'WDPi7
World Bank Discussion Papers
Pnrvate Enterprise
in Africa
Creating a Better Environment
Keith Marsden
Therese Belot



n        i   U    World Bank Discussion Papers
Private Enterprise
in Africa
Creating a Better Environment
Keith Marsden
Therese Belot
The World Bank
Washington, D.C.



The 'World Bank
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First printingJuly 1987
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Keith Marsden is an operations adviser in the Industry Department of the World
Bank; Therese B6lot is a consultant to the Bank.
Library of Congress Cataloging-in-Publication Data
Marsden, Keith.
Private enterprise in Africa.
(World bank discussion papers ; 17)
1. Africa--Economic conditions--1960-
2. Capitalism--Africa. 3. Africa--Economic policy.
I. Bglot, Ther2se, 1947-          .  II. Title.
III. Series.
HC800.M353  1987            330.96'032             87-18419
ISBN 0-8213-0945-5



ABSTRACT
This paper addresses four issues. First, what are the main
constraints to private enterprise and competitive markets in Africa?
Second, how can African governments remove those constraints and foster the
development of an efficient private sector in the future? Third, how can
foreign aid donors best contribute to this goal? And fourth, in the light
of past and current experience, will the economic performance of African
countries be improved if the role of private enterprise is enhanced and
market forces are allowed to operate more freely?
The assessment draws upon a variety of evidence and sources:
cross-country studies; country economic and sector reports; lending
operations experience; analysis by independent observers and development
specialists; attitude surveys conducted among private investors; and
special missions to review the business environment and investment climate
in several African countries.
Chapter I examines barriers to entry faced by private investors
in the agricultural marketing, transport and industrial sectors.
Chapter II reviews obstacles to foreign investment. Chapter III discusses
financial constraints. Labor regulations and price controls are analyzed
in Chapter IV. The relationship between trade policies and the level of
competition is traced in Chapter V. Chapter VI considers the role of
foreign aid donors in promoting private enterprise in Africa.
An Annex summarizes five cross-country studies which have esti-
mated the impact of government and the private sector on economic growth.
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TABLE OF CONTENTS
Page No.
EXECUTIVE SUMMARY AND RECOMMENDATIONS ..........a.................   vii
INTRODUCTION ......................................      .................. 1* 
CHAPTER I.      BARRIERS TO ENTRY . ..... .                 ................. .........  4
1.  Agricultural Marketing ..................o.........            4
2.  Transport ..       ................    ........ ..o... ..      9
3.  Industry so ..... .......................               .     10
CHAPTER II.    OBSTACLES TO FOREIGN INVESTMENT  o......... ..........              16
CHAPTER III.   FINANCIAL CONSTRAINTS  .........o...................                21
1.  Financial Market Regulations  ..... o.....o........           21
2.  Lack of Equity Funds ...            ........................  23
3.  Foreign Exchange Allocation Systems  ..o .........            24
4.  Crowding-Out by Public Sector Borrowing   .......             26
5. Heavy Taxation Squeezing Corporate Profits
and Entrepreneurial Incomes  .................             27
6. Public Investment Programs Monopolizing the
Use of Foreign Loans   ........................            30
CHAPTER IV.    LABOR POLICIES AND PRICE CONTROLS ..o ....o...........              33
1.  Labor Policies  .. .......... .... ... . .... ..              33
2.  Price Controls  ... ..... .   ...... . ........ . ........ .    38
CHAPTER V.      TRADE POLICIES AND COMPETITION .................. oo..    41
1.  Exchange Rate Policies  ........................              41
2.  Import Policies   ....... oo ....  o............ ...          42
3.  Export Policies ...o. ....... ...... .  ............. * *..... *  44
CHAPTER VI.    THE ROLE OF AID DONORS IN PROMOTING
AFRICA'S PRIVATE SECTOR o ............ oo...........              47
1.  Policy Reforms  .....  ...... ..........* ........            47
2. Involving the Private Sector in the
Policy Dialogue .. ..    .... . .. .*.. . . .. ...... ..  .  47
3.  Policy-Based Lending  .. ....           ...................ooooo.  48
4.  Agricultural Development  ........... .o* .....    49
5. Promotion of Small and Medium-Sized
Enterprises  .............. . .. .. . .. . . . .. . . . ...ooo.o..o    49
6.  Restructuring of State-Owned Enterprises  ......    50
7.  Infrastructure and Institutional Development  ..              50
8.  Promotion of Direct Foreign Investment ...... ..    51
9.  Conclusion .......        ........ *.*. . .... .. ......    52
v 



- vi -
TABLE OF CONTENTS (Continued)
Page No.
ANNEX         PRIVATE SECTOR DEVELOPMENT IN AFRICA ..............   53



EXECUTIVE SUMMARY AND RECOMMENDATIONS
1.        What can governments do to create a better environment for
private enterprise in Africa? Development in many countries throughout the
world has shown that the initiative and drive of private investors and
entrepreneurs can be important agents of economic growth. Many African
countries would therefore like to make greater use of the potential
benefits of private entrepreneurship. Economic analysis suggests that
private enterprises contribute most to the generation of high economic
returns (as opposed to just financial rewards to the investor) in a liberal
environment characterized by few constraints on access to inputs and
markets, autonomy in investment and operating decisions and a common frame-
work of incentives applied consistently and uniformly to all actors. Like-
wise, a well-educated and motivated labor force and well-functioning
capital markets are important ingredients of a stimulating business
environment. While these conditions are rarely fulfilled in African
countries, they are important targets to strive for in the interest of
development.
2.        This paper addresses key issues affecting private sector
development in Africa. It is based on several missions to a number of
countries and generalizes, to the extent possible, findings of weaknesses
and constraints in key policy areas. Five areas are examined which
typically have been neglected by governments in the past but are of crucial
importance to a healthy development and performance of the private sector:
(i) barriers to entry, (ii) treatment of foreign investment, (iii)
financial constraints, (iv) labor policies and price controls, and (v)
trade policies and competition. This Executive Summary outlines the main
findings and recommendations; the full paper is attached.
Barriers to Entry
3.        The granting of monopolies to state agricultural marketing boards
has resulted in inefficient operations, misuse of funds, and depressing
effects on farm output. These monopolies should be eliminated and private
traders of agricultural produce of all kinds should be allowed to operate
without obstruction. If existing state marketing boards are able to co-
exist without subsidies, they will widen the choice of both producers and
consumers and perform a useful role in preventing the emergence of private
monopoly or collusion in restraint of trade.
4.        In urban transport, small-scale, private operators have decisive
advantages over public sector producers and over large-scale operators
generally. Yet in many African cities, expensive and inefficient public
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- viii -
bus monopolies endure. And what is true of urban bus systems is true also
of over-the-road passenger and freight systems. Private operators offer
better, cheaper alternatives to public trucking companies. Yet they are
often bypassed. Entry restrictions should be lifted if African countries
are to open up their interiors, move people and goods to work places and
markets faster and more efficiently and remove bottlenecks which are
holding back progress in other sectors.
5.        In many African countries a variety of policies also restrict
private access to and participation in the mining, manufacturing and public
utilities sectors. Sometimes activities reserved for state enterprises (or
joint ventures with majority government ownership) are specified in Invest-
ment Codes or other legislation governing industrial investment. In other
cases, public sector control has been acquired by nationalization of exist-
ing privately-owned enterprises. More frequently, selective use of indus-
trial licensing authority preserves state monopolies in sectors considered
to be politically sensitive or where the pursuit of social goals is made
paramount. These barriers have deprived African economies of the benefits
of private investment (both indigenous and foreign) and the skills, know-
how and initiative which would have accompanied such investment. They have
removed the competitive stimulus to efficiency which public monopolies have
so obviously lacked in some key areas. Governments would achieve their
goals more effectively if they eliminated these barriers and used broader
economic policies and market incentives to guide private decisions in the
desired directions--such as employment creation, training of nationals,
reinvestment of profits, etc.
Obstacles to Foreign Investment
6.        Apart from specific restrictions on entry noted above, foreign
investors are often deterred by various bureaucratic procedures, policies
and practices which create an unfavorable climate for foreign firms.
Obstacles cited in a survey of European investors include:
- internal political pressures leading to price controls
- failure to respect contractual obligations
- restrictions on employment of expatriate staff
- requirements to use local inputs of poor quality
- restrictions on location
- government preferences for large prestige projects
- legislative insecurity, including increases in taxation
after a project has been implemented
- corruption resulting from red tape and a multitude of
authorizations required to do business



- ix -
- excessive legalism and lack of precision in legal texts
- slow and arbitrary decision taking
7.        African governments which wish to promote foreign investment
should take more vigorous action to change these perceptions or else change
the underlying reality. Mechanisms to allow a continuing dialogue between
government and the private sector would lead to a better understanding of
each side's needs and attitudes and a broader consensus on reforms
required. These mechanisms include regular meetings with Chambers of
Commerce and tripartite National Economic Councils and missions by prospec-
tive foreign investors arranged by such organizations as the U.S. Overseas
Private Investment Corporation.
Financial Constraints
8.        Shortage of investment funds and working capital is holding back
development of the private sector, particularly small and medium enter-
prises (SMEs), throughout Africa. In part, this scarcity is simply a
reflection of low income levels and the persistence of large subsistence
(non-monetized) segments of their economies. But it also springs from
weaknesses in policies and institutions which hamper resource wbilization
and restrict the private sector's access tolavailable finance. Serious
constraints were found in six areas. First, financial market regulations
reduce savings deposits and discourage banks from lending to SMEs. Second,
stock markets and merchant banks able to mbbilize equity capital are gener-
ally absent. Third, foreign exchange allocation systems restrict the
supply of foreign currency to private firms. Fourth, the private sector is
crowded-out of financial markets by excessive borrowing by government and
public enterprises. Fifth, heavy taxation squeezes corporate profits and
entrepreneurial incomes and therefore limits the private sector's capacity
to generate internal investment funds. And sixth, foreign loans and grants
are being monopolized by public investment programs.
Financial constraints on private enterprise can be relaxed by:
- allowing interest rates to reflect the state of the credit market
and the foreign exchange market, plus differentials in risks,
maturity and administrative costs of servicing different types of
customer and sizes of loan;
- removing anti-equity biases in financial and fiscal policies such
as interest rate subsidies, double taxation of dividends, and
official bail-outs of loss-making enterprises;
- creating specialized equity-financing institutions and funds;
- adopting legislation to promote the disclosure of corporate and
market trading information and the registration of stockbrokers;
- dismantling foreign exchange controls and import and export
licensing, leading to free convertibility of currency;



x
-  reducing the need for government and public sector borrowing in
domestic credit markets by eliminating budget deficits, restrain-
ing the expansion of public sector employment and wages, seeking
savings in recurrent costs in such fields as education and
housing, reducing losses of public enterprises by restructuring,
stricter monitoring and divestiture and scrutinizing public
investment programs more rigorously to prune potential "white
elephants";
- lowering high marginal tax rates to strengthen incentives and
opportunities to save and invest and to decrease pressures for
tax evasion and corruption;
- allocating a higher proportion of foreign aid funds to local
development finance institutions and commercial banks for onlend-
ing to SMEs;
- encouraging private investors to take over inefficient state-
owned enterprises and to undertake new projects currently
included in public investment plans by guaranteeing long-term
loans to match the investors' own equity contributions; and
- providing private sector development loans, financed by multi-
lateral and bilateral aid donors, to meet the short- and medium-
term foreign exchange requirements of private enterprises, linked
to policy reforms that promote competitive markets and efficient
resource utilization.
Labor Policies and Price Controls
9.        Cumulative evidence suggests that over-regulated labor markets
have generally resulted in bloated bureaucracies and hampered the profit-
ability of enterprises in Africa. In particular, pressures upon employers
to expand or maintain employment, for strictly social considerations, have
proved to be counterproductive. Only economic growth can produce long-term
expansion of employment.
10.       Labor policies should allow firms more flexibility in negotiating
wages, including the possibility of linking wages to employee producti-
vity. Restrictions and penalties on laying off excess or unproductive
workers should be relaxed, so that employers may take on and train new
workers without excessive risks. Fiscal incentives should be given to
encourage greater involvement of employers in the design and execution of
training programs.
11.       The short-term benefits of price controls to consumers have been
far outweighed by their economic costs and destabilizing effects. Price
controls have aggravated shortages and distortions. They have turned the
terms of trade against agricultural producers, caused bureaucratic delays
and market rigidities and restricted resource mobilization by squeezing
profits. Several African countries have taken steps recently to remove



- xi -
price controls completely or to retain them only for a few basic commodi-
ties. Measures to increase market competition, including freedom of entry,
lower tariffs and removal of quantitative restrictions on imports, will
help to ensure that price liberalization does not result in excessive rents
for monopolists.
Trade Policies and Competition
12.       Overvalued exchange rates are found throughout Africa and the
situation has generally deteriorated relative to other regions over the
past decade. Overvalued currencies make it more difficult for African
farmers and manufacturers to sell their products abroad and reduce the
returns in local currency received by exporters. They also result in
foregone benefits in import-substituting sectors by making imports rela-
tively cheaper. Thus, domestic resources are channelled into the produc-
tion of non-traded goods and services. However, a growing number of
African countries have begun to adopt more flexible exchange rate regimes
which rely on demand and supply in the foreign exchange market to determine
the exchange rate. Such measures as allowing exporters to retain a certain
percentage of their foreign exchange earnings, and periodic auctions for
trade-related foreign exchange transactions, can facilitate a transition to
a freely convertible currency which is the most effective mechanism for
ensuring that a realistic exchange rate is sustained.
13.       The level of protection from imports afforded to domestic
producers is highly variable in Africa, reflecting uneven tariff rates and
selective quantitative restrictions. Effective protection tends to be high
for activities with low domestic value-added such as component assembly
industries, reducing competition and encouraging inefficiency. Low or even
negative effective protection in other fields discourages the use of
domestic raw materials and the development of intermediate and capital
goods industries. Quantitative restrictions promote rent-seeking activi-
ties. Substantial rents can be obtained simply by having access to import
licenses. Corruption almost unavoidably flourishes in such a situation.
Politicization of the economic process is encouraged. High tariffs and
quantitative restrictions on imports facilitate the emergence of private
monopolies and "crony-capitalism" which yield few long-term benefits for
society as a whole.
14.       These distortions and weaknesses are being remedied in some
African countries in the context of structural and sectoral adjustment
programs. Tariff rates are being made more uniform and moderate. Quanti-
tative restrictions are being lifted. These reforms are accompanied by a
strengthening of customs administrations to improve revenue collection and
to meet the legitimate complaints of domestic producers who are currently
being undercut by fraudulent imports which evade many of the duties and
domestic taxes imposed upon those who abide by the rules. These measures
need to be replicated throughout Africa.
15.       Biases against exports resulting from overvalued exchange rates
and from high duties and quantitative restrictions on imports are rein-
forced in many African countries by explicit or implicit taxes on exports.



