Ghana - Towards a Dynamic Investment Response

DRAFT CONFIDENTIAL Report No. 8911-GH GHANA AOWARDS A DYNAMIC INVESTMENT RESPONSE October 11, 1990 Western Africa Department Industry and Energy Operations Division CURREiCY EQUIVALENTS Currency Unit = Cedi (0) Cadi 1.00 = US$ 0.3030 US$1.00 = Cedis 330 (June 29, 1990) The exchange rate is now determined by the supply and demand for foreign exchange in the context of an extended interbank system (including authorized dealer banks and eligible foreign exchange bureaux) supported by weekly wholesale auctions by the Bank of Ghana. The selling rate for the US dollar set by the foreign exchange bureaux on June 29, 1990 was US$1 = 0348. ABBREVIATIONS BOG - Bank of Ghana DIC - Divestiture Implementation Committee DRC - Domestic Resource Cost ERP - Economic Recovery Program FDI - Foreign Dire:ct Investment GCB - Ghana Commercial Bank GIC - Ghana Investments Center GOG - Government of Ghana IMF - International Monetary Fund IRS - Internal Revenue Service MIST - Ministry of Industries, Science and Technology NBSSI - National Board for Small Scale Industries NRS - National Revenue Service PIB - Prices and Incomes Board PNDC - Provisional National Defense Council SAP - Structural Adjustment Program SOE - State-Owned Enterprise SSE - Small Scale Enterprise FISCAL YEAR January 1 - December 31 GHANA TOWARDS A DYNAMIC INVESTMENT RESPONSE Table of Contents PRFFACE * SUMMARY AND CONCLUSIONS . . . . . . . . . . . . . . . . . . . . . . . . I. BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . A. Why This Report? . . . . . . . . . . . . . . . . . . . . . . . B. The Economic Setting . . . . . . . . . . . . . . . . . . . . . 2 C. Economic Policy Reforms and Response . . . . . . . . . . . . . 3 D. Role of the Private Sector . . . . . . . . . . . . . . . . . . 5 E. Role of Government in Private Sector Development . . . . . . . 6 II. ADJUSTMENT RESPONSE OF MANUFACTURING UNDER ERP . . . . . . . . . . 8 A. Overall Impact of Policy Reforms . . . . . . . . . . . . . . . 9 B. Coverage and Methodology of the Surveys . . . . . . . . . . . 10 C. Findings of the Medium and Large Enterprise Survey . . . . . . 10 D. Findings of the Small Scale Enterprise Survey . . . . . . . . 12 E. Entrepreneurs' Views of Business Environment Issues . . . . . 18 F. Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . 20 III. THE ENABLING ENVIRONMENT FOR PRIVATE SECTOR DEVELOPMENT . . . . . 21 A. Governance . . . . . . . . . . . . . . . . . . . . . . . . 21 B. Attitude Towards the Role of the Private Sector . . . . . . . 22 C. Institutional Reforms . . . . . . . . . . . . . . . . . . . . 24 1. Financial Sector Development . . . . . . . . . . . . . . 24 2. Policies Towards State-Owned Enterprises . . . . . . . . 27 3. Domestic Pricing Policies . . . . . . . . . . . . . . . . 29 4. Taxation and Investment Incentives . . . . . . . . . . . 31 D. Legal and Regulatory Framework . . . . . . . . . . . . . . . . 38 1. Introducion . . . . . . . . . . . . . . . . . . . . . . 38 2. Business Establishment, Manufacturing Licensing and Investment Approval Procedures . . . . . . . . . . . . . 39 3. Expatriate Quota . . . . . . . . . . . . . . . . . . . . 43 4. Technology Transfer . . . . . . . . . . . . . . . . . . . 43 5. Foreign Exchange Transactions . . . . . . . . . . . . . . 45 6. Labor Laws and Regulations . . . . . . . . . . . . . . . 46 7. Tax Administration . . . . . . . . . . . . . . . . . . . 47 8. Other Regulatory Controls . . . . . . . . . . . . . . . . 48 9. Foreign Direct Investment . . . . . . . . . . . . . . . 48 10. Conclusions . . . . . . . . . . . . . . . . . . . . . . 51 E. Expanding Ma rkets . . . . . . . . . . . . . . . . . . . . . . 53 F. Human Resource Development . . . . . . . . . . . . . . . . . . 55 G. Infrastructure . . . . . . . . . . . . . . . . . . . . . . 57 H. Overview . . . . . . . . . . . . . . . . . . . . . . . . . 57 ANNEXES Annex 1-1 Selected Indicators of Economic Performance, 1975-89 Annex 1-2 Projected Economic Indicators Annex 1-3 Economic Implications of Low Growth on Private Investment Annex 2-1 Non-Traditional Exports Annex 2-2 Impact of Adjustment by Subsector on the Small Scale Enterprise Survey Annex 2-3 Changes under Adjustment for Firms Established by 1983, by Size, in the Small Scale Enterprise Survey Annex 2-4 Adjustment Responses and Constraints, all Firms in the Small Scale Enterprise Survey Annex 2-5 Regulatory Problems for Current Operation by Firms Size Group Annex 2-6 Views of Large Scale Firms on Dealing with Specific Regulations since 1983 Annex 2-7 Problems of Business Environment for New Investment, by Firm Size Annex 3-1 Key Recommendations for Improving the Enabling Environment Annex 3-2 Table 1 - Status of Investment Applications Under the Investment Code in 1988 Annex 3-2 Table 2 - Sectoral Breakdown of Investment Approvals by GIC, 1986-89 Annex 3-2 Table 3 - Ownership Structure of Projects Approved by GIC Annex 3-2 Table 4 - Proposed Capital Structure of Projects Approved by GIC Annex 3-3 Some Details on The Legal and Regulatory Framework Annex 3-4 Some Suggestions for Promoting/Facilitating Investment PREFACE This report is based on field work in Ghana in October/November 1989 by a joint team of Bank staff and officials from the Government of Ghana. The Bank team was led by Surendra Agarwal and comprised Benson* Ateng, Hans GrUss, Akbar Noman, William Steel, Shahla Torabi, Dileep Wagle, and Leila Webster (Bank Staff), and Henk K8ppen, Frederick Moore, J. P. Singh and John Wayem (Consultants). The Government Task Force was led by Kay Amoah (Ghana Investments Centre, GIC) and Seth Addo (Ministry of Industries, Science and Technology, MIST). Dr. E. K. Abaka, Executive Director, National Board for Small-Scale Industries (NBSSI), provided support for the survey of small-scale enterprises (SSEs). Several officials from GIC, MIST and NBSSI participated in the surveys of SSEs and of large enterprises. Messrs. Ebenezer Aryeetey (Ministry of Finance and Economic Planning), Kay Amoah (GIC) and Seth Addo (MIST) discussed an earlier draft of the report in Washington, DC in May 1990 and made significant contributions. Eleanor George and Pamela Blyther provided word processing support. The work was carried out under the direction of M. G. Sri-ram Aiyer. The World Bank wishes to convey its deep appreciation to GIC and MIST for the generous staff and logistical support provided to the mission. Special thanks are due to Dr. Kobena Erbynn, Chief Executive, GIC, and Dr. Kwabena Adjei, Deputy PNDC Secretary, MIST. The mission is also grateful to the Ministry of Finance and Economic Planning, Bank of Ghana, Ghana Export Promotion Council, Ghana Statistical Services, Ministry of Mobilization and Productivity, State Enterprises Commission, Prices and Incomes Board, and Association of Ghana Industries for providing support and information. Finally, a number of banks, and numerous private firms and state-owned enterprises generously gave time and information to the mission. GHANA TOWARDS A DYNAMIC INVESTMENT RESPONSE SUMMARY AND CONCLUSIONS i. Ghana has made significant progress since 1983 in pursuing sound macroeconomic policies through a structural adjustment program that has liberalized markets, altered relative prices to favor efficient production, and focussed public investment on improving physical infrastructure and social sectors. Ghana's economy has grown at an average rate of 5-6 percent per year. Yet the shares of investment and savings in GDP at about 14 and 7 percent, respectively, are clearly much lower than the levels needed to maintain the GDP growth rate of about 5 percent per year, absorb the rapidly growing labor force at higher levels of productivity, and achieve a modest growth in the per capita income in the medium term. As excess capacity in Ghana's economy becomes more fully utilized, substantial increases in new investment will be needed to maintain growth. Most of the improvement so far has been through an increase in public investment. Private investment has risen only modestly except in gold mining where it has increased sharply. Within and outside Ghana, there is an increasing recognition that for Ghana to move from the stabilization phase to sustainable growth--making the fullest use of the country's assets, both human and physical--private investment will need to play a much greater role and become the engine of growth. There is a growing recognition that macroeconomic policy reforms alone are not enough to generate a strong supply response, and major improvements in the financial markets, the legal and regulatory framework, the quality of economic and social governance and public administration are important elements of the enabling environment for private sector development. In order to stimulate growth, Ghana would also need a more efficient public sector. ii. This report has a specific focus. It (a) examines the response of the manufacturing sector to recent policy reforms; (b) analyzes constraints in the enabling environment for private sector development, particularly in the areas of legal and regulatory framework, taxation, and investment incentives; and (c) identifies measures to improve the response of investment to the Economic Recovery Program. Further analytical work is now needed to review the public enterprise sector and develop approaches for the joint evolution of the public and private sectors. The Economic Context iii. Since the beginning of the PNDC Government's Economic Recovery Program (ERP) in 1983, Ghana's economy has grown at 5 to 6 percent per year. The Government has improved production incentives, made progress towards restoring fiscal and monetary discipline, and sharply increased public investment in physical and social infrastructure. The exchange rate is now market determined, the trade regime has been overhauled, and price and distribution controls for a wide range of products have been dismantled. Prices are playing an increasing role in shaping the economy. The overall progress is significant given that the economy was in a total - ii - disarray in 1982: "Rent-seeking" behavior, smuggling, and corruption were wide-spread in reactions to severe price distortions and licensing and administrative controls; confidence in the economy was shaken; and investment had virtually dried up. iv. Yet Ghana faces formidable challenges in moving from adjustment to sustainable growth with equity. So far the recovery in output, savings and investment has been from a very low base; inflation remains high; private investors remain hesitant (except in gold mining); the external position is vulnerable to declining cocoa and stagnant gold prices, and to increasing oil prices; absolute poverty is widespread and a large segment of the population faces economic hardships; the population continues to rise at a rate of about 3 percent per year; per capita income is still significantly short of the level reached in the mid-1970s; and the dependence on external aid is high. v. In order to provide employment opportunities to a rapidly growing labor force and to achieve even a modest increase of 1-2 percent per year in private consumption per capita, the Government expects to maintain a growth rate of about 5 percent per year in the medium term. This, in turn, would require the share of investment in GDP to increase from 14 percent in 1989 to 21 percent in 1995. So far, while public investment has increased from 1.4 percent of GDP in 1980-83 to about 8.3 percent in 1989, private investment increased during the same period from 3.1 percent to only 5.7 percent. vi. Existing businesses.cite the weak banking system, the still poor state of the infrastructure, and the low level of demand as constraints on their expansions. The caution of new investors may also reflect the slow implementation of the state enterprise reform program Including commercialization of enterprises which will remain in the public sector and divestiture of others, uncertainty about the Government's attitude towards private profit, and difficulties in the legal and regulatory framework. vii. Ghana has substantial natural resources and an entrepreneurial labor force. It also has comparative advantage in natural resource-based and labor-intensive industries for export and efficient import substitution. Despite the small size of Ghana's domestic market, a Sub- Saharan Africa location offers businesses freedom from trade restrictions in European and U.S. markets and significant potential for export to those markets as well as the regional African market. The success of Ghana's recent economic policies provides an ideal setting to stimulate private investment. In the transition from stabilization and adjustment to sustainable growth, the private sector will have to become the engine of growth while the public sector focuses on effective implementation of policy reforms to increase competition, and on improving physical infrastructure, education and training and science and technology to create an enabling environment for long-term development. - iii - Adjustment Response of Manufacturing viii. The Government of Ghana has been concerned for some time about the lack of visible signs of new investment to take the place of adversely affected large firms, despite the reforms of trade and pricing policies. At the same time, little is known about the impact of adjustment ea smaller firms. The report shows that the aggragate supply response of the manufacturing sector under the ERP has been positive, if somewhat less than desired. The index of manufacturing output of medium and large enterprises (1977 = 100) has risen steadily from 35 in 1983 to 62 by 1988. In a few industry groups such as wood products, beverages, and non-ferrous basic metals, the output has even recovered to the peak level of 1977. Yet some industries (iron and steel products, paper products, textiles and garments) have continued to suffer. Average capacity utilization has increased from a lcr of 18 percent in 1984 to 40 percent in 1988, despite strong competition from imports, tight availability of new credit and generally restrained demand under the stabilization program. At the firm level, the results of two surveys of small scale and large enterprises show that structural adjustment is taking place and new opportunities are being pursued. ix. According to the survey of 31 large firms, about one-third are operating at over 60 percent of capacity, about one-half report rising output, and a third have increased employment. Short run domestic resource cost ratios for about one-half of the firms are under 1.0, generally those with relatively low effective protection. Many firms in wood-based products, food processing, beer and metalworking do not seem to need much protection to compete with imports in the domestic market, and in some cases have even penetrated neighboring export markets. They benefitted from the improved availability of imported inputs and easing of administrative controls under the ERP. On the other hand, firms with no real comparative advantage at their scale of operations (e.g., automotive batteries, electric light bulbs, and garments) are having difficulty competing with imports. Some of the most highly protected activities (e.g., automotive batteries and textiles) appear to be among the least efficient. Firms facing difficulties are either closing down or trying to adapt by moving into non-competing product lines or by attempting to upgrade technology. On the whole, firms are trying to change production processes to reduce costs and improve quality so as to take advantage of market opportunities. x. The results of the survey of 82 micro and small scale enterprises (SSEs) show that owners of many SSEs are highly entrepreneurial, have departed from the paths of their parents, are able to perceive opportunities, and are willing to take risks. A new generation o' entrepreneurs is emerging in response to the new opportunities under the ERP. Owners of small firms established since 1983 have higher educational qualifications than those of older enterprises, and in many cases started small but moved up quickly. Many have found profitable niches through an ability to adapt quickly to changing market circumstances and technologies. On the other hand, growth in the number of microenterprises has been attributable mainly to self-employment in response to falling real incomes - iv - and scarce opportunities elsewhere. Microenterprises have not adapted as successfully to changed circumstances in the economy, and many have suffered from weak consumer demand for manufactures among the low income and rural population, their major customers. Prospects for microenterprises will only improve when the growth of consumer demand outstrips the net rate of entry. xi. The survey results show that structural adjustment policies have begun altering the structure of industrial production in Ghana. Changes in the exchange rate, trade policy, demand, and prices have had differential effects on firms: negative to the extent that they use imported inputs intensively, compete with liberalized imports, or face constrained demand; and positive to the extent that they can obtain inputs more easily and find market niches. Although both positive and negative effects are found within each size and subsector group, the differences between groups suggest that structural changes are occurring. There is evidence both of growing dynamism at the firm level and of constraints on the realization of that potential. Many firms have engaged in adaptive behavior: almost half of the small firms established before 1983 have undertaken some investment since then to replace outmoded, deteriorated equipment and to change product mix. Only among large scale enterprises is there not much evidence of new firms. Many entrepreneurs have sought new products, techniques, and markets under the stimulus of this competition, and others would do so if they had greater access to resources. ?irms established since 1983 have been relatively more successful in expanding output in all size groups than those already in existence. This suggests that new firms--especially SSEs- -have entered relatively high-growth activities. Among constraints to adjustment, there was an overwhelming agreement (84 percent of respondents) that credit has become tighter during the adjustment period and is seen as a binding constraint to a strong supply response. Most of the firms surveyed have tried to get a bank loan during the past five years, without much success. xii. The fact that some firms have suffered declining production under the ERP has created pressures on the Government for increased protection. The evidence from the survey indicates that import competition is a problem mainly for certain products and large-scale firms, not a general concern. Although 61 percent of the firms interviewed claimed that competition had increased since 1983, only 21 percent mentioned imports as a major source of that competition, and only 12 percent if large-scale firms are excluded. For firms with under 30 exployees, other SSEs are the overwhelming source of competition for about three-quarters of the firms. xiii. Gross distortions in the iaentive framework have been removed under the ERP and price signals are appropriate for efficient import substitution and export growth. In response to pressure for more protection by industry, the Government is undertaking a study to assess the impact of trade policy reforms on the manufacturing industry and to provide a basis to further rationalize the tariff structure. Four points are worth emphasizing: (a) Incentive structure should be such that it encourages efficiency through competition, e.g., import competition and export rivalry. Further reforms should lead over time to a lower and more uniform pattern of protection that can encourage the development of non-traditional - v - exports and efficient import substitution .industries. (b) Exporters should have easy access to inputs at world prices. This will require temporary duty suspension or a well functioning duty drawback scheme for exporters, which is not the case at present. (c) The Government should elimirte the extensive use of concessions and exemptions from statutory duty rates which creates unintended variations in effective protection provided to industry. (d) The Government should continue to resist appeals of large firms for selective protection because (according to survey results) it is generally the inefficient firms who have been adversely affected under the ERP. Efficient firms with a strong comparative advantage are able to compete. Giving firms the time and resources to adjust their cost structures to a new structure of incentives does not mean that all firms will survive. The temptation to protect all existing capacity will have to be resisted if resources are to be released to growth industries and for activities which may be entirely new to Ghana but could develop under the new incentive structure, even though the latter may be less visible and may take time. Otherwise, the continuation of the existing unviable capacity will be at the cost of new activities, and, in the long-term, it will lower growth. xiv. Although there has been a significant relaxation of administrative controls under the ERP, a surprising 32 percent of all firms surveyed felt that dealing wizh government regulations has become more difficult (67 percent in the case of medium at.3 large firms). Fifty-two percent of all firms (72 percent of medium and large firms) cited problems in regulations. Location (the dominant concern for microenterprises), labor regulations (mainly larger firms), price controls (13 percent of all firms and 20 percent of large firms), deterioration in import clearance procedures, and taxes (both the high level and problems related to tax clearance certificates) are among some of the firms' main concerns. Uncertainty about the economy was seen as a restraint on new investment by 38 percent of respondents, especiallv those with 10 or more workers. Medium- and large-scale firms also expressed some reservations about the Government's attitude toward private investment; 36 percent saw it as a moderate or major problem. Taxes are seen as a moderate or major problem for new investment by most firms. Enabling Environment for Private Sector Development xv. Experience to date of many adjusting countries shows that for a rapid and efficient supply response to improvements in the incentive system, supportive changes are also needed in the financial sector, legal framework and regulatory policy, taxation and investment incentives, and the public enterprise sector. Political stability, good economic and social governance for development, the country's attitude towards the role of the private sector and the credibility and sustainability of the reform program are equally important. - vi - Governance xvi. Good governance is a prerequisite for sustainable development. Participation of people, public debate ad free flow of information, accountability and transparency and the rule of law are among the essential features of an enabling environment for a rapidly growing and developing economy. Active participation by private citizens, trade unions, professional associations, academic institutions, business organizations and NGOs in the country's development is clearly consistent with the shift in Ghana in the Government's role from that of economic producer to one of facilitator of economic development. They can also help exert pressure on public officials for better performance and accountability. More can also be done to encourage the free flow of information, which would encourage individuals and entrepreneurs to contribute their energies and skills to Lhe reconstruction of the economy. For the Government to be truly accountable for its actions, a sound system of public accounting and auditing as well as transparent procurement systems are needed. The elimination of unnecessary controls in regulations and procedures and in policies affecting entry and exit of firms will also help reduce the scope for "rent seeking" and increase competition. It is highly unlikely that sound investments would be forthcoming or that economic activity would flourish without predictability in the enforcement of laws and regulations, including civil contracts. An impartial and fair judicial system is of central importance for the establishment of the rule of law, which is as critical to promoting economic development as is a sound and stable macroeconomic setting, efficient infrastructure, and effectively functioning financial markets. Attitude Towards the Role of the Private Sector xvii. While the Government recognizes the role of a dynamic private sector in Ghana's developr'-t, most investors remain uncertain and perceive an ambivalence in attitudes to the private sector. The non-transparency, arbitrariness and complexity of government regulations and procedures are seen as important manifestations of that ambivalence. Some of this perception no doubt is the result of the past government actions in the 1960s, 1970s and early 1980s--partly in response to the widespread corruption and "rent seeking" behavior in the distorted economy--when many state-owned enterprises (SOEs) were created, some private firms were nationalized, and currency reforms shook confidence in the banking system. Despite considerable improvements on these counts in recent years, significant problems of perception remain. The main areas of concern to the private sector are: (a) slow progress in implementing the public enterprise reform program and continued domination of the economy by public enterprises; (b) perceived arbitrary actions by Government against private business (-losure of businesses, publicized investigations of owners, querying of sources of funds obtained for investing, and forced relocation of small businesses); (c) a large perceived gap between official policies and actions; and (d) the control-oriented attitude that still permeates the administration of regulations. What government officials may see as reining in profiteers, investors may see as punishing successful profit- makers. Even when liberalized policies are adopted, they are not fully implemented by administrators who deal with the public, whether because of - vii - residual belief in controls by the Government (e.g., efforts to make firms lower prices of their goods that are no longer officially controlled)., or because training in new procedures has been inadequate. xviii. In an investor-friendly environment entrepreneurs are respected members of the community. The attitude of society towards business owners and their legitimate accumulation of wealth is a very important part of the investment climate. To be perceived by the business community as welcoming, rather than just tolerating a larger private sector, a visible and public campaign in support of private sector development, dissemination of information and the fostering of debate on key private sector concerns among a wider audience would help. The key message of the public campaign should be to indicate unequivocally that private sector investment is central to the sustained economic development and that private investors would be treated fairly. This would also help ensure a consistent attitude within Government. Such public statements would need to be backed by concrete steps to demonstrate and publicize a commitment to supporting the private sector. For example, one subsector such as furniture exports could be sel-.cted for special attention in solving its problems and demonstrating effective government support. Institutional Reforms xix. Financial Sector Development. Ghana's financial sector has been distressed for some time. Recognizing that well-functioning money and capital markets are essential to support private sec*or development, the Government has already made difficult decisions to overhaul the financial sector in the area of regulations, supervision, restructuring of distressed banks, credit policies, and capital market development. Rapid implementation of the financial sector reforms and development of capital markets should be of highest priority to stimulate private investment. It is important to note, however, that the difficulties faced by firms in obtaining credit may also reflect in some cases their limited capacity to inject new equity and the banks' concern for the fir.s' creditworthiness. xx. Policies Towards State-Owned Enterprises.a/ SOEs continue to dominate the economy. Due to the past preferential treatment If SOEs by the Government and their generally poor performance, the SOE sector has been a major constraint to creating a favorable business environment and healthy competition. The effective implementation of the SOE reform program (i.e., commercialization of public enterprises that will remain in the public sector, and divestiture of others) could become a powerful stimulus to privaLe sector investment in Ghana. The response from investors to the divestiture program has been encouraging with over 600 proposals. Yet, progress in implementation has been slow. The contributing f4ctors included the lack of consensus in the Government on a/ This report has only touched upon the key issues in the implementation of the Government's present reform program for SOEs. A more comprehensive analysis o" the SOE sector is planned to be carried out jointly by the Government and Bank staff in order to develop a strategy for joint evolution of the public and private sectors. - viii - the divestiture program, initial reluctance to sell profitable enterprises, lack of comprehensive data on finances and employment, involvement of too many institutions and the highly hierarchical and a long approval process. Long periods of waiting and uncertainty are highly discouraging and are eroding the private sector's confidence in the Government's intentions. xxi. While the SOE reform program is a complex process and will take time to implement, rapid action in achieving actual divestiture of profitable SOEs and practical results, as well as progress in improving the efficiency of SOEs which will remain in the public sector will: (a) send a strong signal that the Government does not intend SOEs to crowd out the private sector, and thus help build confidence in Government's attitude to the private sector; (b) provide enterprise management with the autonomy necessary to run a successful business; and (c) allow the Government to reduce its involvement in directly productive activities and focus its limited resources on policy-making and creating a supportive environment for private sector development. There is a need to explore all possible options in the divestiture program including outright sale, public or employee share issues, leasing, management contracts and liquidation. However, since competition is more important than ownership in inducing efficiency, the Government should grant management of SOEs more autonomy on pricing, staffing and procurement decisions in order to enable them to operate on commercial principles, and hold them accountable for their performance against agreed targets. xxii. Domestic Pricing Policies. Controlled prices often do not ensure adequate profits for producers, and reduce entry incentives and resources for modernization. Ghana has used price controls since 1962 to limit scarcity rents to sellers of products, to fight inflation and to keep down the price of key commodities affecting the cost of living. Price controls, however, proved inefficient in an environment of scarcity and rapid inflation. While the Government has made significant progress in removing comprehensive price controls, and markets now play a major role in the determination of prices, some problems remain, particularly in implementation. Even in the absence of a formal price control for a product. manufacturers can come under strong pressure not to increase their prices, as was the case for soap and beer in 1989, and it is difficult for manufacturers to act outside the Government's instructions. Even if "cost plus' pricing allows a reasonable profit margin, the need to obtain approval creates uncertainty and results in costly delays. Informal pressure to contain price increases creates uncertainty and undermines the private sector's confidence in the Government's announced future policy reforms. While the removal of the remaining controls on prices is desirable to stimulate investment, the elimination of both the formal and informal unofficial pressure and better dissemination of information on the extent of price liberalization alrea^v achieved would improve the present situation. Producers, consumers and Government agencies need to be better informed about the status of the Government's price policy. This would ensure that the positive effects of the Government's policy of price liberalization are not compromised by weak implementation. - ix - xxiii. Taxation and Investment Incentives. The tax regime and investment incentives have a significant effect on the level and composition of investment through their influence on expected returns. Company income tax rates in Ghana at 45-50 percent are high. In many other countries, a rate of 30-35 percent is the norm. The company tax system provides for capital allowances which vary by activity and type of assets, deduction of the interest cost of finance, and tax holidays together with loss carryover beyond the tax exempt period for selected agricultural activities and real estate. However, there is no carryover of operating losses for manufacturing. Varying tax rebates are also available for agricultural and manufacturing exports. The burden of high company tax rates is compounded by relatively high taxes on dividend income (30 percent) and on capital gains (55 percent for assets held for less than 5 years). A lower capital gains tax would encourage mergers and acquisitions, which are needed badly to rationalize the manufacturing sector, and, together with a lower tax on dividend income, encourage equity financing. At present, the rewards of successful ventures are largely taxed away, and investors are likely to choose a safer outlet for their funds (e.g., tax-exempt government bonds or foreign currency holdings). xxiv. The Government is currently reviewing investment taxation and has benefitted from technical assistance from the IMF. In revising the tax system, it is suggested that the following major changes be considered (see paras 3.37 and 3.38): (1) Reduction in company income tax burden through a combination of lower tax rates and an increase in capital allowances across-the-board. Raising allowances at the time of investment would particularly benefit investors by reducing the uncertainty regarding the present value of tax obligations. (2) Introduction of a general carry-over of operating losses including for manufacturing, say, for 5 years in order to sufficiently reduce the burden of risk for entrepreneurs. (3) A sharp cut in the capital gains tax to promote capital transactions and help reduce the large overhang which is locked-in by the high capital gains tax. (4) A sharp reduction in the final withholding tax on dividends to lower the marginal effective tax rate on capital income and to promote equity finance and development of the capital market. (5) Elimination of tax holidays currently available to selected activities. Lower, uniform tax rates with a loss carryover provision are more effective in increasing investment and improving efficiency than the use of tax bolidays. The adverse effect of these measures on fiscal revenues is expected to be small as the collections from company tax on agriculture, manufacturing, real estate and services and construction, and from capital gains and dividends tax in 1989 amounted to less than 1% of total tax revenues. In fact, the effects of tax reforms should be significantly positive due to increased . private sector activity. xXV. The 1985 Investment C-de provides numerous fiscal incentives to encourage investment in selected activities in priority sectors (exemption from customs duty on imports, lower tax rates, rebates on taxes due, and investment and accelerated depreciation allowances), promote regional development, encourage employment in large enterprises, and promote research and development. The tax incentives vary greatly by activity and sector. The fiscal incentives were extended in 1988 to encourage rehabilitation of existing enterprises operating outside the priority sectors of the Investment Code, and which existed before January 1, 1988 and invest at least US$100,000. The question of whether investment incentives, particularly tax incentives, are a cost-effective instrument for encouraging investment has been much debated. Where market failures can be quantified, tax instruments as an interim measure to promote efficiency may be justified. Market imperfections include price distortions and failure of the market to take external benefits into account. Tax incentives, however, are often ad hoc, poorly integrated into the overall system, and difficult to administer. Moreover, studies report that