Tunisia’s Economic Potential Held Back by Outdated Policies

Walid Benamor is an industrious man: his family business, La Pratique Electronique, has grown from just two employees when it was founded in 2001, to over 70 today. This makes him an outlier in a country which has seen its economy stagnate, and its unemployment levels remain stubbornly high, particularly during the slump that followed the 2011 revolution.

Although firmly grounded on Tunisian soil, under Tunisian law, La Pratique Electronique is considered an “offshore” company because it exports at least 70 percent of everything it makes. This means it is allowed to import its raw materials and components duty-free.

The alarm systems and LED lighting units that La Pratique Electronique makes in Tunisia are used for car assembly plants, airports and supermarkets, mainly in France, making it, for many, the kind of success story that epitomizes Tunisia’s economic model, which gives large tax incentives to companies manufacturing exports as part of its Investment Incentives Code. In recent years, however, calls by economists and businessmen for changes to be made to the code have increased, and the Tunisian government has been studying if and how the system should be reformed.

The code draws a distinction between “onshore” and “offshore” companies. Its supporters say incentives provided to offshore companies make Tunisia more attractive to foreign investors, with the offshore sector’s relatively limited regulations protecting them from the corruption and red tape faced in the onshore sector. They also say the system protects Tunisia’s domestic labor market from the “race-to-the-bottom” of global market, as countries compete to produce cheap exports with cheap labor.

How the onshore–offshore system works in practice, though, does not substantiate either argument. The offshore sector has indeed attracted large-scale foreign investment, but the reality is that overall investment levels remain low and Tunisia lags behind its closest competitors. Investors’ surveys show that investment incentives, which amount to approximately two percent of Gross Domestic Product, are largely wasted.  “Roughly 80 percent of the US$850 million Tunisia spends annually on tax incentives to the offshore sector is a waste,” said Antonio Nucifora, lead-author of the recently released World Bank report, The Unfinished Revolution, Bringing Opportunity, Good Jobs and Greater Wealth to all Tunisian. “The companies we surveyed said they would have invested in exactly the same way, with or without the tax breaks,” he added. 

To put this amount in perspective, Tunisia spends roughly the same amount of public money on the incentives to the offshore sector as it spends on public investment projects in infrastructure.  Added to which, the type of investment that has benefited most from the government’s offshore incentives has been in mining, energy and banking—none of which are labor intensive, meaning they do little to absorb Tunisia’s mass of unemployed.  The result is that while average wages in Tunisia are around US$4,000 per year, the cost of each additional job created thanks to the incentives is approximately US$ 20,000 per job per year.

Barriers to entry and to competition characterize the onshore sector.  The high degree of protection Tunisia’s domestic producers receive has led to underperforming companies producing uncompetitive goods and services.  The result is that the low efficiency of the onshore sectors, notably the backbone services to firms, negatively affects the competitiveness of the offshore sectors.  Hence, far from providing the space needed for the country to incubate homegrown industries as countries like South Korea have done, the weak performance of the onshore sector has also undermined the potential of the offshore sector, such that Tunisia offshore firms mainly limit themselves to low value added activities and assembly. 

For companies like La Pratique Electronique, the system has created another problem: the rules and regulations governing it limit the company’s ability to sell its Tunisian-made goods to Tunisians. Thus, while La Pratique Electronique is entitled to make 30 percent of its sales within Tunisia, current regulations make any such direct sales hopelessly complicated.

A case in point is the small rectangular lighting unit the company makes, designed to sit on a factory's perimeter wall. Though it is produced in Tunisia, before selling it to a Tunisian client, the company would have to put together all the relevant documents to “import” it. As many as 40 different sets of paperwork would be required.

For several weeks, the Tunisian customs service would check the paperwork and, using complicated calculations, arrive at unpaid import tariffs for each input, totaling them up for the amount of duty to be levied on each unit to be sold in Tunisia. The lighting unit would end up being more expensive than the same product imported from Europe.

La Pratique Electronique has found a solution, however unsatisfactory. It sells the lighting units, tariff-free, to a trading company in the French port of Marseilles. The trader then ships them to the client in southern Tunisia as an import from Europe that does not attract heavy tariffs. The trading company takes a substantial slice of La Pratique Electronique's earnings from the sale. Benamor calculates annual lost revenue to his company at 100,000 euros (US$130,000), equivalent to one fifth of its total annual sales.

As absurd as Benamor’s predicament is, the system is even more damaging to Tunisia’s onshore companies. Due to the high cost of the incentives provided to offshore companies, onshore companies end up bearing the brunt of the corporate tax burden—which stands at 31 percent, far higher than some of Tunisia’s closest Middle Eastern competitors, such as Morocco or Turkey.  

The overall result is low levels of investment and jobs creation, and especially low levels of employment for university graduates.  “However useful it may once have been, the dual economy is now an obstacle to growth,” observed Antonio Nucifora, “an ambitious overhaul of the code to create an open and investor friendly economic environment, with a competitive tax rate and simple and transparent procedures, would go a long way towards increasing investment and jobs creation in Tunisia.”