easily made available. According to the Doing Business 2006[11] report of the World Bank, when conducting a location analysis outside their home country, investors most frequently use investment or merchant banks, accounting firms, national investment promotion agencies, economic development agencies and general management consulting firms. Companies look for a wide range of information in making their location decisions.

When asked to identify the “ease” of information availability, respondents placed a premium on information on foreign exchange regulations, local taxes and tax exemptions.

Information	Readily available     %	Readily available on request %	Available with delay   %	Difficult to obtain   %	Not available     %	Mean[12]	Standard deviation
Information on forex regulations	40.00	30.00	30.00	0.00	0.00	82	16.9
Information on local taxes	30.00	46.70	23.30	0.00	0.00	81.33	14.79
Information on tax exemptions	23.30	60.00	10.00	6.70	0.00	80	15.76
Information on incorporation/registration of companies, rights of shareholders and obligations under Companies Act 2001	16.70	60.00	16.70	6.70	0.00	77.33	15.52
Regulations and legislations on investment in Mauritius	26.70	33.30	33.30	6.70	0.00	76	18.5
Information on work and residence permits	30.00	30.00	26.70	13.30	0.00	75.33	20.8
Information on customs regulations and procedures	13.30	60.00	13.30	13.30	0.00	74.67	17.37
Information on environmental requirements	26.70	30.00	30.00	13.30	0.00	74	20.44
Information on possibility to establish operation in the proposed development sector	20.00	30.00	33.30	16.70	0.00	70.67	20.16
Monetary costs of registration/licensing required of foreign investors	10.00	53.30	13.30	20.00	3.30	69	21.71
Information on the costs of operation	16.70	33.30	26.70	16.70	6.70	66.67	24.68
Information on mergers and acquisitions	20.00	33.30	6.70	30.00	10.00	63.67	28.95
Licensing procedures	3.30	26.70	36.70	23.30	10.00	57	22.61
Real estate acquisitions/property ownership	3.30	16.70	16.70	40.00	23.30	45	25.7
Total	20.00	38.80	22.60	14.80	3.80

Table 16: Ease of information availability

It is interesting to note that information on the fiscal incentives, that is, on the local taxes and customs duty exemptions score a mean value of 81 and 80 respectively (table 16). Parameters were established and a score of 80 signifies that these information are readily available on request.

 

Doing Business in an alien country requires firstly knowledge on the possibility to establish operation in the alien country in the proposed development sector. This investment related information according to one third of the respondents is available with delay and 16.7% have experienced it as difficult to obtain as can be seen in table 17.

Table 17: Information on possibility to establish operation

Investors need records of all generic procedures that are required for an entrepreneur to start up an industrial or commercial business. These include obtaining all necessary licenses and permits and completing any required notifications, verifications or inscriptions with relevant authorities. The survey reveals that such information availability earns a mean value of 69. This implies that foreign investors get the information with much delay. Such delay may be construed to be either the authorities provide the information with delay, no clear guidelines are provided to investors, lack of clear and concise information or the inexistence of a one-stop-shop portal.

After a study of laws, regulations and publicly available information on business entry, a detailed list of procedures, time, cost and paid-in minimum capital requirements is required. The results further provide insight that company incorporation information is readily available.

Information on the real estate acquisition and property ownership are difficult to obtain. Table 18 shows that more that 23% of the respondents view that information on the real estate is simply not available. This is worth noting, as foreign investors need to acquire or rent real estate to set its business operation.

Table 18: Information on the real estate acquisition

5.1.2.3             Perceptions of Risk

When evaluating foreign investments, foreign investors are generally “very concerned” with key potential risks. From figure 12, operational risks and financial risks are ranked as the issues of most concern.

Figure 12: Greatest perceived risks

5.1.3       Location decision

This section of the questionnaire aimed at identifying the motivating factors for foreign direct investors when choosing Mauritius as their investment base. Thus far the literature has provided insight at the decision making process from a variety of perspectives.  However the question left unanswered is which of the elements have had the highest impact on the decision making process. The analysis includes:

1. The most influential location factors;
2. The decision making process;
3. Strategic motives and objectives for foreign investment.

5.1.3.1             Most influential selection factors

The survey asked respondents to rank the “most critical location factors” when locating operations to Mauritius to understand the exact impact of location factors on investment decisions.