most investment decisions are not affected by such incentives. In Ghana, fiscal incentives under the Investment Code have also not stimulated entrepreneurs to implement approved projects. xxvi. The main determinants of private investment include political and economic stability, government's attitude towards the role of the private sector, adequate markets and hence demand, the availability of inputs, and the clarity of the legal and regulatory framework. Additional factors of importance to foreign investors are favorable terms for the transfer of profits and the repatriation of capital, guarantee against expropriation, provision for compensation in the event of nationalization, absence of discrimination against foreign ownership and control, and freedom from burdensome regulations. xxvii. Fiscal benefits for investment are costly not only in terms of government revenue foregone but also in terms of efficiency because they distort the allocation of resources. Criteria for their implementation is also generally vague and discretionary. Under the fiscal incentives in the Investment Code, exemption from duties on capital equipment favors the use of capital over labor and increases the capital-intensity of the production process. They discriminate generally against small firms. They also conflict with the ongoing trade and tax reforms under the adjustment program. Recognizing these difficulties, some countries such as Indonesia have abolished fiscal incentives. The expected revenue gains from eliminating incentives enabled Indonesia to lower the company tax rates, which benefitted all investors and provided more efficient incentives to investors, both domestic and foreign. xxviii. Given the recent liberalization of the economy and the removal of most price distortions, the system of fiscal incentives and their administration needs to be simplified and amended. The Investment Code and the Tax Code should be neutral in their treatment of various activities. Continued implementation of the present reforms of the tax system and further rationalization of tariffs are the most appropriate instruments to encourage new investment. However, incentives could perhaps continue to play some role in encouraging investment that generates external benefits, e.g., regional development, basic infrastructure, research and development, and training. xxix. The effect on new investment of the elimination of many incentives, if any, should be offset by a more favorable, but neutral, tax treatment of company income. It is thus important that reform of the tax and investment incentives go hand in hand. The report makes the following specific suggestions for reforming the system of investment incentives - xi - embodied in the tax structure and the Investment Code (para 3.50): (1) Eliminate all special fiscal incentives for selected activities in priority areas under the Investment Code, and for activities made eligible in 1988. Replace these with across-the-board lowering of the income tax burden and an increase in capital allowances. (2) Abolish tax holidays currently in the Tax Code, and provide a general carryover of operating losses including for manufacturing. (3) Abolish the income tax rebate for use of labor in large enterprises as tax incentives to promote employment are generally not very effective. Current wages are competitive and measures aimed at a smoother functioning of the labor market and a general improvement in the investment climate would be more effective in creating jobs in the long term. (4) Incorporate all fiscal incentives in the Tax Code rather than in the Investment Code, and give the Internal Revenue Service (IRS) sole responsibility for their administration. The IRS should, on the basis of provisions in the Tax Code and documentary evidence supplied by the enterprise, grant the benefits without any prior approval. XXX. Granting of incentives is currently the principal function of the Ghana Investments Centre (GIC) in terms of staff time. The above changes would enable GIC to focus more on investment promotion and the provision of effective investor services. As an effective institution to publicize Ghana's advantages for investors, identify and contact suitable investors, and facilitate their information search and investment decision, GTC can make a difference in stimulating private investment. Legal and Regulatory Framework xxxi. Clear laws, effectively applied in a transparent manner, are essential to generate a supportive business climate. Excessive regulation and unclear rules discourage new investment and undermine the development of efficient private enterprise. The most effective regulatory apparatus is the discipline of the market whereby businesses function in an environment of competition. The Government, however, should ensure that companies operate within a framework of law and that the conduct of business is transparent. Performance of the private sector in Ghana in the past had also been hindered by a regulatory framework which relied heavily on direct controls. This together with distortions in incentive policies stifled competition, inhibited flexibility, encouraged "rent seekingo and retarded productivity improvements. xxxii. The policy reforms since 1983 set out to create a more market- oriented economy that would permit regulatory controls to be substantially relaxed. Although progress towards deregulation has been made in many areas, it has not always been in an orderly fashion nor as much as appears warranted by the growth of market forces. Remaining problems relate to business establishment and investment licensing procedure , expatriate . quotas, technology transfer, foreign exchange transactions, labor laws and regulations, tax administration, the approval process under the Investment Code, and foreign investment regulations. Collectively, these regulatory requirements sustain an image of Ghana as a country with extensive government intervention in the business sector. This discourages new private investment. They could also become barriers to the growth of existing firms once the immediate constraint on financing is removed. - xii - xxxiii. Legal Environment and Basis for Regulations. A consistent and transparent legal basis for statutes and regulations regarding investment and the conduct of business must be established as soon as possible. Existing laws and regulations governing investment activities were enacted at different times reflecting the prevailing political and economic climate. Important laws relating to private sector activity include the Foreign Exchange Control Act (1961 and amended in 1986), the Industrial Relations Act (1965). the Labor Decree (1967), the Manufacturing Industries Act (1971), the Investment Code (1985), and amendments to the Investment Code in 1988. There is a need to review and amend laws to (a) harmonize conflicting provisions; (b) reflect the considerable liberalization of the economy under the ERP; and (c) provide legal backing for administrative decisions. Also, many businesses do not know the regulations governing foreign exchange, the duty drawback scheme, and other aspects of doing business in Ghana. Additional efforts are needed to widely publicize in clear terms the regulations and procedures as they apply to the conduct of business. Other aspects of the legal environment such as appropriate contract and credit laws, property rights in land, as well as the companies law, the accounting framework and capital market regulations also affect the private sector. An adequate system governing bankruptcy proceedings is a prerequisite for an orderly exit of companies. With the introduction of a special commercial court having jurisdiction over all commercial matters, the Government could ensure that the judiciary provides for the timely and adequate solution of commercial disputes. xxxiv. Business Establishment, Manufacturing Licensing and Investment Approval Procedures. The procedures are quite cumbersome and time consuming and involve duplication of work by various agencies. They offer considerable scope for streamlining (see paras 3.54-3.63). Specifically, the report makes the following major suggestions: (1) Consolidate existing application forms for business registration into one standard form (perhaps with a short form for small businesses), and review the need for certificate of commencement of business from the Registrar General's Office. (2) Simplify registration procedures for microenterprises by arranging for registration to take place near the location of their businesses. (3) Review application form for manufacturing licenses from the Ministry of Industries, qcience and Technology (MIST) to avoid duplication with business registration, and abolish the issuance of provisional license. (4) A license should be granted if the legally required information is provided. The Government should consider eliminating the licensing requirement or at a minimum the need for a license for the expansion of capacity, say up to 30-50Z of the existing capacity, and in the case of new enterprises, for projects below a certain size (e.g., the equivalent of US$250,000). These minimum thresholds should be kept under review and raised as soon as possible. (5) Abolis. the 'Investment Policy License" issued by GIC and thereby the need to apply ann4ally for a license to operate. (6) Establish procedures for local governments to consult business representatives and the national government when they wish to relocate businesses or restrict their location. Avoid relocating enterprises far away from their clientele, and consider providing compensation for the costs of relocation. - xiii - xxxv. Expatriate Quota. To hire expatriates, firms require approval from the GIC and the Immigration Quota Committee in the Ministry of Interior. The quota is granted for a limited period and the process is relatively discretionary and time consuming. Existing firms find ways of dealing with the quota system, though this raises the cost of doing business. For new investors, however, it is crucial that they have control over key staff in the early years of their project. The need for strict controls on employing expatriates in Ghana has been reduced by the impact of the liberalized foreign exchange system, which has substantially increased the cost in cedis. There is a need to adopt a more liberal attitude towards granting expatriate quotas. The size of the quota should be linked to objective criteria, e.g., the investment size, without specifying specific positions. xxxvi. TechnoloaY Transfer. With assistance from the Technical Committee on Technology Transfer Agreements, GIC is responsible for approving all technology transfer agreements with firms outside Ghana, based on 1986 draft guidelines. The draft guidelines limit the use of foreign technology. For example, the use of foreign technology in production for the domestic market is discouraged, and no payment for trademarks/brand names is permitted except for exports. Payment of fees is limited to 5 percent of net sales. With the liberalized foreign exchange system, Ghanaian firms now have to make payments with a more realistic exchange rate, and they are exposed to severe competition. Some of the controls such as the evaluation of the appropriateness of technology are hard to implement, given staff constraints. Regulations are vaguely worded and leave the interpretation to the discretion of the authorities. xxxvii. Overly restrictive conditions for approval could lead to a rejection of many proposals with significant potential, since the impact of technology transfer is often uncertain and thus difficult to assess. For industrial development, enterprises need modern technology and management and marketing skills to compete in the world and domestic markets. The Government should therefore reduce the administrative controls on the transfer of technology to a minimum, and focus instead on becoming a source of information and advice for potential users of foreign know-how. Specifically, GIC should follow the following framework for technology transfer: (1) Allow entrepreneurs to import foreign technology freely. (2) Finalize and issue to the public, guidelines on technology transfer agreements. The guidelines should be clear and unambiguous, contain a set of standard clauses to be included in technology agreements, and list restrictive clauses that are not acceptable. (3) Leave the choice of technology to entrepreneurs, i.e., government agencies should not have to assess the technical know-how to be imported. Allow the terms of contracts to be determined by the parties concerned. (4) Establish a databank (through membership of international organizations) on technologies and technology agreements, and make it readily available to all firms. xxxviii. Foreign Exchange Transactions. Despite the removal of many restrictions on foreign exchange transactions and the simplification of the administrative procedures, transferring foreign exchange to and from Ghana can still be a lengthy and cumbersome process, and it raises the cost of business operations. Given the sharp increase in the cost of foreign - xiv - exchange, some of the administrative controls could be relaxed. A switch to a system of ex-post monitoring of transactions by the Bank of Ghana (BOG) instead of the prior approval still required for a number of payments would significantly cut the time foreign transfers require. The potential cost of such a measure in terms of misuse of foreign exchange should be set against the efficiency gain for local businesses as well as the positive impact on Ghana's image abroad. Such a change would also permit a further simplification of procedures. Export receipts could be transferred directly to the exporters' local (cedi and foreign exchange) accounts in commercial banks, of which the BOG would be notified. The Government should also consider channelling a larger proportion of export proceeds directly through the commercial banks instead of the BOG. Similarly, to reduce the burden of unnecessary work on GIC, requests for transfers of dividends and technical fees could be sent by the companies directly to the BOG or to the commercial banks, supported by proper documentation. xxxix. Labor Laws and Regulations. The private sector has identified the labor laws as one of their major areas of concern. To hire workers, firms need to go through the Labor Department's Public Employment Centers. This makes the hiring of employees a lengthy and time consuming process. The laying-off of workers requires approval of the Ministry of Mobilization and Productivity in terms of procedures and financial implications. Taken together, these regulations add to costs and reduce firms' operational flexibility. For the laying-off of redundant workers, while the legal framework does not cause major problems, the political and financial aspects are so significant that the release of redundant workers becomes very difficult in practice. On the political side, it seems that such decisions cause major difficulties with the unions, committees for defense of the revolution (CDRs), and other quasi-political groups. The lack of flexibility in practice with respect to labor would discourage employment at the margin, and weigh heavily in investors' decisions. It is suggested that the Government should: (1) remove the requirement for firms to go through Public Employment Centres when hiring workers, and instead require firms to inform the Labour Office on new employees; (2) consider encouraging firms to make provisions for the financial obligations incurred to retrenching workers, through changes in the accounting rules; and (3) ensure that labor disputes and the retrenchment of workers are settled within the context of collective agreements and that parties have access to courts for settlement of differences. xl. Tax Administration. The strengthening of tax administration has resulted in a tightening of regulations relating to tax collection. Company income tax is now payable at the end of each quarter on income earned during that quarter. Tax Clearance Certificates (TCCs) are issued if the tax due for the previous quarter has been paid. Separate TCCs are r-quired for a wide range of transactions (e.g., imports, vehicle registration, movement of goods, property purchase, and bidding in the auction). Sales tax is levied at the factory (import) level and is due on the 10th day of the month following the sale by the factory. There is also a separate TCC for the sales and excise taxes. The private sector has complained about the unfair treatment in tax collection, resulting in excessive tax liability, increased working capital needs, and costly delay-. With regard to co$any -income tax, if the assessed tax is not paid - xv - entirely by the end of the quarter, a TCC may be issued for a limited period only. The IRS has the last word. The difficulty is that. especially in the present economic climate, past performance may not be a reliable basis for assessment of future income. The system of multiple TCCs has become an impediment to the normal conduct of business. One firm had to obtain three separate TCCs on the same day for three different purposes. Concerning the sales tax, sales in Ghana are frequently on a 30- or 60-day collection basis, particularly in the case of consumer goods sold through wholesalers or large retailers. This forces companies to advance sales tax to the Government for which they may have to borrow. x1i. Given the difficulty of assessing taxable income in a rapidly changing environment, as well as normal business practices, the Government should consider the following: (1) Allow the IRS to issue a single TCC valid for all transactions on a six-monthly basis. Investigate mechanisms for issuing temporary, single TCC for all transactions to firms that are in the process of seeking adjustments to their assessed tax. (2) Pay market- related interest on any net credit position of taxpayers. (3) Increase the period of payment of the sales tar to 30 days following the end of the month in which goods were sold. As for the TCCs, the objective should be to continue vigorous efforts to encourage voluntary compliance so that TCCs can be phased out as soon as possible. Improvement in the present tax practices will also be conducive to raising investors' confidence in the system. x1ii. Foreian Direct Investment (FDI). Foreign investment will have to play an increasing role in Ghana's future growth. As equity capital, FDI does not burden the country with debt. Because it is invested on the basis of commercial risk, FDI is most likely to be used efficiently. Private foreign investment usually also brings other important benefits such as the transfer of technological and management skills, employment creation, and labor force training. Foreign firms can stimulate domestic entrepreneurs by introducing a source of innovation and competition and can encourage domestic investment. FDI can also have an important role in securing access to world markets. Ghana's inflows of FDI declined from US$16 million in 1980 to US$2 million in 1984, and then increased to US$4 million in 1986. They were estimated at US$20 million in 1988 mainly due to increased FDI in gold mining. Competition among developing countries for attracting FDI flows has been intensifying in recent years. Therefore, Ghana needs to take immediate measures for further improving the investment climate and enhancing its attractiveness for private investment. xliii. Many researchers agree that controls seem to matter more to foreign investors than fiscal incentives. Most foreign investors regard incentives as volatile and transitory. Domestic economic and political stability, country's growth prospects and the attitude toward the role of . the private sector in general, transparency and stability of the regulatory environment, and ready access to foreign exchange for inputs and remitting dividends and profits are considered as most important to increased FDI. Most of these factors are of equal importance to both domestic and foreign investors. In fact, without a thriving local private investment climate, the inflow of FDI and the achievement of the macroeconomic goals of the country will suffer. - xvi - xliv. Restrictions apply to ownership of foreign firms in Ghana and they are treated differently from domestic firms in several respects: minimum capital, reserved products, and access to domestic capital. These restrictions can be a significant disincentive to foreign investors. Ghana should consider gradually reducing restrictions on ownership in order to attract higher levels of FDI. It is suggested that the Government should consider the following changes: (1) Define a Ghanaian company as one with majority ownership in order to facilitate joint ventures with foreign or partly foreign enterprises. (2) Encourage the transfer of technology and know-how by (a) increasing the scopt for full foreign ownership (i.e., when the firm is not a net foreign exchange earner); (b) opening up selected activities listed in the Schedule to the Investment Code to foreign ownership when a significant portion (not 100 percent) is for export; and (c) reducing the amount of minimum employed capital (US$500,000) for allowing foreign businesses to enter into certain activities such as trade. (3) Lift restrictions on the foreign companies' access to credit, and, as an interim measure, require the BOG approval only for lending to foreign firms aboNe a certain threshold. For this purpose, define a foreign company as one with majority foreign ownership. xlv. For sustainable growth, efforts are also needed to build, seek and respond to domestic, regional and overseas demand (e.g. to expand markets), develop the human resource base to improve the technological capability and to absorb new entrants in the labor force into productive activities, and provide adequate infrastructure necessary for the smooth functioning of the private sector. Overview xlvi. Ghana has made remarkable progress since 1983 in pursuing sound macroeconomic policies and has largely succeeded in putting the economy through a structural adjustment program in which relative prices have been changed significantly, markets have been liberalized, and the public sector is being reformed. These actions ( for example, trade and exchange rate policies, financial sector policies, and a better focussed public expenditure program) have had a positive impact on the business climate, and fundamentally changed the prospects for a wide range of economic activities. While some have ceased to be viable and others require adjustment efforts, new opportunities have also been created. xlvii. Yet despite some increase in activity, the private investment response to date in Ghana remains far below the levels needed to generate sustainable growth. Besides the weak banking system, the still poor state of the infrastructure, and the continued dominance of the economy by state enterprises, caution of investors possibly also reflects a concern about the Government's attitude *wards the private sector and difficulties in the legal and regulatory framework. The success of Ghana's recent economic policies provides an ideal setting to encourage private investors. Based on the experience of other countries, this report has suggested actions which should be considered by Ghana to create the right kind of business environment. - xvii - x1viii. The main areas which merit the Government's attention to encourage investor confidence include the following:b/ (1) Consistency in the application of economic policies is vital. Maintenance of a market- determined foreign exchange system, further rationalization of trade policies to facilitate outward orientation, and the rationalization of taxation of investment and of fiscal incentives are important for improving the investment climate and efficiency. Control of inflation will also be critical for removing uncertainty for the private sector. (2) A more rapid and effective implementation of the reform program for state-owned enterprises (commercialization and divestiture) to improve their efficiency, help create more opportunities for the private sector, and build confidence in the Government's reform program. (3) Strengthening the financial sector. (4) Streamlining the administrative approval of investments. (5) Making the legal and regulatory framework simpler and more transparent. (6) Pursuing a regular and constructive dialogue between the Government and the private sector, and giving due recognition to the contribution of businesses to the nation. (7) Restructuring GIC's functions to transform it into an effective agency for providing investvent promotion and investor support services. xlix. Minor improvements in the investment climate will have little impact. Far-reaching actions are needed to convince private investors that the time is ripe for them to become Ghana's engine of growth. The Government has in recent years made determined macroeconomic policy decisions and confronted difficult issues as they have arisen. Therefore, there is the promise that the Government can reasonably be expected to exert the same leadership in boldly following through on the measures needed to encourage a more dynamic investment response to the Economic Recovery Program. b/ A summary of specific recommendations for improving the enabling environment is given in Annex 3-1. GHANA - TOWARDS A DYNAMIC INVESTMENT RESPONSE I. BACKGROUND A. Why This Report? 1.01 Ghana has been an outstanding case among Sub-Saharan African countries undertaking economic reforms. Since the start of the Govern- ment's Economic Recovery Program (ERP) in 1983, Ghana's economy has grown at an average rate of 5-6 percent per year. The Government has improved production incentives, made progress towards restoring fiscal and monetary . discipline, increased public investment in physical infrastructure and social sectors, and managed its external financing strategy well. The declining trend in per capita real income and in living standards has been reversed. 1.02 Yet per capita income remains below the level reached in mid- 1970s and absolute poverty is widespread. To sustain growth and spread the gains, Ghana still faces major challenges in the areas of savings mobiliza- tion, private investment response, inflation, vulnerability to fluctuations in prices of cocoa, gold and oil, absorption of new entrants to the labor force, rapid population growth, and dependence on external aid. 1.03 To maintain a growth rate of about 5 percent per year in the medium term, the share of investment in GDP needs to increase from about 14 percent in 1989 to 21 percent in 1995. Most of the improvement so far has been through an increase in public investment from 1.4 percent of GDP in 1980-83 to about 8.3 percent in 1989. Private investment has risen only from 3.1 percent to 5.7 percent with most of it through increased invest- ment in gold mining. If the Government's reform program is to succeed in moving the economy from stabilization and adjustment to sustainable growth with equity--making the fullest use of the country's assets, both human and physical--private investment will need to play a much greater role and become the engine of growth. However, in order to rely on private sector initiative for growth, Ghana would also need a stronger and more efficient public sector and good economic and social governance. Public investment will have to continue to play an important role in improving physical infrastructure, education and training and science and technology to create a supportive environment for long-term development. 1.04 This report has a specific focus--the analysis of the enabling environment for private sector development. Further analytical work is now needed to review the public enterprise sector and develop approaches for the joint evolution of the public and private sectors. 1.05 The first chapter reviews recent policy reforms and economic performance, and discusses the roles of the private sector and of the Government in Ghana's development. Chapter 2 focuses on the adjustment responses of the manufacturing sector under the ERP. It summarizes the results of two surveys of micro and small-scale enterprises and of large firms in manufacturing to understand the factors responsible for growth of the manufacturing sector, and the constraints on the firms' ability to sustain growth, especially as existing capacity is more fully utilized. An understanding of these issues is important for designing actions to promote a more dynamic supply response from existing entrepreneurs in the short to medium-term. Chapter 3 analyzes constraints imposed by incentive policies, institutional weaknesses and the legal and regulatory framework, and - 2 - identifies ways to improve the enabling environment for private investment. Although, this report does not focus on the agricultural sector, the analysis should be relevant to stimulate private investment in agriculture as well.l/ B. The Economic Setting 1.06 Ghana's principal assets at independence in 1957 were its natural resources (including minerals, forests, and agricultural land suitable for a variety of domestic and export crops) and its relatively well developed human capital and infrastructure. Its relatively high income per capita among African countries was due in large part to enterprising farmers and traders who had helped make it the world's leading exporter of cocoa. B) 1983, most of the assets had been dissipated through a combination of external and internal instability, overambitious development borrowing and expenditure, and misguided policies. Ghana's economic ups and downs have been well documented and need not be recounted here.2/ The salient points of the events and policies that determined the setting for private sector investors until 1983, were the following: * Political instability with seven changes of government between 1966 and 1981 when the current Provisional National Defence Council (PNDC) was constituted. * Emphasis on rapid industrialization led by the state which resulted in a large, inefficient public sector. * Specific actions against private assets.3/ * Neglect of agriculture. * Heavy protection to industry. l/ For details on agriculture, see World Bank, Ghana: Medium Term Aaricultural Development Program, June 1990 (Green Cover). 2/ For details, see World Bank, Ghana: Managing the Transition, November 1984; Ghana: Structural Adjustment for Growth, January 1989; Ghana Second Structural Adjustment Credit, President's Report. February 1989; and Ghana: Economic and Financial Policy Framework, July 1989- June 1992, September 1989. A new economic report is also currently under preparation. 3/ In 1972, the Government took a majority interest in all large mining and timber companies; in 1975, the Investment Policy Decree required all foreign enterprises to become joint ventures with either private Ghanaians or the Government; in 1979 and subsequent years, a large number of relatively small private manufacturing enterprises accused of financial malpractices were confiscated; fifty cedi notes were demonetized; bank deposit accounts in excess of 50,000 cedis were frozen for investigation of tax liability and possible corruption or fraud; bank loans for trade were recalled and all business transac- tions in excess of 1,000 cedis were required to be by checks. - 3 - * Increasing reliance on controls and direct allocation of resourc- es. 1.07 The results were disastrous. Per capita incomes declined by nearly half between 1970 and 1982; declining real wages, political insta- bility, and reduced economic opportunities led talented and skilled Ghanaians to leave the country in uie thousands, depriving it of scarce managerial, administrative, and technical resources; social and physical infrastructure virtually collapsed; there was a vast parallel market in foreign exchange with its related corruption, smuggling and tax evasion; foreign exchange reserves were nea-ly depleted; an!d the country accumulated large external payments arrears. .3y 1983, the economy was in disarray. C. Economic Policy Reforms and Response 1.08 In 1983, the PNDC introduced a package of economic reforms (the ERP), which dramatically broke with the past. The major objectives of the new policies were to: shift relative prices in favor of production, particularly for exports and efficient import substitution; restore fiscal and monetary discipline; initiate the rehabilitation of the country's productive base and economic and social infrastructure; and encourage private investment. The ERP was followed by the Structural Adjustment Program, the first phase of which covered the period 1987-88. A second phase is now being implemented and is scheduled to be completed by end- 1990. The program aims to: (a) maintain an incentive framework that stimulates growth and encourages savings and investment, and strengthens the balance of payments; and (b) improve resource use, particularly in the public sector, while ensuring fiscal and monetary stability. The salient features of the reforms with particular relevance for private sector development are: * Movement towards a market-determined exchange rate through the progressive liberalization of the foreign eichange market. Ghana now has a unified exchange market and the rate is freely deter- mined by the supply and demand for foreign exchange, in the context of an extended interbank system supported by weekly auctions by the Bank of Ghana (BOG). Transfer of profits and dividends and payments for amortization of approved private external borrowing are allowed through the auction. External arrears including blocked capital and dividends have been cleared. * Dismantling of price and distribution controls; only a few essential commodities remain subject to formal price controls. However, there are problems in implementation (paras 3.29-3.31). * Liberalization of interest rates. * Elimination of subsidies and mobilization of resources through improved tax collection and selective increases in consumption taxes and user charges. * Preparation of rolling three-year public investment programs with emphasis on rehabilitation of transport, power, telecommunica- tions, and health and education; and strengthening of planning units in sector ministries. * A-proval of the 1985 Investment Code and the establishment of the Ghana Investments Centre (GIC) to implement it. * Trade reforms. Ghana's import tariffs are now moderate by developing country standards.4/ The import licensing system has been abolished. * Gradual reforms of the tax system. * Initiation of dialogue with the private sector. A conference to promote private investment in Ghana was held in 1988, followed by a second conference supported by MIGA in February 1990. * Initiation of the state-owned enterprises reform program (SOEs). * Reforms of the financial sector. 1.09 Ghana is now well into its seventh year since the introduction of the ERP. Broad economic aggregates indicate a recovery from the depths of 1983 (see Annex 1-1). All sectors have contributed, but the most rapid growth (13.5 percent per year over 1984-88) has been in manufacturing which benefitted from greater availability of inputs under the liberalized economy. But Ghana's external position remains difficult largely because of the declining cocoa prices and rising imports (necessary initially to help resuscitate the economy). Non-cocoa exports more than doubled during the period 1984-89 on the strength of gold, timber, and electricity, but 41 The standard import duty rates are zero for exempt goods, 10 percent for concessionary items, basic raw materials and semi-processed intermediate goods, 15 percent for capital goods and other raw materi- als, 20 percent for consumer goods and 25 percent for luxury goods. Various specific rates apply to alcoholic beverages and tobacco products. To provide temporary protection to selected industries, special taxes of 10 to 40 percent are imposed including selected drugs, textiles and garments, cosmetics, mineral waters. juice, rubber sandals, soaps and some food products. As of Januar 1, 1990, the special tax on imports of textiles was lowered from 4,' ti 10 percent. Goods subject to special taxes account for approximately one half of the manufacturing value added. To reduce distortions caused by the incidence of other taxes on domestic production and imports, sales taxes across most import and domestic commodities have been unified, and they apply on imports to the import duty-inclusive value. However, there is an extensive use of concessions and exemptions from statutory duty rates whi h creates unintended variations in effective protection provided to industry. In fact, exemptions are more common than collections. For the first nine months of 1989, for instance, 76 percent of imported consumer goods were exempted from import duties and 56 percent of the imports covered by the special tax were not taxed. The duty drawback scheme to relieve exporters from duties paid on their direct inputs is not operational; only eight firms have benefitted from the scheme with a total of 18 duty drawbacks between January 1, 1983 and May 1989 - 5 - not enough to stem a substantial worsening of trade balances.5/ Despite a sharp rise in net private transfers, the current account deficit worsened from US$214 million in 1984 to US$348 million in 1989, and was 7 percent of GDP in 1989. Ghana has financed this deficit largely through substantial increases in official grants and net disbursements of official concessional assistance. Diversification and expansion of exports is necessary to sustain imports and reduce the high debt service ratio. Internal "alance has also been difficult to achieve. Although inflation has declined from its peak of 123 percent in 1983, it remains stubbornly high at about 25-30 percent. Unanticipated increases in net foreign assets and the legacy of monetized fiscal deficits of the past have contributed to excess liquidity in the economy. With assistance from the IMF, the Government has prepared a program to eliminate the liquidity overhang in the banking and non- banking sectors. D. Role of the Private Sector 1.10 The Government's medium-term policy aims at establishing a firm foundation for a buoyant, self-reliant, and increasingly integrated economy, with a viable external payments position over the medium term. Alleviation of poverty through increasing the creation of employment opportunities, improved health and education programs and targeted public expenditures for those hardest hit by the reforms remains an important objective of the Government. The Government's specific objectives are to: achieve an average annual rate of growth of real GDP of at least 5 percent; reduce the average annual rate of inflation to 5 percent; and maintain external balance and a strong foreign reserve position. Towards these goals, the Government has sustained major policy reforms over seven years, revived public investment in infrastructure and social sectors, and substantially increased availability of foreign exchange. Programs to reform SOEs and the financial sector are also under implementation. 