Incentives
The role of incentives in attracting investment is a complicated one. It is often assumed that the availability of cheap, compliant labour and a trade union-free environment are the major attractions for foreign investors. Tax and duty concessions also figure prominently in the list of incentives. However, the evolution of international competition and global production chains are changing the priorities of foreign investors. The factory visits conducted by ILO officials in the preparation of this report revealed two major considerations influencing the choice of export platform, namely, human resources and market access.
The availability of appropriately skilled human resources has become important because intensified international competition is forcing zone enterprises to improve their speed and quality of production, and many plants are introducing new technology and organization of work to raise productivity. Such production processes are more skill- and knowledge-intensive and require workers with better basic education who can be trained and retrained to use new technologies and adapt quickly to changes in working arrangements. The more widespread use of computers, for example, requires English language proficiency because the software and operating manuals are invariably in English.
The question of market access has two dimensions: the preferential access granted to certain countries in terms of trade agreements, and the speed with which the market can be reached. Access to markets is affected by the proliferation of regional trade groupings and by the quotas allocated in terms of the Multifibre Arrangement. Foreign investors are selecting export platforms which grant them access to their most important markets, and relocating if a change in trade regime compromises that access. The entry into force of the North American Free Trade Agreement, for example, has attracted substantial amounts of investment into Mexico, much of it at the expense of the Caribbean Basin whose trade agreement with the United States imposes higher tariffs and duties on products entering the United States. The imperative to respond quickly to orders and to fluctuations in market demand also obliges exporters to choose platforms that are strategically located in relation to major markets.
The low nominal wages prevailing in many EPZ-operating countries continue to play a controversial role in determining investment decisions. Labour-intensive assembly and processing operations are attracted to labour surplus economies with low labour costs, but the calculations on which investors base their decisions concern more than just nominal wage rates. Investors would rather examine unit labour costs, a calculation which takes the productivity of labour into account. In addition, many labour-intensive operations are now using expensive technology and materials, with the result that labour costs may make up only a small proportion of total production costs. In such situations the efficient operation of the machinery and optimum use of raw materials generate more important cost savings than low nominal wages.
There remains, however, a substantial number of enterprises which continue to rely on labour-intensive and low-technology production processes in which labour costs constitute a large proportion of total production costs. Such enterprises tend to be competing on price rather than on quality or innovation and consequently see labour as a cost to be contained rather than an asset to be nurtured. Such enterprises respond to increased competition by working harder rather than smarter, and as a result they typically have high rates of labour turnover, absenteeism, wastage and labour unrest. They generally have a negative view of workers' organization and are not willing to enter into collective bargaining arrangements with trade unions. Enterprises in this category are more likely to seek out EPZs with generous tax and duty concessions, low nominal wages, an absence of worker organization and weak systems of labour administration.
Enterprises which do compete on quality and innovation (such as high-tech electronics firms running "no-fault" production lines) are invariably setting standards which are higher than national norms for wages, working conditions, health and safety and training. ILO missions in 15 different countries found very low rates of worker organization in both enterprises which compete on price and those which compete on quality. The reasons for this absence of worker organization were, however, very difficult to establish. In Bangladesh the zones are exempted from the Industrial Relations Ordinance, which provides for organizing and bargaining rights in the rest of the economy, and investors are publicly informed of that fact. In the other countries visited for the preparation of this report there was no official ban on worker organization in the zones, but few of them had taken steps to ensure that worker organization was facilitated. None of the enterprises interviewed stated that a lack of worker organization was an incentive to invest, but a number added that they would not favour the unionization of their workforce and would not be willing to enter into collective agreements. Interestingly enough, zone investors adapt to local conditions in countries where the national labour relations environment includes trade union freedoms and collective bargaining rights. Countries which have an established trade union presence in the zones do not appear to have suffered any loss of investment and have the same investor profile as countries which lack trade union infrastructure. In the Philippines, for example, 59 per cent of zone investment is in the electronics sector, and many of the leading electronics firms have increased their investments despite the presence of trade unions in the zones. Even garment-producing factories which are competing on price are steadily being organized by trade unions which have launched a recruiting drive in the zones, and the same trend is evident in the Dominican Republic where the Labour Code was amended to ensure freedom of association and collective bargaining in the zones.
The incentive regimes in three zone-operating countries, Costa Rica, Sri Lanka and Singapore, are described below.