- xii -
These taxes have retarded the growth and diversification of African
exports, particularly in manufactures which account for only eight percent
of total exports from low-income countries in Sub-Saharan Africa. Vigorous
steps to counter the prevailing "export pessimism" in Africa are indispen-
sable if more rapid and better-balanced economic growth is to be achieved.
The private sector could provide the main driving force behind an outward-
oriented trade strategy if export taxes were removed, realistic exchange
rates adopted, duty draw-back schemes introduced and administered effec-
tively, export credit facilities created, fiscal incentives offered and
export promotion services strengthened.
Role of Aid Donors
16.       The evidence reviewed in the main text of the paper and in the
Annex indicates that there is no shortfall of entrepreneurial spirit in
Africa. The most crucial limiting factor is not entrepreneurship, but
weaknesses in the policy environment which inhibit effective investment.
17.       Aid donors are already helping to remove debilitating restraints
on private enterprise in many ways. Infrastructure development and project
lending in productive sectors are important. Economic analysis and
cross-country studies draw the attention of policy makers to measures which
have been applied successfully. Structural adjustment operations help to
minimize the short-term political and social costs of reforms and endow
immediate financial benefits.
18.       The impact of foreign aid on private sector development could be
further enhanced by:
- involving the private sector more closely and systematically in
the policy dialogue with countries;
- introducing Private Sector Development Loans aimed at reducing
the financial and foreign exchange constraints on private firms
and focusing on policy areas which have been somewhat neglected
in past adjustment operations, such as eliminating statutory
monopolies, applying growth-oriented fiscal policies, deregulat-
ing labor and financial markets, developing equity markets and
fostering direct foreign investment;
- designing agricultural projects to ensure that private enter-
prises can participate fully in the provision of inputs and the
distribution and processing of agricultural output, and are not
preempted or undercut by subsidized public sector organizations;
- expanding the access of indigenous small and medium enterprises
(SMEs) to credit, by lifting interest rate ceilings and other
disincentives which deter financial institutions from undertaking
riskier and more costly SME lending programs;
- strengthening market networks and subcontracting/franchising
relationships which are more effective mechanisms for the



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transfer of information and know-how to SMEs than public institu-
tions and extension services;
- providing guidance and support to governments wishing to pursue
the privatization option as a means of tackling the problems of
their state-owned enterprises;
- shifting some of the burden of local cost financing from govern-
ments to the private sector by tapping the growing body of
experience around the world with the private provision of public
services;
- drawing upon donor's legal expertise for the drafting of new
investment codes and redesign of commercial law to create a more
stable, predictable and transparent business environment over the
long run;
- assisting indigenous entrepreneurs identify, appraise and arrange
financing for private investment projects;
- promoting direct foreign investment by providing insurance
against noncommercial risks (MIGA), by organizing workshops and
study tours for officials of African investment promotion
agencies, by funding missions by potential foreign investors and
subsequent feasibility studies, and by disseminating reports
describing and analyzing the investment climate in Africa to
organizations representing foreign investors.
Conclusion
19.       A growing private sector providing a more diverse array of
products and services is a formidable force for development. Opening the
economy to more indigenous enterprises also provides increased opportuni-
ties for African women who, in many African societies, have a long tradi-
tion of commercial activity. For governments who have gradually realized
the limits of public sector intervention, an enhanced role for the private
sector is not a threat, but welcome relief. And the harsh rhetoric once
heard in Africa against foreign investment is being replaced by a deter-
mined competition for the capital, technology, and employment which indus-
trial country investors can bring to a developing country.
20.       Attitudes and policies are changing rapidly in Africa.  There is
a growing recognition that, given the proper support, the enterprising
energies of Africa's people have enormous development potential. Aid
donors, industrial country investors, African governments, and African
entrepreneurs themselves now have the opportunity before them to engage a
powerful engine to help drive Africa's development forward. It is an
opportunity which no one can afford to ignore.



INTRODUCTION
"It is now generally accepted that over time the major-
ity of public sector enterprises or entities have not
performed efficiently. Instead of accumulating sur-
pluses or supplying services efficiently, a good number
of these enterprises have become a drain on the
national treasuries. Due to this poor performance,
coupled with the growing recognition of the costs of
ineffective public enterprises in terms of foregone
economic development and the scarcity of domestic and
external resources for public sector expenditure,
reappraisal of the strategy of heavy reliance on the
public sector has become imperative. From this
reappraisal, a view has emerged--the need for enhance-
ment of the role of the private sector in develop-
ment.... We in Africa are facing a great challenge.
We believe that the creation of a conducive environment
for the growth of the private sector, an important
agent of economic growth, is essential."--Statement by
Babacar N'Diaye, President of the African Development
Bank at the International Conferen~ce on Privatization,
February 17, 1986, Washington, D.C., U.S.A.
Similar official declarations promoting the role of the private
sector as an engine of economic growth have become common in many African
countries in recent months. This is in marked contrast from 20 to 30 years
ago when African countries first gained their independence. The prevailing
political philosophy at the time stressed the role of government in direct-
ing the development process. It was believed that resources could be allo-
cated more efficiently by central planning than by haphazard market mechan-
isms. Market failures and distortions must be corrected by extensive
government intervention through regulations and administrative controls.
The strategic "commanding heights" of tte economy must be owned by the
state on behalf of the people, not exploited for capitalist greed.
Real political independence required economic independence, it
was argued. Foreign companies and ethnic minorities dominated African
economies during the colonial era. The new leadership had lfttle faith in
the entrepreneurial flair and managerial skills of indigenous entrepreneurs
engaged in small-scale artisan and trading activities. Small-scale indus-
try was thought to be a relic of the past and a barrier to the adoption of
modern technology and economies of scale. So large-scale public investment
had to take the place of foreign private investment as the main driving
force behind a self-reliant development, it was believed. The battle for
independence inevitably left many scars. Human resource development was
low, and indigenous institutions were absent or very poor. Many countries
-1I-



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were not homogenous entities. Regional and tribal imbalances were impor-
tant. In many African societies, the role of the government was seen by
the population very differently from the way it is seen in more developed
market systems.
These views were confirmed by some development economists and
technocrats who were preoccupied with abstract models which reduced the
process of development to the interaction of a few key variables, inevit-
ably those which were most easily quantified such as capital investment.
More intangible factors--entrepreneurship, risk-taking, innovation, incen-
tives, motivation, opportunities, choice, mobility and liberty--tended to
be left out of the equations. International suppliers and even Donor
Agencies reinforced the emphasis on large capital-intensive projects.
Subsequent experience has led to a reappraisal of development
strategies based upon these ideas and approaches. Growth of per capita
income in Sub-Saharan Africa has lagged well behind that in other regions
of the world. In low-income economies in Africa, average per capita GNP
actually declined by 0.2 percent annually between 1965 and 1983, compared
with an annual growth rate of 2.7 percent in all low-income economies. Per
capita GNP in middle-income African economies rose by 1.9 percent annually
over the same period, while the average growth rate for middle-income
countries as a whole was 3.4 percent.
Experience has shown that the information and know-how available
to government officials was generally less precise, and more often misused,
than the information and know-how possessed by market participants (buyers
and sellers). Failures of bureaucratic systems turned out to be more
pervasive than market failures. Abuses resulting from state monopolies
were more pernicious in their effects on people's welfare than entrepre-
neurs striving for profit in competitive markets. The managerial capacity
of governments became overextended. Public enterprises were subject to
political constraints and pressures from special interest groups. They
were frequently set social objectives, such as preserving employment and
restraining inflation, which were difficult to reconcile with efficiency.
They were rarely allowed to go out of business, even if their products and
plants were obsolete and incurring huge losses. Red tape and excessive
bureaucracy undermined the effectiveness of government services. And
government controls over private sector decisions, through licensing,
rationing and regulations, distorted incentives and brought about a mis-
allocation and inefficient utilization of resources.
Post-colonial experience has also demonstrated the reality of
world interdependence. Poor countries can participate in world trade to
their advantage and become stronger and more prosperous as a result.
Foreign investors and commercial partners abroad can provide scarce,
complementary resources that generate substantial benefits for the national
economy, shared by all parties. Indigenous entrepreneurship is more
prevalent than was thought, but needs a positive environment to flourish
and time to gain stature and confidence.
What can governments do to promote efficient private enterprise
and competitive markets? Country analysis suggests that private enterprise



- 3 -
tends to perform most efficiently (in the sense of generating high economic
returns to the country, not just financial rewards to the investors) in
environments with the following characteristics. Entry into any economic
activity is unrestricted. Access to inputs and markets is assured. The
labor force is well educated and motivated. Entrepreneurs are allowed con-
siderable autonomy in their investment and managerial decisions. Property
rights (including intellectual property) are protected by laws which are
objectively enforced. Contractual obligations are respected. Government
policies are applied consistently and uniformly, ensuring fairly equal
treatment among sectors and firms, including non-discrimination between
foreign and nationally-owned enterprises. Market distortions and rigidi-
ties are minimized, so that the prices of capital, labor, foreign exchange
reflect their relative scarcity. Economic incentives are neither repressed
by an excessive burden of taxes, nor feather-bedded by undue subsidies and
protection from competition. Bilateral or multilateral agreements ensure
independent arbitration of disputes affecting foreign investors and provide
insurance cover against non-commerical risks. Government services are
supportive, efficient and administered with integrity. Controls and red-
tape are kept at tolerable levels. The infrastructure (roads, ports,
power, telecommunications, etc.) is adequate. And independent institutions
and competition in general are encouraged.
These conditions are seldom, if ever, united in a single
country. Substantial deficiencies persist in most areas in many African
countries. Nevertheless, they represent valid goals that can be pursued in
national development strategies, even if they are unlikely to be fully
attained in the real world.  The following chapters discuss existing
weaknesses and constraints in key policy areas, illustrated by specific
country and sectoral cases, and review action being taken, or proposed, to
further these goals. The paper does not attempt to be comprehensive. It
focuses on issues which have been somewhat neglected in the past and on
factors which have emerged from analysis and discussions as critical deter-
minants of private sector performance.
Five broad policy areas are examined. The first covers restric-
tions on entry by private investors and the impact of statutory monopolies
and nationalizations. The second comprises various obstacles to foreign
investment, including bureaucratic procedures, corruption and inconsisten-
cies in the way policies and laws are interpreted and applied. The third
consists of financial constraints on private enterprise resulting from
over-regulated financial markets, scarcity of equity funds, biases in the
allocation of foreign exchange, "crowding-out" by excessive public sector
borrowing, heavy taxation squeezing corporate profits and entrepreneurial
incomes and the monopolization of foreign aid by governments and public
investment programs. The fourth combines labor market regulations and
price controls and considers their effects on labor mobility, employment
creation and domestic resource mobilization. Last, but certainly not
least, there is a discussion of trade policies and the role of the exchange
rate, protection from imports and export incentives in determining the
market opportunities available to private enterprises and the extent to
which they are subject to a competitive stimulus to efficiency.



CHlAPTER I. BARRIERS TO ENTRY
In almost all African countries, private entrepreneurs are prohi-
bited from engaging in some economic activities which have been reserved
for state monopolies. The range of activities proscribed varies from
country to country but entry barriers are most prevalent in agricultural
marketing (of inputs and outputs), transport and industry. Specific
examples are cited below.
1. Agricultural Marketing
In the agricultural sector, the FAO List of Marketing Boards
(1981) indicates the existence of more than 100 marketing boards in
tropical African countries. The largest and most numerous are the monopoly
boards for export crops and for domestic food crops. There are also boards
that have monopolies of international trade in commodities for which they
are responsible, but compete with private firms internally and do not have
the power to fix prices., Initially the rationale for the creation of these
boards was stabilization of prices and the management of the food supply
for the growing urban populations. In some countries the-, were introduced
by colonial administrations. However, it is now widely recognized that
these state marketing boards have not only marginalized, distorted or
destroyed highly functional indigenous traditions of "open" competitive
agricultural marketing in Africa, but have also been wasteful and ineffi-
cient in their own operations.
Most marketing board analysts point out the disappointing
performance of the majority of these boards. In a recent seminar in
Leiden, the Netherlands, 23 case studies of farm marketing boards in indi-
vidual African countries were presented. These papers provide revealing
assessments made by marketing specialists.!/ There were few good words
for any marketing boards and many harsh ones. Principal defects identified
were misuse of funds, inefficiency of operations and the depressing effect
on farm production of marketing board policies and practices.
Criticism of use of board funds concentrated on their diversion
to political constituencies and on outright theft by public employees. The
case studies gave the following illustrations. In Cameroon "an enormous
amount (75%) of the funds accumulated from crop exports has been channelled
from rural sector to manufacturing and service sectors, turning terms of
trade against the rural sector." In Malawi "marketing board pricing policy
has been used as an instrument favoring the development of estate agri-
culture at the expense of small holder expansion." "Nigerian marketing
boards have been used to serve various interests and purposes, hardly any
1/ See Kwame Arhin, Paul Hesp and Laurens van der Laan (Edits.)
Marketing Boards in Tropical Africa, KPI London, 1985, and
William 0. Jones, Agricultural Marketing Boards in Tropical Africa
(World Bank, Washington, 1985, mimeo).



of which have benefitted the producers." In Tanzania, "the grower ... is
always voiceless and marginal in the system, and everybody's costs are
considered except the farmers." Frequent embezzlement of money meant for
the purchase of cocoa was reported in Ghana. Theft, embezzlement and
collusion were said to be widespread in ONCAD (Office National de Coopera-
tion et D'Assistance au Developpement) in Senegal. NMC (National Milling
Company) personnel in Tanzania were reported to have '"absconded with funds"
and indulged in "clientage practices that made villagers tolerant of
village officials syphoning funds." Gross abuse of weights and measures
and adulteration of products by agents of marketing boards were found in
Cameroon. In Sierra Leone there were complaints of frauds being practiced
by licensed buying agents who "exploit" farmers by paying them less than
the official price. Before the Sierra Leone Rice Board lost its exclusive
right to import rice "half of its imports were being allocated to influen-
tial politicians to distribute at their discretion."
Related to the political determinants of how revenues extracted
from farmers are allocated are the universally reported inefficiencies of
marketing board operations. A FAO participant in the Leiden seminar con-
cluded that "A most common complaint about grain marketing boards is that
they "lose" money--heaps of it." Inefficiencies derive from a variety of
causes, including the appointment to government positions of political
supporters (the "spoils" system) with consequent burgeoning of staff
numbers and deterioration of staff competence. A number of other circum-
stances contribute to costly and inefficient operations. An official of
the West African Rice Development Association listed the following:
"Inadequate funding and untimely release of funds; non-competitiveness of
government producer prices; inadequate governmental facilities for trans-
porting, storing, packaging and poor location of buying center; unqualified
personnel; and operational bureaucracies that inhibit on-the-spot decisions
by field staff." Furthermore, there are "deliberate efforts by management
to reduce purchases so as to reduce costs of subsidies, and marketing
margins of public marketing institutions are usually very high compared to
that of private traders because of high overhead costs, large permanent
staff, expensive head office facilities, poor management." There are also
"substantial physical losses of rice during marketing." Boards cannot
enforce market regulations or "handle a large quantity of locally produced
rice" and "cannot operate without government subsidy due to high costs of
operation and government pricing policies."
Various participants at the Leiden Seminar spoke of the lack of
economic information that is necessary for making decisions about buying,
selling, storing and transporting produce. The National Cereal Board of
Kenya did not know the size of the crop or the nature of demand. Market
prices are not collected systematically or processed adequately and market
forecasts are very unreliable. This ignorance of national crop and price
statistics extends to the internal accounts of the marketing boards
themselves. "Some agencies in the Sahel haven't presented regular
financial statements for several years."
A management consultant to several marketing boards painted a
grim picture of the awesome responsibilities of managers who may be respon-
sible for 80 percent of a country's export earnings and are under heavy