Overwhelmingly, respondents cite improved quality of life and fiscal incentives. The other variables having large impact include cost of labour and availability of quality labour.

Decision factors	No impact %	Low impact %	Medium Impact %	High Impact %	Very high impact %	TOTAL %	Mean[13]
Quality of beer	6.70	10.00	16.70	43.30	23.30	100	66.67
Discounts	6.70	20.00	13.30	20.00	40.00	100	65.33
Cost of Beer	6.70	16.70	20.00	20.00	36.70	100	64
Easy Availability of Beer	13.30	6.70	13.30	46.70	20.00	100	64
Stable Taste	20.00	10.00	10.00	40.00	20.00	100	58
Advertising in social media	13.30	13.30	23.30	30.00	20.00	100	56
Beer Festivals	10.00	16.70	26.70	30.00	16.70	100	54.67
TV Advertisement	3.30	33.30	16.70	30.00	16.70	100	54
Newspaper advertisement	6.70	3.30	53.30	30.00	6.70	100	52.67
Brand image	16.70	6.70	36.70	20.00	20.00	100	52
Raw  Materials	10.00	16.70	30.00	33.30	10.00	100	52

 

Table 19: Most influential factors

The emerging evidence from table 19 is that tax incentives in Mauritius have a more apparent effect on the location factors and a motivating factor in attracting FDI to Mauritius.

The cost and quality of labour are also factors of important considerations. Fiscal incentives and cost of labour have direct impact on the cost of doing business. In the any business activity, the quality of labour and the unit price paid to the labour are of important variables that investors consider and the survey clearly provides evidence therefor.

Surprisingly, however, the mean value for ease of doing business indicates that foreign investors consider it to be a decision factor of medium importance. The non fiscal incentives, access to raw materials and access to suppliers are factors having low impact on the decision of foreign investors.

Worth noting however, is that infrastructures and the cost of utilities have medium impact on the location of FDI.

5.1.3.2             Decision making process

One of the central elements of the questionnaire asked respondents to rank in order of priority the steps followed in making their location decision. The question had 7 ranked multiple responses. Table 20 gives frequencies for each rank. The mean rank for each modality is given in the last column. A mean rank closer to 1 implies a priority item in the location decision.

Whereas incentives is the most cited by the foreign investors in first order in their priority order, the mean rank shows the cost of operating in Mauritius as being critical for the establishing a business in Mauritius. The leading objective for the majority of companies has therefore likely to rank reducing operating costs and cite fiscal incentives as a more likely way to reduce costs. The question therefore is what has been the strategic motivation for companies to operate in Mauritius.

Factors influencing location decision	N° cit.   (rank 1)	N° cit.   (rank 2)	N° cit.   (rank 3)	N° cit.   (rank 4)	N° cit.   (rank 5)	N° cit.   (rank 6)	N° cit.   (rank 7)	Mean rank
Operating costs excluding incentives	6	8	6	4	3	2	1	3
Incentives	8	5	3	4	3	6	1	3.33
Ease of doing business	6	5	4	6	6	3	0	3.37
Availability of Labour needs	5	7	6	2	3	3	4	3.53
Market access	4	3	7	6	1	1	8	4.07
Availability of capital	0	1	2	5	9	10	3	5.13
Source of raw materials	1	1	2	3	5	5	13	5.57

Table 20:  Decision making factors – order of priority

5.1.3.3             Motives for investment

As found in chapter 3, rational investors base decisions on where to invest on the quality of the investment opportunity, the anticipated returns and the ease with which the investment can take place, adjusted for the foreseeable and unforeseeable risks that will prevent such returns from being realized. Policies aimed at increasing the level of foreign direct investment need to attempt to market opportunities and raise the potential returns, while reducing obstacles and risks associated with such investments.

Investors were analysed based on key motivations:

1. Assets and factors of production (resource based investors)
2. Market size (market seeking FDI)
3. Cost reduction (Efficiency seeking)

Figure 13 below shows the size of each of these three investment motivation categories in the survey. Cost reduction FDI is the most dominant group (57.1%), followed by far with investors for resource-based activities (22.9%) and market size (20%)

Therefore it implies that tax incentives like duty exemption on equipment and materials, exemption on VAT and other rebates play a key role for the cost reduction.

