3.6 Improving conditions for private investment

Granting special benefits is indeed a necessity for the time being. The existing investment promotion regime in Syria was enacted without major modifications of the basic centrally planned system developed during the 1960s and 1970s. In the 1980s and 1990s a gradual process of liberalization started, but its progress has been partial, and with alternating and unpredictable shifts between accelerating and putting the brakes on economic reform. Thus, uncertainty is still present, and the economic system is afflicted by many shortcomings. Therefore, apart from the need of proceeding with economic reform, securing sustainable growth in Syria still calls also for a substantial amount of specific policies for promotion of private investment.

The various Investment Promotion Decrees and Laws (from 1981 to 2000) gave investors a number of temporary privileges, such as import licenses or tax exemptions, in an effort to make the investment projects look more profitable, in spite of the shortcomings of the overall system. These policies had two major defects:

• The advantages in the promotion policy were mostly temporary; and

• Direct promotion was strong, but macro reforms were weaker

The benefits granted were temporary. This is generally thought to be correct as regards special privileges such as tax exemptions, but long-term projects should be viable even after the privileges are removed. A deadline for the benefits means that after a certain number of years the private companies would have to operate in the same rigidly controlled environment of a centrally planned economy, with heavy explicit or implicit taxation and restriction of private economic activity, and then much of their initial profitability may disappear. This important limitation of the policy option chosen by Syria in the 1980s and 1990s severely affected the nature and extent of the projects. If the rigidities were meant to remain in place, it would not be wise to encourage investments that are only profitable if rigidities are removed or investors are exempted from their consequences. Investors, under those conditions, would prefer projects that yield most of their profit in the very first years, disregarding long-term growth, and this would be a very negative feature with grave implications for Syrian economic development.

Under such an arrangement, a rational businessman would look for immediate advantages to be obtained during the period of construction and tax exemption, disregarding long-term gains because, in the long term, the company would have to work in a centrally planned economy that may be supposed to be hostile to private investments. This tends to stimulate investments that aim at reaping most of their profits within the period of exemption or “tax holiday”, and less incentives to develop extended business plans for the long term. There might be investments, but their long-term impact on growth and employment would be very limited. Investment and growth created by a purely specific policy of direct promotion with temporary benefits tend to be spasmodic and not sustainable.

That has been in fact the case. In spite of liberalization measures starting as early as 1981, the Syrian economy has had nearly zero net per capita growth in 1980-1999. There has been growth in the 1990s, much of it due to private investment and the Investment Law, but in ten years it has not been sufficient to offset and overcome the decline of the 1980s. Many projects were abandoned, the sustainability of projects after the expiry of tax holidays is problematic, many companies are not utilizing their full capacity, and the subsistence of macro impediments for private economic activity hinders the enterprises in manifold ways. The employment impact of the projects licensed under the Investment Promotion Law was extremely small. Since the benefits were concentrated on favouring imports of machinery, capital investment per worker tended to be higher than expected for an economy like Syria, thus defeating the purpose of creating employment. Excessive reliance on capital-intensive technologies, apart from not creating employment, means probably that excessive resources are used for the investments when more production could be obtained with less capital. It may also create conditions for an excessive flow of profit remittances and capital repatriations in the future.

Although the resulting growth of the private sector in manufacturing and transportation has had many positive effects in the Syrian economy, much more would be needed to spark sustainable growth in output, income and employment. Something can be achieved by modifying some stipulations in the Investment Law, but even that would not be enough. The missing element is deeper and wider change at the macro level. Unless major institutional and macroeconomic reforms are enacted, the operation of an investment promotion regime is not enough to sustain growth, and may even cause deleterious effects.

a) Procedural and micro reforms

After examining the workings of the existing regime, and holding extensive talks with a sample of investors, a number of recommendations for improving the existing legislation and conditions for private investment can be proposed.

One of them points to upgrade the autonomy and flexibility of the Investment Office, transforming it into an autonomous self-financed Agency, with enlarged functions and governed by a Board of Directors comprising the existing Investment Council plus representatives of the private sector. Another major recommendation is simplifying the authorization process for new projects, eliminating various steps in the procedures. A third recommendation is further flexibility in legal access to foreign currency at market rates.

One problem faced by many projects was the rigidity of the five-year term the Law establishes for the tax holiday. It could be extended for two more years, but even this may not be enough (for instance, some projects involving olive trees have a maturing period of up to 15 years). Expansions through reinvestments later in the project life cycle are not explicitly foreseen in the legislation. To address these and related issues, a recommendation can be made to replace the time-bound tax holiday by the granting of tax credits for every investment, made either initially or later. As profits start accruing, the investor would use available tax credits (determined as a percentage of previous investments) to fulfill profit tax obligations. This solution solves at one stroke all problems concerning the different timing of investments, tax holidays and profits.