- 6 -
political pressure while the infrastructure is collapsing around them. He
spoke of farmer's incomes being reduced by as much as three quarters by
board operations. High operating costs, incompetence, political favor-
itism, and corruption have handicapped boards in achieving their authorized
objectives of stabilizing food prices and incomes and ensuring adequate
supplies of domestic foodcrops to consumers at reasonable prices. It was
suggested that Malawi's marketing boards actually destabilized producer
prices and incomes.
Despite widespread dissatisfaction with the performance of state
marketing boards, the Leiden Seminar noted powerful forces tending to
perpetuate these boards. They were a prominent part of the government
apparatus inherited by the newly independent nations of Africa and were
highly regarded as engines of government by their officers and staffs.
Board officers wield considerable political power, and staff at all levels
can find ways to line their own pockets if they are so disposed. Clients
of a board, too--large growers, produce buyers, shippers, handlers, and
warehousers--may view their own activities as intimately bound up with
those of the board and mistrust change. Another group of civil servants
tends to accept things as they are and react defensively to criticisms.
The staffs of marketing boards are not small and their kinsfolk may be
numerous. For the party in power, marketing boards provide a strong
instrument of political and economic pressure as well as a ready source of
government funds, and probably of private funds as well. And the boards
are weapons that can be used against private domestic monopolies and inter-
national trading companies.
African marketing boards also serve various conventional govern-
ment functions beyond that of marketing farm crops. They have been an
important source of funds that serve agriculture along with the rest of the
country--roads, bridges, railroads, ports and communications. It is easier
to collect taxes in the form of trading profits or operating expenses than
as more visible excise taxes and customs duties, and excessive use of this
device in Africa has come close to killing the goose that laid the golden
egg. In Tanzania, for example, the total exports of the country's major
commodities (cotton, coffee, cloves, sisal, cashews, tobacco and tea)
declined by 34 percent between 1973 and 1980. In general this was the
result of severe cut-backs in production which, in turn, was sparked by
lower official prices paid to the producers. The marked drop in prices was
not due to unfavorable world conditions, but rather to heavy "taxes" on
farmers--export duties combined with ever-increasing marketing and adminis-
trative costs accumulated by the parastatal marketing boards handling the
products. These bloated costs were important factors leading to a reduc-
tion in farmer's share in export earnings to below 50 percent. As a
result, producers directed some of the crops (coffee for example) into
unofficial channels, neglected and even abandoned some tree and bush crops
(coffee, sisal, and cashews) and shifted resources into subsistence
production.2/
2/ See Accelerated Development in Sub-Saharan Africa: An Agenda for
Action (World Bank, 1981).



The story is the same for Ghana. Ghana's share of the world
production of cocoa shrank from one third in the 1950s to one-sixth in
1979. The main reason for this disastrous decline was the heavy "tax"
imposed on farmers through the Cocoa Marketing Board's price policies.
Producer prices for cocoa lagged behind other relevant prices--far behind
in most cases. The price index for all consumer goods rose 22 times
between 1963 and 1979; the price of cocoa in neighboring countries rose 36
times. In contrast, Ghana's farmers received only six times more for their
cocoa. The government had become too dependent upon current revenues from
cocoa marketing to take a longer-term view of the negative effects of its
pricing policies on both output and revenues.
Although resistance to change arising from the factors indicated
earlier persists, several African countries have taken steps to increase
the efficiency of agricultural marketing by allowing private traders to
enter into fields previously confined to state monopolies and in some cases
have even closed down marketing boards. In 1981 the Somali government
eliminated the monopoly power of the Agricultural Development Corporation
(ADC) in the field of maize and sorghum marketing and of the National
Trading Agency (ENC) for imported foodstuffs. Private traders rapidly took
over the bulk of grain distribution. By 1984 ADC's share of total maize
and sorghum purchases in Somalia had dropped to 1.6 percent. Total produc-
tion of these crops increased from 251,000 tons in 1980 to 491,000 tons in
1984. ENC's imports of grains halved over this period and their imports of
oil, tea, sugar and pasta also declined. They were able to compete with
private traders in some areas only because they continued to monopolize
food aid imports and sell at concessionary prices.
In Mali, cereal marketing was liberalized in 1982 and the respon-
sibilities of the state cereal marketing agency (OPAM) reduced and its
operating costs cut. Government price controls remain however. Ground nut
marketing was liberalized in 1983 and a farm input supply agency liqui-
dated. The distribution activities of the general import-export agency
(SOMIEX) were curtailed and several sectors opened up to private
participation.3/
In Madagascar a major liberalization of rice marketing has taken
place. Several parastatal agencies, including GANPA, were abolished in
1983 and price ceilings removed in 1983. In Cameroon, MEDAVIVE has become
defunct and private traders have taken over food crop marketing. In Niger,
reforms were introduced in 1984 to reduce the operating losses of the
cereal marketing agency OPVN and to allow the private sector to participate
in retail trade. In Senegal a government circular published in January
1986 eliminates all restrictive measures other than common law measures
relating to the circulation of grain, other than paddy rice, within the
national territory. The privatization of the paddy rice market will depend
upon the phased disengagement of the Senegal River Valley Authority SAED.
Nigeria abolished all commodity marketing Boards on September 26, 1986.
Subsequently there has been a surge of exports, also influenced in good
measure by the exchange rate adjustment as of that date.
3/ See Justin B. Zulu and Saleh M. Naouli, Adjustment Programs in Africa:
The Recent Experience (IMF, Washington, April 1985).



-8-
Some other African countries are hesitating to eliminate state
marketing monopolies because of uncertainty about whether private traders
can be entrusted with this function. Governments often have adopted a
patronizing attitude to the private trader. They argue that if left on
their own private traders will exploit small farmers and will collude to
drive prices up to consumers. However, both historical and current
experience should leave little doubt that an effective private response
would be forthcoming if existing barriers were removed. It has been
pointed out 4/ that Africa has long traditions of open, competitive
marketing at flexible prices that vary predictably with the season, the
level of scarcity, and with transport and storage costs. In some societies
almost every family is involved, as both buyer and seller, in the food and
agricultural trade. In smallholder economies marketing activities involve
large numbers of transactions dispersed over wide areas in diverse and
changing circumstances. They require rapid, decentralized decisions and
responsibility. As in the case of farming, they are self-financing, so
that the individual trader survives on his or her judgement, skill and
efficiency. Firms in this area are typically small, often involving only
one person or family. While market information is at a premium, and
family, ethnic and other personal links may be an advantage, financial,
educational or physical barriers to entry are few and marketing margins
tend to be low. Where legal barriers to entry exist, and the authorities
attempt to enforce them by punitive fines or imprisonment, the continued
existence of "parallel" or "black" markets in many African countries
demonstrates the vigor and persistence of private traders. Their
"informal" activities even extend to export trade. In Zaire and Rwanda,
substantial quantities of coffee are known to be smuggled through
neighboring countries. In Ghana, it is estimated that 20,000 tons of cocoa
were smuggled annually through the Ivory Coast and Togo during 1980-82.5/
If private trading activities were legitimized for both domestic and export
crop marketing, the dual market structure would be merged and entrepre-
neurial energies directed towards improving the overall distribution system
with benefits accruing to producers and consumers. Free private entry into
export marketing would also result in a wider diffusion of foreign exchange
earnings, providing the funds for diversification of the rural economy. In
Somalia, for example, profits from livestock marketing, which has remained
in private hands, are being channelled into the production of animal feed-
stuffs, fruits and vegetables, footwear and furniture.
The general conclusion that can be drawn from this experience is
that state marketing monopolies should be eliminated and private traders of
agricultural produce of all kinds should be allowed to operate without
obstruction. If existing marketing boards are able to co-exist without
subsidies, they will widen the choice of both producers and consumers and
perform a useful role in preventing the emergence of private monopoly or
collusion in restraint of trade.
4/ See Peter Hopcraft, Grain Marketing Institutions and Policies:
A Perspective on the Sub-Saharan African Experience (1986, mimeo).
5/ See V. Raswant, The Impact of Parallel Markets in Agriculture (1985,
mimeo).



-9-
2. Transport
In many African cities, legal prohibitions prevent privately-
owned and operated small vans and minibuses from competing with the
"modern" (usually state-owned) transit system. The results are almost
invariably negative: poor services for consumers, operating deficits for
the public bus monopoly, and the suppression of entrepreneurial potentials
whose existence cannot be disputed.!
Abidjan, for example, was served by a very active informal system
of common carriers until 1974. The vehicles in question were known as
a'bakas. Originally, they brought goods from outlying areas to city
markets. They naturally evolved into "illegal" common carriers for the low
income areas of the city. In 1974, Abidjan's bus systems SOTRA (Societe de
Transport d'Abidjan), then controlled by Renault but now with majority
government ownership, urged the Ivory Coast Government to ban the a'bakas
in the city limits because of their "unfair competition." Government
agreed to do so. The consequences were unfortunate--for the people of
Abidjan, for the municipal and national budgets, and even for SOTRA.
Before 1974, SOTRA was profitable, despite the competition of informal
carriers. It had a well-managed 300 bus fleet. With the banning of the
atbakas, SOTRA launched a massive fleet expansion and capital construction
program. By 1981 the fleet had 900 buses, and a rise to 1,000 was planned
for 1985. SOTRA has been in deficit since 1975.
Experience in Dakar is similar. That city's public bus company
SOTRAC dates from 1971. It is a majority state-owned company. It has a 15
year franchise (monopoly) on public transport in Cap Vert (the Dakar metro-
politan area). In 1981 SOTRAC had 430 buses and 35 minibuses. The
informal transport sector is dominated by Cars Rapides, organized in 1962
on a cooperative basis, later into a syndicate. In 1981, there were 650
minibuses in operation, a decline from the 1974 peak of 700 vehicles, which
is due to government restrictions on fleet expansion. Cars Rapides do 40%
of all passenger trips, SOTRAC 20%, taxis and private cars 40%. SOTRAC
operates with a growing deficit; amounting to 25% of total operating
costs.
Deficits nothwithstanding, SOTRAC proposed to expand services so
as to achieve effective monopoly of Dakar's public transport. It claimed
it would need an estimated 492 additional buses and much expansion of
facilities, at a probable cost of $61 million. This would entail the
banning of the Cars Rapides, which carried twice as many passengers as
SOTRAC buses, and did so without government subsidy and in face of govern-
ment restrictions on fleet expansion or even replacement. However, until
now the government has only retained SOTRAC's monopoly in the center of
Dakar.
6/ See discussion of this sector in Elliot Berg, The Potentials of the
Private Sector in Africa (paper prepared for Conference on Rehabilita-
tion and Recovery in Sub-Saharan Africa, Paris, November 14-16, 1984).



- 10 -
In Kenya, a happier road has been followed. "Matatu"--the
private minibus variant in that country--were made legal in 1973. Some
3,600 of them operate around Nairobi; about 1,000 provide purely urban
service. (An estimated 30,000 "Matatu" are in use throughout Kenya). The
"modern" transport provider is the Kenya Bus Service, Ltd. (KBS) which has
320 buses under a franchise with the Nairobi City Council. KBS is a a
foreign-owned private company. After 1973 it decided on grounds of "unfair
competition" not to increase its fleet when the matatu were legalized. So
while the population of Nairobi grew from some 500,000 in 1970 to almost
1 million in 1980, the KBS fleet stayed about the same size. The company's
buses ply the main routes. The company covers its costs. Matatu meanwhile
are the backbone of the transport system. They go where the business is,
in low income areas and in peak periods along commuter corridors and charge
roughly the same fares as the KBS. The management of KBS acknowledge that
without the matatu they would be induced to undertake expansion at costs to
them beyond likely returns.
There can be little question that in urban transport small-scale,
private operators have decisive advantages over public sector producers and
over large-scale operators generally.7/ Yet in many African cities,
expensive and inefficient public bus monopolies endure. And what is true
of urban bus systems is true also of over-the-road passenger and freight
systems. Private operators offer better, cheaper alternatives to public
trucking companies. Yet they are often bypassed. Entry restrictions
should be lifted if African countries are to open up their interiors, move
people and goods to work places and markets faster and more efficiently and
remove bottlenecks which are holding back progress in other sectors.
3. Industrial Sector
In many African countries a variety of policies restrict private
access to and participation in the mining, manufacturing and public
utilities sectors. Sometimes activities reserved for state enterprises (or
joint ventures with majority government ownership) are specified in
Investment Codes or other legislation governing industrial investment. In
other cases, public sector control has been acquired by nationalization of
existing privately-owned enterprises. Nationalization took place in
several African countries during the 1970s, for example, in Sudan,
Ethiopia, Somalia, Togo, Ghana, Zaire .... More frequently, selective use
of industrial licensing authority preserves state monopolies in sectors
considered to be politically sensitive or where the pursuit of social goals
is made paramount.
In Ethiopia, the government took over ownership and operation of
over 100 private manufacturing enterprises during the 1970s. Public enter-
prises now account for 96 percent of the total value added in enterprises
with 10 or more workers. Over the past decade, significant limitations
have been introduced on individual and corporate private entrepreneurship.
Some industrial activities regarded as critical (such as petroleum, iron
7/ See, for many examples, Gabriel Roth and George Wynne, Learning from
Abroad: Free Enterprise Urban Transportation (Transaction Books,
New Brunswick and London, 1982).



