The Little (Economic) Engine that Could

Despite the relatively stagnant levels of foreign direct investment around the world in 2010, the small African country of Mauritius recently announced that it expects an 8% increase in FDI this year. By liberalising its economy while also focusing on improving the quality of its institutions, Mauritius has created an environment that investors are confident in.

Economically sound policies paired with strong and inclusive institutions have helped make Mauritius a success. Other developing countries could learn from the Mauritius model.

Mauritius had the same starting point as many other African countries. It gained its independence from Great Britain in the 1960s and relied heavily on agriculture, in particular, sugar cane. The vast bulk of its economic eggs were held in one very risky basket and whenever a cyclone hit or rains failed, the crop that everyone depended on suffered. On top of this, the island is far from other markets and it has an ethnically diverse population. These are factors that some economists say limit growth.

In fact, in the early 1960s experts were predicting that the country was headed for economic and political disaster. In 1961 Nobel Laureate James Meade anticipated poverty and conflict for the island and said: “the outlook for peaceful development is poor.”

How wrong he was.

Unlike most other African countries, Mauritius has experienced relative peace, democratic transitions in government, and steady and impressive economic growth since its independence.

How did this country succeed where so many others have stumbled, if not failed? Two keys: good policies and sound institutions.

An important policy change occurred in 1970 when the government introduced Export Processing Zones (EPZs). EPZs are areas where Mauritian entrepreneurs import goods duty free so long as the goods are used to produce exports. Tax and regulatory rules that applied outside the EPZs were lifted so businesses could operate with reduced labour and business costs.

EPZs attracted investors who began building factories and creating jobs, particularly in the textile industry. Between 1971 and 1976, the number of textile and clothing firms in the country increased from 8 to 45 and employment increase by 35.6 %. Strong growth continued throughout the 1980s and these factories became booming hubs of human, physical, and financial capital. By the 1990s, EPZs were employing over 90,000 people: 21% of the total workforce.

Between 1973 and 1999 real GDP in Mauritius grew at more than twice the average rate for sub-Saharan Africa. The average income increased four-fold during those years whereas the average income in sub-Saharan Africa only increased by 32%.

However, in the early part of the past decade things changed; some trade preferences were lost and new competition from low-cost textile producers in China and Bangladesh meant economic growth in the country stalled: factories closed and unemployment rose.

Again, good policies helped address these problems and put the country back on a path towards economic prosperity. In particular, the government focused on reducing the costs of doing business. Today, it only takes 2 days to open a business in the country (the average time in sub-Saharan Africa is just over 45 days). In 2010 the World Bank ranked Mauritius among the top 20 best countries in the world in terms of legal and regulatory support for doing business.

Some have argued that the growth rate in EPZs is disproportionate to that of other areas in the country and thus cannot explain all of the country’s economic growth and development.

They are right. The economic growth of a country cannot be explained simply by one or two policy changes, however significant. The effectiveness of these changes directly depends on the institutional environment in which they are implemented. Good governance is essential. According to this years’ Ibrahim Index, Mauritius also happens to be the best-governed nation in sub-Saharan Africa.

It’s not the only route to success, but the path to prosperity that Mauritius has travelled should be both an inspiration and a lesson to other developing countries.

Authors: Karol Boudreaux is a senior research fellow at the Mercatus Center; Ben VanMetre is a masters fellow at the Mercatus Center and George Mason University, USA. This article may be republished without prior consent but with acknowledgement to the authors. The views expressed in the article are the authors’.

FMF Feature Article / 15 March 2011