Also, it should be recommended that the minimum size of eligible projects be revised, at least regarding agricultural production projects, and that priority be given to projects oriented to modernizing farming production, in view of the urgent need of modernization in the Syrian farming sector (especially as concerns irrigation equipment).

Other micro reforms and improvements, though not explicitly involving existing legislation for the promotion of private investment, may also be recommended. They include the following:

• Facilitate access to land, especially publicly owned land, including the development of industrial zones provided with all basic services (chiefly electricity and water).

• Facilitate the development of co-operative enterprises for joint development of farming projects (not necessarily involving joint production, but chiefly joint input procurement and joint processing and marketing).

• Facilitate the development of rural micro-finance institutions to expand the use of credit in the countryside, and introduce further flexibility in the banking system to improve credit conditions for private investors.

b) Improving the macro environment

Correcting the shortcomings of existing legislation is necessary but not sufficient. As long as Syria remains basically committed to a macroeconomic scenario dominated by state planning and intervention, the development of private investment cannot but be embryonic and spasmodic. Continuing its efforts initiated in the late 1980s and during the 1990s, the Government should complete a number of reforms to completely overhaul the existing macroeconomic setting of the country.

The macro environment comprises the institutional bases for a market economy, and adequate economic conditions that favour private economic activity. Also, it includes a state sector that accomplishes specific functions, essential for the existence of private investment, as well as for the existence of society under a market economy.

The institutional requirements for a market economy comprise:

• Protection of private property. For private companies to compete with each other, they should have the right to dispose of their property, including intangible assets and intellectual property, and an effective legal protection of their property rights.

• Economic freedom. Companies should enjoy the free choice of their economic activity, of their suppliers, and of fixing the prices of their products or services.

• The rule of law. This requires respect for contracts, a competent and independent judiciary, and sufficient transparency in the conduct of public affairs. All contracts should be deemed obligatory to all parties concerned, and all private or public actors should be held accountable before the law.

• Limited roles of the state. The state has specific functions that it must accomplish for the market economy to work properly. Most of those essential functions of the state in a market economy are covered by the following list: to enforce the law and provide legal security; to ensure the provision of basic social services and public infrastructure; to promote equity in society; to regulate certain private activities (especially due to market failures); to provide a sound monetary system; and to promote competitiveness.

Some of these institutional requirements touch upon the economic conditions necessary for a market economy to work properly. For instance, a sound monetary system rests not only upon the institutional arrangements governing it (such as an independent Central Bank) but also on the maintenance of basic macroeconomic equilibrium (especially a sound fiscal balance).

An economic system allowing the market to work properly should at least secure mobility of resources, adequate incentives, low overhead costs and predictability.

The mobility of resources can be improved by removing obstacles to mobility. These obstacles include trade barriers, inadequate banking system, foreign exchange restrictions, lack of active capital markets, restrictions to foreign investment, rigidities in the labour market, restrictions in the land market and restrictions for accessing and exchanging information.

An adequate banking system is an essential component of a program to increase the mobility of resources. Without efficient banks no business can operate, and much less can it prosper and be competitive.

Any set of government policies implies incentives to private agents, leading them in one direction or another. What counts is not the intention or wishes of the government, but the actual economic incentives created by its policies, and the kind of reaction that economic agents can be expected to have when confronted with such incentives. Taxes and subsidies are the main forms available to the government to create incentives. However, it is easy to develop grave distortions by way of ill-conceived taxes or subsidies, which often achieve the opposite of what was intended.

Taxes should be simple, moderate in size and moderately progressive. When taxing corporations, they should fall more on fixed assets than on outcomes. When taxing individuals, they should fall more on idle resources and consumption than on savings and investment. Taxes should be easily collected, possibly involving incentives for taxpayers to check on each other, and avoid pyramidal effects or double taxation.

A simplified tax structure based on a Value Added Tax (VAT) and income tax should replace the complex collection of specific taxes that still plagues the Syrian tax structure. Two other categories of tax, which may stand in the new tax structure, are a tax on fixed registrable assets and of course customs duties, the latter at a moderate average level and with reduced dispersion. Price subsidies (e.g. paying wheat producers at prices above international levels) should be replaced with direct payments to producers.