For BPO-ITES, non-textile manufacturing and Freeport companies cost reduction is most important (table 21).

5.1.4       Incentives

The evidence gathered so far through the interviews shows that fiscal incentives are obviously capable of affecting the volume and location of FDI. This section of the survey had objectives of:

1. Identifying what kind of tax incentives is likely to have the greatest impact on the investment location decisions on foreign investors;
2. How the incentives can impact on the cost structure of the foreign companies;
3. What if no fiscal incentives would have been provided by the government.

5.1.4.1             Which tax instruments work?

The Government uses several tax instruments and tax incentives schemes as described in chapter 2 in an attempt to influence and lure foreign investors. Figure 14 shows the impact of incentives on foreign firms that have implanted in Mauritius vis-à-vis foreign competitors.

Figure 14: Impact of incentives vis-à-vis foreign competitors

According to the respondents, reduce corporate tax (mean 68.67), exemption on payment of VAT on supplies (mean 64.67) and duty free imports (mean 58.67) play a more important role in the cost structure and competitiveness of the firms when exporting their produce abroad. The low rate of registration duty of 5% instead of the normal rate of 10% has a low impact (mean 41) and can be explained by the fact that the acquisition of the immovable property by the foreign companies is a one off capital expenditure.

	Mean[14]	SD
Reduce corporate tax	68.67	35.5
Duty free imports	58.67	33.6
Exemption on payment of VAT on supplies	64.67	34.71
Tax free dividends	60.67	32.12
No capital gain tax	57.33	31.4
No Land conversion tax	50.67	40.93
5% registration duty for purchase of land	41.33	41
Relief on personal income	48	36062
Investment allowances	50.67	33.93
Free repatriation of dividends	59.33	37.32
Permanent residence	51.33	37.39

Table 22: Table of mean Impact of incentives vis-à-vis foreign competitors

5.1.4.2             Incentives and cost structure

Tax policy has effect on the cost structure of firms. The incentives factor seems to suggest that current incentive schemes provided to the investor (such as tax reductions and duty exemptions) play an important role in an investor’s decision to further expand its commitment to the country. From table 23, taxation reduction and duty exemptions were clearly the most desired incentives for both the foreign investor group as a whole as well as for the individual categories of market seeking, resource-based and export-oriented investors. Respectively, a mean value of 70.6 and 65.33 considered those as desirable. Next in the incentive wish list of investors are tax free dividends and exemption on payment of the 15% Value Added Tax on supplies made.

	No impact	Very low impact	Low Impact	High Impact	Very high impact	TOTAL	Mean
Reduce corporate tax	1	5	4	7	13	30	70.67
Duty free imports	2	4	7	5	12	30	65.33
Free repatriation of dividends	3	6	3	7	11	30	63.33
Tax free dividends	4	6	2	7	11	30	62
Exemption on payment of VAT on supplies	3	6	5	7	9	30	59.33
No capital gain tax	5	4	5	5	11	30	59.33
Investment allowances	4	7	4	8	7	30	54.67
Permanent residence	5	7	2	9	7	30	54.67
Relief on personal income	7	5	5	6	7	30	49.33
5% registration duty for purchase of land	10	7	3	5	5	30	38.67
Total	44	57	40	66	93	300

Table 23: Most attractive incentives

Parameters are established by the notation: No impact (0), Very low impact (20), Low Impact (40), High Impact (80), Very high impact (100).

5.2 Results Analysis

The results of the survey, as revealed and described in precedent section show a key finding in that the existing foreign investors who have been granted an investment certificate have been influenced by incentives, in particular the reduced corporate tax and exemption on the rate of customs duty. The primary concern of foreign investors is in fact the costs of operating in the country and consistent with that the incentives provide the means to reduce the costs of doing business. The purpose of this section is therefore to infer deeper into the results, the reason behind the importance attached to incentives by foreign investors and the kind of investors on whom incentives have had the highest impact on their location decision.

5.2.1       Information on fiscal incentives

The survey showed that information is readily available on the fiscal incentives in all the sectors and most favourable investment schemes. Investors have more information on the incentives than they are made aware of the investment opportunities in the country. The major consideration in the investment promotion for attracting FDI appears to be more focus on the several tax instruments that the government provides to investors making it more appealing and marketing the country as a broad-based low corporate tax destination.