The economy of Costa Rica ran a persistent deficit on the current account, despite the fact that it was an important exporter of bananas and coffee, and so in the 1980s the Government decided to shift from a policy of import substitution to one of export orientation based on clothing and non-traditional agricultural exports. This has been very effective and today non-traditional exports account for over 40 per cent of the total, compared to around 30 per cent for traditional exports. There are three regimes providing duty-free entry for inputs required by export processing plants.
-- The Free Zones Regime provides inter alia for exemption from: all duties and consular taxes on the import of goods, components and parts, containers and other packaging materials, machinery and equipment, parts and supplies; import duty on vehicles required for production, administration and transport; all duties on export or re-export of products and machinery; a ten-year exemption from capital and net assets tax, real estate transfer tax and territorial tax; exemption from sales tax, tax on repatriation of profits and a sliding scale of exemptions from tax on dividends and profits; exemption from municipal tax for ten years; no foreign exchange controls and a wage subsidy of 15 per cent for enterprises located in less developed areas.
-- The Export Contracts Regime covers raw materials, goods, packaging and other non-domestic goods related to a company's operations.
-- The Temporary Admission System offers exporters full tax exemption on all goods entering the country for assembly, reconstruction or repair or incorporation into finished export products; exemption from tariffs on imports of equipment and spare parts, samples, moulds and similar items; and exemption from export, municipal and capital gains taxes. Goods may not be sold locally.
The Free Zones Regime is open to service and production-based enterprises, and enterprises outside the zones may also apply for the same incentives. Enterprises established in the free zones benefit from on-site customs inspection and may sell up to 40 per cent of their output on the local market. Zone enterprises are encouraged to use local raw materials provided they meet the quality, price and delivery criteria set by the enterprise. By 1994 some 5 per cent of the imports into the zones were of Costa Rican origin.
Costa Rica has pursued a highly successful zone strategy, firstly by attracting substantial amounts of investment into non-traditional export sectors, creating a significant number of new jobs, and secondly by evolving the strategy over time to remain competitive in a changing investment and trade environment.
The private sector in Sri Lanka has seen a rapid growth in its share of manufacturing value added since the liberalization of the economy began in 1977. The sectoral composition of the manufacturing boom has been somewhat imbalanced, however, with textiles and clothing accounting for the largest share. Of these, clothing is by far the most successful, and the lack of support from a more dynamic textile sector could now prove a drawback as the clothing sector tries to move up the global production chain. Sri Lanka has worked hard to enhance its incentive system and to improve its procedures for assessing and approving investment applications. Investment is encouraged in non-traditional exports (anything other than tea, rubber and coconut), export-related services, infrastructure, non-traditional agriculture and tourism. The Board of Investment (BOI) oversees the administration of the system and acts as a one-stop shop for foreign investors.
In order to diversify investment the BOI decided to stimulate the electronics sector through a Technology Transfer Fund that makes direct grants to enterprises which export advanced electronic components. The grants may be based on export turnover or be in the form of reimbursement of costs associated with training, acquisition of equipment for testing and calibrating, the manufacture of prototypes, dies and moulds and the development of quality control programmes.
Backward linkages are encouraged by offering the same incentives and rewards to suppliers of inputs to EPZ enterprises as those available to the zone exporters themselves. In addition, the procedures for subcontracting have been simplified. Despite these provisions the development of backward linkages has been slow and may not improve so long as imports remain duty free. Providing equal treatment to imported and local inputs may not be enough to overcome the propensity of most zone enterprises to import. Incentives are also available to small-scale manufacturers who supply zone enterprises, and this has shown some success in the supply of buttons, labels, cables and wires, garment hangers, rubber and leather soles and plastic accessories.
Singapore's incentive structure is interesting not just for the tax incentives it provides but for the non-tax incentives as well. Both deserve further analysis. The range of tax exemptions is highly focused, applying to pioneer and post-pioneer industries (those manufacturing a product which the Government wants to promote) in the manufacturing and service sectors, to research and development organizations, to investments in new technology and to enterprises expanding their activities. Thus, the Government rewards investments which correspond to its longer-term strategic development goals. The non-tax incentives include capital assistance, equity participation and venture capital to enterprises which invest in projects of technological or economic benefit to Singapore. There are a number of measures designed specifically to assist small and medium-sized Singaporean enterprises: