Report No. 48566-MR Mauritania Policy Options to Enhance Private Sector Development Country Economic Memorandum April 2010 PREM 4 Africa Region Document of the World Bank SMH Hydrocarbon Company of Mauritania SNIM National Company of Mining Industries SOMELEC Mauritanian Electricity Company SONELEC Division of SOMELEC UNDP United Nations Development Programme VAT Value-Added Tax WAEMU West African Economic and Monetary Union (WAEMU) WDI Worldwide Development Indicators WDR Worldwide Development Report WHO World Health Organization WTO World Trade Organization Vice President: Obiageli K. Ezekwesili (AFRVP) Country Director: Madani M. Tall (AFCF2) Sector Director: Sudhir Shetty (AFTPM) Country Manager: Francois Rantrua (AFMMR) Sector Manager: Antonella Bassani (AFTP4) Task Team Leader: Manuela Francisco (AFTP4) iii TABLE OF CONTENTS ACKNOWLEDGMENTS ........................................................................................................................ vii EXECUTIVE SUMMARY ..................................................................................................................... viii 1. MAURITANIA'S ECONOMIC GROWTH HISTORY................................................................... 1 A. Brief History of Mauritania's Growth ............................................................................................. 1 B. Political and Cultural Aspects .......................................................................................................... 8 C. Social Aspects and Poverty Trends.................................................................................................. 9 D. Current Investment Climate: Implications and Costs for Growth ................................................. 10 E. Four Key Constraints on Private Sector Development .................................................................. 14 2. THE INFORMAL ECONOMY: DRIVERS AND IMPLICATIONS FOR ENTERPRISE DEVELOPMENT ............................................................................................................................... 22 A. Drivers of Informality from the Fiscal Policy Perspective ............................................................ 22 B. Small Business Taxation ................................................................................................................ 35 C. Conclusions and Policy Recommendations ................................................................................... 40 3. LABOR MARKET IN MAURITANIA: AN ANALYSIS OF LABOR INFORMALITY AND SKILLS MISMATCHES ................................................................................................................... 43 A. Overview of the Labor Market ...................................................................................................... 43 B. Understanding the Informal Sector ................................................................................................ 48 C. Skills Mismatches .......................................................................................................................... 53 D. Conclusions and Policy Recommendations ................................................................................... 58 4. COMPETITION POLICY AS A TOOL TO INCREASE COMPETITIVENESS AND ECONOMIC DIVERSIFICATION.................................................................................................. 60 A. Current Competitive Setup in Mauritania ...................................................................................... 60 B. Framework on Fighting Anti-competitive Market Conduct .......................................................... 64 C. Cost and Benefits of Implementing Competition Law and Policy ................................................ 75 D. Conclusions and Policy Recommendations ................................................................................... 77 5. COMPETITIVE SPECIAL ECONOMIC ZONES......................................................................... 82 A. Rationale for and Typology of Special Economic Zones and Associated Regimes ...................... 82 B. Identifying a Special Economic Zone Regime Adapted to the Mauritanian Context .................... 88 C. Conclusions and Policy Recommendations ................................................................................... 95 REFERENCES ........................................................................................................................................ 101 iv List of Annexes: Annex 1: Economic Indicators.................................................................................................................. 108 Annex 2: Main Provisions and Incentives Included in the Proposed Investment Code` .......................... 112 Annex 3: Economic Growth and Effective Enforcement of Competition Policy and Law ...................... 113 Annex 4: Drivers of Tax Evasion ............................................................................................................. 116 Annex 5: Labor Chapter - Descriptive and Empirical Results .................................................................. 119 Annex 6: Evolution of the Special Economic Zones ................................................................................ 126 List of Boxes: Box 1.1: Mauritania's Industrial Sector Structure ..................................................................................... 5 Box 1.2: Morocco's Experience with Developing Agriculture and Tourism ............................................ 7 Box 1.3: The Costs of Informality ........................................................................................................... 16 Box 2.1: What is "Informality"? .............................................................................................................. 23 Box 2.2: Factors Fueling Informality: Burdensome Regulations and Weak Enforcement...................... 24 Box 2.3: METR Economic Concept ........................................................................................................ 28 Box 2.4: Example of the METR Calculation for the Small Business Regime (Turnover Tax between 4-10 percent) in the Manufacturing Sector in Mauritania .......................................... 29 Box 2.5: Key Areas for Taxpayer Education and Assistance .................................................................. 38 Box 2.6: Improving Local Business Environments by Streamlining Regulatory Fees and Parafiscal Instruments at the Local Level ................................................................................. 39 Box 4.1: Fostering Competition: The East Asian Miracle Revisited ....................................................... 66 Box 4.2: Highlights for Competition Law Design ................................................................................... 68 Box 4.3: The Attributes of the Kenyan and the Zambian Competition Bodies ....................................... 70 Box 4.4: Steps in the Administration and Enforcement of Competition Law ......................................... 71 Box 4.5: The South African Experience with Competition Law Implementation................................... 72 Box 4.6: The Role of Competition Policy Advocacy .............................................................................. 74 Box 4.7: Government Aid Control Programs Helps Channel Public Resources towards Development . 75 Box 5.1: Successful Special Economic Zones around the World ............................................................ 84 Box 5.2: Examples of Less Successful Special Economic Zones............................................................ 87 Box 5.3: Rules Regarding the Incentive Regime, WTO Agreements and Recommended Practices ...... 90 Box 5.4: The Economic Contribution of Tuna Fishing Industry in Mauritius ........................................ 94 Box 5.5: Checklist for the SEZ Dialogue ................................................................................................ 99 List of Figures: Figure 1.1: GPRSP-II Strategic Objectives and Identified Interventions................................................. 14 Figure 2.1: Time Spent to Pay Taxes in Mauritania and in Some Other African Countries .................... 25 Figure 2.2: Comparison of the METRs for Various Tax Regimes for Small Businesses ........................ 33 Figure 2.3: Informal Payments to Facilitate Compliance with Various Administrative Requirements in Mauritania (% of Firms) ............................................................................. 37 Figure 3.1: Unemployment Rates across Age Groups ............................................................................. 45 Figure 3.2: The Unemployment Rate among Groups with Various Levels of Education........................ 46 Figure 3.3: Employment by Sector in Rural Areas .................................................................................. 47 Figure 3.4: Employment by Sector in Urban Areas ................................................................................. 47 Figure 3.5: Level and Composition of Informal Employment ................................................................. 48 Figure 3.6: Informality over the Lifecycle ............................................................................................... 49 Figure 3.7: Percent of Informal Wage Earners (of the Total Informal Workers) Over the Life-cycle .... 51 v Figure 3.8: Perception of Skills Mismatches across Firms ...................................................................... 54 Figure 3.9: Perception of Skills Mismatches across Sectors .................................................................... 54 Figure 3.10: Skills Mismatches and Firms' Openness ............................................................................... 55 Figure 3.11: Skills Mismatches in the More Technology-Advanced Sectors ............................................ 56 Figure 4.1: Elements of a Competition Policy Framework and a Government Aid Control Program..... 65 Figure 4.2: Design of a Competition Policy Framework ......................................................................... 80 Figure 4.3: Design of a Functional Government Aid Control Program ................................................... 81 Figure 5.1: Development of the Strategic Framework for the Studies ..................................................... 98 Figure 5.3: Sector Share of Real GDP (at factor cost) (%), 1991 - 2008 ............................................... 109 List of Tables: Table 1.1: Recent Economic Performance in Mauritania, 2004-08 ........................................................... 3 Table 2.1: Proposed Reforms of the Fiscal Regime ................................................................................. 27 Table 2.2: Turnover Bands for Small Businesses:.................................................................................... 27 Table 2.3: METR Analysis for Large Business compared to other African Countries ............................ 31 Table 2.4: Mauritania: METR Analysis for Small Businesses ................................................................. 32 Table 2.5: Comparison of METRs for Small Business Regime in Mauritania and other African countries ................................................................................................................... 33 Table 3.1: Unemployment, Jobless and Idleness Rates in Mauritania ..................................................... 44 Table 3.2: Unemployment Rates across Regions ..................................................................................... 46 Table 3.3: Breakdown of Activities in the Formal and Informal Sector .................................................. 50 Table 4.1: New Entry in the Formal Manufacturing Market .................................................................... 61 Table 4.2: Dealing with Construction Permits ......................................................................................... 64 Table 4.3: Deterrent Effect of Competition Laws .................................................................................... 76 Table 4.4: Deterrent Effect of Competition Law on Bid-Rigging ............................................................ 77 vi ACKNOWLEDGMENTS The World Bank team consisted of Manuela Francisco (TTL, AFTP4), Richard Auti (AFTP4, Growth), Georgiana Pop (AFTP4, Competition), Jan Loeprick (FIAS, Informality and taxation), Charles Velutini (Informality and taxation), Sebastian James (CICRS, Informality and taxation), Rita Almeida (HDNSP, Labor), Cherif Diallo (AFTH2, Labor) and Claude Baissac (AFTP4, Economic zones). Sid'Ahmed Ould Cheikhna (Economist, AFTP4) provided support and inputs during the mission and preparation of the report. Georgiana Pop also provided support to the overall preparation of the report. The report was prepared under the supervision of Antonella Bassani, Sector Manager (AFTP4), who offered conceptual guidance, provided critical analytical advice, and ensured quality assurance. Special thanks go to Francois Rantrua (Country Manager, AFMMR) who greatly supported the preparation of the report, and provided strategic guidance to the team. The report benefited from useful comments from Philip English (Lead Economist, AFTP4), Vincent Palmade (Lead Economist, AFTFP, Peer reviewer), Setareh Razmara (Lead Social Protection Specialist, AFTH2, Peer Reviewer), Richard Stern (Lead Investment Policy Officer, CICRS, Peer Reviewer), Jean-Francois Marteau (AFTTR), Dominique Guillaume (Mission Chief, IMF), and Taleb Ould Sid'Ahmed (Communications Associates, AFREX) for their comments. The team is also grateful to Nicola Pontara (Senior Economist, OPCFC) who provided useful insights of the Mauritania economy and shared the Household Survey 2004, Tanja Rajadel (Consultant, AFTP3) and Alessandro Magnoli Bocchi (Senior Economist). From the Country Management Unit, Madani Tall (Country Director, AFCF2), Joelle Dehasse (Senior Operations Officer) and Nora Kaoues (Operations Officer) supported the overall process and provided valuable guidance on policy issues. Judite Fernandes provided assistance in document preparation. A dissemination workshop took place in Nouakchott on October 26 ­ 27, 2009. The team is grateful to the government for the support provided to the preparation of this workshop and to the finalization of this report. vii EXECUTIVE SUMMARY 1. Mauritania has undergone massive economic and political changes. Mauritania is a West African country located on the western edge of the Sahara desert, with a population of approximately 3 million people that is mostly concentrated in the urban areas. Since independence in the 1960s, Mauritania's economy has been dependent on natural resources, iron ore first then combined with fisheries, and presently oil and other minerals. The severe droughts of the 1960s and 1970s, which generated migration from rural and urban areas created pressures on the country's administration, through increased demand for education, housing, employment, health, administrative and other services, which continue up to this day. To deal with the increasing social pressures as a result of the massive rural exodus, the political system relied extensively on revenues from natural resource exploitation, but this has led to rural neglect and limited economic diversification. Furthermore, on its way to democratization, the country experienced several episodes of political unrest, starting with a military coup in 1978 which ousted the country's first leader, Ould Daddah, followed by Taya's military regime between 1984 and 2005, and finally, the arrest of democratically elected President Abdallahi in August 20081 by a military junta. In July 2009, General Abdel Aziz was elected President. 2. Natural resources exploitation and more recently oil discovery boosted Mauritania's rate of economic growth, but key challenges remain, in particular the promotion of productive value-adding activities and the creation of a strong, formal class of small and medium-sized enterprises (SMEs). Mauritania's disappointing long-term growth performance is not due to insufficient investment but rather to an uncompetitive private sector and the overreliance on revenues from natural resource exploitation; in fact, public revenues were not channeled to foster the development of other value-adding activities. In addition, the small and fragmented market and the narrow manufacturing base have further reinforced dominance by large business groups, which has systematically crowded SMEs out. As a result, outside mining and oil, trade and other services are the only sectors that have increasingly contributed to growth in the past two decades, while agriculture has had a modest contribution to GDP. Despite its significant contribution to growth in the early 1990s, industrial fishing has progressively deteriorated due to an obsolete domestic fleet and increasing competition from foreign fishing companies. Manufacturing has not yet succeeded to emerge as a growth engine. 3. The Government of Mauritania recognizes the strategic role of the private sector and the urgency of supporting SME development as a catalyst for long-term growth. In the Second Poverty Reduction Strategy Paper (GPRSP-II), the Mauritanian authorities indicated that accelerating economic growth would be based on: (i) optimizing spinoff effects from developing the oil business and implementing more effective policies for harnessing the growth potential of other promising sectors; (ii) a thorough reform of the financial system; (iii) significant improvement in the business climate and the development of SMEs; and (iv) giving a greater economic and land-use planning dimension to the infrastructure that supports growth (World 1 President Sidi Mohamed Ould Cheikh Abdallahi was elected in March 2007, following democratic legislative elections in November 2006. viii Bank, 2006). Furthermore, the Authorities identified several priorities to improve the business climate and promotion of SMEs, as follows: (i) improving the legal environment for businesses; (ii) fighting anti-competitive practices; (iii) making tax and customs policies more favorable to business; (iv) institutional support for the development of trade and commerce; (v) facilities to assist Mauritania's SMEs; and (vi) strengthening of mechanisms for dialogue and concerted action, and of economic monitoring tools. The Mauritanian Centre for Policy Analysis (CMAP) also pinpointed in its Study on Determinants of Growth in Mauritania (2005) to a series of microeconomic constraints that hamper entrepreneurship and investment, among which the most serious are: poor infrastructure, limited competitiveness, the relatively high costs of production factors, the burdensome administrative procedures, and the limited access to financing for small businesses and burdensome taxation. 4. In line with the GPRSP-II, previous World Bank Country Economic Memoranda (CEM), other sectoral studies, and the 2007 Investment Climate Assessment (ICA) point out that the investment environment is not favorable to private sector development. Despite several reforms initiated over the past years, such as trade liberalization, regulatory and administrative reforms in the field of investment (revisions of the investment code), taxation, customs administration and governance, private sector perception of the investment environment is poor. According to the 2007 ICA, the most cited constraints are: limited access to credit and high cost of financing; burdensome taxation and tax policy administration; informal sector and unfair competition from the informal companies; poor access to electricity; lack of skilled workers; corruption; unreliable infrastructure; and administrative procedures and regulations. 5. The Authorities have launched a number of reforms to address investment climate constraints. However, after the Coup D'Etat in August 2008, there is uncertainty as to the progress with reforms in strategic development areas. In addition to the domestic political instability, the global economic slowdown is expected to take a toll on the country's overall growth prospects. 6. This CEM examines the four most constraining factors to private sector development and proposes the formulation of practical solutions to enable the emergence of a strong class of formal private firms. Specifically, to accelerate growth and to attain the four strategic GPRSP II objectives - (i) optimize spinoff effects; (ii) reform financial system; (iii) improve the business climate and the development of SMEs; and (iv) improve business enabling infrastructure) -, the CEM2 analyses the role of taxation to promote firm formalization; skills development to enhance labor productivity; competition policy as a way to address anti- competitive market conduct; and the options for establishing special economic zones as instruments to close infrastructure gaps and promote investment climate reforms. Informal Economy: Drivers and Implications for Enterprise Development 2 The report will not discuss in detail the financial sector or the issue of corruption. These two areas have been already tackled in the joint World Bank ­IMF Financial Sector Assessment (2006) and the Anticorruption Study for Mauritania (2008). ix 7. It is critical to understand the determinants of informality in Mauritania because widespread informality deters SME development and generates unfair competition for formal firms. In Mauritania, the informal economy is vast. Reliable data on the extent and structure of the informal sector is scarce, making it difficult to measure its size. Nevertheless, it is estimated that around 85 percent of the labor force is considered informal and approximately 30 percent of GDP is generated by informal activities. The narrow tax base and the limited number of formal land titles (15,000) are other indicators of the extent of informality in Mauritania. Informality seems to be both the outcome of and an input into an existing attitude towards state regulation and law enforcement. Furthermore, costs associated with the existing tax regime are high especially for small firms. These, together with administrative weaknesses and inadequate enforcement, encourage firms to evade taxes and operate in the informal sector. 8. Firms' decision to operate formally is based on a cost-benefit analysis. The benefits of formalization include enhanced access to finance, legal protection and access to public markets. These are particularly important for SMEs in Mauritania, since formalization opens access to markets and services, and may encourage firms' graduation from the subsistence level. Nevertheless, the transition from informal to formal status assumes, on the firm side, that the marginal benefits of formality exceed the marginal costs of operating formally. Therefore, formalization needs to focus on eliminating the key factors that deters it. 9. In Mauritania, the fiscal regime and fiscal administration are perceived as main drivers of informality. Data from the 2006 ICS highlights that approximately 32 percent of firms perceive tax rates and administration as a major or very severe constraints on their operations. In addition to burdensome and costly taxation (696 hours to deal with tax-related procedures compared to 220 hours in Uganda), other factors may discourage firms to operate formally, in particular the costs in terms of monetary amounts, time and number of procedures for business registration and obtaining various permits. 10. Mauritania's fiscal system is complex, relying on the collection of the minimum tax at customs and revenue collection based on a narrow tax base. The Corporate Income Tax is levied at a single rate of 25 percent of firms' profits (reduced from 40 percent) for those firms with turnover larger than MRO 30 million. There is also a minimum tax rate of 2.5 percent of turnover (self-declared) with a minimum tax floor of MRO 240,000. For small businesses with a turnover below MRO 30 million, a tax of 3 percent is levied on the turnover. Mauritania levies a value added tax of 14 percent and mining royalties which vary between 1.5 ­ 5 percent. Furthermore, municipalities and local governments levy a number of smaller taxes, such as a "business tax" on professionals. 11. Acknowledging the weaknesses of the current tax system, Mauritania engaged in a reform process meant to reduce the fiscal burden. It includes reducing its financial and administrative costs in order to make the effective fiscal burden on investment more competitive. The authorities initiated reforms to streamline the tax administration through the introduction of a large taxpayers' office and a functional administration based on taxpayer's size. Other planned reforms envisage reducing the current minimum turnover tax for large firms from 2.5 to 1 percent. The band-based tax regime for small businesses has just been replaced with a single tax rate of 3 percent of turnover. x 12. To inform the ongoing reform, this report presents a Marginal Effective Tax Rate (METR) analysis which measures the effective tax on an incremental investment by a business, be it large or small. The METR summarizes the main elements of the tax system related to capital investment. It is calculated assuming that taxpayers maximize profits and invest up to the point where the marginal benefit of the incremental investment equals its marginal cost. The METRs for large businesses in manufacturing, services, tourism and mining under the current and planned tax regime suggest that large firms incur an effective tax on investment higher than the standard corporate income tax of 25 percent. These vary between 33 ­ 52 percent under the current tax regime and between 30 ­ 49 percent under the planned regime. Nevertheless, for the large businesses that pay the current minimum tax rate of 2.5 percent on turnover instead of the corporate income tax of 25 percent, the effective tax burden on capital remains almost unchanged, indicating that the minimum tax does not place an additional burden on investment. 13. Furthermore, the METRs for small firms indicate that the nominal tax burden on small businesses in Mauritania is higher than that on larger businesses. This is the case in the manufacturing, tourism, agriculture and mining sectors under the current and planned SME taxation regime. The METRs for small businesses vary between 50-57 percent under the current tax regime and between 44-50 percent under the planned regime. Despite that the nominal tax burden on small businesses is comparable to that of Mali (44 ­ 48 percent) it remains higher than that in Tanzania (30-32 percent) and South Africa (22 ­ 32 percent). Hence, the existing punitive fiscal regime for small businesses makes the adoption of a simplified small business taxation regime critical. 14. Moreover, the current fiscal regime and its administrative weaknesses are perceived to be driving tax evasion. Overall, the 2006 ICS data indicates that on average only 45.6 percent of firms' sales are reported to the tax administration. Firms, especially SMEs, opt to operate in the informal economy, which, in turn, limits their market access and access to finance, and increases their costs as they would incur in unofficial `payments' to maintain their informal status and remain under the radar of tax administration. Empirical analysis based on the 2006 ICS confirms that large firms declare on average a higher percent of their sales than micro firms. 15. To encourage informal SMEs to comply with tax requirements, it is essential to continue reforms to simplify the small business taxation tax regime. In particular, the withholding tax, which concern both large and small enterprises, should be progressively eliminated. Such a withholding tax amounts to 3 percent of imports and public contracts and is 100 percent deductible from the due tax. 16. Finally, the current administrative structures for tax administration require better capacities. The tax department has only limited knowledge about the taxpayer population, except the large taxpayers. In addition, fiscal controls are rare and ineffective, and do not seem to touch the large groups. The low risk of being detected and lax enforcement of penalties discourage compliance and create room for corruption within the tax administration. Certainly, the widespread application of a unique identifier would improve the current situation, but would also impose the streamlining of the tax administration monitoring capacity, a review of the current procedures, training and more comprehensive mindset changes among tax administrators xi and taxpayers. Moreover, procedures, forms and payment modalities need to be designed to reflect small business needs. 17. Given the limited incentives firms have to operate formally, this CEM recommends a strategic approach to encourage enterprise formalization and development. The report provides a first insight into the administrative drivers of informality in Mauritania and proposes: · Continuing the simplification of the tax regime and strengthening of the tax administration (2.1): · Further simplification of the tax regime (including the presumptive regime for micro- enterprises). In particular, the withholding tax should be gradually eliminated (reduce it to 1 percent, and eventually replace it with periodical down payments if the impact on tax revenue is satisfactory) (2.1.1). · Further strengthening the tax administration to better fight (i) tax evasion; and (ii) corruption (2.1.2). The following measures are recommended: o Implement a single fiscal number. This measure is necessary to enable the scrutiny and follow-up of the taxpayer population as well as to exchange and collect information. This requires the adoption of an adapted information system, as provided for in the PRECASP project. o Continue training of the tax administration agents, as provided for in the PRECASP project. o Strengthen fiscal inspections and controls by: Adopting an approach to fiscal inspections based on taxpayers' perceived risk of evasion, in accordance with well-known international practice.3 Collecting the necessary information for the risk approach model from sources outside the tax administration (for example, the customs administration). Improving the formal framework of taxpayers' rights and guarantees (especially, during a fiscal control and tax reimbursement) as well as the appeal mechanisms to encourage fiscal civism. · Strengthening of planned reform in the area of small business taxation, in particular (2.2): · Informing and training the taxpayers through the media and specific activities on: (i) simplified procedures; (ii) system equity; and (iii) use of collected revenues by the State (2.2.1). · Establishing the Centres de Gestion Agrées (Accredited Tax Management Centers) (CGA) to support micro and small enterprises in complying with the simplified tax system. The CGAs could be associations (set up and/or managed by licensed accountants) 3 The taxpayers' classification based on risk category, determined on historical data and the past inspection experience, is a key tool to make fiscal inspection efficient and objective, while fighting corruption within the tax administration. xii which, in exchange of a minimal fee, offer basic accounting services and verification of tax declarations. An incentive for enterprises to be member of such a Centre would be a reduction (a minimum of 15-20 percent) of due tax amount. The administration would accredit CGAs based on professional requirements and a formal accreditation and control procedure (2.2.2). · Aligning reform efforts on the central and local level to ensure that the local tax burden does not become an additional formalization deterrent (2.2.3). · Encouraging formalization by creating links between increased tax compliance and improved access to financing and access to public procurement, which should be complemented by (2.3): o A compliance cost survey to measure and better understand the compliance burden. This survey should cover both rural and urban areas (2.3.1). o Measures to simplify start-up and operation procedures (2.3.2). Facilitating a pilot evaluation of the fiscal revenues in the short run. A forecasting model adapted to the quality of available data could be developed to evaluate impact of the above recommendations on public revenues (2.4). Labor Market in Mauritania: An analysis of Labor Informality and Skills Mismatches 18. Informality, joblessness and skills mismatches are interrelated, their interaction having negative implications for SME development in Mauritania. Jobless rates are high ­ approximately 48.3 percent of the working age population (2004). If individuals who work in household activities are excluded, the overall jobless rate drops to 27.3 percent of the working population. The persistency of joblessness suggests a lack of employment opportunities, skills mismatches and also labor market rigidities. The unemployment rate exceeds 15 percent in 2004 and may have attained 26.3 percent if considering the share of working age population who is not searching for a job because it thinks it cannot find one. The lack of employment opportunities drives individuals into self-employment and precarious wage earning jobs, usually found in the informal sector. As a result, the informal sector in Mauritania is widespread. 19. Typically, the jobless and the idleness rates are higher for females. For example, in 2004 the jobless rate for females attained 68.9 percent compared to 24.7 for males, both in urban and rural areas. The main reason for such a significant gap is the tradition of women being involved in household activities. When excluding individuals who are involved in household activities, the jobless rate for women still reaches 43 percent compared to 22 percent for males. Similarly, idleness rates are higher for females than for male ­ 32.5 percent and 14.7 percent, respectively. 20. Moreover, unemployment is widespread among the youngest. The unemployment rate tends to decrease with age, and attains 53 percent for individuals less than 25 years old, 28 percent for those between 24 and 25 years old and 9.9 percent for those between 35-45 years old. Despite the fact that unemployment rates decrease in the later stages of life, this does not necessarily imply that individuals find jobs, but rather that they stopped searching, as indicated by the EPCV 2004 data. Additionally, unemployment is not exclusive of less educated. Hence, in xiii 2004 unemployment rate may have reached 34.5 percent of the labor force with secondary education and 16.5 percent of those with tertiary education. 21. The formal labor market is small, approximately 85 percent of the labor force being considered informal. Informality affects 87 percent of women in the urban areas compared to 77 percent for males. In addition, around 43 percent of females in the informal sector are wage earners versus 63 percent for males, indicating women's low propensity to have a wage job. Moreover, informality is high among the youth. On average, 96 percent of the population between 19 and 25 years old are informal. Informality tends to decrease with the age of the worker, but still attains approximately 90 percent of individuals with more than 55 years, reflecting that individuals must have gained the right to have a pension, but continue working in the informal sector. 22. Agriculture and retail are the sectors that employ the largest shares of informal workers. These sectors together employ 57 percent of the informal workers, which are most of the time self-employed. On the other hand, mining, services and the public administration absorb more than 80 percent of the formal jobs. Informality is not confined to rural areas or the poorest areas in the country, although it sis smaller in the city of Nouakchott. Nevertheless, 79 percent of the workforce in Nouakchott operates informally, in spite of the fact that the city accounts for 40 percent of the formal workers in the country. 23. Despite that informality creates jobs for the poor the quality of informal jobs is lower than that in the formal sectors due to lower wages and a lack of social security. The overall informal wage gap is approximately 13.7 percent, as both self-employed workers and informal wage earners tend to earn lower wages than the formal sector workers. The formal ­ informal gap is even larger in the rural areas. Informal wage earners earn 17.1 percent lower wages in the urban areas, while this differential is almost 2 times larger in rural areas mostly as a result of concentration of lower productivity agricultural activities in rural areas. 24. On the demand side, firms face a shortage of adequate skills and low productivity. Persistent joblessness might reflect the existence of skills mismatches of the labor force, along with the lack of employment opportunities and labor legislation rigidity. According to EPCV 2004, one in every 5 firms in Mauritania report skills and education of the workforce as a major constraint on their operations. Interviews with private sector highlight that specializations such as law, economics and geography are predominant over specializations required by the private sector, particularly engineering, accounting, mechanics, architecture and agronomy. Based on firms' perception reported in the 2006 ICS, skills mismatches seem to affect the largest firms in Mauritania, in particular those operating in the manufacturing sector. By contrast, only 12 percent of firms with less than 9 employees report that skills mismatches are significant. Despite low international integration of Mauritanian firms (9.2 percent of firms have FDI and 8.6 percent of firms export), more open, technology-advanced and innovative firms are more likely to report skills mismatches. The lack of skills further reinforces low productivity rates (value added per worker is approximately USD 3,000, half of that in Mali and one third of that in Senegal), which in turn are not offset by low wages. 25. Nonetheless, efforts to address the skills gaps are limited, as only few firms provide formal training to their workers and incentives to invest in education are low. Only 25.5 xiv percent of firms offer formal job training programs to their workforce, below the training intensity in Mali (27.8 percent), Senegal (33.2 percent), Brazil (67.1 percent) or China (84.8 percent). Furthermore, even though firms persistently report that lack of skills as a major constraint to growth, few firms are likely to provide training. On average only 23 percent of the firms with concerns with skills mismatch report to have provided training compared to 11 percent of firms that do not report such concerns. 26. On the other hand, overall low returns to education could be an indication of multiple factors, such as low quality of the education system, not-in demand skills as well as slack labor demand. The returns to education are less than 7 percent per additional year, which do not encourage workers to sharpen skills and pursue higher studies. But, there are large differences in the returns across sectors, including between the public and private sectors. Manufacturing, construction and services sectors exhibit the highest returns, where wages of workers with a graduate degree are more than twice the wages for those who have never gone to school. The public- private sector wage gap also tends to be larger for the more educated workers. Furthermore, the rates of return to all formal education degrees in the public sector remain below the rates in the private sector. 27. To address widespread informality and skills development and mismatches, this CEM recommends the following key actions: · Complete the informal sector studies in the urban areas and extend them to the rural areas in order to collect complete information on the characteristics of and constraints on the Mauritanian informal enterprises. The INAP/FTP has already produced studies on four urban areas. These studies should be extended to other urban as well as rural areas (Recommendation 3.1). · Reinforce the capacity of employment institutions in order to strengthen their contribution to diminishing the unemployment rate (3.2). · Include the teaching of practical, thinking and behavioral skills in the education programs (3.3). · Transmit the national strategy on skills development for comments to the technical and financial partners (3.4). · Review international good practices and case studies on skills mismatch (3.5). Competition Policy as a Tool to Increase Competitiveness 28. The absence of a strong, formal class of SMEs and widespread informality indicate that competition in Mauritania is in its infancy. Despite trade liberalization, de facto advantages generated by past state intervention have not yet disappeared. Vested interest groups and large domestic monopolies and oligopolies tend to engage in practices that limit or distort competition primarily aiming to capture the benefits of investment and trade reforms. 29. Enhanced competition enables best price-quality ratios for public and private goods and services, but the dominance of large groups in the Mauritanian market limits the emergence of SMEs in the formal sector. Firm-level data from the 2006 ICS shows that firm xv concentration in the formal manufacturing market is high, mainly because several industrial and commercial groups have acquired between 25.8 and 35.8 percent of market shares. In addition, their ownership is concentrated in the hands of few families and investors. The groups often include banks which mainly serve their preferred clients. As an illustration, the four-firm concentration ration on the lending marker is as high as 69 percent, while the one on the deposits market reaches 67 percent. Therefore, the current market structure and market conduct may exercise upward pressure on prices. 30. Furthermore, very few companies dominate the imports of consumer products. Mauritania removed licenses to produce, sell or import food products in the 1990s. Nonetheless, several examples illustrate the existence of import oligopolies that cumulate high market shares. The four-firm concentration ratio for the imports of wheat and sugar tops 90 percent. Moreover, two firms dominate the rice imports, exhibiting a combined market share of 80 percent. The Herfindhal-Hirschman Indices in these product market exceed 0.18, highlighting high concentration for the imports of wheat, sugar and rice. In addition, firms' behavior creates room for higher benefits for leading Mauritanian commodity traders on the expense local producers. Interviews with private sector revealed that, for instance, imported German dairy products flow through a segmented market that excludes local suppliers from the distribution channel, even when dairy products have lower costs. Moreover, if a leading importer of dairy products were to allocate a share of sales to a local producer, its overseas supplier would withdraw his contract. 31. Competition in network industries is also nascent, while the lack of transparency in public procurement may encourage firms to engage in anti-competitive behavior. The monopoly position of the telephone operator Mauritel SA was dismantled and three mobile phone licenses opened the mobile phone market to competition. By contrast, the privatization of the electricity company (SOMELEC) has failed, despite some steps taken in this direction in 2002. Furthermore, the flaws of the public procurement system, especially the lack of transparency, the highly-centralized procurement process and the lack of an electronic system, create room for collusion among bidders. 32. Additionally, Government regulations may create unnecessary distortions in the market. The existence of administrative and regulatory barriers, particularly burdensome and costly procedures for starting up a business and permits raise hurdles to new entry in the Mauritanian market. Moreover, the existing and planned investment and fiscal incentives may create additional distortions at the expense of scarce public resources. Therefore, the application of a general tax regime to all investors would be more beneficial because it would not discriminate among market operators. 33. The current competition policy framework is limited and, therefore, the tools for correcting market conduct are insufficient. Mauritania adopted a basic legal and institutional framework, but there is no vision or plan defining a clear approach to scoping competition policy. The 2000 Code of Commerce incorporates several competition law principles, but there is a need to develop by-laws for their implementation. The institutional framework includes three different bodies: (i) the Competition Department within the Ministry of Commerce in charge of applying the competition law; (ii) the Market Surveillance Committee in charge of hearing complaints about the violation of antitrust prohibitions; and (iii) the Council of Ministers in charge of granting exemptions from the exiting competition legal provisions. Nevertheless, it xvi needs streamlining mainly through the creation of an independent body (for example, by rendering the Market Surveillance Committee operational), that would cumulate investigation, sanctioning and advocacy powers. In the absence of a strong, independent Competition Agency, the enforcement of the competition law and policy advocacy actions are limited. In addition, the structural weaknesses of the judicial system raise unnecessary hurdles to competition law enforcement. Finally, as the Mauritanian authorities do not systematically perform cost-benefit analyses of government interventions, there is a risk of channeling scarce budgetary resources towards sectors that do not require such support, on the expense of promoting regional or SME development. 34. The CEM argues that creating and enforcing strong policy tools to fight anti- competitive behaviors is essential in order to create a level-playing field for investors. The catalyst for stimulating competition and, hence, a more competitive private sector is the dismantling of concentrated market structures (including financial markets) and the creation of an enabling business environment for SME development. Moreover, taking a balanced approach to any government intervention through investment incentives and special regimes would minimize government-driven market distortions. Hence, the pursuit of a well-designed competition policy would complement trade liberalization and, at the same time, ensure that private and public operators do not engage in anti-competitive conduct. This entails a strategic vision on how to address the most serious distortions resulting from firms' behavior (price fixing, collusion) or government intervention (distortive tax breaks). 35. Competition policy should not take a regulatory approach, but enhance market processes. To help better define the competition policy strategic orientation, this CEM proposes: · In Phase one (Recommendation 4.1): o Map the interplay between the existing legal system and the economic, institutional, political and social structures in Mauritania (4.1.1). o Identify key sectors (for example, cement, consumer goods, food products, network industries) to develop industry case studies (4.1.2). o Develop industry case studies to identify chief impediments to new business development and liberalization in these sectors, to collect firm-level data, to analyze specific sector regulations that could potentially create distortions and to guide the elaboration of a competition policy strategy (4.1.3). · Phase two will evolve around (4.2): o Designing a competition policy strategy (for example, focusing on advocacy activities and addressing price fixing ) (4.2.1). o Improving (for example, through a specific competition law) and developing the legal framework by adopting and implementing secondary legislation (4.2.2). o Establishing an independent competition agency body (for example, by rendering the Market Surveillance Committee operational) in order to apply the competition law (4.2.3). xvii o Undertaking capacity building to focus, for example, on policy advocacy and price fixing agreements, as well as on the implementation of public awareness campaigns and education programs. Building capacities of government bodies and tribunals is one of the major priorities in the competition policy area (4.2.4). 36. Furthermore, the CEM recommends the design of a government aid control program that might complement competition policy and encourage cost-benefit analysis of state intervention measures. This framework may be adopted after creating the premises for a solid competition policy. To take stock of the existing government intervention areas, this CEM recommends: · In Phase one, to focus efforts on building an inventory of all government aid measures that might distort competition by granting specific advantage to certain industries or companies (4.3). · In Phase two (4.4): o Create a legal framework to establish clear criteria and evaluation mechanisms, reporting and monitoring procedures, particularly for measures in sensitive sectors and special economic zones (4.4.1). o Endow the independent Competition Agency/other institution with powers to administer and enforce the government aid control program, including with adequate financial and human resources to develop expertise. Alternatively, the institutional design could envisage a government department within the Ministry of Economy and Finance, but such a structure will raise independence issues (4.4.2). o Design communication campaigns and education programs to promote the rationale and the fundamentals of such a program among government representatives, judiciary, private sectors and the general public (4.4.3). Competitive Special Economic Zones 37. To encourage diversification of the production base and encourage private investment, Mauritania needs to create a business enabling environment and, in particular, close infrastructure gaps. FDI flows have been relatively low, mainly oriented towards natural resource exploitation, financial, air transport and telecommunication sectors. In addition, the business environment does not enable private sector development, affecting the rate of return and risks associated with investments. Overall, the regulatory, administrative and legal framework is cumbersome, and the existing tax regime and investment code are uncompetitive and do not stimulate investment. Moreover, the investment code does not provide specific measures to support regional development or specific sectors, despite some amendments in 2002. 38. Infrastructure is inadequate, both in terms of cost and availability. There is a lack of basic services, and transport infrastructure which affects the country's competitiveness. Key sectors, such as agriculture, fisheries and industrial and craft industry suffer from the absence and inadequate state of infrastructure as well as high costs of production inputs (notably water and electricity). The road network is not extensive and only 10 percent of the total is paved. The paved roads mostly cover the two main towns (Nouakchott and Nouadhibou) and the two main xviii north-south corridors (Nouakchott-Nouadhibou and Nouakchott-Rosso). Similarly, the ports of Nouakchott and Nouadhibou lack capacity and equipment, incur high costs, major environmental issues and an ineffective governance framework, lagging behind their regional competitors (port of Dakar in Senegal). In addition, shortcomings in the international airports of Nouakchott and Nouadhibou include a lack of infrastructure and a poor level of maintenance. 39. The production capacity and distribution of electricity also generate significant costs for firms. The 2006 ICS analysis indicates approximately six electricity outages per month in the manufacturing sector, which last around 3.3 hours and generate losses of on average 3.1 percent of firms' sales. A forthcoming project - the Grande Centrale ­ and the planned restructuring of SOMELEC will also contribute to improving the overall sector performance. By contrast, in the telecommunications sector, the opening up to several mobile phone companies increased access to telephone services for the population and dismantled the monopoly position of the traditional telephone operator Mauritel SA. 40. In addition, there are large gaps between the national infrastructure for general activities and the one supporting activities in strategic sectors. The national infrastructure is generally financed under public sector investment, while the strategic sectors are guaranteed infrastructure as companies in these sectors build their own. This is the case in the mining industry. Such a dual approach to infrastructure management may put SMEs at a disadvantage. The creation of special economic zones not only could help boost development of value-adding activities outside natural resource exploitation, but could also help expansion of infrastructure that would facilitate business operations in other sectors. 41. The CEM assesses the rationale of establishing special economic zones in Mauritania. Special economic zones can be an instrument to encourage economic diversification through increased foreign investment and linkages with domestic SMEs. Nevertheless, they may be a second-best solution due to their enclave nature, which often creates a dual economy and delay country-wide reforms. The success of a special economic zone depends on setting the institutional framework right and avoiding that the businessmen capture government policymaking. However, special economic zones involve significant risks associated with difficulties to manage estate development, promotion and services to attract investment and to offset the zone development costs, including costs for building infrastructure, regulatory costs and loss of fiscal revenues associated with investment incentives. 42. The CEM argues that such zones may create an enabling business environment, in particular by reducing costs of infrastructure and streamlining administrative procedures, but only under a general investment incentive system. A special economic zone regime in Mauritania should aim at encouraging efforts to reform the overall business environment, attracting foreign direct investment in sectors with growth potential, concentrating investments and the development of supporting infrastructure around priority sectors, and promoting exports, technological spillovers and job creation. Importantly, it is recommended that the incentive regime for investments in the special economic zones be the general one, leveling tax conditions for all investors and eliminating potential distortions. 