The lack of information to foreign investors on the ease of doing business, costs of operating a business and on the acquisition of real property is a matter that requires urgent consideration by policy makers. It is the investment climate and the ease which foreign firms can implant their operation in the country that should matter the most.

There is a need to instil greater policy coherence and the formulation and implementation of investment promotion policies not based only on investment incentives of low corporate tax, tax credits, investment allowances and customs duty exemption but also on the comparative advantage that Mauritius offers.

Mauritian investment policy has traditionally been based on a narrow activity or sector approach where investors are provided with a shopping list of incentives and schemes. This has led over time to a proliferation of separate investment incentive schemes, each promoted by a specific ministry or agency.  When they carry different fiscal and other advantages, they act as a deterrent to development of linkages between companies operating under different schemes, such as between the freeport, EPZ or global business and other economic activities.  When, in addition, the frontiers between these schemes become blurred, we witness within the country what may be called harmful tax competition. As a consequence, foreign investors shopped around the various government bodies, each competing to promote its own schemes, so as to extract the best deal, with inevitable consequences on public finances.

5.2.2       Tax behaviour of foreign companies

There are reasons to believe that the impact of taxes on average foreign investors differs depending on the characteristics of the foreign company.

5.2.2.1             Level of investment

The table 24 shows that the impact is more so on investors with an initial investment of between 5 to 15 million rupees. This therefore means that the location decision by investors in this investment range are influenced by the tax credits, investment allowances and low rate of tax on their chargeable income to be able to carry out business operation in Mauritius.

Table 24: Table of mean – Investment vs Fiscal incentives

Cell values are means calculated ignoring non-responses.

No criteria permit discrimination of categories.

Highlighted numbers indicate significantly different category means (t-test) from the rest of the sample (to a confidence (1-p) of 95%).

Fisher’s test results:

Fiscal incentives: V_inter = 2627.65, V_intra = 1250.55, F = 2.10, 1-p = 87.57%

Parameters are established by the notation: No impact (0), Low impact (20), Medium Impact (40), High Impact (80), Very high impact (100).

5.2.2.2             Mode of investment

Investors who have undergone joint ventures have mentioned fiscal incentives of being a decisive factor. It is interesting to note that in a study, Coyne (1994) suggests that small investors and joint ventures are responsive to tax incentives than large ones. Taxes may play a more important role in the cost structure of small companies.

Table 25: Mean importance of fiscal incentives depending on investment mode

Cell values are means calculated ignoring non-responses. Discriminating criteria are highlighted.

Highlighted numbers indicate significantly different category means (t-test) from the rest of the sample (to a confidence (1-p) of 95%).

Fisher’s test results:

Fiscal incentives: V_inter = 6179.73, V_intra = 792.60, F = 7.80, 1-p = 99.92%

Parameters are established by the notation: No impact (0), Low impact (20), Medium Impact (40), High Impact (80), Very high impact (100).

5.2.2.3             Business sector

Fiscal incentives form part of the decision factor of all respondents surveyed. Worth noting, companies operating in the education sector consider the incentives to be of very low impact. An in-depth analysis reveals that companies operating in the education sector and holding an investment certificate (Education) are liable to income tax on their chargeable income at the rate of 15%. These companies are not provided with exemption on customs duty on the import of equipments nor tax credits or investment allowances on the purchase of equipments.

On the other hand, companies operating in the health care sector and having an investment certificate (Healthcare) have a tax holiday for a period of 5 years on their chargeable income and liable to tax credits, investment allowances and customs duty exemption on all medical equipments. This therefore reflects the nature of response.

However, worth noting also in the result is the medium impact of fiscal incentives on the BPO-ITES companies. These companies have exemption provided on their income up to the income year ending 30 June 2012. An ICT company which has incurred capital expenditure on the acquisition of new plant and machinery or computer software is allowed a deduction of 25 per cent of the capital expenditure so incurred by way of investment allowance in respect of the income year in which the expenditure is incurred. Despite so many tax credits, the BPO-ITES companies consider other factors when investing in Mauritius.