- 11 -
and steel) are expressly limited to the public sector and others are
designated to be undertaken by joint government/foreign enterprises (pulp
and paper and plastics). Small-scale industrial activities in areas like
grain milling, oil and seed processing, handicrafts, baking, weaving and
tailoring are open to the private sector, but are subject to the general
limitation that fixed assets in private firms should not exceed Birr
500,000 ($250,000). Further, a private entrepreneur may participate in
only one venture. Private enterprises must either be sole proprietorships
or partnerships not exceeding five partners, all of whom must be working
partners.
There has been no new foreign equity participation in manufactur-
ing in Ethiopia since the nationalizations due in part to protracted nego-
tiations on compensation to foreign owners of nationalized assets. How-
ever, the Ethiopian government adopted a Joint Venture Proclamation in 1983
which invites foreigners to participate in joint ventures in which the
Government holds at least 51 percent of the shares and "which introduce
technology and know-how into the country or which have a positive foreign
exchange impact or which otherwise make positive contributions to economic
and social development and which, in addition create employment opportun-
ities in the country." Private Ethiopian entrepreneurs are excluded from
participating in joint ventures, however.
In Guinea, the period 1962 through 1975-76 was characterized by
massive public investments and the proliferation of parastatal enterprises,
activities largely financed through expansionary monetary policies. Over
100 public enterprises have virtual total control of the manufacturing,
trade and service sectors. The only important enterprises outside the
public sector are three mining companies (CBG, FRIGUIA and AREDOR) in which
the government retains 49 percent of the shares. Though the source of only
28.5 percent of domestic production, the public sector employs most of
Guinea's wage earners, uses almost all domestic and foreign credit, and
consumes most of the country's net foreign exchange earnings and official
imports. Public sector recorded deficits totalled 7.8 percent of GDP
between 1976-81.
In late 1985, Guinea embarked upon a major reform of its
economy. An essential element is returning productive activities to the
private sector is a properly functioning banking system. The public enter-
prise sector will be streamlined by closing down those businesses that are
not performing well. Others will be transferred, wholly or in part, to the
private sector. A new investment code and commercial legislation will
facilitate private investment in these and other activities that are econo-
mically viable. The handful of remaining public companies, largely in the
public utilities, will be given financial and management autonomy.
Sudan is another country where extensive nationalization of pri-
vate industrial enterprises during the 1970s was accompanied by high public
investment in projects with low returns and heavy foreign borrowing. These
parastatatal enterprises, with few exceptions, have eroded their equity
base and accumulated vast losses financed through overdrafts with the
banking systemo At the Consultative Group meeting in Paris in December



- 12 -
1983, the Government announced its intention to produce a private sector
action program. Some parastatals have been converted to private com-
panies. But subsequent policy decision have, if anything, worsened the
environment for private investment. Private activities are in desperate
state due to high cost levels and lack of credit, rigid price regulations,
disruptions in the supply of utility services and imported inputs and
uncertainty about the future business climate. Opportunities for private
investment have been undermined by the creation of the Military Economic
Board (MEB) that put several existing public enterprises under military
control. MEB activities could be better performed by normal private firms
and should be privatized or liquidated.
Following the indigenization decrees of 1972 and 1977 in Nigeria,
which required divestiture of foreign equity holdings, public investment in
manufacturing grew more rapidly than private investment. The pubic sector
has been responsible for two-thirds of total manufacturing investment since
1975. A 1983 review of the public expenditure program found that a number
of pubic sector projects suffer from inadequate project design, high
initial project costs and cost-overruns following implementation delays,
and excess capacity once completed. There had also been an overcommit-
ment of resources across a large number of projects. In recent planning
documents, however, the Nigerian government has indicated that the private
sector is expected to be the prime agent for industrial growth in the
future with the role of the government focused on infrastructure investment
and establishment of an appropriate legal and regulatory environment.
Priority is being given to facilitating private sector activity by simpli-
fying existing regulations and dismantling the ones which are redundant or
have undesirable distortionary effects.
Policy towards foreign private investment was 1-roadly welcoming
in Ghana until the early 1970s. However, the departure of the Busia
government in January 1972 saw a sharp switch. The new regime, led by
Colonel Ignatius Achaempong, reacted to the severe economic difficulties
inherited from its predecessors with a program of economic nationalism. In
1975, legislation was passed allowing the state to take a majority stake in
foreign owned enterprises; some of the larger companies, including the
United Africa Company (UAC) sold 40 percent of their local equity to the
state. While others passed 55 percent to local hands. By 1977 an esti-
mated 49 percent of manufacturing value added came from the state sector,
as well as a substantial proportion of mineral output. Yet having merely
stagnated from 1970-77, by the late 1970s manufacturing had slid into a
precipitious decline. Poor management in the state sector was paralleled
by shortages of foreign exchange, as the cedi became increasingly wildly
overvalued. Many companies simply shut up shop; others struggled on, using
local raw materials wherever possible and improvising repairs. It seemed
initially that life would be made if anything harder for foreign investors
by the arrival of the (second) Rawlings government at the end of 1981.
"Workers Defence Committees" were set up in work places and some enter-
prises were taken over by the employees. In late 1982, for example, an
announcement by UAC that it was laying off workers at two textile mills
because of shortages of imported inputs sparked off a sequence of events



- 13 -
which resulted in a takeover by the workforce. The new government's plat-
form harked back to earlier themes of self-reliance and mobilization, and
was broadly hostile to foreign capital as a means of developing the
country. The overall utilization was estimated to be down to 21 percent by
1982, while the output of the minerals sector continued to fall until 1984,
when none of the major subsectors was producing more than 35 percent of
output in the peak year of production. It is hardly surprising against
this background that there has been little new foreign investment in Ghana
since the mid-1970s.
However, after extensive policy analysis and dialogue with both
the IMF and the World Bank, the Government launched its Economic Recovery
Program in April 1983. This can only be described as a complete turnaround
in economic policy. A central element was successive devaluation of the
cedi. A new investment code published in July 1985 must also be seen as an
integral part of the recovery program. It underlines a new openness to
foreign capital. Approved companies are provided guarantees against
expropriation with standard dispute procedures allowing arbitration under
Unctad rules or within the framework of existing bilateral and multilateral
treaties.  Only net foreign exchange earning ventures can be fully owned by
toreigners however.8/ Ghana's Finance and Economic Planning Minister
Kwesi Botchwey announced the code at an Industrial and Technology Fair in
Accra in March 1986, stressing that foreign investment was a vital supple-
ment to domestic resource mobilization.
Barriers to entry remain for domestic investors in Ghana. An
industrial license is required for manufacturing production, regardless of
the scale involved. Existing firms wishing to change the mix of output or
to expand capacities must also obtain a license. The licensing authority
rests with the Ministry of Industry and the Investment Center. The
practice is meant to prevent too many firms from entering the same industry
and to ensure the use of appropriate technology, but industrial licensing
is not without risks. Private monopolies might be created. If the screen-
ing of projects is too restrictive, or if the authorities are mistaken in
assessing market conditions, supply might fall short of demand, resulting
in windfall profits. Free market entry increases competition and weeds out
inefficient firms. There is little basis for believing that over-extended
officials would be technically qualified to select technologies in a wide
range of ever-changing industries. The ultimate test of appropriate tech-
nology is the choice of consumers who evaluate the price and quality of the
final products.
Zaire is a further example of a country which has swung from
hostility to private investment to actively wooing foreign investors.
During the colonial period, the mining sector was dominated by a Belgian
company, Union Miniere du Haut Katanga. Another Belgian conglomerate, the
Societe Generale de Belgique (SGB) had interests in most sectors of the
economy. There was a large Belgium presence in terms of personnel in the
8/   See Economist Intelligence Unit, Quarterly Economic Review of Ghana,
Sierra Leone, Liberia, No. 3, 1985.



- 14 -
corporate sector and equally in small business. Independence brought
little change until the nationalization of Union Miniere and the creation
of a state enterprise Gecamines in its place in 1967. However, in 1971 a
new policy of economic nationalism was detailed in the Manifeste de la
Nsele. With few exceptions, foreign businesses were nationalized or passed
to private Zairean control (The matter of compensation is till an issue in
1986).
Foreign businesses were frequently handed over to members of the
Zairean elite who had little idea of corporate management and a limited
understanding of the distinction between company and personal accounts.
The second major innovation of the "manifeste" was the establishment of a
predominant planning role for the state, with the aim of converting Zaire
into a major industrial power in the region. "La politique de grands
travaux" involved a number of prestigious projects on an enormous scale,
the largest being the Inga Hydroelectric complex, the Maluka metalurgical
plant and the Sozir oil refinery. It was hoped that Zaire would become an
important exporter of energy, a steel producer and a regional influence in
the oil industry. The government expected to transform a primarily agri-
cultural economy into a modern industrial economy on a western scale
through centralized controls and selective, public investment.
It soon became apparent that the state was not qualified for the
role of centralized planner. Departmental planning was generally of a low
standard. No system of proper accountability was established. Budgets
were made and quickly ignored. "La politique de grands travaux" was one
main reason for regular deficits which were funded by borrowing and the
printing of new money. The Banque du Zaire was unable to resist government
pressures with the result that inflation, money supply, lending to the
government and overvaluation of the fixed currency soared.
Where the "manifeste" had aimed to produce a stable economic
environment with the guiding hand of the state, in practice the reverse
happened as conditions became disordered and government intervention
hindered rather than helped modernization. The Zairenization of the
economy was no more a success than the centralized planning. The private
sector suffered from non-replacement of stocks and machinery and the with-
drawal of working capital. Real GDP declined in the 1970s and, far from
becoming a major industrial power house, Zaire has remained an exporter of
raw materials and an importer of machinery and equipment.
The reversal of these policies came in the late 1970s and 1980s.
Many companies were denationalized and their former owners invited to
return. This met with limited success as numerous former managers and
shareholders declined the offer, not least because of the matter of compen-
sation. The task of attracting fresh investment has also proved extremely
difficult, despite liberalization measures which include the floating of
the Zaire, an end to interest rate restrictions, the guaranteed right to
repatriate profits, the abolition of certain monopolies, and the narrowing
of budget deficits. Legal and other barriers to private sector investment
may be removed, but it takes longer to change fundamental attitudes towards
the overall business climate. They will be helped by the recent signing



- 15 -
of a bilateral investment treaty with the United States guaranteeing most
favored nation treatment to U.S. investors in Zaire. A revision of the
Investment Code is also underway and major positive changes are
expected.9/
Three overall conclusions can be drawn from this examination of
barriers to entry. First, these barriers have deprived African economies
of the benefits of private investment (both indigenous and foreign) and the
skills, know-how and initiative which would have accompanied such invest-
ment. Second, they have removed the competitive stimulus to efficiency
which public monopolies have so obviously lacked in some key areas. Third,
Governments would achieve their goals more effectively if they eliminated
these barriers and used broader economic policies and market incentives to
guide private decisions in the desired directions--such as employment
creation, training of nationals, reinvestment of profits, etc.
9/   See Economist Intelligence Unit, Quarterly Economic Review of Zaire,
Rwanda, Burundi, Annual Supplement 1985 and Investment Climate
Assessment: Republic of Zaire (U.S. Agency for International
Development, November 1985).



- 16 -
CHAPTER II. OBSTACLES TO FOREIGN INVESTMENT
Direct foreign private investment in Africa has declined in real
terms in recent years. It averaged only $530 million annually in 1978-80.
Net foreign investment represented less than 1 percent of total domestic
investment in the Ivory Coast, Nigeria and Botswana during this period.10/
The investment position of the United States, defined as the book value of
U.S. direct investment in and net outstanding loans to their foreign affil-
iates, amounted to US$3.1 billion in Sub-Saharan Africa in 1983. This
constituted 6 percent of U.S. direct investment in all developing
countries.11/ The share of Africa in the flow of Japanese investment in
manufacturing industry in developing countries dropped from 3.3 percent in
1951-1971 to 0.9 percent in 1972-80.12/
The level of foreign private investment in Africa is affected by
barriers to entry and the potential investor's perception of the prevailing
business environment. A survey of 233 industrial firms in the Federal
Republic of Germany found that the most important individual constraint is
difficulty in dealing with government authorities (bureaucracy).   Less
than one fifth of the respondents rated the problem a minor one. Other
factors of particular importance related to conditions regarding the owner-
ship and return (transfer) of capital; the regulations governing local
participation, financing conditions and transfer of the profits rank second
to fourth in the list of individual obstacles. In fifth place investors
put restrictions on the supply of raw materials and intermediates (import
restrictions, cash deposits, customs and compulsory use of local products
both for production and plant investment).  Sixth on the list were "other"
obstacles, those most frequently mentioned being corruption, the risk of
extortion and problems with the local partner. Obstacles connected with
the prevailing political system and the country's general economic and
social policies were next in line. Seventh was uncertainty about whether
legal and contractual rights would be upheld in the courts; eight being
employment legislation, recruitment and dismissal, social regulations, the
right to strike, training obligations, etc., nine taxation; tenth wage
policy, for example statutory minimum wages; eleventh the danger of
nationalization; and twelfth price formation, the fixing of minimum and
maximum prices.13!
10/ See Transnational Corporations in World Development: Third Survey
(United Nations, New York, 1983).
11/ See U.S. Department of Commerce, Survey of Current Business, August
1984.
12/ See Transnational Corporations in World Development: Third Survey
(United Nations, New York 1983).
13/ See Jurgen Riedel, "Attitudes in the Federal Republic of Germany to
the Policies of Developing Countries Regarding Foreign Investors,"
Industry and Development, 1984.



- 17 -
Similar attitudes were encountered in a study sponsored by the
Commission of the European Communities.14/ It concluded that "Africa is,
overall, a zone which is far less sought after by investors in the
developed countries."  The study reports various reasons cited by European
firms. These include the following points:
Permeability of the Market. This is something official statis-
tics tend to ignore, and the authorities tend to be careful not to mention
contraband which is, in fact, an economic reality of considerable
importance in many countries, particularly in Africa.
The Importance of Internal Political Pressure. A classic example
of this is the question of price approval. This is a problem which occurs
frequently in Africa where the domestic prices of everyday goods have to be
approved by the authorities. But although the authorities are committed to
respecting the firm's financial balance, they sometimes, under pressure of
public opinion, postpone or turn down price rises that rising costs have
made inevitable. This issue is linked to the extent of competition in the
market (see Chapters IV and V).
Under-estimating the Effects of their Decisions. The host
Governments often under-estimate the effect of failing to respect contrac-
tual commitments. The decisions are taken by authorities which are not
really au fait with industry and its constraints and their consequences--
which are badly assessed or not assessed at all.
Restrictions on Employing Expatriate Staff. These include
quantitative restrictions laid down in absolute terms for each firm (as in
Nigeria) or as a percentage of the total number of employees; complex exit
visa procedures--there are 28 formalities to complete if an expatriate
wishes to leave Cameroon, even on a temporary basis (for a business trip,
holiday or sick leave); in almost all cases (Zaire, Nigeria, Kenya, etc.),
firms complain about the extremely long time it takes to obtain the
requisite authorizations. They think these procedures (or policies) are
particularly ill-conceived as they already keep their expatriate staff to a
minimum because of the very high costs involved.
Protectionist Measures. One classic measure is to ban imports of
products that are "similar" to those made locally (as in, for example,
Kenya). The interpretation of such a text is often subject to debate
between the businessmen and the Government and it is not easy to furnish
proof one way or the other. Generally speaking, investors complain about
the poor quality of local input and equipment that people try to force on
them (however, they also complain when countries want to open up to imports
of goods competing with theirs).
Restrictions on Location. The national development plans often
channel foreign investors into certain regions which the Government, for
14/ See The Constraints on Industrial Cooperation Between Firms in the EEC
and ACP Countries (EEC, Directorate-General for Development, February
1985).



- 18 -
purely political reasons, considers to have priority, although, economic-
ally speaking, they offer only mediocre opportunities for development.
This is a fairly common situation in the countries of black Africa where
the President's village and the surrounding area are often privileged in
defiance of any economic logic and foreign firms are sent regardless of any
preference for another zone. In other cases, the opposite policy obtains
and whole regions are virtually out of bounds to foreign firms (usually
when they offer particularly attractive development prospects).
A Short-Term View. Industry usually demands short sacrifices for
long-term benefits, but this is not always obvious to the developing
countries, where there is a tendency to look for a quick profit in both
public and private sectors. Their attitude is reflected in the criteria
for approval of industrial projects at the national level. Most of the ACP
countries (particularly those in Africa) have established an industrial
project approval procedure which decides on the granting of advantages
offered by the investment code. In most cases, approval is given or
refused more in the light of a failure to bring in immediate earnings
(particularly in the shape of customs duties) than of any long-term bene-
fits to the economy. In the private sector all European operators regret
that partners in the host countries tend to be investors (usually from the
import trade) who are making quick profits with no risk and no effort--
which is at variance with a proper industrial approach. These attitudes
may result from political and economic instability and incentives biased
towards short term gains and minimal fixed investment.
Preference for Prestige Projects. Workshops and small factories,
which play an essential part in the industrialized countries, are rather
looked down on in the developing countries .... When it was set up and for
seven years after that, the Dakar industrial free zone lay down employment
thresholds (200 and then 100 jobs for Senegalese) and minimum investment
figures (CFAF 200 million and then CFAF 100 million) for people wanting
authorization. In spite of the disastrous record of firms settling in the
zone, it was difficult to convince the Government to do away with the
thresholds because it did not want Senegal to become an industrial "flag of
convenience." In many of the ACP countries, European investors have been
led to build bigger factories than they needed under pressure from their
partners or the Government of the host country. In Mauritania, for
example, the investment code stipulates a minimum of FF 1.3 million, which
often forces investors to overestimate their projects (and penalizes small
projects too).
Instability. Legislative insecurity, largely due to institu-
tional changes come second on the list of constraints for German business-
men in an IFO survey. European firms are unanimous in saying that,
although they are willing to accept investment restrictions (provided they
are clearly laid down in advance), they find it very difficult to cope with
changes after their project has been implemented. The firms' main
complaints here are about taxation. It is by no means rare to see the rate
of tax in force when the firm sets up suddenly shoot up a few years later.
When the profitability of many industrial cooperation projects is only
marginal, few firms can cope with tax increases of this kind without
endangering their financial balance.