43. Importantly, there is a distinction between a special economic zone regime and the area in which various activities will be developed. Mauritania may have the option to set up a xix general special economic zone and grant the status of special economic zone to areas that meet these objectives. Typically, setting up a special economic zone regime requires the adoption of specific legislation, which determines inter alia its objectives, its nature, the institutional responsibilities, management and financial structures, investment incentives, tax and customs regulations, the status of these zones and the criteria for granting this status. Mauritania may establish a general special economic zone regime that would facilitate international transactions, logistical processes, and the processing of goods and products that would be exported in international markets. This zone could also focus on processing natural resources or help develop residential, retail, and tourism activities. Alternatively, the regime and zone may not be treated separately. This would involve designing the regime for a special economic zone. Therefore, the regime would contain the zone location and characteristics. 44. Mauritania may have three options for localization and development of a special economic zone. The first option involves the formalization and streamlining of the Port of Nouakchott. Currently, the zone adjacent to the port is not managed in an efficient way, disposes of inadequate infrastructure, seems to raise environmental and safety issues, and suffers from inefficient land management. Nonetheless, the existing draft legislation extending the port's industrial area to the zone and the experience of the Nouakchott Port Authority in managing national infrastructure may be advantageous. The second option is the transformation of the Port of Nouakchott (the industrial zone and a surrounding area to be determined) into a special economic zone. The current zone regime foresees the expansion of port infrastructure, the development of a container terminal, the lengthening of the main wharf, and modernization of the port management and administration. More effective integration of the port and the industrial zone would potentially contribute to the development of port services, increasing port traffic and its income. The third option is the development of Bay of Nouadhibou integrated project. This project is under consideration and aims to transform the port, the city, and the peninsular region into a multi-activity hub. However, there is a need to upgrade the harbor and the bay by resolving the problem of numerous wrecks, to streamline the functioning of the port area and to ensure sustainable fisheries management and long-term performance. 45. The CEM recommends a strategic framework for defining national goals and evaluating options available for special economic zones. It recommends: · In Phase one, create a "Multisectoral Working Group on Special Economic Zones" force that brings together key institutions. It is recommended that this working group be created by decree adopted by the Ministry of Development and Economic Affairs before end-December 2009. In addition, it is recommended that the Ministry invite all the other concerned ministries and administrative agencies, such as the Ministry of Finance, the Ministry of Fisheries, the Ministry of Trade, Agriculture and Tourism, the Agency for Investment Promotion, the customs administration, the tax administration, etc. This working group would seek assistance by a technical partner and aims at implementing a strategic framework for special economic zones (Recommendation 5.1). o The Working Group would define the objectives and the options for the Government consideration, and make a list of the existing pilot projects that would be retained as defining the strategy. The key elements should include: (i) the economic development objectives, particularly regarding job creation, sought investment, the economic activities xx to be developed, and the private sector participation through public-private partnerships; (ii) initial identification of one or several potential sites and pilot projects; and (iii) pre- selection of one or several zones which would correspond to the objectives and the characteristics of one or several envisaged administrative and regulatory regimes. It is recommended that the proposed strategic framework be a short report which would include various programs on private sector development and the sectoral strategies. It is also recommended that the report contains a functional and sectoral matrix which contains the administrative and institutional pre-requisites. It is anticipated that the report elaboration require 6 months (5.1.1). o The report comprising the Working Group recommendations should be subsequently submitted for validation to the Council of Ministers and the options and/or pilot projects should be endorsed by the Council (5.1.2). o After deciding on the strategy, it is recommended to undertake studies to validate the options and/or the retained pilot projects. The pre-feasibility studies should include the following four analytical elements: (i) a competitiveness study for Mauritania focusing on the comparative advantages of Nouakchott and Nouadhibou areas compared to their regional competitors and complementing an investment climate study; (ii) an estimation of potential national, regional and international demand for the activities to be developed under the zone regime and/or the retained development sites; (iii) an estimation of the economic impact (costs and advantages) of potential demand, based on development scenarios corresponding to specific political choice and demand estimation results; and (iv) a detailed analysis of the regulatory, legal and institutional framework , including the envisaged revisions and developments, as well as of the necessary reforms to implement and manage the zone regime. These studies would require one year preparation. They should be developed under the leadership of either the Working Group or another coordination structure. In the latter case, the report produced by the Working Group should propose such a coordination structure to the Council of Ministers (5.1.3). 46. Following the completion of the pre-feasibility, a feasibility study should be undertaken if a real economic potential for developing a special economic zone has been identified. · In Phase two, the following analyses should be undertaken (5.2): o An analysis of land availability and a proposal to develop mechanisms for land acquisition necessary for the project; site selection, environmental and social impact studies, and compensatory measures (5.2.1). o An analysis of facilities and infrastructure needs and the design of implementation plans. estimate investment costs (facilities, infrastructure and development), including simulation of profitability based on the demand studies and the associated economic simulations (5.2.2). o An outline of a public-private partnership to finance the development and management of the projects (5.2.3). 47. With regard to the current draft Investment Code, it is recommended to (Recommendation 5.3.): xxi · Finalize the consultations on the Code before its publication, with technical support by FIAS in order to ensure its conformity with international standards (5.3.1). · Eliminate the articles on free zones and special economic zones from Chapter III.2 of the Code Replace articles 20 through 32 with a single article which would include a reference to the existence of a free zone/special economic zone regime without providing details on the associated regimes, fiscal incentives, etc (5.3.2). · Evaluate the provisions of the Investment Code based on the general corporate taxation rules. Leave the decision to formulate a strategic framework on special economic zones to the Multisectoral Working Group on Special Economic Zones/Free Zones proposed in this CEM. The necessary legislation should be subsequently implemented and should reflect the recommendations by the Multisectoral Working Group, national and international technical experts and governmental decisions (5.3.3). 48. Finally, the main issues, recommendations and priority actions in the four areas of this CEM are summarized below. xxii Matrix of the Main Issues and Recommendations Informal Economy and Taxation Timetable Challenges Specifc recommendations Stakeholders Implementation Coordinating Comments March June 2010 Dec. Dec. agency agency 2010 2010 2011 Lack of compliance with the Continue the simplification of the DGI fiscal rules tax regime : Reduce the withholding tax to X 1 percent, and eventually replace it with periodical down payments. Evaluate the impact of the X previous measure on revenues and, if satisfactory, eliminate completely the withholding tax. Further strengthening the tax DGI, DGI Under the administration: customs, assumption Implement a single fiscal X public buyers, that the number. banks strengthening Continue the training of the tax of the DGI administration agents. X information Strengthen fiscal inspections system and controls by: (mentioned in o Adopting an approach to X PRECASP) is fiscal inspections based on done taxpayers' perceived risk of evasion o Collecting the necessary X information for the risk approach o Improving the formal X framework of taxpayers' rights and guarantees as well as the appeal mechanisms. To encourage compliance of X DGI, DGI informal taxpayers, inform and train accountants, them through the media and specific business activities on: (i) simplified associations, procedures; (ii) system equity; and professional (iii) use of collected revenues by the associations xxiii Timetable Challenges Specifc recommendations Stakeholders Implementation Coordinating Comments March June 2010 Dec. Dec. agency agency 2010 2010 2011 State Establish the Centres de Gestion DGI, DGI Agrées (CGA) to support micro and accountants small enterprises in complying with the tax system: Define a functioning model (a X reduction of due tax amount for member micro-enterprises, CGA professional requirements/obligations). Define the accreditation X procedure for the CGA. Encouraging formalization by DGI, DGI creating links between increased tax Statistics compliance and improved access to Institute financing and access to public procurement, through: A compliance cost survey to X measure and better understand the compliance burden. This survey should cover both rural and urban areas. Measures to simplify start-up and operation procedures. X xxiv Labor market and skills mismatch Timetable Challenges Specific recommendations Stakeholders Implementation Coordinating Comments Dec. March June Sept. agency agency 2009 2010 2010 2010 Limited information and data on Complete the informal sector studies X MEFP Resource the informal sector in the urban areas and extend them to mobilization for the rural areas the studies is important Reinforce the capacity of X MEFP/ MEFP The World Bank employment institutions in order to Employment could finance strengthen their contribution to Directorate technical diminishing the unemployment rate. assistance Low level of human capital, lack of Include the teaching of practical, X IPN/IGEN Activity to skills and skills mismatch thinking and behavioral skills in the include in the education programs. PNDSE II Transmit the national strategy on X skills development for comments to the technical and financial partners. Review international good practices X MEFP and case studies on skills mismatch xxv Competition Policy Timetable Challenges Specific recommendations Stakeholders Implementation Coordinating Comments March Dec. June Dec. agency agency 2010 2010 2011 2011 Lack of sectoral data to guide Map the interplay between the X Ministry of Justice Ministry of Trade Ministry of A working the strategic framework for existing legal system and the Market Trade group would be fighting anti-competitive economic, institutional, political Surveillance MAED set up until end- practices and social structures in Mauritania Committee November 2009 Regulatory agency to prepare a for telecom, competition Identify key sectors (for example, X electricity and policy strategy cement, consumer goods, food water products, network industries) to CMAP The working develop industry case studies Ministry of group will Develop industry case studies in X Industry identify priority the identified sectors Chamber of sectors and Commerce undertake the Traders recommended Association studies Employers Association Consumers' Association Prime Minister's Office Agency for Private Investment Definition of the strategic Design a competition policy X Ministry of Justice Ministry of Trade Ministry of guidelines (advocacy and/or strategy: Economic and Trade law implementation), Finance MAED strengthening the appeal Commissions of mechanism (the reform of the Parliament judiciary is key) Improve (for example, X Ministry of Justice Ministry of Trade Prime through a specific competition Economic and Minister's law) and develop the legal Finance Office/ Slow process to enact a framework by adopting and Commissions of Ministry of specific competition law implementing secondary the Parliament Trade legislation Lack of budgetary and human xxvi Timetable Challenges Specific recommendations Stakeholders Implementation Coordinating Comments March Dec. June Dec. agency agency 2010 2010 2011 2011 resources; slow administrative Establishing an independent X process; lack of real competition agency body (for operational independence example, by rendering the Market Surveillance Committee operational) in order to apply the competition law Undertaking capacity building X The to focus, for example, on implementation policy advocacy and price of advocay fixing agreements, as well as activities will on the implementation of be possible public awareness campaigns when the and education programs. competition authority becomes operational. Advocacy activities could be one of the main components of the competition strategy Lack of data Build an inventory of all X Ministry of Trade Ministry of Ministry of government aid measures that Finance/MAED Finance/MAE might distort competition by D granting specific advantage to certain industries or companies Significant administrative Create a legal framework to X Ministry of Trade Ministry of Ministry of costs, legal and institutional establish clear criteria and Competition Finance/MAED Finance/MAE reforms evaluation mechanisms, reporting Agency (for D and monitoring procedures, example, the particularly for measures in Market sensitive sectors and special Surveillance economic zones Committee xxvii Timetable Challenges Specific recommendations Stakeholders Implementation Coordinating Comments March Dec. June Dec. agency agency 2010 2010 2011 2011 Endow the independent X Competition Agency /another institution with powers to administer and enforce the government aid control program., including adequate financial and human resources to develop expertise Design communication campaigns X and education programs to promote the rationale and the fundamentals of such a program among government representatives, judiciary, private sectors and the general public xxviii Special Economic Zones/free Zones Timetable From July Implementing Coordinatin Challenges Specific recommendations Dec. March June Stakeholders Comments 2010 - agency g agency 2009 2010 2010 June 2011 Incorporation and definition of Finalize the consultations on the Code MAED, MAED MAED Consultation free zones and special economic before its publication concerned of financial zones in the Investment Code Ministries and technical X partners is recommended, including FIAS Finalize the consultations on the Code MAED, MAED MAED before its publication, with technical ministères support by FIAS in order to ensure its concernés conformity with international standards. Eliminate the articles on free zones and special economic zones from Chapter III.2 of the Code Replace articles 20 X through 32 with a single article which would include a reference to the existence of a free zone/special economic zone regime without providing details on the associated regimes, fiscal incentives, etc. Evaluate the provisions of the Investment Code based on the general X corporate taxation rules. Absence of a strategic framework Create a "Multisectoral Working Group MAED, MAED MAED Required defining the objectives and the on Special Economic Zones" force that concerned technical options brings together key institutions. It is Ministries and assistance to recommended that this working group administrative establish the be created by decree adopted by the X bodies list of Ministry of Development and Economic concerned Affairs before end-December 2009. In Ministries and addition, it is recommended that the administrative Ministry invite all the other concerned bodies ministries and administrative agencies, xxix Timetable From July Implementing Coordinatin Challenges Specific recommendations Dec. March June Stakeholders Comments 2010 - agency g agency 2009 2010 2010 June 2011 inter alia : Ministry of Finance, Ministry of Fisheries, Ministry of Economy. Definition by the Working Group of the MAED, MAED MAED Required objectives and the options for the concerned technical Government consideration, drafting a Ministries and assistance to list of the existing pilot projects that administrative facilitate the would be retained as defining the bodies development strategy. The key elements should of the strategic include: framework economic development objectives, particularly regarding job creation, sought investment, the economic activities to be developed, and the private sector participation through PPP; initial identification of one or several potential sites and pilot projects; X pre-selection of one or several zones which would correspond to the objectives and the characteristics of one or several envisaged administrative and regulatory regimes. It is recommended that the proposed strategic framework be a short report which would include various programs on private sector development and the sectoral strategies. It is also recommended that the report include a functional and sectoral matrix which contains the administrative and institutional pre-requisites. xxx Timetable From July Implementing Coordinatin Challenges Specific recommendations Dec. March June Stakeholders Comments 2010 - agency g agency 2009 2010 2010 June 2011 Submit the report comprising the MAED, MAED MAED Working Group recommendations and Council of X the options and/or pilot projects for Ministers validation to the Council of Ministers Undertake pre-feasibility studies to Lack of economic analyses validate the options and/or the retained Structure to Hiring of identifying the opportunities and pilot projects. The pre-feasibility studies manage the international risks associated with the SEZ/FZ should include: studies; it consulting A competitiveness study for could be companies Mauritania focusing on the integrated comparative advantages of within MAED Nouakchott and Nouadhibou areas compared to their regional competitors and complementing an investment climate study; X An estimation of potential national, regional and international demand for the activities/products to be developed under the zone regime and/or the retained development sites; An economic analysis; A detailed analysis of the regulatory, legal and institutional framework. xxxi 1. MAURITANIA'S ECONOMIC GROWTH HISTORY Mauritania is a country blessed with natural resources, such as iron ore, copper, oil and fisheries. Since independence, the economy has increasingly relied on the extractive industry, which has generated a high stream of revenues. Until recently4 the macroeconomic performance had been satisfactory. Outside mining and oil, trade and services have had an increasing contribution to GDP since the 1990s. Agriculture contribution to growth has been small and shrinking, while the manufacturing sector has not succeeded to take off. The potential to develop a sustainable, diversified economy outside natural resource exploitation is high, but the country needs to continue reforms to addresses critical constraints to growth that hamper private business development. This chapter takes stock of the economic, social and political characteristics of the country, highlighting the country's structural shifts towards natural resource exploitation to the detriment of other value-adding activities. It discusses the main constraints to growth and sets the stage for the analysis that follows in the other chapters, which focuses on (i) the role of taxation to promote formalization, (ii) skills development to improve labor productivity, (iii) competition policy as a means to address anti-competitive market conduct; and (iv) the establishment of a special economic zone as an instrument to close infrastructure gaps and promote investment climate reforms. A. BRIEF HISTORY OF MAURITANIA'S GROWTH 1.1 Since gaining independence from France in 1960, Mauritania's economy has been driven principally by a high and sustained rent stream from iron ore, fisheries and foreign aid, while the potentially strong contribution of the agricultural sector to the early stages of economic growth has been limited. The significant rent stream helped maintain a relatively high ratio of investment to GDP, averaging 21.2 percent during 1970 ­ 2004 (World Development Indicators, 2008). Data on economic growth for the first decade after independence indicate that per capita GDP grew on average at 5.7 percent annually through the 1960s due to the start-up of a large and remote iron ore mine on the northern border (see Table 1 in Annex 1). This boosted the average annual growth rate in GDP per capita for the entire period since independence, but only to just over 1 percent. Whatever real GDP growth occurred prior to the recent oil-related construction boom therefore appears to have occurred in the early-1960s and average GDP per capita has subsequently stagnated, so that Mauritania remains a low-income country, with 3.1 million people in 2007. 1.2 Mauritania's revenues from iron exploitation and fisheries were remarkable for their duration and size, while agriculture growth was limited. Agricultural growth was lackluster (barely 1 percent per annum through the 1960s), and the start-up of the iron ore mine launched the Mauritanian economy on a rent-driven growth path in the early-1960s. The reliance on revenues from iron exploitation and fisheries may have contributed to the neglect of other sectors, including agriculture. The sustained distortion of the production structure of the Mauritanian economy, and most notably the minimal commercialization of the agricultural products, repressed an important early market for domestic businesses, namely the demand from 4 There is no up-to-date macroeconomic data since August 2008. 1 prospering farmers and herders for simple consumer goods and inputs. World Bank data indicate that rent from iron ore averaged 24.2 percent of GDP annually through the 1970s (see Table 1 in Annex 1).5 The early reliance on rent, first from iron ore, was consolidated by a rise in foreign aid in response to the acute drought that commenced in the 1960s to around 2.5 percent of GNI, and was subsequently further augmented by an expansion of fisheries rent. Mauritania opted to rely on revenues from its fisheries by licensing foreign access rather than by expanding domestic production (Auty and Pontara, 2008). At times the total revenues (from iron mining, fisheries and foreign aid) reached 40 percent of GNI and rarely fell below 30 percent (World Development Indicators, 2008). 1.3 Meanwhile, the 1969-74 drought prompted many rural families to migrate to the cities, notably Nouakchott, contributing to the dependence of those on rent. The migration from rural to urban areas led to the population expansion of Nouakchott from negligible size at independence to more than one-quarter of the population by the mid-2000s. When rainfall conditions eventually improved through the late-1970s, many migrants remained in the city supported by the expansion of foreign aid which went beyond its objective of easing the immediate severity of the drought crisis. Mauritania sustained the highest flow of aid relative to GNI at on average 19 percent, with Mali next with 15 percent, in 1960 ­ 2004. This is not surprising given that rural growth options were severely constrained by inadequate road transport within the main crop-growing area of the Senegal Valley and also between there and Nouakchott, the country's principal market and port. (Table 2 in Annex 1). Macroeconomic Outlook and Sector Performance 1.4 Macroeconomic performance has been satisfactory in 2007-08 despite the decline in oil production after 2006 and the impact of external shocks, such as food price volatility. The construction of the offshore oil production facilities and two new gold mines (which benefited from booming mineral prices) accelerated Mauritania's rate of economic growth through the mid-2000s. Due to technical difficulties related to oil exploitation, real GDP growth was 1 percent in 2007 and expected to have reached 5 percent in 2008 (stood at 11.4 in 2006). Nonetheless, the non-oil GDP growth rate represented 4.1 percent in 2006 and 5.9 percent in 2007 (and expected to have reached 5.7 in 2008), mainly linked to an increase in agricultural and mining projects (see Table 1.1). Furthermore, the economic reforms pursued in response to the revelation of the flawed National Accounts6 have shown positive results including a near- doubling in foreign exchange reserves. The foreign exchange reserves are estimated to have covered 1.9 months of annual goods and service imports by the close of 2007. A fall in inflation was, however, reversed by the rising cost of food through 2007-08 (7.3 percent, period average). Part of this was passed on by the government to consumers and triggered street disturbances. As a response, the authorities adopted additional fiscal measures in the 2008 budget to alleviate the social impact of price increases, while maintaining the non-oil fiscal balance unchanged (IMF, 2008). 5 Data are not available for the 1960s. 6 In 2004, it was revealed that, under the Taya regime, the Central Bank financed unofficial public expenditures in the early-1990s, which distorted the National Accounts. 2 Table 1.1: Recent Economic Performance in Mauritania, 2004-08 2004 2005 2006 2007a 2008a Real GDP growth 5.2 5.4 11.4 1.0 5.0 Real (non-oil) GDP growth (%) 5.2 5.4 4.1 5.9 5.7 CPI (period average, %) 10.4 12.1 6.2 7.3 12.5 Current account balance (% of GDP) -34.6 -47.2 -1.3 -11.4 -6.3 Overall fiscal balance (% of GDP), incl. grants -4.8 -7.1 46.0 -2.0 -3.9 Gross official reserves (in months of imports) 0.6 1.1 2.6 1.9 2.8 GDP per capita (US$) 541 658 938 952 1,196 Nominal GDP (US$ million) 1,493 1,857 2,699 2,819 3,625 a / projections Source: IMF, 2008. 1.5 The reliance on revenues from natural resource exploitation may have contributed to the neglect of other sectors. On average, the share of agriculture in GDP has attained a mere 3.7 percent of GDP during 1991 ­ 2008. Livestock has had a more stable and significant contribution to growth ­ an average of 13 percent of GDP during 1991 ­ 2008, but the sector has been shrinking since 2000, attaining 11 percent of GDP in 2008. In spite of the fact that industrial fishing has been the main growth engine in the early 1990s, the sector contribution to GDP has been significantly declining since the late 1990s as a result of deteriorating conditions of the domestic fleet and increasing competition from foreign fishing companies. Small industries and crafts represented on average 7 percent of GDP during 1991 - 2008, but their contribution to GDP has shrunk since 2000, highlighting the decline of manufacturing. Failure to create a prospering agricultural sector and the demand for domestic goods partly explains why manufacturing in Mauritania has not registered a more sustained growth over time. Trade, transport and communications and other services have had an increasing contribution to growth since the 1990s ­ an average of 10.7 percent of GDP, 4.9 percent and 11.0 percent, respectively during 1991 - 2008. This may suggest that income inequality has skewed aggregate domestic demand towards more sophisticated goods that tended to be imported and has nurtured trade monopolies rather than domestic production. 1.6 The sharp surge in GDP growth arising from the start-up of the Chinguetti oil field in 2006 abruptly reversed in 2007 due to unexpected difficulties rooted in the geology of the new field, but two gold mines helped sustain the growth stimulus. Actual oil production fell well short of the original oil revenue scenario, which assumed that production would commence in March 2006 from the first of three fields with an estimated 310 million barrels of reserves, then plateau at around 75,000 barrels per day (bpd) and taper off over fifteen years. Unexpected geological difficulties cut the oil flow from the first field to only 36,000 bpd during 2006 and then 15,000 in 2007, well below the original projections (IMF, 2008). Despite the disappointing drop in oil production in 2007, the expansion of new mining projects and a good harvest in that year sustained economic growth within the non-oil sector.7 Construction commenced on the Tasiast gold project in November 2005 and production started in 2007 (World Bank, 2006). The reserves are initially expected to support a mine life of 8 years.8 The production of the second 7 The mining sector represented on average 12.6 percent of GDP during 1991 ­ 2008. 8 Tasiat is projected to produce on average 3.25 tons of gold annually at 3.1gms of gold per tonne of ore with a cash operating cost of US$240 per ounce. The mine is economically viable at a price of US$370 per ounce and at 3 mine for copper/gold commenced in 2006 with a planned life of 9 years, which once again can be extended.9 1.7 The relatively low foreign direct investment (FDI) level is testimony to the lack of investment opportunities outside natural resource. FDI flows10 in Mauritania were relatively low in 2000 ­ 2003, merely exceeding an average of US$60 million, and falling behind those attracted by Côte d'Ivoire (on average US$240 million) or Mali (on average US$149 million) in the same period. However, in 2003-2005 FDI flows registered a sudden spike mainly associated with investment in natural resource exploitation (US$814 million in 2005), followed by a sharp decline in the FDI flows in 2006 ­ 2007 as result of technical problems with the oil exploitation and the lack of viable opportunities in other sectors of the economy. FDI flows in Mauritania during 2006-2007 were lower (on average US$154 million) than those in Burkina Faso (on average US$317 million), Côte d'Ivoire (on average US$319 million) and Mali (on average US$222 million) (see Figure 3 in Annex 1). Outside oil, FDI targeted financial, air transport, and the telecommunications sector. The other sectors received virtually no FDI. 1.8 Moreover, the Mauritanian exports are limited due to firms' low competitiveness in international markets. Capital intensity and productivity of Mauritanian firms are weak. The invested capital per employee is on average US$1,950 compared to almost US$3,500 in Botswana, US$5,000 in Senegal, US$5,500 in China, and US$6,600 in South Africa. The value added of invested capital is 190 percent, compared to almost 220 percent in China and more than 400 percent in South Africa. Furthermore, only 16 percent of the manufacturing firms export part or all of their production, compared to 46 percent for Senegal, 52 percent for China, and 61 percent for South Africa (see Box 1.1) (ICA, 2007). US$600 it could double the total output by exploiting ore with 2.25 g/tonne purity, extending the life of the mine to 15-20 years. 9 The initial resource base comprises 18.2 million tons of sulphide ore grading 1.8 percent copper and 1.4g/t gold. The mine will produce 30,000 tons of copper concentrate per annum and a further 470 kg per annum of gold doré. 10 Typically, attractiveness of economic conditions (market size, income levels, resources, location, labor availability, skills and costs, physical infrastructure, supplier base and technology support), the policy framework towards the private sector, trade, industry, and FDI and its implementation (macro policies, private ownership, financial markets entry/exit policies, trade strategy, competition policy, support for SMEs, FDI policies), and the investment strategies of multinational enterprises (risk perception, location, sourcing, integration transfer) are key determinants and factors associated with the extent and pattern of FDI. 4 Box 1.1: Mauritania's Industrial Sector Structure A UNDP study on Mauritania's industrial strategy (2002) identified the weaknesses in the country's industrial sector and the extent to which its structure is biased toward exporting unprocessed natural resources and rent seeking. The report pinpoints four demographic groups of industrial companies, each with particular characteristics, as follows: · Very large export companies, which exploit the country's natural resources (iron, industrial fishing, gold, copper, and oil). At the time of the study, these companies, which do not rely on the domestic market for their capital needs, represented almost 20 percent of GDP. · Substitution companies, whose activities are geared to the domestic market. Typically, these companies are associated with, or part of, a corporate network that includes one or more commercial companies and a national bank. These companies are oligopolistic, with more or less direct control by the main national banks as a vital component. These companies only represented about 4.5 percent of GDP. · Proto-industrial companies, which were created just before the industrialization process began. Typical activities of these companies include ironworks, small printing presses, small construction workshops, etc. These companies represent the largest demographic group, with an estimated total of about 3,000. The main portion of industrial employment is in this group, with an estimated total of 50,000 ­ or an average of 16 employees per company. It is estimated that this represents about 60 percent of the urban manpower. Typically, these companies work either entirely or partially in the informal sector. Therefore, they are largely immune to fiscal pressure, though they do face serious financing difficulties. The study does not provide an estimate of their contribution to GDP. · Very short term subsistence activity, defined in the report as being "local and craft services - the very small scale direct processing of raw materials." These businesses operate entirely in the informal sector and have no access to financing other than microcredit and direct support. Although the study does not provide an estimate of their contribution to GDP, the probable contribution of the last two groups is less than the first two but is vital to the country's economy and employment. In any case, it is probably greater than indicated by the official statistical data. Source: UNDP, 2002. 1.9 The endowment with natural resources may not necessarily be a "curse" for Mauritania, provided it uses revenues from natural resource exploitation to stimulate economic diversification and promote a business enabling environment, including adequate institutions. Empirical research suggests that countries with large natural resource wealth tend to lag behind comparable countries in terms of real GDP growth (Sachs and Warner, 2001), quality of institutions and governance (Sala-i-Martin and Subramanian, 2003) and social indicators. Nevertheless, "the natural resource curse" is not necessarily a fatality for Mauritania. The revenues from natural resource exploitation, if well managed, may support the emergence of other value-adding activities. Countries, such as Indonesia, Chile, Botswana, South Africa and Malaysia, have managed to build institutions and sustain growth while decreasing their dependency on natural resource revenues (World Bank, 2006). This suggests that the creation of a competitive market outside natural resource exploitation backed by reforms to promote a business enabling environment is one possible solution to avoid overreliance on transfers from natural resource exploitation and to reduce rent-seeking activities. 1.10 Agriculture is one of the sectors with growth potential, particularly cropping and livestock herding. Mauritania's irrigated area retains the potential to boost both productivity and farm incomes by orders of magnitude, while livestock rearing is also capable of at least doubling productivity (World Bank, 2006). The remarkably limited scale of commercial agriculture relative to GDP (8 percent in the early-2000s) contributed to keep around 60 percent of the rural population in poverty. Cropping and herding were estimated to have contributed around 2.6 percent and 11.6 percent of GDP, respectively in 2007, although the distribution of the 5 employment share between cropping and herding is reversed, with cropping having employed in mid-2000s more than 40 percent of the workforce in rural areas, while livestock herding only 11 percent (EPCV, 2004). The main drawbacks in the agriculture sector are the lack of good irrigation systems, not only waters and canals, but also rural roads to transport inputs (seeds, fertilizers, pesticides) and crops to enable the marketing of final products in a timely manner. The performance of the sector also suffers from the lack of inputs, technical and productivity skills and sanitary standards. 1.11 Although agro-processing, the production of soft beverages and by-products of livestock (red meat, skins) may offer promising value-adding opportunities, the manufacturing sector has not emerged to its full potential. This is due, on the one hand, to the small size of the local domestic market which did not generate a strong domestic demand and, on the other hand, to market distortions such as the absence of more commercial farm production, the limited access to finance, the unreliable infrastructure, the lack of skilled workers, scarce industrial entrepreneurial experience and the existence of import monopolies (World Bank, 2006). For example, two plants (a combined capacity of 50,000 tons) ensure the domestic dairy production, but they do not use their full capacity. This is mainly due to the control of domestic sales by import monopolies. Similarly, only one local firm produces syrups, the rest of soft drinks commercialized in Mauritania being imported. Domestic and international demand also exists for by-products of livestock, such as red meat and animal skins. For example, the FAO projections for red meat envisage a domestic demand of 96,000 tons and a projected domestic consumption of 19 kg/person/day in 2015. The national production is estimated to reach 130,000 tons, yielding a surplus of 34,000 tons that could be exported (CMAP, 2005). 1.12 In addition, fish processing industry is little developed. The existing fish processing units (around 60) have low capacity utilization (30 percent) due to limited local landings. The fisheries role may be expanded. More than 90 percent of the fish caught in Mauritanian waters is exported and the activity of foreign vessels dominates the sector. Industrial and artisanal fishing employ around 4,000 and 11,000 people, respectively. Fish processing in Mauritania is limited, hampering the increase in the local value added. In addition, the local industrial fishing fleet is obsolete, facing competition from foreign modern vessels. The potential of developing local fish processing exists, provided that reforms are taken to improve the current port and transport facilities for industrial and artisanal fishing, to modernize the Mauritanian fleet and to develop an artisanal fishing port in Nouakchott or Nouadhibou (World Bank, 2006). 1.13 Trade and services have made the most significant contribution to GDP in the past twenty years and continue to retain growth potential, especially tourism. Ten large industrial and commercial groups dominate the Mauritanian domestic and foreign trade and services, particularly the trade of cereals, rice, sugar, fisheries, construction materials, hotels and financial services. Most of these groups include a bank in their structure and engage in partnerships with foreign companies (mostly in the agro-business and fisheries), being the main investors in the country. At the other end, there are many individual, informal traders of consumers' goods, and a limited emerging class of small and medium-sized entrepreneurs that mostly provide services and suffer from limited access to finance. Tourism has growth potential, and could expand to 100,000 visitors by 2015, which may imply a contribution equivalent to 8 percent of GDP. The main attractions are the scenery, which can be viewed by a mix of desert walks, camel rides and motoring, and the ancient oasis towns (the town of Chinguetti; the oasis centre of Atar). The 6 number of OECD visitors expanded from 1,000 in 1996 to 12,000 during 2003-2004 before dropping by around 20 percent in response to domestic political uncertainty. Given that tourism rely on modest lodges and tents, as opposed to the large-foreign owned hotels associated with mass tourism, it has the advantage of easing entry by local firms and also attracting some higher margin tourists (see Box 1.2) (World Bank, 2006). Box 1.2: Morocco's Experience with Developing Agriculture and Tourism Agriculture is a leading sector of the Moroccan economy and it can contribute from 14 percent to 18 percent of the GDP according to years. The areas under cultivation include arable lands and those with permanent crops. They represent 9,661,000 hectares. Agricultural development in Morocco has been dominated by investment in irrigation for more than 70 years. In 1977, two-thirds of Morocco's population was rural, and virtually all of Morocco's 1.2 million private land owners were rainfed farmers. Rainfed farms produced 76 percent of crop production by value, and almost all of livestock production. Some 75 per cent of rural poor people depend on agriculture for a livelihood. Yet many of them have access to only a limited amount of non-irrigated arable land, which has a poor agricultural potential. Because farmers often do not have formal title to land, it is difficult for them to obtain credit to start activities that diversify their sources of income. The goal of Morocco's long-term 2020 strategy for rural development is now to correct regional and local imbalances and develop and optimize natural resources. Its objectives are to: (i) increase agricultural production; (ii) increase opportunities for agricultural employment and income; (iii) create and diversify employment in off-farm and non-farm activities; (iv) halt environmental degradation; (v) improve education and professional training for rural women and men; (vi) improve services related to the quality of life and well-being; and (vii) correct regional and local imbalances in infrastructure and regional development. The approach gives preference to grass-roots initiatives and to participation and accountability of rural communities and local partnerships. The country's new Green Morocco Strategy will implement an agricultural policy that has as its aims: (i) a competitive upgrading of the agricultural sector in terms of modernization, integration into the world market and creation of wealth for the whole value chain; (ii) an approach that takes into account the whole sector and its sociological and territorial components, giving priority to human development; (iii) optimization and sustainable management of natural resources; and (iv) definition of the support policies needed for sustainable growth Morocco has a long-term tourism development strategy and has recently highlighted its flexibility by introducing a new program to supplement "Vision 2010". The 10-year plan has been largely successful, but given that it is nearing its conclusion, the government has launched "Cap 2009" to retool the sector's objectives and pump cash into the market in preparation for the upcoming launch of Vision 2020. Taken together, the two plans aim to boost arrival numbers, upgrade infrastructure and increase the quality of human resources. The number of tourists rose by 69 percent between 2001 and 2007, and another 7 percent from 2007 to 2008, bringing the total arrivals to around 7.9 million. Hotel construction has been keeping pace with the increases and total bed capacity has already increased more than 47 percent since the start of the plan. Since tourism attracts more investment and contributes around 6 percent to the GDP annually, the government is taking proactive measures to ensure that this momentum continues, even during the downturn. With tourist receipts decreasing by 3.5 percent, from 58.67 billion Dirhams in 2007 to 56.6 billion dirhams in 2008, Cap 2009 will seek to use internet marketing to expand the arrivals base beyond the traditional European markets. The program will receive a budget increase of 10 percent in 2009 to facilitate the entry into new markets, particularly Eastern Europe, Russia, the Gulf and China. Domestically, Cap identifies Marrakech, Fez, Casablanca and Agadir as priority regions, which is consistent with the country's promotion of high-end cultural and beach tourism. The component Plan Azur, Plan Biladi and Plan Madain are aiming to develop resorts, bolster domestic tourism and showcase the country's cultural destinations, with the Plan Azur expected to be the linchpin of the three, as Morocco looks to capture some of the lucrative regional resort market. Source: World Bank; IFAD, Oxford Business Group, 2009. 1.14 Despite the existing potential to develop productive sectors, the natural resource- driven growth could have inflicted the Dutch disease effects on the economy.11 The real effective exchange rate appreciated between 2004-2007, followed by a depreciation in 2007. The depreciation of 2007 coincides with the drop in oil revenues after 2006. At the same time, the 11 The 2006 CEM also noted that the Dutch disease effects may have affected the economy, in particular the growth of the Mauritanian agricultural sector. Comparing Mauritania with Chad ­ which has a similar per capita oil reserves ­ the latter embarked on oil-driven growth with stronger oil revenue absorptive potential than Mauritania. 7 tradable sector has not developed substantially beyond the traditional iron and fish exports. Therefore, the currency appreciation could have slowed down the expansion of agriculture and fish processing. The natural resource-driven growth, coupled with significant inflows of foreign aid and the decline of agriculture, may have also fueled the expansion of the service sector (an average of 20.4 percent of GDP during 2004-2007) more than expected for a country like Mauritania. The Dutch disease effects may be pervasive for Mauritania as they make imports of goods cheaper, boosting real wages to higher levels. This may hurt export competitiveness, especially because Mauritania has a small manufacturing sector and exports only few products. Nevertheless, the recent real exchange rate depreciation may create the conditions for catching up with the loss in competitiveness of the tradable sector, provided that Mauritania also promotes an enabling environment for private investment development. 1.15 The future is, however, uncertain and will depend on the economic and political evolution following the coup of August 2008 as well as the global slowdown. Before the political crisis of August 2008 it was envisaged that non-hydrocarbon minerals extraction (copper and gold) along with fisheries and a planned expansion in public investment drawing on donor pledges would drive economic growth through 2011 at a projected annual GDP growth rate of 6 percent. The start-up of the second and third of the three initial oil fields, previously delayed from 2010 to 2012, was projected to result in oil production that would peak at 62,000 bpd in 2014 before tapering off by 2027. Nevertheless, the materialization of this scenario is now uncertain given the political and economic developments in Mauritania and as well as economic developments around the world. B. POLITICAL AND CULTURAL ASPECTS 1.16 Mauritania has undergone several episodes of political unrest. Mauritania is no exception to the fact that extra revenue from rent has insulated successive governments from political accountability by reducing reliance on other sources of taxation and providing a source of patronage with which governments can maintain the support of the elite. The rent from mineral extraction largely accrued to the government rather than being dispersed across many economic agents, which further limited an effective built up of savings and investments.12 Moreover, Mauritania's rent-driven growth has also sustained autocratic regimes that, until the coup of 2005, for long periods neglected rural interests. The country's first leader, Ould Daddah was removed by a military coup in 1978, which ushered in periods of political instability. The displaced leader in 2005, Taya, had himself staged a successful coup in 1984 and established the Parti Républicain Democratique et Social (PRDS) to legitimize the military regime. Taya built a political alliance of powerful Arab-Berber groups, prominent businessmen and some of the ruling black African elites to form the backbone of PRDS (Jourde, 2001). Taya used intra-tribal and inter-religious rivalries to divide and rule (N'Diaye, 2006). Tribal solidarities and conflicts were important and tribal identity revived with the wave of democratization and economic reform of the early-1990s, which Taya embraced (Ould Cheick, 1994, Marchesin, 1994). 12 The literature suggests that dispersed economic linkages like those from small-scale farming confer substantially greater growth benefits than concentrated linkages, which are associated with mines and plantations (Baldwin, 1956, Mellor, 1976, Bevan et al., 1987, Engerman and Sokoloff, 1997 and Isham et al., 2005). 8 Overall, the Mauritanian political regime remained based on neo-patrimonialism, a system that channeled rent in return for loyalty and dependence within a formal political and administrative system. The system rewarded tribal leaders for their support with positions in government and key sectors of the economy that conferred access to public resources with which they could reward their constituencies (Marianne, 2001, Ould Ahmed Salem, 2000). Legislative and presidential elections were held in 1992, 1997 and 2003. Taya won each presidential election comfortably while his PRDS party reinforced its domination. Whatever the outward appearance, however, control of rent allocation allowed Taya's regime to function as a military oligarchy within an outwardly multi-party system (Marianne, 2001). Policies under Taya's regime delayed critical reforms. Evidence emerged in 2004 of large extra-budgetary unofficial public expenditures from the early-1990s that were financed by the Central Bank and resulted in less than one-tenth of the official reserves of US$432 million being confirmed.13 This tarnished the government's reputation for sound macro management and delayed critical second generation economic reforms including banking, foreign exchange transactions, and governance capacity building, causing the International Financial Institutions (IFIs) to scale back assistance. 1.17 Despite several reforms initiated in 2005 Mauritania continued to experience political unrest, which culminated with the coup of August 2008. Faced with the risks of an external imbalance and rising inflation, the Taya government commenced reforms that were strengthened by the new military regime in 2005. Elections were held for the legislature in November 2006 and for President in March 2007, which saw a former central bank governor, Sidi Mohamed Ould Cheikh Abdallahi, assume office. Unfortunately, conflicts between the executive and legislature destabilized the political climate in 2008. On August 6, 2008, a military junta led by General Mohamed Ould Abdel Aziz perpetrated a coup, which overthrew President Abdallahi in response to the president's efforts to replace the military leadership. Following the coup, General Abdel Aziz became President of the High Council of State. The international community condemned this undemocratic change in power, and requested the Mauritanian leaders to restore the constitutional order in the country. Following the elections in July 2009, General Abdel Aziz became President and a new government was appointed. C. SOCIAL ASPECTS AND POVERTY TRENDS 1.18 The shifts in population since independence have been associated with a significant change in the nature of Mauritania's endowment of social capital. In place of the self- sufficiency encouraged by the early reliance of the vast majority on herding and subsistence agriculture, the subsequent rural-urban migration prompted many of the new urban residents to rely on the hospitality of relatives and to wait for access to the political patronage system and informal employment. The extended family social system required successful urbanites to redistribute income to their kin who were less fortunate. The social safety net afforded by the extended family faces growing strain as wealthier urban residents find their obligations to the less fortunate increasingly onerous. Such concerns exert pressure on the government to distort policy to prop up this impromptu social safety-net, as with a recent 10 percent rise in civil 13 Investigations revealed that the unreported extra-budgetary spending under the Taya government had pushed public expenditure to 44.5 percent of GDP in 2003 incurring a fiscal deficit of around 6.5 percent of GDP (IMF, 2008, 23). The practice was not disclosed to the IFIs for a decade and its discovery then necessitated the recalculation of the National Accounts. 9 service wages in response to higher food prices during 2007-08. Whatever the policy consequences, the deployment of rent over the decades has helped to transform Mauritania's social capital from a self-sufficient one into a dependent one. 1.19 These socio-economic trends have been associated with high income inequality and disappointing progress in the accumulation of human capital. In recent years the GINI coefficient fluctuated and the most recent estimate is around 0.39 for 2004 (World Bank, 2008a). Low rural incomes make a significant contribution to overall income inequality, but inequality is higher in urban areas, with 59 percent of the rural population classified as living in poverty compared to 29 percent in the cities. Overall, 47 percent of the population lived in poverty in 2004. Mauritania ranked 137 out of 177 countries according to the Human Development Index 2007. Moreover, the hike in inflation caused by the upward evolution of international food prices in 2007-08 is likely to have had adversely affected poor households and increased the share of population living below the poverty line (IMF, 2008). 