For BPO-ITES companies, it the quality and cost of labour, ease of doing business and the ability to hire technical staff are factors that affect the location decision (see appendix A.5)

5.2.3       No fiscal incentives scenario

As fiscal incentives appear to have effect on the location decisions of foreign investors, it comes obvious to comprehend if foreign companies would have invested in Mauritius in the case where the government would have provided no fiscal incentives to companies including the tax credits, investment allowances or more generally the cost-reducing incentives. The question was to state clearly and explicitly what would have been the situation in the absence of the fiscal incentives.

70% of the foreign investors would not have invested in Mauritius if they would not have got a smorgasbord of reduced corporate tax, tax credits, investment allowances and import duty exemptions (figure 15).

The result has important policy implications. By default, it means that the incentives provided by government helps start up companies to reduce their initial expenses and more profit to trade off against other deficiencies of operating in Mauritius. Without the incentives, Mauritius is not an attractive base for business. To make up for the deficiencies, the incentives are a form of subsidy to help the business organization help to reduce their operating costs.

By this, therefore, one can conclude that the respondents who consider incentives as the decisive factor for doing business in Mauritius can be described as being the footloose investors as described by Morriset (2003) and that without the incentives, the companies would not exist. The result sheds light on the existence of serious deficiencies in the investment climate.

It is interesting to note again that the majority of companies operating in the BPO-ITES sector would have invested even without the incentives.

Surprisingly, while it is generally acknowledge that Mauritius has a comparative advantage in the tourism and hospitality sectors, the results show that the incentives affect the foreign investors. This can be attributed to the fact that:

• initial investment in the new hotels are massive;
• high rate of duty on construction materials;
• low hotel room occupancy rate at start following construction;

Table 26: No incentive scenario – response by sector

Yes – Would have invested even without incentives

No – Would not have invested without the incentives

The graph below provides an indication and the relationship between the importance attached to corporate tax and what if no fiscal incentives.

Figure 16: Regression analysis

• The graph shows 30 points of coordinates for “reduce corporate tax” and “invest if no fiscal incentives”
• Dependence is significant.
• Regression line equation: Invest if no fiscal incentives = 0.01 * Reduce corporate tax + 0.99
• Correlation coefficient: +0.79 (Reduce corporate tax explains 62% of the variance of Invest if no fiscal incentives)
• Standard deviation of regression coefficient: 0.002

Investors were asked if Mauritius cancels its entire incentive package, would they still invest. The results are provided in the figure below.

Figure 17: No incentive scenario

For 26.7% of the respondents, if such a situation arises, they will invest elsewhere. However, it is it worth noting that 46.7% will still invest to expand their business operations in the country.

To the question about whether the foreign controlled companies compared the list of incentives provided by the government with that of other countries, 60% of the respondents affirmed that they had compared the incentives with that of other countries.

5.3 Hypothesis testing

This section of the analysis tests the hypotheses of the impact of fiscal incentives on FDI. Four hypotheses were identified and the testing is carried out using statistical tools.

Hypothesis test I

H1             Fiscal Incentives have more impact on FDI than the cost of doing business

H1a           Fiscal incentives have less impact on FDI than the cost of doing business

For the chosen test, which is a paired-samples t-test, the variables used were the 2 types of cost (cost of utilities and access to raw materials) and fiscal incentives measured on a five point Likert scale. Parameters are established by the notation: No impact (0), Low impact (20), Medium Impact (50), High Impact (80), Very high impact (100).

The t-Test: Paired Two Sample for Means, using an alpha value of 0.05 was conducted to evaluate the impact on FDI, results of which are shown in the table below.

	FISCAL INCENTIVES	COST
Mean	65.333	42.000
Variance	1349.885	699.310
Observations	30.000	30.000
Pearson Correlation	0.528
Hypothesized Mean Difference	0.000
Df	29.000
t Stat	3.996
P(T<=t) one-tail	0.000
t Critical one-tail	1.699
P(T<=t) two-tail	0.000
t Critical two-tail	2.045

Table 27: t-Test: Paired Two Sample for Means fiscal incentives v/s cost

The null hypothesis is rejected if the test value of t is greater than the critical value. Since t is less than the critical value, H1 is not rejected.