- 19 -
Slow and Arbitrary Decision-Making. During the negotiating
period, the talks, which are at a fairly high level, take place in good
conditions, but the further people go into detail--and down the hierarchy--
the harder the decisions are and the longer they take. The firms complain
about the time the attendant procedures takes, as two or three years may
often be needed to negotiate with different departments to get approval.
Corruption. Because of all the red tape, many decisions and
authorizations cannot be obtained without "compensation," particularly
since the civil service pay is often so poor. These illicit payments ulti-
mately become the oil that is vital to the workings of any firm. While
they may be unavoidable and able to be coped with on a small scale, they
become a real millstone when failure to pay causes a firm to seize up
because they have become, in a way, institutionalized.
Unsuitable Legislation. Generally speaking, the more a govern-
ment restricts the freedom of the foreign investor, the less that investor
will be attracted by the country-in-question. His degree of interest in a
given country will depend on the balance between constraint and attrac-
tion. The more comparative advantages a country has, the readier the
foreign firms will be to accept restrictions. The ACP countries as a whole
have to be seen as not very attractive here, so the degree of constraints
and restrictions ought by rights to be fairly small. But in many cases, it
is, in the eyes of the businessmen themselves, out of all proportion with
the interest of an industrial cooperation project.
Excessive Legalism. Because they very often lack the relevant
technical knowledge, the authorities in developing countries deliberatel,
hide behind a veritable barrage of laws and regulations destined to protect
the host country from any abuses from the foreign firms. This attitude
often leads to excessive legalism, resulting in a pointless observing of
the texts or, in many cases, to a restrictive interpretation of them.
Texts that are lacking in precision or difficult to understand are
certainly open to any interpretation--which is fine for the authorities,
which are calling the tune, but not for the firms. The texts are inter-
preted generously and favorably for the firms while the project is being
promoted (so as to attract the investor) and retrictively once the invest-
ment decision has been taken. European firms involved in industrial
cooperation thus often get the impression that they have been caught in a
trap. The negative effects (counter publicity and a loss of good will) of
this attitude are, clearly, sizeable and lasting.
The attitudes to foreign investment in Africa revealed by this
EEC Study may be said to be one-sided. These attitudes are nevertheless
often critical in determining the level and direction of direct investment
flows from abroad. If they reflect serious misconceptions or distortions,
African governments which wish to promote such investment may need to take
more vigorous action to change these perceptions or else change the under-
lying reality. A mechanism to allow a continuing dialogue between the
private sector and government is desirable. The Chamber of Commerce and
Industry is performing this role in several African countries. In Zaire,
for example, a dinner/debate was organized by ANEZA (the Zaire Chamber of



- 20 -
Commerce) in January 1986. This brought together leading Zairean entre-
preneurs and top managers of foreign-owned companies with ministers and
senior civil servants and provided the opportunity for a very frank
exchange of views.15/ The U.S. Overseas Private Investment Corporation
(OPIC) has also been invited to send a mission composed of prospective
investors to study the business climate and hold talks with the government
and local counterparts. In Mauritius, a National Economic Council was
established in December 1981. It acts as a forum for discussion of
economic policies with representatives of business and labor. Such mechan-
isms can lead to a better understanding of each side's needs and attitudes
and a broader consensus on reforms required to promote development.
15/ See Discours Du Citoyen Bemba Saolona, President de L' ANEZA (ANEZA,
Kinshasa, January 14, 1986).



- 21 -
CHAPTER III. FINANCIAL CONSTRAINTS
Shortage of investment funds and working capital is holding back
development of the private sector, particularly small and medium enter-
prises (SMEs), throughout Africa. In part, this scarcity is simply a
reflection of low income levels and the persistence of large subsistence
(non-monetized) segments of their economies. But it also springs from
weaknesses in policies and institutions which hamper resource mobilization
and restrict the private sector's access to available finance. Six
constraints are examined: first, financial market regulations which reduce
savings deposits and discourage banks from lending to SMEs; second, the
absence of stock markets and merchant banks able to mobilize equity
capital; third, foreign exchange allocation systems which restrict the
supply of foreign exchange funds to private firms; fourth, crowding-out of
the private sector from financial markets by excessive borrowing by govern-
ment and public enterprises; fifth, heavy taxation which squeezes corporate
profits and entrepreneurial incomes and therefore limits their capacity to
generate internal investment funds; and sixth, public investment programs
which monopolize the use of foreign loans and grants.
1. Financial Market Regulations
A World Bank analysis of interest rate policy in a number of
developing countries from 1970 to 1982 revealed that by and large nominal
interest rates were set by government, rates changed little overtime, and
hence real rates were primarily determined by variations in the rate of
inflation. Real deposit rates over the period were negative; in many
countries they were 3 to 6 percentage points below the real rates that
prevailed in the developed countries in this period, thus encouraging
outflow of funds. In countries with very high inflation, deposit rates
were substantially negative, sometimes reaching levels below minus 20
percent. The variability of real rates, as well as the level affected
resource mobilization. As a result, in many African countries total
domestic credit that could be made available to borrowers (public and
private) by the monetary authorities and banks expanded slowly in real
terms over the past decade, and in some countries actually declined in
relation to GDP.
In Kenya, for example, although its financial depth as measured
by the ratio of money and quasi-money (M2) to GDP compared favorably with
other countries in the same income category, its financial depth was
seriously eroded during the period 1978 to 1983. The ratio of M2 to GDP
fell from 32 percent to 25 percent. The resurgence of inflation and the
ceilings on loan rates, along with the substantial reserves the Government
required the banking system to hold, kept deposit rates low and weakened
the ability of the commercial banks to mobilize deposits. The decline in
the financial depth was accompanied by a slide in the domestic saving
rates. The ratio of gross private saving to GDP deteriorated from a peak
of nearly 27 percent of GDP in 1977 to a low of 11 percent in 1983.



- 22 -
Similarly, in Ghana the M2/GDP ratio declined from 29 percent in
1977 to 12 percent in 1984. At the same time, there was a decline in the
banking habit, an increasing preference for holding liquid funds outside
the banking system, and an increasing velocity in money circulation as
firms and individuals sought to move out of financial assets and into fixed
assets as hedges against inflation. These trends were aggravated in
1982/83 by a substantial drop in public confidence in the banking system
following the demonetization of + 50 notes and the freezing of all bank
accounts in amounts above t 50,000. While the government has taken
important steps to address these problems since 1983 as part of the econo-
mic reforms under the Economic Recovery Program, the process of reversing
past trends is still at an early stage and public confidence in the banking
system has yet to be significantly restored.
Low loan rate ceilings fixed by governments have also restricted
the operating "spreads" of financial institutions and discouraged lending
to smaller, riskier businesses. In Nigeria, for example, low interest
rates applicable to agricultural credit makes lending to smallholders
extremely unattractive given the high costs of administering numerous small
loans and low recovery rates. In some countries, governments have tried to
compensate for these financial market disincentives through direct credit
programs aimed at disadvantaged groups. Most of these directed credit
programs are not designed to reallocate financial resources per se, but to
affect the allocation of physical resources through financial reallocation
and to offset differences between economic and financial returns through
explicit or implicit interest rate subsidies. Experience has shown that
much of the subsidized credit programs went to wealthy individuals or those
with political influence, while smaller borrowers had to pay higher
interest rates in the informal credit markets. Directed credits often
induced recipients to use overly capital-intensive methods.
Many governments have recognized that in the past they have
overextended their capacity to manage the economy through intervention in
resource allocation. A number of countries are moving toward greater
reliance on market forces for credit allocation. Complex systems of credit
allocation are being dismantled and interest rates are now being allowed to
reflect the state of the credit market and the foreign exchange market,
plus differential's in risk and maturity. In Ivory Coast, for example, the
central bank has pursued a more realistic interest rate policy since 1981,
keeping domestic rates more in line with international ones to avoid large
outflows of domestic surplus funds and enable deposit money banks to
attract large foreign depositors. Real rates of return on time and saving
deposits became positive for large savers in 1981 and all savers in 1982.
The private sector's financial savings responded positively.
Under the World Bank's Second Structural Adjustment Credit to
Kenya in 1982, the Government proposed to keep the level and structure of
interest rates under review to ensure that they continued to be appro- -
priate, given the domestic rate of inflation and the structure of inter-
national interest rates. In Malawi, the government raised deposit rates by
two percent in May 1983 and proposed to make adjustments, as need arises,
to keep interest rates positive. In Senegal, as a step towards improving



- 23 -
mobilization of personal savings, a new social housing bank was estab-
lished. In Guinea, the government has decided to completely rebuild the
banking system. The central bank is being reorganized and strengthened. A
new Banking Law has been adopted which creates an appropriate basis for the
establishment and regulation of commercial banks and other financial insti-
tutions. And the six existing state banks are being liquidated and inde-
pendently managed commercial banks have replaced them. The International
Finance Corporation has put in $1 million equity for the establishment of a
multipurpose bank-Banque Internationale Pour le Commerce et l'Industrie de
la Guinee (BICI-GUI) as a joint venture with French commercial banks. IDA
has provided $2 million for management and technical assistance to BICI-GUI
and further equity has come from the German Finance Company for Investments
in Developing Countries (DEG).
In late 1985, the Malawi government agreed during negotiations
for a World Bank industrial and agricultural credit project to annually
review and revise interest rates to ensure that the rates charged by
INDEBANK (the Industrial and Development Bank of Malawi) and the commercial
banks on their agricultural loans are positive in real terms, in line with
the overall interest rate structure in the country, adequate to enable the
institutions to cover their administrative expenses, provide for possible
losses and earn adequate profit margins.
2. Lack of Equity Funds
Very few African countries have active equity markets, either in
the form of stock exchanges or merchant banks which can provide a full
range of securities related services: underwriting, brokerage, dealership,
corporate financial advisory services, investment management, etc. The
financial policies of many countries have inadvertently had an anti-equity
bias. In the 1970s inflation with low interest rates deepened equity
values through retained earnings, but retarded the growth of equity markets
external to firms. A second source of anti-equity bias has been many
government programs, which in one way or another reduced the cost and risk
of debt, but not of equity, finance. Such programs include explicit or
implicit insurance that covered not only small depositors but large sophis-
ticated investors; lender-of-last-resort facilities that guaranteed the
liquidity of financial intermediaries; special institutions (Development
Finance Institutions, agricultural banks, etc.) and lending programs that
provide debt at subsidized rates; aspects of tax policy that made equity
financing more expensive, in particular by treating interest as a cost
before calculating profit taxes and the double taxation of dividends; and
lastly, bail-outs for corporations that diminished the danger of excessive
financing with debt. Equally important, controls on output prices often
reduce corporate earnings and hence their ability to raise equity funds.
However, nascent capital markets do exist in some countries.
In Kenya, secondary trading in long-term securities is carried
out by six Nairobi-based stockbroking firms whose association, formed in
1954, is known as the Nairobi Stock Exchange. This Exchange has no phys-
ical trading floor. Instead, brokers hold a daily call-over at which
prices for concluded transactions and for securities still on offer are
announced. The broker act only as agents for clients and typically match
buy and sell orders in-house. New issues of long-term private-sector



- 24 -
securities in Kenya are controlled by Government through a Capital Issues
Committee set up in 1971 under the Ministry of Finance and Planning. This
Committee approves issue prices, the timing of sales and the allotment plan
for shares. However, since the Committee's inception there have been very
few new public issues of equity securities.
At the request of the Kenyan Government, an IFC mission undertook
a study in 1984 which recommended several measures to facilitate the
development of the capital market in Kenya. These measures included:
- establishment of a Capital Markets Development Authority to
promote the disclosure of corporate and market trading informa-
tion, registration and regulation of securities professionals and
measures to provide adequate protection for investors;
-  promulgation of a Capital Markets Law to provide the legal basis
for the development activities of the Capital Markets Development
Authority;
-  review and amendment of other laws, such as the Companies Act and
the Foreign Investments Protection Act, which may hamper the
primary issue, investment in and trading of capital markets
securities.
- setting prices of all equity and debt securities issues by
negotiations between the issue and his underwriter(s) rather than
by the Government through the Capital Issues Committee.
IFC followed up this study in 1985 by providing additional
finance to Industrial Promotion Services (Kenya) Limited, a private venture
capital company, to expand its program of equity finance for small and
medium enterprises in Kenya.
Capital market studies should be undertaken in other African
countries to ascertain the scope for similar action and to identify ways of
eliminating their anti-equity biases. In general these measures are likely
to include removing interest rate subsidies, eliminating double taxation of
dividends, ceasing to bail-out loss-making enterprises, creating special-
ized equity-financing institutions and funds and adopting legislation to
promote the disclosure of corporate and trading information and registra-
tion of stockbrokers.
3. Foreign Exchange Allocation Systems
At present, only Zaire, Guinea and members of WAMO allow their
currencies to be freely converted into foreign exchange. Most African
countries have adopted centralized systems of foreign exchange budgeting
and allocation usually managed by the Central Bank combined with import
licensing by Ministries of Finance and Trade.  The systems are intended to
limit aggregate imports to the amount of foreign exchange available and to
regulate the structure of imports to maximize economic benefits.  These are
desirable objectives, but in practice the use of administrative systems
rather than price as the allocative mechanism has resulted in distorted



- 25 -
incentives, cumbersome and drawn-out bureaucratic procedures and biases in
the rationing process which favor those with political power or economic
influence over the allocating authorities.
In Ghana, for example, the import licensing system was generally
perceived by the private sector to be procedurally complex and overly rigid
and time consuming, often resulting in substantial delays in arrival of
imports, significant additional administrative costs and considerable
uncertainties in production planning at the plant level (one firm indicated
that it had taken 5 months and some 65 visits to different government
offices to process an import license). Further uncertainty arose because
issuance of an import license did not ensure a firm of access to foreign
exchange cover, for which approval had to be obtained subsequently from the
Bank of Ghana. This resulted in additional delays, as in the past import
licenses have been issued in excess of foreign exchange availability. The
system was said to focus principally upon the requirements of larger firms
(mostly SOEs), and discriminated against small enterprises despite the fact
that their products tend to be less import-intensive and could contribute
to output at a lower unit foreign exchange cost. However, in recent months
steps have been taken to phase out the licensing system and a foreign
exchange auction introduced.
These weaknesses are now being recognized by other countries and
action taken to minimize if not eliminate them. In Malawi, for example,
the foreign exchange allocation system operated jointly by the Ministry of
Trade and Industry and the Reserve Bank of Malawi came under considerable
pressure due to adverse economic conditions that Malawi was then
experiencing. This led the Reserve Bank to try to reduce imports through
delays of foreign exchange allocations. These allocations also became
concentrated in the established traders and discouraged the development of
new, indigenous entrepreneurship. As part of a Third Structural Adjustment
Program, the Government intends to pursue an active exchange rate
management policy which will hopefully make an allocation system
redundant. Nigeria also abolished its import licensing system in September
1986 and substituted a foreign exchange auction.
In June 1985, the Government of Zambia presented An Action
Program for Economic Restructuring to the Consultative Group for Zambia.
This Action Program spelled-out the defects of the existing foreign
exchange allocation system in these words--"in order to cope with the
severe shortages of foreign exchange that have characterized the economy
during the past several years, a centralized system of foreign exchange
budgeting and allocation has been instituted. It is necessary to have both
an import license and foreign exchange backing prior to importing an item.
The system has proved to be cumbersome and costly to administer; officials
have to make foreign exchange allocation decisions on a firm-by-firm and
product-by-product bases. Budgeting of foreign exchange has also been
problematic, with the result that a considerable over-hang of import
licenses issued without foreign exchange has developed ....  The foreign
exchange control and import licensing systems, by excluding a wide range of
competing imports of consumer goods from the domestic market, has provided
high protection to import substituting activities and tended to reinforce
the protection effects of the tariff structure."