1.11 Yet, increased investment since 1983 has been driven'largely by public investment assisted by foreign grants and concessionary loans. Private investment fell to 2.4 percent of GDP in 1986 and then rose to about 5.7 percent of GDP in 1989, in large part from increased investment in gold mining. The increase in private investment has been from a very low base, and data includes investment by SOEs from own savings and/or domestic borrowings. Thus, there is no clear evidence of broad-based growth of private investment to the levels required. 1.12 To achieve self-sustaining growth, there is an urgent need to accelerate investment by the private sector and move it into a leading role.6/ As excess capacity in Ghana's economy becomes more fully uti- lized, substantial increases in new investment will be needed to maintain 5/ Non-traditional expL:ts also grew almost eight-fold albeit from a low base, and reached US$35 million in 1989. 6/ In 1989, the share of investment in GDP was 14.1 percent and the share of savings 7.1 percent. These shares are clearly much lower than the 22-23 percent investment rate and 19 percent savings rate in a broad sample of countries which have consistently achieved 3-7 percent per annum overall growth. See World Bank, World Development Report, 1989, Table*2.1. - 6 - growth. For real GDP growth to average 5 percent per year in the mediur term in order to absorb the rapidly growing labor force at higher levels of productivity, and achieve even a modest growth in the per capita income (about 2 percent a year) and in private consumption per capita (about 1.2 percent a year), the share of investment in GDP needs to increase to about 21 percent by 1995, and 25 percent by 2000 (see Annex 1-2). Since public investment is expected to grow more slowly than in the past, private investment will have to grow at an average of about 12 percent a year in real terms. If private investment were to grow at a much slower rate than targeted, say only 2 percent a year rather than 12 percent, GDP growth could be sustained at only 2 to 3 percent a year. In this scenario, real private consumption per capita would also decline in the late 1990s (see Annex 1-3). 1.13 Ghana has attractive potential for investors, both domestic and foreign. It has substantial natural resources and an entrepreneurial labor force. It also has significant comparative advantage in natural resource- based and labor-intensive industries, and agricultural activities for both export and efficient import substitution. Despite the small size of Ghana's domestic market, a Sub-Saharan Africa location offers businesses freedom from trade restrictions in European and U.S. markets and signifi- cant potential for export to those markets as well as the regional African market. The success of Ghana's recent economic policies has fundamentally changed the prospects for a ide range of economic activities, and provides an ideal setting to stimulate private investment. Yet private investors have been reluctant to commit themselves in a major way to new investments except in gold mining. There is a growing recognition that macroeconomic policy reforms alone are not enough to generate a strong supply response. Major improvements are also needed in the financial system, the legal and regulatory framework, the quality of economic and social governance and public administration to promote private sector development. 1.14 With a good policy environment and complementary public expendi- tures, private investment in Ghana should be able to sustain the recovery: (a) in the short- to medium-term, by continuing to raise capacity utiliza- tion and investing in existing plant to restructure it to make it competi- tive under liberalized trade and exchange rate policies; and (b) in the medium- to long-term by investing in new capacity for both exports and the expanding domestic market. Thriving investment by Ghanaian entrepreneurs will be essential before any significant inflow of foreign direct invest- ment can be expected to occur. This report seeks to understand the current constraints and institutional weaknesses in order to suggest appropriate actions for improving the business environment for potential investors. The Government has a central role to play in stimulating private investment as discussed below. E. Role of Government in Private Sector Development 1.15 The public and private sector have complementary roles to play in the country's development. It is not a case of either one or the other. Both the private and public sector will have to find their relative strengths in Ghana and the combination which improves the country's international comparative advantage. Ghana needs a more efficient public sector if it is to be able to rely on private sector initiatives to develop the country (see below); the issues related to the governance, reforms of the SOEs, and human resource and infrastructure development are discussed - 7 - in paras 3.02-3.06, 3.19-3.28 and 3.107-3.115, respectively). A private sector can operate more efficiently if it works within the environment of a market system, which provides price signals that encourage efficient production. Otherwise, the private sector is likely to act in an inefficient way, wasting the economy's resources on inappropriate activities. The existence of a sizeable and strong private sector is therefore not sufficient to ensure efficient development. Improvements in the market environment to increase competition are necessary to ensure that private sector activities are done more efficiently. 1.16 Private sector development7/ requires a supportive (or "enabling") business environment consisting of: (a) a stable macroeconomic setting; (b) a financial system that provides the incentives and institutions needed to mobilize and allocate financial resources efficiently; (c) economic incentives that promote efficient resource allocation by the private sector; (d) laws and regulations that protect the public interest but do not unnecessarily interfere with private initiative; and (e) the services in infrastructure and human resource development necessary to permit private enterprises to function effectively (paras 3.107-3.115).8/ In all these areas, the Government has a critical supporting role to play, while minimizing the distottions caused by regulations, taxes, subsidies, and other policies. 1.17 Ghana now has most elements of the appropriate macro-policy framework in place for moving towards sustainable growth and to enable the private sector to become the engine of growth. The Government efforts for private sector development should now focus on (a) the continuation of tariff reforms so that the incentive structure encourages efficiency through competition, e.g., import competition and export rivalry; (b) further reforms in taxation and investment incentives to stimulate efficient investment; and (c) reforming the institutional capabilities (e.g., the development of the financial sector, reforms of state-owned enterprises, and complementary investments in education and physical infrastructure) and the legal framework and regulatory policy in order to help increase competition and reduce the cost of doing business. 7/ Private sector development pertains not only to the realm of industry, agriculture, finance and commerce, but also to all areas of activity in which private initiative can have a useful role. These activities include private enterprise activities in education, health, infra- structure and other services as well as informal activities. 8/ See World Bank, Developing the Private Sector, A Challenge for the World Bank Groap, 1989. - 8 - II. ADJUSTMENT RESPONSE OF MANUFACTURING UNDER ERP 2.01 Structural adjustment policies can have both adverse and positive effects on different parts of the industrial sector. Many governments are increasingly concerned about the lack of visible signs of new investment to take the place of adversely affected large firms, in the context of reforms of macroeconomic policies to correct critical distortions that contributed to economic stagnation in the late 1970s and early 1980s. Ghana's economic reforms have had positive effects in reviving the economy since 1983. After a decade of decline, industrial production has recovered rapidly, especially as access to imported inputs increased. But import liberaliza- tion has also increased competition for some producers, leading to renewed calls for protection from some large industries and a perception that the ERP is adversely affecting industry. At the same time, little is known about the impact of adjustment on smaller firms. 2.02 Industrialization was a central focus of Ghana's drive to modernize the economy in the 1960s through a combination of state-owned industries and major foreign investments or joint ventures, while the role of the indigenous private sector was generally ignored.91 Nevertheless, industry remains a relatively small share of Ghana's economy at about a tenth of GDP; agriculture accounts for over one half. Most large manufac- turing enterprises in Ghana were established in the 1960s and some in the 1950s. Very little maintenance was carried out in the 1970s and early 1980s because of the lack of foreign exchange for needed spares. The capital stock is therefore very old and obsolete. By 1984, over 80 percent of the medium and large-scale industrial capacity that had been created was idle, largely due to lack of foreign exchange for needed inputs. 2.03 Small scale enterprises (SSEs) have long been a widespread source of income in Ghana. A sample survey in 1963 estimated that small-scale manufacturing accounted for 17 percent of total non-agricultural employment, as against 3 percent in large scale manufacturing.lo/ As real incomes fell and employment opportunities in large firms and the public sector diminished in the 1970s, many people initiated part-time businesses or became self-employed. Whether small manufacturing expanded as a result is unclear, however. Trading rather than manufacturing activities were favored by the large distortions between official and parallel market prices and by the uncertain investment climate.11/ 9/ SOEs in 1986 accounted for just under a quarter of the number of medium and large manufacturing firms, 40 percent of employment and 44 percent of value added in manufacturing. 101 By 1973, roughly 363,000 people were employed in SSEs (over 300,000 of them in rural areas) and 64,000 in the large sector. 11/ Nevertheless, some small p'oducers were effectively shielded from import competition by the economic crisis--for example, metal workers, vehicle repair shops and low-cost furniture makers. The more technically astute entrepreneurs succeeded through innovative use of local raw and waste materials to produce import substitutes, for example in making soap. On the other hand, many SSEs--such as printers, cosmetics producers, and even weavers of traditional kente cloth--could not reduce-their reliance on imported inputs, and they remained severely constrained. Although small scale firms are estimated to contribute only about a quarter of Ghana's manufacturing value added, they account for some 85 percent of manufacturing employment--most of it outside the principal urban centers. 2.04 Two surveys, one of small scale enterprises and the other of medium and large firms, were carried out to understand at the firm level the impact of the policy reforms on enterprise performance and development. Specific objectives of the surveys were to: (a) analyze how entrepreneurs have responded to policy changes, and the dynamics of their supply response; (b) identify constraints on growth; (c) analyze relative incentives and efficiency of different activities; and (d) learn more about the dynamic potential of small firms and their owners. A. Overall Impact of Policy Reforms 2.05 The aggregate supply response of the manufacturing sector to the reforms has been positive (see Table 2.1), although somewhat slower than expected. Total output in the medium and large scale manufacturing sector has recovered rapidly--although not yet to its 1977 peak level. Between 1977 and 1983, output had fallen from an index of 100 to 35, and several major industry groups such as textiles, apparel and leather goods, iron and steel products, and non-ferrous metals had fallen much lower. After the ERP, the index of manufacturing output rose steadily from 35 in 1983 to 62 by 1988, with a few industry groups such as wood products, beverages, and non-ferrous basic metals recovering almost to their 1977 levels. Medium and large scale industries that have continued to suffer include steel products, paper products, and textiles and garments. Capacity utilization has gradually increased from a low of 18 percent in 1984 to about 40 percent by 1988. Non-traditional exports of both agricultural and processed and semi-processed goods also increased substantially from US$24 million in 1986 to US$42 million in 1988, but dropped to US$35 million in 1989 due to difficulties in activities such as fresh and canned tuna and aluminum products (see Annex 2-1). Table 2.1: PRODUCTION, CAPACITY UTILIZATION, EMPLOYMENT AND LABOR PRODUCTIVITY IN MEDIUM AND LARGE-SCALE MANUFACTURING 1977 1983 1984 1985 1988 1987 1988 Index of manufacturing production 100 36 39 49 54 57 62 Average capacity uti- lization (%) 43 30 18 25 25 35 40 No. of persons employed ('000) 89 58 58 62 62 n.a. n.a. Index of labor productivity 100 64 63 71 78 n.a. n.a. Source: Ghana Statistical Service, Quarterly Digest of Statistics (various years) and Industrial Statistics (various years). - 10 - 2.06 Though these gains may appear unspectacular, they were achieved in the face of strong competition from imports, tight credit availability and generally restrained consumer demand, and therefore demonstrate a good potential for growth. The positive aspects of the liberalized economic structure and easier availability of domestic and imported inputs enabled manufacturers to improve output performance and product quality. Increased domestic and import competition has eroded monopolistic market shares, squeezed inefficient industrial activities, and is leading to a reallocation of resources more in keeping with comparative advantage. B. Coverage and Methodology of the Surveys 2.07 The survey of micro and small scale enterprises covered 82 firms in four locations: Accra/Tema area, Nsawam, Oda and Mankessim. About 40 percent of firms in the sample were established after 1983. Firms were predominantly in food processing, soap and cosmetics, metal products, textiles and garments, wood and wood products, and building materials. The sample of medium and large enterprises covered 31 firms, located mostly in the Accra/Tema region. Sample firms were mostly in food and beverages, textiles and apparel, rubber and plastics, chemicals and pharmaceuticals, and wood, leather, metal and paper products. Over half of fins in the sample were over 25 years of age, and only 3 firms were established after 1980. 2.08 In both surveys, questionnaires were combined with detailed interviews of respondents. The questionnaires were designed to obtain data on physical performance, entrepreneurs' perceptions of the state of the market, product strategies, and the nature of the constraints facing them. In the survey of medium and large scale enterprises, detailed cost data were also sought to estimate domestic resource costs (DRCs) of foreign exchange earned or saved as an indicator of the economic efficiency of firms.12/ C. Findings of the Medium and Large Enterprise Survey 2.09 Performance. The survey confirmed that competitive pressures generated from the economic reforms were forcing firms to adjust to major shifts in relative prices. Many firms that had long been accustomed to profitable working under monopolistic conditions had to increase capacity utilization, improve quality or look for alternative lines of business. In general, firms in the survey showed a steady improvement in performance since the introduction of the reforms. About one-third of sample units (mostly the larger ones) were operating at over 60 percent of capacity. About one-half of the firms reported a rising output despite increased competition, and about a third of the units have increased employment. The economic liberalization involved both positive and negative effects for 12/ DRC estimates were also made for another 92 firms for which cost data was available from an earlier survey by the Ministry of Industries, Science and Technology (MIST) in 1987. In addition, some DRC estimates for the intervening period, 1988-89, were available from subsector studies carried out by MIST's consultants. This allowed a broad analysis of whether movements in the industrial structure were keeping pace with the pattern of economic comparative advantage. - 11 - manufacturers, but on balance the positive effects outweighed the negative effects. 2.10 The results did not reveal a clear relationship between size of unit and performance. Some correlation was observed between capacity utilization and size of unit but financial profitability showed no clear correlation. Smaller firms with relatively low rates of capacity utilization were profitable, indicating that the ability to find market niches was an important determinant of profitability. 2.11 Efficiency. Analysis of economic efficiency produced some moderately encouraging results. Short-run DRC ratios were under 1.0 for slightly more than one-half of the firms analyzed (16 out of 28 firms), although the majority of these (9 out of 16) were operating below 60 percent of their capacity. These results suggest a potential for lowering DRCs through increased capacity utilization. Long-run DRCs, wherever estimation was possible, were broadly consistent with the short-run DRCs. Activities whose average DRCs indicated economic comparative advantage, such as furniture, were by and large subject to relatively low effective protection (although DRCs vary widely within subsectors). Conversely, some of the most highly protected activities (e.g., automotive batteries, textiles) appeared to be among the least efficient. 2.12 A comparison of the survey estimates of economic efficiency and those from the earlier survey and subsector studies by MIST (see footnote 12) suggests a gradual widening of the pool of efficient industries over the past three years. Besides rubber, beer, and food processing, which had acceptable short-run DRCs in 1987, activities with efficient DRCs included structural and fabricated metals, furniture and wood products, plastic products, non-metallic mineral products, such as pottery and china, and some electrical equipment. To some extent, this may merely reflect sampling variations between the different surveys. On balance, however, the impression is that many manufacturing activities show increasing resilience and growing competitive strength. 2.13 Constraints. When asked to identify the principal factors limiting capacity utilization, 24 out of 31 firms pointed to the problem of credit availability, and 11 firms to the problem of raw material availability. The two problems are probably interrelated because the high import content of most activities meant that availability of raw materials was determined by firms' ability to pre-finance foreign purchases at depreciated exchange rates through the auction. Twenty one firms also identified problems on the demand side, probably reflecting the erosion of a formerly assured market by competition from imports. 2.14 Manufacturers were affected from import competition in different ways. The garment industry has suffered because with low per capita income people turned to chE..per 'imported' used clothing. As a result, domestic off-take from textile units shrank, and local manufacturers of yarn and piecegoods came under pressure. Other activities of doubtful economic value at their existing scale of production such as automotive batteries, electric light bulbs and wire nails were also unable to compete with imports. - 12 - 2.15 On the other hand, the existir.g economic environment appeared well-suited to many activities, such as wood-based products, food processing, beer, and metal-working, many of which had relatively up-to- date technology and adequate economies of scale. These firms did not seem to need much tariff assistance to compete successfully in the domestic market, and in some cases were able to penetrate neighboring export markets. Not surprisingly, they were less concerned about market demand as a constraint on performance than less efficient firms. 2.16 According to the survey, lack of credit has been a binding constraint to a stronger supply response. The firms' needs for working capital have increased sharply due to the increase in prices of imported inputs in cedis and the requirement of 100 percent cash in advance to obtain foreign exchange through the auction. In addition, the firms' need for term financing has also increased for modernization and rehabilitation of plant and equipment. Many firms in the survey have long-term plans to expand production and reduce costs through modernization, but the difficulty of finance is limiting their capacity to adjust. However, it is important to note that the difficulties cited by firms in obtaining credit may also reflect in some cases their limited capacity to inject new equity and the banks' concern for the firms' creditworthiness. A supplementary mini-survey of 15 enterprises found that of the 11 firms that had actually made investments during the past five years, only two were able to finance these with domestic credit; seven firms had to implement their projects with foreign financing; and another two firms used their own resources. 2.17 Adjustment Response. According to the survey findings, a wide range of activities appears to Iave an economic comparative advantage. The majority of the enterprises in such activities (e.g., wood processing, beer, and metal-working) have benefitted from the improved availability of imported inputs and technology and the relaxation of administrative controls in recent years, and have been able to cope with the pressures of competition under the ERP without much difficulty. On the other hand, enterprises with no real comparative advantage (e.g., garments, automotive batteries and/or electric light bulb assembly) have had difficulty coping with competition from imports. Firms facing difficulties were either closing down or trying to adapt by moving into non-competing product lines or upgrading technology. Production processes are being changed gradually to reduce costs and improve the quality of the final product. D. Findings of the Small Scale Enterprise Survey 2.18 Firm Characteristics. The majority of the 82 firms (including the 33 microenterprises with 3 or fewer paid workers) were registered, tax- paying, indigenous and sole-proprietorships. Their principal source of finance was own savings, and their use of public services low (25 percent of the sample used no services at all, and over 30 percent used only electricity). Tnput sources varied considerably, 22 percent using no imported inputs at all, another 22 percent using exclusively imported inputs, and the rest using a mix of the two. Linkages with the large scale sector were somewhat limited on the input side (only 27 percent reported buying inputs regularly from large firms), but were fairly high on the output side with a large proportion selling to larger businesses. - 13 - 2.19 Entrepreneurial Dynamism. The survey provided useful insights into the adaptive behavior of the microenterprise and small scale sector. It showed that there is no shortage of entrepreneurs in Ghana and that a new generation of entrepreneurs is emerging, partially in response to an environment that offers greater freedom and opportunities for private business than previously. Many firm owners were highly entrepreneurial in that they have departed from the paths of their parents, are able to perceive opportunities, and are willing to take risks. The percentage of owners who went into business to apply their training was significantly higher for newer entrepreneurs (43 percent) than for pre-1984 owners (13 percent). None of the parents of the post-1983 entrepreneurs in medium- sized firms was in business versus 38 percent of pre-1984 owners. Owners of more recently established firms also have higher educational qualifications than those of older enterprises. 2.20 A continaum of entrepreneurs can be envisioned, with those at one end driven mainly by the excess supply of labor and those at the other driven mainly by consumer demand for their products. The former generally are seeking income for survival and are artisanal in nature.13/ They tend to rely on apprenticeships for their training with relatively few years of formal schooling and, to a great extent, they follow the paths of their parents. Many are microenterprises that operate in informal settings, e.g., roadsides and backyards. The general impression irom interviews was that many of them have not adapted to changed circumstances in the economy, but rather have continued production much as in times past. Production in most microerlerprises, both new and old, has declined or stagnated since 1983. There is evidence that this group has grown in numbers as more people have sought self-employment in response to falling real incomes and scarce opportunities. Although income per capita has recovered somewhat since 1983, it has not yet reached former levels and demand for manufactures remains weak among low-income and rural consumers, the major customers for microenterprise products. As a result, it appears that a slowly growing pie is being cut into ever smaller pieces in an expanding microenterprise sector. Prospects for microenterprises will only improve when the growth of consumer demand outstrips the net rate of entry. 2.21 At the other end of the continuum are firm owners who are highly entrepreneurial (see Boxes 2.1 and 2.2). A number have willingly left large companies to risk starting their own businesses in response to the new business environment. Their goals go beyond basic income generation to the building of enterprises and the accumulation of profits. They are well educated, both formally and through significant past job experience, and dynamic in the sense that they demonstrate a keen ability to recognize opportunities in the rapidly changing economy and a willingness to act on their perceptions. Most started small but moved up, some more quickly than others. They have found profitable niches through an ability to adapt quickly to changing market circumstances and technologies. They often produce specialized, non-traditional items such as freezers, water coolers and drums, or undertake innovative processing of local materials. Within each size category, new firms established since 1983 have had a greater 131 For example, metal products and repair, furniture, tie and dye fabrics, made-to-order garments, simple food processing, and crude soap-making. - 14 - Box 2.1: Entrepreneurship in Ghana - The Case of an Entrepreneur The owner Is a dynamic entrepreneur and stands apart from the many small firms owners in Ghana who are in business primarily to generate subsistence income. His goal is to build a profitable btsiness that relies as far as possible on the use of local expertise and raw materials. He has been buffeted by shifting economic policies and conditions over the past 20 years and 1. still struggling to secure a niche for himself. His company produces chalk for schools, starch for glue used in textile production and cement made from local materials. Chalk production started up in 1967 with fou workers in the owner's back yard. Labor has gone from a peak of 100 in the mid-1970s to a low of 1" in 1983 to a current total of 40. He trained as an engineer for years abroad, and obtained substantial work experience in aluminum processing in Ghana and overseas. He discovered a new and more cost-effective way of producing chalk while working abroad. He returned home, designed new machines and taught local metal workers how to make them. His long-term contract to supply chalk to the Government was lost when it was put on tender. Slack demand and increased prices for imported plaster of paris led to a 50 percent cut in chalk production. As demand for chalk declined, he started producing starch, the key Ingredient in the glue used to print cloth. The traditional method involves extracting starch from cassava and purifying it for commercial use. Peeling cassava is highly labor-intensive; the price of cassava has increased; and availability has become a problem. The entrepreneur used his ingenuity to improve on tradition by devising a means of extracting the starch from maize to make the processed starch. In addition, he substituted a locally brewed alkaline solution (which uses imported caustic soda) as the purifier in place of the imported sulfur dioxide. Again he designed his equipment and commissioned local metal workers to produce it. When the cedi was devalued and the tariff schedule rationalized, the price of caustic soda needed to process the raw starch rose from 4 to 280 cedis per kilogram. Working capital was diminished and the cost of stocking seasonal and now more expensive maize became prohibitive. He continues to produce starch but he does not stock maize anymore; his clients have to bring it themselves and he simply charges them a processing fee. He is forced to buy his caustic soda in small amounts because he cannot afford bulk quantities. His latest venture, Initiated four years ago, is cement production, based on all local raw materials. Production is relatively limited but final prices are competitive, and the volume can increase if credit were available. He has met the major shifts in the economy of the past 20 years with flexibility, innovation and resilience. As imports have taken his markets and the exchange rate reforms have raised the costs of his inputs, he has shifted products and invented new technologies as they were needed. He was able to make these shifts successfully because of his solid training and talent as an engineer, his conviction that Ghana should increase its self-reliance through exploiting its indigenous resources, and his strong character that would not be defeated. Though he has been in business for over 20 years, he Is one of the group of entrepreneurs who will lead private sector development in Ghana. tendency to grow. As imports were liberalized, new firms sprang up to supply low-cost substitutes. Examples include knives made from used band saw blades and discarded metal packing strips, low quality pottery and kitchen utensils, locally mixed paints, and simple agricultural implements. With devaluation of the cedi, prices of imported inputs rose and many of the more dynamic entrepreneurs sought ways to make greater use of local raw materials.141 With the devaluation, firt are also looking for exports. 14/ Successful examples include the use of crushed oyster shells to obtain quick lime for locally made paint, a new method of processing local clay to make bricks, utilization of locally produced aluminum sheets to produce low-cost filing cabinets and reworking scrap metal to make trunks, water coolers and commercial freezers. - 15 - Box 2.2: Engineerina Capability: The Growth of a Firm Ghana Is gradually developing two prerequisites for a dynamic Industrlalization process: engineering capability and entrepreneurs in medium-sized firms. One engineering firm's technical skills have enabled it to grow from a microonterprise to 18 workers producing 30 types of agricultural machinery. Although the firm's growth has resulted mainly from reinvesting profits, outside financial and technical assistance has played an Important role. It Is ready to move to a permanent building where it can both grow and become more specialized. The entrepreneur began by making simple laboratory equipment for secondary schools as a way of supplementing his income as a technician at the University of Science and Technology (UST) In Kumasi. He was well trained in two of Ghana's polytechnic schools and a heavy mechanical engineering course abroad. Although he soon gained a market with one ministry and moved to a shop in the timber market, the Government's inability to pay on time created financial difficulties. He shifted to producing saw benches, circular saws, and other simple equipment for the local furniture and woodworking industry. The business did not really take off for about four years, when he added agricultural and food processing machinery. Demand was strong, and two years later he imported used machine tools with an external loan, arranged through the Technology Consultancy Centre at UST. After another five years of growth, he obtained additional equipment through a loan from a local development bank. Four main factors account for this firm's ability to compete successfully with imports and the growing number of domestic makers of agricultural equipment: * Technical adaptation, such as substituting sealed, self-lubricating, stainless steel bearings in its corn mills for the normal imported bronze bearings that must be oiled and that wear out quickly. * Low cost, achieved by using locally available scrap, used (but durable) machine tools, and servicing them In-house. * High quality workmanship, with a strong training program for new employees. * After-sales services, including speedy replacement of worn-out parts and a willingness to visit clients to solve problems. The firm contributes in several ways to raising productivity in the economy. It responds to customers' needs, for example, by inventing a shea butter kneading machine to free women from this time-consuming task. It promotes specialization by purchasing some parts from other engineering firms and a foundry. It trains workers to do high quality work with minimum wastage through a three-year apprenticeship program (supplemented by evening classes at the technical institute), hiring only the most reliable graduates. New, small sawmills are buying logs from those with timber concessions and saving them into lumber which they then sell to larger exporting firms. One enterprising individual collects the mountains of sawdust from the large sawmills and compresses it into briquettes that serve as low-cost substitutes for charcoal. 2.22 Capacity Utilization. It is difficult to d-ine capacity accurately in small, artisanal firms. Firms were asked how much more they could produce with their existing equipment if they could sell everything they produced. Low rates are to be expected among microenterprises, in which low entry barriers lead easily to market saturation. Eighty-six percent of the firms were operating at 50 percent or less of capacity, with an average of 36 percent and slightly higher average rates for newer, small firms (42 percent), and slightly lower rates for medium/large firms and - 16 - more recently established microenterprises (27 and 32 percent, respectively). Variations are much greater within than between subsectors. In general, firms producing for up-scale markets are thriving, whereas those producing for low-income markets are facing severe market constraints. 2.23 Constraints. Firms were asked to state their single main concern, and then to cite up to three others. Lack of credit was found to be the major concern with 23 percent of firms citing it for raw materials, and another 11 percent for equipment. The state of the market came next with 17 percent of firms finding the lack of demand as a major problem; six percent felt there were too many competitors in the same business. Larger enterprises were more concerned with the credit problem than with market demand. Eighty-four percent of respondents said that credit has become tighter during the adjustment period. Nearly half (47 percent) of all firms in this survey and nearly three-quarters of respondents in the medium/large enterprise survey have tried to get a bank loan during the past five years. However, fifty-six percent of all firms could not get credit for raw materials and 44 percent could not get it for equipment. In addition to the limited capacity of the financial system to provide new resources, such a situation is perhaps also a reflection of the poor financial condition of some of the enterprises. For the existing small enterprises, dealing with government regulations did not emerge as a binding constraint. Yet, a surprising 32 percent of all firms surveyed felt that dealing with government regulations has become more difficult (67 percent in the case of medium and larger firms); 39 percent felt that they have in fact become easier to deal with. 2.24 Adjustment Response. The survey results show that structural adjustment policies have begun altering the structure of industrial production in Ghana. Changes in the exchange rate, trade policy, demand, and prices have had differential effects on firms: negative to the extent that they use imported inputs intensively, or face constrained demand; and positive to the extent that they can obtain inputs more easily and find market niches. Some import substituting firms have had difficulty competing with liberalized imports, while others have benefitted from the rising price of competing imports. Although effects vary within each size and subsector group, the differences between groups suggest that structural changes are occurring. There is evidence both of growing dynamism at the firm level and of constraints on the realization of that potential. New small enterprises are performing well, and almost one-half of the firms established before 1983 have undertaken some investment since then. Employment has recovered strongly in microenterprises and SSEs, although much of this growth is driven by excess supply of labor rather than production-generated demand. Despite import liberalization, domestic small firms are cited as the leading source of competition by large-scale firms as well as by SSEs themselves. Many entrepreneurs have sought new products, techniques, and markets under the stimt-us of this competition, and others would do so if they had greater access to resources. 2.25 Table 2.2 presents survey results on the impact of adjustment on production and employment, by size group. For the entire sample, approximately the same proportion of firms increased production (39 percent) from 1983 to 1989 as decreased (43 percent). When broken down by size and period of establishment, however, declines in production - 17 - predominated among microenterprises and SSEs established by 1983, whereas increases in production predominated for new SSEs and for large firms from the medium/large-scale survey. Firms established since 1983 have been relatively more successful in expanding output in all size groups than those already in existence. This suggests that new firms--especially SSEs- -have entered relatively high-growth activities, which is expected given entrepreneurial dynamism in Ghana. Table 2.2: IMPACT OF ADJUSTMENT ON PRODUCTION AND OUTPUT BY FIRM SIZE: FIRMS ESTABLISHED BY AND AFTER 1983 (percentage of respondents in each category) Size categories: a/ Size categories: a/ Large All firms V. Med./ V. Med./ scale Impact surveyed Micro small Small Large Micro small Small Large survey b/ All Firms established by 1983 Firms established after 1983 Years Change In production: Increase 89 29 31 83 43 34 70 43 n.a. s Decrease 43 65 44 67 43 48 20 14 n.a. 29 Change in employment: Increase 62 47 58 78 71 58 80 71 n.a. 35 Decrease 16 18 25 11 29 6 0 29 n.a. 39 New firms as percent of all firms in sample 40 n.a. n.a. n.a. n.a. 48 38 44 0 n.a. (Number of fi rms) (82) (17) (16) (9) (7) (16) (10) (7) (0) (31) a/ Categories are based on the number of full-time wage workers: micro = a or fewer; very small = 4-9; small = 10-29; medium/large = 30 or more; data are also shown from a separate survey of the large-scale sector for which some comparable data were obtained. b/ Medium and large enterprise survey (paras 2.09-2.17). 2.26 Significant differences in adjustment impact are apparent between subsectors (see Annex 2-2). Wood products had the highest proportion of firms showing an increase in both production and employment. Building materials and metal products had the highest proportion of firms whose production had declined. Interestingly, a much higher proportion of firms reported an increase in employment (62 percent) than in production (39 percent). This is perhaps because excess supply of labor has increasingly had to seek income-earning opportunities outside the public sector. The relatively high growth of microenterprises suggests that many workers are looking to this sector for income (part-time workers account for 50 percent of microenterprise employment). 2.27 The firms in the survey show visible signs of encouraging adaptive behavior to new price incentives. The product mix was changed significantly during the ERP by 34 percent of the firms surveyed (Annex 2- 3). As the construction industry picked up, metal workers began producing metal gates and burglar alarm systems. Having lost his contract to produce chalk for the Ministry of Education, one entrepreneur shifted into production of starch for the textile industry (see Box 2.1). Changes in product mix were made by the largest number of firms in the soap and cosmetics and the textiles and garments subsectors (83 percent and 50 - 18 - percent of firms, respectively; Annex 2-2). The food, wood, and metal products subsectors had less need to change because their dependence on imported inputs is low (19, 10, and 18 percent, respectively) and their products tend to be suited to individual tastes, making them less vulnerable to competition from standardized imports. A number of firms are also shifting their marketing strategies. 2.28 Contrary to some observers' perceptions, investment is taking place, at least among SSEs. Nearly half of all firms established by 1983 have purchased some new equipment to replace outmoded equipment that had deteriorated and to change product mix (Annex 2-3). The share is somewhat lower for microenterprises, and about 56 percent for other size groups. In addition, new firms are entering, at least among smaller ones. Nearly half of the microenterprises sampled were established since 1983 (high birth and death rates are expected in this group); 38 percent and 44 percent of the very small and small enterprises, respectively, entered since 1983 (Table 2.2). Only among large scale enterprises is there not much evidence of new firms. 2.29 Sources of Competition. Decline of production in some firms under the ERP has created protectionist pressures on the Government. The evidence from the survey indicates that import competition is a problem mainly for certain products and large-scale firms, not a general concern. Although 61 percent of the firms interviewed claimed that competition had increased since 1983 (Annex 2-2), only 21 percent mentioned imports as a major source of that competition (see Annex 2-4), and only 12 percent if large-scale firms are excluded. In contrast, of 31 large-scale firms interviewed in two surveys, 50 percent said that imports are a main source of competition. But for firms with less than .' employees, other SSEs are the overwhelming source of competition for about three-quarters of tb firms. Thus, pressure from imports can be seen as a selective measurb to help increase domestic competition and redress the past bias toward highly- protected large-scale investments. E. Entrepreneurs' Views of Business Environment Issues 2.30 The two surveys also sought existing firms' views on business environment to supplement the detailed review of the legal and regulatory aspects in general (see Annexes 2-5, 2-6 and 2-7 and Chapter 3). Caution is needed in interpreting these findings as the responses would be expected to be greatly influenced by the firms' experience with the stringent regulatory framework which existed before 1983. Moreover, existing businesses are likely to know how to get around existing regulations because of their familiarity with the system. Potential new investors are likely to carefully assess the impact of regulations on their businesses before deciding to invest. 2.31 Concerns about restrained demand (in particular by microenterprises) and the lack of credit dominated firms' responses to a request for their top four problems of operation. The high level of taxes and the requirement of tax clearance certificates (TCCs) for almost every business transaction were also a major concern. As for regulatory problems, 48 percent of all firms (18 percent of medium and large firms) interviewed replied 'none" and 52 percent of all firms (72 percent of medium and large firms) cited problems. Location was the dominant concern - 19 - of micro and very small enterprises, some of which have been forced to relocate away from main thoroughfares or be demolished by the Accra Metropolitan Authority (and other urban councils).15/ For example, a wood carver who had to relocate along with the timber market in Tema has lost virtually all his trade because the new location is far from the main road. Like many small producers, his customers were primarily passers-by, rather than people specifically seeking out his product. Rattan furniture makers near the Accra Airport are no longer allowed a small structure in which to store stock, so they can only display what they can carry each day. Wayside vehicle repair establishments have been moved far away from the main road. 2.32 Registration (or the lack thereof) as a business enterprise--a comparatively simple and automatic process at the Registrar-General's Office--apparently posed some difficulty for a number of microenterprises and very small firms.16/ Licensing (by MIST) was seen as a problem by some SSEs. Labor regulations--both restrictions against laying off workers and iinimum wage requirements--were important mainly for the larger firms. The fact that price controls were mentioned as a problem by 13 percent of the respondents (20 percent of medium and large scale firms) shows that prices have not yet been fully liberalized in practice. More than half of the large firms felt that import clearance procedures have deteriorated. 2.33 Perceptions of changes in the regulatory environment differed by size category. About three-quarters of large-scale firms said that regulations had become easier since 1983, while one-quarter of these firms said that there has not been any change or that regulations have become more difficult. In contrast, over 43 percent of SSEs said that regulations had become more difficult to deal with--approximately the same share that cited specific regulatory problems (mainly location and labor restrictions, and licensing to a lesser extent). Although regulatory problems may not be a primary immediate concern for existing businesses, some attention is warranted to reduce this adverse trend, whether it is in fact or in perception by SSE owners. Microenterprises tended to see no significant changes in regulations--presumably because they are the least affected. 151 The city officials state that they are aware of the need to encourage small businesses and that they have exercised considerable patience in getting them to leave land on which they held at best a permit subject to termination on 72 hours' notice. The authorities (at least in Accra) are trying to organize small producers and sellers and provide them specific locations. The question is whether this can be accomplished with greater participation by the entrepreneurs and without destroying their investments or moving them far away from their customers. At the minimum, the business environment would benefit from greater consultation between local authorities, the national Government, and the entLipreneurs concerned before actions are taken. 16/ The process of going to the Registrar-General's Office in Accra to register is relatively costly and intimidating for self-employed, often poorly educated microentrepreneurs. Microenterprises that are not registered as a business face possible harassment from the authorities. - 20 - 2.34 Principal constraints for the expansion of operations were the difficulties in obtaining credit and raw materials, followed by taxes. Uncertainty about the economy was seen as a restraint on new investment by 38 percent of respondents, especially those with 10 or more workers. Medium and large scale firms also expressed reservations about the Government's attitude toward private investment; 36 percent saw it as a moderate or major problem. Taxes are seen as a moderate or major problem for new investment by more than half (62 percent) of respondents. Only large-scale firms saw obtaining other approvals (including investment code benefits) as a moderate or major problem. F. Conclusions 2.35 While manufacturing output has grown rapidly under the ERP, it has yet to recover fully to its peak of the 1970s. PrivTate investment was expected to be a driving force in the recovery of the sector, but has been below expectations. The surveys of over 100 manufacturing firms show that the Government's adjustment policies have forced firms to become more competitive through a combination of strategies, including adaptation, innovation and investment. There is a strong evidence in Ghana of entrepreneurial initiative and dynamism, manifested in the seeking of new lines and new markets, and in the attempt to increase productivity through process improvements and investments in modernization of facilities. Resource allocation has begun to move closer to economic comparative advantage. Enterprises of doubtful economic value are finding it increasingly difficult to withstand the competition, while easier availability of imported inputs has permitted relatively efficient enterprises to take root and expand. Overall, the structure of the sector has slowly begun tc shift away from relatively inefficient activities propped up by high protection in the past and towards more efficient activities. Although new investment in large-scale firms has been limited, there is evidence that some investment is taking place in small scale enterprises. Yet, for potentially dynamic firms, the lack of finance has affected their ability to further increase capacity utilization and modernize their facilities. Therefore, a rapid implementation of the ongoing financial sector reforms and improvements in the legal and regulatory constraints are critical for a strong supply response. - 21 - III. THE ENABLING ENVIRONMENT FOR PRIVATE SECTOR DEVELOPMENT 3.01 Experience to date of many adjusting countries shows that for a rapid and efficient supply response to improvements in the macroeconomic setting and the incentive system, supportive changes are also needed in (a) the institutional framework, e.g., in policies towards the financial sector, public enterprises, pricing, and taxation and investment incentives that supports the reforms of macroeconomic policies and incentives; and (b) laws and regulations that protect public and private interests, but do not unnecessarily interfere with private initiative. Expanding markets, human resource development and adequate physical infrastructure are also essential elements of the enabling environment for private sector development. Finally, a climate of political stability, the existence of good economic and social governance for development, the positive attitudes of the country towards the role of the private sector and the credibility and sustainability of the reform program are equally important. This chapter analyzes the main issues in each area and suggests actions to improve the business environment in order to stimulate the investment response of the private sector. Key recommendations for improving the enabling environment are summarized in Annex 3-1. A. Governance 3.02 Good governance is a precondition for sustainable development.17/ The essential features of good governance for economic and social development include at least the following: participation, public debate and free flow of information, accountability and transparency, and the rule of law. The presence of these key ingredients is an essential part of the enabling environment for a rapidly growing and developing economy. 3.03 Participation. There is increasing recognition based on the experience of development projects during the past decades that only by active participation at the grassroot level can the delivery of services be established on a sustainable level, in terms of both management and affordability (e.g., rural water supply). If development is to proceed, people at the various levels of the beneficiary, the service providers and the policymakers, all will have to be understood on their own terms, within their own cultural parameters and, in the case of the poor, given increased power to act on their own behalf. In this regard, intermediaries have an important role to play. They can create links both upwards and downwards in society, voicing local concerns more effectively than grassroots institutions. The establishment of self-policing professional associations should therefore be encouraged to ensure that appropriate professional standards are adopted and maintained. Similarly, intermediate non- governmental agencies can help assure the provisions of a ..hole range of services more efficiently. Therefore, efforts should be made to nurture independent unions, chambers of commerce, professional associations, academic institutions, research centers, trade associations, NGOs, etc., to 171 See, World Bank, Sub-Saharan Africa - From Crisis to Sustainable Growth, A Long-Term Perspective Study, 1989. - 22 - promote institutional pluralism which is central to sustainable development. These institutions can help exert pressure on public officials for better performance and accountability. Active participation by local governments, private citizens, trade unions, cooperatives, women's groups, business organizations, and NGOs in the country's development is consistent with the shift in Ghana in the Government's role from that of economic producer and provider to one of facilitator of economic development. 3.04 Public Debate and the Free Flow of Information. The free exchange of ideas and the free flow of information are central to economic and social development. Such an open environment would encourage entrepreneurs to contribute their energies and skills to reconstruction of the economy. In Ghana, there has generally been a lack of effective communication and constructive debate between the private sector and the senior decision-makers in the Government on issues of mutual concern (see para 3.11). Information on the current state of the economy and likely future economic developments is woefully inadequate and not easily available on time. This is clearly an area, in which the Government has a comparative advantage in collecting and disseminating certain kinds of information to producers and consumers. 3.05 Accountability. Governments should be truly accountable for their actions. They should make information available to the public in a sufficiently transparent manner so that both the costs of particular decisions and their benefits and who such benefits accrue to would be known. Such a practice will help provide a basis for a national dialogue to build consensus on major issues of concern to the country. Accountability also requires that there is a sound and transparent system of public accounting and auditing, and the timely publication of audited accounts of public enterprises. The elimination of unnecessary controls in the legal and regulatory framework and in policies affecting entry and exit of firms will help reduce the scope for "rent seeking" as well as increase competition. Transparent procurement systems for the public sector will also help improve competition and encourage active participation by the private sector. 3.06 Rule of Law is a fundamental prerequisite for economic development. It is highly unlikely that sound investments would be forthcoming or that economic activity would flourish without the predictability in the enforcement of laws and regulations and if civil contracts cannot be easily and quickly enforced. Economic transactions are likely to be severely curtailed or forced into an underground economy without the honest administration of the rule of law. An independent and authoritative judicial system is of central importance for the establishment of the rule of law, which is as critical for promoting economic development as is a sound and stable macroeconomic setting, efficient infrastructure, and effectively functioning financial markets. B. Attitude Towards the Role of the Private Sector 3.07 While the Government recognizes the role of a dynamic private sector in Ghana's development, most investors remain uncertain and perceive an ambivalence in attitudes to the private sector. The non-transparency, arbitrariness and complexity of government regulations and procedures are - 23 - important manifestations of that ambivalence. Some of this perception no doubt is the result of past government actions in the 1960s, 1970s and early 1980s--partly in response to the widespread corruption and "rent seeking" behavior in the distorted economy--when many SOEs were created, some private firms were nationalized, and currency reforms shook confidence in the banking system (see para 1.06). 3.08 Although there 1ave been considerable improvements on these counts in recent years, significant problems of perception remain: (a) slow progress in implementing the public enterprise reform program and continued domination of the economy by public enterprises; (b) arbitrary actions by Government against private business (closure of businesses and investigations of owners, querying of sources of funds obtained for investing, and forced relocation of microenterprises to inconvenient sites); (c) a large perceived gap between official policies and regulations and actions; and (d) the control-oriented attitude that still permeates the administration of regulations. What government officials may see as reining in profiteers, investors may see as punishing successful profit- makers. Even when liberalized policies are adopted, they are not implemented by administrators who deal with the public, possibly because of the residual belief in controls by the Government (e.g., efforts to make firms lower prices of their goods that are no longer officially controlled), or because it takes time for changes in attitudes to occur, or because training in new procedures has been inadequate. 3.09 The fear of being asked to explain the source of investment funds exacerbates the problem of credit by encouraging very high debt/equity ratios. In addition, economic and political uncertainties make private inv'-, i look for very short pay-back periods for their equity. This also tends to push up the debt/equity ratio and the demand for credit.18/ 3.10 An investor-friendly environment requires that entrepreneurs are treated as respected members of the community. In a competitive environment, profits are a reflection of efficiency and successful operations and marketing. The attitude of society towards business owners and their legitimate accumulation of wealth is a very important part of the investment climate. Therefore, society must respect the achievements of businesses, even if investors become visible by reaping returns on their investments. To be perceived by the business community as welcoming, even embracing, rather than just tolerating a larger private sector, the Government needs to launch a visible and public campaign in support of private sector development, disseminate information and foster debate on key private sector concerns among a wider audience. 3.11 Until recently the private sector has had relatively limited communication with the senior decision-makers of the Government. While some ad hoc meetings had taken place in the past between the Government and the private sector, there was perhaps a notable change in the relationship recently, as seen by a meeting in February 1990, just prior to the Investment Promotion Conference sponsored by MIGA and the Ghana Investments Center (GIC). Its purpose was to facilitate an exchange of views between 18! Many investors in Ghana are looking for pay-back periods of 1-2 years, with several looking for as short as one year or less. - 24 - the private sector and the Government on concerns of the business community. Such meetings are now expected to be held at least twice a year. This development is a step in the right direction. 3.12 Change in attitudes will not, however, come quickly or easily. Even as the leadership takes the initiative to encourage private investment, there is a concern that the private sector will again exploit Ghana's wealth. The result is continued ambivalence towards the private investor. Public statements from top Government officials indicating unequivocally that private sector investment is central to sustained economic development, and that private investors would be treated fairly and not subjected to arbitrary government action, would help ensure a consistent attitude within Government. Public statements would need to be backed by concrete steps to demonstrate and publicize a commitment to supporting the private sector. As one step, the Government should consider launching a well-publicized campaign to facilitate the development of a local resource based industry, say the wood furniture industry, which is clearly competitive, already exporting, and capable of expanding. The Government should charge officials with finding ways to eliminate or streamline procedures for this industry. Firms with complaints should be encouraged to address a designated senior decision-maker (for example, the PNDC Member and Chairman of the Committee of Secretaries--or at least to an ombudsman in his office), whose job will be to find ways to eliminate red tape. This will serve as a pilot case to find where the real obstacles are and how these can be removed. As problems are solved, demand will be generated to solve similar problems in other sectors and it will become easier to reach global solutions. Although initially limited, a successful handling of one subsector will demonstrate the Government's commitment to supporting the private sector and help send a signal to administrators that they are supposed to facilitate rather than create barriers. Another concrete step that the Government could consider is a series of recognition awards for different categories of entrepreneurs, e.g., small business; microentrepreneur; engineer; factory; small-scale and large-scale exporters; technological innovators; resource-based processor; etc. This will help publicize positive things that are going on and demonstrate the Government's support for the private sector. C. Institutional Reforms 1. Financial Sector Development 3.13 Ghana's financial sector is distressed. Well-functioning financial markets, that is money and capital markets, are essential to support private sector development through a wide range of financial services and instruments to meet the needs of firms and savers, and assistance in management and other areas needed by clients. At present, these conditions do not exist in Ghana, and the financial sector has been uni'le to meet the needs of firms that should be expanding after reforms in the incentive system under the ERP. 3.14 Ghana's banking system was adversely affected by the deteriorating economy and high inflation, and unsatisfactory monetary and financial policies that repressed financial intermediation. The Bank of Ghana imposed monetary control through strict credit ceilings and by controlling interest rates. The Government borrowed heavily from the banks - 25 - to finance budgetary deficits. Recurrent government interventions led the banks to support inefficient or ailing public and private enterprises. Beginning 1983, the large foreign currency denominated liabilities of banks were severely affected by the continuing depreciation of the cedi under the ERP. Borrowers' financial distress led to "ever-greening" and increasing exposure of the banking system to distressed corporate enterprises. These developments led to pervasive financial distress characterized by: (a) huge non-performing loan portfolios; (b) inadequate provisions for portfolio losses; (c) inflated profits; (d) high operational costs; (e) excessive foreign exchange exposure; and (f) insolvency of several financial institutions in the context of the sector's overall capital inadequacy. The problem was compounded further by inadequate accounting, management information and internal control systems. As a result, intermediation was affected adversely, and there was a loss of confidence in the banking system. 3.15 Under the ERP, the Government began reforming financial sector policies by gradually deregulating the interest rates, and liberalizing them fully in February 1988. With declining inflation in the mid-1980s, deposit rates became positive in real terms for the first time in more than a decade, though in later years fluctuating inflation rendered them, at times, negative again. Sectoral credit targets were also gradually phased out except for a minimum requirement to the agriculture sector. In order to improve the management of liquidity and money in the economy, the Bank of Ghana began to use more actively the cash reserve ratio and later increased its recourse to primary sales of government paper. The new Consolidated Discount House began operations in November 1987 to foster an interbank market and to develop a money market. 3.16 Despite these reforms, there is an anomaly in Ghana's financial sector. On the one hand, there is excess liquidity in the system with banks unwilling to undertake further deposits on account of their inability to expand their lending. On the other hand, there is a shortage of credit- available to the real economy. The intermediation margins are very high (over 200 percent over the cost of funds) mainly because a large share of the banks' funds are tied up in non-performing loans, no interest is earned on minimum cash reserves required, and the banking environment is not competitive. In addition, most credit from the banking system is in overdrafts; time deposits account for a small portion of the banks' deposits (about 13 and 21 percent for primary and secondary banks, respectively). Because of the rudimentary nature of the capital market in Ghana, the private sector has not been able to raise any term finance or risk capital from other resources. 3.17 The Government introduced a program of major financial sector reforms in 1988. The basic objectives of these reforms are to: (a) enhance the soundness of banking institutions by improving regulations and strengthening bank supervision; (b) restructure financially distressed banks; (c) improve resource mobilization and increase the efficiency of credit allocation by the banking system; (d) initiate the development of money and capital markets; (e) support an initial program for corporate restructuring; and (vi) strengthen the accounting and auditing professions and training of bankers. - 26 - 3.18 A new banking law was promulgated in August 1989. Supervisory functions of the Bank of Ghana over the banking system have been significantly strengthened.19/ To foster a sound, dynamic banking system and increase competition in banking, seven distressed banks are being restructured by increasing their capital base, restructuring their portfolios, upgrading their management, and bringing their operations in line with the improved regulatory framework. The non-performing loans of all deposit money banks to SOEs (about 022.5 billion) were replaced with Bank of Ghana promissory notes in November 1989, and afterwards with Bank of Ghana bonds in April 1990. The non-performing loans to the private sector (estimated at about 036 billion as of December 1988) will also be redeemed partly on a face value and partly on a discount by a new agency, the Non-Performing Assets Recovery Trust (NPART) established in February 1990, whose function will be to realize its assets to the extent possible with assistance fram a newly appointed special judiciary tribunal. To increase competition in banking, the Government is encouraging the entry of new privately-owned domestic or foreign banks. Two new foreign banks have already been established, and IFC is presently promoting the establishment of a leasing company. After consideration over a decade, the Ghana Stock Exchange was finally established in 1989, and, in the near term, the Government will have t> focus on the regulatory framework for the stock exchange. The Gov-rnmEnt has also begun work to put in place, with assistance from the I ?, a new system of managing monetary control whereby overall liquidity wi-_ be managed primarily through control of net domestic assets of the Bank of Ghana by open-market operations and other indirect controls rather than through credit ceilings on individual banks.20/ Recognizing that bank restructuring should proceed parallel to a program for restructuring client businesses in arrears, a study was carried out to assess the magnitude of the distress to private and public sector enterprises caused, inter alia, by high inflation, devaluations of the cedi, and changes in the trade regime. The second phase of the study to examine the institutional arrangements for the enterprise restructuring process has also been completed. Rapid implementation of the financial sector reforms should be of highest priority to stimulate private investment and maximize gains from the policy reforms under the ERP. 19/ As a result, total provisions for non-performing loans in the banking system increased from about 06 billion at the end-1987 to about 042 billion at the end of l'-9; the total loans and advances by all commercial and secondary banks at the end of 1988 were about 066 billion. 20/ In this context and to control inflation, the Bank of Ghana sold financial instruments worth 08 billion through auction in the first quarter of 1990 to absorb excess liquidity, and further such sales are planned. - 27 - 2. Policies Towards State-Owned Enterprises 21/ 3.19 Following the state-led development policies during the 1960s and 1970s, the SOE sector has grown very large. At the beginning of the ERP, there were some 235 SOEs including 181 and 54 SOEs with majority and minority state holdings, respectively. (There are, however, recent indications that the actual number of SOEs may be much higher than the previous estimates.) SOEs continue to dominate the economy. In manufacturing alone (medium and large enterprises), SOEs accounted in 1986 for at least 45 percent of the value added and 40 percent of employment. 3.20 The SOE sector has been a major constraint to creating a favorable business environment and healthy competition. The past preferential treatment of SOEs by the Government has adversely affected the competitiveness of the private sector and the operational efficiency of the SOEs. Subsidies and subventions to many SOEs have been a heavy burden on the budget. Their privileged access to funds at low or zero cost encouraged their growing indebtedness and crowded out the private sector's access to the financial sector. SOEs have been able to borrow from external sources with government guarantee, reducing the risk premium further. Many SOEs have been virtually exempted from paying custom duties, excise and sales taxes. In some cases, their debt service and taxes due to the Government have been in arrears for a long time. 3.21 On the other hand, SOEs had the disadvantage of interference by the Government in their day-to-day operations. For example, SOEs did not enjoy the autonomy in negotiating collective bargaining agreements with their employees on terms and conditions relevant to market forces or to manage their staffing in accordance with business and commercial conditions. In procuring goods and services, SOEs have been subject to the delays involved in extensive bureaucratic procedures and often have been required to buy from or sell to other SOEs at unfavorable prices. 3.22 Recognizing these issues, the Government initiated comprehensive reforms of its SOE sector under the ERP. The major thrust of the program includes the following: (a) policy reforms to ensure that SOEs operate in a commercial manner, including decontrol of prices and increased competition; (b) institutional reforms to increase autonomy and accountability of SOEs and to strengthen the Government's performance monitoring and evaluation system; (c) a divestiture program to reduce the financial and managerial burden of the SOEs on the Government; and (d) improvement in the efficiency of priority SOEs through staffing reductions, training programs, and preparation of corporate plans and financial audits. 3.23 Overall progress in implementing the SOE reform program has been very slow. Most efforts so far concentrated on preparing the ground work, reaching consensus and strengthening the institutions for implementing the program. 211 This section briefly touches upon the key issues in the implementation of the Government's present reform program for SOEs. A more comprehensive analysis of the SOE sector is planned to be carried out jointly by the Government and Bank staff in order to develop a strategy for joint evolution of the public and private sectors. - 28 - 3.24 In the area of improving the policy framework for SOEs, the studies on pricing, staffing, redeployment, and procurement issues were recently completed, and are under review by the Government. The studies have highlighted the importance of immediate actions by the Government to give increased autonomy to the SOEs in their day-to-day operations and hold them accountable for their performance. For pricing, the study has emphasized the urgent need for further deregulation of prices particularly for rice, sugar, edible oil, soap, matches, cement, and roofing sheets, and that prices should be determined according to market forces rather than through administrative mechanisms. In the area of procurement. the study has recommended the elimination of formal and informal preferential treatment that SOEs may receive from the Government and its agencies in procurement of their goods and services in comparison with the private sector, and the removal of informal arrangements requiring SOEs to purchase their goods from other SOEs to the maximum extent possible. An expeditious implementation of these reform measures will help improve competition and improve the efficiency of the SOEs. 3.25 The effective implementation of the SOE reform program (i.e., commercialization of public enterprises that will remain in the public sector, and divestiture of others) could become a powerful stimulus to private sector investment in Ghana. Initially, the PNDC approved an original list of 32 SOEs for the first phase of the divestiture program, advertised in May 1988. The Government was reluctant to divest profitable SOEs, but recognized that the divestiture would have benefits for both the enterprise, through increased equity investment, new management and technology, and the Government, through revenues from divestiture, increased taxes from higher profitability, and elimination of future demands for financial support. The list was subsequently expanded to include an additional 46 SOEs, based on the investors' interest. 3.26 The response from the private investors has been encouraging with over 600 proposals. Yet progress in the implementation of the divestiture program until very recently was very slow. The factors contributing to a slow progress included the lack of consensus in the Government on the divestiture program, initial reluctance to sell profitable enterprises, lack of comprehensive data on assets, liabilities and employment, legal issues pertaining to the transfer of ownership, the involvement of too many institutions and the highly hierarchical and a long approval process. As a result, there were prolonged delays in responding to investors' proposals and concluding the transactions.22/ Meanwhile, the performance of SOEs tends to deteriorate further during this waiting period. Long periods of waiting and uncertainty are highly discouraging and could erode the private sector's confidence in the Government's intentions. There has been a growing skepticism among investors. 22/ The case of one investor, interviewed in August 1989, illustrates this point. He registered his interest and submitted his proposal to the Divestiture Implementation Committee (DIC) in March 1988; he was invited to negotiations in April 1989, and a memorandum of understanding was signed. However, until August 1989, he had not received any concrete response from the Government, whether positive or negative. - 29 - 3.27 The pace of the divestiture program has however picked up with the recent strengthening of the DIC. As of June 1990, 21 SOEs have been effectively liquidated, and 6 SOEs have been privatized. At the same time, a new priority list of 34 SOEs for divestiture has been prepared by DIC, replacing the previous lists. The new list, based on the investors' interest and the readiness of enterprises for divestiture, includes some attractive and profitable enterprises, and many joint ventures. DIC plans to divest 10 more SOEs by December 1990. Progress has also been made to improve the efficiency of some 14 major SOEs producing public goods and services through the use of corporate plans and performance contracts between the Government and firms. 3.28 While the SOE reform program is a complex process and will take time to implement, rapid action in achieving actual divestitures of profitable SOEs and practical results as well as progress in improving the efficiency of SOEs which will remain in the public sector will: (a) send a strong signal to the private sector that the Government does not intend- SOEs to crowd out the private sector, and thus help build private sector confidence in the Government's attitude towards the private sector; (b) provide enterprise management with the autonomy necessary to run a successful business; and (c) allow the Government to reduce its role in direct productive activities and focus its limited resources on policies and creating a supportive environment for private sector development. There is need to explore all possible options in the divestiture program including outright sale, public or employee share issues, leasing, management contracts and liquidation. However, since competition is more important than ownership in inducing efficiency, the Government should take active actions to grant the managements of SOEs complete autonomy on pricing, staffing and procurement decisions in order to enable them to operate on commercial principles, and hold them accountable for their performance against agreed targets. For monopoly enterprises, there is also a need for a regulatory mechanism, irrespective of whether the firm is in private or public hands, and strong measures are needed to deter anti- competitive behavior. 3. Domestic Pricing Policies 3.29 Controlled prices often do not ensure adequate profits for producers, and reduce entry incentives and resources for modernization and technological change. Ghana has used price controls since 1962 to limit scarcity rents to sellers of products, to fight inflation and to keep down the price of key commodities affecting the cost of living.23/ Price controls, however, proved inefficient in an environment of scarcity and rapid inflation. The Government has made significant progress in reducing the coverage of price controls and dismantling of distribution controls. By July 1985, the rigid price controls by PIB had been reduced to eight essential commodities (imported rice, sugar, baby food, textiles, soaps and detergents, matches, drugs, and cement). Prices c- beer, cigarettes, and petroleum products are determined in conjunction with the Government's budget because of their revenue implications. Remaining price controls take the form of flexible price caps which allow the full cost plus a 23/ By 1970, for example, nearly 6,000 prices for 700 groups of products were controlled by the Prices and Incomes Board (PIB). - 30 - profit margin to be passed on to the consumer. Besides cocoa and coffee, prices of palm oil, fresh fruit bunches, rubber, cotton, tobacco, rice and maize continue to be influenced by various government agencies, Agricultural Commodity Pricing Committee, and SOEs in some way, at least for large producers of these crops. Prices of goods of many SOEs also continue to be regulated in some form, according to a recent study for the State Enterprises Commission; SOEs generally require approval from the respective sector ministries and in some cases from the Ministry of Trade and Tourism before raising prices. Minimum f.o.b. prices for non- traditional exports are set quarterly by the Ghana Export Promotion Council in consultation with the Ministry of Trade, the Bank of Ghana and exporters. 3.30 While Ghana has made significant progress in removing comprehensive price controls, and markets now play a major role in the determination of prices, some problems remain, particularly in implementation. Even in the absence of a formal price control for a product, manufacturers can come under strong pressure not to increase their prices, as was the case for soap and beer in 1989, and it is difficult for manufacturers to act outside the Government's instructions. They may also exercise price restraint because they do not know which products are subject to control. Following examples illustrate the point that there is still some way to go in implementing fully the Government's recent price liberalization efforts: (a) The breweries were advised by the Government in early 1989 on the decontrol of price for beer. When the breweries raised their prices in mid-1989, they were advised by the Government to revert back to their former prices. (b) The largest producer of soap was informed by PIB in January 1989 about the decontrol of prices of soap and detergents. 'When it raised its price in February 1989, the firm was stopped and had to revert back to the previous price. (c) Prices of cement, approved by PIB during May 1983 and September 1988, have always been less than those requested by GHACEM (a state-owned cement producer). At present, there are two prices of cement--the PIB controlled price of 01,400 per bag for cement allocated by the Ministry of Works and Housing, and the free market price ranging between 01,900 and 02,000 per bag. (d) The retail price of matches from the New Match Factory (a joint-venture between the Government and a foreign firm) in the market was two times the 'controlled' retail price, giving wind-fall profits to traders and restricting the generation of internal resources needed for rehabilitation of the factory. 3.31 Price controls can be a significant disincentive to private investment. Even if "cost plus' pricing allows a reasonable profit margin, the need to obtain approval creates uncertainty, and the delays in getting price approval can be costly. While the number of products subject to control has been greatly reduced, informal pressure to contain price increases makes this a more important issue than it may appear to be. This creates uncertainty and undermines the private sector's confidence in the Government's announced future policy reforms. While the removal of the remaining controls on prices is desirable from the point of view of stimulating investment, the elimination of both the formal and informal unofficial pressure and better dissemination of information on the extent of price liberalization already achieved would constitute a major improvement in the present situation. Producers, consumers and government agencies need to be better informed about the status of the Government's - 31 - price policy. :his would ensure that the positive effects of the Government's policv of price liberalization are not compromised by weak implementation. Determination of prices within the framework of the market is an important element of supportive environment for private sector development. 4. Taxation and Investment Incentives 3.32 Tax regime and investment incentives have a significant effect on the level and composition of investment through their influence on expected returns from investment. Company income in Ghana is taxed through a combination of taxes on profits, dividends and capital gains, and offset by fairly generous incentives in the form of capital allowances, tax rebates, tax holidays and duty exemptions on equipment for a wide range of priority activities under the 1985 Investment Code. In the area of taxes and investment incentives, the Government has to balance the competing demands for a low marginal effective tax rate to encourage investment, and for revenue generation. This section reviews the company income tax system and investment incentives, and suggests changes for further improving the incentive regime for efficient private sector development. (a) Taxation 3.33 Company income tax rates in Ghana are high compared to rates in many potential capital exporters and other developing countries, even though they were recently reduced. The company tax is 45 percent for manufacturing, farming, exports, construction, and real estate, and 50 percent for all other activities including banking, insurance, commerce and printing. In many other countries, a rate of 30-35 percent is the norm. 3.34 The company tax system provides for capital allowances which vary by activity and type of assets, and also the deduction of the interest cost of finance. To encourage investment in selected areas, the tax code provides for tax holidays ranging from 3 to 10 years for agricultural activities and real estate, and a loss carryover for two years after the tax exempt period. However, there is no carryover of operating losses for manufacturing. A rebate on taxable income (25 to 60 percent) is provided for companies exporting part of their output.24/ 3.35 There is a 30 percent final tax on dividends paid out by the company from after tax income.251 The capital gains tax rates on the sale of assets, including business stocks and shares, are also high and vary with the length of the holding period (from 55 percent for assets held 24/ The rebate increases with the share of sales for export, and is higher for agricultural exports than for manufactured exports. A manufacturing firm exporting 5 to 15 percent of its sales is entitled to a rebate of 25 percent on taxable income, and a firm exporting 25 percent or more of its sales is entitled to a rebate of 60 percent. 25/ Interest earnings are exempt from the payment of tax except on treasury bills held by corporations. - 32 - for less than 5 years to 15 percent for assets held over 20 years).26/ In some cases and in periods of inflation, the capital gains tax can raise the real effective tax rate to over 100 percent. A further disincentive is the use of historic cost as a basis for calculating depreciation, as stipulated by the tax code. In a situation where asset price, rise rapidly due to exchange rate adjustments, profits (and taxes) are inflated, and eventually firms will have difficulty replacing their assets. The lack of general carryover of operating losses would deter investment particularly in ventures that expect returns in the longer term or face more than average risks. High capital gains taxes would also deter firms from engaging in mergers and acquisitions which are badly needed for rationalization of the manufacturing sector, including the divestiture of SOEs. In the present situation where many firms in the industry are operating at low levels of capacity utilization with run down plant and equipment and high production costs, mergers and sales to consolidate the industry can help. The high tax on capital gains and dividends will also deter equity financing; at present rewards of successful ventures are largely taxed away, and investors are likely to choose a safer outlet for their funds (e.g., tax-exempt government bonds or foreign currency holdings). 3.36 All domestic earnings of foreign companies and individuals are subject to the same taxes as for Ghanaians except for the Selective Alien Employment Tax for each expatriate employed (0500,000 each year) unless exempted by the GIC. There is a minimum tax of 35 percent on total income of foreign businesses. Ghana has currently no active double taxation agreements with investor countries. 3.37 Suggestions for Reform. The Government is currently reviewing investment taxation in order to identify the variety of taxes that fall on investment income and increase the tax wedges on different types of projects, and has sought assistance from the IMF.27/ For revisions of the tax system, the following changes should be considered in order to stimulate investment and minimize distortions in the allocation of investment: (i) Reduction in company income tax burden through a combination of lower tax rates (from the current 45 to about 30 percent with immediate effect for at least manufacturing, agriculture, construction, real estate and exports, and in a phased manner for other sectors currently subject to 50 percent rate) and an increase in capital allowances across-the-board. Raising of allowances granted at the time of investment would be of particular benefit to investors, by reducing the uncertainty regarding the present value of tax obligations. To avoid distortion in investment 26/ Gains are computed on the basis of the price received from the asset less the purchase price and allowable deductions. The free initial allowance was increased and the rate structure was altered in the 1990 budget. Although the tax has not been shifted to an inflation adjustment basis, the previous treatment of capital allowances in the calculation of the capital gains tax is to be discontinued. 27/ See IMF, Ghana: Revitalizing the Private Sector Through Capital Income Tax Reform, February 1990. - 33 - allocation, all sector-specific and all asset-specific investment allowances other than those for depreciation should be equal. (ii) Introduction of a general carry-over of operating losses for all sectors currently subject to the 45 percent tax rate for a period of, say, 5 years in order to sufficiently reduce the burden of risk that the entrepreneurs carry. Under the present system, investors would avoid projects with high risks, and they may integrate unrelated operations under the same company to absorb expected losses. The tax system should not encourage such resulting economic costs. (iii) A sharp cut in the capital gains tax to about five percent to promote capital transactions. To help promote the divestiture and encourage efficient restructuring of manufacturing, mergers and acquisitions should be exempt from the capital gains tax during, say, five years. This should help reduce the large overhang of potential capital transactions, locked-in by high capital gains taxes, and could even result in more revenue collection. On the other hand, a higher capital gains tax rate than 5 percent could be applied to real estate to counter speculation. (iv) Reduction in the present final withholding tax of 30 percent on dividends to 10 percent in order to further lower the marginal effective tax rate on capital income and to promote equity finance and development of the capital market. (v) Elimination of tax holidays currently available to selected activities. Tax holidays are not only costly to the Government except when the investment would not have been undertaken without the tax holiday, but also affect resource allocation. Tax holidays may also encourage short- term investments that cease when the holiday period ends. In addition, if the home country taxes foreign-source income and the tax rate is as high as in Ghana, tax holidays will provide no benefits to the firm, and will in fact merely transfer revenue from Ghana to the home country. Therefore, generally lower, uniform tax rates with a loss carryover provision are much more 4esirable for increasing investment and improving efficiency than the use of tax holidays. (vi) Besides lowering tax rates in general, Ghana should negotiate double taxation agreements at least with a few potential capital exporting countries such as the UK, USA, Japan, and Canada to encourage foreign investment. (vii) To help improve the firms' financial structure, consider waiving for a specified period the stamp duty on the firms' conversion of revaluation surplus into shareholders' equity. 3.38 The adverse effect of the above measures on net fiscal revenues is expected to be small. The company tax collections from agriculture, manufacturing, real estate, and services and construction were about 01.3 billion or 4Z of the total company income tax collections of about 032.7 billion in 1989. The collections of capital gains tax (0149 million), and dividends tax (0138 million) in 1989 together amounted to only 0.2Z of the total tax revenue of 0175 billion. Therefore, if one takes into account the increased private sector activity which the above measures should result in, the effects of these tax reforms should be significantly - 34 - positive on the budgetary revenues. In addition, any adverse effect on budgetary revenues in the short term should be more than offset by the elimination of other investment incentives under the Investment Code (see para 3.50). (b) Investment Incentives 3.39 The 1985 Investment Code provides numerous incentives to encourage investment in selected activities in priority sectors, promote regional development, encourage employment in large enterprises, and promote research and development. An investment to qualify under the Code must also contribute to Ghana's development generally according to broad criteria (para 3.41). The priority sectors under the Code are: (a) agriculture (crops and livestock, and other agricultural activity including services as may be prescribed); (b) manufacturing (for export, using predominantly local raw materials, and producing agricultural machinery and equipment); (c) construction (real estate, roads, and any other activity that may be prescribed); and (d) net foreign exchange earning enterprises related to tourism. Eligibility criteria for 'selected activities' are vague and open to interpretation, which creates uncertainty among investors and may even encourage undue pressure from investors on the GIC. While GIC has tried to define these areas for its internal operating guidelines (e.g., manufacturing for export requires the activity to be a net earner of foreign exchange), the guidelines are not published, and are applied flexibly. 3.40 The Code offers for priority activities exemption from customs duty on imported machinery, equipment and accessories (e.g., spare parts) and relief in company income tax (lower tax rates, rebates on taxes due, and investment and accelerated depreciation allowances). The tax incentives vary greatly by activity and sector. The locational incentive consists of a reduction for an indefinite period in the company income tax ranging from 15 to 40 percent of the tax payable depending on the geographical location. Enterprises located in an area lacking basic infrastructure, which have to build such infrastructure at a cost, may also be granted a (unspecified) reduction or deferral of income tax. To create jobs, an income tax rebate is given, equal to the employers' social security contribution for employees above a minimum (quite high) level; the minimum levels are 20 in agriculture, 100 in manufacturing and 75 in construction and building. For foreign investment, the Code provides for free transferability of dividends and foreign capital, and the resolution of disputes according to international procedures, and guarantees against expropriation. 3.41 To qualify for incentives under the Code, the investment must also have a favorable impact on the country's development--development of the productive sectors, use of local raw materials, creation of jobs, an increase in export ea-.iings, import savings, transfer of technology and others, and any othet objective the GIC considers relevant. In practice, the GIC has interpreted this to mean an acceptable financial rate of return for the project (a cut-off rate of 22 percent but this criterion appears to be used with considerable flexibility). 3.42 The fiscal incentives under the Code were extended as part of the 1988 budget to encourage rehabilitation of existing enterprises or expand - 35 - operations in new activities, both outside the priority sectors of the Investment Code, and which existed before January 1, 1988 and invest at least US$100,000. The eligible enterprises should be in: (a) agriculture (support services, such as land clearing, preparation and harvesting services, transfer of agricultural produce); (b) manufacturing (mostly using imported raw materials but contributing to government revenue through taxes, such as breweries, tobacco, pharmaceuticals and plastics, and enterprises producing for agriculture, engineering and other support services); (c) construction and building industries (engineering, contracting, plant pools and other services); and (d) services such as haulage, transportation, provision of utilities, and health care. To qualify, these activities must also increase government revenue, create employment, save imports or provide vital services to activities in priority areas. 3.43 The investment approval process is time consuming. Projects approved by GIC in 1988 were submitted on average 10 months earlier, and of the 164 applications submitted in 1988, only 34 were approved in that same year (see Annex 3-2). Three quarters of all approvals between 1986 and 1988 (about 440 projects) were for investments in manufacturing, and 14 percent for agriculture. More than one-third of approvals were for wood processing, financed mainly under external lines of credit in support of the ERP. Total cost of approved projects was about US$860 million. Only limited information is available on actual implementation of approved projects. Data on actual imports of machinery and equipment (for which import duty exemption has been granted) indicate that of the 440 approved projects, nearly 60 percent appear to have started their implementation; data on actual commencement of operations of projects are not available. Most of these (90 percent) concern rehabilitationlexpansion rather than the establishment of new capacity. The value of machinery and equipment imports at about US$126 million is only 15 percent of the total investment cost of all approved projects.28/ 3.44 Issues. The question of whether investment incentives, particularly tax incentives, are a cost-effective instrument for encouraging investment has been much debated. Where market failures can be quantified, tax instruments as an interim measture to promote efficiency may be justified. Market imperfections include price distortions and failure of the market to take external benefits into account. Tax incentives, however, are often ad hoc, poorly integrated into the overall system, and difficult to administer. Moreover, studies report that most investment decisions are not affected by such incentives. In Ghana, the analysis indicates that fiscal incentives under the Investment Code have not stimulated entrepreneurs to implement approved projects (para 3.43). Most of the projects actually implemented during 1986-88 (about 60 percent) were in the wood processing industry with a very high potential for growth. These rehabilitation and maintenance plans would most likely have gone ahead even withiut the fiscal incentives under the Investment Code. 'While 28/ While data on total project costs associated with the imports of plant and machinery are not available, it is estimated that US$126 million in plant and machinery perhaps supported a total investment of about US$160 million, which is only 18 percent of the total amount approved during 1986-1988. - 36 - weaknesses in the financial sector may have contributed to an extent, it is likely that weaknesses in the overall business climate also played a role. The main determinants of private investment include political and economic stability, government's attitude towards the role of the private sector, adequate markets and hence demand, the availability of inputs, and the clarity of the legal and regulatory framework. Additional factors of importance to foreign investors are the favorable terms for the transfer of profits and the repatriation of capital, guarantee against expropriation, provision for compensation in the event of nationalization, absence of discrimination against foreign ownership and control, and freedom from burdensome regulations. Although tariff protection may be an important investment incentive in some cases, the evidence suggests that other incentives are not a significant factor in investment decisions. 3.45 Fiscal benefits for investment such as the exemption from statutory customs duty on imports for priority sectors under the Investment Code are costly not only in terms of government revenue forgone but also in terms of productive efficiency because they distort the allocation of resources. Criteria for their implementation are also generally vague and discretionary. Exemption from customs duties on capital equipment under the Investment Code favors the use of capital over labor, and increases the capital-intensity of the production process. It also conflicts with the trade and tax reforms of the Government under the adjustment program. Similarly, tax incentives under the Code to promote employment are unlikely to be effective. In a labor surplus economy like Ghana, wage rates are low enough to encourage labor-intensive industries with no further incentives provided the rigidities in the labor market are reduced (e.g., high severance payments and rules governing the laying-off of workers). 3.46 Recognizing these difficulties, some countries have abolished fiscal incentives. Indonesia, for example, found that the numerous and often contradictory tax incentives created an excessively complicated system, unable to fulfill its revenue function or to achieve the anticipated objectives. Under the incentive structure in Indonesia, firms in the same industry were taxed under different rules and the same firm faced a different tax regime at various times. Such incentives created effective tax rates that varied both between and within sectors and thus misallocated the capital stock. In view of these problems, Indonesia eliminated all tax incentives for investment so as to make tax administration simple, transparent, and the least distortionary to economic behavior. The expected revenue gains from eliminating incentives enabled Indcnesia to lower the company tax rates, which benefitted all investors and provided more efficient incentives to investors, both domestic and foreign. 3.47 Many of the investment incentives offered by the Code were intended to correct for distortions, which existed prior to the ERP and even in 1985, and help direct resources to are,.. that were considered economically worthwhile. Policy-induced distortions in Ghana have now largely disappeared under the ERP. Fiscal benefits to investment in selected activities seem no longer justified, and they are costly in terms of foregone.revenue and reduced productive efficiency. The Investment Code and the Tax Code should be neutral in their treatment of various activities. Continued reforms of the tax system and of tariffs aimed at their further rationalization are the most appropriate instruments to - 37 - encourage new investment. However, incentives could perhaps continue to play some role in encouraging investment that generates external benefits, e.g., regional development (location), basic infrastructure, research and development, and training. 3.48 Incentives and the eligibility criteria under the Investment Code are discriminatory. First, the incentives have a distinct pro-capital bias (e.g., duty exemption on imported equipment). Second, the 1988 budget statement puts new investors at a relative disadvantage by limiting incentives only to existing enterprises, and discriminates against small firms, which are unable to achieve the US$100,000 minimum threshold for investment. Finally, the Code discriminates generally against small firms, which are not eligible for tax benefits aimed at stimulating employment. The foreign investors are also discriminated under the Code (see paras 3.90-3.93). 3.49 Some fiscal incentives relevant to new investments are included in the Tax Code and administered by the IRS but are not mentioned in the Investment Code (e.g., the rebate on taxable income for exporters, and selected tax holiday provisions). This creates confusion. 3.50 Suggestions for Reform. Given the liberalization of the economy and the removal of most price distortions, the system of fiscal incentives and their administration needs to be simplified and amended. The broad thrust of amendments to fiscal incentives should be: (a) the neutrality of the tax/incentives regime through the elimination of incentives for selected activities; and (b) moving the administration of the remaining incentives to the tax authorities and out of the hands of GIC. The effect on new investment of the elimination of many incentives, if any, should be offset by a more favorable, but neutral, tax treatment of company income. It is thus important that reform of the tax and investment incentives go hand in hand. It is suggested that the Government more Apecifically: (i) Eliminate all special incentives for selected activities in priority areas under the Investment Code, and for activities made eligible for incentives in amendments of the Code under the 1988 budget (e.g., duty exemptions on imports, and various incentives affecting the tax liability of enterprises). Replace these with across-the-board lowering of the income tax burden and an increase in capital allowances. The level of overall investment can be promoted better by a more favorable, but neutral, tax treatment of company income. (ii) Abolish tax holidays currently provided in the Tax Code, and provide-a general carry-over of operating losses for all sectors currently subject to the 45 percent tax rate for a period of, say, 5 years. (iii) Abolish the income tax rebate for use of labor in large enterprises. While there may be some justification for an employment incentive due to the pro-capital bias of the tax system and the rigidities in the labor market, tax incentives to promote employment are unlikely to be effective. Current wage rates are low enough to encourage labor- intensive methods. Measures aimed at a smoother functioning of the labor market and a general improvement in the investment climate would be more effective in creating jobs in the long term. - 38 - (iv) Consider retaining current tax breaks provided under the Investment Code relating to location, research and development, and expenditures on basic infrastructure, and extend them to expenditures on training by allowing firms to set off a specified percentage, say, 150 percent, of training expenditures against income. These incentives could help firms in offsetting higher infrastructure costs of non-urban location, and compensate for externalities to the firm of expenditures on R&D and training. (v) Incorporate all fiscal incentives (higher depreciation or capital allowances, and incentives for R&D, location, basic infrastructure and training) in the Tax Code rather than in the Investment Code, and give IRS sole responsibility for their administration. The IRS should, on the basis of provisions in the Tax Code and documentary evidence supplied by the enterprise, grant the benefits without any prior approval. D. Legal and Regulatory Framework 1. Introduction 3.51 Clear laws that are effectively applied in a transparent manner are essential to generate a supportive business climate. Excessive regulations and unclear rules discourage new private investment and undermine the development of efficient private enterprise. Government regulation of private sector activity has a legitimate role (e.g., environment, safety and health, and fair treatment of labor), but governments should resist the temptation to intervene in decisions which should be taken by entrepreneurs who bear the financial risk for those decisions. The most effective regulatory apparatus is the discipline of the market whereby businesses function in an environment of competition. The Government, however, should ensure that companies operate within a framework of law and that the conduct of business is transparent. 3.52 Performance of the private sector in Ghana in the past had been hindered by a regulatory framework with heavy reliance on direct controls. This was in part due to the overall approach of public sector led economic development and the reliance upon administrative controls for economic management in the face of scarcity of foreign exchange, capital and other resources. Foreign investment was also, throughout the most period, viewed as economic domination of Ghana. Private entrepreneurs have had to contend with a complex regulatory environment which, together with distortions in incentive policies, stifled competition, inhibited flexibility, encouraged *rent seeking" and retarded productivity improvements. Rather than promoting private sector development, the regulatory framework discouraged new private sector investment and undermined the development of an efficient private sector. By the early 1980s, private investment had virtually dried up. 3.53 The policy reforms that have been gradually introduced since 1983 set out to create a more market-oriented economy that would permit regulatory controls to be substantially relaxed. Although progress towards deregulation has been made in many areas, it has not always been in an orderly fashion, nor as much as appears warranted by the growth of market -39 - forces.29/ Remaining problems relate to business establishment and investment licensing procedures, expatriate quotas, technology transfer, foreign exchange transactions, labor laws and regulations, tax administration, the approval process under the Investment Code, and foreign investment regulations. While none of the regulatory requirements on its own can be considered an unsurmountable impediment to development of the private sector, collectively, they sustain an image of Ghana as a country with extensive government intervention in the business sector, in a way that is discouraging to new private investment. They could also become barriers to the growth of existing firms once the immediate constraint on * financing is removed. The main issues related to the regulatory policies are discussed below. 2. Business Establishment, Manufacturing Licensing and Investment Approval Procedures 3.54 There are three principal registration, licensing, and investment approval steps for establishing a business in Ghana. (a) Registration 3.55 The registration procedure with the Registrar General's Office is quite cumbersome (Annex 3-3). The filing of the various applications and forms is time consuming and involves some unnecessary paperwork, especially when the information required under each form is, to a certain extent, identical. Efforts should be made to consolidate existing application forms for business registration into one standard form (perhaps with a short form for small businesses) and to streamline the whole process. Registration procedures for microenterprises could also be simplified by arranging for registration to take place near the locations of their businesses. The necessity for the 'Certificate of Commencement of Business" should also be reviewed given that the company cannot actually commence its operations without complying with other licensing requirements anyway. Subsequent to the registration, one has to obtain a license from MIST or GIC as discussed below. While the Registrar General's Office performs a useful function by keeping a central register of businesses, MIST or GIC need to avoid duplication of work already undertaken by the Registrar General's Office. They should rely largely on the information provided by the company to the Registrar General's Office, without requiring the submission of all the information again. Therefore, there is need to review the relationship between the registration and licensing 29! Relaxation of controls in the area of foreign exchange transactions, trade and prices are noteworthy. To stimulate a recovery of private investment more directly, the Government also introduced a new Investment Code in 1985 covering all areas except petroleum at mining, which are dealt with by separate legislation, and established GIC as a one-stop agency. However, a number of other institutions continue to be involved in the investment process (e.g., MIST, the Ministry of the Interior, the Bank of Ghana, and a Technical Committee on Technology Transfer). Thus, while the creation of a one-stop agency has in some ways simplified the process for the investor, many institutions still exercise some form of control. - 40 - requirements to develop procedures which avoid duplication of work for the investor as well as the Government. (b) Manufacturing/Establishment License 3.56 Following the registration with the Registrar General's Office, the company has to decide whether to apply for the incentives and benefits under the 1985 Investment Code (PNDC Law 116) or to apply just for a ManufacturJng or Establishment-License which is a prerequisite for starting its operati.ons, but does not convey any special investment incentives to the company. Approval under the Investment Code is deemed to be the manufacturing license within the scope of the Manufacturing Industries Act, 1971 (Act 356), in the case of a manufacturing enterprise or an establishment license in the case of other enterprises. 3.57 Any new or expanding manufacturing enterprise requires a manufacturing license before starting or expanding operations. The applications have to be su.bmitted to GIC (in the case of incentives under the Code, expatriate quota, technology transfer and foreign ownership) or MIST. Small scale enterprises can also submit their application to the National Board for Small Scale Industries (NBSSI), which can forward them to MIST for a decision. The Project Officer responsible within MIST for the particular subsector carries out an appraisal of the project, obtains an assessment report from the Environmental Protection Council, and submits his findings to the in-house "Technical Committee" for a decision. According to MIST, nearly all applications for manufacturing licenses are approved. 3.58 The project appraisal criteria for the issue of manufacturing license by MIST is not clear. According to Section 1(2) of the Manufacturing Industries Act of 1971, "the Minister may issue a license on such terms and conditions as he may think fit". The refusal or granting the license is thus left to the discretion of MIST. Furthermore, by the Manufacturing Industries (Exemption) Instrument, 1972 (E.I. 105) ,industries wholly owned by Ghanaians and employing less than five persons and with a fixed capital investment of less than 010,000" and "industries wholly owned by Ghanaians involving non-mechanized processing" are exempted from the requirements of the Manufacturing Industries Act, provided they submit certain specified information. At today's price levels, the threshold of 010,000 is so small that even the smallest business will need a manufacturing license to operate. The purpose of requiring the submission of specified information for such small enterprises is not clear. MIST first issues a "Provisional License" specifying requirements to be fulfilled prior to the issuance of a permanent "Manufacturing License" (Annex 3-3). 3.59 The purpose of the manufacturing license is twofold: (a) it enables MIST to collect data on enterprises and to establish a register of industries; and (b) the license is required for other Government agencies as proof that MIST has approved the business. Thus, Section 4 of the Manufacturing Industries Act states that "no import or export license, immigration quota or other concession shall be granted by any authority under any enactment or otherwise to any person establishing or expanding a manufacturing industry, unless he is the holder of a valid license issued under Section 1 of this Act". -41 - 3.60 The Manufacturing Industries Act does not prescribe specific appraisal criteria and leaves the decision on approval entirely to the discretion of MYST. There does not seem to be a need for MIST to evaluate investment proposals. A license should be granted if the legally required information is provided. Since any new business has to be registered with the Registrar General's Office, the Government could satisfy its informa- tion needs by relying on the registration procedures, leading to the elimination or at least some relaxation of the licensing require- ments.301 As a minimum, elimination of the need for a manufacturing license for the expansion of capacity, say, up to 30-50Z of the existing capacity, and in the case of new enterprises, for projects below a certain size (e.g., the equivalent of US$250,000), should be considered. These minimum thresholds should be raised as soon as possible. For large projects requiring a manufacturing license from MIST, the application form should be reviewed to avoid duplication with business registration, and clear criteria for the granting of manufacturing license by MIST should be established. MIST should also consider abolishing the provisional license and issuing only a revocable permanent license, which could be revoked if the conditions of the license are not adhered to. (c) Approval Process under the Investment Code 3.61 . The Investment Code governs all investments except in petroleum and minerals. Any enterprise seeking an approval under the Code has to submit an application to GIC, the agency responsible for "the encouragement, promotion and coordination of investments in the Ghanaian economy". GIC carries out an initial analysis of the proposed investment and within 14 days after receipt of the application, requests other relevant ministries, departments or agencies, the Bank of Ghana and the Environmental Protection Council to submit, within 21 days, their comments on the investment application. The Chief Executive Officer of GIC decides on all investments up to US$500,000 or on those outside the priority areas, irrespective of their size. All other investment proposals are submitted to the GIC's Board for final decision, which is chaired by the PNDC Member and Chairman of the Committee of Secretaries, and includes the Secretary for Finance and Economic Planning, and the Governor, Bank of Ghana. 3.62 The Investment Code, 1985. While the Code was viewed upon its enactment in July 1985 as a major improvement representing a new openness to private capital, a major revision of the Code is now necessary to reflect the policy changes which have occurred in the Ghanaian economy since 1985. In the context of such a revision, the following points should be addressed: (i) GIC as One-Stop Shop. According to the Code, GIC is to secure all licenses, authorities, approvals and permits required to enable any approval granted by the Centre to have full effect. This implies that GIC is a one-stop-shop. However, the practice suggests that this is not the case. GIC is the central authority for approving new investments under the Code, but actions by other Government ministries or agencies are required to actually implement the approved project. The debate over whether GIC 301 For projects approved under the Investment Code, GIC should inform MIST of licenses it has issued in order to centralize information. - 42 - should or should not be a true one-stop-shop is, however, somewhat irrelevant as long as the other agencies do not overrule or contradict the decisions taken by GIC and as long as the granting of further permits, licenses and approvals is done in a timely and speedy fashion. However, this is not always the case in practice. (ii) Priority Areas for Incentives and Appraisal Criteria. The Code defines the priority areas of investments (agriculture, manufacturing, construction and building industries, and tourism) and the benefits and incentives for each area. Eligibility of fiscal incentives available under the Code was widened in the 1988 budget statement. As discussed earlier. eligibility criteria for defining the priority areas in the Code are vague and open to interpretation, and decisions seem to be made on a case-by-case basis and at the discretion of GIC (paras 3.39 and 3.41).31/ There is clearly a need to review the question of priority areas and fiscal incentives under Code. The appraisal criteria (Section 22 of the Code referring to the project's contribution to general development objectives) for the approval process are also vague and discretionary, and their purpose and relevancy are not clear. According to GIC, the appraisal in practice is more or less a formality if the investment is within the priority areas. For investments outside the priority areas, the appraisal seems to be limited to the assessment of the financial rate of return. However, in this context, GIC indicated that--in addition to its functions as regulatory and promotion agency--it also acts as "protector of the interests of naive or innocent investorso. There is therefore the risk that decisions may not be based on the criteria and functions stated in the Code. (iii) Time Limit for GIC Approval. There is no time limit for GIC to make a final decision on the investment proposal, provided the application is complete. A time limit (say a total of 60 days) should be introduced so that if no negative decision has been rendered within that period, the application could be deemed approved. (iv) Annual Filing. To ensure that there has been no change in the ownership structure of the approved enterprise, GIC requires the annual filing of an "Application for License to Operate" against a fee, which is a prerequisite for the annually renewable 'Investment Policy License". The Government should consider abolishing the Investment Policy License issued by GIC and thereby the need to apply annually for a license to operate. (v) Foreign Exchange Transactions. The Code refers to foreign exchange earning enterprises and their ability to retain a certain portion of their foreign exchange earnings in external accounts provided they obtain a permission from the Bank of Ghana. While GIC grants the enterprise--in principle--a certain status as foreign exchange earner, the Bank of Ghana then issues the particular permits regarding the retention account, external account, repatriation of dividends, etc. To avoid 31/ Another example of the wide discretionary powers assigned to GIC, under the Code is that GIC can defer the payment of stamp duty up to five years if it is satisfied that the circumstances prevailing at the time of the application for the benefit, justify such deferment. The criteria for deferment of the stamp duty is not defined. -43 - duplication of work between GIC and the Bank of Ghana, changes in the Code are necessary in light of the recent changes concerning foreign exchange transactions. 3.63 There is a clear need for a thorough review and subsequent modification of the Investment Code. Such amendments to the Code should go hand in hand with amendments or redrafting of other relevant laws (like the Foreign Exchange Control Act) in order to: (a) harmonize conflicting provisions; (b) reflect the 'new" more open attitude of the Government with respect to private investment; and (c) capture, in particular, the changes in the tax system and the area of foreign exchange transactions. In the context of an overall review of the regulatory framework (going beyond the Investment Code), additional issues would also need to be addressed as discussed below. 3. Expatriate Quota 3.64 The GIC is responsible for issuing firms with an immigrant quota, which allows the firm to hire a certain number of expatriates in specified positions. The firm has then to apply to the Immigration Quota Committee in the Ministry of Interior for the issue of the immigration papers. The Quota Committee examines security aspects of the individuals proposed by the firm and whether they have the required qualifications for the jobs. The quota is granted for a limited period. The process is relatively discretionary. It is important to ensure that the Immigration Quota Committee does not question the quota approved by the GIC, but is only concerned with the security aspects of the particular individuals. This is not the case in practice, and delays occur as enterprises are required at times to justify for a second time the need for hiring expatriates and their numbers and qualifications, having previously gone through the process with GIC. 3.65 Existing firms which have been in business for a long time can find ways of dealing with the quota system, though this raises the cost of doing business. For new investors, however, it is crucial that they have control over key staff in the early years of their project. There is precedent in developing countries for liberalizing the granting of quotas for hiring expatriates. In many countries, strict rules governing the temporary residence of foreign manpower have been eased. In Malaysia, expatriates are granted a residence permit for 10 years, and in the Philippines for two years. The need for strict controls on employing expatriates in Ghana has been reduced by the impact of the liberalized foreign exchange system, which has substantially increased the cost of employing expatriates in cedis. There is need to adopt a more liberal attitude towards granting expatriate quotas, subject, of course, to security clearance from the Ministry of Interior. The size of the quota should be linked to objective criteria, e.g., the investment size, without specifying specific positions. 4. Technology Transfer 3.66 With assistance from the Technical Committee on Technology Transfer Agreements, GIC is responsible for approving all Ghanaian firms' technology transfer agreements with firms outside Ghana. The Committe- follows guidelines drafted in 1986 but never approved or issued. The o ,t - 44 - guidelines limit, and iipose conditions on, the use of foreign technology. They require that local raw materials and local alternative technologies be used whenever available, and that the technology is appropriate for Ghanaian conditions. The use of foreign technology in production for the domestic market is discouraged (but not prohibited), and no payment for trademarks/brand names is permitted except in the case of exports. Payment of fees is limited to 5 percent of net sales, though it can be higher than this in the case of exports. Furthermore, the draft guidelines prohibit clauses in agreements that constitute restrictive practices, limit the duration of agreements to 5 years, and insist on the inclusion of training programs. The tight control by the Government perhaps reflects a concern about local firms' limited capabilities in concluding agreements that are fair in terms of the choice of technology, royalty fees, and conditions relating to the use of technology, and that inappropriate agreements could lead to a loss of valuable foreign exchange to Ghana. Whatever may be the justification for the restrictions and conditions that are presently imposed on technology transfer agreements, their implementation raises some difficulties. Some of the controls, such as the evaluation of the appropriateness of technology, are hard to implement, given staff constraints. The problem is compounded by the ambiguity of many regulations, which are vaguely worded and leave the interpretation wide open and at the discretion of the authorities. Furthermore, the regulations do not have a clear legal status as they have not been formally adopted. 3.67 The pricing issue has been simplified by the liberalized foreign exchange system. Previously, a tight control over technology fees was perhaps necessary to prevent firms from taking advantage of the overvalued cedi by inflating fees. Now, not only do Ghanaian firms have to make payments with a more realistic exchange rate, but they are exposed to severe competition and cannot in any case afford to pay excessive fees. 3.68 Overly restrictive conditions for approval could not only stop bad agreements but could also lead to a rejection of many proposals with significant potential, since the impact of technology transfer is often uncertain and thus difficult to assess. There are good reasons why Ghana should adopt a more open policy towards the use of foreign know-how. The principal argument is that for industrial development, enterprises in Ghana need modern technology as well as management and marketing skills in order to compete successfully in the world and domestic markets, especially with the relaxation of protective barriers under the ERP. The Government should therefore reduce the administrative controls on the transfer of technology to a minimum, and focus instead on becoming a source of information and advice for potential users of foreign know-how. 3.69 Specifically, GIC should follow the following framework for technology transfer: (a) allow entrepreneurs to import foreign technology; (b) finalize and issue to the public, guidelines on technology transfer agreements. The guidelines should be clear and unambiguous, contain a set of standard clauses to be included in technology agreements, and list restrictive clauses that are not acceptable; (c) leave the choice of technology to entrepreneurs, i.e., government agencies should not have to assess the technical know-how to be imported; (d) allow the terms of contracts to be determined by the parties concerned; (e) abolish restrictions on the use of foreign technologies or foreign trade -45 - marks/brand names; (f) establish a databank (through membership of international organizations, such as the World Industrial Property Organization) on technologies and technology agreements, and make it readily available to all firms; and (g) provide investors services with assistance from local institutions. 5. Foreign Exchange Transactions 3.70 A central element of the ERP has been the easing of regulatory controls on foreign exchange transactions. Many restrictions on access to and use of foreign exchange have been removed or relaxed, and the exchange rate of the cedi is now largely market determined. The remittance abroad of interest and dividends as well as the (legitimate) repatriation of capital are no longer restricted, and the backlog of such past payments has been cleared. 3.71 Residents in Ghana are now allowed to maintain various types of foreign exchange accounts. The two important accounts for businesses are the foreign exchange retention and external accounts. The foreign exchange retention account allows the exporters to hold a portion of their export earnings (35 percent in the case of non-traditional exports). The retained earnings can be used for any legitimate purpose, but prior payment approval of the BOG is needed for certain payments (e.g., interest and dividends). Since early 1989, this account can be maintained at any bank in Ghana but all transactions held in the accounts have to pass through the Ghana Commercial Bank (GCB) in London and the BOG, which creates delays. GCB in London transfers retention funds to the BOG, which in turn credits the funds to the exporter's local bank. The external account is held abroad and it is granted as a privilege to exporters who have special foreign exchange commitments (e.g., loan repayments) in excess of their retention funds. Use of the account, which is funded from export proceeds as needed, is monitored (ex-post) by the BOG on the basis of monthly statements by the respective commercial bank. 3.72 Despite the removal of many restrictions on foreign exchange transactions and the simplification of the administrative procedures, transferring foreign exchange to and from Ghana can still be a lengthy and cumbersome process, and it raises the cost of business operations. While inefficiency of the banks accounts for some of the delays (e.g., the excessive time often required to open L/Cs), the complex regulations relating to foreign exchange transfer, together with time consuming import and export procedures, remain important contributory factors. There is wide spread lack of information about the procedures governing foreign exchange transactions. Not only are individuals and firms involved in the transactions badly informed, but even the staff of the banks are often unaware of the latest regulations. While the frequent changes in procedures due to the continuing liberalization of the economy help to explain this situation, they makL it all the more necessary for the BOG to employ an effective system for ensuring that all concerned are properly informed. The present system of publishing and circulating notices fails to do this. Ghana would benefit by making sure that potential investors are fully informed of the country's liberal foreign exchange regime. 3.73 As long as restrictions exist regarding the use of foreign exchange, some form of control on foreign exchange transactions is - 46 - unavoidable. However, given the sharp increase in the cost of foreign exchange, some of the administrative controls could be relaxed. A switch to a system of ex-post monitoring of transactions by the BOG instead of the prior approval still required for a number of payments would significantly cut the time foreign transfers require. The potential cost of such a measure in terms of misuse of foreign exchange should be set against the efficiency gain for local business as well as the positive impact on Ghana's image abroad. Such a change would also permit a further simplification of procedures. Export receipts could be transferred directly to the exporters' local (cedi and foreign exchange) accounts, of which the BOG would be notified. The Government should also consider channelling a larger proportion of export proceeds directly through the commercial banks instead of the BOG. Similarly, to reduce the burden of unnecessary work on GIC, requests for transfers of dividends and technical fees could be sent by the companies directly to the Bank of Ghana or to the commercial banks, supported by proper documentation. 6. Labor Laws and Regulations 3.74 Labor regulations under the Industrial Relations Act of 1965 and the Labor Decree of 1967 apply to all establishments irrespective of their size or nature of operations. The Ministry of Mobilization and Productivity is responsible for monitoring the firms' compliance with the laws. To hire workers, firms should go through the Labor Department's Public Employment Centers which can make the process of hiring new employees quite a lengthy and time consuming process. At the national level, the minimum wage is set by the Tripartite Committee on Wages and Salaries which consists of representatives of the Government, employers and trade unions. At the company level, the wages are subject to the collective bargaining process between employer and employees. Negotiations take place between the employer and, in the case of the manufacturing enterprises, the Industrial and Commercial Workers' Union of TUC (Ghana). To initiate the retrenchment process, an advance notice of about two months and consultations with the union representing the company's employees are required. An attempt is made to reach an agreement on the necessity of the lay-offs, the number of workers to be laid off and the benefits to be paid pursuant to the collective agreement (usually 2 to 2-1/4 months' basic pay for each year of service). The firm has to also submit to the Ministry of Mobilization and Productivity, deta-,ted information on its operations, inventory, financial position, employment data, and plans for retrenchment and rehiring if necessary in the future. The Deputy PNDC Secretary meets with the company and the union in order to reach a final agreement on the layoff procedures and financial implications (see Annex 3-3). 3.75 The legal framework governing labor issues does not appear to impose on paper any particular problems or difficulties on employers. Nevertheless, the private sector has identified the labor laws as one of their major areas of concern. Taken together, these regulatioz are quite cumbersome, adding to costs and reducing firms' operational flexibility. The problems seem to arise in the practical application of the laws and regulations. For the laying-off of redundant workers, the legal framework does not cause major problems but the political and financial aspects are so significant that the release of redundant workers becomes very difficult in practice. On the political side, it seems that such decisions--even if well justified on economic grounds or because of individual malfeasance-- -47 - cause major difficulties with the unions, committees for defense of the revolution (CDRs), and other quasi-political groups. The laying-off of workers is an unpopular decision and it is quite natural that while the company concerned wants to have as much flexibility as possible--the unions and other representatives of the affected workers tend to oppose such moves. The lack of flexibility in practice with respect to labor is likely to discourage employment at the margin, and weigh heavily in investors' decisions. It is suggested that the Government should: (a) remove the requirement for firms to go through Public Employment Centres when hiring workers, and instead require firms to inform the Labour Office on new - employees; (b) consider encouraging firms to make provisions for the financial obligations incurred to retrenching workers, through changes in the accounting rules, as necessary; and (c) ensure that labor disputes and the retrenchment of workers when necessary are settled within the context of collective agreements and that parties have access to courts for settlement of differences. 7. Tax Administration 3.76 The strengthening of tax administration in Ghana has resulted in a tightening of regulations relating to tax collection. Company income tax is now payable at the end of each quarter on income earned during that quarter. Tax assessments are sent out by the IRS at the beginning of the quarter using income estimates based on earnings in recent years. TCCs are issued if the tax due for the previous quarter has been paid. Separate TCCs are required for a wide range of transactions (e.g., imports, vehicle registration, movement of goods, property purchase, bidding in the auction). Sales tax is levied at the factory (import) level and is due on the 10th day of the month following the sale by the factory. There is also a separate TCC for the sales and excise taxes. 3.77 The recent efforts made at strengthening tax collection have been successful in raising revenue. They have also led to complaints about unfair treatment, resulting in excessive tax liability, increased working capital needs, and costly delays. With regard to company income tax, the problem appears to be mainly one of assessment. If the taxpayer disagrees with the assessment he can negotiate with the IRS. If, after negotiations, the agreed tax is not paid entirely by the end of the quarter, a TCC may be issued for a limited period only. The IRS clearly has the last word. The difficulty is that, especially in the present economic climate, past performance may not be a reliable basis for assessment of future income. The system of multiple TCCs 'has become a particularly bothersome impediment to the normal conduct of business. One firm had to obtain three separate TCCs on the same day for three different purposes. 3.78 The system of levying sales tax works if sales are against cash. Frequently, however, they are on a 30- nr 60-day collection basis (particularly in the case of conslimer goods sold through a':lesalers or large retailers), forcing companies to advance sales tax to the Government for which they may have to borrow. Another issue is that small firms may not receive the sales tax exemption from suppliers on their purchased inputs nor any credit for sales tax paid from the IRS. 3.79 The measures to improve tax collection should also take into account the adverse effects on the firms' liquidity position and the 48 - circumstances in which many enterprises have to operate. Given the difficulty of assessing the taxable income in a rapidly changing environment, as well as the normal business practices, the Government should consider the following: (a) Allow the issue of a single TCC valid for all transactions on a six-monthly basis. Investigate mechanisms for issuing temporary, single TCC for all transactions to firms that are in the process of seeking adjustments to their assessed tax. (b) Pay market- related interest on any net credit position of taxpayers. (c) Increase the period of payment of sales tax to 30 days following the end of the month in which goods were sold. As for the TCCs, the objective should be to continue vigorous efforts to encourage voluntary compliance so that TCCs can be phased out as soon as possible. Improvement in the present tax practices will also be conducive to raising investors' confidence in the system. 8. Other Regulatory Controls 3.80 Government intervention can be of considerable annoyance to individual firms in other ways, causing inefficiency and raising costs. Cumbersome import and export procedures remain a source of frequent complaints. They are costly not only in terms of the effort required to deal with them, but also because of the additional demand on working capital they generate. This is illustrated by the example of the furniture industry, a promising source of non-traditional exports. Furniture exporters have to reconcile demands for different valuations in export contracts, one on a c.i.f. basis (shippers' council) and one on a f.o.b. basis (Forest Products Inspection Board). Export documents have to be signed in Takoradi (the port for timber exports) even when goods are shipped from Tema. There is need to simplify import and export procedures to reduce costs and delays. For furniture exports specifically, export contracts should be allowed to be on c.i.f. basis for purposes of FPIB inspection (e.g., the same as required for the shippers' council); and documents for furniture exports should be allowed to be signed in more than one location more convenient to exporters. The allocation of shipping is of concern to several private companies. Importers and exporters are not free to choose their own shipping agent, but have to use the agent assigned to them by the shippers' council. This often means delays and higher costs. Firms should be given more freedom in choice of shipping agent, and restrictions should be removed entirely for exporters, at least. The Government's procurement policy tends to discriminate against private enterprise. While there may not be a formal requirement as such, in practice both government agencies and SOEs, when purchasing goods and services, are expected to give preference to suppliers from the public sector. Given the importance of public procurement, access to this market would be a major stimulus to private activity and investment, in addition to generating efficiency gains as a result of increased competition. 9. Foreign Direct Investment 3.81 Foreign investment will have to play an increasing role in GAana's future growth. As equity capital, foreign direct investment (FDI) does not burden the country with debt. Because it is invested on the basis of commercial risk, FDI is most likely to be used efficiently. Private foreign investment usually also brings other important benefits such as the transfer of technological and management skills, employment creation, and - 49- labor force training. Foreign firms can stimulate domestic entrepreneurs by introducing a source of innovation and competition and can encourage domestic investment. FDI can also have an important role in securing access to world markets. Multinationals have played an important role in the growth of manufactured exports in a country such as Brazil where the main reason for FDI was access to a large domestic market. 3.82 Ghana's inflows of FDI declined from US$16 million in 1980 to US$2 million in 1984, and then increased to US$4 million in 1986. They are estimated at US$20 million in 1988 mainly due to increased FDI in gold mining. As a comparison, FDI inflows to Mauritius increased steadily from US$1 million in 1980 to US$31 million in 1987, mostly in textiles and tourism, and are estimated to be about US$24 million in 1988. 3.83 Unfortunately, as the need and desire on the part of developing countries for FDI have increased, the share of FDI flows to developing countries has declined from 1982 to 1987. FDI flows to the Sub-Saharan Africa region have declined as a percentage of FDI flows to all developing countries. While from 1975-80 its share accounted for 10 percent of FDI flows to developing countries, its share dropped to 3.4 percent in 1987. Competition among developing countries for attracting FDI flows has intensified. This trend underscores the urgent need for countries in Sub- Saharan Africa, including Ghana, to take immediate measures for further improving their investment climates and enhancing their attractiveness for private investment. 3.84 Factors Influencing Foreign Direct Investment. Empirical attempts to estimate the determinants of FDI have produced mixed results. Nonetheless, many researchers agree that controls seem to matter more to foreign investors than fiscal incentives. Most foreign investors regard incentives as volatile and transitory. The single most important factor for attracting investment is domestic economic and political stability. Stable growth in domestic incomes and relative political stability have been the cornerstone of East Asia's success in attracting FDI flows. Conditions of high inflation, overvalued currency, threats of nationalization and frequent changes of government policies can quickly undermine investors' enthusiasm. 3.85 A second set of factors concerns the country's attitude toward the role of the private sector in general. For FDI, high levels of local private investment are seen as a mark of confidence in the economy. Despite its large domestic market, until the mid-1980s India's policies were not conducive to domestic private investment and the Government traditionally played a significant role directly or indirectly in large segments of the economy. These conditions and other barriers to FDI discouraged foreign investors. Recent liberalization of domestic markets in India has begun to spark foreign investors' interest. 3.86 Business is driven by the profit motive. The attitude of society towards its businessmen and their legitimate accumulation of wealth is a very important part of the investment climate. An investor-friendly environment also requires that businessmen are treated as respected members of the community. Concurrently, businessmen should be expected to make major contributions to national goals. - 50 - 3.87 Another set of factors concerns the transparency and stability of the regulatory environment. Experience shows that countries need to do more than extend hospitality towards private domestic and foreign investment. The transparency of regulations is important since investors need to know in advance how regulations will apply to their particular investment. A high degree of variability in the interpretation of regulations and the need to obtain approval of multiple government agencies will make an otherwise hospitable investment environment unattractive. Uncertainties created by constantly changing regulations can also be a significant deterrent to investment flows. The treatment of expatriates and timely approval of work permits of reasonable durations are also important. 3.88 One critical feature of the regulatory environment is the extent of controls on foreign exchange transactions. Foreign investors need ready access to foreign exchange for inputs and freedom to remit dividends and profits, and ultimately, their capital investment. Much of the success of Mauritius' export processing zone is attributable to liberal policies related to profit and dividend remittances and easy access to foreign exchange for imports. Ghana's export retention scheme is a step in the right direction as it provides investors greater access to foreign exchange for their production needs. Above all, prudent management of the exchange rate is most critical to the investors. 3.89 Most of the above factors are of equal importance to both domestic and foreign investors. In fact, without a thriving local private investment climate, the inflow of FDI and the achievement of the macroeconomic goals of the country will suffer. 3.90 Foreign Investment Regulations in Ghana. Restrictions apply to ownership of foreign firms in Ghana, and they are treated differently from domestic firms in several respects. A Schedule to the Investment Code lists 20 enterprises reserved for Ghanaians. However, firms that engage in retail or wholesale trade, produce brokerage or represent foreign business can be owned by non-Ghanaians provided such firms' employed capital is at least US$500,000. Such a large amount of foreign capital as a minimum requirement serves to discourage foreign private investors in these areas. Manufacturing of garments and of suitcases and other luggage items are also prohibited to foreign investors unless the production is entirely for exports. Such a restriction can be a significant disincentive to foreign investors, and Ghana would forego potential benefits not only in terms of capital but also from the transfer of technological and management skills, training and access to world markets. 3.91 With regard to joint ventures with Ghanaian partners, the Investment Code requires that each non-Ghanaian must invest at least US$60,000 in foreign capital. For an enterprise to be wholly owned by a non Ghanaian, foreign capital of at least US$100,000 is required. Furthermore, the Code (Section 21(3)) stipulates that an enterprise wholly owned by a non-Ghanaian may only be approved if it is a net foreign exchange earning enterprise. Read together with the definition of "Ghanaian' as applied to companies (... means any company the entire capital or financial interest in which is owned by citizens of Ghana...), this means that a joint venture involving a locally incorporated company (with the smallest possible share by a non-Ghanaian) and a foreign investor - 51 - cannot be approved under the Code unless the joint venture is a net foreign exchange earning enterprise. By restricting wholly non-Ghanaian and joint Ghanaian/foreign ownership to net foreign exchange earning enterprises, the Code reduces the scope for joint ventures in view of the definition of a Ghanaian company. 3.92 Access of foreign firms operating in Ghana to domestic capital is also restricted. Local banks must obtain approval from the Bank of Ghana before lending to foreign companies. A "foreign" company is normally considered to be one with majority foreign shareholding, but sometimes foreign control over management is used as the criterion. Besides the prudential limits on lending to individual customers, the BOG also considers the firm's turnover, equity, source of capital, whether assets have been revalued, etc. The BOG is reportedly extremely tight-fisted when approving applications from banks for lending to foreign companies. The criteria used are far from clear. It seems that foreign companies are discriminated against. 3.93 In recent years, many developing countries have substantially reduced the differential treatment of foreign investors vis-a-vis domestic investors. Indonesia and Thailand, for example, have eliminated differential treatment regarding export requirements. Ghana should also consider gradually reducing or eliminating such restrictions on ownership in order to attract higher levels of foreign direct investment. It is suggested that the Government should: (a) define a Ghanaian company as one with majority ownership in order to facilitate joint ventures with foreign or partly foreign enterprises; (b) encourage transfer of technology and know-how by (i) increasing the scope for full foreign ownership (i.e., when the firm is not a net foreign exchange earner); (ii) opening up selected activities listed in the schedule to the Investment Code to foreign ownership when a significant portion of the output (not 100 percent) is for export; and (iii) reducing the amount of minimum employed capital for allowing foreign business to enter into certain activities such as trade and represent foreign businesses; and (c) lift restrictions on the foreign companies' access to credit, and, as an interim measure, require Bank of Ghana approval only for lending to foreign firms above a certain threshold. For this purpose, define a foreign company as one with majority foreign ownership. 10. Conclusions 3.94 A consistent and transparent legal basis for statutes and regulations regarding investment must be established as soon as possible. Existing laws and regulations governing investment activities were enacted at different times reflecting the prevailing political and economic climate. Important laws relating to private sector activity include the Foreign Exchange Control Act (1961 and amended in 1986), the Industrial Relations Act (1965), the Labor Decree (1967), the Manufacturing Industries Act (1971), the Investment Code (1985), and amendments to the Investment Code under the 1988 Budget Speech. There is a need to review and amend laws to harmonize conflicting provisions, and reflect the 'new" more open attitude of the Government with respect to private investment. Also, many businesses are unaware of the regulations governing foreign exchange, the duty drawback scheme, and other aspects of doing business in Ghana. Additional efforts are needed to widely publicize to the private sector in - 52 - clear terms the regulations and procedures as they apply to the conduct of business. 3.95 Other aspects of the legal environment, such as, appropriate contract and credit laws, property rights in land, as well as the companies law, the accounting framework and capital market regulations also affect private sector. '. adequate system governing bankruptcy proceedings is a prerequisite ft, orderly exit of companies. To a large extent, Ghana has a well deve. Led system of laws and regulations. On the other hand, investors need confidence in the enforceability of laws and agreements without incurring unreasonable delays and high costs of enforcing laws and agreements between private parties. In the past, some complaints were voiced that the system of courts was overburdened with cases and that decisions were rendered only after an unduly long period. With the introduction of a special commercial court having jurisdiction over all commercial matters, the Government should ensure that the judiciary can provide for the timely and adequate solution of commercial disputes. 3.96 Administrative controls are more restrictive and bureaucratic than they need be for a supportive business environment, given that part of the regulatory function can now be left to the price mechanism. These controls reduce initiative and impose costs on the business community at a time when firms are facing strong competition. Administering regulations is costly to the Government as well. Many regulations and procedures should be removed and/or simplified and relaxed. The present widespread system of prior approvals should be replaced by a system of ex-post monitoring in areas where an element of control is considered necessary to economize on administrative resources and minimize bureaucratic interference. The Government should also consider developing antitrust laws to discourage monopolies and collusive oligopolies and encourage competitive behavior. However, antitrust laws are less appropriate in ensuring competitive behavior when efficiency calls for large plants with scale economies. In such situations, lower entry barriers and foreign competition together may be the best answer. 3.97 Because of the legal inconsistencies as well as the vagueness of the criteria employed in the application of certain regulations, much discretionary power rests in the hands of those charged with implementing the rules. This creates uncertainty and undermines business confidence (e.g., the outcome of applications for expatriate quota, investment incentives, and access to domestic credit in the case of foreign companies is often in doubt). Even though complete automaticity may not be attainable, a much greater degree of transparency is needed, at least. 3.98 Some regulations discriminate against particular groups of investors or businesses. For example, small firms do not have access to some incentives, the use of foreign technology for domestic production is discouraged, undermining indu4.rial development, and the full foreign ownership is allowed only in cases where firms are net foreign exchange earners. Regulations should generally be neutral in their treatment of business. 3.99 Overlapping responsibilities of government agencies create duplication of work as well as uncertainty and delays. There is a need to - 53 - clarify the responsibilities of GIC vis-a-vis other agencies involved in investment decisions (MIST, BOG, and the Ministry of Interior). 3.100 The business community in Ghana is not always fully aware of the current rules and procedures. Such information is not easy to come by, partly because the Government's efforts of informing the public about these matters have not been very effective in the past. The Association of Ghana Industries and other private sector organizations do not have the capacity to systematically collect such information for their members. There is a need to improve the dissemination of information on existing rules and regulations, and strengthen the dialogue with the private sector on ways and means of improving the business climate. This would also require a particular effort on the part of the private sector to become better organized and strengthen its capacity for formulating policy proposals. Recent Government efforts to initiate meetings through GIC twice a year with the private sector to discuss areas of mutual concerns is a step in the right direction. 3.101 Although a thorough review and subsequent modification of the whole legal and regulatory framework is called for, changes in the various laws should be made simultaneously and a piece-meal approach should be avoided. The contemplated changes through formal amendments or revisions would send a clear signal to investors. They need consistency as far as the various laws and their application in practice are concerned, publicity as far as the dissemination of Government decisions is concerned, transparency as far as the process is concerned, and continuity as far as their operation in a continuously changing environment is concerned. E. Expanding Markets 3.102 Sustainable growth in the manufacturing sector will require efforts to build, seek and respond to domestic, regional and overseas demand. All parts of the continuum of industrial activities (informal enterprises, small and medium scale enterprises and large firms) have an important role to play in the industrialization of the country. In Ghana, microenterprises mostly serve the needs of the low-income population for inexpensive manufactures and offer income-earning opportunities. Small and medium enterprises have shown the flexibility to adapt techniques to local resources and products to changing niche markets. They can build the technical, managerial, and entrepreneurial experience necessary for efficient expansion of the large-scale sector. Efficient large-scale firms can generate relatively more rapid growth of output and productivity through access to global information and technology. 3.103 Domestically, farmers have a relatively high propensity to spend incremental income on simple products of local, small enterprises, including productivity-raising inputs and implements. Thus, it is reasonable to expect that rising agricultural incomes of about 60 percent of the total population of Ghana should provide a steady growth in demand for manufactures. The results of the small scale enterprise survey (Chapter 2) show that while the number of microenterprises has grown in recent years to absorb increasing numbers of workers who have few alternative means of earning a living, prospects for individual microenterprises are constrained by weak demand among the lower-income population. Therefore, growth in agricultural and net gains in rural - 54- income will help build demand for goods of microenterprises. Growing domestic demand will also stimulate small scale enterprises, which in the survey of SSEs were found to be most dynamic and able to contribute significantly to long-term output growth by preparing experienced entrepreneurs from which the "missing-middle" can emerge. Entrepreneurs of SSEs, established since the ERP began, tended to be better educated, more responsive to demand and more able to seize opportunities than the owners of older businesses. 3.104 The experience of other countries such as Japan, Korea and Taiwan shows that the development of inter-industry linkages can help enhance the spread effects of industrial growth and facilitate diffusion of technology and skills through subcontracting relationships. In Ghana, relatively few inter-industry linkages presently exist. To make subcontracting more attractive, the Government should consider providing technical assistance and training and supporting quality control programs. 3.105 Given the small size of Ghana's domestic market, an outward- oriented perspective to exploit regional and overseas export markets will be necessary, if a rapid growth in manufacturing is to be achieved and maintained. Besides processing of exportable raw materials, opportunities could include manufacturing of handicrafts for general use, for special orders for niche markets that offer high returns for meeting specialized demand (e.g., wooden toys, tropical fruit juices and food products for African residents overseas), and for some standardized products (e.g., knocked-down furniture, garments). A successful export drive would require maintenance of a realistic exchange rate, unrestricted access to imported inputs at world market prices and financing, and technical, marketing and managerial expertise to produce and sell exportable manufactures. To acquire these skills, Ghana will likely need foreign partners that can bridge information gaps on outside markets, provide on-the-job training, and serve as catalysts for entering export markets. The resounding success of Bangladesh with garment export clearly illustrates the important role foreign partners can play as catalysts for entry into extremely competitive export markets.32/ 32/ Bangladesh has increased exports of garments from US$4 million in 1980/81 to US$300 million in 1986/87. Bangladesh's garment exports were initiated through an agreement to collaborate, between a new local firm and Daewoo of Korea, in the areas of technical training, purchases of machinery and fabric, plant start-up and marketing. Following the successful entry of this local firm into the garment export market, many initial workers of the local firm, who were trained by Daewoo in Korea left the firm to set up their own--often competing--garment export firms, and the garment industry for exports took off. In addition to foreign exchange earnings, nearly a quarter of a million workers have been trained and employed as skilled and semi-skilled workers in Bangladesh's garment export sector. It has also swelled confidence in Bangladesh, a country that was thought incapable of breaking into world markets in manufactures. Thus there is a spontaneous process in these associations which can lead to the transformation of a whole sector. - 55 - 3.106 In order to ensure that foreign firms develop significant linkages with local companies and generate positive spill-over benefits in the areas of technical training or technology transfer to local firms, Ghana should consider identifying firms that can contribute to the country's development and convince them to locate in the country. To generate benefits to the economy which are external to the firm, support could also be provided as a transitional measure to foreign firms that develop local subcontracting networks. F. Human Resource Development 3.107 Human resource development is central to the absorption of new entrants in the labor force into productive activities. According to the 1984 Population Census, out of a total labor force of 5.4 million, around 60 percent are engaged in farming and fishing and only 16 percent in other production-related activities.33/ The level of education and particularly formal training of the labor force is low. Ninety-eight percent of those working in other production-related occupations have received no formal (commercial or technical) training. If basic school leavers are to be absorbed in farming, production, and trading in the same proportions as exist today, opportunities are required for around 140,000 in farming, 40,000 in productive activities and 30,000 in trading. The real issue here is at what level of productivity and income level people will be employed. 3.108 The experience of other countries has shown that education, rather than physical assets, is the key to sustained growth in productivity. Technological capability is essentially embodied in people, not in machinery. Expansion of general education over time can enhance industrial productivity. At the lowest level, simple literacy and numeracy would help. Inclusion of elementary bookkeeping skills in the curriculum would assist the many graduates who become entrepreneurs. At the middle and secondary school levels, basic technical, accounting and managerial skills, including hands-on experience, would help prepare the majority who will not end up in professional occupations. 3.109 The Government has realized for some time that if the ERP is to succeed, the skills and attitudes of Ghanaian youth would have to be changed so that they would be prepared to become productive farmers or skilled artisans and craftsmen ready to work for their own, their community's and their country's development. The Government has therefore initiated a sector-wide program of education reforms as an integral part of its national plan for economic recovery and sustained growth, including teaching of vocational skills. Each junior secondary school will now offer at least one pre-vocational subject to familiarize students with the use of hand tools, and the senior secondary schools will in the future offer three 33/ Of the 887,000 workers in other production-related activities, fewer than 30 percent are in the formal sector. Over 500,000 are self- employed with no employees, 32,000 are self-employed and have employees, and 22,000 are unpaid family members. Almost 60,000 of those employed are classified as apprentices, most of them in the informal sector. - 56 - to five programs of specialization covering agriculture, technical, vocational, business and general arts and science. 3.110 Informal apprenticeship training, which represents the vast majority (about 80 percent) of all training in Ghana, involves no theory but much repetitious practice of a limited number of processes, often, over a long period of time. The system is effective at what it does, but this is limited. Skill quality is often low and apprentices can be no more skilled than their masters. Government support to upgrade the skills of the masters should be strengthened. Where tradesmen are geographically concentrated, short courses can be organized. Where tradesmen are scattered, however, as in rural areas, mobile training squads might be appropriate. The timing of all up-grading courses needs to be based on an examination of the work rhythms of the particular trade and structure. In addition to skills upgrading, consideration should be given to holding similar courses in simple business methods. These are slowly being incorporated into some of the existing training courses but not yet into the majority of government-sponsored training. Such courses should build upon rudimentary accounting, farm budgeting and materials costing skills taught in the junior secondary schools. 3.111 In addition to the informal apprenticeship system, Ghanaian youth can obtain skills training through a wide range of formal and non- formal training institutions and programs such as the National Vocational Training Institute, Ghana Education Service and Ghana Regional Appropriate Technology Industrial Service (GRATIS). Except for GRATIS and a few other institutes, most training programs are geared to produce graduates for jobs in the formal employment sector. The system of formal, non-formal and informal training needs to be more supportive of the growing number of junior secondary school graduates, who will require further skills development. Besides the technical subjects, the training should also include simple business administration, accounting and marketing skills. An earlier report by a joint Bank/Ghanaian study team in March 1989 has made detailed recommendations to strengthen the basic education system for self-employment and rural development at higher levels of productivity. 3.112 To encourage self-employment, NBSSI has recently begun a small Entrepreneurship Development Program (EDP). Continuation of well- designed EDPs can help promote business oriented human resource development, which can act as the seed-bed for future medium and large entrepreneurs. Improving techn cal and managerial capability will be important to raise productivity and move from small to medium and large- scale modern enterprises. For the modern sector, overseas training in firms and expatriate technicians working alongside the trainees over an extended period under actual operating conditions are generally effective. Science and technology and particularly the work of the Council of Industrial and Scientific Research can be made generally more relevant to the needs of enterprises. Adaptation of products and technology to the local environment and raising the quality of products for export markets should be the priorities. Since technology must be learned through the "learning by doing" process, the Government should encourage linkages with non-Ghanaian enterprises for access to technology, markets, and skill upgrading. Actual choices of linkages with enterprises outside the country are better left to individual Ghanaian entrepreneurs, based on their perception of costs, benefits and potential opportunities. However, - 57 - because of the externalities of benefits to the economy, financial incentives may have to be offered for technology linkages for the Ghanaian entrepreneurs and the non-Ghanaian partner. 3.113 Continued efforts to improve the educational and training systems and upgrading of technological skills are essential if Ghana is to be able to compete in an increasingly competitive international * environment. G. Infrastructure 3.114 Adequate roads, railways, ports, water, electricity and telecommunications are essential parts of the enabling environment for the smooth functioning of the private sector. Appropriate provision and increased efficiency of the public sector in providing physical infrastructure and public services promote competitive private sector .growth in agriculture and manufacturing by lowering the cost of doing business. While the Government has made remarkable progress in all these areas under the ERP and the efforts to rehabilitate and build capacity are continuing, there is still a long way to go. For example, transport costs remain abnormally high. Transport of farm products from nearby farms to city markets it. Ghana is about three times the cost expected on a good road. Unit road transport cost at USc7 per ton-kilometer for cocoa is about 100 percent more than comparable costs in Nigeria. In many cases, transportation accounts for up to 70 percent of the marketing margin of agricultural produce as a result of the poor state of the roads. High transport costs thus inhibit most economic activities in agriculture and manufacturing. The Government has recently allocated about 40 percent of its budget resources to the rehabilitation of the transport sector (roads, railways, ports), and results are beginning to show. Similarly, substantial rehabilitation and investments in the telecommunication facilities have linked Accra to all major parts of the world. The Government's decision to give priority to improving physical infrastructure is very important for private sector growth. 3.115 The provision of transport, water, telecommunication and other services is also an area where private sector can perhaps play an important role. Frequently, these services are considered public goods and assumed to be provided by Government. However, given an appropriate framework, the private sector may be willing in many situations to deliver these services. This could help relieve public institutions of the burden of day-to-day operations so that they can concentrate on the tasks of sector policy making, planning and regulation. There are precedents for private sector involvement in providing some physical infrastructure and services (e.g., water supply under lease contracts in COte d'Ivoire and the Republic of Guinea, and power generation under a build-own-operate-power scheme in Pakistan). In Ghana, the private sector already plays a major role in transport of people as well as of goods. H. Overview 3.116 Ghana has made remarkable progress since 1983 in pursuing sound macroeconomic policies and has largely succeeded in putting the economy through a structural adjustment program in which relative prices have been changed significantly, markets have been liberalized, and the public sector - 58 - is being reformed. These actions (for example, trade and exchange rate policies, financial sector policies, and a better focussed public expenditure program) have had a profound impact on the business climate. The switch from administrative controls to reliance on the price mechanism has fundamentally changed the prospects for a wide range of economic activities. While some have ceased to be viable and others require adjustment efforts, new opportunities have also been created. 3.117 Ghana has substantial natural resources and entrepreneurial labor force. It also has significant comparative advantage in natural resource- based and labor-intensive industries, and agricultural activities fcr both export and efficient import substitution. Despite the small size %.' Ghana's domestic market, a Sub-Saharan Africa location offers busine-ss freedom from trade restrictions in European and U.S. markets and t-r 'e significant potential for establishing export-oriented activities Lo: :.se markets as well as the regional African market. 3.118 Yet despite some apparent increase in private sector activity, the private investment response to date in Ghana remains far below the levels needed to generate sustainable growth. While the weak banking system, the still poor state of the infrastructure, and the continued dominance of the economy by state enterprises are possible factors, the caution of investors possibly also reflects a concern about the Government's attitude towards the private sector and the difficulties in the legal and regulatory framework. The success of Ghana's recent economic policies provides an ideal setting to encourage private investors. This report has suggested actions which should be considered by Ghana to create the right kind of business environment. 3.119 The main areas which merit the Government's attention to encourage investor confidence include the following: - Consistency in the application of economic policies is vital to investor confidence. Maintenance of a market-determined foreign exchange system, further rationalization of trade policies to facilitate outward orientation, and the rationalization of taxation of investment and of fiscal incentives for investment are important for improving the investment climate and the efficiency of investment. Control of inflation will also be critical for removing uncertainty for the private sector. - A more rapid and effective implementation of the reform program for state-owned enterprises (commercialization and divestiture) to improve their efficiency and help create more opportunities for the private sector, and to build confidence in the Government's reform program. - Strengthening the financial sector. - Streamlining the administrative approval of investments. - Making the legal and regulatory framework simpler and more transparent. - 59 - - Pursuing a regular and constructive dialogue between the Government and the private sector, and giving due recognition to the contribution of businessmen to the nation. - Restructuring GIC's functions to transform it into an effective agency for providing investment promotion and investor support services. 3.120 For sustainable growth, efforts are also needed to build, seek and respond to domestic, regional and overseas demand (e.g. to expand markets), develop the human resource base to improve the technological capability and to absorb new entrants in the labor force into productive activities, and provide adequate infrastructure necessary for the smooth functioning of the private sector. 3.121 It would be unrealistic to expect a strong private investment response -immediately. Overcoming the uncertainties created by past actions and restoring private sector confidence in the Government's commitment to private initiative may take time. Thriving investment by Ghanaian entrepreneurs will be necessary before any significant inflow of foreign direct investment can be expected to occur. Maintenance of macroeconomic stability, particularly control of inflation and consistent application of economic policies, will also be vital in reducing uncertainty for the private sector. 3.122 Minor improvements in the investment climate will have little impact. Far-reaching actions are needed to convince private investors that the time is ripe for them to become Ghana's engine of growth. The Government has in recent years made determined macroeconomic po'icy decisions and confronted difficult issues as they have arisen. Therefore, there is the promise that the Government can reasonably be expected to exert the same leadership in boldly following through on the measures needed to encourage a more dynamic investment response to the Economic Recovery Program. AF41E225 ANNEX 1-1 SELECTED INDICATORS OF ECONOMIC PEFORMANCE, 1975-89 Actual Est. 1975-82 1983 1984-88 1989 Real Growth Rates (Z p.a.) GDP -0.9 -4.6 5.3 6.0 Agriculture 1.1 -7.0 1.9 5.3 Cocoa -4.1 -14.4 6.7 15.0 Industry . -7.9 -11.9 11.6 8.1 Mining -7.5 -14.8 10.9 9.0 Manufacturing -9.4 -11.1 13.5 8.0 Services 1.0 2.3 7.8 5.2 GNY -0.9 -4.8 5.3 3.7 Exports a! -5.5 -45.8 20.1 16.9 Imports a/ -10.5 -10.5 22.1 5.0 Ratios (Z) b/ Budget balance/GDP c/ -4.6 -2.7 0.4 0.8 Current account balance/GNP -0.5 -0.4 -5.2 -7.1 Gross domestic investment/GDP 3.5 3.8 12.3 14.1 Gross domestic savings/GDP 3.7 3.6 6.4 5.7 Prices Terms of trade (Z change) -4.4 36.7 -0.3 -21.2 Domestic inflation (Z p.a.) 66.8 122.9 26.1 25.0 External Debt b/ Public M4LT debt ($m) d/ 1,212 1,551 3,289 3,389 Debt-service ratio (2) el 12.8 31.9 67.3 56.7 a/ Based on balance of payments data. bi For the last year of multi-year periods. c/ Budget balance includes program grants but excludes capital expenditures financed from project aid. d/ Includes obligations to the IMF. el Includes repurchases from the IMF and payments of external arrears. Source: Quarterly Digest of Statistics (various issues); Ministry of Finance and Economic Planning; Staff Estimates. ANNEX 1-2 PROJECTED ECONOMIC INDICATORS Est. Projected 1985-89 1990-95 1996-2000 Real Growth Rates (Z p.a.) GDP 5.5 5.0 5.0 Industry 10.9 11.0 9.1 Mining 10.5 19.2 4.7 Manufacturing 12.4 10.0 10.0 Agriculture 2.5 2.9 3.2 Cocoa 8.3 1.2 3.0 Forestry 1.4 1.0 1.0 Other 1.7 3.6 3.5 Services 7.3 4.7 4.4 Investment 13.5 8.8 8.6 Public 24.9 8.5 4.4 Private 4.3 9.5 13.4 National Savings 22.5 17.4 13.8 Private Consumption Per Capita 0.8 1.2 1.5 Exports 13.4 6.3 5.0 Imports 10.1 4.7 5.2 Shares of GDP (Z) a/ Investment 14.1 20.9 25.4 Public 8.3 12.5 12.7 Private 5.7 8.3 12.7 National Savings 7.1 13.9 20.8 Current Accott Balance -7.0 -6.9 -4.5 Budget Balance b/ 0.8 0 0.1 External Debt c/ 68.0 64.b 56.8 Other Selected Indicators Debt-Service Ratio (Z) A/ c/ 56.7 20.8 20.5 Inflation Rate (Z p.a.) 25.9 7.4 5.0 Terms of Trade (Z) -22.0 -7.7 12.5 a/ Last year for each period. h/ Includes program grants and excludeq capital expenditures financed from project aid. c/ Includes repurchase obligations from the IMF. Source: Ghana Macroeconomic Model, World Bark. ANNEX 1-3 ECONOMIC IMPLICATIONS OF LOW GROWTH OF PRIVATE INVESTMENT (growth rates in % per year) Base Case Low Private Investment 1990-95 1996-2000 1990-95 1996-2000 GDP 5.0 5.0 3.3 2.1 Private Investment * 9.5 13.4 2.8 1.6 Private Consumption Per Capita 1.2 1.5 0.1 -0.6 Source: Ghana macroeconomic model, World Bank. ANNEX 2-1 Page 1 of 2 NON-TRADITIONAL EXPORTS 1. Central to Ghana's 'astained economic growth will be the increased foreign exchange earnings to finance the imports needed to rebuild infrastructure and produce goods for domeitic consumption and for export, and to service the country's debt. An export promotion strategy needs to encompass the improved performance of traditional exports (e.g., cocoa, gold, timber, and electricity) and diversification of exportable products. The diversification of exports will help reduce the country's present reliance on a few commodities that are subject to volatile world market conditions and prices. 2. Major changes in relative prices as a result of exchange rate and trade policy reforms under the ERP have increased Ghana's prospects for significant export growth. As a result, non-traditional exports have already shown substantial improvements. They increased from US$24 million in 1986 to US$42 million in 1988, but declined to US$35 million in 1989. They currently account for about 4-5 percent of Ghana's total exports. Non-traditional exports cover agricultural products (principally pineapples, cocoa waste, tuna and other fish, kolanuts, yam) and processed and semi-processed goods (e.g., aluminum sheets, coils and household utensils, furniture and furniture parts, wooden toys, salt, canned tuna, crude glycerine, etc). There are increasing signs that firms are responding to the improved incentives; the total number of non-traditional exporters has increased from 725 in 1987 to 1,380 in 1989 and the number of export items has increased from 132 in 1987 to 167 in 1989. 3. Ghana has a large potential for increasing non-traditional exports: (a) In fresh agricultural produce, pineapple exports'offer excellent potential, whose exp-rts have already increased from 565 tons in 1983 (US$200,000) to about 8,000 tons in 1989 with diversified market outlets (US$2.1 million). Other products such as sheanuts, rubber, kolanuts, fresh fruit other than pineapple, vegetables, flowers and spices also offer some potential. (b) There is some potential for increasing export of tuna, both fresh and canned, and other fish. (c) The most significant potential is in wood processing. Ghana has plentiful forestry resources and its timber types are eagerly sought in European markets. Logs and lumber are already an important traditional source of foreign exchange, and veneer is also well established as an export product. However, other wood processing for export (i.e., furniture and parts, wooden toys) is of recent origin. With technical know-how and improvements in quality, Ghana could expand exports of wood products substantially. (d) Selected manufactures. With very few agro-processing and other exceptions, manufacturing in Ghana has been developed on the philosophy of import- substitution. This, however, has been changed dramatically by the recent policy reforms. While capacity utilization has improved from very low levels in 1983 to about 45 percent in 1989. exports of manufactures can help raise capacity use provided the production costs are lowered. Some products such as aluminum products have responded-to the incentives for export provided by the right to retain about 35 percent of foreign exchange proceeds. ANNEX 2-1 Page 2 of 2 4. Despite the significant potential and the availability of opportunities for exports, particularly to the EEC market without trade restrictions, the response so far has been below expectations. Based on the experience of successful exporting countries in East Asia and other regions of the world, in order to become successful exporters, firms need to (a) be at equal footing with foreign competitors; (b) develop the technical, marketing and managerial know-how, and information for competing in international markets; and (c) have access to infrastructure and institutions which are adequate to support export and related trade and production activities. They also need the capacity to package the various elements needed for initiating exports with the help of catalysts (foreign and domestic). In terms of policies, while Ghana already has a realistic exchange rate, producers' access to raw materials and intermediate inputs (and capital goods) is not fully at world market prices. The duty drawback scheme, which has been in operation for a number of years, has not worked well. Because of difficulties in its implementation, only eight firms have benefitted from the scheme with a total of 18 duty drawbacks between January 1, 1983 and May 1989. There is clearly a need to revamp the duty drawback system or preferably to replace it with a temporary duty suspension system which avoids the burden imposed on exporters with the duty drawback system, in terms of working capital requirements and interest charges. Weaknesses in the financial sector have also placed the exporters at a dEsadvantage because of the lack of pre-shipment and post-shipment export finance. In addition, exports of furniture are subject to a levy of 2 percent of f.o.b. value for the Forest Products Inspection Board and 1 percent for the Timber Export Development Board, which should be removed. ANNEX 2-2 IMPACT OF ADJUSTMENT BY SUBSECTOR IN THE SMALL SCALE ENTERPRISE SURVEY (Percentage of respondents in each category) Change since 1983 All firms Food Textiles, Wood Building Soap & Metal or start-u surveyed a/ products garments products materials cosmetics products Change in production: Increase 39 53 55 62 14 43 14 Decrease 43 40 44 23 72 29 58 Change in employment: Increase 82 44 71 88 67 25 71 Decrease 18 22 29 14 33 75 14 Product mix changed 36 23 50 31 43 83 29 Purchased new equipment 49 73 50 67 - 29 33 33 Selling In different kts. 15 7 11 15 29 43 20 Imported share raw mat'Is. Actual % share 26 b/ 19 26 10 17 55 18 Change since 1983: Greater 11 29 0 0 0 17 0 Smaller 17 14 0 0 50 17 0 Easier to get: Imported inputs 68 75 100 75 75 67 40 Domestic Inputs 56 67 86 45 100 33 43 Harder to get/too costly: Imported inputs 18 8 0 25 0 0 40 Domestic Inputs 21 13 14 45 0 0 14 Credit harder to get 84 63 75 100 100 80 100 Deln ihgovernmt reations is: Easier 39 44 50 14 33 0 50 Harder 32 22 25 57 67 50 13 Competition Is greater 61 33 88 64 100 71 46 Major competition from: Imports 12 7 11 0 0 29 21 Small firms 77 71 89 100 84 57 57 Have exported (direct or indirect) 9 21 11 8 0 14 7 Have considered eporting 38 21 56 54 29 43 27 Constraint on sales: Resources (could sell more) 52 60 33 42 43 86 64 Demand: 48 40 66 58 58 14 35 Can sell current prodction but no more 24 7 33 25 29 14 21 Can't sell current production 24 33 33 33 29 0 14 (Number of firms) (82) (15) (9) (13) (7) (7) (15) a/ includes firms In all sulsectors. 5/ Does not include 24 large-scale firms from the separate survey of medium and large enterprises. With those firms Included, - the overall average lmDort share is 34 percent. ANNEX 2-3 CHANGES UNDER ADJJSTMET FOR FIRMS ESTABLISHED BY 1983, BY SIZE. IN THE SMALL SCALE ENTERPRISE SURVEY (percentage of respondents In each category) All firms SIze categories b/ Question surveyed a/ Micro Very small Small Med.Aarge c/ Bought new equipment 49 43 56 56 57 Product mix changed 34e/ 40 27 63 45 c/ Sellin In different maket t 15 12 19 0 43 imported share of raw materials: Actual % share 34.0 c/ 19.1 12.1 82.8 52.6 c/ Change sInce 1983: Greater 9 c/ 11 11 25 8 c/ Smaller 28 5/ 22 11 13 83 d/ Easier to get: Imported iruts 73 a/ 89 64 50 88 C/ Domestic Inputs 57 d/ 64 44 17 67 d/ Harder to get or too costly: Imported Irputs 12C/ 0 18 33 0c/ Domestic Iruts 20 / 21 25 33 0 U/ Credit harder to get 84 83 100 100 100 Dealing with government regulations Is: Easier 39 77 50 80 33 Harder 32 22 38 40 67 Competition Is greater 61 53 84 33 71 (Number of firms) (82) (17) (16) (9) (7) a/ Includes firms established after 1983 as well as before. b/ Categores are based on theruer of fu-time wage workers: mcro 3 or fewer; very sall 49;small 10-29; medum/arge - 30 or more; data are also shown from a separate survey of the largescale sector for Mich some comparable data were obtaIned. c/ Includes an additional 24 firms from a separate survey of large-scale enterprises. ANNEX 2-4 AD%JSMNT RESPONSES AND CONSTRAINTS, ALL FIRMS IN THE SMALL SCALE ENTERPRISE SURVEY (percentage of respondents In each category) All firms Size categories: a/ Question surveyed Micro Very small Small Med./Large Major competition from: Imports 21 b/ 13 8 7 50 b/ Small firms 656/ 75 72 72 37i/ Bank loan: Have ever had one 32 18 19 60 86 Have tried to get one in last 5 years 47 28 48 73 71 Have exported 9 8 8 7 14 (directly or Indirectly) Have considered 38 28 48 44 43 exporting Constraint on sales: Resources (could sell more) 52 44 58 64 43 Demaind: Can sell current production but no more 24 19 23 21 57 Can't sell current production 24 38 19 14 0 (Number of firms) (82) (33) (26) (16) (7) a/ Categories are based on the number of full-time wage workers: micro - 3 or fewer; very small - 4-9; smaIl 10-29; medlum/large . 30 or more; data are also shom from a separate survey of the large-scale sector for shich some comparable data were obtaIned. b/ Includes an additIanal 24 firms from a separate survey of large-scale enterprises. ANNEX 2-5 REGULATORY PROBLEMS FOR CURRENT OPERATION BY FIRM SIZE GROUP (percentage of respondents in each category) Size categories: b/ All firms Very Medium, Problem surveyed P/ Micro Small Small Large I/ Share citing business environment issues among top 4 problems of operation Taxes 14 9 4 13 30 Infrastructure: Electricity outages 7 a 12 0 7 Transportation costs 5 3 8 13 0 Other 8 3 12 13 0 Business environment 6 0 8 0 14 Regulations, licensing 3 0 0 0 14 Getting foreign exchange 4 0 0* 8 0 Share eitInq business environment issues among top 4 problems for expansion Taxes 12 14 4 31 0 Electricity outages 3 0 8 0 0 Regulations, licenetng 3 0 8 0 0 Malor regulatory problems None 48 56 62 so 18 Firms citing problems 52 44 36 44 72 Of which, percentage citing: S/ Location 33 71 75 29 8 Employment regulations 20 0 0 57 20 Minimum wage 13 0 13 29 12 Price controls 13 0 13 0 20 Licensing 11 0 13 29 8 Registration 11 57 13 0 0 Investment code 9 0 0 0 18 Other 13 0 13 0 20 Difficulty in deslilg with regulations now vs. 1993 Much easier 22 17 14 0 38 Somewhat easier 81 33 14 33 38 About the same 26 39 29 22 17 Worse 22 11 43 44 8 (Number of fires) (106) (33) (26) (18) (31) 3/ Includes 82 small and medium-scale firms covered under thn small enterprise survey and 24 large firms that were asked the se* questions in the survey of large enterprises. 6/ Size categories are based on the number of full-time wage workers In 1989: micro a 3 or fewer; very small a 4-9; small a 10-29; medium/large a 89+. . s/ The total exceeds lOX because some firms cited two problems. ANNEX 2-6 VIEWS OF LARGE SCALE FIRMS ON DEALING WITH SPECIFIC REGULATIONS SINCE 1983 a/ Percent rating of relative ease since 1983 as: Z with no About Somewhat Much Problem opinion Worse the same easier easier Price controls 9.7 6.5 6.5 6.5 71.0 Labor retrenchment 25.8 9.7 32.3 22.6 9.7 Export procedure 54.8 0.0 12.9 25.8 6.5 Import clearing 12.9 22.6 41.9 16.1 6.5 Investment approval 32.3 0.0 29.0 25.8 12.9 Manufacturing license 45.2 0.0 12.9 25.8 16.1 Investment Code benefits 41.9 0.0 22.6 16.1 19.4 a/ Based on 31 firms covered under the survey of large-scale firms. ANNEX 2-7 PROBLEMS OF BUSINESS ENVIRONMENT FOR NEW INVESTMENT, BY FIRM SIZE (percentage of respondents in each category) Size categories: k/ Problems and its All firms Very Medium, importance survey%d ?/ Micro Small Small Large p/ General business environment Uncertainty about economy Moderate/major 38 37 27 48 46 None 32 30 42 23 33 Government attitude toward private investment Moderate/major 18 8 1 9 38, None 78 84 77 190 so Regulatory problems Level of taxes Moderate/major 82 52 72 89 84 None 24 28 24 23 25 Government approval (other than registration A Inv. Code) Moderate/major 9 0 5 9 24 None 73 91 81 82 S9 Getting Investment code benefits Moderate/major 7 9 9 9 22 None 78 100 199 100 61 Getting registered Moderate/major 2 9 4 9 3 None 91 83 92 38 90 Other problems Getting credit Moderate/major 89 87 91 18e 83 None 7 7 9 9 8 Level of demand Moderate/major 55 8 34 so 89 None 33 19 48 3 37 Getting technical assistance Moderate/major 28 35 32 36 11 None 53 so 37 45 70 (Number of fires) (198) (33) (28) (18) (31) p/ Includes 82 small and medium-scale firms covered under tre small enterprise survey, and 24 large-scale firma that were asked the same questions in a separate survey of large enterprises. b/ Size categories are based on the number of full-time wage workers in 1989: micro = 3 or fewer; very small a 4-9; small = 19-29; medium/large a 30 or more. Note: The percentage responding *minor problem* is not shown. ANNEX 3-1 Page 1 of 5 KEY RECOMMENDATIONS FOR IMPROVING THE ENABLING ENVIRONMENT Financial Intermediation * Rapid implementation of financial sector reform program. * Development of capital markets. Legal Environment and Basis for Regulations * Review and amend or repeal laws, including the Foreign Exchange Control Act (1961 and amended in 1986), the Industrial Relations Act (1965), the Labor Decree (1967), the Manufacturing Industries Act (1971), the Investment Code (1985), and amendments to the Investment Code under the 1988 Budget Sieech, to (a) harmonize conflicting provisions; (b) capture the considerable liberalization of the economic environment under the ERP; (c) reflect the new, more open attitude of the Government with respect to private investment; and (d) provide legal backing for administrative decisions. Business Establishment, Manufacturing Licensing and Investment Approval Procedures * Consolidate existing application forms for business registration into one standard form (perhaps with a short form for small businesses); and review need for certificate of commencement of business from the Registrar General's Office. * Simplify registration procedures for microenterprises by arranging for registration to take place near the location of their businesses. * Review application form for manufacturing license from Ministry of Industries, Science and Technology (MIST) to avoid duplication with business registration; and abolish the issuance of provisional license. * Ensure that GIC informs MIST of licenses it has issued in order to centralize information. * Abolish the 'Investment Policy License' issued by GIC and thereby the need to apply annually for a license to operate. * Consider eliminating the need for a manufacturing license entirely or at a minimum for the expansion of capacity, say up to 30-50Z of the existing capacity, and in the case of new enterprises, for nrojects below a certain size (e.g., the equivalent of US$250,000). This threshold should be raised as soon as possible. * Change the principal function of GIC from that of a regulatory body to that of a promotional and facilitating agency and allow GIC to also develop a business advisory service. ANNEX 3-1 Page 2 of 5 Foreign Exchange Transactions * Abolish the need for prior GIC approval to remit interest, dividends and technical fees. The Bank of Ghana should adopt a system of ex- post monitoring of remittances instead of requiring prior approval. * Allow direct transfer of export earnings to exporters' local cedi and foreign exchange accounts. * Ensure effective dissemination to the public of changes in foreign exchange regulations. * Inform potential investors of Ghana's liberal foreign exchange regime. Import/Export Procedures * Generally, simplify procedures to reduce costs and delays. For furniture exports specifically, allow export contracts to be on c.i.f. basis for purposes of the Forest Products Inspection Board's inspection (e.g., the same as required for the shippers' council), and export documents to be signed in more than one location more convenient to exporters. * Give firms more freedom in choice of shipping agent, and remove restriction entirely for exporters, at least. Technology Transfer * Fi-alize and issue to the public guidelines on technology transfer agreements. The guidelines should be clear and unambiguous, contain a set of standard clauses to be included in technology agreements, and list restrictive clauses that are not aqceptable. * Leave the choice of technology to entrepreneurs, i.e., government agencies should not have to assess the technical know-how to be imported. Allow the terms of contracts to be determined by the parties concerned. Abolish restrictions on the use of foreign technologies or foreign trademarks/brand names. * Establish a databank (through membership of international organizations, such as the World Industrial Property Organization) on technologies and technology agreements, and make it readily available to all firms. Provide investors services with assistance from local institutions. Expatriate Quota * Adopt a more liberal attitude in granting expatriate quotas subject, of course, to security clearances from the Ministry of Interior. Possibly give a minimum number without specifying specific positions and relate it to investment size. ANNEX 3-1 Page 3 of 5 Foreign Investment Regulations * Define a Ghanaian company as one with majority Ghanaian ownership in order to facilitate joint ventures with foreign or partly foreign enterprises. * To encourage transfer of technology and know-how: (a) increase scope for full foreign ownership (i.e., when the firm is not a net foreign exchange earner); (b) open up selected activities listed in the Annex of the Investment Code to foreign ownership when a significant portion (not 100 percent) is for export; and (c) reduce the amount of minimum employed capital (US$500,000) for allowing foreign business to enter into certain activities such as trade and represent foreign businesses. * Lift restrictions on access to credit to foreign companies and as an interim measure, require Bank of Ghana approval only for lending to foreign firms above a certain threshold (Z of net worth). For this purpose, define a foreign company as one with majority foreign ownership. Labor Laws and Regulations * Remove the requirement for firms to go through Public Employment Centers when hiring workers, and instead require firms to inform the Labour Office on new employees. * Consider encouraging firms to make provisions for the financial obligations incurred to retrenching workers, through changes in the accounting rules, as necessary. * Ensure that labor disputes and the retrenchment of workers when necessary are settled within the context of collective agreements and that parties have access to courts for settlement of differences. Location of Micro and Very Small Enterprises * Establish procedures for local governments to consult business representatives and the national government when they wish to relocate businesses or restrict their location. Avoid relocating enterprises far away from their clientele, and consider providing compensation for the costs of relocation. Taxation * Reduce the company income tax burden through a combination of lower tax rates (from the current 45 to about 30 percent with immediate effect for agriculture, manufacturing, construction, real estate and exports, and in a phased manner for other sectors currently subject to 50Z rate) and an increase in capital allowances across-the-board. Eliminate tax holidays currently available to selected activities. ANNEX 3-1 Page 4 of 5 * Introduce a general carryover of operating losses for all sectors currently subject to the 45 percent rate including manufacturing for a period of, say, 5 years. * Reduce the capital gains tax to about 5 percent (with exceptions, e.g., zero rate for mergers/acquisitions during a specified period of 5 years, and higher rates for real estate). * Reduce the final withholding tax on dividends from 30 to 10 percent. * Negotiate double taxation agreements with at least a few potential capital exporting countries such as the U.K., U.S.A., Japan and Canada. * Consider waiving for a specified period the stamp duty on conversion of revaluation surplus into shareholders' equity. Tax Administration * Allow the issue of a single tax clearance certificate (TCC) valid for all transactions on a six monthly basis. Investigate mechanisms for issuing temporary, single TCC for all transactions to firms that are in the process of seeking adjustments to their assessed tax. * Pay market-related interest on any net credit position of tax payers. * Increase the period of payment of sales tax to 30 ;days following the end of the month in which goods were sold. Fiscal Incentives * Eliminate all special incentives for selected activities in priority areas under the Investment Code, and for activities made eligible for incentives in amendments of the Code under the 1988 budget (e.g., dut exemptions on imports, and various incentives affecting the tax liability of enterprises). Replace these with across-the-board lowering of the income tax, an increase in capital allowances and a general carryover of operating losses for all productive sectors. * Abolish tax holidays currently provided in the Tax Code. * Abolish the income tax rebate for use of labor in large enterprises. * Consider retaining current tax breaks provided under the Investment Code relating to location, research and development, and expenditures on basic infrastructure, and extend them to expenditures on training by allowing firms to set off a specified percentage, say 150 percent of training expenditures, against income. * Incorporate all fiscal incentives (higher depreciation or capital allowances, and incentives for R&D, location, basic infrastructure and training) in the Tax Code rather than in the Investment Code, and give ANNEX 3-1 Page 5 of 5 the Internal Revenue Service (IRS) sole responsibility for their administration. The IRS should, on the basis of provisions in the Tax Code and documentary evidence supplied by the enterprise, grant the benefits without any prior approval. Revise the Investment Code. Price Controls * Continue progress towards decontrol of prices to ensure consistency and ensure that public and government agencies are well-informed about the extent of price liberalization. * Discontinue formal and informal pressure on all firms (private and SOEs) to contain price increases of items which are not subject to price control. Promotion of Non-Traditional Exports * Continue market-based approach to determination of the exchange rate. Adopt further tariff reforms following completion of the ongoing tariff study. * Consider shifting to a temporary duty-free admission basis so that exporters have access to inputs at world prices or, at least in the interim, simplify and effectively implement the duty drawback scheme. * Introduce pre-shipment and post-shipment export credit, and insurance schemes. * Eliminate export levy on furniture and other wood products (2Z levy to Forest Products Inspection Board and 1Z for Timber Export Development Board). ANNEX 3-2 Table 1 STATUS OF INVESTMENT APPLICATIONS UNDER THE INVESTMENT CODE IN 1988 (Number of Applications) Received 164 Approved 100 of which: Board (69) Chief Executive (31) Rejected 7 Withdrawn 5 Suspended 28 Under processing 16 To be considered under 1988 budget statement 8 a/ The applications processed include many carried ovrer from previous years. Source: GIC. ANNEX 3-2 Table 2 SECTORAL BREAKDOWN OF INVESTMENT APPROVALS BY GIC (1986-89) 1989 1986 1987 1988 Jan-Sept. Agriculture 23 25 11 4 Crops 14 16 8 3 Livestock 9 2 2 - Fisheries - 7 1 1 Manufacturing 118 106 76 26 Food and beverages 23 15 16 3 Textiles and garments 1 2 3 - Wood and wood products 64 49 18 10 Paper and paper products 1 2 - 2 Printing and publishing 3 10 1 3 Chemicals and chemical products 7 13 6 1 Rubber products 2 1 2 - Plastic products - 4 9 1 Pottery, china, earthenware - 2 - - Glass and glass products 2 - - - Other non-metallic products 3 - 1 2 Basic metals and fabr. metal prods. 10 8 14 3 Other 2 - 6 1 Building and construction - 5 2 1 Real estate development - 3 2 1 Roads and bridges - 2 - - Tourism 6 6 5 3 Restaurants - 2 3 - Hotels and resorts 6 4 2 3 Services 5 2 6 10 Transport and storage - - 3 3 Consultancy - 1 2 3 Other 5 1 1 4 Total 152 144 100 44 Source: GIC. ANNEX 3-2 Table 3 OWNERSHIP STRUCTURE OF PROJECTS APPROVED BY GIC 1986 1987 1988 100? private Ghanaian 88 66 51 100% State 5 2 1 100? Foreign 1 4 - Joint Foreign/Private Ghanaian 52 70 44 Joint Foreign/State 2 1 2 Joint State/Foreign Private Ghanaian 2 1 2 Joint State/Private Ghanaian 2 - - Total 152 144 100 Source: GIC. ANNEX 3-2 Table 4 PROPOSED CAPITAL STRUCTURE OF PROJECTS APPROVED BY GIC Source of Finance 1986 1987 1988 $ m. .m. Z $m. Z Foreign 199.1 62 226.6 62 119.2 68 - equity 28.3 9 42.7 12 27.6 16 - loans 170.8 53 183.9 50 91.6 52 Domestic 119.8 38 140.9 38 55.1 32 - equity 59.4 19 72.0 20 42.3 24 - loans 60.4 19 68.9 18 12.8 8 Total 318.9 100 367.5 100 174.3 100 Source: GIC. ANNEX 3-3 Page 1 of 2 SOME DETAILS ON THE LEGAL AND REGULATORY FRAMEWORK Registration 1. The application for registration at the Registrar General's Office is a prerequisite for all new businesses in Ghana. In the case of an individual, the application is limited to the registration of the "business name" (Registration of Business Names Act, 1962 (No. 151); after having furnished some basic .information, a "Certificate of Registration" is issued which has to be renewed annually. In cases of partnerships or companies, the procedures are set forth in the Company Code, 1963 (No. 119). After a review of the application and the information concerning the company, a "Certificate of Incorporation" is issued against payment of a fee. This Certificate has to be renewed annually against a fee and upon the filing of an annual return with the Registrar General. After the registration, the company has to file Form 3 "Returns of Particulars of the Company under Section 27 (1) of the Companies Code on Incorporation" and Form 4 "Declaration that Conditions of Section 28 of the Company Code, 1963, have been complied with'. Only then is a "Certificate of Commence- ment of Business" issued against payment of a stamp duty of 0.2 percent of the stated capital of the company. The company is not allowed to commence its operations before the issuance of this Certificate. Provisional License 2. The main provisions of a provisional license are: (a) non- transferability of the license; (b) freeze on the scope of operations; (c) project to be completed within 12 months from the date of issue of this certificate after which period the company should reapply to the Ministry for consideration for a permanent certificate; (d) freeze on the plant capacity within 12 months without the Ministry's prior approval; and (e) the permanent certificate to be issued after a satisfactory inspection of the company's operation by the Ministry in order to ensure the provision of suitable land and accommodation/buildings, water and electricity, environmental protection measures, health hazards and fire outbreaks; certificates of inspection from the electricity companies, the Chief Inspector of Factories, and the Ghana Standards Board. Labor Regulations 3. Hiring of Laborers. To hire workers, firms should go through the Labor Department's Public Employment Centers, which makes the process of hiring new employees quite a lengthy and time consuming process. Any company employing new people has to contact the appropriate center and inform it about the number of vacancies and the desired qualificatio.7 of employees. Usually, the center will provide the company with three to five applicants for each vacancy. If none of the applicants is acceptable to the company, the company may advertise the open positions in newspapers with the proviso that interested persons should report to the nearest ANNEX 3-3 Page 2 of 2 Public Employment Center which, in turn, would refer that person to the company. The company is only allowed to hire persons who are registered with a center and carry a labor card. 4. Wage Setting. At the national level, the minimum wage is set by the Tripartite Committee on Wages and Salaries which consists of representatives of the Government, employers and trade unions. However, the minimum wage level is somewhat irrelevant because very few laborers receive only the minimum wage. In larger enterprises, even the lowest paid worker commonly receives a salary larger than the minimum wage, and a variety of fringe benefits boost the total wage levels to well abvve the minimum wage. 5. Collective Bargaining Process. At the company level, the wages are subject to the collective bargaining process between employer and employees. Negotiations take place between the employer and, in the case of the manufacturing enterprises, the Industrial and Commercial Workers' Union of TUC (Ghana). The collective agreement usually has a duration of two to three years with the possibility of a mutually agreed extension. Some contain a *wage opening" clause which permits the renegotiation of the wage levels after one year. These agreements have to be registered with the Labor Department. The wage levels negotiated and reflected in the collective agreements have to be in conformity with the guidelines established by the Prices and Incomes Board. If they exceed these guidelines, the agreements may ne' be approved. The collective agreement usually covers the basic wages; the fringe benefits related to housing, transpo rt, medical services, lunch allowance, leave allowance, bonuses, etc.; grievance procedures; end of service benefits; and severance payments. The fringe benefits can amount to much more than 100 percent of the base salary. 6. Retrenchment process starts with an advance notice of about two months and consultations with the union representing the company's employees. An attempt is made to reach an agreement on the necessity of the lay-offs, the number of workers to be laid off and the benefits to be paid pursuant to the collective agreement (usually 2 to 2-1/4 months' basic pay for each year of service). The minutes of this meeting reflecting the agreements or disagreements is sent to the Ministry of Mobilization and Productivity. The firm has to also submit to the Ministry detailed information on its operations, inventory, financial position, employment data, and plans for retrenchment and rehiring if necessary in the future. The Deputy PNDC Secretary for Mobilization and Productivity meets with the company and the union in order to reach a final agreement on the layoff procedures and the financial implications. ANNEX 3-4 Page 1 of 3 SOME SUGGESTIONS FOR PROMOTING/FACILITATING INVESTMENT 1. Background on GIC. Under the 1985 Investment Code, the Ghana Investments Center (GIC) is entrusted with a very broad mandate to encourage, promote and coordinate investments in Ghana outside of mining and petroleum. It is responsible for administering the Investment Code. Its main functions include (a) investment promotion through identification of investment opportunities and potential investors, dissemination of information, and organization of promotional activities; (b) the approval of investment projects and the granting of incentives and benefits offered by the Code; (c) acting as a 'one stop' agency in securing the various approvals and licenses the investor needs to obtain final approval by the GIC; (d) overseeing the implementation of all new investments in Ghana outside mining and petroleum; and (v) reviewing, approving and monitoring all technology transfer agreements being entered into or renewed with foreign parties. 2. The GIC is governed by a high level board comprising the chairman and seven members. The PNDC Member and Chairman of the Committee of Secretaries is the chairman of the board. The Secretary for Finance and Economic Planning and the Governor of the Bank of Ghana are members of the board. A chief executive, who is member of the board, is in charge of day- to-day administration of the Centre. The GIC comprises six departments, i.e., project development and promotion, project processing, monitoring and follow-up services, economics and statistics, administration and records, and the legal department. The Centre has about 160 employees of whom about one-fourth are professionals with the largest number in the project processing department. There are many vacancies at professional level, and several professional staff do not have the necessary qualification. The monitoring department is particularly weak: out of six positions, only those of director and deputy director are currently filled. The staffing of the GIC reflects the emphasis on processing of applications, at the expense of the monitoring and promotional functions. The GIC is subject to civil service rules in its staffing. 3. The breadth of the mandate of GIC poses a challenge. The challenge is compounded by the conflicts in the situation that GIC inherited. On the .one hand, GIC operates under severe resource constraints, and, on the other hand, it must contend with the control- oriented approaches toward private investment in parts of the Code, in other laws and regulations, and in the GIC's own staff and organizational procedures. While GIC is responsible for informing potential investors abou* investment opportunities and aspects of business in Ghana, including relevant laws and regulations, incentives and investment application and approval procedures, its efforts in this area have been weak, and hampered by a lack of staff and financial resources. 4. Promoting/Facilitating Investment. To increase private sector investment for sustainable growth, Ghana would have to launch strong investment promotion and facilitating efforts aimed at both domestic and ANNEX 3-4 Page 2 f 3 foreign investors. This report has so far argued for a significant reduction in the GIC's present role in the screening and approval of investment projects for granting fiscal incentives under the Code, and for abolition and relaxation of many of the regulatory mechanisms. These changes will greatly reduce GIC's current workload. This would provide an opportunity of a major reorientation of GIC's functions as well as for a reallocation of its resources away from investment approval and towards a stronger promotional and facilitating role. GIC might also become active in providing business advisory services. At the moment, financial institutions complain that the majority of project proposals submitted to them for financing are poorly prepared. Recognizing the importance of investment promotion, the GIC in collaboration with MIGA conducted an investment promotion conference in Ghana in February 1990, and has also recently obtained technical assistance from the Irish Development Authority (IDA). The following paragraphs discuss some of the points which GIC should take into account in formulating its investment promotion efforts to enhance their effectiveness and increase the chances of success in attracting investment in a cost-effective manner. 5. Investment promotion programs are generally more successful if they are focusse4,on export-oriented investment for export to world markets and to regional iharkets. Investment promotion should also be complementary to the Government's efforts to improve the investment climate. Investment oriented for the'4omestic market will be primarily influenced by the investment climate and the inherent attractiveness cf Ghana's domestic market. The report has outlined measures for the Government's consideration to;further improve and rationalize the incentive framework, and remove barriers in the legal and regulatory area for private investment. 6. In its investment promotion, Ghana should focus on both build. ig its image in the.investment community and generating investment more directly through'personal techniques, such as presentations tailored to specific companies. However, efforts to generate investment directly will generally be successful only when there is a favorable image of the country among investors. Before committing the capital of their firms, foreign investors are likely to scan the environment from information about the investment climate of a particular country. In this respect, it is essential that through improvements in the investment climate, the Government should make efforts to make existing investors happy in order to ease the way for new investors before initiating any major effort at image building. Once a program to reform the fiscal incentive system and to overhaul the legal and regulatory framework has been developed and put in place, Ghana's efforts to engage in an image-building program would be most successful. In Ghana's context, it will not be cost-effective to mount a general image-building program. It should initiate its promotion program by targeting countries and firms which may be interested in investing in Ghana's tremendous potential in wood processing (e.g., furniture and parts) and agro-industries, and possibly in garment manufacturing for export. Since personal, direct contact with investors generate investment effectively, Ghana should consider establishing in the future a small overseas marketing presence that would allow its investment promoters to be ANNEX 3-4 Page 3 of 3 physically close to prospective investors. In Ghana's case, only a few overseas offices are likely to suffice.11 7. Based on the experience of other countries, investment promotion programs are best implemented by quasi-government organization, which while reporting to the government, are not enmeshed within the conventional government and civil-service structure. Separation from the conventional apparatus of government gives these organizations certain inherent advantages over government organizations in carrying out the investment promotion function. At the same time, quasi-government agencies can have close contact with the government. To be successful, promotion agencies would need to have the flexibility to attract per'onnel with the marketing expertise, obtain sufficient autonomy to design and implement promotion strategies, and develop integrated management control systems.in order to generate sufficient, timely information with which agencies could simultaneously control, evaluate, and motivate marketing representatives. These conditions do not currently exist in the GIC, and significant changes in its functions and organization would be necessary if the GIC is to become a strong investment promotion and facilitating body. The promotion program should be separated from the screening function, as it requires different skills and approaches. At a minimum, the promotional program should reside in an entirely separate division with its own separate budget. 1/ In the case of St. Lucia, a Caribbean nation, its only overseas office in New York staffed by one professional succeeded in managing a successful promotional program by relying heavily on direct mail and telemarketing and the intensive follow-up of leads generated from these techniques. Since 1987, St. Lucia has moved from 43rd to 27th in international ranking as a location for U.S. electronics firms; moved to 6th place in the entire Western Hemisphere, behind Canada, Mexico, Costa Rica, Barbados, and Jamaica, as a relocation and expansion site for U.S. electronics firms.