Creating a better business environment is crucial for bolstering growth in Africa
IN MID-2006 the World Economic Forum held an Africa regional meeting in Cape Town. The opening panel featured three presidents: Thabo Mbeki of South Africa, Armando Guebuza of Mozambique, and Jakaya Kikwete of Tanzania. A little over a decade ago, the presidents of these countries might have discussed apartheid, civil war, and alternatives to the market economy. This time around they discussed policies to promote economic growth and support the private sector as the engine of growth. Pointed questions from young Africans in the audience—unencumbered by any apprehension about African “big men”—were about term limits for heads of state.
The debate in and about Africa has changed, and so has the reality on the ground. Although performance varies from country to country, and there are still plenty of laggards, macroeconomic policy has much improved, fiscal deficits are under better control, inflation has come down dramatically, debt levels are substantially reduced, and the share of international trade in the economies has risen. Coupled with these improvements, the number of conflicts across the continent has dwindled—down to about half a dozen from about 20 reported by the International Peace Research Institute as recently as 1999 (Gleditsch and others, 2002).
About that time, Paul Collier, Oxford’s eminent observer of African economic development, surmised that peace and macroeconomic stability would give African economies positive per capita income growth. In fact, 3 percent per capita growth would not be too hard to achieve if economies also started opening up and allowed businesses to flourish (World Bank, 2000). But Collier was too cautious. Peace, macroeconomic stability, and a small dose of business-friendly policies have brought annual per capita growth of 3–5 percent to more than a dozen African countries, home to more than one-fourth of Africa’s population. Moreover, there has been an acceleration of growth across the continent, with Africa growing faster than Latin America for several years in a row. This is quite a turnaround from the last three decades of the 20th century, when per capita income, on average, shrank slightly.
Of course, the same growth slowdown occurred in Asia in the decades preceding the 1950s (see Chart 1), before it took off with spectacular growth. Can Africa now effect a similar takeoff? Given the scope for catching up with more advanced economies, analysts believe that African economies technically have a good chance to achieve growth rates approaching 10 percent (assuming population growth of a bit over 2 percent annually). Thus, it is conceivable that Africa could, on average, reach the income level of recent entrants to the European Union by 2050. Were this to happen, today’s children in Africa would leapfrog all of history’s stages of development in a lifetime. To make it happen, however, Africa desperately needs major improvements in its business climate—long seen as deterring mainstream investment—combined with long-term policies to strengthen education and develop infrastructure. At the same time, it will need to maintain well-founded macroeconomic policies.
Chart 1Asian rebound
Source: Maddison (2001).
Sources of growth
One of Africa’s biggest problems is that, in general, growth is not being driven by expansion of the formal sector. To some degree, the current upturn has been triggered by strong commodity prices, coupled with resource transfers from remittances and aid. Ghana is a case in point. Remittances equivalent to 10 percent of GDP, aid flows of about 5 percent of GDP, and a boom in cocoa prices and other commodities have stimulated domestic demand. People from rural areas are moving to urban areas, where demand is strong. In their new, mostly informal urban occupations, productivity tends to be double or more that in rural occupations, thereby improving overall growth (World Bank, 2006).
While informal sector expansion is useful, sustained growth eventually requires larger firms operating in the formal economy that can get access to credit and trade with more and more partners, benefit from contract enforcement, and hire larger workforces. In a few countries, some signs of activity are emerging beyond basic informal urban activities and outside the commodity sector.
In recent years, the cut-flower business out of Kenya and Uganda has blossomed; fish products from Uganda have found new markets. Most recently the Nigerian film industry, “Nollywood,” has overtaken both Hollywood and the Indian Bollywood industries in the number of films produced annually. Nollywood, now the second largest source of jobs in Nigeria after agriculture, provides jobs for a million people.
So there is dynamism, and all the successes emerged without specific government support. The question is how this dynamism can be unleashed further. Clearly the immediate focus needs to be on creating a better investment climate, in which firms can be formally established and can flourish. Encouraging private investment is critical for sustaining growth in the economy. In the successful East Asian economies, private investment was five times that of public investment. In contrast, in Africa in recent decades public investment has been double that of private investment.
Creating a better business environment
For longer-term development, governments and outside observers typically worry about levels of education and the state of physical infrastructure. These are clearly deficient. But plenty of things can be done to improve the business climate more quickly—for example, streamlining the myriad rules and regulations that make life hard for businesses and that drive people into the informal sector. These rules govern the registration of new businesses and the ability of companies to hire workers and get credit, trade and enforce contracts, and reinvest.
Some observers feel that rules and regulations do not matter much in Africa because enforcement is weak and most people operate in the informal economy. But that approach gets things backward. People are in the informal economy because rules are overly restrictive in the formal sector, whereas enforcement is by bureaucratic discretion rather than by the book. The Doing Business project of the World Bank Group has shown that rules for business are more cumbersome in Africa than anywhere in the world (see Chart 2). Nowhere is it harder to form a business, nowhere is it harder for banks to get comfortable with the credit history of prospective borrowers, and nowhere is it more cumbersome to trade. Even labor regulation is often prohibitive. Sierra Leone leads the world in the required number of remunerated vacation days for formally employed workers—38 a year. The result: the informal sector blossoms. The regulations that ostensibly protect citizens leave them exposed and reduce opportunities for more productive and better-paid work.
Chart 2Speed bumps
Source: World Bank, Doing Business database.
Note: OECD=countries in the Organization for Economic Cooperation and Development; EAP=East Asia and Pacific; ECA=Europe and Central Asia; LCR=Latin America and the Caribbean; MNA=Middle East and North Africa; SAR=South Asia; AFR=sub-Saharan Africa.
Cutting red tape also applies on the trade front. Africa obviously suffers tremendously from bad roads, unreliable or nonexistent electricity supply, inefficient ports, and the like. But the biggest holdup for goods is not the time spent in transit: it is the paperwork, inspections, and customs procedures, according to the Doing Business data (see Chart 3).
Chart 3Paper wait
Source: World Bank, Doing Business database.
Similarly, short-term gains can be made by improving the management of existing companies. Even if workers’ educational standards are relatively low, what matters is how rudimentary skills are put to use. African textile and garment firms are almost as productive as Chinese ones on the factory floor (see Chart 4, left panel). The biggest productivity differences recorded in the World Bank’s enterprise surveys are 2 to 1. But, overall, Chinese firms are much more productive. When taking into account the purchasing, selling, and other activities of a firm (total factor productivity), the productivity differences can be as high as 10 to 1 (see Chart 4, right panel). In other words, African workers with decent management can be very productive. We do not have to wait for children to go to school and come back in eight years or so before growth can start to take off.
Chart 4Productivity gap
Starting to change
Just three years back, when the World Bank Group’s Doing Business series appeared for the first time, African ministers were upset that, yet again, the World Bank was chiding them for insufficient progress rather than recognizing the significant advances made on the macroeconomic front. Today, governments throughout the continent have started to embrace the microeconomic reform agenda. According to the 2006 Doing Business report, Africa was in the middle of the pack of reformers in 2005. The latest report shows that two African countries—Ghana and Tanzania—were among the top reformers in 2006 (World Bank and International Finance Corporation, 2006a, b). The most popular reform in Africa is simplification of business registration. Property titling and registration has also gained momentum. Africa is thus tackling the basic issues highlighted and popularized by the Peruvian economist Hernando de Soto (see “Hearing the Dogs Bark” in F&D, December 2003).
Creating a more business-friendly environment may seem difficult, but African countries are edging in the right direction. Even if we take out the front-runners with the best business environment in sub-Saharan Africa—Botswana, Mauritius, Namibia, and South Africa—several other countries have made advances in different areas. Thus, if we took the best regulations currently in place in these other countries and combined them into a hypothetical “reformed country,” the country would look like Sweden on the indicators of the Doing Business report—hypothetically among the top 20 countries in the world.
When it comes to substantive reforms, it is useful to ask businesses for feedback. Some form of formal public-private dialogue is critical. Encouragingly, more and more African governments are establishing some type of investor council that opens up communication between the private sector and the highest levels of government.
Much remains to be done, but it is obviously possible to advance greatly with only partial reforms. India is a case in point. Small reforms of the domestic business environment in the mid-1980s opened up opportunities for businesses and signaled that the government was abandoning ideas of central planning (Rodrik and Subramanian, 2004).
The reforms to consider in the poorest countries will typically include business registration, contract enforcement, property titling and registration, trade facilitation, credit bureaus, and tax reform. In Africa, taxes are very high for businesses. Those collected from formal businesses exceed the levels in all other parts of the world (see Chart 5). No wonder firms remain informal. Ghana, one of the top reformers in Africa, was very successful in raising revenues to plug its fiscal deficit. Revenue generation rose by 7 percentage points of GDP in just five years from 2000 onward—good for the government budget, but a massive burden on the private sector. In Africa as a whole, government expenditure net of transfer payments is higher than in most parts of the world and close to industrial country levels.
Advancing the agenda
African leaders have not begun to embrace change just because the World Bank said so. Upon reflection, governments in Africa and elsewhere have come to realize that a better business environment is actually good politics. It helps create jobs and reduce the informal sector, where people are unprotected and often employed in low-paid work. It helps integrate young people and women in the workforce. All in all, the agenda is about success on the basis of rules, and not on the basis of whom one knows.
Governments all over the world have learned that stable macroeconomic policy is good for a country, and the poor in particular, not least because the poor cannot take their money out of the country or otherwise hedge against inflation. At the same time, there has been a backlash, mostly in Latin America, against privatization of state assets in the natural resource sector and in infrastructure. Many governments are reluctant to let go of what they believe to be control of the commanding heights of the economy. But the very same governments that resist high-profile privatizations are embracing reforms of the business environment, not least in Africa.
It is hoped that collaborative efforts among governments, the private sector, and donor nations will help advance the agenda. Under the stewardship of the New Partnership for Africa’s development, the Investment Climate Facility for Africa was launched in June 2006 at the World Economic Forum meeting in Cape Town. With more than $100 million committed by donors so far, the facility has the potential to facilitate and support reform efforts in the business environment all over Africa during its planned seven-year life.
Critical to success will be the message that governments send out. If reforms are just on paper to satisfy some outside party, but governments do not seem to embrace the reform spirit, they will not work. Equally, if firms become convinced that governments will, step by step, move ahead with reforms, they will invest even when initial reforms are modest. After all, investors make the biggest returns when they invest in a weak business environment that subsequently improves.
“If firms become convinced that governments will, step by step, move ahead with reforms, they will invest even when initial reforms are modest.”
Trite as it sounds, the leaders of Africa are the ultimate key to success. What heads of state like Thabo Mbeki, Armando Guebuza, and Jakaya Kikwete say at meetings like that of the World Economic Forum actually matters. They set the tone. When the tone is right and action follows, even if it is only step by step, private investors at home and abroad will take heart and take risks. When the history of the 21st century will be written, it may become clear that Africa today is where East Asia was in the late 1950s—just about to surprise the world.
Michael Klein is the Chief Economist of the International Finance Corporation.
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