- 26 -
The Action Program went on to say that "GRZ is convinced that the
allocative formula must eventually include:
(i)  increasing the reliance upon market forces rather than adminis-
trative mechanisms for allocating resources. This implies the
gradual dismantling of the foreign exchange controls, import and
export licensing and interest rate regulations;
(ii)  restoring balance and increasing the uniformity of the incentive
system, particularly between exports and import substitutes, as
well as between agriculture and industry. This implies a major
reform in the trade regime with greater reliance on the exchange
rate as a mechanism for allocating foreign exchange, elimination
of import restrictions, rationalization of the tariff structure
and review of investment incentives; and
(iii)  introducing greater automaticity into the determination of the
exchange rate consistent with the long-run prospects for exports
and terms of trade.
The Government of Zambia took action along the above lines in
1986. They provide useful guidelines for other African countries to
follow. The broad objective should be to dismantle foreign exchange
controls and import and export licensing, leading to free convertibility of
currency.
4. Crowding-Out by Public Sector Borrowing
Private firms' access to bank credit has been restricted in many
countries because governments and public enterprises have been given first
claim on financial resources, both foreign and domestic. The latest IMF
data show that the public sector's share of outstanding domestic credit
from the monetary authorities and banks topped 60 percent in 14 out of 35
countries covered by the statistics. The private sector's share was less
than 25 percent in six countries--Burundi, Ethiopia, Ghana, Sierra Leone,
Tanzania and Zaire. Only in Botswana and Cameroon were governments net
lenders rather than borrowers of domestic financial resources.16/
Governments' demands for domestic credit increased for three
basic reasons. First, the growth of expenditure on public investment and
current services outpaced the growth of revenue, resulting in widening
budgetary deficits. For example, deficits reached 10.6 percent of GDP in
Kenya in 1980/81, 16.5 percent in Malawi in 1981, and 11.5 percent in
Senegal in 1980/81. Second, the income of public enterprises did not cover
their operating costs. The gap was filled by additional loans provided
directly by the banking system or by government subsidies which, in turn,
were financed by government borrowing. In Ghana, for example, the combined
operating deficit of SOEs in 1982 amounted to 2,880 million cedis (net of
their hidden costs and subsidies), equal to 3 percent of GDP and the same
as total government expenditure on education, health, social security and
welfare that year. Third, although foreign aid grants and concessionary
loans from abroad finance a significant proportion of their public
16/ See IMF, International Financial Statistics, March 1986.



- 27 -
investment programs, some African countries found it increasingly more
difficult to borrow in international commercial markets. They there-
fore drew more heavily on private domestic savings to meet their residual
financing needs.
However, there is evidence that African countries are becoming
increasingly aware of the negative effects of budgetary deficits and heavy
government borrowing on private sector opportunities and the efficiency of
resource utilization in the economy as a whole. Steps are being taken,
sometimes in the context of structural adjustment programs, to curb the
public sector's financial appetite in several countries.  These measures
include:
- restraining the expansion of public sector employment and wages
(for example, in Kenya and Senegal);
- reducing recurrent expenditure by cost savings in such fields as
education and housing (Mauritius and Ivory Coast);
- reducing losses of, and subsidies to, public enterprise by
restructuring, stricter monitoring of their performance and
divestiture (Togo and Senegal); and
- subjecting public investment programs (PIPs) to more rigorous
scrutiny and pruning potential "white elephants" (Kenya, Malawi,
Mauritius, Ivory Coast, Senegal, Togo).
In many cases, African governments are also trying to eliminate their
budgetary deficits by raising tax revenues. This may be achieved without
negative repercussions by broadening the tax base or improving tax collec-
tion.  But there is a risk that imposing higher marginal tax rates on
individuals and firms which are already heavily burdened by taxes may be
counterproductive:  encouraging tax evasion and corruption; reducing the
citizen's willingness to work, save and invest; and squeezing profits which
could have been ploughed back into the business to expand capacity, raise
productivity or diversify output.  This risk is discussed more fully below.
5. Heavy Taxation Squeezing Corporate Profits and Entrepreneural Incomes
All countries must seek a balance in their fiscal policies
between the need to raise revenue to pay for essential government services
and the need to create adequate incentives to work, save and invest. They
must also aim for an equitable sharing of the tax burden, both within and
between different income groups, and avoid undue distortions in the
after-tax returns to different economic activities.
In many African countries it has proved to be difficult to
recorcile these objectives. The rates of taxes on corporate income are
frequently high by international standards. For example, they are 60
percent in Ghana, Zaire and Sudan compared with 30 percent in Taiwan and
Korea and 18.5 percent in Hong Kong. And depreciation allowances are



- 28 -
usually based upon historical costs. So in countries which have
experienced rapid inflation the effective tax rate on real net income has
been significantly greater.
Rates of personal income tax also tend to be high in Africa. The
top marginal rate is 80 percent in Zambia and Rwanda, 70 percent in Sudan
and 60 percent in Zaire and Ghana. These rates are reached at relatively
low income thresholds.
High corporate and personal income taxes have had four negative
effects. First, they have reduced the private sector's capacity to accumu-
late reserves to finance expansion, modernization and diversification
projects and reduced savings for initial investment in new enterprises.
Second, they have deterred foreign investors (especially in "footloose"
labor-intensive industries like textiles, clothing and electronics) who
have found more hospitable fiscal environments in East Asia. Third, entre-
preneurial efforts have been diverted from formal productive activities,
where financial transactions are more readily audited, to real estate
speculation, trading and "underground" activities where earnings can be
more easily hidden from the tax authorities. Fourth, high tax rates have
increased the pressures for corruption of lowly-paid tax officials. Wide-
spread corruption has undermined the integrity of public administration and
weakened respect for the law.17/
In some countries, the net result has been a contraction of the
tax base and lower tax revenues. Government attempts to stem the fall in
revenues by raising tax rates still further have only accelerated the
decline. Ghana, for example, introduced a series of tax measures such as a
special sales tax on imports, excise taxes and advance tax payments for
selected manufacturing sectors and a substantially higher registration fee
for retailers. Moreover, Ghana postponed or kept to a minimum crucial
adjustments in the tax system such as the level of personal exemptions,
depreciation allowances for corporations and personal income tax brackets.
These adjustments were needed to take account of rapid inflation and
devaluation of the exchange rate. Consequently the tax burden on those
individuals and private enterprises which abided by the tax laws increased
sharply, while the actual tax revenues dropped from 13.8 percent of GDP in
1975 to 6.5 percent in 1984.
Similarly, in Sudan the maximum tax rate on personal income was
raised from 60 to 70 percent and new development and defense taxes were
imposed, but the tax revenue/GDP ratio declined from 15.2 percent in 1976
to 12.5 percent in 1984. As GDP in constant prices also fell during this
period, the real decline in government revenues was even greater. In
Zaire, "bracket creep" has resulted in the top marginal income tax of 60
percent being applied on incomes as low as $1,200 per annum. An IMF study
of the tax returns of a sample of 20 enterprises found that the average
17/ See, for example, David J. Gould, Bureaucratic Corruption and
Underdevelopment in the Third World: The Case of Zaire (Pargamon
Press, New York, 1980).



- 29 -
employee paid 39 percent of his gross earnings as income tax. Enterprises
are subject to a turnover tax which increased from 13.5 percent to 18.0
percent of sales, and a development tax amounting to 7 percent of sales.
Yet total government revenue in Zaire fell from 29.7 percent of GDP in 1974
to about 15 percent in 1984.
A reappraisal of tax policy is underway in several African
countries. In Ghana, a recent IMF/World Bank fiscal mission has recom-
mended that the corporate tax rate should be lowered to 45 percent. For
personal incomes, the mission proposed a three-fold increase in the tax
exemption level, and a reduction of the top marginal rate to 40 percent.
The mission further recommended an adjustment in depreciation allowances to
permit corporations to maintain their income generating assets in the face
of exchange rate adjustments and other price escalations.
In Zaire, several studies are being undertaken to assess the
incidence of current taxation practices on the competitiveness and invest-
ment behavior of industrial enterprises. These studies are financed under
the World Bank's SOFIDE III Credit. The adoption of a tax reform program
satisfactory to the Bank forms part of the conditionality for the release
of the second tranche of the proposed Industrial Sector Adjustment Credit
for Zaire.
Mauritius is an example of a country which has successfully used
fiscal incentives to diversify its economy and create employment. Its
Export Processing Zone Act (EPZA) of 1970 granted: (1) tax holidays on
corporate profits for ten years (extended up to 20 years on a declining
basis since 1980); (2) tax holidays on dividends for any five-year period
during the first 10 years; (3) free repatriation of capital and dividends;
and (4) duty free entry of capital goods and inputs. These incentives were
available only to firms exporting all of their output.
Further measures introduced in 1984 included a reduction in the
corporate tax rate on non-EPZ firms from 65 to 35 percent and a system of
corporate tax benefits to non-EPZ exporters in which the rate is reduced by
2 percentage points for each 10 percent of output exported. The 1985/86
budget limited the corporate tax rate of EPZ firms to 15 percent over the
whole life of the firm and exempted dividends from income tax for a period
of 10 years.
Against this background, the share of manufacturing in GDP rose
from 8.0 percent in 1970 to 15.9 percent in 1983 and its share of total
employment went up from 6.4 percent to 19.0 percent over the same period.
Manufacturing, which contributed only 2.2 percent of Mauritian exports in
1970, accounted for 38.6 percent in 1983. The period 1983-85 has witnessed
a further industrial boom. Manufactured exports rose by 35 percent to
reach US$156 million and in 1985 are expected to surpass sugar as
Mauritius' main exports. The number of exporting enterprises increased by
118 to reach a total of 237 firms in mid 1985. Fixed investment in plant
and machinery increased by 50 percent in 1983 and by nearly 130 percent in
1984, reaching about $12.2 million. Export firms created 22,300 additional
jobs in 1983-1984.



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Botswana, which has one of the fastest growing economies in
Sub-Saharan Africa, has a corporate tax on capital gains and income of 35
percent. The Financial Assistance Program introduced in 1982 offers
liberal grants and tax holidays for productive ventures by local and
foreign investors producing goods for export or import substitution.18/
In Malawi, the Government is carrying out a study of its tax
system. The study will investigate ways to improve the responsiveness of
the tax system and its efficiency, i.e., to remove or reduce disincentives
for savings and distortions in resource allocation. In Niger, the Govern-
ment has recognized that the fiscal regime discriminated against private
enterprises by exempting parastatals from the turnover tax. In its new
Standby Program with the IMF, it is committed to introducing a value-added
tax. The emphasis under its Structural Adjustment Program with the World
Bank will be on improving the efficiency of the tax system. A reform of
the Investment Code will be included in a broader study of fiscal incen-
tives and taxes and duties on external trade. Such studies are called for
in other African countries as a basis for much needed reforms of their tax
and investment codes, including reducing the reliance on import duties as
the major source of revenue and lowering high marginal tax rates to streng-
then incentives and opportunities to save and invest and to decrease
pressures for tax evasion and corruption.
6. Public Investment Programs Monopolizing the Use of Foreign Loans
Private domestic saving are low in many African countries, for
reasons already indicated. Public savings have also declined because
government current expenditure has risen faster than government revenue and
many state-owned enterprises have incurred losses. Thus African countries
have had to rely increasingly on foreign savings, that is financial flows
from abroad, to finance their gross domestic investment. This is true
particularly of IDA eligible countries (low-income countries) in Africa.
In 1970-74 gross investment in these countries averaged 17.9 percent of
their GDP. 84 percent of this investment was financed by domestic savings
(public and private). By 1984, however, their investment/GDP ratio had
dropped to 14.3 percent and foreign savings accounted for 55 percent of
total investment.19/
Private enterprises have had very limited access to medium- and
long-term loans from abroad, either directly or indirectly through domestic
financial intermediaries. This is shown by an analysis of foreign debt
data classified by type of debtor. At the end of 1984, outstanding and
disbursed medium- and long-term debt to Sub-Saharan African countries
amounted to $56.5 billion. Only 0.6 percent of this total represented
direct loans to private enterprises, whereas state-owned enterprises
(SOEs) received 13.9 percent and mixed public/private enterprises 1.6
18/ See U.S. Department of Commerce, Investment Climate in Foreign
Countries, Volume III, Africa, August 1985.
19/ See World Bank, Financing Adjustment with Growth in Sub-Saharan
Africa, 1986-90, February 1986.