From this we infer that fiscal incentives have more impact than cost of utilities and access to raw materials in location decision to Mauritius.

Hypothesis test II

H2             Fiscal Incentives have more impact on FDI than labour needs

H2b           Fiscal incentives have less impact on FDI than labour needs

For the chosen test, which is a paired-samples t-test, the variables used were the 3 types of cost (ability to hire technical staff, ability to hire management staff and availability of quality labour) and fiscal incentives measured on a five point Likert scale. Parameters are established by the notation: No impact (0), Low impact (20), Medium Impact (50), High Impact (80), Very high impact (100).

The t-Test: Paired Two Sample for Means, using an alpha value of 0.05 was conducted to evaluate the impact on FDI, results of which are shown in the table below.

	FISCAL INCENTIVES	LABOUR NEEDS
Mean	65.333	58.222
Variance	1349.885	1023.550
Observations	30.000	30.000
Pearson Correlation	0.094
Hypothesized Mean Difference	0.000
Df	29.000
t Stat	0.840
P(T<=t) one-tail	0.204
t Critical one-tail	1.699
P(T<=t) two-tail	0.408
t Critical two-tail	2.045

Table 28: t-Test: Paired Two Sample for Means Fiscal incentives vs Labour needs

The null hypothesis is rejected if the test value of t is greater than the critical value. Since t is less than the critical value, the null hypothesis H2 is accepted.

Hypothesis test III

H3             Fiscal Incentives have more impact on FDI than infrastructure

H3c           Fiscal incentives have less impact on FDI than infrastructure

For the chosen test, which is a paired-samples t-test, the variables used were the 4 types of cost (reliability and quality of infrastructure, available land with all services in place, access to suppliers and port and airport infrastructures) and fiscal incentives measured on a five point Likert scale. Parameters are established by the notation: No impact (0), Low impact (20), Medium Impact (50), High Impact (80), Very high impact (100).

The t-Test: Paired Two Sample for Means, using an alpha value of 0.05 was conducted to evaluate the impact on FDI, results of which are shown in the table below.

	FISCAL INCENTIVES	INFRASTRUCTURE
Mean	65.333	47.500
Variance	1349.885	361.638
Observations	30.000	30.000
Pearson Correlation	0.439
Hypothesized Mean Difference	0.000
df	29.000
t Stat	2.948
P(T<=t) one-tail	0.003
t Critical one-tail	1.699
P(T<=t) two-tail	0.006
t Critical two-tail	2.045

Table 29: t-Test: Paired Two Sample for Means Fiscal incentives vs Infrastructure

The null hypothesis is rejected if the test value of t is greater than the critical value. Since t is less than the critical value, the null hypothesis H3 is accepted. This therefore implies that fiscal incentives have more impact on FDI than infrastructure.

Hypothesis test IV

H4             Fiscal Incentives have more impact on FDI than ease of doing business

H4d           Fiscal incentives have less impact on FDI than ease of doing business

For the chosen test, which is a paired-samples t-test, the variables used were the 7 types of cost (market access, stable social and political environment, ease of doing business, crime and safety, enforcement of laws, quality of life, status of resident) and fiscal incentives measured on a five point Likert scale. Parameters are established by the notation: No impact (0), Low impact (20), Medium Impact (50), High Impact (80), Very high impact (100).

The t-Test: Paired Two Sample for Means, using an alpha value of 0.05 was conducted to evaluate the impact on FDI, results of which are shown in the table below.

	FISCAL INCENTIVES	EASE OF DOING BUSINESS
Mean	65.333	51.714
Variance	1349.885	343.054
Observations	30.000	30.000
Pearson Correlation	0.583
Hypothesized Mean Difference	0.000
Df	29.000
t Stat	2.486
P(T<=t) one-tail	0.009
t Critical one-tail	1.699
P(T<=t) two-tail	0.019
t Critical two-tail	2.045

Table 30: t-Test: Paired Two Sample for Means Fiscal incentives vs Ease of doing business

The null hypothesis is rejected if the test value of t is greater than the critical value. Since t is less than the critical value, the null hypothesis H4 is accepted.

Chapter 6: Recommendation and Conclusion

This chapter creates connection with the research questions in order to respond to the main problem of the study. It concludes with the main observations of the research area and provides the recommendations based on the findings. The project ends with directions for further research.

