The Taxation Myth and Attracting Investment in Malawi

Updated: Jan 21


Tax holidays are not effective business incentives. They are not the reason firms will stay and continue investing in Malawi’s economy.

As recent as 2016, the GoM published a 28-page handbook naming the different tax incentives on the land. Studies illustrate how foreign direct and local investment have not translated into development of industry for many African countries, and certainly not for Malawi. One such study is one conducted by the IISD in December 2012, which looks at corporate taxes and highlighted the lack of effect that corporate tax exemptions have on the economy and all they promise. Although Mr. Nsiku, its author, does not offer specific solutions related to alternatives, he does make the point on the chunk of the pie that these incentives, alone, nibble.

Under the pretext of keeping investor activity toned and relaxed, in turn staying unceasingly refreshed to continue spurring local growth, tax holidays and exemptions have been executed severally during Malawi’s development trajectory. This article dispels the efficacy of these measures in promoting growth and development.

As ActionAid recently appealed to the Malawi government to do away with awarding large corporations tax-based incentives on their operations in Malawi, it is important for the GoM to consider the costs to the tax base that relies on a minute formal sector. ActionAid was right. Presently, with 83.7% of the country’s population residing in rural areas (2015 World Urbanization Prospects) and perpetually engaged in subsistence activities, rural economic activity is mainly invested in the informal sector. The surge in rural-urban influx is not only a recent phenomenon, but also has not occurred at a scale large enough to tip the rural-urban divide.

Informality means activities go unrecorded and so not within the scope of the keen eye of the MRA’s Commissioner General. Even when migration to urban areas happens, economic migrants seeking urban opportunities scarcely engage in business activity through formal institutions to be captured in national income accounting. The precariousness and informality of economic activities by urban migrants account for the outcome that rural-urban influx does not linearly correlate with the growth of the formal sector, and does not naturally lead to the growth of the tax base government needs to finance public goods and services.

Why do Corporations Set Up Shop?

Two main reasons.

The first – perhaps most important – is the prospect of a positive profit, no matter how small, being a business strategy for large firms to enter any market. This is the driving force for any large foreign, but also local, firm to set up shop in Malawi. Profit-making firms rely on a price-cost margin that guides engagement in a particular market to happen when, in the least, they break even. This also implies that, as long as the market dynamic for business requires that you make an economic profit of zero, you have no reason to leave the market. So, as long as the occasion to make profit avails, a business firm is unlikely going to postpone its activities because of the absence of a tax incentive.

The second concerns the consolidation of international market power, even when profits in one location or country do not look positive in the short-run. A unique feature of multi-market firms is the relocation of profits from some locations to those locations where profits may be relatively small or negative due to existing competition or the need for investments that would incite demand to long-term profit levels that could be reaped once the investments pay off. Armchair evidence would show that, typically, companies that easily employ this strategy are international mobile companies, supermarkets and commercial banks. An example close to the heart is the strategy Shoprite used when they opened their first supermarket in Lilongwe in 2001, when they strategized with preliminary too-low prices, accepting to make losses in the first years, and then raising prices immediately Kandodo Superstores were driven out of the market – taking their high-quality bread to obscurity with them.

Business strategy is hardly premeditated on the premise of a market’s tax regime. So, tax holidays/exemptions only feature as a short-term market disturbance that many large investors would otherwise not mind foregoing, if the long-term business environment appears promising. In other words, they constitute the short-term gift that has no influence on business operations in the future, and so on all economic benefits that are envisioned to be reaped over time.

The Look of an Investment-Friendly Environment

This article would like to argue that tax holidays are the myth that both governments and corporations themselves connive to sugarcoat the expectations of taxpayers and jobseekers. After all, the establishment of companies has both skilled and unskilled workers chasing new job opportunities created. It creates a myopia on individuals’ psyche that the personal interest is foremost important. Public investment agencies, on the other hand, are painted with promises of market competition, job creation and economic growth, and keep them talking a positive language that is only fodder to a campaign message of a political election that would soon ensue. In response, extended periods of tax-free terms are granted through legal documents to protect the 'national interest.'

But, we should all know the insignificance of taxes in the business environment equation. And this borders on what really makes for a conducive environment – to use an abused term in the world of development – for business and competitiveness.

The parameters that we should really consider when boosting the country’s business competitiveness environment should hardly dwell on the tax system, despite its charm in signaling the friendliness of the local economy to foreign investment. And it is not the first thing that business environment strengthening programs such as the BESTAP have pried their eyes on. Instead, what matters to a potential investment is whether, once the investment materializes, business transactions will be easy for any firm to stay and remain profitable.

In this vein, Malawians need to expend energies on transport, an important vehicle for facilitating transactions. Currently, the cost of transport is very high in Malawi, and the reasons are many, beyond the fuel cost – a liter of petrol/gasoline is currently at US$1.14 – argument, which actually reveals that Malawi’s fuel costs are not significantly different from its more competitive neighbors. The real problem lies in the costs of maintaining a vehicle, scarcity of vehicle parts, mainly due to high vehicle servicing prices as well as a road maintenance system that damages vehicles and limits scale of operation.

Utility services will not go unmentioned as indispensable ingredients of manufacturing and service provision. The poor infrastructure of electricity (struggling to service 9-10% of the population) and water raise investors’ financial and psychological costs of running a business in the country. Add to this the high and unjustifiable costs of telecommunications, which make business communications an impossible affair, are an important feature to address in the performance of the economy. In many developed economies, information systems and technology for communications are among the cheapest as they operate on scale economies, but also in competitive markets where efficiency drives prices down as quality improves. The telecommunications duopoly for mobile technologies in Malawi keeps prices for mobile services exorbitant and inaccessible to small and large enterprises alike. We do not want to start on the monopoly that Malawi Telecommunications Limited currently holds in the ground telephones’ sector.

Yet a crucial source of country competitiveness for business in Malawi, a factor that has led to the country’s low attractiveness, is the low levels of skills needed to run businesses. A local pool of talent is not only good for investors’ business, but also a cheaper contrast to the costs of employing expatriates to perform certain tasks. The likelihood of hiring a University graduate who hardly navigates English grammar, to use a simple example, is currently a Malawi business investor’s nightmare. The education system that refuses to set high standards and spend adequately on the education of its young people is identifiably an important setback in Malawi’s drive to becoming an investor darling. This includes that an uneducated pool of workers perpetuates the informality that is making it relatively difficult for the Commissioner General to appropriate taxes from a wider base.

The competitiveness for Malawi to become a vibrant business hub is a simple concept to actualize for our government. And, its export, growth and development or private sector strategies do not have to be impregnated by propositions of what Malawi is capable of producing for an export-driven economy. In fact, selling the smiles of Malawians that earned the country the “Warm Heart of Africa” brand has been overdone, and does not work in an investment negotiation. Rather it has to focus on what makes Malawi a viable destination for business transactions.

And the enhancement of business transactions is what this article is telling the Malawi government to turn its head to.

#ECONOMICSANDDEVELOPMENT

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