- 31 -
percent. These figures cover MLT lending in all forms--suppliers credits,
bank loans, bonds and loans and credits from multilateral and bilateral aid
organizations.
Loans to development finance institutions (DFIs) accounted for a
further 0.8 percent of outstanding foreign debt. This is a very low figure
considering that these DFI's were intended to be the principal source of
investment funds for enterprises in the private sector. And the amount
available for private enterprises was even less, because SOE's were also
beneficiaries of DFI subloans in most African countries.
Governments provided most of the initial equity capital for
development banks during the 1960s and early 1970s. But subsequently there
has been little injection of loanable funds from public treasuries. Nor
have DFI's been very effective in mobilizing domestic private savings. So
they have been largely dependent on funds from abroad. The response from
foreign lenders, both official and private, has clearly fallen far short of
the African private sector's needs.
The responsibility for this neglect of the private sector may lie
more with governments than with foreign lenders, however. Governments
guarantee repayment of this debt. Governments therefore have the final say
in how the funds are used. The data demonstrate that African governments
have preferred to use foreign MLT loans for their own public investment
programs and to cover their external and budgetary deficits on current
account. Loans to central governments and central banks for these purposes
accounted for three quarters of total foreign debt. Equally evidently,
foreign lenders have acquiesced with these priorities and perhaps even
encouraged them. Some official sources of concessional loans may have
shared the preference of governments for public investment, because it
allowed foreign donors more direct involvement in the selection of projects
and in procurement. Some lenders may not have wished to challenge a
government's choice of a public sector executant for a given project, on
the grounds that overt support for the private sector might be regarded as
interfering with a nation's political sovereignty. Whatever the reason,
the net result is that foreign loans have reinforced the heavy public
sector bias of African investments.
In the case of the World Bank, IBRD and IDA loans and credits for
DFI's in Sub-Saharan Africa amounted to just $109.6 million in FY84 and
FY85 combined, out of total Bank commitments to the region of $3,964.9
million in those two years. World Bank lending for small enterprise devel-
opment in Africa reached only $41 million in this period.20/ However, it
should be pointed out that some agricultural and rural development projects
include agricultural credit components intended for private farmers and
smallholders. Bank and IDA cumulative agricultural credit operations
represented 3 percent of total IBRD/IDA lending to Africa by June 30,
1985. Also, some proportion of non-project lending and sector loans has
reached private firms to ease their foreign exchange constraints on raw
material inputs and spare parts. Sector and non-project lending accounted
for 10 percent of the cumulative total.
20/ See World Bank Annual Report 1985, Tables 4.2 and 4.5.



- 32 -
There are signs of a reappraisal of investment strategies on the
part of both foreign lenders and African governments in recent months.
Guinea and Togo, for example, have requested foreign aid organizations to
help finance their privatization programs by providing loans to private
enterprises willing to take-over, invest in or acquire the physical assets
of state-owned enterprises. A USAID policy paper states that "AID resour-
ces should be channelled through the private sector rather than the public
sector, when host country conditions make this possible. In many cases, it
may be feasible to contract with a private sector firm to provide what
might have been provided through a government ministry."21/ The World
Bank is expanding its sectoral and structural adjustment lending to provide
quick-disbursing funds which can be allocated to a larger number of private
enterprises through commercial banks. The issue of how to achieve a better
balance in the distribution of aid resources between the public and private
sectors should be included on the agenda of meetings of consultative groups
and aid consortia. Priority consideration should be given to action in
three areas: (i) allocating a higher proportion of foreign aid funds to
local development finance institutions and commercial banks for onlending
to SMEs; (ii) encouraging private investors to take over inefficient
state-owned enterprises and to undertake new projects currently included in
public investment plans by guaranteeing long-term loans to match the
investors' own equity contributions; and (iii) introducing Private Sector
Development Loans to meet the short- and medium-term foreign exchange
requirements of private enterprises, linked to policy reforms that promote
competitive markets and efficient resource utilization.
21/ See U.S. Agency for International Development, A.I.D. Policy Paper:
Private Enterprise Development, Washington, D.C., 1985.



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CHAPTER IV. LABOR POLICIES AND PRICE CONTROLS
1. Labor Policies
Cumulative evidence suggests that over-regulated labor markets
have generally resulted in bloated bureaucracies and hampered the profit-
ability of enterprises in Africa. In particular, pressures upon employers
to expand or maintain employment, for strictly social considerations, have
proved to be counterproductive. Only economic growth can produce long-term
expansion of employment.
Botswana's labor legislation has tried to find a balance between
protection of the rights, safety and welfare of workers, the needs of
employers and the need for labor market flexibility. Minimum wages, the
length of the work week, annual and maternity leave, hiring and termination
procedures are laid down. There is no provision for sick leave although it
is given in practice. Dismissal of workers is allowed if there is mis-
conduct, willful disobedience, lack of skill, substantial neglect of duties
or unexcused absence from work. While government does not set wages in the
private sector, it does attempt to restrain wage inequality and insure that
private and public sector wages are comparable.22/
In Mauritius, basic wage rates, working hours, sick leave, annual
leave, authorized absence from work and compensation on termination of
service are all regulated by legislation. A compulsory national pension
plan is also in force, with contributions required from employers and
employees. Labor-management relations are relatively stable and strikes
are uncommon. The interests of the employers are coordinated through the
Mauritius Employers' Federation for the EPZ under the Mauritius Export
Processing Zone Association (MEPZA). Mauritian employees are organized
into several powerful federations comprising some 36 unions. These unions
have a record of responsible behavior, and are improving their capability
to effectively represent their 80,000 members.
However, under the Second Structural Adjustment Credit 1983, the
Mauritius government recognized that the labor legislation and the mechan-
isms for wage negotiations were cumbersome, created wage inequities and
prevented labor mobility among various sectors. Wage policy has become an
important part of adjustment policies in Mauritius. The policy is imple-
mented annually through a national wage award (the cost of living adjust-
ment), which is based on the previous year's inflation rate. The cost of
living adjustment for 1984/85 equaled about 3 percent, compared to the rise
in the cost of living index in 1983/84 of 5.6 percent. The Government
continues to view wage restraint as vital to improve the country's export
competitiveness. It proposed to liberalize minimum wage rates for male
workers in the Export Processing Zone in order to encourage the hiring of
male workers.
22/ Botswana: Foreign Investment Climate, USDC, August 1985.



- 34 -
In Burkino Faso, a source of modern private sector discontent
with regulations is what is felt to be excessive control over hiring and
firing decisions. Though the legislation may be reasonable, in practice it
is extremely difficult for modern sector employers to cut back on staff, or
even to reduce working hours. According to some managers, approval by CDR
(Revolutionary Defense Committee) representatives is required. Hiring new
people generally involves going through the government's labor exchange.
Smaller and/or 100% private firms have fewer such problems. But most firms
have some public sector participation, and this opens the door to the
restrictions noted. One large firm has sought for months approval to fire
120 employees, without success.23/
The general conclusion that can be drawn from African experience
is that labor policies should allow firms more flexibility in negotiating
wages, including the possibility of linking wages to employee producti-
vity. Restrictions and penalties on laying off excess or unproductive
workers should be relaxed, so that employers may take on and train new
workers without excessive risks.
A recent World Bank report on Senegal states:
"It is no coincidence that the fastest growth in employ-
ment over the past decade (outside the public sector)
has been in those branches of the Senegalese economy
that are least regulated, such as artisanal production.
Small-scale firms that largely escape payroll taxes,
social security charges, government pressures to take on
unneeded workers, and stiff penalties in order to lay
off excess labor in times of slump, have a rate of new
employment generation far in excess (estimated four
times as high) of that for large-scale enterprises.
The report recomuended that the government should move strongly in the
direction of more liberal employment policies for large-scale public and
private enterprises.
The Senagalese Government responded in its Letter of Development
Policy in December 1985. Its proposed action program included the follow-
ing statement on labor policy:
"Easing of employment regulations and increase in flexibility in
determining wages."
Easing of the operation of the labor market is an important condition
for the success of the economic adjustment program. This will be done
gradually and on several fronts: employment regulations, formulas for
worker incentives, collective bargaining, etc. The following measures
will be taken or considered after the necessary studies have been
conducted:
23/ Elliot E. Berg, Mobilization of the Private Sector in Burkina Faso,
December, 1985.



- 35 -
(i) Hiring, dismissal and employment contracts.
-    introduction of provisions enabling employers to
recruit Senagalese workers directly or through
employment agencies;
-    sharp reduction in the time taken by public employment
agencies to reply to job announcements by enterprises;
-    enhancement of the resources and performance
(quantitative and qualitative) of public employment
agencies;
-    introduction of new provisions designed to better take
into account the economic difficulties of enterprises
submitting requests for large lay-offs;
-    introduction of provisions permitting unlimited
renewals of fixed-term employment contracts.
(ii) Compensation
-    study of the link between external competitiveness,
productivity and nominal wages, and proposal of
appropriate measures to be implemented;
-    encouraging enterprises and trade unions to make
increases in bonuses and wage supplements contingent on
changes in productivity and the operating results of
each enterprise. Greater attention to these criteria
in possible government arbitration proceedings (in the
event of disagreement);
-    reduction of the social security costs borne by
labor-intensive enterprises.
(iii) New formulas for the determination and distribution of
compensation
-    Study of the possibilities of a link between employee
compensation and enterprise profits, and proposal of
appropriate measures to be implemented.
This statement provides a framework for an approach to labor
market reforms which could be usefully followed in other African countries.
Training is another important area where the needs of private
enterprises are not being fully met by government institutions. Too often
the instruction remains theoretical and unrelated to the specific job
requirements of employers. Some countries are therefore encouraging
greater involvement of employers in the design and execution of training
programs by providing grants and tax incentives. In Botswana, for example,



- 36 -
training sponsored by new investors under the Automatic Financial
Assistance (AFA) program at institutions licensed by the Botswana Ministry
of Education is automatically eligible for full reimbursement, provided
total costs do not exceed $1,750 per trainee per year. Half the cost of
training outside Botswana, off-the-job training done with business and/or
training costing over $1,750 per trainee per year is refunded if special
permission is received in advance.24/ In Lesotho, the Lesotho National
Development Corporation (LNDC) established a $150,000 Training Grant Fund
in 1980. Under this program LNDC reimburses 80 percent of the costs
incurred by new project promotors in training Basotho workers.
A narrow indigenous technological base and lack of skills have
undoubtedly retarded industrial development in Africa generally. However,
some African and Asian countries have achieved impressive growth of manu-
facturing output and exports despite low initial levels of educational
attainment, as measured by enrollment rates, whereas other countries in
these two regions with similar educational endowments have performed
poorly. The table below illustrates this fact. In Morocco, Tunisia,
Pakistan and Thailand, only 11-16 percent of the population in their age
group were enrolled at secondary schools in 1965, on a par with Ghana's
13 percent. Their enrollment rates for higher education were just 1-2
percent. Yet the first four countries achieved an annual growth of
manufactured output in the 6-11 percent range over the period 1965-84,
whereas Ghana's manufacturing production declined in real terms. Morocco,
Tunisia, Thailand and Pakistan were also successful in penetrating overseas
markets. Their manufactured exports rose 30,35,68 and 10-fold, respec-
tively, in current prices between 1965 and 1983. Ghana's remained
negligible.
Cameroon, Ivory Coast, Zambia and Zimbabwe started out in 1965
with even lower levels of human resources development. A bare 5-7 percent
of their populations of secondary school age were enrolled and less than
one percent were enrolled in higher educational institutions. But again
their industrial performances have been sharply contrasting. Despite a
more rapid increase in secondary enrollment rates in both Zimbabwe and
Zambia, their manufacturing output growth rates have lagged well behind
those of Cameroon and Cote d'Ivoire.
Improvement in basic educational levels undoubtedly facilitates
industrial development but clearly can be undermined by other factors. It
seems also true that low initial educational levels are not an insurmount-
able obstacle to export success. You don't need a Ph.D from MIT to sew
shirts and jeans, weave silk, process foodstuffs, assemble radios or make
other labor-intensive product which constitute the bulk of the exports of
Morocco, Tunisia, Thailand, Pakistan, Cote d'Ivoire and Cameroon. Skills
and know-how that were lacking were obtained by hiring expatriates, through
direct foreign investment or by collaboration with overseas customers and
suppliers. Indigenous skills were developed progressively by on-the-job
experience and institutional training. Export growth stimulated more rapid
24/ See USDC, Investment Climate in Foreign Countries, op. cit.



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EDUCATIONAL ATTAINMENT AND INDUSTRIAL GROWrH
IN SELECTED AFRICAN AND ASIAN COUNTRIES
Higher        Average Annual
Secondary     Education         Growth of         Manufacturing
School       Enrollment       Manufacturing          Exports
Enrollment         Rate             Output           (millions of
(%)             (%)              %                 dollars)
1965   1983     1965   1983    1965-73  1973-84     1965     1983
Cameroon          5.0   21.0      (.)   2.0       7.5     13.5        6.0     78.0
Cote d'Ivoire     6.0   19.0      (.)    3.0      8.9      5.0       15.0    235.0
Morocco          11.0  29.0       1.0   6.0       6.1      5.8       23.0    707.0
Pakistan         12.0  16.0       2.0   2.0       6.2      7.5      190.0   1,964.0
Thailand         14.0  29.0       2.0   22.0     11.4     10.0       30.0   2,058.0
Tunisia          16.0  33.0       2.0   6.0      10.4     10.2       23.0    816.0
Ghana            13.0  38.0       1.0   2.0       6.5    -6.9         7.0       (:)
Zambia            7.0   17.0     n.a.   2.0       9.8     0.8         1.0       8.0
Zimbabwe          6.0  39.0       (.)    3.0     n.a.      2.3      116.0      n.a.
Source: WDR 1986.
(.)  Less than 0.5 percent.
(:)  Less than $0.5 million.
income growth, which in turn generated higher tax revenues which were used
to expand the educational system. Skill formation is a dynamic, interac-
tive process which is rooted in effective economic policies. A country's
capacity to absorb technology and to generate a constant stream of process
adaptation and improvement, raw material substitution and product design
changes depends largely upon action taken at the enterprise level. Employ-
ees have to be motivated by appropriate remuneration systems. Effective
organizational structures and management techniques must be adopted.
Information reaching the enterprise through market networks must be effec-
tively utilized. Enterprise decisions in these areas are taken in response
to economic incentives and competitive pressures, both of which can be
strongly influenced by government policies.



- 38 -
2. Price Controls
Most African governments have exercised controls over.the prices
of agricultural and industrial products and services such a electricity,
transport and telecommunications. The rationale for price controls was
three-fold: (1) to ensure that people with low income can afford to buy
basic necessities; (2) to contain inflationary pressures fueled by rapid
monetary growth; and (3) to prevent abuses by monopolists.
Experience suggests that the short-term benefits of price
controls to consumers are generally far outweighed by their economic cost
and destabilizing effects. Price controls have aggravated shortages and
distortions and affected the profitability of many enterprises adversely.
As the case of Ghana illustrates, the effects of price controls tend to be
opposite from the one anticipated. A World Bank mission recently observed
that consumer prices continued to rise, as small retailers were too
numerous to monitor. Retail stores run by the Government were constantly
short of supplies. Profits were shifted from large producers, who were
closely watched, to small retailers, who could sell at whatever prices the
consumers were able to pay. Large private distributors of food products
were forced out of business, while consumers continued to pay high prices
as food supply fell.
Pernicious effects of agricultural price controls have been
observed in Zambia. Until 1982, the Government set prices for virtually
all crops and livestock on the basis of estimated costs of production on
commercial farms, and the bulk of agricultural products were sold to public
sector marketing boards. For the most part producer prices for crops were
below import/export parity prices. This pattern of holding domestic prices
below international prices subsidizes consumers and industrial users of
agricultural commodities at the expense of the agriculture sector. Price
controls on raw material inputs raise the effective protection afforded
downstream industrial users. A comparison of the changes shows that the
latter increased substantially faster than the former. Thus, the terms of
trade moved against agricultural producers who had to pay more in terms of
agricultural output for commodities which they purchased from the indus-
trial sector.
Price controls are particularly burdensome and costly and repre-
sent a major disincentive to private operators. There are often long
delays involved between an enterprise's request for a price increase and
the Government's ruling on the request. In Burkina Faso, a bicycle manu-
facturer had to wait for 18 months to increase prices while the price of
imported spare parts increased substantially in the meantime. In addition,
he had to spare weeks of scarce managerial resources to comply with the
heavy bureaucratic requirements for the preparation of the file. This had
a serious effect on the profitability of his company.
Price control enforcement require large staffs, adding pressure
to already strained budgets. In Ethiopia the price control administration
employs 800 persons, but is is recognized that they are insufficient to
perform this task effectively.