1.20 Despite a sustained high level of total government expenditure relative to GDP, Mauritania has spent insufficient resources on education in recent years. The education expenditure represented on average 3.6 percent of GDP in 2002 ­ 2006. Low human capital and lack of skills find their roots in low schooling enrolment rates. Also, Mauritania has very low alphabetization rates. Approximately 44 percent of the population never went to school and, among the group who did, 35 percent have attended at most primary school (National Household Survey, 2004). Moreover, the retention rates beyond the fifth year in school dropped from around 78 percent in 1990 to 44 percent in 2006 (World Bank, 2008d). Meanwhile, although female primary school enrolment matched that of boys, substantially fewer girls continued secondary education due to traditions regarding household duties and early marriage. Overall, levels of professional training in Mauritania remain inadequate to meet the needs of public and private sectors.14 1.21 Mauritania fares somehow better compared to its regional peers with regard to health, although it deploys a smaller fraction of its GDP on this sector (2.5 percent of GDP in 2001 - 2005). Life expectancy had risen to around 53 years in 2006, compared with 56 in Senegal, 47 in Mali and Burkina Faso and 44 in Niger and Chad, the region's laggards. However, infant mortality at 120/1,000 was 50 percent above that of Senegal and little different from Burkina Faso, Mali and Niger despite their substantially lower per capita incomes; under-five mortality remained high in Mauritania at 184/1000 and one-third of children were malnourished (WHO, 2006). A feature common to Mauritania's human capital indicators and its poverty indices is for rural areas to be lower than the national average. D. CURRENT INVESTMENT CLIMATE: IMPLICATIONS AND COSTS FOR GROWTH Policy Reforms to Create an Enabling Business Environment 1.22 In Mauritania, successive governments over the last 20 years have recognized that the private sector must play a greater role in the economy. It is also widely accepted that the 14 See Chapter 3 for a detailed analysis of the labor market characteristics and the drivers of low human capital. 10 country's productive base must be diversified and the dependence on income from mining reduced. In order to achieve this, and for the private sector to be able to play the expected role, the government must press on with its business environment reform effort. 1.23 Mauritania has initiated a series of reforms, in particular it has introduced trade reforms over the last two decades. They have led to (i) the removal of non-tariff barriers and quotas; (ii) the elimination of import and export licenses; (iii) the streamlining and reduction of rates; (iv) the elimination of customs exemptions; and (v) the modernization of procedures. All customs duties are now ad valorem, which increases the transparency of the tariff system. The number of tariffs decreased from 13 in 1997 to 4 in 2000, while the maximum nominal tariff decreased from 30 to 20 percent. In 2006, the average weighted tariff was 9.8 percent for manufactured products and 3.5 percent for agricultural products, lower than the correspondent figure for Senegal (10.9 percent and 9.1 percent, respectively) and Mali (11.9 percent and 8.3 percent, respectively) (ICA, 2007). 1.24 Regulatory and administrative reforms have also been initiated. One important reform is the proposed reform of the 2002 Investment Code.15 The 2002 Investment Code is regarded as an improvement compared to the previous legislation, particularly with regard to general provisions as well as specific innovations such as the Guichet Unique (one-stop shop).16 However, the benefits it offers to investors with regard to investment incentive policies are less beneficial than those provided by legislation in neighboring countries that are direct competitors (Senegal, Mali, Morocco, and Tunisia). Furthermore, it does not include any specific measure aimed at promoting regional or sectoral development. Also, the provision relating to administrative arrangements are inadequate, and reflect a fragmented and sparse approach that does not provide investors with adequate clarity or transparency regarding the legal system in which they are required to operate. A new Draft Investment Code was being proposed before the coup of August 2008. 1.25 Additionally, tax reform has become a governmental priority. This reform has two essential objectives: (i) to encourage investment and economic activity; and (ii) to widen the tax base so as to increase government revenue. In addition to reforming the Investment Code, it is vital to reform the tax incentive scheme, with a significant reduction in VAT, preparation for domestic tax reform, and the implementation of various administrative measures, including: (i) the creation of data centers in Nouakchott and Nouadhibou; and (ii) the reduction of the VAT application threshold to MRO 30 million. Improvement of corporate taxation is also envisaged, 15 There have been many changes to the Investment Code over the last 20 years. The 1989 Code introduced major changes: the targeted tax incentives arrangements were replaced by general arrangements, and discriminatory practices such as monopolies, price controls, and exclusive licenses, were eliminated. The limited success of this Code led the government to formulate a new Code in 2002, which emphasized the liberalization of market entry and operational terms. Mauritania's comparative inability to attract direct foreign investment has been partly attributed to the inadequacies of this Code. 16 The introduction of the Guichet Unique (one-stop shop) in 1997 was meant to be a practical and effective tool for supporting company requirements, and its objective was to reduce the costs and delays involved in setting up businesses. This helped to centralize and coordinate the various procedures and authorizations required. However, the Guichet only managed to obtain 10 approvals out of the 57 projects that were registered in the first two years. The 2002 Investment Code introduced many changes, including the "silent approval" principle, which meant that an investment was automatically approved within 45 days unless a reason was given to the contrary. 11 with among others (i) the integration of tax incentives into standard procedure (General Tax Code and Customs Code); and (ii) a reduction in local taxes. 1.26 Mauritania also took steps to streamline customs administration. These include the alignment of customs tariffs with the WAEMU classification (a minimum reduction from 3.5 percent to 3 percent in the customs tariff), an improvement in the management of customs procedures by modernizing management computer software and linking it to the internet (ASYCUDA ++ system), the examination of the possibility of having customs clearance carried out in private customs clearance warehouses and areas located within or outside ports, and the reorganization of the Directorate General of Customs. 1.27 Furthermore, the authorities made efforts to strengthen administrative capacity and practices. Moreover, with regard to the strengthening of administrative capacities, the various initiatives of the last few years have not had the impact anticipated and require continued efforts. These initiatives were mainly focused on reorganizing the Ministries, inter-ministerial coordination, staff development, and the development of data systems and information management. As for the administrative practices with direct impact on businesses and diversification, it is recommended that the focus be placed on (i) continuing the reform of government institutions;17 and (ii) improving the legal and judicial framework for business. 18 Vision for Accelerating Economic Growth and Addressing Its Main Impediments 1.28 The government sets forward its vision for long term sustained growth in the GPRSP-II. The document emphasizes the need and urgency of supporting SMEs development and improving competitiveness. The strategy indicates that accelerating economic growth will be primarily based on: (i) optimizing spinoff effects from developing the oil business and implementing more effective policies for harnessing the growth potential of other promising sectors; (ii) a thorough reform of the financial system; (iii) significant improvement in the business climate and the development of SMEs; and (iv) giving a greater economic and land-use planning dimension to the infrastructure that supports growth (World Bank, 2006). Furthermore, the GPRSP-II identifies several priorities to improve the business climate and promotion of SMEs, as follows: (i) improving the legal environment for businesses; (ii) fighting anti-competitive practices; (iii) making tax and customs policies more favorable to business; (iv) institutional support for the development of trade and commerce; (v) facilities to assist Mauritania's SMEs; and (vi) strengthening of mechanisms for dialogue and concerted action, and of economic monitoring tools. 1.29 Moreover, the Mauritanian Centre for Policy Analysis (Centre Mauritanien d'Analyse de Politiques ­ CMAP) highlighted in its Study on Determinants of Growth in 17 Simplifying regulation and eliminating discretionary powers will eventually lead to significant progress. Priority must be given to institutions directly in contact with business. Reforming the Investment Code, strengthening the Guichet Unique, and simplifying taxation and customs procedures should also help. 18 The current measures include (i) the anticipated publication of the Gazette du Palais, the purpose of which is to publicize judicial decisions and legal notifications; (ii) strengthening procedures for conciliation and commercial arbitration; (iii) training of judges and staff; and (iv) strengthening the Commercial Code's implementation measures. 12 Mauritania (2005) the main areas that hamper private sector development. The CMAP Study pointed out the insufficient diversification of economic activities outside resource exploitation, poor infrastructure, limited competitiveness, the relatively high costs of production factors, the burdensome administrative procedures, the limited access to financing for small businesses and the significant taxation that hamper entrepreneurship and investment. 1.30 Other growth studies, such as the 2003 World Bank Report on Regulatory Reform, Market Performance and Poverty Reduction pointed out that concentration of enterprises within a small number of investment groups might affect competition. It highlighted the need to develop and apply the statutory principles to ensure free competition. In addition, the 2006 Country Economic Memorandum (CEM) highlighted the need to promote competition and identified the lack of enforcement of existing competition law (including weak institutional capacity) as one of the main constraints to private sector development. 1.31 Furthermore, the 2007 Investment Climate Assessment (ICA) and other surveys indicate that business perception of the investment environment is poor, suggesting that the continuation of economic and policy reforms is key to improve the investment climate. Approximately 45 percent of the firms identify under-developed financial markets, limited access to credit and high cost of financing for enterprises operating in the formal sector as the main constraints to business operation. Furthermore, around 37 percent of firms highlight taxation and tax policy administration, while 34 percent of firms report they are mostly affected by anti-competitive practices of the companies operating in the informal sector. Poor access to electricity (30 percent), customs and foreign trade regulations (24 percent), lack of skilled workers (22 percent), corruption (18 percent), and unreliable infrastructure (16 percent) are also cited as hampering private sector development (World Bank 2007b). Furthermore, according to the World Economic Forum's Global Competitiveness Index (2008-2009) Mauritania ranks 131th out of 134 countries in terms of business competitiveness,19 well behind Senegal (96) and also trailing Burkina Faso (127) and Mali (117). It confirms that market size, higher education, infrastructure, and the markets for goods and financial services are especially problematic. Similarly, Mauritania lags in the World Bank (2010) Doing Business Survey in which it ranks 166 out of 183 economies, behind Senegal (157) and Burkina Faso (147). 1.32 To attain the four strategic GPRSP objectives (i) optimize spinoff effects; (ii) reform the financial system; (iii) improve the business climate and the development of SMEs; and (iv) improve business enabling infrastructure), this Country Economic Memorandum (CEM)20 examines four venues of intervention to address the critical constraints to private sector development (see Figure 1.1). They are: (i) the role of taxation to promote formalization; (ii) skills development to improve labor productivity; (iii) competition policy as a means to address anti-competitive market conduct; and (iv) the establishment of a special economic zone as an instrument to close infrastructure gaps and promote investment climate reforms. 19 Mauritania ranked 125th out of 131 countries in the previous ranking of the Global Competitiveness Index (2007- 2008). 20 The report will not discuss in detail the financial sector or the issue of corruption. These two areas have been already examined in the joint World Bank ­IMF Financial Sector Assessment (2006) and the Anticorruption Study for Mauritania (2008). 13 Figure 1.1: GPRSP-II Strategic Objectives and Identified Interventions GPRSP-II Overarching Goal: To Accelerate Growth Business Climate and SME Development: Improve legal environment Fight anti-competitive practices Financial Spinoff Effects Make tax and customs policies more favorable for business Infrastructure GPRSP System Institutional support for the development of trade (World Bank) Facilities to assist SMEs (World Bank) Objectives (IMF) Strengthen mechanisms for dialogue and monitoring tools (World Bank) Tackle Eliminate Identified Create Special Strengthen Create Special Informality Labor Market Interventions Economic Competition Economic through Constraints Zones Policy Oversight Zones Fiscal Policy (skills development) E. FOUR KEY CONSTRAINTS ON PRIVATE SECTOR DEVELOPMENT 1.33 Identified among most serious constraints, tax rates associated with widespread informality generate numerous costs both for firms and society (ICA, 2007). Most of Mauritanian SMEs operate informally. They are the largest source of domestic employment and provide a livelihood for the majority of the population, especially to the poor. Widespread informality needs to be analyzed in the context of the transition from a traditional herding and agricultural economy and strong informal, but narrow, networks of trust, to more diverse market- oriented activities. Along with these cultural determinants, informality is linked to the high formalization costs, weak enforcement, and limited benefits devolving from formalization since, for example, complying with tax requirements does not seem to improve access to credit. It is also both the outcome and an input into a casual attitude towards state regulation and the law in general. Estimating the full extent of informality is difficult due to the lack of reliable data. It is estimated that approximately 30 percent of GDP is generated by informal firms/activities (Heritage Foundation, 2007). Several other indicators suggest that informality is very widespread: the very narrow tax base; about 70 percent of the urban labor force in the informal economy; and approximately 15,000 formal land titles for the entire country. 1.34 The current tax system provides a stark example of the dominance of informal activities in Mauritania. The Corporate Income Tax (CIT) has been reduced to 25 percent of firms' profit, but the cost to comply with the tax system can be problematic, especially for SMEs. Few firms, including SMEs are registered. The Mauritanian Tax Department (Direction 14 Générale d'Impôts - DGI) does not yet have a solid database covering firms outside the large taxpayer office that are regularly paying taxes. Concerning informality among formal firms, or tax evasion, it is estimated that roughly 50 percent of revenue is not declared (ICA, 2007). Until recently, the DGI did not collect data on its small taxpayer base. The introduction of a unique identifier number would help improve this situation. 1.35 At the firm level, the main costs of operating informally in Mauritania seem to be the inability to access government contracts and formal financial services, to benefit from legal protection and fear of detection. From a wider economic and societal perspective, the costs of informality include the spillover effect of non-compliant behavior on the rest of the economy, especially other compliant firms (see Box 1.3).21 Moreover, for formal firms informality poses a challenge in terms of unfair competition as a result of lower production costs. For example, informal firms incur lower wage costs by employing informal workers22 and avoiding tax payments on inputs and on profits. Tax evasion may enable low productivity retailers to compete with larger and more productive ones. Moreover, widespread informality creates pressure on compliant firms to move away from compliance. This seems to be of particular relevance in Mauritania, as unfair competition from the informal economy is perceived as a major constraint by the private manufacturing sector. Approximately one-third of the firms report practices from the informal sector as a major obstacle to operate and grow. 1.36 Informality is also associated with corruption. Neo-patrimonialism and years of rent- seeking development have led to corrupt practices. In the Mauritanian society, wealth used to be redistributed based on affiliation to ethnical or tribal groups or statute. These practices were engrained in the political and administrative institutions, weakening their accountability. Corruption also affects the judiciary, through selective access to justice, fact manipulation, celerity when treating cases (some cases remain idle for long periods of time, while others are quickly treated without any particular reason), and hidden costs (certain legal taxes levied in accordance with existing decrees) (World Bank, 2008).23 Despite existing challenges, Mauritania has now the opportunity to follow a new path. To this end, the authorities took several measures to improve governance, such as the adherence to the Extractive Industries Transparency Initiative (EITI), the adoption of an Ethics Code for public servants and a law on wealth declarations of high public officials. In addition, the Government is currently preparing an anti- corruption strategy which should be accompanied by capacity building and strengthening of the public procurement system. 1.37 Operating in the informal sector also reduces the firms' incentives to expand or undertake new investments. Typically, the companies operating in the informal sector in 21 Entrepreneurs decide to stay informal because the total costs of entry, operation, and exit associated with joining the formal sector are greater than the potential benefits from being formal. They are willing to forgo the benefits of better protection of property rights and to bear the cost of extra-legality (in the form of bribes, costly finance) because it is more beneficial to remain informal. 22 In addition to tax avoidance unfair advantages result from lower costs of production as informal or partially formal firms rely on cheaper informal labor. See Rajadel et al, 2007 p. 41. 23 In addition, there is uncertainty regarding law enforcement: the existing dual legal system (French "modern" law and "traditional" religious or customary law) often generates tensions. The executive powers often exert pressures on judges, as they control their promotions, sanctions and transfers. Many judges are impartial as they are active members of political parties, representing tribal and/or regional interests (World Bank, 2008). 15 Mauritania are micro enterprises that wish to maintain their size in order to remain under the radar of the administration. According to the 2006 ICS informal firms have to rely more on finance from family and friends than formal companies. On average, family and friends account for 20 percent of their financing sources compared to 8 percent for the formal firms. Also, very few small and medium firms seemed to have participated in public procurement (World Bank, 2007b). Box 1.3: The Costs of Informality Although informality offers benefits to businesses by evading taxes, social contributions, regulatory fees and compliance cost, it also involves significant costs, such as: · Limitation on investment and company growth. Companies in the informal sector need to operate under the radar of the administration, trying to avoid attracting attention of the government. Consequently, the owners of informal enterprises usually prefer to keep the company at a size that allows operating within the informal sector. Additionally, the lack of access to finance puts a limit to investments and growth of informal enterprises. · Exclusion from public incentive schemes and public procurement contracts. By nature, informal enterprises cannot apply for incentives offered by the government. In addition, informal businesses are usually not allowed to bid for public contracts. · Lower productivity. Informal enterprises operate in an uncertain state and some of them may not invest in the company and its employees. The informal business operates typically with outdated machinery and untrained personnel below its potential productivity. Often, the owner of the enterprise can only afford this business because he or she saves other costs due to its illegal status. · Costly measures to stay informal. In order to stay outside the view of the public administration, firms may take various measures such as abrupt changes of location or activities, bribes, closures and new establishments, splitting the business into several smaller units at various locations. Informality has a negative effect on the labor force because of: · Non-coverage by minimum wage legislation and social security system. Informal enterprises do not offer social protection and often pay below minimum wage or union wages. · Absence of trade union organization. Employees of informal enterprises are not represented by their unions in collective agreements and often do not receive individual support. · Little job security. Labor protection rules such as redundancy rules, requirements to lay-off employees, paid holidays, maternity leaves or severance payments are often not applied. Source: FIAS, 2005. 1.38 Next, understanding labor informality is essential because informal workers are not exclusive of the informal sector. The household survey from 2004 indicates that self- employment is dominant in Mauritania with only 30.4 percent of those employed being wage earners, many of whom are employed in the public sector (40 percent). When defining informal labor by non-registration for social security, over two thirds of Mauritanian wage earners are informal (Rajadel et al, 2007). Despite being lower than in the last years, the rigidity index of labor market regulations24 remains relatively high (39) and exceeds the average in Sub-Saharan Africa (35.5) (Doing Business, 2010). Since the employment procedures are relatively complex,25 26 they may create incentives for informal hiring (see Table 4 in Annex 1). 24 The 2004 Labor Code provides the main regulatory framework in Mauritania. 25 The rigidity of the employment index captures the complexity of different practices including hiring procedures, rigidity in hours of work and firing procedures. According to the 2010 Doing Business indicators, the labor taxes and contributions (17.6 percent) are higher in Mauritania compared to Sierra Leone (11.3 percent) and the average for Sub-Saharan Africa (12.7 percent). However, firing costs tend to be lower in Mauritania (31 weeks of salary) than in other West African countries, particularly Senegal (38 weeks of salary). 16 1.39 Widespread informality may reduce incentives to investment in human capital because wages paid by firms operating in the informal sector are lower. Mauritania faces high informality rates among the less educated. The informal workers (either self employed or informal wage earners) earn 13.7 percent lower wages than formal sector workers (irrespective of their characteristics) (EPCV, 2004). The low returns to education (for both informal and formal workers, but particularly acute for the informal ones) may discourage individuals to invest in schooling to acquire human capital. This has important welfare implications since those with low quality employment are less likely to be able to break away from poverty traps, both intra and inter generationally. Furthermore, there is no evidence that informal, more dynamic sectors are associated with higher growth (World Bank, 2007b). 1.40 Even though the SMEs in the informal sector27 create jobs, the quality of informal jobs is low28 which may contribute to the low productivity of the manufacturing sector. The low quality of informal jobs is indicated by low wages and absence of social protection, and may contribute to explain the low labor productivity of the manufacturing sector. Measured as value added per worker labor productivity in Mauritania is around US$3,000, half of that in Mali and one-third of that in Senegal (ICA, 2007).29 It represents between 11 percent and 73 percent of labor productivity in South Africa and Lesotho, respectively. Yet, the low productivity is not offset by low wages. The minimum wage in 2004 was US$74 compared to US$ 47 in Mali and US$93 in Senegal. The unit labor costs in Mauritania are also relatively high, reaching 48 percent of value added compared with 29 percent in Senegal, 25 percent in China and 19 percent in Mali. 1.41 The lack of appropriate working skills may also hurt firm productivity. Lack of skills and low human capital in Mauritania find their roots in low schooling enrollment rates. Among the working age population, only 48.8 percent know how to read and write fluently.30 It is also widely recognized that there is a gap between the education curricula and the labor market needs, suggesting the existence of skills mismatches. Certain specializations such as law, economics and geography are predominant over specializations demanded by the private sector, such as engineering, accounting, mechanics, architecture and agronomy. This pinpoint to the fact that investment in education that is not matching the private sector needs represents a sunk cost. To compensate for this lack of domestic skills, firms in Mauritania resort to hiring foreign labor (Senegal, Mali, Guinea, and Algeria to supply skilled labor in tourism, fisheries and constructions) or employing unskilled workers. The lack of adequate skills are a significant constraint to rising labor productivity and firms' growth as firms' capital investment is not exploited to its full potential. Evidence shows that skills are a greater concern for firms operating 26 The labor taxes and contributions include the amount of taxes and mandatory contributions on labor paid by the business as a percentage of commercial profits. This amount includes mandatory social security contributions paid by the employer both to public and private entities, as well as other taxes or contributions related to employing workers. 27 Discussed in Chapter 2. 28 Discussed in Chapter 3. 29 Total factor productivity remains low, representing only around 23 percent of that of South Africa, the continent's most efficient producer and two-thirds that of Morocco (ICA, 2007). 30 Among the remaining group, 41.9 percent do not know how to read and write at all and approximately 43.9 percent of the population never actually went to school. Among the group who did, 35 percent have completed at most the primary school (EPCV, 2004). 17 in the formal manufacturing sector and at the technological frontier in Mauritania (World Bank, 2007b), inhibiting their growth. 1.42 Migration is both a response to the lack of job opportunities in the domestic market and a way to exit the informal sector. In 2005, the emigrants leaving Mauritania accounted for 3.4 percent of the total population, exceeding the immigrant flows (2.2 percent of the population, World Bank, 2008).31 According to SNE 2008, an increasing share of young population leave the country to find better employment opportunities in Western and Southern Africa (Senegal, Côte d'Ivoire, Angola), in the Gulf countries (United Arab Emirates), in Europe (France, Spain) and in the United States. On the other hand, the immigrants from neighboring countries (Senegal, Mali, Guinea, Tunis and Algeria) offer skilled labor in certain sectors, such as tourism, fisheries, and constructions. For example, in 2008-2009 the number of immigrants from Mali working in Mauritania reached 72,000. Finally, the immigrant waves from rural to urban areas,32 in particular to the capital city, have substantially increased as the share of agriculture in the GDP has diminished. 1.43 The third hurdle to the emergence of dynamic, formal SMEs and enterprise formalization is associated with the market dominance by large groups and firms' behavior in the market.33 Ten large business groups dominate the market and often incorporate banks. Leading Mauritanian commodity traders (as well as their foreign partners) benefit at the expense of local producers, even when domestic goods are more competitive. For instance, imported German dairy products flow through a segmented market that excludes local suppliers from the distribution channel, even when the domestic dairy products have lower costs (and a lower margin on domestic sales). Interviews with private operators (2005) highlighted that if the leading importer of dairy products were to allocate a share of sales to a local producer his overseas supplier would withdraw his contract and award it elsewhere. A second example concerns Dutch suppliers of imported potatoes, whose local distribution contract is tied to the importation of a similar volume of onions, which shut out domestic onion production that is one- third cheaper. 1.44 The current market structure and market conduct may exercise upward pressures on consumer prices.34 The high concentration of market share in several sectors, along with small market size, the undiversified economic base and the predominance of trading activities continue to fuel increases in the price level and raise concerns about potential (anti-) competitive behavior, in particular through tied sales or price fixing. For example, the pass-through effect of high international food prices in 2007 coupled with a decline in coarse grain production tightened food supply and bolstered local prices in Mauritania as well. The heavy reliance on food imports, coupled with the concentrated structure of the country's import market, may have 31 Migration and Remittance Factbook 2008. 32 To reduce impact of domestic migration from rural to urban areas, the authorities organize a yearly operation to encourage young people to return to the rural areas. To this end, the authorities provide them with free transportation, agriculture equipment and inputs, and, sometimes, small grants to facilitate their living conditions before the cropping season. 33 Chapter 4 presents an analysis of the Mauritanian market structure and market behavior. 34 Price benchmarking in several sectors in Mauritania and neighboring countries require detailed firm-level data, which are currently not available. 18 magnified the impact of exogenous food price shocks. For instance, the price of imported wheat increased by over 75 percent in 2008, from US$200 for a ton to US$356 (USAID's Famine Early Warning System Network, 2008). 1.45 Meanwhile, the existence of significant administrative and regulatory barriers may prevent new firms to enter the market, hamper competition, increase formal labor costs and create room for corruption. Official constraints on the most basic feature of market competition, pricing freedom, were removed in the 1990s.35 Freedom of pricing is now a principle of the commercial code, but some oversight remains as the law still provides for the authorities to set prices for some products by decree. However, other administrative and regulatory procedures may raise barriers to entry. Several examples are the procedures for and the costs of starting up a business, licensing procedures, access to and cost of financing, the tax regulations, the customs and trade regulations, and the labor market regulations. 1.46 The fourth constraint which impedes private sector development is poor infrastructure. Most sectoral studies cite access to basic services (electricity, water, and sewerage), transport infrastructure (roads, railway, airports and ports) and commercial infrastructure (collection, warehousing, distribution) as inadequate and insufficient. The 2005 CMAP Report on Sources of Growth highlights that the development of the agricultural sector remains limited due to the lack of infrastructure required increasing its added value. This is a major obstacle to improve the sector's competitiveness, including collection systems, storage and packaging infrastructure, wholesale markets, and transport infrastructure. In the fisheries sector, the current status of infrastructure limits the unloading and processing of small deep-sea fish species, which lowers the added value of these fish. Poor infrastructure also has a significant geographic and demographic impact36 as more than half of the country's population currently lives outside the cities of Nouakchott and Nouadhibou. 1.47 Mauritania's economic orientation towards natural resource exploitation created gaps between the national infrastructure supporting SME activities and infrastructure for strategic sectors. The former comes under public sector control, whereas the latter is generally financed directly by companies that are active in these sectors, thus guaranteeing the infrastructure required for their activities.37 Nevertheless, the road network is not extensive, with slightly more than 10,000 km of roads, of which approximately 3,000 km are paved, accounting for barely 10 percent of the total if only passable roads are included. The paved roads are mainly concentrated in the two main towns (Nouakchott and Nouadhibou) and on the two main north- south corridors (Nouakchott-Nouadhibou and Noukchott-Rosso). Large areas of the country are only serviced by unpaved roads and tracks. The road network is of strategic importance: 35 Before 1991, the retail prices of many consumer goods were fixed by law, and margins were controlled for many products. 36 The geographic distribution of the population has changed over the last 25 years, with massive migration toward Nouakchott. The country has one of the lowest population densities in the world, with 1 inhabitant per square km (3 million inhabitants in just over 1 million square km). Nouakchott currently has a population of more than 800,000 people. It is projected that the city's population will increase to more than 1 million over the next few years. Nouadhibou has a population of more than 100,000 (5,000 in 1960). The rest of the population, accounting for more than half of the total, is spread out across the country. 37 The SNIM (National Mining Company) directly controls the only rail network in the country (a single track of more than 800 km between Zouerat and Nouadhibou), and the ore terminal in Nouadhibou. 19 according to the 2004 World Bank report on the transport sector, 90 percent of passenger traffic and 80 percent of freight traffic uses the road system. 1.48 The lack of capacity in the ports limits their competitiveness compared to their regional competitors due to lower productivity and higher transport costs (notably Dakar, which takes a significant part of Nouakchott's potential market). The two major ports, Nouakchott and Nouadhibou lack capacity (wharves and equipment). 38 The high operating costs are the combined effects of limited traffic volumes driving unit costs higher, insufficient competition as there are only two shipping lines operating in the country, limited wharfing and loading/unloading equipment, and limited storage space. According to a study from 2006 produced for the Ministry of Economy and Development, the productivity of maritime transportation is lower than in the neighboring countries. In particular: (i) the average productivity is lower due to lack of equipment and inefficient labor; (ii) the cost of stopping over is higher ­ US$9,174 for a vessel of 33,000 tons in Nouakchott, compared to around US$1,412 in Cotonou, US$3,952 in Dakar and US$4,234 in Abidjan; (iii) a total transportation cost higher than that in Dakar with US$226-706 per container. Moreover, only two companies accounted for the bulk of maritime transport - Maersk with 65 percent and Sogeco with 12 percent. Similarly, the international airports of Nouakchott and Nouadhibou lack airport infrastructure and have generally poor level of maintenance. Restricted domestic and international traffic in the airports is a significant barrier to investment. 1.49 The unreliable provision of electricity also has a negative impact on firms' operations. Production capacity and distribution networks of electricity are problematic. According to the ICA (2007) 43.8 percent of the surveyed companies in the manufacturing sector consider supply of electricity to be a major or extremely severe obstacle to operate and grow.39 In 2006, Mauritanian manufacturing companies had to deal with approximately six electricity outages per month, lasting on average 3.3 hours. These outages resulted in an average loss of about 3.1 percent of firms' sales. Also, the assessment points out significant problems relating to the water supply for industrial use. Similarly, in the industrial and craft industry sectors, the CMAP Report points out that the cost of production inputs, in particular water and electricity, is still abnormally high. The unit consumption cost of electricity in 2004 was at least 64 percent lower than the level recorded in Mali and Senegal (CMAP, 2005). The forthcoming project - the Grande Centrale - is expected to resolve many of the current issues. Forecasts for natural gas production that would allow such a power plant to operate are on the verge of being confirmed. The planned restructuring of the Société Mauritanienne d'Electricité (SOMELEC) will also allow it to improve its performance. 38 Until recently, the port of Nouakchott had no oil carrying capacity, and this is still limited by draft issues. This requires costly coastal shipping between the Nouadhibou and Nouakchott facilities. National control of the ports is not optimal as it is shared between several supervisory ministries and management structures. The ore port of Nouadhibou is not part of Port Autonome de Nouakchott and comes under the supervisory authority of the Ministry of Mines and Industry. The oil terminal is managed by the Ministry of Energy. 39 The technical details of the project are still being drawn up. Two possible scenarios are currently under consideration: (i) an 85 MW dual fuel power plant planned for 2010 focusing on Nouakchott's requirements; and (ii) a 200 MW gas powered plant, the latter being the preferred scenario. 20 1.50 Nevertheless, the liberalization of the telecommunication sector has shown that a concerted reform effort with regard to infrastructure can have a major impact on supply, the cost of services, and economic growth. The opening up to several mobile telecommunication operators dismantled the monopoly position of the traditional telephone operator Mauritel SA, and increased coverage and access to telephone services from 0.6 to 18.8 telephones for 100 persons in 1999-2004. The Telecommunication Regulatory Agency has also granted mobile phone licenses to Mauritel Mobiles (a subsidiary of Mauritel SA), Mattel and Chinguittel. The 2005 CMAP report indicated that investment in the sector had a significant effect on GDP (between 2 and 4 percent per year during the 2000-2003 privatization period) as well as an absolute and relative reduction in communication costs.40 The positive impact of reforms is clearly shown in the 2007 ICA in which telecommunication is perceived as a minor obstacle to firms' operation (telecommunication is listed as 17th out of 18 constraints to growth). 1.51 Concerning the regulatory framework governing infrastructure, the GPRSP-II highlights several shortcomings that need to be addressed, including administrative capacity. It proposes improvements in three areas: (i) the regulatory framework for infrastructure tendering and management; (ii) the administrative framework; and (iii) infrastructure projects involving construction and maintenance.41 Furthermore, concerning the road transport, the main objective is to create a support fund for private carriers which will support the management and operational training of transport companies. In civil aviation, the objective is to help the Civil Aviation Directorate improve its management and technical capabilities. In maritime transport, reform must mainly assist the rationalization of port management, specifically that of the port of Nouakchott. 1.52 This Country Economic Memorandum will address the above-mentioned four cross- cutting areas to improve the investment climate and to stimulate SME development. It does not take a sectoral approach and therefore does not look at, for example, how Mauritania should stimulate agriculture development. Chapter 2 will discuss the drivers of informality, in particular looking at taxation issues and propose actions to encourage business formalization. Chapter 3 will address the labor market informality, the roots of the low human capital investment in the workforce and skills mismatches. Chapter 4 will analyze the market structure and behavior, focusing on the role of adopting a strategic competition policy framework to counteract anticompetitive market behavior and stimulate private sector development. Finally, Chapter 5 will provide options to support economic diversification and to promote the creation of adequate infrastructure, mainly through special economic zones. 40 Telephone communication costs were higher than those in Mali in 2004, but 67 percent lower than those in Senegal. 41 As an illustration, in the land transport sector, liberalization begun in 2005 must be reinforced, in particular by enacting a land transport regulatory framework that would open the market to competition and provide safe operation standards. At the same time, the law regulating civil aviation must be revised, particularly in technical areas, to bring Mauritania into line with international standards. In the telecommunications sector, the already implemented reform must be consolidated, with clarification of the roles and responsibilities of institutional actors and the strengthening of competition 21 2. THE INFORMAL ECONOMY: DRIVERS AND IMPLICATIONS FOR ENTERPRISE DEVELOPMENT In Mauritania, the informal economy is vast. Numerous factors play a role in explaining the extent of informality such as the tax burden, administrative barriers, cultural determinants and weak law enforcement. Understanding the determinants of informality is key, mainly because widespread informality harms SME development potential and creates unfair competition for formal firms. This, together with the dominance of several large group, squeezes firms out of the market, and hurts the development of a strong, formal class of SMEs. From a fiscal perspective, high costs imposed by the tax regime, administrative weaknesses and inadequate enforcement have been key drives of informality. Mauritania started a reform process meant to reduce the fiscal burden, including financial and administrative costs to reduce such burden on investment and encourage business formalization. Nevertheless, tax evasion is high even among formal firms. The main challenges are related to sustaining the reform momentum with a focus on further simplification of the tax regime and the administration. This chapter attempts to frame and discuss the factors driving informality and tax evasion. To support and inform the reform efforts, the Marginal Effective Tax Rate (METR) is calculated, highlighting the main constraints to marginal investment. In addition, the chapter provides a snapshot of the characteristics and drivers of tax evasion. Finally, the chapter reviews the small business taxation regime and planned reforms in order to highlight remaining challenges and provide "good practice" options for several key implementation and design challenges. A. DRIVERS OF INFORMALITY FROM THE FISCAL POLICY PERSPECTIVE 2.1 Understanding the drivers of informality in Mauritania and its costs for SME development is essential. Informality typically entails unprotected workers, excessive regulation, low productivity, unfair competition, evasion of the rule of law, underpayment or nonpayment of taxes, and "underground work" (Perry et al, 2007) (see Box 2.1). In Mauritania, informality is linked to high formalization costs, lack of substantial benefits from formalization and weak enforcement. In the long run, the costs of widespread informality affect firm performance and productivity as informal firms do not have access to the formal sources of finance or government contracts, cannot benefit from legal protection and have less incentive to grow because of fear of detection. Informal firms seem to be less productive because they may operate with outdated equipment, pay lower wages and, hence, discourage investment in human capital and skills. 2.2 Although supporting small informal firms may help achieve pro-poor growth in Mauritania, informality has negative implications for government revenues and the integrity of public institutions. Most micro and small firms are informal and provide employment to the majority of the poor. Nevertheless, as many formal firms' perception of informality being a major barrier to growth is high, this may determine formal, registered firms to evade regulations by underreporting their sales for tax purposes, not registering all their workers with the social security administration, or not complying with other mandatory licensing or safety regulations. This further fuels the informal sector and perpetuates a non-compliant behavior among all firms. Non-compliance with tax collection and other regulations gradually erodes the rule of law and the integrity of public institutions, limiting the government ability to 22 provide public goods such as infrastructure or to take measures to alleviate poverty. In the long- run, such failures may create serious hurdles to increased investment and private sector development. Box 2.1: What is "Informality"? The informal economy is often also referred to as informal sector, black economy, shadow economy, hidden economy or even illegal economy. It encompasses day laborers, small farmers, subsistence traders and street vendors, but also a substantial number of small and medium sized firms with a significant growth potential. Given its heterogeneous nature it is clear that there are a multitude of definitions for the informal economy, often resulting in differing policy recommendations (Scheider and Enste, 2000). The most evident distinction has to be made between informal workers and informal enterprises. This chapter is focused on the latter. From a tax perspective the informal economy is often described as the total amount of evaded taxes (the sum of all unreported taxable money). Evidently, different policy recommendations apply to those who pay some taxes and evade others and those who are completely outside of the tax regime. Informality has different forms and dimensions: Firm operates Firm complies Firm complies Firm formally Firm is fully entirely outside the with a small with most legal complies with compliant with formal economy number of legal and regulatory legal and legal and and regulatory obligations regulatory regulatory obligations, but not obligations, but obligations with others does not entirely respect all obligations Source: Engelschalk, 2007 Informality and formality are not "all-or-nothing" stages but multi-dimensional with varying degrees. Some firms are registered but do not pay (all) taxes, did not obtain a land title for the firms' premises, or do not have the licenses required for their business. Others may be fully compliant with corporate taxation, but never declare their workers in order to avoid social security contributions. Very broadly, this report uses the term informality to describe entrepreneurs above the subsistence level who are hidden from the state and produce legal, but unregistered, goods and/or services. The Impact of Fiscal Regulations and Other Administrative Requirements 2.3 Formalization entails benefits but also costs. The benefits of formalization range from increased access to financing, and enhanced legal protection and access to public procurement. Formalization opens markets and access to a wide range of services, and can be a key tool for encouraging growth of small and medium sized firms which are partly or wholly outside the formal system. Accordingly, one of the central goals for any SME policy in Mauritania is to facilitate and encourage graduation of firms above the subsistence level42 who can benefit from becoming formal. 42 A common threshold to disaggregate micro firms and distinguish subsistence activities is the personal income tax exemption level. Enterprises which operate with profits below the personal income tax threshold should not be taxed, but should have the option to register and obtain an official tax clearance, protecting them from further harassment. 23 2.4 Research finds that entrepreneurs make formalization decisions based on a cost- benefit analysis, and that they will operate formally up to the point where the marginal costs are less than the benefits of formality (SIDA, 2004). Transition from an informal to a formal status is gradual and requires interventions to encourage formalization to focus on key areas that are identified as main barriers to formalization (see Box 2.2). In Mauritania, the fiscal regime and its administrative weaknesses are widely perceived to be driving evasion among firms and encouraging small firms to remain in the informal economy. One important reason for non-compliance in Mauritania seems to be the perception among business operators that the tax system is overly complicated and the tax burden is too high. Data from ICS (2006) indicates that tax rates and administration are primary concerns for the private sector. About 32 percent perceive tax rates and administration as a major or very severe constraint (World Bank, 2007b). The IFC's Doing Business indicators also highlight the heavy taxation for firms in Mauritania. Box 2.2: Factors Fueling Informality: Burdensome Regulations and Weak Enforcement Burdensome regulation is associated with a large informal economy, but there is no evidence whether regulatory simplification can lead to enterprise formalization. A vast body of literature exists on the informal sector in general and determinants of its size and enterprise formalization strategies (Djankov et al, 2002, 2008, 2009 and 2010). However, this literature remains inconclusive on whether regulatory simplification alone can lead to enterprise formalization. While cross-country studies show correlation, causality, for example between less business entry regulation and the number of formal firms, has not yet been demonstrated (De Sa, 2005). Nonetheless, the areas and regulatory policies which have been commonly identified as contributors to informality include (FIAS, 2005): · Lack of information. Firms, in particular smaller ones, may not have access to information on how to register or operate a firm.43 · High taxes and social contributions. High tax rates or problems with tax administration may provide a strong incentive to be informal. In addition, the growth of formal companies is constrained by a heavy tax burden. · High start-up costs and administrative barriers. Start-up procedures may be designed in an inefficient manner asking new businesses to go through a high number of steps and submitting documentation that takes a lot of time and financial resources to produce. Also, in many cases, the start-up procedures are duplicated on several levels of administration, for example with general licenses to be obtained on federal, state and municipality level. Therefore, new enterprises often cannot afford high start-up costs in form of fees for registration, approvals and licenses as well as stamp duties and obligatory notary public services. · Land. Procedures to register land force and/or encourage companies to operate on land that is not registered. Land related informality has two dire economic consequences. First, it prevents many small businesses from accessing the capital markets because they cannot pledge their real estate as loan collateral. The second consequence is that it can allow well-connected businesses, to access prime informal or government land at way below the fair market rate. · Rigid labor market rules. Rigid labor market rules combined with high labor related taxation such as hefty social contributions discourage companies from formally hiring their employees, and rely on informal subcontractors.44 · Inadequate sector specific policies. Sector-specific policy can also encourage companies to operate informally. For example, overly restrictive health standards fuel informality in food processing; consequently, food processors remain sub-scale and most food production in the developing world escapes completely any kind of control. · Weak enforcement poses a low risk of detection. The lack of public sector capacity diminishes the risk of informally operating businesses to be detected. Many company registrars do not follow up on missing annual returns and licensing authorities do not enforce the obligation to operate with a valid license. Standardization offices, tax authorities, or customs do not have a sufficient number of experienced inspectors. The involved authorities lack an effective system of information exchange, which give businesses the chance to be partially informal without the risk of being detected. In addition, penalties are often not updated and do not pose a threat to the informal sector. 43 For example in Madagascar a survey of informal firms showed that less than 1 out of 3 firms are well informed about the necessary formalization steps (FIAS, 2007). 44 The Doing Business project of the World Bank has shown a strong correlation between these labor rules and the level of informal labor, see: www.doingbusiness.org 24 2.5 The cost to comply with the tax system can be significant, and is often problematic for small firms. Figure 2.1 shows the time taken for businesses to comply with their tax liability. In the case of Mauritania it amounts to about 696 hours which includes preparation by tax accountants, filling tax returns, waiting in queues to file tax returns, and going to tax offices to confirm withholding tax payments. Especially for small business these compliance costs can impact the viability of a business operation and become an important incentive to avoid formal administrative requirements. Figure 2.1: Time Spent to Pay Taxes in Mauritania and in Some Other African Countries Uganda Tanzania Mauritania 0 100 200 300 400 500 600 700 800 Hours Source: Doing Business 2010. 