6.1           Conclusion

Foreign direct investment contributes to economic growth. It provides additional capital and skills and serves as a vehicle for introducing new technology to a country. It provides employment and increase tax revenues, which government can reinvest in the social sectors and infrastructure improvements. Mauritius is increasingly aware of the role of FDI as an engine of growth and has progressively sought ways to attract larger volumes of FDI flows to the economy.

This dissertation primarily aimed at understanding as to whether fiscal incentives affect cross border movements of foreign investors to Mauritius and thus inward FDI and to determine likely factors attracting FDI to the country. Evidence shows that taxes affect net return on capital of the foreign direct investors and have influenced the capital movements as more than two-third of them would have chosen another location for their investment if no fiscal incentives would have been provided. Compared to other locations and countries, Mauritius has a low tax regime. The effective tax rate is much lower when considering the tax credits, investment allowances and accelerated depreciation mechanisms that are put in place. Fiscal incentive is what Mauritius used to create the market failure that was put forward by Hymer (1976). According to Hymer, in the absence of some sort of failure in the market for advantage, there will be no gains from controlling a foreign operation and hence international operations will not take place. Therefore, for the foreign investors to ‘buy’ the advantage and create the market imperfections, the incentives are provided.

However, in addition to the role and contribution of fiscal incentives in bringing FDI to the country, other factors without their presence would have never helped to attract FDI to Mauritius. Notwithstanding the basic factors that countries in pursuit of FDI should possess like political and economic stability, the location needs to possess the factors of production and the comparative advantage thereon against other countries. The decision making process thus according to executives of the companies where the control and management of operations are by non-citizens revealed that it starts with an analysis of the operating costs, followed secondly by an analysis of the list of incentives and ease of doing business. The operating costs mean the comparative advantage that the country can provide. According to M. Porter, the operating costs that determine the competitiveness of firms operating in a country.

Operating costs is determined by the efficiency of the support industries in the country, the macro-economic policies, demand and factor conditions that are put forward by the country to lure investors to set operations and trade hassle free. The operational risks have thus been considered to the element of concerned.

It is unfortunate and disturbing to note that the foreign controlled companies issued with an investment certificate to benefit from incentives and be treated as tax incentives companies under the Income Tax Act would relocate their operations abroad if government decides to review the tax rate at a higher level. Worst, if Mauritius would not have been a low tax regime and no duty exemptions would have been provided to the foreign controlled companies, they would have not invested in the country. While considering their investment base, these companies seek information on the most favourable fiscal regimes and how best they can optimize from not paying corporate tax. As already stated in the foregoing chapter, the resultant has been over the years in Mauritius the shopping around by potential foreign investors of the list of investment schemes that are most favourable. The ultimate consequence is the loss for the treasury and loss of revenue for development in infrastructures and other factors that could have made up for the deficiencies in the investment environment vis-à-vis foreign countries competing for FDI. Incentives cannot make up for the deficiencies in the business climate when considering it with that of other developed countries. Therefore Mauritius should move from the incentive base location to a favourable business and investment climate to attract FDI. According to Lall (2000) rational investors are likely to base decisions on where to invest on the quality of the investment opportunity, the anticipated returns and the ease with which the investment can take place, adjusted for the foreseeable and unforeseeable risks that will prevent such returns from being realized.

Consistent with the results of incentives being a determining factor, the results show that the country is marketed with the incentive schemes that have been put in place to sway investment decision. The way the country is promoted and the nature of information affects decisions of investors. Operating costs, a key factor, is available with delay while information that will ease business start up is difficult to obtain. This has important implications for the policy makers. The Board of Investment, the national investment promotion agency, should focus more on promoting the island for its sound economic environment and facilitate the investment climate for ease of doing business. The focus should be on what can differentiate the country from others rather than focusing on incentives for the country to attract substantial FDI.

With foreign investors being competitive only because of incentives means subsidizing inefficient operations in the country. What many researchers have called as ‘footloose’ investors, the focus should be on investors who can generate positive externalities and remain competitive and in business in the country even without the incentives. It is with competitive processes and innovation that companies can compete on the global market.

6.2           Recommendations

1. What really matters – Operating costs

Incentives have an impact on FDI and affect the decisions of investors. They have played a decisive role in the location decisions to reduce the operating costs. To get the most of FDI, the costs of doing business in Mauritius should be brought out to lower levels. Government should concentrate on assisting investors by concentrating on strengthening the economic foundations and work on strategies to improve the physical infrastructures. Utility rates should be competitive for businesses to compete. The focus should be on:

1. Better infrastructures
2. Support logistics facilities
3. Clustering of activities
4. Labour productivity
5. Transport costs

Given the broad scope, the investment incentives in question should be considered part of the economy’s innovation and growth policies rather than a policy area that is only of relevance for foreign investors.

2. Improving human capital

 In addition to modernising the infrastructures, government should consider its efforts to raise the level of education and labour skills as these can help to make the country remain competitive in the wake of globalisation and fierce competition. As noted repeatedly above, the quality of labour is an important component of the economic fundamentals that determine the location of FDI. In addition to attracting FDI and facilitating the realisation of spillovers, these policies will also promote growth and development of local industry. In particular, with better and quality labour due to education, training and R&D activities, the likelihood for linkages between foreign and local firms is enhanced.

3. Environment for attracting FDI

 Government should work to improve the overall business climate as part of the investment promotion policy. It takes on average more that 46 days for a small business to start operation in the country[15]. The country has outlived an archaic and cumbersome system that makes it extremely difficult to obtain planning clearances before an investor can start a business. Therefore, there is need to make things simple, transparent and rule based and build a new, open and competitive service platform. Government must be determined to overcome bottlenecks in the implementation of all investment projects, both local and foreign and to put into actions facilitation measures by creating a more conducive business environment for doing business in Mauritius, by improving the investment climate to world standards and boosting investment which is critical to create jobs, promote employment and return to high growth.

Foreign controlled companies need:

1. their project to be approved by the Board of Investment and be issued with an Investment Certificate to benefit from incentives;
2. PMO authorisation to acquire immovable property or rights to immovable property prior start of operation;
3. Building and Development permits which are delivered after 42 days from the date of application as per the Local Government Act and Planning and Development Act;
4. Trade licence to operate in the locality;
5. Permits and licences for the particular area of activity;
6. In cases of sensitive projects listed in the Schedule to the Environment Protection Act, an Environment Impact Assessment Licence (EIA) from the Ministry of Environment.

Taking these into account, there is an urgent need to put an end to suffocating bureaucracies that stifle enterprise and improve efficiency in the business climate that encourages private investment. Bottlenecks with regard to entry and utilisation of goods, services and capital must be removed to set a new course towards modernizing the country. The proposal is a legal framework that would allow businesses to start operations on the basis of self-adherence to comprehensive and clear guidelines. To allow easy business start-up, authorities must exercise ex-post control to check for compliance and ease of doing of business by investors, acquisition of properties by foreigners and for enterprises to start their business activities within minimum working days.

The removal of the administrative burden to investors should represent the ‘Key Selling Proposition’ to market Mauritius as a ‘free-from-hassles’ investment destination rather than a ‘low tax regime’. Mauritius must shake off the old mindset and adopt a high growth permissive framework.

 Policies for attracting FDI

 A number of key policy issues need to be addressed before the international community will seriously commit itself to the long-term investment that is required for improving prospects of attracting high quality FDI in support of sustainable growth. The key argument for attracting FDI is to create an environment with favourable conditions for private investment. The result will be instead of marketing the country on incentives and attracting free rider investors, focus should be on promoting the country on conducive environment based on:

1. Ease of doing business,
2. Promotion of openness in domestic and foreign trade with focus on removing import constraints,
3. Acknowledging that investors ideally seek countries with a sound track record with strong investment protection laws and practices and Mauritius already has a good regulatory and legal system.

6.3           Areas for further research

 The debate around the impact of taxes and fiscal incentives on FDI is far from being over. Old questions will lead to new answers and new questions will also emerge in the future. The first direction for research could be to examine more closely the effect of tax policy on the composition of FDI and have a better chance of attracting the right type of investment and maximising its impact on the economy.

The second direction lies in the question whether tax incentives should only be directed at investors that make the right things in the host country, such as environment safe projects or those leading to employment or transfers of technology and skills.

 

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