Another economic condition of an efficient market economy is to have low overhead costs. This is achieved through improved basic services (better roads, better electricity, better telecommunication services) and through a more efficient and less expensive government. Even if a company is able to contain costs within its boundaries, it should still be paying the cost of being in an inefficient country. This country cost increases the cost of all products, imposes the added cost on domestic consumers, and lowers the country’s competitiveness in foreign markets.

Finally, a market economy should be predictable. Two main factors contribute to this: a stable macroeconomic framework (especially after stability has been maintained for a number of years), and expectations that future political and social events will have no perturbing effects on the macroeconomic environment. The latter requires a basic social and political consensus, so that alternation in power would not mean a radical departure from existing policy.

The absence of predictability makes investment too risky. Investors would demand exceptionally high rates of return to accept bringing capital into the country, or would require exceptional guarantees, that may prove too heavy for the public budget. Creditors would apply higher rates of interest to any loans taken by the country's banks, or by the country's public or private sectors in international financial markets. The difference between those rates of interest and the rates charged to “predictable” countries is a measure of the so-called country risk. Country cost and country risk, the results respectively of high overhead costs and low predictability, are the main factors affecting a country economic performance in the world economy.

The reforms to the macro scenario have had, so far, a piecemeal approach. They are adopted one by one, in a non-integrated manner. This creates an unequal economic structure, where some aspects are more advanced than others, like a person with one foot on the ground floor and another in the third floor, and thus subject to unbearable strains.

The opposite course of a sweeping and sudden reform of everything would also be unwise. A country suddenly passing from a centrally planned economy to a fully deregulated market economy would face disaster and possibly major social and political upheaval.

Reforms should be gradual but integrated, advancing on all fronts at once. The following are the main aspects to be included in the process of reform:

• Resource allocation policies, implying taxes, trade, prices and subsidies;

• Money and banking, implying foreign exchange liberalization and currency convertibility, banking reform, independence of monetary institutions and policy and development of capital markets; and

• Reduction of inefficiencies and overhead costs, implying administrative reform of the public sector, simplification of administrative procedures, and improvements in basic infrastructures and services.

c) Promoting agricultural investment

Specific recommendations for agricultural investment are listed below:

(i) to improve and decentralize agricultural planning.

(ii) to introduce more initiative and innovation in the strategic-crop sector in a gradual manner, continuing and deepening the process of flexibility in agricultural planning that has begun in recent years. A growing percentage of available land, water, credit and inputs presently allocated to strategic crops should not be allocated by plan, but on demand, letting farmers decide on the best allocation of those funds. Some 10 percent of the resources could initially be allocated in this manner, and gradually progress towards higher percentages.

(iii) to promote foreign investment in agricultural export products. Foreign capital and technology is needed to expand production of specific high-quality agricultural products, especially fruit and vegetables, for export to the EU and other markets.

(iv) to develop improved rural finance; to improve and diversify sources and modes of financing agricultural activity and rural industry and marketing; to promote rural micro-finance and the development of adequate banking techniques to reach small farmers through group credit at reasonable administrative costs with sustainable rates of interest and credit conditions; and to promote the gradual upgrade of small producers to the status of normal bank customers.

(v) to promote marketing of agricultural products; to promote integration of farmers into vertical commodity chains for production, processing, domestic marketing and export of selected agricultural products; and to improve administrative procedures for export, and logistic and port facilities, for rapid dispatch of perishable commodities to their destination by ship or air.

(vi) to foster on-farm investment for modernization of irrigation systems. Modernization of irrigation systems in Syria involves shifting all gravity and flood systems to pressurized sprinklers and drip irrigation. Metering water is essential to create incentives for investing in the modernization of systems. The form of payment for irrigation should consist of a basic fee for the use of irrigation water, plus penalties of increasing value for exceeding allotted amounts of water.

To modernize irrigation systems, government policy should secure credit funds and promote private investment for financing the conversion of 50 percent of irrigated lands to sprinklers and drip irrigation in ten years.^[39] The cost is about US$120 million per year, only for new irrigation equipment. Another US$30-40 million per year are necessary for other related investments: improvements in off-farm irrigation infrastructure; technical assistance to farms to modernize cultivation systems, change crop schedules, and learn to access new markets. Upgrading the equipment is only one step: upgrading the farms and improving the skills of farmers should follow.

This may be taken also as a general concept for the modernization of agriculture and agribusiness in Syria. Investment in machines and infrastructure should not imply neglecting the main sources of economic innovation and growth, human ingenuity and skills, of which Syrians over many centuries have shown they have an inexhaustible supply. They only need the right macroeconomic environment to release those forces and make them work.