2.6 In addition to burdensome and costly taxation, other administrative barriers may discourage firms to operate in the formal sector. For example, the costs in terms of monetary amounts, time and number of procedures for business registration and obtaining of construction permits may deter companies from operating in the formal sector. Start-up costs for small firms can still be significant and involve 9 different steps, 19 days and a cost equivalent to 34.7 percent of GNI per capita (Doing Business, 2010).These costs are higher in Mauritania (149 rank for business registration and 154 rank for dealing with construction permits out of 183 countries) compared with other countries from the region such as Senegal (102 rank for business registration and 124 rank for dealing with construction permits) and the Gambia (114 rank for business registration and 79 rank for dealing with construction permits). Fiscal Burden on Investment Measured by the Marginal Effective Tax Rate (METR) 2.7 In the 2006 ICA, taxation in Mauritania has been singled out as a key constraint for businesses. The Government of Mauritania initiated a review of its tax system and is in the process of designing and implementing an important set of reforms to facilitate and improve compliance with the fiscal regime. In particular, the planned reforms aim at further simplifying the current fiscal regime with the objective of easing the tax burden (rates and administration) for all taxpayers. 25 2.8 The Government has already implemented some tax reforms including a reduction of the Corporate Income Tax (BIC) over the last 6 years from a high 40 percent to a competitive rate of currently 25 percent.45 In addition, a number of important reforms in the area of tax administration, notably the introduction of a large taxpayers' office and an ongoing move towards a functional administration based on taxpayer size, are encouraging. Most importantly, a further reduction of tax rates, especially for the minimum turnover tax rate from 3 percent to 1 percent, the consolidation of other tax instruments, and the introduction a new presumptive46 tax regime for small taxpayers are pursued. Yet, the fiscal regime remains overly complicated47 and is largely based on collection of the minimum tax at customs and revenue collection from a very small number of large firms (IMF, 2008). Basic Structure of the Mauritanian Tax System 2.9 The Mauritanian fiscal regime involves several taxation layers based on the company size. Corporate Income Tax (CIT) is levied on businesses at a single rate of 25 percent on profit for those with turnover greater than MRO 3 million for the service sector and greater than MRO 6 million for other sectors.48 There is also a minimum tax of 2.5 percent of turnover (self-declared) with the minimum tax floor being 240,000 MRO. In addition, a withholding tax of 3 percent49 is levied on the value of imports and public contracts. It is 100 percent deductible from CIT. 2.10 For small businesses, with a turnover below MRO 30 million, a tax rate of 3 percent is levied on turnover, replacing a more complex taxation regime since 2009 (see also Table 2.2). The reforms in 2009 replaced all taxes for small businesses based on turnover thresholds with a single tax rate of 3 percent of turnover and raised the turnover threshold for defining small businesses to MRO 30 million (see Table 2.1). There are also specific tax rates for non- commercial businesses (which comprise mainly income from professional services), which are taxed at a single rate of 35 percent of income (BNC) with the minimum tax threshold of MRO 120,000. 2.11 Salaries and wages are taxed at marginal rates starting from 5 percent to a maximum marginal rate of 33 percent. Mauritania levies a value added tax (VAT) of 14 percent. Mining royalty ranges from 1.5 percent to 5 percent. Mining exports are exempt from the standard export tax of 3 percent.50 Municipalities and local governments levy a number of smaller taxes, such as a "business tax" (patente) levied on professionals. 45 The CIT was reduced from 40 percent to 35 percent (2001) to 25 percent (2002) to 20 percent and (2003) raised again to 25 percent (2005). 46 Presumptive taxation (self-declaration regime) covers a number of procedures under which the "desired' base for taxation (direct or indirect) is not itself measured but is inferred from some simple indicators which are more easily measured than the base itself (Ahmad and Stern, 1991). 47 In a recent study Djankov et al (2008) show that higher effective corporate income taxes are associated with a larger size of the informal sector, and slower economic growth. Moreover, the regulatory burden and administrative costs can be a contributor to the decision to operate informally (Thiessen, 2003). 48 The CIT is considered the general regime. 49 This rate has been significantly reduced in the recent period. 50 MBendi.com: http://www.mbendi.co.za/indy/ming/af/mu/p0005.htm#30 as of August 13, 2008. 26 Table 2.1: Proposed Reforms of the Fiscal Regime Current Corporate Income Tax Regime Planned Corporate Income Tax Regime Medium and Large businesses Turnover larger than MRO 30 million Turnover larger than MRO 30 million CIT on profit: 25 percent CIT on profit: 25 percent Minimum turnover tax (self-declared): Minimum turnover tax (self-declared): 2.5 percent51 1 percent Minimum tax floor: MRO 240,000 Small businesses Turnover lower than MRO 30 million Turnover lower than MRO 30 million A single tax rate of 3 percent of turnover (self- A single tax rate of 3 percent of turnover (self- declared) declared) Source: National Authorities, 2008. Table 2.2: Turnover Bands for Small Businesses: Replaced by a Single Tax Rate of 3 percent on Turnover since 2009 The standard (band based) regime for tax on The standard regime for tax on turnover for turnover (in MRO) firms that are not subject to VAT (in MRO) Trading companies and housing providers: Trading and processing companies: <500,000 : 20,000 <500,000 : 10,000 between 500,001 - 1,000,000 : 50,000 between 500,000 - 1,000,000 : 20,000 between 1,000,000 - 2,000,000 : 75,000 between 1,000,000 - 2,000,000 : 30,000 between 2,000,000 - 4,000,000 : 150,000 between 2,000,000 - 4,000,000 : 50,000 between 4,000,000 ­ 6,000,000 : 240,000 between 4,000,000 - 6,000,000 : 90,000 Service providers: Service providers: <200,000 : 20,000 <200,000 : 15,000 between 200,000 - 500,000 : 35,000 between 200,000 - 500,000 : 30,000 between 500,000 ­ 1,000,000 : 75,000 between 500,000 - 1,000,000 : 45,000 between 1,000,000 - 2,000,000 : 150,000 between 1,000,000 - 2,000,000 : 60,000 between 2,000,000 - 3,000,000 : 240,000 between 2,000,000 - 3,000,000 : 90,000 Source: Mauritania's Tax Code, 2008. 2.12 To support Government efforts in streamlining the existing fiscal regime, the marginal effective tax rate (METR) provides a measure of the fiscal burden in Mauritania. METR is calculated for firms (large and small businesses) which are resident in Mauritania for four broad classes of capital - equipment, building, land and inventory. Furthermore, the METR is calculated for five important sectors of the Mauritanian economy, such as manufacturing, agriculture, finance, tourism and mining. It is calculated both for large and small businesses, taking into account the existing general tax regime and the impact of planned reforms for the general regime (large companies) and for small business (see Box 2.3 and Box 2.4). 51 The minimum tax of 3 percent on turnover (self-declared) is applicable to firms subject to VAT. Firms have to pay this tax even if they do not make profits. They may also carry forward their losses. The corporate income tax of 25 percent is applicable on firms' profits. 27 Box 2.3: METR Economic Concept The impact of business taxes on investment is one of the most important issues in tax policy. This issue is complicated by the fact that tax regimes are complex, and differ substantially across jurisdictions and types of capital. A comparison of statutory tax rates is not sufficient and must incorporate: (i) tax depreciation (write-off) rates; (ii) special investment credits and allowances; (iii) other taxes on business capital ­ property taxes, capital taxes, turnover taxes, capital transfer taxes; and (iv) tax holidays. The Marginal Effective Tax Rate (METR) on capital summarizes the key elements of the business tax system as it relates to capital investment. The METR is a summary measure of the effective rate of tax imposed on the rate of return (ROR) generated by the marginal unit of capital a firm invests in. Various "stakeholders" hold an interest in firms as debt and equity holders. In order to satisfy these stakeholders, an investment must earn a rate of return (ROR) after the payment of all business taxes which is greater than or equal to the "hurdle" ROR required by these stakeholders. The threshold ROR is the minimum ROR acceptable to these stakeholders. The METR is calculated assuming that taxpayers maximize profits and as a result invest up to the point where the marginal benefit of the incremental investment equals its marginal cost. A profit maximizing investor would invest up to the point the returns from the marginal investment would equal the market rate of return. The METR incorporates all the taxes that impact the incentive to invest in capital. However, taxes such as fees of a flat amount are not included as they are fixed costs and hence do not appear in any calculation of the marginal investment. For example, the threshold ROR is 10 percent, all capital projects which earn a ROR greater than 10 percent, after the payment of all business taxes, will be undertaken. The firm will invest in all projects with a ROR greater than the threshold rate of return, investing in projects with the highest ROR first, moving down the "menu" of capital projects until the last (marginal) project undertaken earns a ROR of exactly 10 percent. If the business tax system is such that in order to earn a ROR of 10 percent after paying business taxes, an investment must earn a ROR of 15 percent before paying business taxes. In this case, the METR is simply: (15%-10%)/15% = 33.33%. The METR measures the share of the investment rate of return before tax needed to cover the taxes. In this case 33.33 percent of the before-tax ROR on a marginal investment is required to cover its taxes. Market Return on Capital (r) After Tax Profit = (Production [Y=F(K)]-Variable Costs) - Taxes Output/Production Optimal Operation (Maximum Profit) Compliance cost (C) Fixed costs of Business K* Unviable Investment (K1) Capital Investment (K) Unviable Investment (Formal business) (K2) Optimal Capital Invested (K*) The graph illustrates the impact of the cost of compliance on the viability of an investment and the METRs. After-Tax Profit is measured as the output less the fixed costs and variable costs less taxes. While businesses invest to the point of maximizing profit, the fixed costs element does not enter the calculation. The compliance costs (modeled here as a fixed cost of complying with the tax system) impacts whether a business would become viable or not if it were to comply with the tax system. However, it might be possible for some businesses to become viable provided they stay out of the tax system. This is the area between capital investment K1 and K2. The figure considers the specific case of a firm that is willing to pay the taxes owed, yet the cost of compliance would make formal operations unprofitable. In fact, the region of informality would be even greater when one considers that the after-tax income would actually be higher. While the analysis above used a cost of compliance which is considered as a fixed cost,52 it is likely that the costs could show some amount of dependence with the turnover and tax regimes. This calls for a greater amount of information using survey data. 52 Cost of Compliance Surveys in New Zealand, South Africa and India have shown that there is a strong fixed cost element to the cost of compliance. See: Engelschalk, 2008. 28 Box 2.4: Example of the METR Calculation for the Small Business Regime (Turnover Tax between 4-10 percent) in the Manufacturing Sector in Mauritania 1. The marginal effective tax rate (t) is defined as t = (rG - rN)/rG where, the gross-of-tax rate of return (rG), the net-of-tax rate of return (rN) 2. The net-of-tax rate of return on capital (rN) is defined by the formula rN = ßi + (1 - ß) - where i is the nominal interest rate, is the return from equity, ß is the debt to equity ratio and is the inflation rate. In Mauritania, i = 12.56%53, ß = 0.4 , = 12.56% , = 7.3% Therefore, rN = 4%. 3. The real cost of financing (rf) is one of the main components of cost of capital, or gross-of-tax rate of return (rG) on capital. The real cost of financing (rf) is defined by rf = ßi(1 - U) + (1 - ß) - where the parameters are as above and U is the corporate income tax rate. In Mauritania, i, ß, , are as above and U= 0% the corporate income tax rate in the case of a small business, as they are assessed via the turnover tax. Therefore, rf = 12.5%. with ß = the ratio of debt to assets ratio, i = cost of debt, U = the statutory corporate, income tax rate, = cost of equity, and = inflation rate. The cost of financing for the firm is the weighted-average of the cost of financing net of the inflation rate. 4. The gross-of-tax rate of return (rG) on capital54 A. Depreciable assets (buildings, machinery and equipment) rG = (1+tm)(rf +)[1 - A]/[(1-U)(1- tp -tg)] - Where tm = tax on transfer of property, or a transaction tax (import duty and sales tax) on capital goods wherever this is applicable, rf = real cost of financing as defined above, = economic depreciation rate, k = investment tax credit rate, A = the present value of tax benefit from the investment allowance and depreciation allowance, = capital tax rate, = tax depreciation rate, tp = property tax rate based on the rental value, and tg = gross receipts tax rate, or presumptive tax that is based on the gross revenue. In Mauritania, Apart from the parameters used above, tm =14%, = 20.5% (equipment) and 9% (building), tg = 8%, (This does not include investment allowance and capital taxes) Therefore, rG = 11.41% (for equipment) and, rG = 6.50% (for building) B. Inventory 53 `i' is derived from the international interest rate using the arbitrage assumption that the local interest rate after deducting taxes on interest income and after inflation should equal the international interest rate. As the international real interest rate is known (r*=4%) and so is the personal income tax on interest income (Ti=10%), the nominal interest can then be derived as (r*+)/(1-Ti). 54 Formulas provided here are only for the regular case where companies are profitable and pay taxes. For the tax- holiday case or the case of tax reduction for a limited period, the formulas for depreciable assets are more complicated in that the present value of tax allowances needs to be adjusted to reflect the true impact of the tax holiday or tax reduction on METR. For non-depreciable assets such as inventory and land, the formula for the tax- holiday case is the same as that for the taxpaying case except that the statutory tax rate(s) may differ due to the lower or zero rate arising from tax incentives. 29 rG = (1+tm)(rf +U)/[(1-U)(1-tg)] + Where tm = sales tax on raw materials where it is applicable, and = 1 for the FIFO accounting method, 0 for LIFO, and 0.5 for the average cost method. In Mauritania, Inventory, the average cost method is used = 0.5, therefore, rG = 5.71%. C. Land rG = rf (1+tm) [1 + (1-U)/(rf + )]/[(1-U)(1- tp -tg)] Where tm = property transfer tax. In the case of Mauritania, Land, tp = 8% (tax on immovable property), therefore, rG = 13.94%. 5. Aggregation of METR ti = (j rGijwij - rN i)/ j rGijwij where j denotes asset type (investments in buildings, machinery, inventories, and land), and wij denotes the weight of asset type j in industry i. In Mauritania, in the manufacturing sector, wij, the asset weights for manufacturing sector are: equipment = 52.4%, building = 28.5%, land = 0.9%, inventory = 18.1%. These ratios vary by sector. rG for each of the asset class is given as above and so is rN, Therefore METR = 56%. Source: Staff calculations; Mintz and Chen (2008). METR Analysis for Large Businesses55 2.13 The analysis of the general regime for large businesses assumes that large taxpayers are able to source funds from international financial markets and import equipment, and typically pay a corporate tax rate of 25 percent. In addition, they are not eligible for tax holidays (or the tax holiday was exhausted). The other assumptions include: (i) VAT of 14 percent on inputs (can be credited against VAT paid on output, so there is no effective tax on capital); (ii) customs duty of 5 percent on machinery plus a "taxe statistique" of 3 percent, considering that 100 percent of machinery is imported; (iii) domestic inflation of 7.3 percent; (iv) mining royalty of 5 percent; (v) straight-line depreciation; (vi) a withholding tax on interest and dividends of 10 percent; and (vii) as the financial sector is exempt from taxation, the VAT is an effective sales tax of 14 percent on capital inputs. 2.14 Large firms in Mauritania incur an effective tax on investment in a business higher than the standard corporate income tax of 25 percent. Ranging between 33 and 52 percent the METRs are higher than the corporate income tax rate. The METRs under the current and planned regime in agriculture, manufacturing and financial services are also higher than those in other African countries, except Burkina Faso (see Table 2.3). A higher METR is the result of different factors, such as (i) the customs duty of 5 percent on capital inputs which is assumed to 55 There are several parameters included in the METR formula. A simple formula is given as follows: Rg = (Rf ­ + )(1-uZ)/(1-u) ; Where Rg is the ROI with tax, Rn=(R­ + ) ; Rn is the Roi without Tax, where is the inflation, u the CIT, Z the depreciation allowances and the economic depreciation. In the case of Mauritania for the general regime, the Gross Real Rate of return for the marginal project with tax is 4.65 percent, while without tax is 3 percent. 30 be absorbed by the business and raises the cost of capital investment; and (ii) inflation, which acts as an effective tax on capital. On the other hand, the generous depreciation on equipment which can be deducted in 5 years lowers the cost of capital. In the case of mining the royalty raises the cost of capital for the mining sector. The financial sector is typically exempt for VAT purposes and therefore this sector cannot credit the tax paid on capital inputs. In more advanced economies, businesses would have to absorb this tax, increasing the cost of capital. Table 2.3: METR Analysis for Large Business compared to other African Countries Mauritania General With With Burkina South regime current planned Mali Tanzania Nigeria Faso Africa (corporate minimum minimum income tax tax: 3% tax : 1% of 25%) Agriculture 26% 46% 23% 6% -5% 37% 33% 30% Manufacturing 37% 57% 15% 21% 28% 35% 35% 29% Financial 45% 55% 30% 30% 18% 52% 52% 49% Services Tourism - - - - - 37% 35% 30% Source: Staff calculations. 2.15 For large firms that pay the current minimum tax of 3 percent on turnover instead of the standard corporate income tax rate of 25 percent, the effective burden of the tax on capital remains almost unchanged. The METR analysis implies that the minimum tax does not place an additional burden on investment for a profit maximizing firm. 2.16 Compared to the Doing Business indicator on paying taxes, the METR shows a lower tax burden for the large firms in Mauritania. Doing Business indicates that total taxes paid56 amount to approximately 90 percent of profits.57 The METR on the other hand does not look at accounting profit. It takes into account the cost to invest in capital and because capital investment is subsidized by higher tax depreciation, this burden is lower in percentage terms than the accounting version of the burden. Furthermore, the Doing Business total tax rate for Mauritania should be interpreted cautiously. All taxes on turnover look excessively high when measured by the Doing Business methodology. This is the result of the fact that in Mauritania, as in the other countries, the representative business that has been modeled is one that pays a minimum corporate tax of 4 percent of sales. METR Analysis for Small Businesses The analysis of the small business taxation regime assumes that small businesses source funds from domestic financial markets. It further makes the same assumptions as for the 56 This can be easily seen using the following example; say the turnover is 100 and the minimum tax is 4; for a business that has an 8 percent profit on sales this implies a 50 percent effective rate just for the minimum tax when measured as a percentage of the profit. On the other hand for a business that returns profit of 16 percent on sales the effective rate is 25 percent. 57 This calculation is based on a higher turnover tax rate of 4 percent applicable in 2007. 31 taxation of large businesses, except that (i) small business pay corporate income tax under the turnover tax regime of 6 percent (average of the effective turnover tax for the separate turnover bands). Under the planned regime, small businesses pay a turnover tax of 3 percent; (ii) small businesses do not register for VAT, incurring an effective sales tax on capital inputs of 14 percent; (iii) small businesses also pay a turnover tax of 2 percent (average of the effective turnover tax for the separate turnover bands) based on thresholds in lieu of VAT; and (iv) financial small businesses have not been included. 2.17 The overall impact of taxation on investment for small businesses in Mauritania is higher than in the case of large businesses. This is due to two reasons. First, financing is sourced from the domestic market and financial income is taxed. Therefore, the METR must also include the tax on interest and dividend payments, as opposed to the case of large businesses that pay international interest rates for their financing. Second, small businesses are exempt for VAT. Hence they face an effective sales tax on capital inputs of 14 percent as they do not receive credit for VAT paid on capital inputs. It is assumed that this tax is absorbed by the firm. The new presumptive regime that replaces the turnover bands with a single tax rate of 3 percent on turnover lowers the METRs to some extent (see Table 2.4). Table 2.4: Mauritania: METR Analysis for Small Businesses Manufacturing Tourism Agriculture Mining Old SME taxation regime 56% 51% 50% 57% (turnover tax of 4-6 percent) New SME taxation regime 49% 45% 44% 50% (turnover tax of 3 percent) Source: Staff calculations. 2.18 The nominal tax burden on small businesses in Mauritania will continue to be much higher than that on larger businesses even after the introduction of the new SME taxation regime. The METRs for the SME taxation regime represent an improvement over the old SME taxation regime; but they remain higher than the general regime. This is because turnover taxes impose a higher burden than taxes on profits. This analysis does not include any issues related to the cost of compliance. By reducing compliance costs with a simple regime based on a single turnover tax, many businesses will in turn face higher effective tax rates (see Figure 2.2). 32 Figure 2.2: Comparison of the METRs for Various Tax Regimes for Small Businesses 60% General Regime 50% SME Old Regime 40% SME New Regime 30% 20% 10% 0% g re g m in rin tu is in ul ur tu M ic ac To gr uf A an M Source: Staff calculations. 2.19 The METR results for Mauritania in the planned small business regime are comparable to Mali, but higher than in other African countries. The METRs for the small business regime are higher (50 ­ 56 percent under the old regime and 44-49 percent under the planned regime) than those in other African countries, such as Tanzania (30-32 percent) and South Africa (22-32 percent) (see Table 2.5). Moreover, METRs in Mauritania are much higher than those for the manufacturing sector for the US (25 percent) and for the UK (28 percent) (Mintz and Chen, 2008).58 Table 2.5: Comparison of METRs for Small Business Regime in Mauritania and other African countries Mauritania South Mali Tanzania Existing Planned Africa regime regime Small Business 44-48% 30-32% 22-32% 50-56% 44-49% Regime Source: Staff calculations. Note: Mining is not included for comparison purposes. Factors Driving Tax Evasion in Mauritania 2.20 Literature that investigates the determinants of informality defines informality as tax evasion (lack of tax compliance) by registered, formal firms. Many contributions in this field confirm that unevenly enforced and burdensome regulations (de Soto, 1989; Djankov et al., 2002; Loayaza et al., 2005; Loayza and Rigolini, 2006), corruption (Friedman et al, 2000), financial development and entry costs (Straub, 2005) are significantly associated with informality. 58 The methodology used by Mintz and Chen is slightly different. They calculated METRs for most economies of the world using a limited set of paramaters (taxes). Therefore, these comparisons should be interpreted cautiously. 33 2.21 Gatti and Honorati (2008)59 find that more tax compliance is associated with more access to credit and Perry et al. (2007)60 highlight that corruption is positively related to informality as well as that firms constrained by labor market regulations evade a higher fraction of taxes and/or social contributions. In addition, Perry et al. find that enforcement of tax regulations lead to lower informality. For each percentage point increase in the probability that a firm is visited by tax inspectors, the fraction of underreported sales and workers are reduced by 1-2 percentage points. While they do not find evidence for any impact of access to financial services on informality, companies that sell to large firms (that is, companies with more than 100 employees) exhibit lower rates of underreporting than other firms. 2.22 Overall, based on firm-level data from the ICS (2006) in Mauritania firms perceive that, on average, only 45.6 percent of firms' sales61 are reported for tax purposes. Moreover, the descriptive analysis in Table 2 in Annex 4 shows that, on average, firms operating in the informal sector perceive that only 31.2 percent of sales are declared to the tax administration. The perceived level of sales declared in the formal sector is higher - on average 53.9 percent of sales declared. 2.23 On average, firms perceive that the percentage of sales that large firms declare to the tax administration is more than two times higher than that declared by micro firms. Large firms declare 68.9 percent of their sales, compared to 31. 2 percent declared by micro firms, 47.9 percent declared by small firms and 54.9 percent declared by medium firms. This indicates that micro firms are typically the ones that evade taxes the most. Moreover, family businesses declare only 43.4 of their sales, compared to 73.1 percent for private limited firms and 54.5 percent for firms whose legal status is partnership. 2.24 Firms perceive that foreign-owned firms operating in Mauritania declare for tax purposes, on average, 62.2 percent of their sales, while domestic firms declare 44 percent. Furthermore, firms undergoing external audits declare on average 73.2 percent of their sales as opposed to only 48.9 percent declared by firms that are not audited. Nonetheless, exporters declare on average only 47 percent which is comparable to 45.5 percent of sales declared by non- exporters. Similarly, there is not a significant difference between the percentage of sales declared by firms for which foreign competition is very important (on average, 65.2 percent) and firms for which it is not (on average, 56.8 percent). 2.25 Access to credit does not seem to be associated with greater tax compliance in Mauritania. Firms that perceive access to credit as a major or severe constraint to their business operations declare on average 51.2 percent of their sales for tax purposes, while those who perceive access to credit as a minor to moderate constraint declare only slightly more ­ on 59 Gatti and Honorati (2008) use firm-level data from the World Bank ICS. The surveys cover a large number of developing countries between 1999-2005. 60 Perry et al (2007) use firm-level data from the World Bank's Enterprise Survey Database. The surveys cover several countries from Latin America, including Argentina, Bolivia, Colombia, Mexico, Panama, Peru, Uruguay. 61 The dependent variable is the percentage of sales declared for tax purposes. It is based on the following question from the 2006 ICS: "What percentage of total sales is generally declared to the tax administration by the firms in your sector?" The assumption is that the perceived rate reported by the firms will be close to the sales declared for tax purposes by them. 34 average 54.4 percent. Moreover, firms that have loans do not report on average higher shares of their sales for tax purposes than other firms (on average 53.3 compared to 59.2 percent). Hence access to credit alone may not necessarily encourage firms' formalization. 2.26 Lastly, the descriptive analysis shows that Mauritanian firms in manufacturing and services seem to declare more than those in retail. On average, the firms in manufacturing sector declare 58.7 percent of their sales. Similarly, firms in service sector declare 55.3 percent, while those in retail only 37 percent. 2.27 In order to investigate the determinants of tax evasion in Mauritania, a model that explains the level of tax evasion (percentage of sales declared for tax purposes) is estimated. The model allows for a number of idiosyncratic variables (firm size, whether a firm has a loan, firm age) and controls for region and sector. Other specifications test the effect of the number of fiscal inspections in the past 12 months, whether tax inspectors requested bribes, fiscal administration, whether a firm imports or exports directly or both, labor regulations, contract enforcement and whether fiscal administration is considered a major or severe obstacle to business operations and growth. Micro firms are the omitted variable as they are considered informal. Results are reported in Table 2 in Annex 4. 2.28 Empirical analysis confirms that large firms declare on average a significantly higher percentage of sales for tax purposes than micro firms. Also, small and medium-sized firms do not report, on average, significantly more than micro firms. Similarly, when measuring firm size as employment or sales, respectively (logarithm of employment and logarithm of sales, respectively), larger firms declare on average a significantly higher percentage of their sales. On average, an increase of 1 percent in firm's employment is associated with an increase of 7.68 percentage points in the sales declared for tax purposes. 2.29 The number of visits by tax inspectors seems to increase the likelihood of paying taxes. There is a positive and significant relationship between the declared sales for tax purposes and the bribes paid to tax inspectors and the number of visits by tax inspectors. Firms that receive more visits from the tax administration and pay higher bribes declare on average a higher share of their sales for tax purposes. However, firms that have been operating longer in the market and are more familiar with the system, as proxied by firms' age, declare on average a lower percentage of their sales, indicating that they have found a way to "cut corners" and evade fiscal requirements. B. SMALL BUSINESS TAXATION Questions for the Design of the New Small Business Taxation Regime 2.30 The presumptive regime in place until 2008 in Mauritania not only has had an extremely high METR on new investment, but it also placed the highest burden on the lower end of the companies falling under this regime. Such taxation regime contradicts the basic principles of small business tax regime design. The rates of a presumptive regime need to be high enough to encourage firms at the upper end of the threshold to join the general system and low enough to encourage currently informal entrepreneurs to comply with tax requirements. 35 2.31 To simplify the small business taxation regime, the Mauritanian authorities the introduced in 2009 a single self-assessed rate of 3 percent for all small firms. The previous presumptive regime distinguished between traders and service providers (assuming higher profitability of the latter activities) used different turnover bands and registration thresholds. A single rate would result in some more profitable firms benefiting more than others that are less profitable, but the significant benefits of an easily administered, simple regime may justify some disparity. Tax policy makers always face tradeoffs between simplicity, fairness, efficiency and administrative feasibility. The simplification of the SME tax regime in 2009 represents a progress in that respect. 2.32 Presumptive tax systems can be more attractive than net income taxation, because they tend to result in a lower tax burden for high-profit enterprises. The METR results show that the tax on new investments is less advantageous for firms in the new presumptive regime than in the general regime. However, for high profit firms a single turnover-based tax is obviously very interesting. It is thus crucial to ensure that this system is applied to small businesses only, and to avoid an abuse of the presumptive system by larger enterprises in order to protect tax revenues. This requires the definition of a clear and objective system threshold, which cannot be easily manipulated by larger businesses. In addition, appropriate safeguards and checks to detect abuses by large businesses are needed to ensure that the new presumptive regime does not become a haven for tax evasion. 2.33 A withholding tax of 3 percent on imports and public contracts is imposed on small and large enterprises. Practice suggests that even if the withholding tax guarantees minimum fiscal revenue, it (i) increases the complexity of the tax system; and (ii) tends to transform a direct tax into an indirect one (enterprises often consider it as de facto not subject to control). Hence, in an effort to increase transparency and tax compliance, tax administrations have gradually eliminated this type of tax. In Mauritania, this gradual elimination (for all enterprises) could encourage SME formalization since (i) fiscal procedures would be simplified ­ as the enterprises under the presumptive regime would not have to reconcile the withholding tax with the due tax; and (ii) the withholding tax is often considered as "not being subject to control" and does not encourage enterprises to fulfill their tax filing obligations. Tax Administration 2.34 Currently, the Tax Department (DGI) has only very limited knowledge about the taxpayer population outside the large taxpayers' office. The widespread application of a unique identifier would significantly improve the current situation. Yet, the restructuring process of the DGI according to taxpayer size was ongoing before the coup d' Etat. A move to a modern, self-assessed turnover tax for small taxpayers is challenging even with a more solid foundation. Reforming the administrative structures for the administration of the new small business regime will require a significant improvement of monitoring capacity, a review of current procedures, training efforts and a veritable change of culture among tax administrators as well as taxpayers. This is not a small task and many of these reforms have to precede the introduction of the new regime in order to make it work. 36 Figure 2.3: Informal Payments to Facilitate Compliance with Various Administrative Requirements in Mauritania (% of Firms) 84.8 90 80 65.6 63.7 70 54.5 60 50 36.5 40 30 17.1 20 8.5 10 0 License or telephone line Import license Construction administration Connection to Connection to Connection to patent electricity permit a fixed Fiscal water Source: World Bank, 2007b. 2.35 Minimizing compliance costs for small firms is essential in Mauritania. Given that administrative costs of tax procedures are an important deterrent for compliance by small firms, the new regime should be designed with minimum compliance costs. Procedures, forms and payment modalities must be tailored to small business needs with the presumptive regime based on self-assessed simplified returns by taxpayers (who should be able to declare turnover, self- assess liability, and pay in a single step). Many tax assessments seem to result from negotiations between the taxpayers and tax officials. These negotiations are non-transparent and prone to abuse. The current prevalence of corruption in the tax administration, captured in the ICA, shows that more than 50 percent of manufacturing firms report informal payments to the tax authority. 2.36 Monitoring and enforcement capacity of the tax authority in Mauritania is limited. The current tax administration for small firms is entirely based on annual assessments by officials from the tax authority. Taxpayers complain about frequent bargaining and informal payments. Consequently, reeducation and monitoring of the tax authority's officials will be required to ensure business friendly and non abusive practices towards small taxpayers. In addition, the establishment of a solid database is critical to allow for more standardized and thus transparent audit/verification procedures. A formal and transparent procedure for small tax payer complaints and disciplinary matters will help build trust in the new tax regime for small businesses. Such an internal communication and education effort may precede the introduction of the new regime. 2.37 However, it is important to keep administrative efforts and costs of dealing with small taxpayers to a minimum. Revenue benefits from administering small taxpayers are minimal and will remain small even if the new system encourages the regularization of many currently informal businesses. It is therefore important to fundamentally change the approach towards small taxpayers. The turnover based tax should be self-assessed by small businesses limiting the administrative efforts to risk-based turnover verifications. These verifications need to be kept to a minimum and focus on firms at the upper end of the presumptive threshold in 37 order to increase efficiency. Rare, but regular audits and, if necessary, penalties are sufficient to ensure that taxpayers understand the risk of failing to assess their liabilities accurately. 2.38 Furthermore, there is no planning for support services to help small taxpayers comply with the new regime in Mauritania. Self-assessment by small taxpayers requires an education and capacity building effort in order to ensure that firms can comply with the new procedures. However, practically no small firm in Mauritania relies on external assistance by accountants to monitor their business activities. While it can be expected that small firms practice some form of record keeping, it is not clear to what extent such record keeping corresponds to any commonly accepted standards (even for the turnover based regime). Education campaigns and support services will be required to facilitate compliance for small taxpayers. A well-designed communication campaign will help change attitudes towards small taxpayers as well as taxpayers' attitudes towards the tax authority (see Box 2.5). Box 2.5: Key Areas for Taxpayer Education and Assistance The key areas for tax payer education and assistance may be summarized as follows: · Educate the taxpayers on the laws and how they operate: Tax laws are by their nature complex, it is the onus of the tax administration to convey this to the taxpayers in a language easily understood by them. Pamphlets explaining the operation of the various taxes are the most popular method of communication. However, the audience need not necessarily be those who do not know much about the tax system. Even tax lawyers and tax accountants need to be informed of the true intent of the law. In this case, tax bylaws could help clarify the law with examples and calculation that clearly bring out the intent of the law. Putting these explanations into the bylaws has the advantage of giving it legal sanction that a pamphlet does not. · Educate taxpayers on how to maintain their books of accounts in a manner as required by law. Taxpayers in most cases maintain books of accounts in a manner that is convenient to them. However, for the purpose of paying taxes, the Tax Administration expects the maintenance of accounts in a certain format. Hence, it is the responsibility of the Tax Administration to train taxpayers on the correct format that is to be used to maintain accounts. This could be done with the assistance of the accounting community. A classic example is the separation of personal expenses from business expenses. Typically a small business might mix both these expenses as what matters is what the business person takes home. However, for tax purposes there is a separation of the individual and the business and as a result businesses, especially small businesses, must be trained to account for personal expenditures. Similarly, the tax administration might want to separate capital expenditures from revenue expenses, while businesses might be comfortable with operating on a cash basis. · Inform taxpayers about the important dates when tax requirements are to be met. Taxpayers need to be told through the media the required dates for them to comply with their tax liability and be provided the required assistance. Important dates include the dates to file tax returns, pay tax installments, information requirements to the tax authorities and so on. Taxpayers might also need to be reminded on a regular basis of requirements that are transaction driven such as paying the withholding tax collected by the withholding agent on behalf of the taxpayers, the liability of which generally arises within a certain period of the transaction. · Provide the required information and assist taxpayers to complete their tax returns and other relevant forms in the required format. Under Self-Assessment it is the primary responsibility of the taxpayer to calculate its tax liability. In the case of the income tax, the law is complex and the determination of the taxable income book profits can be quite challenging for a person without the background in tax accounting or tax law. Even in the case of VAT, the calculation of the tax liability can quickly get complex when one includes exempt supply, exempt persons, zero-rating, and partial export, etc. While taxpayers can employ tax accountants or lawyers to help them with complying with their tax liabilities, it is the responsibility of the tax administration to provide enough support through tax guides, support through call centers or even direct support at the tax office. This is especially for those businesses who cannot afford to employ costly tax accountants or lawyers. · Provide information on how taxpayers may pay their taxes. While trivial, this is a useful function of the taxpayer education and assistance. Taxpayers need to know which offices they can pay their taxes if it is to be paid in cash or, if paid through banks, which banks accept tax payments. Source: Adapted from: IFC Tax Simplification Toolkit, forthcoming. 38 2.39 In addition, a reform of local taxation is being discussed as part of the ongoing decentralization efforts in Mauritania. Currently, firms in the presumptive regime pay communal taxes. With an increase of the threshold for the general regime to MRO 30 million many more taxpayers will be part of this local taxation arrangement. This raises questions on the preparedness at the local level for such an increase in taxpayer population. The main objective of these reform efforts is to increase the yield of local taxation for communities.62 In light of the planned increase of the threshold for the presumptive regime, it is necessary to align these reform efforts at the central and local level and ensure that the local tax burden does not become a formalization deterrent (see Box 2.6). Box 2.6: Improving Local Business Environments by Streamlining Regulatory Fees and Parafiscal Instruments at the Local Level Streamlining regulatory fees and parafiscal instruments at the local level would involve in a first phase the assembly of an inventory of all instruments involving a payment made by businesses to local authorities, such as the fee amount, the frequency of payment, the purpose of instrument, and the legal basis. An exhaustive inventory is needed to provide an overall picture and inform all subsequent decisions on the removal and streamlining of the fees and related instruments. Next, reform steps include (1) a check of the legality of the each instrument, (2) a categorization of the instruments into three main categories: user charges, standard taxes, and regulatory fees, (3) and, for regulatory fees, an assessment of their purpose, revenue impact and effect on the business environment.63 Furthermore: · User charges, which are in effect a price for a specific service (or good) delivered by the public sector, will be maintained, though the reform may help introduce a rules-based approach to setting the amount of the charges; · Standard taxes should be approached within the context of the larger fiscal decentralization scheme. Various options can be considered including strengthening property (and land) taxes, or piggybacking on national taxes (income tax, VAT). · Regulatory fees should be reviewed according to their de facto purpose. All instruments which serve solely to generate revenue, and are not directly related to a service or valid regulation, can be considered as taxes (or parafiscal instruments). They could be assessed based on the average revenue generated. When intakes are negligible and below a certain threshold, their elimination could be envisaged. Multiple fees that are an important source of local government revenue may be replaced by a single business levy merging several instruments into one. However, when the instrument in question (a permit, license, or other form of authorization) fulfills a legitimate regulatory function, the fee would likely be kept, but set on a cost-recovery basis (or lower). If strong political support is assured, a reform implementation process could be based on the "reversal of the burden of proof" principle. The most drastic reform option for local taxes and fees would be a reform based on this principle. This approach has been pioneered in Sweden and subsequently adopted in several countries (Hungary, Mexico, Kenya) and is being further developed by FIAS to reform licensing regimes. Applying the "reversal of the burden of proof" principle would mean that local authorities or line ministries (i.e. the "owners" of the each instrument under review), would need to prove that their instruments match pre-defined criteria of legality, efficiency, purpose and business-friendliness. Should the relevant agencies fail to justify their instruments, or to notify their existence past a set deadline, these would be eliminated by default. This mechanism reverses the incentives to share data and information about instruments used. All `surviving' taxes and fees would be listed in a centralized registry. The registry would lessen uncertainty and improve transparence for operators, as no regulation outside of the registry would be enforceable against businesses. 62 The total current collection is small with only about MRO 1.6 billion, amounting to roughly MRO 500 per inhabitant. About 40 percent of local taxation revenues come from property taxes (tax on land, tax on housing) with the majority of taxes collected in Nouakchott and Nouadhibou. 63 See Corthay (2009) for a detailed description of the reform process and evaluation criteria. 39 Source: FIAS Licensing Team, 2008. 2.40 Finally, minimizing compliance costs to encourage participation in the formal economy in Mauritania goes beyond taxation issues and may include streamlining of start- up and operations procedures, such as business licensing and labor regulations. In Mauritania, business registration is particularly cumbersome and costly, especially for small firms. Efforts to facilitate tax registration should thus be coordinated with the reforms initiated by the Directorate General for Private Investment (DGPIP) to streamline business registration procedures. The DGPIP is in the process of evaluating the options for (re-) establishing64 a one- stop shop for investors, possibly including start-up procedures. The long-term objective should be a single business number for all businesses, and, ideally a single `one-stop' agency allowing small businesses to fulfill all business formation requirements in a single step (business registration, licensing, and taxation) at one location. C. CONCLUSIONS AND POLICY RECOMMENDATIONS 2.41 Informal economic activity is very widespread as well as tax evasion even among formal companies. About 70 percent of the urban labor force operate informally and only half the revenues of the companies operating in the formal sector are declared for tax purposes. Numerous factors play a role in explaining the extent of informality such as cultural determinants, administrative barriers, and tax burden. In addition, several key issues stand out. · The analysis of the fiscal burden in terms of its financial and administrative costs illustrates that the planned reform steps are going in the right direction. However, compliance levels are very low, both among large and small Mauritanian firms. · The nominal burden and compliance costs of the small business tax regime are likely to deter formalization of small Mauritanian firms. The planned introduction of a new tax regime for small businesses is an important step in the right direction, yet, as discussed above, several implementation challenges are still unresolved. 2.42 On the other hand, it is well understood that the State should ensure that the level of fiscal revenues be maintained/increased. International practice suggests that the below recommendations proposing the simplification of the tax regime and the strengthening of the tax administration (particularly through more efficient tax inspections) could enhance tax revenues. In particular, enterprise formalization directly contributes to widening the tax base and, hence, enhancing tax revenues. However, some simplification measures, such as the elimination (even gradually) of the withholding tax could affect the stream of tax revenues in the short run. Consequently, the Government could consider undertaking a quantitative analysis of the impact of the below recommendations. This aspect is also included in the below recommendations. 64 A "one stop shop" was already established in 1997 but failed to improve services for firms as representatives from different ministries were not delegated full time and most investors had to continue to visit every ministry. The one- stop shop became a "one-more-stop shop." 40 2.43 To sustain the ongoing reform dynamic in the tax area, it is recommended to: · Continuing the simplification of the tax regime and strengthening of the tax administration (2.1): · Further simplification of the tax regime (including the presumptive regime for micro- enterprises). In particular, the withholding tax should be gradually eliminated (reduce it to 1 percent, and eventually replace it with periodical down payments if the impact on tax revenue is satisfactory) (2.1.1). · Further strengthening the tax administration to better fight (i) tax evasion; and (ii) corruption (2.1.2). The following measures are recommended: · Implement a single fiscal number. This measure is necessary to enable the scrutiny and follow-up of the taxpayer population as well as to exchange and collect information. This requires the adoption of an adapted information system, as provided for in the PRECASP project. · Continue training of the tax administration agents, as provided for in the PRECASP project. · Strengthen fiscal inspections and controls by: o Adopting an approach to fiscal inspections based on taxpayers' perceived risk of evasion, in accordance with well-known international practice.65 o Collecting the necessary information for the risk approach model from sources outside the tax administration (for example, the customs administration). o Improving the formal framework of taxpayers' rights and guarantees (especially, during a fiscal control and tax recovery) as well as the appeal mechanisms to encourage tax compliance. 2.44 To strengthen the reform in the area of small business taxation, it is recommended (Recommendation 2.2): · Inform and train the taxpayers through the media and specific activities on: (i) simplified procedures; (ii) system equity; and (iii) use of collected revenues by the State (2.2.1). · Establish the Centres de Gestion Agrées (Accredited Tax Management Centers) (CGA) to support micro and small enterprises in complying with the simplified tax system. The CGAs could be associations (set up and/or managed by licensed accountants) which, in exchange of a minimal fee, offer basic accounting services and verification of tax declarations. An incentive for enterprises to be member of such a Centre would be a reduction (a minimum of 15-20 percent) of due tax amount. The administration would accredit CGAs based on professional requirements and a formal accreditation and control procedure (2.2.2). 65 The taxpayers' classification based on risk category, determined on historical data and the past inspection experience, is a key tool to make fiscal inspection efficient and objective, while fighting corruption within the tax administration. 41 · Align reform efforts on the central and local level to ensure that the local tax burden does not become an additional formalization deterrent (2.2.3). 2.45 Formalization could be encouraged by linking increased tax compliance to improved access to financing and access to public procurement (Recommendation 2.3). It is also recommended to undertake: · A compliance cost survey to measure and better understand the compliance burden. This survey should cover both rural and urban areas (2.3.1). · Measures to simplify start-up and operation procedures (2.3.2). 2.46 In order to facilitating a pilot calculation of the fiscal revenues in the short run, a forecasting model adapted to the quality of available data could be developed to evaluate the impact of the above recommendations on public revenues (2.4). 42 3. LABOR MARKET IN MAURITANIA: AN ANALYSIS OF LABOR INFORMALITY AND SKILLS MISMATCHES The informal sector may be an important source of employment, especially for the poor. Most SMEs in Mauritania operate informally, with agriculture and retail absorbing the largest share of informal jobs. The quality of informal jobs is arguably lower than that in the formal sector because of lower wages and lack of social security benefits. Typically, informal workers earn 13.7 percent lower wages than formal sector workers. Hence, the informal sector limits the individuals' incentives to invest in human capital and also fuels existing low productivity. At the same time, persistent joblessness may indicate, among others, the lack of employment opportunities given the narrow base of formal SMEs and skills mismatches. Firms, especially more open and innovative ones, report skills and education as a major constraint on their operations and increased investment. Therefore, the lack of adequate skills, on the one hand, may prevent individuals from getting a formal job, and, on the other hand, impede SMEs from taking off and utilizing efficiently their capital investments. This chapter proposes a detailed overview of the labor market in the country, by focusing on labor informality and skills mismatches and their implications for SME development. The analysis is based on data from the 2004 National Household Survey and the 2006 Investment Climate Survey for Mauritania. A. OVERVIEW OF THE LABOR MARKET Unemployment, Jobless and Idleness Rates 3.1 To analyze labor market characteristics, this chapter uses the following conceptual definitions regarding labor market variables. Working age population is defined as those men and women with ages between 16 years old and 60 years old. The employment status follows the international standard and refers to the seven days prior to the National Household survey interview. Unemployed is defined as individuals who are jobless but actively searching for a job. Furthermore, jobless is defined as individuals that are not working (have not worked during the seven days prior to the interview). Idle are defined as individuals that are not working, not looking for a job and are also not in school. It is worth noting that the jobless rate is more appropriate for comparison across countries than unemployment and idleness rates as it is not sensitive to definitions of active search, which naturally vary across countries. Moreover, this chapter follows the ILO definition of labor informality and defines an informal worker as either someone in self employment (considered a worker "á son compte" in EPCV) or as someone with a wage job (which includes apprentices and hourly activities) but without access to social security. Finally, a poverty line of US$1 a day is used, which translates into MRO 94,600 in 2004. The poverty line for extreme poverty was set at MRO 71,550. 3.2 Labor supply has grown as a result of population growth, but labor market participation has remained low. Population in Mauritania has increased from 2.6 million 43 persons in 2001 to 3.1 million in 2007, while the dependency ratio66 has slightly decreased from 82 percent in 2001 to 77 percent in 2007.67 Growing labor supply has not been absorbed by the labor market, as indicated by a high jobless rate- approximately 48.3 percent of the working age population. The unemployment rate is also high, attaining 15.3 percent or 26.3 percent according to the definition of unemployment applied in this study68 (EPCV, 2004). It exceeds even the unemployment rate in Senegal, Mali and Morocco which stand at 5.8, 8.8, and 11.2 percent, respectively (Rajadel, et al., 2007). In addition, 21.6 percent of the overall working age population is idle69 because it is jobless, out of school and also not searching for a job. Table 3.1: Unemployment, Jobless and Idleness Rates in Mauritania Unemployment rate Jobless rate Idleness rate Male 19.2% 24.7% 14.7% Female 40.1% 68.9% 32.5% Total 26.3% 48.3% 21.6% Source: EPCV, 2004. 3.3 The jobless and idleness rates for females are consistently higher than those for male. The jobless rates are 24.7 percent for male and 68.9 percent for female, reflecting the fact that in urban and rural areas women traditionally work in household activities and devote more time to the family. However, excluding those individuals who are involved in household activities, the jobless rate reaches 27.3 percent of the working population. In this case, the jobless rate for women is still as high as 43 percent and is 22 percent for male but there are no significant differences among jobless rates in rural and in urban areas (approximately 30 percent in both areas) (EPCV, 2004). Although the idleness rate (21.6 percent) does not include individuals who were engaging in domestic tasks, females still report higher idleness rates (32.5 percent) than males (14.7 percent) (see Table 3.1) (EPCV, 2004). 3.4 The formal labor market represents only a small portion of the total labor market, accounting only for 15-16 percent of the active population. Enterprises operating in the manufacturing sector declare only 52.5 percent of their personnel, while the ones operating in other sectors declare only 45 percent of their employees. Moreover, based on the EPCV (2004), 87 percent of the surveyed individuals do not have a written contract. 3.5 Self-employment represents a predominant share of the active population. Approximately 52 percent of the employed population is self employed. Wage earners (30.4 percent of the employed) form the second major group of employed people. Wage earners are 66 The dependency ratio is the ratio of the economically dependent part of the population to the productive part. It includes children who are too young to work, and older individuals. This definition considers children those below the age of 15 and older individuals those above 65 years (World Bank, DDP, 2008). 67 Recent projections of the population show a continuous increase in the total number of nationals, which are projected to reach 4 million individuals by 2020 (UN, 2008). Although fertility rates have been falling, they still remain at relatively high levels, reaching 5.59 in 2005. Life expectancy at birth is 52 years for males and 55 years for females. 68 The share of the working age population who is searching for a job or who does not search because they think they that cannot find one. 69 Idleness is defined as individuals that are not working, not looking for a job and are also not in school. 44 mostly employed by the public sector (40 percent), private individuals or households (35 percent) and only less than a fifth report working for a private company (Rajadel et al., 2007). Differences across Gender, Age, Education Level and Region 3.6 There are large discrepancies in jobless, idleness and unemployment rates across males and females. The jobless rate is 68.9 percent for females, three times higher compared to males (24.7 percent). Additionally, the percentage of women that are out of the job market (idle) is 32.5 percent for females, two times larger than for men (14.7 percent) (see Table 3.1). Idleness rates also tend to be consistently higher for females than for males throughout all the periods of the working life. The percentage of females (40.1 percent) that are unemployed is also higher than that of males (19.2 percent) 3.7 The unemployment rate significantly affects the youngest. The unemployment rate is 53 percent for those individuals with less than 25 years old but it is still 28 percent for those between 24 and 35 years old compared to only 9.9 percent for those between 35 and 45 years old. The unemployment rate decreases significantly at the latter stages of life, however, this does not mean that individuals find jobs (see Figure 3.1). Data shows that they simply stop searching. Also, idleness is far from being exclusively a youth problem, persisting throughout the working life. Figure 3.1: Unemployment Rates across Age Groups 70% 60% 50% Male Female 40% Urban 30% Rural T otal 20% 10% 0% less 25 25-35 35-45 45-55 55 plus Source: EPCV, 2004. 3.8 Unemployment is not exclusive of the less educated workers. Although the unemployment rate is higher for the low educated it is still high for those with secondary or with post secondary education. Unemployment reaches approximately 34.5 percent of the labor force with secondary education and is 16.5 percent for those with tertiary education. In particular, unemployment rates among recent graduates reach more than 50 percent of the population with less than 27 years old. This raises the question of whether demand for workers with secondary or tertiary education is greater than supply or whether secondary and tertiary education provides the skills needed in the labor market (see Figure 3.2). 45 Figure 3.2: The Unemployment Rate among Groups with Various Levels of Education 45% 39.4% 40% 34.5% 35% 30% 24.7% 25% 21.4% 20% 16.5% 15% 10% 5% 0% Literate Primary Tertiary pre-school Secondary school or Never in Source: EPCV, 2004. 3.9 Additionally, there are significant regional differences in the unemployment rate, with unemployment rates being higher in urban areas. The unemployment rate is well above the national average in the city of Nouadhibou (39.5 percent), Nouakchott (29.2 percent) and exceed 40 percent for Guidimagha and Inchiri (see Table 3.2). In addition, unemployment rates are higher in urban areas than rural areas. This holds across most education groups, but the difference between unemployment rates in urban versus rural areas is higher for individuals with graduate education who tend to be concentrated in the large urban areas of Nouakchott and Nouadhibou, respectively. Table 3.2: Unemployment Rates across Regions Region/town Unemployment rate (%) Male Female Total Hodh Charghy 8.0 14.4 10.1 Hodh Gharby 13.2 31.7 2.1 Assaba 9.2 28.9 18.0 Gorgol 17.5 48.5 27.4 Brakna 22.0 47.1 28.7 Trarza 15.0 42.5 22.5 Adrar 27.0 64.1 39.3 Nouadhibou 34.1 55.5 39.5 Tagant 24.7 54.2 33.1 Guidimagha 29.3 66.5 41.4 Tiris Zmmour 23.1 67.4 35.7 Inchiri 33.4 79.0 50.6 Nouakchott 23.7 39.3 29.2 Total 19.2 40.1 26.3 Source: EPCV, 2004. 46 Sectoral Dynamics 3.10 Most of the workforce is employed in agriculture, livestock herding, trade and services. According to the 2004 EPCV, in 2004 agriculture and livestock absorbed around 29.2 percent of the working age population, much less than in 2000 when, according to 2000 EPCV, these sectors absorbed almost half of the working age population (49.3 percent). In 2004, trade and services employed 33.3 percent of the working age population, a significant increase compared to 2000 ­ 13 percent (EPCV, 2004 and 2000). Fisheries, mining and construction sectors employed only small shares of the working age population ­ 4 percent, 1.9 percent and 4.3 percent, respectively, in 2004, compared to 1.9 percent, 0.6 percent and 1.5 percent, respectively in 2000 (EPCV, 2000). Figure 3.3: Employment by Sector in Rural Areas Public administration, 3.2% O ther, 7.5% Services, 5.7% Agriculture, 44.7% Retail, 20.1% Transport, 2.2% Fisheries, 1.3% Construction, 2.5% Livestock, 11.1% Manufacturing, Mining, 0.2% 1.5% Source: EPCV, 2004. Figure 3.4: Employment by Sector in Urban Areas Live stock, 0.7% Manufacturing, Agriculture , 2.6% Fishe rie s, 4.6% 3.1% O ther, 14.7% Mining, 2.5% Public administration, Construction, 5.3% 15.0% Transport, 5.5% Se rvices, 15.8% Retail, 30.3% Source: EPCV, 2004. 47 3.11 Agricultural activities account for more than 40 percent of the workforce in rural areas. In 2004, agriculture and retail employed most of the workforce in the rural areas (44.7 percent and 20.1 percent, respectively). In the urban areas the workforce was absorbed by retail (30.3 percent), services (15.8 percent) and the public administration (15 percent) (see Figure 3.4). B. UNDERSTANDING THE INFORMAL SECTOR Characteristics of Informal Sector Workers 3.12 Approximately 85 percent of the labor force is considered informal.70 Almost 50 percent of the working age population is jobless. The persistency of joblessness might reflect the lack of employment opportunities, skills mismatches of the workers as well as rigidities of the labor legislation. The inability to find employment has important consequences, especially for the poor. Therefore, workers who cannot find formal employment are forced to join the informal sector.71 Furthermore, most workers in Mauritania are either self employed or not covered by any type of social security agreement. Among informal workers, more than half (55 percent) are self employed. Figure 3.5: Level and Composition of Informal Employment 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Urban Rural Male Female Percentage of informal wage earners Percentage of self-employed Source: EPCV, 2004. 3.13 Informality disproportionally affects females especially in urban areas. Informality affects 93 percent of females versus 88 percent of males. The difference between genders is even more acute in the urban areas. On average, 87 percent of females are considered informal sector 70 This report uses the ILO definition of informality. According to the definition used in this Report 98 percent and 97 percent of the workforce "a la tâche" and apprentices/non paid workers, respectively, are considered informal because they do not have the right to a pension. According to this definition, 67.9 percent of the salaried workforce is informal. 71 Usually labor markets in developing countries are characterized by the existence of "good" and "bad" jobs or the "covered" and "uncovered" sectors. This distinction normally refers to either low productivity jobs, where workers do not have access to social security, and/or to other mandatory benefits, or to high productivity jobs, where workers tend to have access to social security and other benefits. 48 workers in the urban area versus 77 percent for males. Approximately 43 percent of the women in the informal sector are wage earners versus 63 percent for males. This lower rate of informal wage earners within the informal sector is actually explained by the lower propensity of women to have a wage job. Finally, 56 percent of women in the population are self employed versus 49 percent of males (see Figure above 3.5). 3.14 Labor informality is high among the youth. On average 96 percent of those workers between 16 and 25 years old are informal. Although informality tends to decrease with the age of the worker, it is very high in the latter stages of the working life. For example, approximately 90 percent of individuals with more than 55 years are considered informal. This high number (especially when compared with the 45-55 year old) is likely to reflect, among other things, the fact that some individuals gain the right to a pension in the formal sector and continue working in the informal sector after that (see Figure 3.6). Figure 3.6: Informality over the Lifecycle 100% 90% Total Male 80% Female Urban Rural 70% 60% less 25 25-35 35-45 45-55 55 plus Source: EPCV, 2004 3.15 More educated workers are less likely to be informal. Approximately 89 percent of those with primary education are informal. This number falls to 40 percent when individuals have a graduate education. Having more years of education reduces the probability to start out in the informal sector. Nonetheless, a person with tertiary education still has a one-third probability to be informal at the age 35-45 years old. 3.16 Agriculture and retail have the largest shares of informal workers. Agriculture and retail together employ 57 percent of the informal workers, and most of them are self-employed workers. Self employment tends to be higher in the rural areas rather than in the urban areas. By contrast, mining, services and the public administration represent more than 80 percent of the formal employment. Nonetheless, informality is a wide ranging phenomenon within the country and is not restricted to rural areas or the poorest regions in Mauritania. The region where informality is smaller is the city of Nouakchott. But, it is still striking to see that informality in there still accounts for 79 percent of the workforce, even though the city accounts for approximately 40 percent of the formal sector workers in the country. 49 Table 3.3: Breakdown of Activities in the Formal and Informal Sector Formal sector Informal sector Agriculture 1.5% 30.0% Livestock 1.0% 7.5% Fisheries 2.3% 2.7% Mining 8.2% 0.4% Manufacturing 1.1% 2.3% Construction 0.9% 4.0% Transport 2.3% 3.8% Retail 1.5% 27.0% Services 11.3% 9.8% Public administration 61.2% 2.0% Other 8.7% 10.6% Total 100% 100% Source: EPCV, 2004. 3.17 Although informative, the statistics reported above cannot capture simultaneously the effects of different firm characteristics in Mauritania. For example, it is possible that one of the reasons informality is over represented among women is due to their smaller investment in schooling or labor market experience. In order to account for this, the propensity of each worker to be informal is estimated as a function of their observable characteristics. 3.18 The strict labor market regulations are likely to be another determinant of labor informality, especially for the informal wage earners. Intentionally or not, strict labor market (and other) regulations impose rigidities and distort the incentives for factor reallocation, capital accumulation, competition, and innovation (Loayza, Oviedo and Serven, 2005, Almeida and Carneiro, 2009). The rigidity of labor market regulations, the low level of enforcement and the mismatch between payments and benefits create a disincentive of firms and workers to hire formally. As previously indicated, even though the rigidity index of labor market regulations (39) has fallen over time in Mauritania, it is still higher than the average of Sub-Saharan Africa (35.5) (Doing Business, 2010). 3.19 The following econometric model estimates the propensity of Mauritanian workers to be informal as a function of their observable characteristics. The model assumes: Pr ob( Informal ) = X i + i + r where Prob is the probability that each individual i is informal, Xi is a set of observable worker characteristics, r are regional fixed effects and i are unobservable characteristics that influence this choice. Assuming that the residuals are normally distributed, the equation above can be estimated by maximum likelihood (probit). Standard errors are not clustered and results are reported in Table 1 in Annex 5. 3.20 Empirical analysis shows that there are significant gender differences in the propensity to be an informal sector worker. After accounting for several differences in the characteristics of males and females, women are still almost 2 percentage points more likely than men to be informal sector workers. Informality is also still more prevalent in rural areas than in urban areas. Empirical results confirm that informality is overall more prevalent in agriculture 50 (with self-employment being more common than wage-employment) and retailing and less prevalent in the mining sector as well as in the public administration. 3.21 Informality tends to decrease with the age of the individual. Empirical evidence (see the findings in column (2) of the Table 1 in Annex 5) also shows that the different age groups have different roles within the informal sector. The youngest workers tend to be wage earners workers, while older workers are more likely to be self- employed or the owners of small businesses. For example, 66 percent of informal sector workers 16-25 years old are wage earners, compared to 47 percent for the 25-35 years old and 37 percent for the 35 and 45 years. (see Figure 3.7). Figure 3.7: Percent of Informal Wage Earners (of the Total Informal Workers) Over the Life-cycle 70% 66% 60% 50% 47% 40% 37% 31% 30% 22% 20% 10% 0% 16-25 25-35 35-45 45-55 55 plus Source: EPCV, 2004. 3.22 The propensity to be an informal worker also varies according to the individual's degree of education.72Individuals with tertiary degrees are 17 percentage points less likely to be informal than those who never went to school. Furthermore, having tertiary education increases the probability of being an informal wage earner versus being a self employed worker. The Earnings Gap between the Formal and the Informal Sector 3.23 To better capture the effects of several observable characteristics in the labor earnings, the following Mincer equations are estimated: ln Wageit = Self + InformalWage + X it + it (2) ln Wageit where is the logarithm of labor earnings for individual i in 2004, and Xit includes a set of individual level characteristics as gender, age, years of schooling (captured by dummy variables for never in school or pre-school (omitted), primary education, secondary education, 72 Across various educational groups (never went to school or has less than primary education (omitted category), primary education, secondary education, tertiary education, traditional education and those with alphabetization), the propensity to be in the informal sector declines monotonically with education, all else constant. 51 tertiary education, traditional education and alphabetization), 2-digit ISIC industry, dummy for rural areas and 8 regional dummies for the different covered districts (Hodh, Charghy, Hodh, Gharby, Assaba, Gorgol, Brakna, Trarza, Adrar, Nouadhibou, Tagant Guidimagha, Tiris, Zmmour, Inchiri and Nouakchott). The main coefficient of interest are and which, all else constant, capture the informal wage premium for the self employed workers and the informal wage earners, relative to formal sector workers, respectively. Tables 7 in Annex 5 reports the least squares estimates for the two main coefficients of interest.73 3.24 The overall informal wage gap is approximately of 13.7 percent in Mauritania. Informal workers (either self employed or informal wage earners) earn 13.7 percent lower wages than formal sector workers (irrespective of their characteristics). There is much more dispersion of earnings in the informal sector. While wages in the formal sector do not differ significantly across rural and urban areas, there are large differences in the informal sector. There are also significant differences across urban and rural areas with the formal-informal gaps being larger in the rural areas. In particular, informal wage earners earn 17.1 percent lower wages in the urban areas. This differential is almost 2 times larger in rural areas. Part of this difference is explained by the concentration of the agricultural activities in the rural areas, where labor productivity (and thus wages) is lower. However, even when accounting for this, wages in the urban areas remain higher. 3.25 The informal wage gap tends to be larger for females than for males. On average, the female workers in the informal sector receive 38 percent less than males if they are self- employed and 41 percent less if they are informal wage earners, respectively. Males in the informal sector that are wage earners receive 14.6 percent less than males that are self-employed. 3.26 Both self-employed workers and wage earners in the informal sector tend to earn lower wages than formal sector workers, although the wage gap is only statistically significant for the informal wage earners. On average, informal wage earners earn wages 20 percentage points lower than for individuals who are self-employed. From simply compensating differential perspective, one would expect earnings for the self employed to be higher to account for the non- payment of social security and other benefits that are offered in the formal sector, but this is not the case. 73 To document the heterogeneity in the informal wage premium, the regression is run separately for different sub- samples. Table 2 in Annex 5 reports the results for the whole sample, males, females, urban and rural areas in columns (1) to (5) respectively. Table 3 in Annex 5 reports the results for each 2-digit ISIC economic activity. 52 C. SKILLS MISMATCHES74 Evidence on Skills Mismatches 3.27 Persistency of joblessness might reflect lack of employment opportunities as well as an intrinsic skills mismatch of the labor force, labor legislation rigidity and other factors which makes them less attractive to employers. Information on managerial perceptions on skills and education of the workforce helps understanding the importance and extent of this problem. The analysis of this topic requires very detailed data on skills supplied in the market and on skills demanded by the firm, which is currently not available for Mauritania. Nevertheless, the firm level ICS (2006) provides useful information.75 3.28 One in every 5 firms in Mauritania reports skills and education of the workforce as a major constraint on their operations and growth. This increases to 34.6 percent when looking at the share of firms reporting that skills are viewed at least as a moderate obstacle to firm growth. Although skills and education of the workforce are seen as an important obstacle, firms in Mauritania do not view it as one of their top constraints in the country.76 Nonetheless, Mauritanian firms are more likely to report skills as a major obstacle than firms in Tanzania, Uganda or India, although less likely to do so than firms operating in China, Brazil or Eritrea. 74 The mismatch between supply and demand of skills is often referred to as skill mismatch. Skills mismatch might capture two different realities. On the one hand, it might capture the fact that some workers could be doing jobs requiring education levels below the ones they currently have (over qualification). On the other hand, it might capture the lack of skills supplied by workers compared to the needs of the labor market. In the context of developing countries, the most important source of skills mismatches refers to the second case, which is the one analyzed in this chapter. 75 The ICS (2006) has the advantage of being the largest firm level data set available in the country with simultaneous information on the use of skilled labor, measure of skills mismatches and several detailed firm characteristics. The ICS is based on a sample of 237 firms. In particular, the ICS collects information on the perceptions of several constraints to growth including those regarding the adequacy of the skills and education of the workforce, which they rated on a four-point scale. Based on this question a dummy variable is built, which equals 1 if skills are rated as a major or severe obstacle. Because perceptions can be influenced by the manager's propensity to report how problematic are different dimensions of the investment climate, the deviation of how firms report skills being an obstacle relatively to the "mean" rating of obstacles in the firm is computed. A positive value for the mean of this variable shows that the firm rates skills of the workforce as being an above the average obstacle to the firm (compared to other obstacles reported). The main shortcoming of this measure it that it is subjective and it does not capture exactly the types of skills that are in highest demand. 76 Data on the relative perceptions across countries shows that on average firms tend to rate skills as being less of a problem than other items they are questioned about. 53 Figure 3.8: Perception of Skills Mismatches across Firms 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% M icro ent rep ris es Small ent erp ris es M ed ium-s ized Larg e ent rep ris es Very larg e ent rep ris es ent rep ris es Source: ICS, 2006. 3.29 In Mauritania, skills mismatch disproportionally affects the largest firms in the country. While all the very large firms in the sample report skills as being a severe obstacle for productivity and growth, only 12 percent of those with less than 9 employees report that skills mismatches are important. Furthermore, skills are seen as a bigger constraint for firms operating in manufacturing than in services. One in every 3 firms operating in the manufacturing sector tends to rate skills as being a severe obstacle to growth (see Figures 3.8 and 3.9). Figure 3.9: Perception of Skills Mismatches across Sectors 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: ICS, 2006. 54 3.30 More open77 and more innovative firms are more likely to report skills mismatches as a major constraint to growth. Usually more open firms are more likely to innovate and to adopt new technology as well as launch new products, which are strongly related with skills upgrading of the workforce (Feenstra and Hanson, 1997; Hanson and Harrison, 1999 and Almeida and Fernandes, 2008). Although the overall degree of integration in Mauritania is low (only 9.2 percent of firms have FDI and only 8.6 percent of firms export), evidence clearly highlights that those firms tend to report skills as being a bigger obstacle. On average, firms with foreign direct participation or that export are 2 times more likely to report skills mismatches as a constraint (see Figure 3.10). Although the gap is smaller, importers also seem to be more affected by the lack of skills in the workforce than firms not importing. Imports have been argued to embody state-of-the-art technologies which are often not available domestically in developing countries. Moreover, when interacting with foreign suppliers importers may gain access to tacit, non-codified forms of knowledge, which are not transferable by means of market transactions. As a result, importers feel more the effect of lack of skills of the nationals.78 Figure 3.10: Skills Mismatches and Firms' Openness 40% 37.9% 35% 30.6% 30% 25% 19.9% 20% 17.3% 17.1% 17.3% 15% 10% 5% 0% Foreign Non-foreign Open Not open Importer Non- company company importer Source: ICS, 2006. 3.31 Firms operating in more technology-advanced sectors and firms using internet and email tend to be more likely to report skills mismatches as a major concern.79 Firms who frequently use internet and email in their contact with clients/suppliers are more than 2 times more likely to report skills as being a major constraint on their operations and growth. Moreover, 38 percent of the high tech firms report skills and education of available workforce as a major 77 Open firms are considered firms that receive FDI. 78 One should be cautious when inferring causality. It is possible that participation in global markets causes differences in perceptions but it is also very likely that firms with different perceptions also differ in a number of other characteristics. Most importantly, perceptions regarding skills may affect the capacity of firms to participate in the foreign markets. Thus, one should not infer causality from these simple correlations (see Tybout, 2000). 79 As emphasized by the 2007 World Development Report (World Bank 2006a), in addition to the specific knowledge, increasingly other types of skills, including the thinking and behavioral skills, are becoming important for the labor market integration of the youngest cohorts. Thinking skills include critical and creative thinking while the behavioral skills include issues like perseverance, self-discipline, teamwork, the ability to negotiate conflict and manage risks. Unfortunately, available data does not allow highlighting the importance of these factors in Mauritania. 55 constraint for growth, which is 8 percentage points above the share of firms operating in non- high tech sectors (see Figure 3.11). Among manufacturing industries, chemicals and plastics, and garments and leather (the most technologically innovative) regard skills as a major obstacle to growth. Figure 3.11: Skills Mismatches in the More Technology-Advanced Sectors 40% 38% 34% 35% 31% 30% 25% 20% 14% 15% 10% 5% 0% firms not using firms using non-high tech high tech firms email/telephone email/telephone firms Source: ICS, 2006. Filling the Skills Gap 3.32 Even though skill mismatches are an important obstacle for firms' growth, only a reduced number of firms in Mauritania provide formal job training to their workers. The investment in formal job training can address, in part, skills gap. However, few firms offer formal job training programs to their workforce (only 25.5 percent). This is still a small share, close to the training intensity in Mali (27.8 percent) but well below Senegal (33.2 percent) and much lower than in countries such as Brazil (67.1 percent) or China ( 84.8 percent) (World Bank, 2007b). The larger80 and more open firms are, the more training they offer. Micro and small enterprises' limited offer of job training may be the result of economies of scale (there is evidence of large fixed costs in the supply of formal training programs (see Almeida and Carneiro, 2008)), and/or the lack of benefits (return) on the investment in training. It is also worth noting that SMEs may offer informal training, but there is no information available to enable an overview of such informal training offered by SMEs in Mauritania. 3.33 Firms that face skills constraints invest more in training. Although there is no perfect match between firms who report skills as a major binding constraint and the incidence of job training, those who report skills as being an obstacle also tend to report a higher proportion of job training. On average, 23 percent of the firms reporting concerns with skills mismatch report training versus 11 percent for firms who do not report those concerns. This finding suggests that firms use job training programs to increase the skills level of their current workforce. Also, there is a positive correlation between the skill base (skilled workers defined as professionals, managers and skilled production workers) and training provided by firms. This shows that 80 This positive correlation seems to be a stylized fact across several developing and developed countries (see Pierre and Scarpetta, 2004, and Almeida and Aterido, 2008). 56 private sector firms in Mauritania are less likely to provide formal job training to low skilled or even to unskilled workers, which is in line with evidence from other countries. The Returns to Education 3.34 There are positive and increasing returns to education in Mauritania. Education starts paying off after completing any formal education degree but the returns are low. On average completing the primary education yields a 22 percent return over not having completed any education. An individual with secondary education earns 60 percent higher wages than an individual that never went to school (see Table 4 in Annex 5). The highest return is naturally for individuals with graduate degrees, where returns are 100 percent (however returns to education are non-linear). This implies that the wage for an individual with graduate education is approximately twice the wage of someone who never went to school. This increasing pattern of the returns to education has been found in African countries (Schultz, 2001). 3.35 There is a large heterogeneity in the returns across sectors of activity, and there are also differences on returns between public and private sectors. The highest returns are observed in the manufacturing, construction and services sectors. In these sectors, wages of workers with a graduate degree are more than twice the wages for someone who has never gone to school. Graduate returns are 128 for manufacturing and services and 137 for construction relatively to individuals that never went to school. Furthermore, rates of return to all formal education degrees in the public sector are below the rates found in the private sector. The public- private wage gap tends to be larger for the more educated workers. Returns to the secondary and tertiary education are 14 and 30 points higher, respectively, in the private than in the public sector. This may relate to the larger wage compression in the public sector. Also, returns to education are larger for higher education graduates working in the urban private sector compared to the one in the rural sector. 3.36 However, returns to education in the country are still below those for developed countries. Assuming that tertiary studies (graduate) require on average 16 years to complete, the return to education reported above implies a return of less than 7 percent per additional year of schooling. This number is above the market rate but still below the 10 percent estimates found across multiple studies for developed countries (nevertheless, smaller rates compared to developed countries are consistent with other studies for African countries (Oyelere, 2006). 3.37 The lower returns could be signaling low quality of the education system, not-in- demand skills as well as slack labor demand. On the one hand, it is possible that, in spite of educated workers still being a scarce resource, there is low quality of the education provided or that the skills are not in line with private sector needs.81 Alternatively, the returns to education can simply translate a slack demand for higher skills in the private sector due to the low technology installed, casting doubts on the assumption that demand is larger than supply. This is also in line with the fact that there are large unemployment rates among educated individuals 81 Evidence shows that returns to tertiary education are higher for the younger cohorts, so quality of education alone cannot be the only explanation (see Table 6 in Annex 5). The rates of return to different schooling degrees by age cohort, which have presumably received decreased schooling quality over time due to the massification of the education system, were computed. 57 especially in urban areas -if labor were a very scarce and valued resource, unemployment rates among this group of individuals would not be high. 3.38 Migration has been an important response to the lack of good job opportunities at home and a channel to move out of labor informality. In 2005, the stock of emigrants from Mauritania represented 3.4 percent of the total population, outpacing the immigrants stock (2.2 percent of the population) (World Bank, 2008).82 According to the SNE (2008) there is an increasing share of the younger cohorts leaving the country to find better opportunities in west and southern Africa (Senegal, Côte d'Ivoire, Angola), Gulf Arab countries (United Arab Emirates), Europe (France, Spain) and the United States. On the other hand, immigrants from neighboring countries (Senegal, Mali, Guinea, Ghana, Tunisia and Algeria) supply skilled labor force in certain areas, such as tourism, fisheries, construction and mechanics. Migration flows in Mauritania into urban areas,83 particularly to the capital city, have also intensified as agricultural share decreases as a proportion of GDP. D. CONCLUSIONS AND POLICY RECOMMENDATIONS 3.39 There are large idleness rates which affect a large part of the population including those less than 25 years old. This "exclusion" from labor market participation early in life will significantly hamper the effectiveness of any human capital investment (WDR, 2007). This in part reflects the large discouragement rates in the labor market. Individuals simply prefer to stay out of the labor market and rely on informal safety nets rather than to look for a job. One of the underlying causes for this discouragement is the lack of opportunities for productive employment, suggesting the need to improve the overall investment climate and foster formalization. However, the analysis also suggests that there is some inadequacy between the existing skills and the market needs. 3.40 Informality in the country is a wide and heterogeneous phenomenon. Most workers in Mauritania are considered informal workers, being self employed and not covered by any type of social security agreement. Informality rates are high even among the more educated workers and its persistency throughout life suggests that education is not enough to move out of informality. Moreover, there are large formal-informal wage gaps which are not explained exclusively by workers characteristics. The findings suggest that the characteristics of formal and informal workers do not differ substantially but receive different returns, and that some informal sector workers simply wait for an opportunity in the formal sector. 3.41 Mauritania is caught in a "vicious circle" preventing the improvement of worker skills. Low skills feed into firms with low labor productivity and with a low technological base. Firms find it difficult to invest in job training due to the large costs involved in the process. On the worker side, there are above market returns to invest in education, notably secondary and tertiary education but there is also a high risk of joblessness and unemployment among this 82 Migration and Remittances Factbook, 2008. 83 In order to reduce the impact of internal migration from rural to urban areas, the authorities organize every year an operation to encourage youth to return to the rural areas. To this end, the authorities grant them free transportation, equipment and inputs for agriculture and, sometime, small grants to facilitate their living conditions before the harvesting season. 58 group. This is possibly due to the low quality of schooling but also lack of opportunities in the private sector. 3.42 Skills mismatches matter especially for the larger and more open firms. The current skills of the workforce are rated by managers as an obstacle to firm productivity and growth in one of every five manufacturing firms. To overcome this gap, some, few firms, invest in formal job training programs (especially the larger and the more high-technology ones). The smaller and informal firms face high training costs, low financing capacities and possibly lack of information and thus, simply have to rely on the low level of skills available in the workforce. 3.43 Even if the supply of skills and labor were to be appropriate for the market needs, many individuals would still find difficult to find good employment opportunities. This is likely to happen because of many different reasons that are outside the scope of the analysis in this report. In particular, a poor investment climate to conduct business and strict labor market regulations are likely to significantly constrain labor productivity and employment growth. 3.44 To support improvement of the Mauritanian labor market, it is recommended to: · Complete the informal sector studies in the urban areas and extend them to the rural areas in order to collect complete information on the characteristics of and constraints on the Mauritanian informal enterprises. The INAP/FTP has already produced studies on four urban areas. These studies should be extended to other urban as well as rural areas (Recommendation 3.1). · Reinforce the capacity of employment institutions in order to strengthen their contribution to diminishing the unemployment rate (3.2). · Include the teaching of practical, thinking and behavioral skills in the education programs (3.3). · Transmit the national strategy on skills development for comments to the technical and financial partners (3.4). · Review international good practices and case studies on skills mismatch (3.5). 59 4. COMPETITION POLICY AS A TOOL TO INCREASE COMPETITIVENESS AND ECONOMIC DIVERSIFICATION The transition towards market processes, trade and economic liberalization in Mauritania has not automatically translated into higher degrees of inter-firm rivalry. Large incumbent groups dominate several sectors and tend to crowd out small businesses which, in turn, may not have any other option but to operate informally. This, coupled with a narrow manufacturing base, has led to higher market concentration and reinforced monopolistic structures in some sectors. Enhanced competition in Mauritania is therefore essential to stimulate investment and encourage firms to operate formally. More competition among firms leads to better price-quality ratio and increased welfare for both private and public consumers. One negative effect of the imperfect markets in Mauritania is that firms may exploit their market position, engaging in anticompetitive behavior, which not only hurts consumers' interests, but also public spending entailed by public procurement processes. In addition, burdensome administrative requirements and associated costs raise barriers to entry in the market and, thus, limit the emergence of formal SMEs or the expansion of existing investment. The main challenges stem from creating and enforcing policy tools to fight anti-competitive behavior in private and public markets. The current competition policy framework provides a basic legal framework, but law enforcement is virtually inexistent, due to unclear and weak administrative capacities. This chapter discusses the main shortcomings of the current competition legal and institutional framework and presents a strategy to enhance competition policy oversight. A. CURRENT COMPETITIVE SETUP IN MAURITANIA 4.1 Despite trade liberalization, competition has not automatically occurred in Mauritania. Mauritania has gradually liberalized the trade of goods and services through the elimination of the authorizations system, the abolition of export and import monopolies and the reduction of the number and value of customs duties. The lowering of the trade tariffs created the premises for the Mauritanian firms to be exposed to international competition. Nevertheless, de facto advantages stemming from the past state involvement in certain sectors (such as mining) have not disappeared because customers and suppliers, especially SMEs, may have assumed that the state still stands behind these firms (World Bank, 2003). This coupled with preferential procurement and underdeveloped capital market has discouraged enhanced inter-firm rivalry. 84 4.2 An important factor that limits the emergence of formal SMEs and fuels informality in Mauritania is the dominance of large groups in the economy. SMEs face difficulties in competing against the large groups because of their limited access to financing, lack of reliable financial statements, lack of qualified personnel, high operational costs and high tax burdens (ICA, 2007). Firm-level data shows that, overall, the firm concentration in the formal 84 In explaining why lowering of barriers to trade, investment and entry are not sufficient to prevent private firms from engaging in anti-competitive practices, Khemani (2007) argues that the lack of physical and business infrastructure, significant human capital shortages, limited property protection, uncertainty regarding property deeds, underdeveloped financial systems coupled with informational asymmetries and pressures by large incumbent groups with connections to the government and political groups raise de facto barriers to entry in the market and stimulate firms' tendency to engage in anticompetitive practices or monopolize certain markets. 60 manufacturing sector is high (ICS, 2007), with several industrial and commercial groups dominating several markets.85 Their market shares are significant, between 25.8 and 35.8 percent both in the local and national market. Furthermore, 92.3 percent of firms perceive that there were no new entries in the monopolistic or duopolistic markets in 2005 (Table 4.1) (ICA, 2007).86 Table 4.1: New Entry in the Formal Manufacturing Market87 Market structure Monopoly/duopoly Oligopoly (2-5 Competition (+5 All Sample firms) firms) (67 obs) Number of entries in firm's main formal market One entry 7.7 25.0 20.6 19.4 Between 2 and 5 0.0 25.0 32.4 23.9 entries No entry 92.3 50.0 47.1 56.7 Source: World Bank, Mauritania ICA, 2007. 4.3 Furthermore, ownership concentration is high. Industrial and commercial groups in Mauritania are family owned or controlled by a small group of investors, which further increases the level of aggregate concentration. The groups often include banks, commercial or industrial companies. Despite the existence of ten banks and the opening up to foreign banks in 2006, the banking market still exhibits relatively high market segmentation and limited competition, particularly for retail clients. For example, the four-firm concentration ratio on the lending market is 69 percent, while the one on the deposits market attains 67 percent. 88 Moreover, large Mauritanian banks mainly serve their clients within the groups (ICA, 2007). 4.4 Imports of consumer products are dominated by few companies, while some other companies enjoy quasi monopolistic positions or exclusive rights. Despite the elimination of the license to produce, sell or import food products, such as rice in the 1990s, import oligopolies exist for consumers' products such as wheat, rice and sugar. The four-firm concentration ratio for the imports of wheat and sugar tops 90 percent, while the import of rice is dominated by two firms which have a combined market share of 80 percent. Moreover, the Herfindhal-Hirschman Index (HHI) exceeds 0.18, which indicates high levels of market concentration for the imports of 85 The 10 main groups are: Group MAOA (Mohamed Abdellahi Ould Abdellahi); Group AON (Abdellahi Ould Noueigued); Group Bouamatou (Mohamed Ould Bouamatou); Group Tajedine (Isselmou Ould Tajedine); Group ASML (Ahmed Saleck Ould Mohamed Lemine); Group Abass (Moulaye Ould Abass); Group HKD (Hadia Kaou Diagana); Companies MIREX and SIREX (Brahim Ould Ghadda); Group Hamoud (Mohamed Lemine Ould Hamoud); Groupe Ballouhey (Bastien Ballouhey) (French ownership). 86 Market concentration assessment may be complemented by price and firms' profit margins analyses in specific sectors and markets. Due to limited firm-level data, price benchmarking in several sectors in Mauritania is currently not available. 87 All sample of 67 observations. 88 The Herfindhal-Hirschman Index (HHI) for the lending and deposits market ranks between 0.1 and 0.18, which indicates the existence of moderate concentration in these, as a result of the entry of new banks on the market. However, in addition to this index, market dynamics (including interest rate evolution) and banks behavior would indicate that competition is still in its infancy. Typically, HHI offers a static overview and should be complemented with an analysis of company behavior. HHI is calculated as the sum of the squares of the market shares of each individual bank. More weight is given to firms with larger size. An HHI < 0.1 (or 1000) indicates an unconcentrated market; if 0.1 < HHI < 0.18 there is moderate concentration; HHI > 0.18 indicates high concentration. 61 wheat, rice and sugar. Even if its monopoly position ended in 1992, the Société Nationale d'Importation et d'Exportation (SONIMEX) (64 percent woned by the State) has a dominant position in the market of food product imports.89 Similarly, the domestic dairy sector has two plants (Tiviski and Top Lait) with a combined annual capacity of 50,000 tons but they struggle with low plant utilization due to the control of domestic sales by import monopolies (World Bank, 2006). The construction sector, notably the cement market, is dominated by a duopoly composed of the Ciment de Mauritanie and MAFCI, while SAMIA (Société Arabe des Industries Métallurgiques) is the sole producer of plaster, gypsum and marble (Mauritanian Chamber of Commerce, 2008). The marketing and export of frozen fish90 that is subject to local landing (but not processed in the mainland) are the exclusive prerogative of the Mauritanian Fish Marketing Company (Société Mauritanienne de Commercialisation de Poissons ­ SMCP91), as set forth in the Decree no. 99 of 2006.92 4.5 Additionally, opening up of network industries is in its infancy. The monopoly position of the telephone operator Mauritel SA was dismantled by granting three other mobile phone licenses, which introduced more competition and compensated for the limitations of the fixed telephone network. By contrast, the liberalization of the energy market is still in its early phase, despite the abolition of the production and distribution monopoly of electricity in 1999. The company SONELEC was divided into two entities in 2001, the electricity and water divisions. An attempt to privatize 51 percent of the electricity company (SOMELEC) has failed, although consultations to sell this share to a foreign company were initiated in 2002 (ICA, 2007). 4.6 Moreover, the public procurement system lacks transparency, which may encourage firms to engage in anti-competitive behavior. Large contracts fall under the jurisdiction of the Central Procurement Commission (CPC), which retains the responsibility of regulation, control, recourse/complaint, evaluation and award of contracts. According to a recent World Bank study, awarding of public contracts lacks transparency, the public procurement code does not meet international best-practice, the procurement process is highly-centralized and there is no electronic system to facilitate it (World Bank, 2008). The study formulated recommendations to improve the public procurement system, in particular: (i) a new, independent entity (Autorité de Régulation des Marchés Publics) should be established to advise the government on procurement-related regulation, collect statistics on procurement, assess and build capacity, and order independent audits. It will include commissions in charge of sanctions and of resolving disputes; (ii) emphasis on competitive bidding (Appel d'offres) as the default procurement method; (iii) clearer stipulations on advertising requirements. All contracts subject 89 SONIMEX role is to oversee the price level and impose low prices in order to avoid that the other importers charge high profit margins on consumers. However, it is necessary to diminish its decision making power and to reduce the State participation in the company. 90 Fishing is divided into industrial and artisanal fishing. Fish exports represent 215,000 tons, amounting to 44 percent of total exports. The sector represents 6 percent of GDP and 21 percent of tax revenues, and creates directly and indirectly approximately 38,000 jobs, representing 6 percent of the total active population (Mauritanian Chamber of Commerce, 2008). 91 Private operators hold around 65 percent of SMCP capital (World Bank, 2003). The SMCP negotiates the export price and pays the fishermen this price minus 1.5 percent in commission for the maintenance of frigorific equipment (Decree no. 99 of 2006). 92 Most processing of Mauritanian fish occurs on foreign vessels and the local landings are limited. Only around sixty local fish processing units are located along the coast between Nouakchott and Nouadhibou, which function at low levels of capacity utilization with associated high costs. 62 to competitive bidding are to be advertised in the Public Procurement Journal, or other national or international publications as well as electronically, according to a sample format to be issued by regulation; and (iv) limits on change orders after contract award. The contract value cannot increase by more than 20 percent. Currently, the public procurement system may encourage firms to collude when bidding for public contracts, given that the lack of transparency may prevent firms from being well informed and also encourage corruption. Anecdotal evidence suggests that the submission of several bids for public workings by the same bidder and the collusion between several bidders are common practices. Collusion may lead to higher prices for the government and lower quality and, hence, unnecessary spending on the acquisition of goods and services from private firms. This is particularly important if such products and services are homogeneous or they are not easily substituted and only few firms operate in those specific markets. 4.7 Government intervention may also distort the competitive environment in Mauritania at the expense of scarce public resources. In particular, the existing and planned investment and fiscal incentives do not target vital sectors and may also create distortions in the market. For example, the 2002 Investment Code does not include any specific measures aimed at promoting regional development, education, training or environmental protection. The government planned to adopt a new Investment Code which included a series of fiscal incentives. According to the IMF, the planned fiscal incentives would potentially create distortions in the market. Therefore, their elimination and the application of the general tax regime to all investors is viewed as more beneficial to the creation of a stable and credible investment environment that does not discriminate among firms.93 4.8 Furthermore, the existence of administrative and regulatory barriers may be an additional hurdle to the creation of a strong, formal class of SMEs. Starting a business is more costly in Mauritania than in some of the neighbor countries. Mauritania is ranked 149 for starting a business (out of 183 countries), behind Sierra Leone (58), and Senegal (102).94 It takes 19 days and 9 procedures to start a business. Although the cost of starting up a business is not 93 The IMF Report on Reforms of Income Taxes and Investment Incentives in Mauritania (2008) recommended the elimination of fiscal incentives from the new draft Investment Code, the imposition of a uniform tariff of 5 percent on imported equipment and the reduction of this rate; and the introduction of tax credit for investment. The amendments which the Government has decided to reflect in the draft Investment Code were stalled after the coup of August 2008. 94 Doing Business records all procedures that are officially required for an entrepreneur to start up and formally operate an industrial or commercial business. These include obtaining all necessary licenses and permits and completing any required notifications, verifications or inscriptions for a company with less than 50 employees and an equivalent initial capital of 10 times the gross national income per capita (GNI). To interpret the statistical data, one should consider 5 methodological limitations, as follows: (i) the collected statistical data cover the enterprises from the largest economic city of the country and could not be representative for the regulations in other regions of the country; (ii) data are typically related to a certain type of enterprise, namely a limited company of defined size and may not be representative for the regulations that govern other types of enterprises, for example, the self- employed; (iii) the transaction described in a standard case study discuss specific issues and may not be representative for a wide range of issues that enterprises are confronted with; and (iv) time-related indicators involve a certain judgment call of the interviewed professionals. In case the interviewees indicate different estimates, the time-related indicators published in the Doing Business represent the median of various responses which correspond to the respective assumptions. 63 extremely high (34.7 percent of GNI per capita,95) the minimum capital paid represents 450.4 percent of GNI per capita96 (Doing Business, 2010). This seems to play an important role as to register a company or not, with approximately 17.7 percent of informal firms reporting that the minimum capital paid is a barrier to business registration (ICA, 2007). 4.9 Moreover, obtaining various licenses is burdensome. For example, the duration of dealing with construction permits is as high as 201 days, and involves 25 procedures, at a cost of 506.3 percent of income per capita, compared to 7 procedures, 65 days to obtain the permit and a cost of 37.3 percent of income per capita in New Zealand. Compared to other countries in the region, Mauritania ranks behind The Gambia, Mali, Guinea-Bissau, and Senegal in terms of the number of procedures, behind The Gambia, Guinea-Bissau and Mali in terms of the number of days to deal with construction permits, and behind Guinea, the Gambia and Senegal in terms of cost of dealing with licenses (see Table 4.2). Table 4.2: Dealing with Construction Permits Procedures Duration (days) Cost Doing Business (number) (% of income per Rank capita) The Gambia 17 146 336.4 140 Mali 14 185 818.5 156 Senegal 16 220 463.1 157 Mauritania 25 201 506.3 166 Guinea 32 255 249.6 173 Guinea-Bissau 15 167 2,020 181 Source: Doing Business, 2010. B. FRAMEWORK ON FIGHTING ANTI-COMPETITIVE MARKET CONDUCT Competition Policy Strategy 4.10 Competition policy is important to create a level-playing field for all firms and to correct distortions stemming from firms' anticompetitive behavior and government regulation. The GRSP II and 2003 World Bank Report on Regulatory Reform, Market Performance and Poverty Reduction and the CEM (2006) highlighted that competition would need to develop among Mauritania's formal businesses, including through the application of competition statutory principles. Competition policy complements investment and trade liberalization, privatization and deregulation in Mauritania, mainly ensuring that competitive processes are enhanced and promoted, and the benefits of market interactions do not remain in the hands of few monopolistic groups. Moreover, it supports the streamlining of government regulations, helping reduce regulatory barriers that may hurt firm creation and/or expansion. 4.11 The current competition policy setup in Mauritania is limited to a basic legal and institutional framework. Despite incipient antitrust legal provisions and institutional capacity, there is no vision or plan defining a clear approach to competition policy. Broadly, competition 95 Compared to 0.4 percent of GNI in New Zeeland, 4.9 percent in the OECD countries, 31.9 percent in South Asia and 118 percent in Sub-Saharan Africa. 96 Compared to 0.6 percent of GNI in South Asia, 19 percent in the OECD countries and 173.4 percent in Sub- Saharan Africa. 64 enhancing policies may include all the policies aiming to ensure the proper functioning of the market, such as trade policies (external tariffs), foreign investment policies (including relaxed ownership requirements based on national treatment of foreign investment), public procurement regulations and deregulation. In a narrow sense, competition policy should address the anti- competitive practices by companies or national authorities (price fixing, restrictive agreements, and concerted practices), the improper exploitation of market power by powerful firms over the weaker ones (abuse of dominant position) and the state authorities' behavior and unnecessary intervention that might distort competition (government aid). It provides for a wide range of tools, such as competition law (also referred to as antitrust or antimonopoly law), institutional framework (competition enforcement body), advocacy, education and communication tools, and sets the stage for the development of government aid97 control programs (OECD, 2006). Figure 4.1: Elements of a Competition Policy Framework and a Government Aid Control Program Competition Policy: Government Aid Control Program: To remedy market distortions by private and To rationalize the use of public resources public undertakings to enhance trade and investment Competition Policy Strategy Government Aid Control Strategy Awareness/ Legal Framework Enforcement Legal Framework Enforcement Inventory Education Institutional Research/ Institutional Monitoring & Awareness/ Policy Advocacy Framework Sectoral Analyses Framework Reporting Education 4.12 The lack of vision on how to approach competition policy is partly due to the lack of understanding of the benefits of market processes, the scope of the antitrust system and tools that competition policy provides to dismantle harmful monopolies or combat anticompetitive practices by powerful groups. The lack of a strategic approach on how to develop and implement the competition policy continues to fuel the current market structures in Mauritania, limiting action to remedy the existing distortions of competition by private and public operators. Box 4.1 showcases the experience of several East Asian countries with the design and implementation of competition policy. The establishment of appropriate mechanisms for ensuring competition, effective shareholder governance and judicial systems must be 97 Government aid is defined as the level of support or help the public sector can give to an industry/company, which is likely to distort the competition between industries/companies and pose a threat to the operation of the domestic market. Examples of government aid include direct grants, fiscal incentives, subsidized loans or where there are benefits to companies from subsidized business support schemes (reduced cost business consultancy, subsidized rents, training). 65 complemented with other substantive economic law reforms that create and define protection systems of private property rights; establish contract principles and enforcement mechanisms; recognize the formation of business enterprises in the form of partnerships, corporations, and sole proprietorships and specify the means for governing such bodies; promote capital formation (sale of securities, issuance of debts, assets pledging); and facilitate the exit of assets through bankruptcy procedures (see Figure 4.1) (Kovacic, 2001). 4.13 Additionally, Mauritania does not have a mechanism to assess state interventions with potential anticompetitive impact. The lack of a mechanism to perform cost-benefit analyses of state interventions (including direct or indirect financial assistance) that do not necessarily need specific state support distorts the use of scarce budgetary resources and, ultimately, the competitive environment. Setting a framework to assess the government aid schemes could primarily help rationalize the use of public resources, taking into account their impact on investment decisions of investors in other sectors and, more broadly, on the investment environment. It may also support the design of an inventory of all government aid measures, which enhance transparency of public spending, and the creation of a legal and institutional framework to ensure implementation, communication and monitoring of all interventions (see Figure 4.1). Box 4.1: Fostering Competition: The East Asian Miracle Revisited The success of the East Asian "miracle" economies of Japan, Korea, Malaysia and Singapore is well-known, and their interventionist industrial policies are often cited as "miracle" growth solutions. These economies have indeed displayed a significant degree of government intervention and "administrative guidance". For example, Japan's Ministry of Trade and Industry encouraged cartels and mergers and granted export credits to stimulate productivity and dynamic efficiency. However, proponents of fostering competitiveness and growth recognize that oligopolistic rivalry was preferred to channel subsidies to selected "national champions", as part of the industrialization strategy. Michael Porter (2007) and a team of Japanese researchers examined a sample of 20 internationally competitive sectors and seven uncompetitive ones in terms of the nature, timing, and extent of government interventions. They showed that the government-led model with major subsidies was almost entirely absent and found little evidence of interventions in competition. Moreover, studies of certain industries, such as electronics, automobiles and consumer durables indicate strong rivalry between Korean and Japanese firms. Additionally, enforcement of competition laws has recently become central to reviving the East Asian economies, particularly because of the side effects ­ or in some cases, unintended consequences ­ of certain liberalizing reforms in the 1990s. Studies of several competition authorities from East Asia have shown that the great majority of anti- trust cases relate to inputs purchased by business firms from other firms. Anti-competitive practices by suppliers raise the cost of doing business and reduce the competitiveness of harmed firms. Some examples of alleged anti- competitive behavior include bid-rigging for high-way constructions in Japan, collusion between local ferry service operators in Malaysia, exclusive dealing in steel and sheet glass in Thailand. Moreover, simplifying regulations to allow increased competition has proven to be effective in several East Asian markets. For example, the entry policy in the broadband internet market in Korea has been relaxed, the only requirement being to file a simple report. By balancing the technical advantages of network infrastructure with the efficiency advantages of competition, Korea has achieved one of the highest rates of broadband penetration at competitive prices. Another example was Vietnam's decision in 1998 to abolish quotas on rice exporters and to allow private firms to export. This led to the emergence of new rice traders, increased competition and raised prices for rice growers. A study in 2004 showed that the entry of foreign banks in Thailand broke the domestic banking cartel, bringing about a remarkable improvement in service. Similarly, the introduction of competition in air services in Indonesia in the late 1990s transformed the industry and allowed for low cost carriers to compete against incumbent network carriers. Source: FIAS (2007); Porter et al. (2007); UK Department for International Development (2006). 66 Legal Framework 4.14 The Commercial Code from 2000 constitutes the basic legal framework in Mauritania. Mauritania's 2000 Commercial Code (of French law origin) sets forth the legal competition rules in its Chapter 5 ("Price freedom and competition"98). Chapter 5 also contains legal provisions on consumer protection. The competition legal framework typically includes a competition law and secondary legislation.99 Unfortunately, the legal framework on competition is not very well-known and does not include by-laws for implementation. This suggests that it would be useful to adopt a specific competition law (like, for example, the law 99-019 on telecommunications) and secondary legislation. The general legal framework should also include legal provision regarding the regulated sectors (such a telecommunications, electricity and water, postal services). To this end, it is worth noting that the law 99-019 on telecommunications includes specific provisions on competition in this sector. 4.15 The Commercial Code provides for some basic antitrust elements, such as the prohibition of anticompetitive concerted practices and abuse of dominance as well as the possibility of consultations on draft laws or rules that might distort competition. In particular, the agreements that limit the access to markets, fix prices, limit or control production, distribution and investments, and share product or the resource markets are prohibited by law (Article 1233 of the Code of Commerce). The abuse of dominant position in the form of refusal to sell, tying or discriminatory selling conditions by a firm in the domestic market or in a significant part of it is prohibited (Article 1234 of the Code of Commerce). The law also provides that the government should consult the "Market Surveillance Committee" (Comité de Surveillance du Marché) on draft laws or other rules that could have effects on the market, in particular if they place quantitative restrictions on entering a market or profession, create exclusive rights in certain areas, or impose uniform prices or terms of sale (Article 1250). However, the Commercial Code does not tackle merger control, limiting the actions in case of mergers creating or consolidating a dominant position and leading to significant restrictions or distortions of competition in the whole market or in a significant part of it.100 Furthermore, the 98 In French, "Livre V: De La Liberté des Prix et de la Concurrence", Code de Commerce, 2000. 99 The competition law covers restrictive agreements, dominance and merger control (applicable both to private and public enterprises); provides the establishment of law enforcement bodies; and equips the competition agency with enforcement tools, namely investigative and sanctioning powers. The secondary legislation provides guidance on the competition law implementation, and helps define the affected markets (such as product and geographical markets). Secondary legislation may encompass: (i) implementation of the provisions on restrictive agreements, abuse of dominance and merger authorization (including the definition of product and geographical markets; the definition of market dominance and thresholds of market shares above which dominance is determined; calculation of firms turnover in case of mergers, abuse of dominance, or restrictive agreements; the calculation of sanctions and fines and the types of remedies that can be imposed in case of conditional approval of mergers); (ii) exemption regulations covering, for example, research and development and specialization agreements, agreements promoting exports or SME development, changing in the production processes to stop the decline of an industry; (iii) application of the competition-related provisions in the regulated sectors (telecommunications, network industries) and coordination with other sectoral policies; and (iv) the organization, competences and functioning procedures of the competition agency. This is not an exhaustive list of pieces of secondary legislation, but presents essential elements that are desirable. 100 Not all economic concentrations achieved through mergers that create or consolidate a dominant position are prohibited. Generally, mergers are approved if they are compatible with a normal competitive environment, increase economic efficiency and export competitiveness, and reduce prices. 67 lack of secondary legislation to expand and explain the existing antitrust provisions hinders the application of the antitrust clauses of the Commercial Code. For example, there is no clear guidance on the procedural rules for notifying transactions or filing complaints in case of anticompetitive behavior, the investigation procedure, the definition of relevant product and geographical markets affected by the anticompetitive practices, the definition of a minimum threshold below which decisions on anticompetitive practices and mergers do not apply to undertakings whose turnover and market share fall below this threshold, and the organization and functioning of the competition body. 4.16 The Commercial Code includes some sanctions against anticompetitive conduct, but there is no clarity as to how these are implemented. Sanctioning measures through imprisonment (between two and one year prison) and/or fines (ranging from MRO50,000101 to MRO 800,000102) for infringing Articles 1233 and 1234 are provided for all individuals taking part in the establishment, organization and implementation of any restrictive agreement may be sanctioned (Article 1237). Furthermore, a fine of maximum 5 percent of the turnover is applicable to enterprises (or maximum MRO 3,000,000103 to any personne morale) for infringing Articles 1233 and 1234. In addition, the Commercial Code provides for sanctions ranging between MRO 100,000 ­ 200,000 for trading companies that impose directly or indirectly to a minimum selling price for goods, services or a certain profit margin to their distributing companies. However, the way in which the sanctioning measures are determined and implemented is not clearly explained. Box 4.2: Highlights for Competition Law Design Generally, the competition law focuses on the whole range of transactions concluded between businesses in the market, such as inter-firm and ownership agreements, linkages, associations and other institutional arrangements. The competition law is "a general law of general applicability", which applies to all firms engaging in commercial transactions, in both public (state enterprises) and private sectors. Sometimes, competition laws do not apply in certain areas, such as labor market, financial services or charitable activities, because these areas are subject to specific regulations. However, there is an increasing agreement regarding the enforcement of the competition law also in the sectors that were traditionally exempted. For instance, coordinating competition policy and financial regulations governing the banking sector is desirable, especially when customers are affected by banks' strategic behavior. For example, depositors face significant switching costs when closing an account despite the zero cost when opening an account. This is mostly the case in which banks benefit by market segmentation and do not unilaterally benefit by reducing exit costs. Consequently, the competition policy will further trigger a reduction of the switching costs and, more importantly, will help transfer the gains from cost cuts to the consumers. The design of the competition legal framework incorporates structural provisions to tackle dominance, monopolies, mergers, joint-ventures as well as behavioral provisions to combat horizontal restraints ­ collusion (price-fixing agreements, market sharing, bid-rigging) and price discrimination - vertical constraints (resale price maintenance, exclusive dealing), refusal to deal, predatory pricing and non-price predation among others. Special attention is paid to specialization and research and development agreements, which, in some jurisdictions, such as the European Union, are subject to block exemptions in order to encourage investment and innovations. In other jurisdictions, such as South Africa, exemptions may be granted for agreements promoting exports and SME development. Source: OECD, 2007; International Competition Network: www.icn.org 101 Approximately US$223.24. 102 Approximately US$3,540. 103 Approximately US$13,394.5. 68 4.17 The Commercial Code provides certain exemptions from the competition rules, which are assessed and granted by the Council of Ministers. The Commercial Code provides exemptions from the competition rules in case of practices resulting from a government's law or regulation, which might contribute to economic and social progress, provided that these practices do not restrict competition more than the necessary conditions to fulfill their objective. Although the exemption assessment is typically the attribute of the competition body, in Mauritania the Council of Ministers assesses the exemption conditions and grants them through decree. Institutional Setup for Competition Law Administration and Enforcement 4.18 Mauritania lacks an independent specialized Competition Agency, which may hamper the enforcement of the competition provision in the Commercial Code. The independence104 of the competition agency should be construed in the sense of isolation from political interference and also resource independence. By law, the body responsible for hearing complaints about the violation of antitrust prohibitions is the "Market Surveillance Committee" (Comité de Surveillance du Marché). The Committee is chaired by a high-level public official appointed upon proposal by the Minister of Commerce. The Committee and the local price and consumer monitoring committees at commune levels are also responsible for applying the aspects of the law concerned with fair pricing and supply of necessary commodities. The members of the national and local committees are to include representatives of enterprises, consumers and the government. However, in practice, the Committee has never been active. Currently, the Directorate for Competition and Markets (hereafter called Competition Directorate) within the Ministry of Commerce is charged with the enforcement of the existing competition as well as the consumer protection legislation. In addition, the Council of Ministers is in charge of granting exemptions from the competition rules. Furthermore, in spite of the fact that members of the national and local committees cannot participate in decisions about matters in which they have a commercial interest (Article 1249), which represents per se a valuable safeguard, the structure of these various "competition" bodies creates room for negotiations in case of disputes among their interests (World Bank, 2003). 4.19 Moreover, the current Competition Directorate has limited capacity, exclusively tackling consumer protection. The Competition Directorate had 79 staff in 2008, including the management positions. However, it has been so far exclusively enforcing the consumer protection legislation. In particular, it has focused on investigations regarding the commercialization of basic food products (rice, sugar, powder milk), monitoring of advertising, price control and analysis. A project to establish an independent Competition Council directly under the coordination of the President of the Republic has been initiated, however, but limited progress has been made. Box 4.3 highlights the attributes of the Kenyan and the Zambian competition bodies. 104 In some jurisdictions ( Bundeskartellamt in Germany), the competition agency is reporting to the Minister of Economy, while in others it is established directly under the supervision of the President of the Republic. Irrespective to its organizational structure, the competition agency should operate independently in its decision- making process, without interference from the government level. 69 Box 4.3: The Attributes of the Kenyan and the Zambian Competition Bodies Kenya The Monopolies and Prices Commission (MPC) of Kenya is a Department of the Ministry of Finance. Its mandate is to enforce Competition Principles and Rules in accordance with the provisions of the Restrictive Trade Practices, Monopolies and Price Control Act, Cap 504 of the Laws of Kenya. The Act was enacted in 1988 and came into force on 1st February 1989. The role of Monopolies and Prices Commission is that of economic regulation and creation of a competition culture through advocacy and other educational programs. As currently formulated, the main objective of the competition policy is to contribute to enhancing investments, employment, level of savings and, hence, general economic growth and development. The Commission is mandated to encourage competition in the economy by prohibiting restrictive trade practices, controlling monopolies, concentration of economic power and other anticompetitive behavior. The Commission is also mandated to advise the Government on Competition Policy and Law and its implementation. The main functions of the MPC are: 1. Oversight of market structure. The Commission analyses mergers and takeovers and recommends to the minister for approval/rejection. The Commission also assesses unwarranted concentrations of economic power and may formulate recommendations to the minister for divestiture- where necessary. The main aim is to reduce the scenario of a few (monopolists) firms dominating the economy, which may lead to consumer exploitation. 2. Oversight of market conduct. The Commission prohibits restrictive trade practices such as price-fixing, cartel behavior, market/territorial allocation, exclusive dealings, tied purchases, trade discrimination etc. The approach If restrictive practices are not properly addressed, they may reduce the quality and quantity of goods in the market, drive prices up due to lessened competition, and impact negatively on consumers, especially the vulnerable groups. 3. Enforcement and compliance. The Commission is actively involved in ensuring that various ministerial orders and agreements between firms are compliant with the competition legal provisions. This task often involves site visits (in case of agreements) and/or industry studies. 4. Advisory role. The Commission takes an active role in advising the government on domestic, regional and international trade and competition related issues, including participation in EAC, COMESA, WTO treaties. 5. Advocacy role. This function is directed towards the creation of a competition culture at all levels of the economy. Zambia The Zambian Competition Commission (ZCC) was established in 1997 under the Competition and Fair trading Act Section 4 of Chapter 417 of the Laws of Zambia to prevent anti-competitive and restrictive business practices and to promote consumers' welfare. The law came into force in February 1995. The Zambia Competition Commission is an autonomous corporate body under the Ministry of Commerce, Trade and Industry. The Competition Act covers agreements and concerted practices of enterprises and organizations that may have an anti-competitive effect as well as the abuse of market power by enterprises that have a dominant position in their market. The act also deals with consumers' protection issues. ZCC has a wide range of enforcement and investigation powers. The decision-making body of the Commission is made of Commissioners. The Government appoints Commissioners from the Ministry of Commerce, Trade and Industry, and the Ministry of Finance. Other Commissioners represent trade and professional associations such as the Zambia Bureau of Standards, the Zambia Association of Chambers of Commerce and Industry, the Zambia Congress of Trade Unions, the Economics Association of Zambia, the Law Association of Zambia, the Zambia Institute of Certified Accountants, the Engineering Institute of Zambia, and the Consumers' Movement. Source: Ministry of Finance of Kenya, www.treasury.go.ke; The Zambian Competition Commission, www.zcc.com.zm 70 Box 4.4: Steps in the Administration and Enforcement of Competition Law The administration and enforcement of the competition law should not be overly aggressive to prevent investment, business confidence and innovation nor too lax to facilitate monopolistic behavior. Generally, competition law enforcement should not take a regulatory approach to competition, but rather remove barriers to facilitate business transactions. It typically involves: · Investigation of competition cases following complaints by firms or consumers (with more weight given to complaints by consumers than competitors) or ex officio, and gathering of evidence; · Enforcement (adjudication) of legislation by the decision-making body of the Competition Agency and/or by a judicial authority; · Appeal mechanism at a court and/or special tribunal, which typically involves a high level of expertise in economics, business and competition law; · Advocacy, including consultation mechanisms on government's legislation and regulations by the Competition Agency to ensure that the competition considerations are incorporated in other government policies and regulations Enforcement procedure (Anti-competitive behavior of fims) Complaints (firms/ Adjudication and consumers) Investigation imposition of fines Appeal mechanism or (Competition Agency) (Competition Agency (Higher Courts) Ex officio action and/or Tribunal) (Competition Agency) Advocacy procedure (Government laws, regulations, policies) Approval or Draf law Follow up on Send for comments recommendations or regulation implementation (Government) (Competition Agency) to alter the draft (Competition Agency) (Competition Agency) 4.20 In the absence of a strong, independent Competition Agency, the enforcement of the competition law remains limited. The Competition Directorate has not yet opened investigations pursuing the existing competition law, nor did it take steps to initiate the development of the current competition legal framework. As the competition law does not clearly specify the establishment of an independent specialized Competition Agency with investigative, direct sanctioning and advocacy powers, the current Competition Directorate has no power to deter anticompetitive practices. The Competition Directorate has also limited operational independence and budgetary and human resource capacity (including the lack of solid expertise on antitrust administration), which coupled with the idleness of the Market Surveillance Committee as well as the lack of support at government level stemming from the lack of understanding of and education on the competition benefits, markets processes and antitrust tools translates into an institutional vacuum for competition law administration and enforcement. Similarly, advocacy on competition policy issues is inexistent. Furthermore, the 71 lack of coordination between the Competition Department and other government bodies and sectoral regulators limits the incorporation of any competition considerations into other economic and sectoral policies. Box 4.5 showcases the South African experience with the competition law implementation, as South Africa is one of the best practices in Sub-Saharan Africa. 4.21 In addition, the Mauritanian judicial system suffers from structural weaknesses, which further limit competition law enforcement. The judicial system is weak and has not yet built solid commercial and business expertise to deal with antitrust cases. The investor confidence in the judiciary is low, mainly because of the lack of transparency and consistency in interpreting regulations and laws, and the limited effectiveness in organizing a functioning judicial system. According to 2010 Doing Business, it takes 46 procedures to enforce contracts in Mauritania being one of the most burdensome processes in the West African countries (only Guinea has 50 procedures, while the international benchmark is Ireland with 20 procedures). The cost of enforcing contracts usually represents 23.2 percent of the claim comparable to other Western African countries, such as Ghana (23 percent), and Guinea Bissau (25 percent), but far behind the international benchmark of 0.1 percent in Bhutan. Furthermore, it takes 370 days, comparable to other Western African countries, but behind the international benchmark of 150 days in Singapore. Besides the judges' limited expertise and the lack of resources, corruption is frequently cited as the main flaw of the judicial system in addition to significant interferences and pressures by various influential political groups (Heritage Foundation, 2007).105 All these limitations raise significant barriers to developing an effective competition legal framework and to ensuring an impartial and transparent enforcement and adjudication of competition cases. Box 4.5: The South African Experience with Competition Law Implementation The Competition Act 89 of 1998 and its subsequent revisions set the chief competition legal framework in South Africa. The Competition Act covers restrictive practices, abuse of dominant position, and mergers, and is applicable both to private and public undertakings. It provides for the establishment of a Competition Commission responsible for the investigation, control and evaluation of anti-competitive behavior, of a Competition Tribunal responsible for adjudicating such matters and of a Competition Appeal court. With respect to mergers, the Competition Commission of South Africa has built a solid case record in merger review, which typically includes product and geographic market definition, assessment of competitive effects and entry, efficiencies, failing firms, and remedies of a structural or behavioral nature. Similarly, in respect of abuse of dominance (unilateral conduct/monopolization), including market power issues the main types of practices dealt with are exclusionary practices, such as requiring or inducing a supplier or customer not to deal with a competitor, refusal to supply scarce goods to a competitor, tying, predatory pricing, price discrimination, and excessive pricing. As for cartels, the Competition Commission has a wide array of tools to detect, investigate and prosecute cartels, including investigative tools, a leniency program, and a system of penalties for firms. The Competition Commission also engages in advocacy of pro-competitive policies and legislation with other national Departments of Government and with sector regulators. Source: Competition Commission of South Africa, www.compcom.co.za Source: Competition Commission of South Africa, www.compcom.co.za 105 Reforms of the judiciary have been initiated in 2006. A 2006 law restated the independence of the judiciary, provided for a code of ethics and launched a training program for judges (UNDP, 2007). 72 Competition Policy Advocacy and Communication 4.22 Competition policy advocacy is as important as law enforcement in Mauritania in order to promote policies that do not raise anticompetitive barriers through government regulation. In order to ensure the creation of a coherent mix of policies supporting investment and trade in Mauritania, competition policy considerations should be integrated into other sectoral policies and regulations, and exemptions from its application should be clearly specified. Advocacy involves mechanisms of consultation on other legislative initiatives and regulations as well as public awareness campaign on competition principles, involving government bodies, judiciary, private sector and civil society. Communication on competition policy and law complements advocacy activities and includes access to information, publication of annual reports and all decisions made on competition cases. 4.23 As Mauritania does not have a strong independent competition body, the advocacy role of the Competition Directorate is inexistent, while the Market Surveillance Committee's activities regarding potential regulatory constraints are limited. This is mainly the result of the lack of capacity and independence of the Competition Directorate as well as of limited understanding of antitrust fundamentals within the Ministry of Commerce and other ministries. For example, there is no coordination between the Ministry of Commerce and the Ministry of Economy and Finance on competition issues, while competition policy has not yet been included on the economic policy agenda of the government. 4.24 Awareness on competition policy issues and sectors dynamics is also very limited. Most governmental bodies and private companies do not seem to be aware of the importance of a well-functioning competition policy framework, while studies analyzing sector dynamics and concentration106 are not available, including data on competing firms, their market shares, production, prices and costs, profit margins, productivity dynamics. More generally, detailed sectoral analyses and competitiveness studies have not yet been produced which limit, together with missing sectoral data, the performance of in-depth competition analyses (see Box 4.6). 4.25 Finally, strong vested interest may limit competition policy and law design and implementation in Mauritania. The existence of strong vested interests, pressure groups and social networks may raise additional obstacle to the competition policy design and implementation. By contrast, a solid constituency for the competition agency, including strong political commitment on the government side may help avoid regulatory capture, strengthen the competition body's independence in decision-making and shield it against political interference. 106 Sectoral analyses are essential in designing and implementing competition law and policy. However, even more advanced economies lack such studies, although they are highly recommended to inform competition body about the market trends. 73 Box 4.6: The Role of Competition Policy Advocacy Government policies and regulations sometimes discourage investment and restrict competition, through prohibitions in certain sectors. On the one hand, trade restrictions can reduce the size of the market for investments, limiting the economies of scale needed for an investment to be viable. On the other hand, although they restrict competition for a period of time, the incentives to innovate or invest, such as licensing or protection of intellectual property rights are necessary and should be allowed in order to reward investments. Competition principles should be also considered in the privatization processes in order to avoid replacing public monopolies with private ones. This is the result of potentially conflicting interests during privatizations, mainly between the government desire to create a more efficient industry and the desire to sell the state-owned assets at the highest prices. The benefits of granting potential investors exclusivity rights during privatizations or the short-term budgetary windfalls should be balanced with the long-term benefits of competition and private investment developments. The advocacy role of the competition agency should therefore include an evaluation of the costs associated with privatization arrangements, especially when they lead to the creation of private monopolies. Hence, it is advisable that the competition agency be involved in the early stages of the privatization process. Additionally, undertaking research and designing sectoral studies (including market concentration, behavioral pattern of firms, price evolutions, barriers to entry in specific sectors) are essential to understand the economic dynamics in various manufacturing and service sectors as well as to inform competition policy investigations and decisions-making processes. Source: OECD Policy Framework for Investment, 2006. A Framework for Government Aid107 Control 4.26 Currently, Mauritania does not perform cost-benefit analyses of government aid targeted to support certain sectors. As such a government aid control framework does not exist. Linked to the principle of preventing and remedying distortions of competition in the market, the fundamental objective of government aid control is to ensure that state interventions both by central and local authorities do not create unjustified advantages in certain sectors or for certain enterprises, and misallocate funds in areas in which they are not entirely justified. Its introduction could help rationalize the use of public resources, monitor and control government aid granted through special economic regimes and in special economic zones, and support SME development and formalization. In addition, Government aid control programs could help prevent and correct restrictions of competition stemming from granting government aid to public or private sector operators, or special regimes. However, while government aid interventions are meant to boost economic activities in general, they should not be seen as permanent interventionist measures (see Box 4.7). 107 The term of government aid may be encountered in some other jurisdictions as "state aid". For example, the European Union (EU) has developed a comprehensive state aid framework, rules and procedures to streamline the use of public aid towards improving the competitiveness of EU industry and creating sustainable jobs (, aid is allowed for research and development, innovation and risk capital for small firms). 74 Box 4.7: Government Aid Control Programs Helps Channel Public Resources towards Development Although state interventions are generally deemed incompatible with the functioning of a market economy, in some circumstances, state intervention is necessary for the well-functioning of the economy and an equitable welfare distribution. Public financial support that constitute aid may take various forms, ranging from grants, interest rate rebates to loan guarantees, tax exemptions, accelerated depreciation allowances, capital injections, sale or rental of the publicly- owned land at a value less than the market price, and privileged access to infrastructure without any fee payment. The elements defining government aids are the use of public resources, the advantages granted to certain enterprises or certain sectors, the selectivity of public resource provision, the distortion of competition, and the effects on business relations. Generally, government aids that would seriously distort competition should be prohibited, while the ones that support the promotion of economic development where their benefits outweigh the distortion of competition should be allowed. General measures open to all companies are not considered government aids as they do not provide any advantage to those companies/sectors compared to others. In some instances, government aid, if rationally and economically used, can encourage development in areas where the standard of living is very low and unemployment is high. It is desirable to channel public aid towards activities that incite economic diversification, reduce poverty and enhance SME development and formalization, such as: (i) target government aid to the regions or areas that suffer from poverty, low standard of living and chronic unemployment, by supporting initial investments in material and immaterial assets relating to the setting up of a new firm or diversification of activities of exiting firms; (ii) support the SME development, particularly in relation to investment in tangible (land, machinery) and intangible assets (expenditure linked to technology transfer), costs of consulting services or participation in fairs and exhibition; (iii) stimulate employment, and training and adult education, by providing schemes that aim at creating new jobs or covering training costs of firms that wish their employees to acquire new skills; (iv) support one time rescuing and restructuring of companies facing difficulties, to keep the firms afloat for the time a restructuring or liquidation plan is prepared, and restore firms' long-term viability; (v) encourage innovation and research and development (R&D), by targeting costs relating to R&D studies, the preparation of feasibility studies, the functioning of young innovative companies or innovation advisory services; and (vi) protect the environment, to support costs relating to the rehabilitation of polluted industrial sites, relocation of firms from environmentally-damaged areas or investment in new energy saving projects.108 In order to allow for an efficient and effective provision of government aid, based on a thorough cost-benefit analysis, a government aid control framework should incorporate a series of legal and institutional tools such as: (i) a government aid control policy, including the development of a law defining the main principles and categories of government aid (including bylaws for implementation) and the institutional framework in charge of its application;109 (ii) cost-benefit analyses of the public aid measures and assessment of conformity with the government aid legislation; and (iii) a clear inventory, reporting and monitoring mechanism of all public aids and special regimes, particularly the public aid granted in sensitive sectors or special economic zones. Source: OECD, 2006 and 2007. C. COST AND BENEFITS OF IMPLEMENTING COMPETITION LAW AND POLICY 4.27 The adoption and implementation of an effective competition law and policy entails costs and benefits for the Mauritanian government. A cost-benefit analysis informs the Government on the resources involved in this process and helps distinguish between short- and long-term effects as well as the distribution of the costs and benefits. Although evidence of such analyses is parsimonious, the principal benefits of implementing a competition policy framework in Mauritania will devolve from (i) deterrent effect of the competition law as it will help impede 108 This list of possible interventions is not exhaustive. 109 In some jurisdictions, the application of government aid law is ensured by the competition body (in the European Union, the European Commission's Directorate General Competition is in charge of the application of Community competition and state aid rules). 75 anti-competitive transactions from taking place, limit competition and drive prices up; (ii) remedial effect of the law, as it will reduce the harmful behavior of firms, and break up anti- competitive acts and regulations that are currently in existence; (iii) general applicability of the law to all types of private and public transactions (imports, public utilities, public procurement, tradable and non-tradable goods and services) (see Annex 3). 4.28 The adoption of a competition policy in Mauritania will encourage price reductions, stimulate investment and exports, and contribute to SME formalization. More specifically, the existence of an effective competition policy framework will in the short run lower domestic prices (for instance, in the cement markets, food products, import prices of wheat, sugar, rice) and stimulate export development and competitiveness in Mauritania. In the long run, it will improve economic performance due to increased export competitiveness, incite investment in manufacturing activities and stimulate innovative processes. Moreover, in concert with a more comprehensive streamlining of business procedures, the competition policy will help dismantle regulatory barriers, such as tax regimes with anti-competitive effects, and therefore reduce transaction costs. Furthermore, this will stimulate enterprise development and will contribute to the SME formalization. The benefits of operating in the formal sector will increase, as the competition law will provide additional protection to formal firms against anti-competitive behavior and also support opening up of the markets by dismantling existing harmful monopolies or oligopolies (see Table 4.3). Table 4.3: Deterrent Effect of Competition Laws Jurisdiction Overcharge on Deterrent effect** Annual average vitamins imports* US$ million deterrent effect as a % (1990 ­ 1999) of enforcement outlays US$ million Brazil 183.37 72.09 65 Mexico 151.98 44.59 46 Peru 18.91 6.98 7 Source: Simon J. Evenett, 2004, Cost-Benefit Analyses of Implementing Competition Law (Oxford SAID Business School); *excess price resulting from the existence of anticompetitive behavior in the vitamin import market; **deterrent effect resulting from antitrust enforcement. 4.29 The costs of implementing the competition policy depend on the scope of the competition law and the competition institutional design. The main costs relate to the drafting and adoption of a separate competition law in Mauritania (building on the current competition law provisions from the Commercial Code), the creation of an independent competition agency that will require endowments with adequate qualified staff (lawyers and economists), infrastructure (IT), and other budgetary resources to facilitate investigations of anti-competitive practices, policy advocacy activities and participation in international cooperation and exchanges of best practices. All these costs will have a fiscal impact on government spending and should be therefore carefully considered. At the same time, the enactment of the competition law will also prevent collusion and bid-rigging in public procurement of goods and services, and consequently mitigate the overall government spending. For example, Table 4.4 shows the percentage of government spending that would justify a US$5million investment in competition law enforcement in several economies from Latin America. 76 Table 4.4: Deterrent Effect of Competition Law on Bid-Rigging Economies % of Government spending, assuming a 15 percent overcharge Bolivia 3.87 Peru 0.75 Costa Rica 1.64 Ecuador 2.14 Guatemala 3.58 Source: Simon J. Evenett, 2004, Cost-Benefit Analyses of Implementing Competition Law (Oxford SAID Business School). D. CONCLUSIONS AND POLICY RECOMMENDATIONS 4.30 Economic, legal, institutional, political and social constraints affect competition in Mauritania. The design of a competition policy framework in Mauritania should take into account the conditions identified as constraints to competitiveness and competition in the domestic market. Although the 2003 World Bank Report on Regulatory Reform, Market Performance and Poverty Reduction recommended the application of competition statutory principles, little progress have been made with the enforcement of existing competition rules. The most notable impediments to competition stem from: · Economic constraints stemming from the fragmented and little diversified domestic market, the high concentration of firms in the formal manufacturing sector; the dominance of several groups in several markets, including the banking sector; the existence of import monopolies and oligopolies; the absence of a strong "middle-class" of SMEs which suffers from the lack of access to financing and high operating costs (including high tax burdens); anti-competitive practices in public procurement; the existence of special regimes granting fiscal incentives; the limited competition in network industries (electricity sector); and significant administrative and regulatory barriers to entry. · Legal constraints relating to the insufficient competition legal framework to combat anti-competitive practices; · Institutional constraints devolving from the lack of independence and capacity (human and budgetary) to develop and enforce the competition law, a weak judiciary (court) system, the lack of coordination between the Competition Department/Market Surveillance Committee and the other ministries, parliamentary bodies, courts, and private sector. · Political and social constraints resulting from the concentration of power in the hands of few elites and powerful vested interests (private firms with monopolistic positions in the market or state-owned enterprises), which may exercise pressures on shaping public policy and affect institutional independence (courts' independence). 4.31 It is recommended that competition policy design in Mauritania to follow a phased approach. In order to shape the competition policy framework so that it addresses the constraints identified above, it is recommended that Mauritania undertake a pre-implementation 77 analysis that will help define a clear orientation of the competition strategy towards advocacy actions and/or enforcement. 4.32 First, an analytical assessment of the institutional and social interactions and industry case studies will help shape the competition policy focus. Phase one should include an in-depth pre-implementation assessment which will (Recommendation 4.1): o Map the interplay between the existing legal system and the economic, institutional, political and social structures in Mauritania (4.1.1). o Identify key sectors (for example, cement, consumer goods, food products, network industries) to develop industry case studies (4.1.2). o Develop industry case studies to identify chief impediments to new business development and liberalization in these sectors, to collect firm-level data, to analyze specific sector regulations that could potentially create distortions and to guide the elaboration of a competition policy strategy (4.1.3). 4.33 The design of competition policy elements should be sequenced in the second phase. It is recommended that Phase two evolve around (4.2): o Designing a competition policy strategy (for example, focusing on advocacy activities and addressing price fixing ) (4.2.1). o Improving (for example, through a specific competition law) and developing the legal framework by adopting and implementing secondary legislation (4.2.2). o Establishing an independent competition agency body (for example, by rendering the Market Surveillance Committee operational) in order to apply the competition law (4.2.3). o Undertaking capacity building to focus, for example, on policy advocacy and price fixing agreements, as well as on the implementation of public awareness campaigns and education programs. Building capacities of government bodies and tribunals is one of the major priorities in the competition policy area (4.2.4). 4.34 As a first priority in the second phase, it is recommended that Mauritania improves its legal framework (for example, enact a specific competition law). As the legal competition framework is in its infancy, it is recommended that Mauritania develop the legal framework, which incorporates non-discriminatory and transparency criteria, clearly specifies exempted sectors (if any), and applies to both public and private undertakings. Furthermore, it is recommended to adopt secondary legislation to provide detailed guidance on the investigation and sanctioning procedures, to define horizontal and vertical exemptions to encourage, for example, export promotion, SME development and innovation, to facilitate relevant market definition, and to define the organization and functioning of the Competition Agency (see Figure 4.2). 4.35 To ensure adequate enforcement, it is subsequently recommended to establish an independent Competition Agency ­ for example, by rendering the Market Surveillance Committee operational. The lack of independence, capacity and resources of the Competition 78 Directorate (within the Ministry of Commerce) as well as the idleness of the Market Surveillance Committee hamper the development of the current competition framework and limits enforcement. Hence, it is recommended to (i) render the Market Surveillance Committee operational and endow it with investigative, decision-making and sanctioning powers; (ii) establish an appeal mechanism which will include a specialized court on competition matters in order to ensure separation of competition cases from other cases; and (iii) develop capacity by providing adequate budgetary resources and hiring lawyers and economists who will build expertise on competition issues. 4.36 Furthermore, Mauritania should develop an enforcement record in the competition area, with a focus on policy advocacy and collusion. In order to remove any regulatory and policy-based hurdles as well as deter private firms and groups from creating distortions in the market and abusing their dominant positions, it is recommended to (i) focus enforcement on measures that support policy advocacy with the aim of lowering any policy-based barriers, and ensuring coordination with other government economic policies, regulatory reforms and privatization agenda (setting up consultation and coordination mechanisms involving the Competition Agency, other government ministries and regulatory authorities such as the Telecommunication Regulatory Agency and the Agency for Access to Universal Services; and (ii) gradually tackle the most blatant violations of competition, by first emphasizing actions against collusion (price fixing agreements), followed by actions against abuses of dominant position and, finally, merger control110 in order to allow for expertise and the legal and institutional frameworks to develop. 4.37 Finally, in parallel with capacity building, Mauritania should disseminate information on competition policy. As the public authorities, judiciary, and private sector lack knowledge of competition policy and coordination on competition-related issues is limited, it is recommended to (i) design and implement education and awareness raising campaigns on competition policy and law involving government bodies, private sector, judges and lawyers, academia and civil society; (ii) expand sectoral analyses to keep abreast with sectors dynamics and to collect firm-level data; and (iii) develop information tools via internet and printed media to disseminate the content of the competition policy and future enforcement actions. 110 Merger control requires substantial resources (human and financial) and expertise. As the Mauritanian market is small and the market liberalization is in progress, the incidence of mergers and acquisitions is relatively limited. Privatization deals can be tackled under the policy advocacy activities. 79 Figure 4.2: Design of a Competition Policy Framework First phase Second phase Map of interactions between Competition policy strategy legal, economic, institutional, political and social structures Enforcement: Advocacy/ Collusion Competition law / Independent Industry secondary Competition case studies legislation Agency Public awareness/ Education/ Reasearch/ Information 4.38 To facilitate policy design and implementation, the government aid control program may follow the adoption of a competition policy. The adoption and implementation of the competition policy and the government aid control program may be sequenced by, first, developing a solid competition policy framework and, subsequently, enacting the government aid control program. The development of the former will lay the foundations for the latter, educate government officials, private sector and the general public on the benefits of creating a competitive market as well as the policy tools that are available to take corrective actions in case of harmful competition distortions. Moreover, by first designing and implementing a competition policy structured around advocacy and fighting collusion, potential distortions generated by other government policies, including those resulting from financial incentives may be addressed through competition policy tools. Alternatively, these two policy options may be developed in parallel, provided that government resources that need to be allocated for such reform processes are available. 4.39 Lastly, with regard to the design of a government aid control a sequenced approach should also be considered, including: · In Phase one, to focus efforts on building an inventory of all government aid measures that might distort competition by granting specific advantage to certain industries or companies (4.3). 80 · In Phase two (4.4): o Create a legal framework to establish clear criteria and evaluation mechanisms, reporting and monitoring procedures, particularly for measures in sensitive sectors and special economic zones (4.4.1). o Endow the independent Competition Agency/other institution with powers to administer and enforce the government aid control program, including with adequate financial and human resources to develop expertise. Alternatively, the institutional design could envisage a government department within the Ministry of Economy and Finance, but such a structure will raise independence issues (4.4.2). o Design communication campaigns and education programs to promote the rationale and the fundamentals of such a program among government representatives, judiciary, private sectors and the general public (4.4.3). Figure 4.3: Design of a Functional Government Aid Control Program First phase Second phase Government aid control strategy Inventory of Enforcement/ government Monitoring/ aid measures Reporting/ Law on Independent Inventory governement Competition aid control / Agency/ secondary other body legislation Public awareness/ Education/ Information 81 5. COMPETITIVE SPECIAL ECONOMIC ZONES A special economic zone can be regarded as an instrument that may stimulate investment climate reforms, reduce informality, attract foreign direct investment, create linkages with domestic SMEs and offer incentives for their creation, and contribute to closing infrastructure gaps in Mauritania. Additionally, a special economic zone would generate a demonstration effect for the whole economy, encouraging exports and technology transfers. Nevertheless, it may be a second-best solution as it may create economic enclaves, at the expense of the rest of the economy. Mauritania defined a strategic framework to accelerate economic growth, which includes a series of reforms meant to streamline the overall business and investment-related governance framework, to remove regulatory and administrative barriers and to improve infrastructure to attract more investment and move up on the international value-added chain. The main challenges stem from the identification and design of a special economic zone regime which is appropriate to the Mauritanian context, in particular to address the existing infrastructure gaps. This chapter proposes an evaluation of the objectives and options to promote value-adding activities and exports, and examines the typology of special economic zones and their associated regimes. It also proposes several options for the development and localization of such economic zones. A. RATIONALE FOR AND TYPOLOGY OF SPECIAL ECONOMIC ZONES111 AND ASSOCIATED REGIMES 5.3 Special economic zones may promote economic diversification through foreign direct investment and linkages with domestic SMEs, and close infrastructure gaps in Mauritania. Under propitious circumstances and good management they may create employment and increase foreign exchange earnings (Watson, 2001). They also generate income, spillover benefits, including linkages with the domestic SMEs, learning by domestic firms, skills development, transfer of know-how, the upgrading of the capabilities of local suppliers and officials in response to foreign demand, and learning by foreign investors and buyers about the economy as a source of exports. Special economic zones may be a way to attract investors, develop export industries and induce the creation of domestic SMEs through backward and forward linkages. But their existence per se cannot induce FDI especially if foreign investors perceive the overall business environment, political and social stability and physical infrastructure as unfavorable. See Box 5.1 for examples of successful special economic zones around the World. 5.4 Special economic zones can be regarded as a second-best solution, compared to country-wide reforms. The CEM (2006) raises the issue of the relevance of a dual track approach to foster economic diversification and investment outside the natural resources exploitation. This approach envisages establishing an investment- and business-friendly 111 Special economic zones result from the evolution of the concept of the free zone, the historical origins of which are commercial. Initially, the aim of free zones was to encourage trade along international commercial routes. The evolution of the concept to its current characteristics started in the 1950s and 1960s with the development of industrial export processing zones, and later of free ports and variants of these. 82 environment outside the rent driven economy and continuing the long-term reform within the rent driven economy. Special economic zones may support investment outside natural resource exploitation as well as business environment reforms inside the zones. Setting the institutional framework "right" is very important as a first-best policy in the wrong institutional setting which will do considerably less good than a second-best policy in an appropriate institutional setting. Therefore, special economic zones may create an appropriate business environment and avoid that the businessmen capture government policymaking. They may also ensure a more strategic collaboration between public and private sectors, designed to elicit information about objectives, distribute responsibilities for solutions and evaluate outcomes (Rodrik, 2004). Therefore, special economic zones may be a way to set off rent-seeking behavior, establishing a business-friendly environment at a smaller scale and reducing resistance to economy-wide reform. Nonetheless, such special economic zone regimes may be viewed as temporary policy instruments as the Mauritanian economy develops. See Box 5.2 for examples of less successful cases of special economic zones. 5.4. Nevertheless, the welfare implications of special economic zones are ambiguous (Watson, 2001). A major disadvantage of special economic zones stems from their enclave nature, which often creates a dual economy and delay economy-wide reforms, such as trade reforms. The major risks associated with the special economic zone relate to the difficulties to manage the estate development, promotion and services well enough to attract investors and to offset the zone development costs, including costs for building infrastructure, regulatory costs and loss of fiscal revenues associated with investment incentives. Special economic zones have had a mixed and often disappointing record of performance in economies breaking into manufacturing for export because of mistakes in location and policy regimes. They have been mostly successful in countries at a later stage of development, which had substantial sophistication in trade policies and public administration, as part of a larger package of export development measures. Their limited success might have also be linked to a high degree of government interference and increasing distortions resulting from regulations, such as rigid labor market regulations (World Bank, 1992). Moreover, generous tax incentives have had less impact on foreign investment in the special economic zones because the practical impact of tax breaks depends to a larger extent on tax laws in the investor's home country. The business environment is generally more important for foreign investors (Watson, 2001). 5.5. Practical evidence from other developing countries suggests that special economic zones and associated regimes, mainly free zones, can help promote the following objectives: (i) be a catalyst for the diversification of processing and export activity, especially of natural products currently exported raw ­ mining, oil, agriculture, livestock, and fishing products; (ii) concentrate these activities into an environment that would benefit from better physical infrastructure than exists elsewhere in the country and would be of equal quality to that elsewhere in the sub-region; and (iii) provide this environment with a specific regulatory and administrative framework capable of facilitating investment and of supporting the creation and operation of companies focused on processing and export. 83 Box 5.1: Successful Special Economic Zones around the World Special Economic Zones in China ­ pioneering activity diversification and economic reforms The Chinese special economic zones were established in 1978 to restructure the economy and, in particular, attract foreign investment. The State strategic objective was to test a "controlled economic liberalization" after more than 30 years of economic and political isolation. Deng Xiaoping describes this process as « crossing on the other side of the river, feeling every stone ». Initially established only on the Chinese coast (4 SEZ, 3 in Guangdong province and 1 in Fujian), the number of economic zones has increased in the 1980s and 1990s to include a large number of towns and expand this regime inside the country. Today, there are 200 zones having different names and regimes: free commercial zones, free industrial zones, technological zones, etc. The strategy proved to be successful: China is the first world exporter and the first recipient of FDI among emerging economies. The SEZ have played a key role: between 1979 and 1995, the country received 40 percent of FDI channeled towards developing countries; out of this, the coastal areas received 90 percent; out of which, Guangdong received around 40 percent. The three zones of this region absorbed 50 percent of FDI. Nowadays, China is a reference in this field, and promotes special economic zones in Africa and other regions. Special Economic Zones and Mauritius ­ the role of domestic capital in creating value added chains The free zone in Mauritius was created in 1971, mainly to absorb a surplus of labor supply. The zone became the destination of capital from Hong Kong, which was limited by quotas and tariffs on textiles in Europe and the United States. Domestic and foreign companies created joint ventures. However, after 1985, the majority of companies operating in the free zones are from Mauritius. These companies specialize in textile production, competing internationally and relocating the low value added activities in Madagascar, while maintaining in Mauritius the key higher value added operations: design, spinning, weaving, knitting, etc. The cooperation State-enterprise anchored the development of this sector, mainly through training, investment credits, and the negotiation of international trade and investment agreements, making Mauritius: (i) the second largest world producer of knitted textiles; (ii) the third largest world exporter of tissues of pure wool; and (iii) the fourth largest world supplier of t-shirt to Europe. The free zone hires 60,000 persons (total population of 1.1 million), hosts 500 enterprises, exports an equivalent of US$1.2 billion per year, out of which more than 80 percent in the textile industry. China and United Arab Emirates - Projects in "ready-to-go" zones The increase in the number of projects in "ready-to-go" zones is one of the most impressive recent trends in special economic zone development. These projects are proposed to host countries by countries with the technical and financial means, or by specialized companies. The most recent example is the initiative undertaken by the Peoples' Republic of China. In November 2006, China proposed launching five special economic zones in Africa, each specializing in one principal activity. The selected countries are (i) Zambia (mining); (ii) Mauritius (international trade); (iii) Tanzania (logistics and maritime transport); and (iv) Egypt (various activities). The host country for the fifth zone has not yet been determined. The main objective for these zones is to serve as bases for China's direct investments in Africa. Although focused on specific sectors, each zone is expected to develop a range of activities. For example, China is set to invest USD 500 million in the Mauritius zone, covering 220 hectares and creating 13,000 jobs. It is estimated that roughly 40 Chinese companies will operate in the area. Similarly, China intends to invest large amounts in infrastructure in Zambia's economic zone and to provide Chinese investors there with 800 million dollars in investment credits, 250 million of which will go toward building a copper smelter. The investment is expected to create 30,000 jobs. United Arab Emirates projects under way in the region have similar characteristics. The new integrated special zone in Dakar, Senegal, proposed by the Jafza International group, should by 2010 cover an area of 650 hectares surrounding the future international airport. The goal is for the zone to cover an area of 10,000 hectares and to be used for a range of activities. This type of project represents a clear opportunity for recipient countries: direct investments in strategic infrastructures and in processing natural resources that are generally exported without any real added value; development of industrial activities and of upstream and downstream services; direct and indirect job creation; providing models for local companies; and importing a Chinese or Emirates development model, both of which have produced impressive results. In this project type, the recipient country is guaranteed entrance into a marketing network, a logistics system, and a well functioning international business network. This risk transfer is also at work in project management. While these projects have not been in operation long enough to provide evidence of risks, some of these can already be identified: (i) loss of strategic control over the project, with the main decisions being taken by the project promoter; (ii) loss of control over project implementation, with project managers bypassing government; and (iii) potential opportunity cost of the project. The potential loss of economic sovereignty that accompanies some of these projects is the subject of often intense debate in candidate countries, as is the case in Zambia and Mauritius. These risks must be considered seriously and control and compensation measures must be put into place. 84 5.6. Furthermore, such a regime can play a positive role in the strategic reform process and in projects initiated throughout the country, especially by serving as an accelerator and demonstrator for some of them, including (i) establishing a business climate more favorable to private investment; (ii) reforming tax and commercial arrangements; and (iii) expanding national strategic physical infrastructure.112 Therefore, such a regime would also have the potential advantage of attracting domestic capital (for example through joint ventures) and increasing its productivity. The regime would enable a limited administrative capacity to be concentrated and focused on a catalytic project, the beneficial economic results of which would be felt relatively quickly. 5.7. There are multiple types of zones, each with specific development objectives within specific contexts. A recent FIAS study on free zones uses the expression "special economic zone" in a generic way,113 covering all types of free zones. On this basis, the study identifies six main types: · Commercial free zones, close to the original concept, the activity of which is restricted to warehousing, storage, and commercialization. These zones are linked to ports, and more rarely to airports. · Traditional industrial free zones, which are essentially industrial zones providing specific customs regimes and investment incentives to operators, including management of the dedicated zone, simplified administrative procedures, and a specific tax arrangement. Activities are generally focused on exports. Recently, the concept has evolved toward a balance between activities focused on exports and those focused on the domestic market. A recent development consists of industrial free zones known as "hybrid," which welcome exports as well as other activities. · Industrial free enterprises. In some cases, there is no defined industrial zone, the free zone being an administrative arrangement applied to companies located in all or part of the national territory. There is therefore no management organization for the industrial park, only an administrative structure dedicated to the existing regime. 112 In practice, a series of infrastructure projects have been initiated. Existing projects or those about to be implemented include land transport, air transport, maritime and river transport and electricity. The project on land transport aims at: (i) linking the national road network with the road networks of neighboring countries (mainly Algeria, Mali, and Senegal) with the construction of the Rosso Bridge; (ii) the construction of secondary roads to support decentralization and the promotion of subsistence activities, especially cattle farming and agriculture; and (iii) improving maintenance. The air transport strategy provides for: (i) the construction of the forthcoming Nouakchott international airport, at an estimated cost of $170 million; and (ii) the improvement of other national airports including Nouadhibou, Nema, and Zouerate. Furthermore, the project on maritime and river transport aims at: (i) expanding the port of Nouakchott; and (ii) expanding the port of Nouadhibou. Finally, the project on electricity provides: (i) the construction of a new power plant; (ii) the electrification of 30 municipalities currently unconnected to the network; (iii) the expansion and/or rehabilitation the power plants serving Nouakchott, Nouadhibou and 13 other urban centers; and (iv) the electrification expansion in these cities 113 Other studies and institutions use their own terminology, and this can conflict with that used by FIAS. For example, the OECD (2004) differentiates between free zones and special economic zones, and both of these from industrial zones. Other studies use the expression "export processing zone" to describe all zones with activity focused on foreign markets. This includes special economic zones. This report uses the FIAS terminology. 85 · Enterprise zones, which are mainly designed to revitalize cities or urban areas in trouble and are mandated to facilitate the diversification of activities, typically following the collapse of a specific sector or of a historical industrial area. These zones are mainly found in the old industrial areas of developed countries. · Free ports, in the Anglo-American sense, consist of sometimes large sections of the national territory under a specific regime. They include urban and rural areas and port and/or airport infrastructure, and cover all or almost all economic activity taking place in the zone. However, the name "free port" leads to confusion with free zones or commercial ports. These free ports are commonly known as "special economic zones" in French, and they correspond to zones developed in China after 1979. · · Specialized zones, such as technological or scientific zones, petrochemical zones, which are focused on the development of a specific sector. 5.8. As far as impact is concerned, special economic zones may generate both static and dynamic profits:114 · Static profits: these are direct and indirect profits generated by the investment and activity of the special economic zone and the companies operating within it, measured by the net financial transactions directly or indirectly attributable to the zone and its activity. Direct static profits mainly include (i) net investment (infrastructure and companies); (ii) salaries paid to employees; (iii) net foreign currency generated by the export of goods and services produced by the companies; (iv) social contributions paid by the companies; (v) taxes and other costs paid by the zone and the companies; and (vi) profits, if these are distributed or reinvested into the local economy. Indirect static benefits include (i) investment generated upstream and downstream by the companies, the activities of which are associated with those of the special economic zone, typically, transport activity and accounting and banking services; (ii) salaries associated with these activities; (iii) social contributions paid by these companies; (iv) taxes and other costs paid by the companies; and (v) these companies' profits, which are generally distributed or reinvested locally because most of the upstream and downstream activity is in fact generated by local companies. · Dynamic profits: these consist of the spill-over and demonstration effects that the special economic zone and the companies located within it have on the rest of the domestic economy. These effects vary and include the transfer of technology, demonstration effects of productive investment and export activities, and the demonstration effects of special economic zones on efforts toward economic reform. Technology transfers take place through training and professional apprenticeships, both formal and informal, from which employees (workers, supervisors, managers) benefit as well as through sub- 114 The cost-benefit studies carried out in the 1980s on static impact have revealed the marginal impact of special industrial economic zones developed and financed entirely by the public sector. This was particularly the case with industrial export processing zones established during the 1960s and 1970s in South East Asia and Latin America on the basis of a large investment in infrastructure, bureaucratic administrative management, costly incentive arrangements (especially in financial and tax matters), and restrictions on the kind of investments and activities permitted. 86 contracting and service contracts with the companies in the special economic zone. For their part, demonstration effects consist mainly of the impact the companies within the special economic zone have on local companies and investors in terms of encouragement, whether the latter act as suppliers of services to the former or not. The demonstration effects of the special economic zones on efforts for economic reform consist mainly of ongoing encouragement to improve the investment climate and the creation of an administrative structure that is sensitive to the needs of investors and exporting companies. Box 5.2: Examples of Less Successful Special Economic Zones Russia The SEZ Kaliningrad was first introduced in 1991. The SEZ regime has been subsequently extended and reformed by a law enacted in April 2006. The SEZ Kaliningrad had the following features: · Free customs zone, which included exemptions from import taxes, and hence cheaper imports for local production, lowering manufacturers' costs and promoting export sales, primarily to Russia. · A system of regional import quotas under which the rights to import 35 categories of goods duty-free were auctioned off. · The goods of entire local manufacture and with 15 percent value-added for electronics and household appliances and 30 percent value-added for other goods could be further transported to mainland Russia without paying customs duties. Although SEZ Kaliningrad was established to take advantage of its geographic location in a coastal province, its success was limited. The reasons for its failure are mainly linked to the inadequate investment environment, poor infrastructure and the overall economic and political system perceived as unstable. Until the passage of a new legislative framework in the mid-2000s, the incentives offered by SEZs such as Kaliningrad were not guaranteed by law. The lack of trust and confidence this engendered in would-be investors is indicative of the main impediment to FDI inflow into Russia. Unlike Chinese SEZs the customs regime of SEZ Kaliningrad did not focus on attracting foreign direct investment. The economy and political system have been perceived to be unstable, a view which was reinforced by the financial crisis of 1998. In comparison to China, Russia lacks a large investment- minded diaspora. Moreover, the regions in which SEZs have been established, including Kaliningrad lacked the resources needed to develop the zones. Finally, infrastructure for the effective development of the territory was inadequate, and regional resources were not mobilized for this purpose. India Export processing zones have been established long time ago in India, but were still under a certain amount of regulation with respect to labor and taxes until about ten years ago (post-1991). In 2000, the government decided to use SEZs to increase industrial capacity and put India on an export-led growth path. This was a shift from an import-substitution model to an export-promotion one. The strategic objective was to create employment for local people and to stimulate the technology transfer that would benefit domestic industry. One of the reasons for the limited and uneven success of SEZs in India was the lack of export diversification. Past Indian SEZs have not made a particularly high contribution to exports, nor are they diverse. In 2004-2005, SEZs accounted for barely 5 percent of India's exports. Moreover, most of them evolved around the IT sector. This concentration on one sector is always risky. With regard to fiscal deregulation in order to attract investment, the positive impacts of investment need to be balanced with the loss in government revenues. The revenue loss coming from SEZs is estimated to amount to US$40 billion over the next 5 years, by some conservative estimates, and possibly much more. The annual tax concessions envisaged originally in the SEZ proposals is five times the annual budget for the National Rural Employment Guarantee Scheme. Compared to other budget allocations, the revenue loss from tax incentives is significant. For example, the allocations in the 2007-08 budget for Secondary Education are about US$900 million; for the Rajiv Gandhi National Drinking Water Mission US$1.4 billion; for the National Rural Health Mission US$2.4 billion; for the entire North-Eastern Region US$3.5 billion; and for women's development US$5.5 billion. Neither employment nor infrastructure benefits were significant. In April 2005 all the SEZs in the country combined were providing employment to only about one million people. Some estimates show that there will be only one job created for every four taken away (from relocations to establish the SEZs). Moreover, only few skilled workers and staff are likely to benefit. In Punjab, when Pepsico entered in the 1980s, it promised 50,000 jobs. Nonetheless, in 1991 the Food Production Ministry acknowledged that it had created only 482. The SEZs have not seen real infrastructure development except in real estate growth. In April 2007, of the 63 new SEZs, which were given approval since March 2006, none had yet developed infrastructure and started manufacturing. SEZs proved to create enclaves and parallel institutions, with infrastructure only benefiting the main stakeholders. Noida is one example. It has good roads and adequate services, primarily catering to Delhi, while the rest of the area lags far behind. Source: Curtis, Hill and Lin (2006); www.zmag.org. 87 B. IDENTIFYING A SPECIAL ECONOMIC ZONE REGIME ADAPTED TO THE MAURITANIAN CONTEXT Options for Special Economic Zone Regimes 5.9. The increase in projects in special economic zones at the sub-regional level is both a risk and an opportunity for Mauritania: (i) a risk because this country is at the "bottom of the curve," for investment especially in relation to its neighbors (Mali, Morocco, and Senegal); and (ii) an opportunity because the massive investments under way in the region clearly show the strategic importance of Africa. Furthermore, natural resources related revenues can help the country explore other value-adding activities. 5.10. Identifying a regime adapted to the needs of Mauritania depends on what objectives are set for this regime. These objectives must be aligned with the national development strategy, namely GPRSP-II and aim to: · Encourage efforts to reform the business environment; · Attract direct foreign investments in priority sectors; · Concentrate investments and the development of supporting infrastructures around priority sectors; · Increase exports of processed goods; · Promote jobs and encourage training in order to have a qualified workforce; · Provide support to the urban development policy; · Increase the availability of serviceable land; · Play a catalyzing role in the various development areas identified by the government; · Encourage the government to participate in structural reform efforts. 5.11. A special economic zone regime can be different from the area in which the productive activities will be developed. Ultimately, Mauritania may set up a general special economic zone regime and ­ depending on strategy, options, and opportunities ­ then grant the status of special economic zone to environments that meet these objectives: urban regions, border regions, port or airport areas, regions producing agriculture or mining resources, tourist sites, and so forth. 5.12. The regime for special economic zones entails a legislative process stipulating the regime objectives, its nature, the role and responsibilities of institutional actors, management of the zones, investment incentives, tax and customs regulations, the specific status of these zones and the criteria for granting this status, permitted financial structures, and so forth. 5.13. Mauritania may also set up a general special economic zone regime that would enable the creation of various types of zones. For example, legislation may plan for zones suited for specific objectives and contexts. The special economic zone regime may plan for the creation of zones with a commercial focus, where the trade and limited processing activities are be encouraged and promoted. The main goal of this type of zone would be to facilitate international transactions, logistical processes, and the light processing of goods and products intended for external markets. Similarly, the regime might allow some zones to focus on industrial activities where the processing of goods intended for external markets would be 88 encouraged. This type of zone could focus on processing natural resources, which are exported in raw form at present. Lastly, it would also leave room for multi-purpose zones that would combine commercial and service activities. These zones might also include residential, retail, and tourism activities. 5.14. The role of the Mauritanian public sector would mainly be to establish the special economic zone regime and, in partnership with the private sector, to develop specific initiatives or pilot projects. An alternative option would be not to separate regime and zone but instead to set up the regime specifically for one special economic zone whose location and characteristics would be determined within the regime itself, though this would not greatly alter the role and responsibilities of the public sector. 5.15. A regime for special economic zones would require a regulatory framework defining the rules for zone management as well as development, financing, and operation. Establishment of the regime would need be based on comprehensive due diligence to define rules, including a detailed analysis of the existing regulatory and administrative framework (laws, statutes, rules, procedures, and operations that could affect implementation of the regime and management and/or development and operation of the zones). The regime should also include a review of the Constitution, all zone-related legislation, the Investment Code, the Tax Code, regulations governing the public domain, land ownership, management of state enterprises, customs and environmental regulations, port legislation, regulation of industries, etc. The review of legislation should include the integration, replacement, or amendment of existing regulations that could affect implementation of the regime. 5.16. The regulatory framework should articulate the positioning of the zone regime in terms of: · Governance and management (legal authority and administration for the zones): Although there are several options, assigning legal oversight of the zones to a specific governmental administrative entity is generally advocated (as opposed to sharing legal authority across various institutions). The selected legal and administrative entity should ideally not have jurisdiction over amendments to zone related legislation, which must be enacted in accordance with the Constitution (the Presidency, Council of Ministers, or Parliament). If a distinction is made between the legal authorities of the zone regime versus that of the zones themselves, it is imperative to clearly define the functions of the respective entities responsible for zone development, financing, and management and operation. The legal authority should be decentralized throughout the respective regional institutions (i.e., provinces or wilayas, prefectures, and municipalities--to be defined) and the private sector. · Funding: In the case of differentiation between zone regime management and zone- specific management, a distinction must be made between the financing for zone regime administration and zone management and operation. In this case, the rules of governance must be very specific, identifying not only the mechanisms for funding and management and operation but also each entity's responsibilities. It is generally preferable to leave the terms of zone regime management flexible, including the respective roles of entities responsible for key areas of financing such as basic infrastructure (ports and airports, 89 roads and access, delivery of water and electricity, waste water treatment facilities, etc.) to avoid creating future technical restrictions or limitations. · Incentives: Investment and operation incentives in line with international standards should be built into the zone regime to make it attractive to both investors operating in economically developed areas and those participating in zone development, financing, and management and operation (see Box 5.3). Such measures should include all rules for investment, land ownership, commercial transactions (import/export), and operational licenses as well as various types of administrative support for investment and operation. Box 5.3: Rules Regarding the Incentive Regime, WTO Agreements and Recommended Practices The World Trade Organization agreements do not refer to economic zones, and they are not considered as hampering trade development. By contrast, these agreements prohibit a series of traditional incentive measures. This is, for example, the agreement on subsidies and compensatory measures that prohibits any export subsidy and subsidies for the domestic inputs. Consequently, any incentive having the objective or generating results that are contrary to this agreement should be phased out following the calendar for entry into force. This calendar initially set January 1, 2003 as date of entry into force. This was postponed for 2010. The countries with a share in the world exports lower than 0.1 percent in 1998 ­ 2000 and a national income lower than USD 20 billion in 2000 have been granted an extension. This is Mauritania's case. The FIAS report proposes an incentive regime based on the following principles: 1. Rationalization of fiscal incentives. Ideally, all regimes should be harmonized within a single fiscal legal regime and not to create a special fiscal regime for enterprises operating in the economic zone. These enterprises should benefit from the same fiscal incentives as are all the domestic enterprises which were granted fiscal incentives; 2. Promotion of de-monopolization and deregulation of public services and the telecommunication sector; and 3. Establishment of an incentive regime that is not contrary to the WTO agreements. Source: Special Economic Zones. Performance, Lessons Learned and Implications for Zone Development. FIAS. 2008. 5.17. Establishing a regime for special economic zones thus requires comprehensive legislative, regulatory, and administrative research. This due diligence should provide the information needed to define the regime. From a legislative point of view, there are several possible options, including (i) a single legislative act that establishes the regime and defines its characteristics and operations, including governance and administration, forms of funding, investment incentives and rules, and operations; and (ii) a progressive legislative approach based on the adaptation of existing laws. 5.18. Effective governance and administration are crucial to the success of an regime for special economic zones in Mauritania. If a general, regime-wide mode of governance and administration is selected, the specific functions of each regulatory authority must be clearly defined. On the other hand, zone-specific management does not require the establishment of a specific administrative structure (for example, this decentralized approach is generally an adequate solution). The models below may be applied separately or in combination: 90 · Government agency: Under this model, a special administrative structure is established with jurisdiction over individual zones or system-wide. Depending on the scenario (system-wide versus zone-specific management), the functions of the selected agency will vary and are determined by (and subsequently affect) those of local government. · City zone: Under this model, the entire city or municipality is declared a zone, including all spaces and infrastructure it may contain. The city retains its normal administrative functions and takes on those defined in the zone regime. If the city has a port operating under a separate legal authority, it should be integrated into the zone. · Port zone: Under this model, the port itself is declared a zone, and the functions of the zone regime are added to the port authority's normal responsibilities. · A combination of the options above. 5.19. Whereas the administration of the regime for special economic zones must be assigned to public institutions, this is not the case for the management and operation of the zones, including their infrastructure. In the past, government oversight of management in the zones consisted of the administration of the rules governing their activities. In many cases, the management entity was either the same as that administering the zone regime or was directly dependent on it. As financial management is often problematic in government-owned zones (which are often operated at a loss), privatized management may be used where privatization of infrastructure is not feasible. This type of privatization is carried out in one of two ways: (i) through a management and leasing contract for the zone, or (ii) through any commercially viable infrastructure it may contain. In the first case, responsibility for zone management is assigned to a private company or a part of a private company. The functions and responsibilities of these private management entities usually include: (i) property management (building rentals, collection of revenue, road maintenance, security, etc.); and (ii) business service management (oversight of common services, business centers, etc). In the latter case, the managing company is paid a fixed income by the government. In the case of a leasing contract, the company "rents" the zone or any infrastructure it may contain (including its costs and revenue) to the government for a fixed period at a predetermined annual rental fee. The company is responsible for managing the zone with the aim of earning a profit. The first type of contract (property management) generally extends over two years, whereas the second type (business services) normally extends over at least five years. 5.20. The government retains ownership of the zone regime, formulating needs, strategies, and parameters, including the division of responsibilities between the public and private sectors. Cooperation with the private sector is required relatively early in the implementation process for the regime. The private sector should be closely consulted during the strategic evaluation of options and projected demand. This assessment of demand must incorporate two dimensions: demand for the "end product" (zone users) and demand for the "intermediate product" (zone developers and financial and commercial partners). As the latter group must participate as early as possible in regime development and/or in aspects and components requiring private participation, both potential and confirmed partners must carry out their own economic, financial, environmental, and regulatory due diligence. 91 5.21. A similar scenario operates in the area of funding, particularly through public- private partnerships. Ideally, public investment in infrastructure is limited to investment that cannot be developed and managed in a financially and commercially viable way by private entities. The boundary between what is potentially profitable and what is not depends on the nature of the zone regime, its context, the objectives assigned to it, its size, etc. The total investment required for establishing a zone regime can reach hundreds of millions and sometimes billions of dollars depending on the type of regime selected. Generally, the government must invest heavily in basic infrastructure (ports, airports, roads, urban planning, water, electricity) to elicit private investment. In the case of commercial or industrial zones as opposed to multi-activity zones, the total investment required is lower, the development cycle shorter, and the period required for developing private sector investment in operational infrastructure shorter as well. Public investment helps encourage and boost private investment by demonstrating that the project enjoys significant government support. As a result, private financial participation is generally accompanied by private management and/or private ownership of infrastructure financed in this way. Several mechanisms may be considered for special economic zones, such as concessions, BOT (build-operate-transfer) contracts, and BOO (build-operate-own) contracts. Localization and Development Options 5.22. Formalizing and streamlining the functioning of the Port of Nouakchott industrial zone is the first option. Currently, this zone is adjacent to the port but is not managed in an integrated manner despite the fact that the land it comprises is owned by the government. As a result, its infrastructure is inadequate, environmental and safety aspects seem to be unregulated and/or unmanaged, support to businesses operating in the zone is largely deficient, land use is inefficient, and the potential for growth is significantly diminished. The existing draft decree extending the port's industrial area to the zone is an attractive opportunity due to the prior existence of the Nouakchott Port Authority, an entity with experience in managing national infrastructure. Depending on the modalities, objectives, and measures established, connecting the two areas could provide a solution to the above-mentioned deficiencies. On the other hand, placing an industrial zone whose direct and indirect economic contribution is important for Mauritania under the direct management of a port authority (which is not designed for this purpose and may not have the capacity for oversight of industrial zone operations) may be risky. 5.23. The second option is the transformation of the Port of Nouakchott (including the industrial zone and a surrounding area to be determined) into a special economic zone. The proposed expansion of the Port of Nouakchott could be carried out based on a strategic refocusing of port activities, which continue to increase along with port traffic (which doubled between 2000 and 2005, reaching 1.8 million tons). Traffic is composed of bulk (including oil, which represents 50 percent of the total) and containers (25 percent). Currently, the growth in traffic and expected increase in bulk liquids and containers are limited by the port's under- capacity and low productivity. Average occupancy of the port's three wharves is 85 percent and 92 is increasing. The average waiting rate115 is more than 50 percent and is increasing rapidly. Costs and delays in handling cargo and containers are high. These constraints, combined with the port's relatively narrow market (1.8 million tons versus 9.5 million for Dakar and 17 million for Abidjan) make the Port of Nouakchott the most expensive in the sub-region. The need for redevelopment of the port, with projected traffic estimated at 4 million tons by 2015 and 8 million tons by 2025, is widely recognized. The current zone regime foresees the expansion of port infrastructure including the development of a container terminal, lengthening of the main wharf, and modernization of the port's management and administration. Within this context, a redesign of the port's industrial zone in the manner proposed above would present a significant opportunity for the port itself. Indeed, better integration of the port and the industrial zone would expand the port's services compared to its regional competitors, potentially increasing traffic and, subsequently, its income. Integrating port expansion with one of the zone regimes described above could provide potentially lucrative opportunities. 5.24. The third option is the Bay of Nouadhibou integrated development project. This project, now under consideration by the government of Mauritania, aims to transform the port, the city, and the peninsular region into a multi-activity hub. Studies conducted by the Catram Consultants­Port Authority of Le Havre­Tourism Interface consortium have focused on identifying strategic options and pursuing those offering the best chance of success. Activities being considered include the development of (i) a container/dry-bulk hub; (ii) a hydrocarbons port; (iii) a tourist attraction (protected natural site); (iv) a fishing hub; (v) a commercial port and regional hub; and (vi) a combination of some or all of these activities. The optimal result would be a hub whose activities would focus on fishing, regional trade, and tourism. Nouadhibou and its region are thought to have the necessary infrastructure and/or significant comparative advantages. Beyond these considerations, a number of issues must be resolved. Among them: · Upgrading the harbor and the bay, and in particular addressing the problem of wrecks, a major hazard to navigation and the environment. Some sources estimate the number of wrecks at more than 100. An extraction project targeting the removal of 55 wrecks is currently under way. Supported by EU funding, with an estimated cost of more than EUR 26 million, the project recently launched a call for tender. Meanwhile, the expansion of the Nouadhibou Port Authority (Port Autonome de Nouadhibou, PAN) for fisheries related traffic is anticipated, supported by Spanish financing of up to EUR 18.2 million. These investments are expected to reverse the decline in outbound port traffic. · Streamlining the functioning of the port area. Currently, the ore port of Nouadhibou is managed directly by the National Iron Ore Mining Company (Direction Générale de la Société Nationale Industrielle et Minière, SNIM) whereas the oil terminal is managed by the State Petroleum Company (Société Mauritanienne des Industries du Raffinage, SOMIR). PAN's jurisdiction is limited to the commercial port and to fishing. This arrangement is seen by a number of institutional players as limiting the prospects of the port and, in turn, the prospects of the region. Streamlining the functioning of the port area would allow for resolution of the dual problems of PAN's isolation within the city and 115 The waiting rate is defined as the time spent waiting for a quay (where a ship is loaded or unloaded) over total time at port. A 50 percent waiting rate means that on average, boats spend as much time waiting for berthing availability (productive time) as they are at berthing. 93 the resulting lack of space. It should be noted that the ore port will increase its capacity in 2009-10 to accommodate ships of 180,000 tons (versus the current limit of 150,000 tons) and to achieve a loading capacity of 10,000 tons per hour (versus the current capacity of 5,000 tons per hour). The goal is to increase export capacity to 26 million tons per year. 5.25. Sustainable fisheries management and long-term performance are vital to any development project in the region. A recent World Bank study of the sector cites the risks it is facing in terms of sustainability. Mauritania's recognition of these risks and establishment of programs for sustainable management of its fisheries resources are essential for the feasibility of a hub in Nouadhibou. For example, fisheries products accounted for 42 percent of PAN output in 2005 (approximately 180,000 tons out of a total of more than 405,000 tons). In 2000, the traffic of fishery products passing through the port exceeded 250,000 tons, down from 350,000 tons in 1990. The imperative of sustainable management is especially important considering the government's objectives to increase value added in the sector as well as promoting artisanal fisheries (Box 5.4 summarizes the experience of Mauritius in developing a fishing hub with high added value, based partly on the country's regime for special economic zones). Box 5.4: The Economic Contribution of Tuna Fishing Industry in Mauritius Mauritius is located on the Southern border of tuna shoal in the Indian Ocean. Despite this location, various governments have developed a fishing policy (initiated in the 1950s) based on increasing value added. The Mauritian strategy was primarily supported by the quality of infrastructure in the main harbor of the island ­ the commercial harbor of Port Louis. Hence, the country became the regional hub for vessels from Asia (Japan, Taiwan and other countries). Mauritius invested in the infrastructure necessary to support upstream and downstream activities, such as repairing and equipment, shipping-related services, freezing facilities and processing. The free export zones status (in place since 1971) facilitated the development of three main sectors: repairing and equipment; (ii) shipping-related services; and (iii) tuna processing. Repairing and equipment yields around Euro 3 million a year from the shipbuilding yards of CNOI and Taylor Smith. 350 persons work for these two shipbuilding yards. The two yards mainly serve the tuna fishers from France and Taiwan that operate in this area. Shipping-related services yield Euro 135 million per year, mainly through logistical activities: landing, transshipment, supply. Processing activities contribute a significant share to the economy. There are three processing factories having around 3,000 employees and yielding more than Euro 80 million turnover. Having in view its geographical location vis-á-vis tuna shoal, Mauritius is nowadays importing frozen tuna from Seychelles, which is subsequently processed in the local units. The exports of frozen fish, however, are only worth Euro 600,000. The enterprises mainly supply the European markets. American and Malaysian investments are currently underway to develop operations for their respective markets. Overall, the fishing activities yield the following revenues. Share of total Activity Value (Euro) (%) Licences 1,500,000 0.7 Repairing and equipment 3,000,000 1.3 Shipping-related services 135,000,000 60 Export of frozen tuna 600,000 0.3 Export of processed tuna 85,000,000 37.8 Total 25,100,000 100 Source: Indian Ocean Commission, Review of the Economic Contribution of Tuna and Tuna Like Fish to the Economies of IOC Member Countries, 2007-2008 94 C. CONCLUSIONS AND POLICY RECOMMENDATIONS 5.26. Economic diversification is largely affected by numerous microeconomic constraints, which limit the growth of value-adding activities and exports, reinforcing the current structural bias towards rent cycling and exports of primary goods, and the prevalence of informal sector. The business environment in Mauritania is not favorable to private sector development, while the regulatory and administrative procedures raise additional obstacles to attracting investment, particularly FDI. The general governance framework remains cumbersome and increases the costs of compliance with regulation, including corruption. The existing investment code is uncompetitive and restrictive to companies. Furthermore, heavy taxation, and ineffective customs and tariff structures discourage investment, especially FDI. In addition, capital and labor are expensive hampering Mauritania's competitiveness (in particular, compared to neighbors like Mali and Senegal). 5.27. With regard to infrastructure, Mauritania faces severe difficulties in terms of cost and availability. There is a severe lack of basic services (water, electricity, sewage collection and treatment), transport infrastructure (road, air, rail, ports), and commercial infrastructure (collection, storage, distribution), which has a negative impact on the economy. Moreover, the gap between the national infrastructure supporting SME activities and infrastructure for strategic sectors reinforces the rent seeking behaviors, exclusive arrangements and monopolies, while accentuating structural deficiencies, such as poor road maintenance, lack of access to means of communication, the cost and availability of water and electricity, lack of storage and distribution facilities, lack of unloading facilities for the small-scale fishing industry, etc. 5.28. Establishment of a special economic zone regime could help address infrastructure gaps and encourage the development of new value-adding activities. A two-phased approach to designing a strategic framework is therefore recommended. The strategic framework will define national goals and evaluate options available to the country vis-à-vis its regime for special economic zones. This would include determining whether the best option is a general or a specific regime. It is recommended that: · In Phase one, create a "Multisectoral Working Group on Special Economic Zones" force that brings together key institutions. It is recommended that this working group be created by decree adopted by the Ministry of Development and Economic Affairs before end-December 2009. In addition, it is recommended that the Ministry invite all the other concerned ministries and administrative agencies, such as the Ministry of Finance, the Ministry of Fisheries, the Ministry of Trade, Agriculture and Tourism, the Agency for Investment Promotion, the customs administration, the tax administration, etc. This working group would seek assistance by a technical partner and aims at implementing a strategic framework for special economic zones (Recommendation 5.1). o The Working Group would define the objectives and the options for the Government consideration, and make a list of the existing pilot projects that would be retained as defining the strategy. The key elements should include: (i) the economic development objectives, particularly regarding job creation, sought investment, the economic activities to be developed, and the private sector participation through public-private partnerships; (ii) initial identification of one or several potential sites and pilot 95 projects; and (iii) pre-selection of one or several zones which would correspond to the objectives and the characteristics of one or several envisaged administrative and regulatory regimes. It is recommended that the proposed strategic framework be a short report which would include various programs on private sector development and the sectoral strategies. It is also recommended that the report contains a functional and sectoral matrix which contains the administrative and institutional pre- requisites. It is anticipated that the report elaboration require 6 months (5.1.1). o The report comprising the Working Group recommendations should be subsequently submitted for validation to the Council of Ministers and the options and/or pilot projects should be endorsed by the Council (5.1.2). o After deciding on the strategy, it is recommended to undertake studies to validate the options and/or the retained pilot projects. The pre-feasibility studies should include the following four analytical elements: (i) a competitiveness study for Mauritania focusing on the comparative advantages of Nouakchott and Nouadhibou areas compared to their regional competitors and complementing an investment climate study; (ii) an estimation of potential national, regional and international demand for the activities to be developed under the zone regime and/or the retained development sites; (iii) an estimation of the economic impact (costs and advantages) of potential demand, based on development scenarios corresponding to specific political choice and demand estimation results; and (iv) a detailed analysis of the regulatory, legal and institutional framework , including the envisaged revisions and developments, as well as of the necessary reforms to implement and manage the zone regime. These studies would require one year preparation. They should be developed under the lead of either the Working Group or another coordination structure. In the latter case, the report produced by the Working Group should propose such a coordination structure to the Council of Ministers (5.1.3). 49. Following the completion of the pre-feasibility, the Government would make a decision regarding the special economic zone project/special economic zone regime. During Phase two, a feasibility study should be undertaken based on the results of the pre- feasibility phase. If the latter concluded that Mauritania has a real economic potential for developing a special economic zone (including the opportunity costs), it is recommended that: · In Phase two, the following analyses should be undertaken (5.2): o An analysis of land availability and a proposal to develop mechanisms for land acquisition necessary for the project; site selection, environmental and social impact studies, and compensatory measures (5.2.1). o An analysis of facilities and infrastructure needs and the design of implementation plans; estimate investment costs (facilities, infrastructure and development), including simulation of profitability based on the demand studies and the associated economic simulations (5.2.2). o An outline of a public-private partnership to finance the development and management of the projects (5.2.3). 96 50. The definition of the details of this phase cannot be clearly defined as they are dependent on the results of the previous phase as well as the identified opportunities, in particular regarding the PPP projects that could be presented to the Government. 51. With regard to the current draft Investment Code, sent for comments on October 20, 2009, it is recommended to (Recommendation 5.3.): · Finalize the consultations on the Code before its publication, with technical support by FIAS in order to ensure its conformity with international standards (5.3.1). · Eliminate the articles on free zones and special economic zones from Chapter III.2 of the Code Replace articles 20 through 32 with a single article which would include a reference to the existence of a free zone/special economic zone regime without providing details on the associated regimes, fiscal incentives, etc (5.3.2). · Evaluate the provisions of the Investment Code based on the general corporate taxation rules. Leave the decision to formulate a strategic framework on special economic zones to the Multisectoral Working Group on Special Economic Zones/Free Zones proposed in this CEM. The necessary legislation should be subsequently implemented and should reflect the recommendations by the Multisectoral Working Group, national and international technical experts and governmental decisions (5.3.3). 97 Figure 5.1: Development of the Strategic Framework for the Studies Study « Sources of Growth » Phase 1: Strategic objectives Regime components Site pre-selection Phase 1: Ad hoc Pre-feasibility study Working Group Conclusion Phase 1: Scenario submission Coordination mechanism for the studies Phase 2: Feasibility study 98 Box 5.5: Checklist for the SEZ Dialogue The questions below form part of the initial reflection on the SEZ programme. These questions are introductory and exploratory. In line with the report's recommendations, the next step should see the establishment of a formal strategic framework, to begin with the formation of a Zone Task Force ­ or an equivalent body. This body, composed of key government representatives, would define the key objectives of the SEZ programme. Initial Questions 2) What are the key strategic objectives that an SEZ programme will seek to achieve? Below are some of the typical objectives assigned to SEZ programmes. These includes some of those discussed with the Mauritanian Government during the June 2008 mission: o Employment creation and labour force development o Regulatory reform o Public sector capacity development o Government revenues o Demonstration effect for the domestic private sector o Infrastructure development o Development of a specific location/environment o Foreign investment o Domestic investment o Sectoral growth o Regional development o Export promotion o Manufacturing and transformation of domestic primary products o Manufacturing and transformation of products for the domestic market o Environmental protection o Anti-corruption 3) Does the government foresee the establishment of an SEZ regime ­ with specific zones to be identified and developed separately and through a variety of modalities (including private sector ownership and development) ­ or does it foresee the development of one specific zone in a pre- selected environment? 4) What is the anticipated role of the government in: o Developing the strategic framework for the SEZ programme? o Developing the regulatory environment? o Developing the zone/zones? o Administering the regulatory environment? o Managing the permit/application regime? o Managing the zone? o Financing the development of the zone? o Financing the management of the zone? o Financing the promotion of the zone? 5) What is the anticipated role of donors in the same? 6) What is the anticipated role for the private sector in the same? 7) What is the anticipated development timeline for the SEZ programme? 8) What are the anticipated locations of possible special economic zones? 9) What are the anticipated hurdles/risks that will make achieving the Government objectives difficult, or will require specific governmental action to address: 99 o Financial? o Economic and demand-related? o Regulatory (domestic and international)? o Fiscal? o Budgetary? o Environmental? o Regional competitive? o Infrastructural? 10) What are the anticipated institutional and regulatory changes that will accompany the development of an SEZ regime? 11) Will addressing these hurdles be part of the SEZ programme development itself, or will they require action on the part of other stakeholders? 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World Economic Forum (2007) Global Competitiveness Index 2007, Davos: Global Economic Forum. 107 Annex 1: Economic Indicators Table 1: Rent and Economic Growth in Mauritania from 1960-2004 1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94 1995-99 2000-04 1 Rent indices Ore depletion n.a. n.a. 27.7 20.7 15.3 5.0 0.9 2.7 11.5 (% GNI) Aid (%GNI) 2.5 6.7 10.1 32.5 26.2 24.6 21.0 14.7 16.7 Growth indices GDP per capita 414.9 423.5 422.6 336.9 454.2 491.9 462.8 446.5 431.1 (US$2000) GDP growth 0.9 4.2 3.3 10.3 6.3 4.1 1.2 1.0 3.4 (%/year) GDP per capita -1.7 1.3 0.4 7.8 3.6 1.4 -1.5 -1.6 0.8 (%/year) Population growth 2.5 2.6 2.7 2.7 2.7 2.5 2.6 2.8 2.9 (%/year) Crop output 46.8 50.8 34.4 36.8 42.8 77.0 75.5 112.8 96.5 index2 Source: World Bank (2008a), note: 1. Time series data for fisheries are not available, but around 8 percent of GDP annually was extracted din recent years from the EU for fisheries licences. 2. 1999-2001 = 100. Table 2: Scale of Foreign Aid in Mauritania, Sahel Economies and Other Regions 1965-2004 (% of GNI) 1965- 1970- 1975- 1980- 1985- 1990- 1995- 2000- 1960- 69 74 79 84 89 94 99 04 04 Burkina Faso 4.3 7.6 9.9 11.8 11.6 17.3 15.9 13.0 11.4 Chad 4.5 7.0 8.5 8.0. 17.0 15.7 14.3 10.4 10.7 Mali 6.9 11.1 12.3 17.6 24.0 18.5 17.4 13.9 15.1 Mauritania 6.7 10.1 32.5 26.2 24.6 21.0 14.7 16.7 19.1 Niger 3.7 7.4 9.9 10.0 16.8 18.6 13.9 14.7 9.5 Senegal 5.3 5.4 7.1 11.2 13.1 12.7 11.1 9.2 9.5 Six Sahel countries 5.3 8.1 13.4 14.3 17.9 17.3 14.6 13.6 12.6 Sub-Saharan Africa 2.5 2.0 2.6 3.2 5.0 6.4 4.9 5.0 4.0 South Asia 2.4 1.7 2.1 1.8 1.6 1.7 0.9 0.8 1.6 East Asia Pacific 0.7 1.0 1.1 0.8 0.8 1.0 0.6 0.4 0.8 Source: World Bank (2008a). 108 Figure 1: Consumer Price Index, December 2004 ­ February 2008 Source: IMF, 2008. Figure 5.2: Sector Share of Real GDP (at factor cost) (%), 1991 - 2008 25 Agriculture 20 Livestock Mining 15 Oil Industrial fishing Small industries and 10 crafts Construction and public works T ransport and 5 communications T rade, restaurants, hotels Other services 0 1991 1993 1995 1997 1999 2001 2003 2005 2007 Source: National Authorities and IMF, 2008; 2007 and 2008 data are estimates. 109 Figure 3: FDI Flows116 (US$ at Current Prices in millions) 900 800 700 Benin 600 Burkina Faso 500 Côte d'Ivoire 400 Mali 300 Mauritania 200 Senegal 100 0 2000 2001 2002 2003 2004 2005 2006 2007 Source: UNCTAD, World Investment Report, 2008. Table 3: Poverty Indicators 2000-2004 2000 2004 1. Overall poverty incidence (P0) (%) National 51 47 Rural 66 59 Urban 28 29 By region Rural­river 77 66 Rural­other 60 57 Urban­Nouakchott 29 26 Urban­other 27 33 2. Overall contribution to poverty (C0) (%) Rural 80 75 Urban 20 25 By region Rural­­river 35 17 Rural­­other 45 58 Urban­­Nouakchott 12 13 Urban­­other 8 12 3. Inequality (Gini coefficient) National 0.39 0.39 Rural 0.37 0.35 Urban 0.35 0.39 By activity (national) Public sector 0.35 0.39 Private sector 0.35 0.39 Self-employed farmers 0.36 0.33 Other self-employed 0.38 0.40 Source : National Mauritanian Statistics Office (ONS), "Enquête Permanente sur les Conditions de Vie des 116 FDI flows are net flows and comprise capital provided (either directly or through other related enterprises). FDI includes the three following components: equity capital, reinvested earnings and intra-company loans. 110 Ménages" (EPCV) (Nouakchott, 2000 and 2004) Table 4: Hiring/Firing Indices Difficulty of Rigidity of Difficulty of Firing cost Rigidity of hiring index hours index firing index (weeks of employment salary) index Burkina Faso 33 20 10 34 21 Mauritania 56 20 40 31 39 Benin 39 40 40 36 40 Sierra Leone 33 40 50 189 41 Senegal 72 53 50 38 59 Sub-Saharan 37.3 29.3 39.8 67.6 35.5 Africa Source: Doing Business 2010. Table 5: Indirect and Invisible Costs (% of Firms' Sales) Indirect costs* Invisible costs ** Total Cost of indirect and Cost of corruption: invisible Losses manager's informal costs due to time to payments Cost of power deal with to get security Transport Telecom Customs outages regulations things done measures Mauritania2006 2.89 1.54 0.94 3.05 0.10 2.89 0.41 11.82 BurkinaFaso2006 2.23 0.70 1.63 1.20 0.05 1.48 0.86 8.20 Benin2004 - - 0.48 1.16 0.06 4.27 0.57 6.55 Mali2007 1.96 0.86 0.26 1.39 0.05 0.24 0.12 4.60 Uganda2006 1.08 0.50 0.52 28.16 0.06 2.18 0.43 32.93 Zambia2007 0.61 0.71 0.68 1.79 0.04 0.05 0.93 4.81 Source: World Bank, Enterprise Surveys 2004-2007. Estimates are based on at least 15 observations. * Indirect costs include transport costs, electricity costs (cost of fuel used to run generators), telecommunications cost, costs associated with the regulatory environment (sum of (1) interest paid on bureaucratic procedures to start a business and minimum capital requirement, plus (2) cost of custom clearance times the estimated number of trips) (World Bank and World Economic Forum, forthcoming). ** Invisible costs include losses due to power interruptions estimated from reported time of interruptions, losses due to transport delays, cost of manager time spent on dealing with regulations plus losses due to labor regulations rigidities, informal payments to get things done, cost of security measure (World Bank and World Economic Forum, forthcoming). 111 Annex 2: Main Provisions and Incentives Included in the Proposed Investment Code` The proposed draft of the new Investment Code attempts to streamline the fundamental economic rights of investors. In particular, several measures concern the freedom of establishment and of private investment, freedom of employment, prices, investment protection against expropriation, among others. In addition, the Code includes important measures such as the end of special regimes, with the exception of the SNIM regime. A general regime applies to all investments greater than or equal to MRO 100 million and that generate more than 10 permanent paid positions. The eligibility threshold for the general scheme has been reduced to MRO 30 for activities relating to the fishing, aquaculture, agriculture, livestock, animal health, health, education and training, renewable energy, applied research, technological innovation, tourism, handicrafts, new information, communication, and environmental technology sectors. A conventional regime applies at the investor's request and granted by decree, based on the investment's economic contribution to the country (amount invested, employment created, expected impact). The application threshold for this regime is an investment greater than or equal to MRO 1.5 billion or one that generates at least 200 permanent paid positions. The main incentives are listed below. General Regime · Exemptions on customs duties, import charges and taxes, and imported capital goods · Exemptions on profits, taxes on industrial and commercial profits and on minimum income tax for the first 10 years · Exemptions on taxes on industrial and commercial profits and on minimum income tax on reinvested profits for 3 years after that initial period · Ceilings on customs duties, import charges, and taxes other than VAT up to a maximum rate of 5 percent on raw materials, semi-finished goods, and inputs · Exemption from all export duties and tax on exported goods · Exemptions on local taxes and duties except for charges associated with the setting-up of businesses in economic development zones (free trade zones, industrial estates, development hubs, industrial zones, technological centers), if applicable · Companies with majority foreign ownership may use expatriate management or supervisory staff without the need for work authorizations or permits for up to 10 percent of its overall personnel · The expatriate staff benefits from (i) special customs tariff and tax exemptions on the import of their personal belongings and one private vehicle per household; and (ii) a tax ceiling on their salary or management fees up to a maximum of 20 percent of the gross amount Conventional Regime In addition to the General Regime: · Customs duty exemptions · Exemptions on taxes on industrial and commercial profits, minimum income tax (if applicable), and capital- gains tax Source: Statement of motives from the draft Investment Code. 112 Annex 3: Economic Growth and Effective Enforcement of Competition Policy and Law 1. Intensity of domestic competition beyond trade liberalization tends to be associated with economic growth. Although theoretical work does not provide a clear-cut answer to whether the intensity of domestic competition beyond trade liberalization has a positive impact on economic growth and whether a monopolist's higher tendency to innovate is outweighed by the productivity gains resulting from competition (Rey, 1997; Aghion and Howitt, 1998), empirical studies showed, based on industry or firm level data, that: · Higher market concentration is associated with lesser technical efficiency (Caves and Barton, 1990; Green and Mayes, 1991); Caves and Associates, 1992); · Fewer competitors and higher average rents are associated with lower productivity (Nickell, 1996); · Trade liberalization and industrial deregulation can have positive effects on lower-level productivity (Harrison, 1994; LaPorta and Lopez-de-Silanes 1999); · Increases in concentration and other measures of monopoly power restrain innovation (Geroski, 1990; Blundell et al., 1995). 2. Furthermore, empirical evidence highlights that the effectiveness of competition policy117 and the intensity of competition are positively associated with economic development (Khemani, 2007).118 Competition effects on growth go beyond those of trade liberalization, institutional quality, and an enabling policy environment (Dutz and Hayri, 2000). Figure 2.10 shows that the least-developed countries (referred to as "IDA countries")119, with lower levels of per capita GDP growth also have low intensity of competition in the local markets, while a few countries with a higher degree of competition ( Kenya, Indonesia, India) do not necessarily exhibit higher per capita income probably due to other structural constraints, such as unfriendly business environment, high dependency on one or two commodities, limited economic diversification, low level of industrial upgrading and low production capacities. 117 Models to measure the relation between the effectiveness of competition policy and growth are parsimonious. The effectiveness of competition policy is very difficult to estimate since it requires a qualitative and quantitative assessment of the types of anticompetitive practices investigated by the Competition Agency, the cases handled, resolved and appealed before courts, the quality of advocacy and communication activities, etc. In this context, the effectiveness of the competition policy is determined based on direct responses of business executives of large international and domestic firms. This should be interpreted cautiously, because perceptions in the developing and the least-developed countries might be biased by the lack of clear understanding of market processes and the elements of an antitrust system. 118 Based on cross-country regressions using data from over 100 countries over the ten-year period 1986 ­ 1995. 119 Based on the International Development Agency (IDA) ranking and definition. 113 Figure 1: Intensity of per capita GDP and intensity of competition in the local markets Source: FIAS, Khemani (2007), based on data derived from perception surveys of policymakers, businesses, other public and private organizations and academia (Global Competitiveness Report 2006 ­ 2007; World Bank DDP, 2005). 1. Additionally, the least-developed countries tend to have ineffective competition policy regimes, which are associated with high degree of concentration and dominance by few large firms as well as lower business competitiveness (see Figure 1 and 2). Figure 2: Effectiveness of Competition and Market Dominance Source: FIAS, Khemani (2007), Global Competitiveness Report 2006 ­ 2007. 114 Figure 3: Business Competitiveness Index and Effectiveness of Competition Policy Source: FIAS, Khemani (2007), Global Competitiveness Report 2006 ­ 2007. 2. Similarly, higher intensity of competition in the domestic markets tends to be associated with increased effectiveness of competition policy. This sketches the interplay (without determining causality) between high market concentration and dominance by few large firms, weak competition and low business competitiveness in the least-developed countries (see Figure 3). Figure 4: Intensity of Competition and Effectiveness of Competition Policy Source: FIAS, Khemani (2007), Global Competitiveness Report 2006 ­ 2007. 115 Annex 4: Drivers of Tax Evasion Table 1: Factors Influencing the Compliance Behavior of Businesses Category Generic characteristics Business profile · Structure ­ sole trader, partnership, company, trust · Size and age of the business · Type of activity carried out · Business focus ­ local versus international · Financial data ­ capital investment · Business intermediaries Industry factors · Definition/size of the industry · Major participants in the industry · Profit margins · Cost structures · Industry regulation · Working patterns · Industry issues such as level of competition, seasonal factors and infrastructure issues Sociological · Cultural norms factors · Ethnic background · Attitude to government · Age and gender · Educational level Economic factors · Investment · Demographic interest rates · The tax system · Government policies · International influence · Inflation · Markets Psychological · Greed, risk, fear, trust factors · Values · Fairness/equity · Opportunity to evade Source: Engelschalk, 2008 116 Table 2: Descriptive Statistics: Drivers of Tax Informality Number of observations Means All sample 343 45.63 Formal 196 53.91 Informal 118 31.22 Small firms 109 47.93 Medium firms 47 54.97 Large firms 40 68.97 Private held limited company 63 73.09 Family business (sole proprietorship) 137 43.40 Partnership 28 54.78 Domestic owned firms 310 44.05 Foreign owned firms 32 62.29 Non exporter 329 45.57 Exporter 14 41.12 Not externally audited 190 48.95 Externally audited 38 73.26 Foreign competition unimportant 59 56.86 Foreign competition important 17 65.23 Access to credit as a minor obstacle 128 54.40 Access to credit as a major/severe obstacle 100 51.22 Fiscal administration as a minor obstacle 169 53.66 Fiscal administration as a major/severe obstacle 59 51.11 Manufacturing 76 58.73 Retail 43 37.02 Services 109 55.32 No fiscal inspection 22 49.95 Fiscal inspection 206 53.33 No loans 192 52.95 Loans 35 53.37 117 Table 3: Firm-level correlates of the share of sales declared for tax purposes Independent (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) variables Services 1.161 1.501 1.797 -0.130 -1.243 -0.415 -1.729 -0.622 -3.172 -0.195 (4.960) (4.983) (4.791) (5.115) (5.215) (5.165) (5.337) (5.747) (5.126) (5.193) Retail -15.222 -14.935 -14.191 - -19.708 -19.323 -20.193 -19.338 -18.330 -19.083 (6.528) (6.452) (6.197) 16.208 (6.633) (6.556) (6.734) (7.279) (6.905) (6.586) (6.599) Region -4.722 -3.967 -5.195 -5.587 -0.674 -4.531 -0.779 -8.136 0.264 -4.964 (6.212) (6.177) (6.111) (6.273) (6.596) (6.713) (6.613) (7.058) (6.658) (6.781) Small 0.868 0.050 -0.0384 -0.0937 -0.075 -0.014 -12.229 -1.023 (6.307) (6.372) (6.430) (6.364) (6.443) (7.880) (7.168)* (6.379) Medium 3.762 3.523 -2.903 -4.755 -2.806 -5.802 -11.048 -4.888 (7.417) (7.433) (7.586) (7.535) (7.605) (8.968) (8.391) (7.554) Large 18.050 18.667 19.121 20.432 19.425 19.546 -11.870 20.384 (7.956)** (7.989) (8.243) (8.163) (8.287) (9.342) ** (10.987) (8.179) ** ** ** ** ** ** Log 7.680 0.069 employment (2.897)*** (0.047) Log sales 6.774 9.662 (1.634)*** (2.343)*** Loan -6.862 -3.064 -2.055 -4.064 -13.593 -2.363 (6.184) (6.390) (6.466) (6.801) (6.466)** (6.555) Age -0.658 -0.610 -0.669 -0.630 (0.293)** (0.290) (0.295) (0.294) ** ** ** Fiscal visits 2.544 2.522 2.493 3.034 2.486 (1.004) (0.992)** (1.013) (1.140)*** (0.997) ** ** Fiscal bribe 10.328 14.938 (4.309)** (4.955)*** Trade -5.799 (12.947) Labor 0.896 regulations (5.598) Enforcement -4.163 (8.623) Fiscal -2.242 administration (4.859) Cons 55.088 40.237 34.653 58.042 56.941 55.010 57.708 49.603 29.694 56.062 (8.977) (10.749) (9.354) (9.386) (11.023) (10.921) (11.178) (12.078) (11.327) (11.144) *** *** *** *** *** *** *** *** *** *** Number of 228 228 222 227 205 205 205 164 194 205 observations F-statistics 3.92 5.58 7.93 3.53 4.21 4.46 3.79 3.63 5.17 4.06 Adjusted R- 0.0717 0.0746 0.1114 0.0726 0.1241 0.1449 0.1205 0.1507 0.1628 0.1416 squared Note: The dependent variable is the percentage of sales declared for tax purposes; the control variables are region and sector; standard error in paranthesis; micro firms are the omitted variable. Significance: .01-***; .05-**; .1-*. 118 Annex 5: Labor Chapter - Descriptive and Empirical Results Table 1: Propensity to be informal sector worker in Mauritania Propensity to be Informal Sector Worker in Mauritania Informal Worker Informal Wage Earner Conditional on Being Informal (1) (2) 25-25 years old -0.00088 -0.22372*** [0.00661] [0.01557] 35-45 years old -0.02247*** -0.32986*** [0.00793] [0.01438] 45-55 years old -0.04145*** -0.36711*** [0.01016] [0.01373] More than 55 years old -0.04233*** -0.37233*** [0.01540] [0.01353] Primary Education -0.02525*** 0.01219 [0.00814] [0.01751] Secondary Education -0.10795*** 0.0137 [0.01346] [0.02080] Tertiary Education -0.17191*** 0.07472* [0.02549] [0.04417] Traditional Education -0.01623** -0.02867* [0.00714] [0.01589] Alphabetization -0.02205 0.09458** [0.02548] [0.04684] Female 0.01922*** -0.02592* [0.00381] [0.01394] Rural Areas 0.01081** -0.01768 [0.00502] [0.01583] Livestock 0.00811 0.17855*** [0.01113] [0.02405] Fisheries -0.01159 0.16333*** [0.01405] [0.03247] Mining -0.48907*** 0.53253*** [0.06361] [0.02153] Manufacturing -0.09012*** -0.05856 [0.03117] [0.03886] Construction -0.00968 0.28172*** [0.01406] [0.02583] Transport -0.05123** 0.28370*** 119 Propensity to be Informal Sector Worker in Mauritania [0.02133] [0.02829] Retail 0.03031*** -0.07147*** [0.00686] [0.01857] Services -0.10098*** 0.25929*** [0.02216] [0.02167] Administration -0.62201*** 0.52438*** [0.03758] [0.01508] Other -0.06475*** 0.24525*** [0.01757] [0.02036] Poor 0.01509*** 0.02881** [0.00403] [0.01241] Region dummies Yes Yes Observations 10,420 9,120 Source: Staff calculations based on EPCV (2004) Note: Dependent variable is a dummy variable equal to one if the individual is an informal sector worker in column (1) and an informal wage earner in column (2). Sample in column (1) are all the workers and in column (2) all the informal workers. Omitted categories are individuals with less than 25 years, that never went to school or with primary and those who work in agriculture. Regional dummies included in the model but coefficients not reported in the table. Table 2: Formal-informal wage premium by occupational groups across different samples (male/females, urban/rural areas) The Formal -Informal Wage Premium by Occupational Group Across Different Samples. All Sample Males Females Urban areas Rural Areas (1) (2) (3) (4) (5) Self employed -0.03246 0.06381 -0.38274*** 0.03512 -0.17231** [0.03858] [0.04084] [0.10181] [0.04366] [0.08187] Informal Wage Earner -0.20205*** -0.14605*** -0.41023*** -0.17161*** -0.29664*** [0.03537] [0.03756] [0.09212] [0.03749] [0.08020] Observations 7,908 6,035 1,873 4,042 3,866 R-squared 0.307 0.236 0.243 0.284 0.307 Source: Author's calculations based on EPCV (2004) Note: table reports the least squares estimates for the formal-informal wage premium. The regression controls for differences across workers in several characteristcs as years of schooling, gender, geografical location, potential and potential experience. Results in columns (2) to (5) refer to different sub samples. 120 Table 3: Formal-Informal Wage Premium by Occupational Group Across Different Samples (Various Sectors of Activity) The Formal -Informal Wage Premium by Occupational Group Across Different Samples. Agriculture Elevage Fishing Mining Manufacturing BTP Transport Retail Services Administration Other (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) Self employed -0.21498 0.35329 -0.21189 0.7381 -0.19232 0.0096 0.34624** 0.11622 0.08422 -0.06113 -0.14499* [0.40462] [0.46932] [0.15906] [0.69460] [0.27843] [0.21198] [0.16935] [0.19614] [0.09412] [0.15900] [0.08129] Informal Wage Earner 0.0554 0.0129 -0.29416* -0.52550*** -0.26635 -0.23646 0.05135 -0.15965 -0.24216*** -0.14649*** -0.20645*** [0.40712] [0.47423] [0.15126] [0.10529] [0.28160] [0.20694] [0.15592] [0.19742] [0.08619] [0.05148] [0.07683] Observations 1391 553 283 200 176 309 310 2001 797 976 912 R-squared 0.271 0.275 0.173 0.479 0.512 0.277 0.24 0.258 0.4 0.217 0.391 Source: Author's calculations based on EPCV (2004) Note: table reports the least squares estimates for the formal-informal wage premium. The regression controls for differences across workers in several characteristcs as years of schooling, gender, geografical location, potential and potential experience. Table 4: Returns to Education in Urban and Rural Areas, in Public and Private Sectors Returns to Education in Urban and Rural Areas, Public and Private Sector National Urban Rural Private Public (1) (2) (3) (4) (5) Primary Education 0.2256*** 0.2436*** 0.2059*** 0.2184*** 0.1237 [0.0284] [0.0356] [0.0470] [0.0310] [0.0833] Secondary Education 0.6043*** 0.6036*** 0.6642*** 0.5965*** 0.4511*** [0.0334] [0.0395] [0.0633] [0.0388] [0.0843] Terciary Education 1.0063*** 1.0307*** 1.0062*** 1.1122*** 0.8276*** [0.0476] [0.0525] [0.1117] [0.0660] [0.0907] Observations 6135 3321 2814 5118 1017 R-squared 0.329 0.296 0.327 0.336 0.222 Source: Author's calculations based on EPCV (2004) Note: Table reports the least squares estimates of a Mincer type equation where the dependent variable is log of labor earnings. Independent variables include, schooling categories reported (omitted category is never in school). We also include as controls (though not reported) gender, potential experience and its square, urban/rural dummies, sector of activity, regional location, public employment (dummy). Table 5: Returns to Education in Different Sectors Returns To Education in Different Sectors Agriculture Elevage Fishing Mining Manufacturin BTP Transport Retail Services Administratio Other (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) Primary Education 0.0743 0.1749 -0.0529 0.3477** 0.4876** 0.3389*** 0.1115 0.1329** 0.4667*** 0.0828 0.2284*** [0.0910] [0.1177] [0.1336] [0.1341] [0.1970] [0.1112] [0.1298] [0.0588] [0.0823] [0.0942] [0.0639] Secondary Education 0.3326** 0.9410*** 0.3458** 0.4535*** 0.6176** 0.7897*** 0.7762*** 0.5567*** 0.6467*** 0.4345*** 0.5914*** [0.1562] [0.2261] [0.1440] [0.1590] [0.2500] [0.1359] [0.1493] [0.0741] [0.0937] [0.0965] [0.0749] Terciary Education 0.8741** 0.2057 0.5718*** 0.8682*** 1.2877*** 1.3703*** 1.1888*** 0.9454*** 1.2821*** 0.8412*** 1.1821*** [0.4373] [0.4778] [0.2086] [0.1942] [0.3668] [0.1999] [0.2930] [0.1412] [0.1250] [0.1020] [0.1244] Observations 1151 352 235 176 124 264 236 1335 664 865 733 R-squared 0.283 0.293 0.196 0.49 0.585 0.326 0.306 0.273 0.424 0.233 0.412 Source: Author's calculations based on EPCV (2004) Note: Table reports the least squares estimates of a Mincer type equation where the dependent variable is log of labor earnings. Independent variables include, schooling categories reported (omitted category is never in school). We also include as controls (though not reported) gender, potential experience and its square, urban/rural dummies, sector of activity, regional location, public employment (dummy). 121 Table 6: Returns to Education Across Age Cohorts 16-25 25-35 35-45 45-55 (1) (2) (3) (4) Primary Education 0.0918 0.1197** 0.2209*** 0.3127*** [0.0570] [0.0510] [0.0542] [0.0661] Secondary Education 0.3191*** 0.4094*** 0.4225*** 0.5383*** [0.0803] [0.0562] [0.0511] [0.0682] Tertiary Education 1.0919*** 0.7991*** 0.7464*** 0.7849*** [0.2574] [0.0859] [0.0694] [0.0923] Observations 929 1575 1769 1401 R-squared 0.24 0.309 0.324 0.373 Source: Author's calculations based on EPCV (2004) Note: Table reports the least squares estimates of a Mincer type equation where the dependent variable is log of labor earnings for different age groups. To analyze the informality causes, the sector wage differentials across the formal and the informal sector are computed based on the 2004 EPCV data, following the model specified below.120 Standard earnings functions of the following format are estimated separately for males and females and for formal and the informal sector. The definition of formal-informal workers is the one reported above (where informal workers capture self employed and the informal wage earners). ln Wageit = X it + it (2) ln Wageit where is the logarithm of labor earnings for individual i in 2004, and Xi includes a set of individual level characteristics as years of schooling a dummy for completion of secondary school, experience and experience-squared (proxied by age-schooling-six), 2-digit ISIC industry, dummy for rural areas and 8 regional dummies for the different covered districts (Hodh, Charghy, Hodh, Gharby, Assaba, Gorgol, Brakna, Trarza, Adrar, Nouadhibou, Tagant, Guidimagha, Tiris, Zmmour, Inchiri and Nouakchott). In the specification (2) the linear returns to education are modeled but the earnings are allowed to differ if workers hold more than secondary education. 120 The EPCV (2004) data exhibits some data limitations that cannot be overcome. A large constraint of this data is that respondents could report their labor earnings on a daily, weekly, or monthly basis but information on the number of hours worked in each month is not available. Throughout the analysis, the information on the individual labor earnings is used but, to minimize inconsistencies, only those individuals reporting monthly earnings are taken into account. Thus, all those workers who report having daily or weekly earnings are excluded. This implies that information on earnings for 79% of the self-employed and 91% of the all wage earners is only used. Since labor earnings were not adjusted to take into consideration regional differences in standards of living regional dummies are always included in the analytical work. 122 Table 7: Returns for Men and Women in the Formal and in the Informal Sector Returns for Men and Women in the Formal and in the Informal Sector Males Females Formal Sector Informal Sector Formal Sector Informal Sector (1) (2) (3) (4) Primary Education 0.02665 -0.0158 0.55017 0.0983 [0.07248] [0.03198] [0.33549] [0.06396] Secondary Education 0.20481*** 0.27574*** 0.43821 0.37428*** [0.06277] [0.03699] [0.29655] [0.08699] Tertiary Education 0.54984*** 0.82443*** 0.74476** 0.39280* [0.06903] [0.06909] [0.31205] [0.21119] Rural Areas 0.01807 -0.02221 -0.22369 -0.23815*** [0.05781] [0.03350] [0.24246] [0.06048] Livestock 0 0.14131*** -1.066 0.44041 [0.00000] [0.04954] [0.93536] [0.27708] Fisheries 0.63795* 0.58744*** -0.39204 0.09454 [0.34809] [0.06926] [1.07357] [0.21494] Mining 0.87864*** 0.26547* -0.71521 -0.07627 [0.33714] [0.13757] [0.86179] [0.81280] Manufacturing 0.71080** 0.60157*** -1.06781 0.01485 [0.35168] [0.10324] [0.96078] [0.13327] Construction 0.72011* 0.45263*** 0.54838 0.3623 [0.37845] [0.05755] [1.17837] [0.27989] Transport 0.34764 0.45699*** -0.75927 0.11294 [0.35031] [0.06260] [0.94884] [0.21237] Retail 0.58245 0.55002*** - 0.19073*** [0.37223] [0.04015] [0.07052] Services 0.43502 0.36673*** -0.76779 -0.14717* [0.33308] [0.05243] [0.78597] [0.07983] Administration 0.28645 0.32448*** -1.14879 0.12187 [0.32641] [0.07577] [0.76446] [0.13980] Other 0.27914 0.24581*** -0.95927 -0.17028** [0.33383] [0.04717] [0.80129] [0.08253] Hodh Gharby 0.11805 -0.22709*** -0.23342 -0.16448* [0.15979] [0.06448] [0.54490] [0.08904] Assaba 0.00905 -0.02764 0.24141 0.03516 [0.18151] [0.05890] [0.48256] [0.08077] Gorgol -0.00344 0.21045*** 0.06577 0.39654*** [0.14365] [0.04973] [0.39304] [0.09522] Brakna 0.01595 -0.20922*** -0.15974 -0.24544*** [0.13594] [0.04869] [0.42139] [0.08645] Trarza 0.12336 0.09809** -0.01769 0.15576* [0.12692] [0.04905] [0.37518] [0.08418] Adrar 0.06389 -0.14970** -0.32777 -0.25619** [0.15325] [0.07090] [0.51543] [0.12728] Nouadhibou 0.19747 0.0386 0.06131 0.16699 [0.13336] [0.07546] [0.40872] [0.14067] Tagant -0.05241 -0.04115 -0.29062 -0.04926 [0.14800] [0.07720] [0.46889] [0.12593] 123 Guidimagha 0.30449 0.44355*** - 0.66478*** [0.24342] [0.07318] [0.17032] Tiris Zmmour -0.02053 0.00387 -0.07688 0.51525** [0.14472] [0.11083] [0.45001] [0.20067] Inchiri 0.12171 -0.21819** -0.20443 0.63475*** [0.16824] [0.10104] [0.50304] [0.24159] Nouakchott 0.11796 -0.00067 0.09619 0.25824*** [0.12146] [0.05161] [0.35358] [0.07967] Region dummies Yes Yes Yes Yes Observations 885 3724 203 1432 R-squared 0.208 0.178 0.126 0.174 Source: Staff calculations. Note: Dependent variable is log labor earnings. Columns (1) and (2) refer to the sample of male workers and columns (3) and (4) to the sample of females workers. Samples (1) and (3) refer to the formal sector workers while samples (2) and (4) refer to the sample of informal sector workers (covering self-employed and the informal wage earners). In order to better understand what share of the total wage premium is actually explained by the differences in the returns, a simple decomposition is run. The formal wage gap is divided into two components: one that is explained by the difference across sectors in the characteristics of workers (or composition of employment) and, the other explained by the differences in the returns (or prices) of these same characteristics (which we consider essentially unexplained). Taking the reduced form equation for log earnings above for the formal and the informal sector, one can write the difference in earnings: inf ormal where ln Wage formal - l nWageinf ormal is the formal wage premium and X ( formal - inf ormal ) is the unexplained premium weighted by the average characteristics of the informal-sector workers. The raw formal log wage premium, ln Wage formal - l nWageinf ormal and the unexplained premium (weighted by the average characteristics of the formal-sector workers).121 121 There are two shortcomings of the analysis which are worth highlighting. First, because of their importance in total employment of the informal sector, self-employed people and small entrepreneurs were included in all of the above analyses. But measuring the earnings of the self-employed is particularly difficult. Profits may be confused with returns to labor, and the return to the work of unpaid family members may have been lumped into the measured income of the self-employed person. Second, wage premiums were calculated using the point estimates from the Mincer wage equations reported above. However, if workers freely choose between employment in the formal and informal sectors, the wage and the sector of employment will be simultaneously determined and, it is likely that the same unobserved individual characteristics that determine earnings will also determine sector selection. For example, it is possible that those who self select into the formal sector have higher returns to their (unobserved characteristics) there. If this is the case, it is possible that the wages observed among informal-sector workers are higher than those in the informal sector for an average worker in the population. In other words the least squares estimates reported above could be biased. Some techniques are available for incorporating this simultaneity into empirical work when the selection rule is clear. Unfortunately there is no clear consensus on how the workers sort themselves (or are sorted) into each sector. Consequently, this problem is not addressed in this analysis. 124 Table 8: Formal ­ Informal Wage Gaps by Gender, Explained and Unexplained Wage Gaps Total Formal-Informal Wage Gaps by Gender, Explained and Unexplained Wage Gaps. Males Females (1) (2) Mean Log Formal Wage 3.49 3.17 Mean Log Informal Wage 3.13 2.40 Difference in mean log wages (Formal - Informal Sector) 0.37 0.77 Decomposition: Explained difference (FW) 0.58 -0.26 Unexplained difference (FW) -0.22 1.03 Source: Author's calculations based on the EPCV (2004) Note: Table reports the formal-informal wage gap for males and females in column (1) and (2) respectively. Table also reports the decomposition of the formal-informal wage premium into an explained and an unexplained component using the decomposition presented in the main text. FW stands for the formal weights 125 Annex 6: Evolution of the Special Economic Zones 1. From the late 1980s, the zones' economic environment changed profoundly. With the liberalization of trade and investment as well as the reorientation of development policies toward a greater role for the private sector, governments have seen special economic zones compete to attract foreign capital. The principal effect of this competition has been the redefinition of their supply of services ­ so that they become more sensitive to the needs of companies ­ and a restructuring of their development and operational and management model ­ so that they become more profitable. The emergence of private special economic zones, and their proliferation since then, has only accelerated this phenomenon. The vast majority of zones created since the early 1990s are either private or reserve a primary role to the private sector (development, capital, management, promotion, etc.). From an inventory carried out by FIAS, 62 percent of the 2,301 registered zones in developing or emerging countries were developed and/or are managed by the private sector, up from around 25 percent at the end of the 1980s, most of these then in Mexico. 2. The main changes in special economic zones include (i) a new kind of regulatory regime, (ii) an expansion of authorized activities, (iii) an expansion of domestic capital and companies, (iv) an expansion of the local market and domestic inputs; and (v) a redefinition of the respective roles of the public and private sectors. 3. The redefinition of regulatory regimes (administrative, financial, and incentive related) is due to several factors: (i) the need to reduce the budgetary costs of these regimes, especially in view of the marginal static impact of the first generation of industrial export processing zones, (ii) the mandatory need to end incentives on export subsidies in contravention of WTO rules; and (iii) pressures that have played a positive role in the evolution of concepts and practices, forcing host countries to rethink the nature of potential sources of competitiveness in their special economic zones. 4. One of the most important changes in the area of investment incentives, other than the changes mentioned above, is the rationalization and unification of domestic incentive regimes for all export activity, whether within the special economic zones or outside of them. This unification enables the leveling of tax conditions and restricts potentially unfair competition resulting from parallel and contradictory arrangements. Similarly, procedures for authorizing investment and for operational administration (especially for import and export, both of which are vital for companies) were widely reviewed and improved, mainly with the aim of preventing arbitrary decisions, the risk of corruption, and delays in authorization. Thus, authorization procedures have become normalized, automated, and prompt. Similarly, customs procedures have been computerized and decentralized, minimizing administrative and financial costs and the risk of corruption, and now provide savings in terms of time, a factor that has become crucial in an international competitive environment. 5. Both the number and type of permitted activities have increased, with some diversification upstream and downstream from traditional commercial and industrial activities. For instance, some zones now allow support services for industrial companies operating within the zone such as industrial maintenance, cleaning, technical and professional training, call centers, office-related services, etc. This diversification has been particularly 126 significant for "Just in Time" activities (automobile industry in Mexico, electronics industry in Malaysia, textile industry in Mauritius, etc.). Similarly, commercial zones have been opened up to clean, light processing activities (manufacturing, assembly, packaging, conditioning, labeling, etc.) as well as activities related to commerce and transportation such as business centers, exhibition venues, and trade fairs. In terms of diversification, special economic (free port) zones are the most versatile. In the broadest sense, these zones are home to tourism activities (hotels, conference centers), residential areas, and various other activities (industry, services, trade, research). Typical examples of this process are China's special economic zones. 6. Once prohibited, domestic capital and domestic companies are now permitted to operate in special economic zones. Special economic zones were once reserved for foreign capital because investments using local capital were seen as losses for the local economy. This interpretation and the resulting limitations now look to be counter-productive in that (i) this reinforced the artificial superposition of special economic zones onto the local economy, (ii) this reduced their contributions to growth and their dynamic impact; and (iii) in some cases, domestic companies were even relocating offshore and investing in foreign zones. The zones were thus secure enclaves separating the outside from the inside, with the goal of avoiding "contamination." This protective positioning constrained exchanges between the domestic economy and the external economy and curbed the sustainability of the zones themselves. In effect, these exchanges were based on a narrow and static comparative advantage (labor costs, other costs, market proximity) that entailed expensive financial and tax incentives. This meant that they were highly sensitive to competition from other zones with similar competitive profiles. For this reason, they were unable to control the high turnover rate of companies seeking low-cost solutions ("footloose" companies) with few ties to the local economy. They thus contributed little added value other than employee salaries and the net export value. 7. Permitting local capital and companies has sparked a fundamental change in the relationship between the zones and their hosting economies as well as in the economic impact of these zones in that (i) local capital may have ties to foreign interests and thereby obtain industrial and commercial experience, access to outside markets that would otherwise be hard to tap, foreign capital, etc.; and (ii) local companies can move into activities, production sectors, and markets that were previously inaccessible. Local companies often have more to gain from raising productivity in order to remain competitive whereas foreign companies tend to explore other horizons. Lastly, local companies reinvest their profits back into the same zone or the local economy. 8. Liberalizing export regulations has been accompanied by an opening of the local market to products made in the domestic special economic zones. Although this was generally not permitted in the past due to the protection extended to local, state-owned, and private monopolies working in import-substitution, companies in the special economic zones can now market their products in the host country so long as customs requirements and other regulations are met. Given the economies of scale affecting intermediary products and other inputs, it is now widely recognized that this is economically advantageous for the consumer. 127 9. Along similar lines, import regulations were loosened and the market in the special economic zone was opened to local inputs. Companies in the zones have found it easier to "import" domestic inputs (intermediary services and goods), which are treated as exports and therefore sources of foreign exchange by the authorities. 10. The respective roles of the state and the private sector have fundamentally changed, with the former now focusing on creating a strategic arrangement (economic orientation, regime type, geographical location, development and management model), setting up and administering regimes (both direct and indirect via private partnerships), promoting projects among domestic and external participants, and investing in essential infrastructure. The private sector is now playing a key role in implementing the strategy (preferably devised alongside a state partner), mostly by assuming an important role in project development, managing part or the whole zone, making general investments (in commercially viable infrastructure, industrial or commercial parks, tourism/residential/commercial activities, etc.), and promoting the project among end- users. 11. The expected impacts of this redistribution for the public sector are a significant decrease in development costs and operational/managerial/promotional costs; focusing on the national economic development strategy and maximizing profits, managing costs and negative impacts (environment, social displacement, etc.), drawing up and enforcing regulation and a legislative arrangement, creating an environment conducive to the overall success of projects; better guarantees of success by involving private partners in order to minimize project risk; specialization of management duties, with the private sector offering expertise in managing land and real estate or services, and supporting operational infrastructures. 12. Private sector may benefit from similar positive impacts, notably: the opportunity for long-term investment in a strategic national project; commercial income from various types of project-generated revenue inclusion in a project with an international or regional strategy, etc. 128