- 39 -
Price liberalization is a politically sensitive issue. While
many governments in the region recognize the many adverse effects of price
controls, liberalization usually takes place in a gradual manner.
In Senegal, the government began to gradually eliminate subsidies
on basic foods with the adoption, in 1975, of the true pricing policy
(verite des prix). By 1980, under the first World Bank Structural
Adjustment Credit, the last subsidy was abolished. Some sensitive food
products such as rice, bread and ground nut oil
remained under a system of government fixed prices but the prices of other
goods and services were entirely uncontrolled by the end of 1980, except
for certain crops subject to preliminary approval and monitoring. The 1986
SAC for Senegal proposed the progressive elimination of all price
controls.
In order to allow market forces to play a more important role in
the economy, the Zambian Government abolished the control of all wholesale
and retail prices in December 1982, except for three essential commodities:
wheat flour, maize flour and candles. Since then, prices for a wide range
of commodities have increased, thereby helping to restrain domestic demand,
while increasing the profitability of firms. Most recently, the price of
wheat flour and bread was also decontrolled. Over the last three years,
producer prices for most agricultural crops have been increased consider-
ably in real terms. Together with concessionary tax rates for agricultural
income and freer marketing arrangements for the livestock sector, these
measures have already led to increases in the area under cultivation and in
the marketed production of various crops and livestocks.
In Ghana, price controls have been substantially liberalized
since 1985. Except for textile products, tobacco and beverages, and some
less important items which remain subject to controls, manufacturers are
only required to report price changes, with no prior approval needed.
The Ghana National Procurement Authority has removed most food items from
its list, retaining only sugar, rice, flour and edible oil. The liberali-
zation of price controls has been welcomed by private businesses, while the
combination of higher prices and larger production volumes are beginning to
turn former seller's markets to buyers' markets. A World Bank mission to
Ghana in 1986 recommended abolishing the remaining price controls espe-
cially on textiles, and phasing out the government's procurement and dis-
tribution activities, except in situations needed to render monopolies
ineffective, and to assure adequate supplies in the most disadvantaged
areas.
Nigeria removed all controls on ex-factory prices in September
1986. Prices have not changed significantly since then. Until 1983, the
Government of Malawi maintained a system of formal and informal price
controls on a variety of items that were considered essential either as
consumer products or production inputs. This system, which evolved during
the 1970s, reached a level that was seriously hampering the industrial
sector. By the early 1980s, with increased inflationary pressures, it was
creating serious disincentives for producers, by failing to signal
shortages and surpluses, causing inefficiencies and imposing a financial
burden on those firms experiencing large increases in their input prices.



- 40 -
Under SAL II, the Government implemented a price liberalization program,
reducing the number of items on the price control list from 56 in December
1983, to 9 in August 1985. The Government is committed to carry out the
price liberalization program to is conclusion.
In Niger, the number of products and services subject to the
fixed price ceiling system was reduced from over 50 items to 7 items in
November 1985. The Government also proposed to reduce the number of
products subject to controls over profit and distribution margins.
Again, these country examples indicate the path that could be
followed by other African countries in which price controls cause excessive
market rigidities and hamper resource mobilization. Measures to increase
market competition, including freedom of entry and removal of quantitative
restrictions on imports, will help to ensure that price liberalization does
not result in excessive rents for monopolists.



- 41 -
CHAPTER V. TRADE POLICIES AND COMPETITION
The last broad policy area reviewed is trade policy. This topic
has not been left to the end because it is the least important. On the
contrary, sound trade policy is probably the key element in the promotion
of efficient private enterprise and open, competitive markets. In its
absence, many of the reforms discussed in this paper would be undermined
and ineffective, or might even have perverse results.
Trade policy issues in Africa can be discussed under three
headings: (1) exchange rate policies; (2) import policies; and (3) export
policies.
1. Exchange Rate Policies
A country's exchange rate affects not only the market opportun-
ities for all tradables but also the rewards of their producers. An over-
valued exchange rate makes it more difficult for farmers and manufacturers
to sell their products abroad and reduces the returns in local currency
received by exporters. Similarly, an overvalued currency has the effect of
subsidizing imports which undercut the producers of import substitutes,
unless import restrictions are imposed. Thus, resources are diverted into
the production of non-traded goods and services.
Loss of exports (actual or potential) deprives a country of some
important inputs needed for growth and efficiency. Exports increase the
availability of foreign exchange which is one of the main determinants of
the overall level of economic activity. Exports broaden markets and allow
economies of scale to be achieved. Exporting activities expose producers
to new technologies, new products and new marketing techniques. Exports
create jobs and raise incomes.
Overvalued currencies also result in foregone benefits in
import-substituting sectors. By making imports relatively cheaper, over-
valuation undermines incentives in natural resource-based activities such
as agriculture, forestry, mining, agro-industries and basic industries. It
further discriminates against the development of appropriate domestic tech-
nology, and through cheaper imports of capital goods, encourages relative
capital-intensive methods of production, thus discouraging employment
creation.25/
There is widespread evidence of overvalued exchange rates in
Africa and the situation has generally deteriorated relative to other
regions over the past decade. IMF indexes of real effective exchange rates
(that is, nominal exchange rates adjusted for relative rates of inflation)
show that the weighted average index for all Sub-Saharan Africa appreciated
by 75 percent between 1974 and 1984; whereas, the index for Asia depre-
25/ See Guy Pfefferman, "Overvalued Exchange Rates and Development,"
Finance and Development, March 1985.



- 42 -
ciated by about 26 percent and for the western hemisphere by 30 percent
over the same period.26/
However, the costs and losses arising from currency overvaluation
are being recognized. A growing number of African countries, particularly
lower income countries, have adopted more flexible exchange rate regimes
which rely on supply and demand in the foreign exchange market to determine
the exchange rate.
Nigeria, for example, introduced a foreign exchange auction in
September 1986. Zaire devalued the zaire by 77.5 percent against the SDR
in September 1983, and introduced a dual exchange rate regime as an interim
measure prior to complete liberalization. By 1985 the real effective
exchange rate had fallen by three-quarters and the premium on the parallel
market was no more than 10 percent, roughly in line with the cost of bank
commissions. In late 1985, Zambia also introduced an auction system for
most trade-related exchange transactions. Although the government and
selected public enterprises continue to receive an administrative alloca-
tion of foreign exchange, the value of the foreign exchange is determined
by the auction. After the introduction of the new system, the nominal
exchange rate fell by two-thirds in three weeks. Guinea and Gambia are
establishing similar systems intended to lead to a unified, market-
determined exchange rate. Ghana has made substantial devaluations but has
maintained its administrative controls over foreign exchange allocations.
The availability of foreign exchange to the private sector remains highly
constrained, except for exporters who are allowed to retain 25 percent of
their foreign exchange earnings. Hopefully, this Foreign Exchange
Retention Scheme will facilitate a transition to a freely convertible
currency which is the most effective mechanism for ensuring that a
realistic exchange rate is sustained.
2. Import Policies
The structure of tariffs on imports is highly uneven in most
African countries, with low rates on foodstuffs, raw materials and
machinery, and high rates on luxuries and products in direct competition
with domestic industries. In Zaire, for example, tariffs on intermediate
inputs are at 0 percent or 3 percent; on finished goods, up to 150 per-
cent. This tariff structure results in substantial rates of effective
protection on activities with low domestic value-added such as component
assembly industries. High effective protection in these cases reduces
competition and provides a powerful incentive to inefficient import-substi-
tution industries. Low or even negative effective protection in other
fields discourages the use of domestic raw materials and the development of
intermediate and capital goods industries.
These tariff-induced distortions are further accentuated in many
countries by quantitative restrictions on imports. These are often intro-
duced to correct trade imbalances arising from overvalued exchange rates.
Quantitative restrictions promote rent-seeking activities (rents are
26/ See World Bank, Financing Adjustment with Growth in Sub-Saharan
Africa, 1986-90, February 1986.



- 43 -
incomes generated because of an artificially created scarcity).  Substan-
tial rents are obtained simply by having access to import licenses.
Corruption almost unavoidably flourishes in such a situation. Politiciza-
tion of the economic process is encouraged. The attainment of political
power becomes vitally important from a private economic point of view, and
this, in turn, fosters divisiveness between those who have political power
and can extract rent, and the rest of the population. High tariffs and
quantitative restrictions on imports facilitate the emergence of private
monopolies and "crony-capitalism" which yield few long-term benefits for
society as a whole.
Another prevalent weakness in African trade regimes is the grant-
ing of import duty exemptions to government enterprises and foreign aid
financed projects. This practice subjects private enterprises to unfair
competition and retards the development of domestic industries capable of
making the same products, especially when such exemptions coincide with
currency overvaluation and heavy domestic tax burdens on local producers.
These distortions and weaknesses are being remedied in some
African countries in the context of structural adjustment programs. In
Kenya, for example, the government announced in 1980 that it would gradual-
ly phase out quantitative restrictions and aake the tariff the major form
of protection. Tariff rates would be made more uniform and moderate.
Twenty percent of import items subject to quotas were given free import
status in 1982; a further 20 percent were to be transferred to this list
each year. In Mauritius, the government agreed in 1983 to eliminate the
discretionary system of industrial protection by gradually shifting to a
generalized, time-phased program of declining tariffs.
In 1983, the Ivory Coast government adopted an action program to
harmonize levels of effective protection through a comprehensive reform of
the Customs Code. Quantitative restrictions would be phased out and
replaced by temporary import surcharges during a maximum period of five
years. In Senegal, customs duties on all imports were raised to 15 percent
in 1980, and the Government proposed to gradually eliminate some exemptions
applied to imported capital and intermediate goods. In Togo, quantitative
restrictions are limited and customs duties vary from 5 to 40 percent, but
the tariff system is complex. In 1985, the Government requested IDA to
undertake a study to simplify and standardize the system.
In Zaire, the government announced in 1986 its intention to
implement a program of tariff rationalization which would lower the average
level of protection offered to the manufacturing sector and reduce the
dispersion of protection rates that currently exist. This would be done by
introducing a basic minimum duty of 10 percent on all imports, including
raw materials and intermediate goods, and by reducing tariffs on finished
goods progressively, aiming to establish maximum nominal rates of protec-
tion of about 30 percent in three years. In cases where it is considered
desirable to limit the consumption of luxury goods, for example, excise
taxes would be applied--equally to imported and domestically produced
goods--so as not to provide incentives for the inefficient domestic produc-
tion of these luxuries. Similarly, in cases of "dumping" by overseas



- 44 -
suppliers, a temporary import surcharge might be indicated. In addition to
reforming the tariff structure, the Government is taking measures to
provide institutional support to these reforms. Thus, a tariff commission
composed of representatives from relevant economic ministries and the
private sector has been established. Furthermore, a program of specific
actions to improve the functioning of the Customs Administration Authority
(OFIDA) has already been launched. This program includes incentives for
customs officers through higher salaries and participation in penalties,
training, logistic support, improvement of data processing and better
organization. Its aim is to improve revenue collection and to meet the
legitimate complaints of domestic producers who are currently being under-
cut by fraudulent imports which evade many of the duties and taxes imposed
upon those who abide by the rules.
3. Export Policies
The anti-export bias resulting from overvalued exchange rates and
from high duties and quantitative restrictions on imports has already been
noted. Unfortunately, in many African countries this bias is reinforced by
explicit or implicit taxes on exports. During the late 1970s, revenue from
export taxes reached 70 percent of total tax revenue in Uganda, 26 percent
in Ethiopia, 24 percent in Ghana, 20 percent in Rwanda, 19 percent in
Burundi and 17 percent in Somalia, for example.27/ In addition, the heavy
administrative costs and wide operating margins of state export marketing
boards act as a disguised tax on the primary producers of export
commodities, even if there are no direct transfers to the national
treasury.
Several countries have laws on the books which provide for tax
and duty rebates on imported inputs that are processed for export. But,
frequently, the criteria of eligibility are so discretionary and the admin-
istrative procedures so cumbersome that potential exporters are deterred
from making the effort required to break into export markets. In many
cases, an export license is required for each export consignment, acting as
a disincentive and reducing the flexibility needed to respond quickly to
export opportunities and to meet the delivery requirements of overseas
customers.
The combined effects of these biases and barriers confine African
exports, by and large, to commodities in which African countries have
pronounced comparative advantages due to climate (tropical foodstuffs and
wood) or geology (various minerals). Potential comparative advantages in
labor-intensive manufacturers are dissipated because lower wage rates
(compared with major East Asian exporters) are more than offset by higher
taxes and other excessive costs resulting from the various policy weak-
nesses discussed earlier. Most successful Asian exporters operate at least
within a tax-free export regime and in many cases receive export subsidies
to counterbalance the tariff protection provided for sales in the domestic
27/ See IMF, Taxation in Sub-Saharan Africa: Statistical Analysis, March
1981.



- 45 -
markets. Manufactures account for only eight percent of total exports from
low income countries in Sub-Saharan Africa compared with 51 percent for all
low-income countries.28/
Mauritius is one African country which has demonstrated that by
creating appropriate incentives and a favorable business environment, it is
possible to eliminate dependence on primary commodities and penetrate
highly competitive foreign markets with an expanding range of manufactured
products. In 1985 over 50 percent of Mauritian exports were estimated to
originate in manufacturing industries other than sugar refining--the tradi-
tional export industry. Several factors are responsible for Mauritius'
success: generous fiscal incentives (noted in Chapter III); a hardworking
labor force (well-educated but with little previous industrial experience);
sound labor policies; and a democratic, pluralist society which fosters
racial harmony while encouraging entrepreneurs from varied ethnic and
religious backgrounds.
Other African countries are trying to follow suit by adopting
similar policies. Under the SAL III, Malawi will take a number of steps to
promote exports. A three-year project financed with the assistance of UNDP
will strengthen the staff of the Malawi Export Promotion Council (MEPC) in
the area of export promotion policy, product and market development, and
trade information services. A center to train exporters and government
officials in export promotion will be established. To meet the credit
demands of small- and medium-sized exporters and to encourage the export of
non-traditional products, the government is to set up an export credit
facility to provide pre- and post-shipment financing, export credit guaran-
tee, and export credit insurance. The duty rebate system will be stream-
lined and made operative.
In Burundi, the government proposes to eliminate all export taxes
on local manufactured products. It will also reactivate the drawback
system which exists, but is not well known to exporters. In Ghana, the
formation of an inter-ministerial Export Promotion Council gives official
recognition to the importance of exports which will be facilitated by
ongoing reforms toward a realistic valuation of domestic currency and a
liberalization of the trade regime.
In Zaire, the 1983 devaluation and the adoption of a realistic
market-determined exchange rate has already begun to provide a potent
stimulus to exports. Under the terms of a World Bank Industrial Sector
Adjustment credit approved in 1986, these measures will be followed up by
the abolition of all export duties and other taxes on manufactured
exports. It is expected that the loss of fiscal revenues will be negligi-
ble and far outweighed by the revenue increases resulting from tariff
reform and the corporate taxes on expanding export activities.
Furthermore, the government will eliminate all the administrative
bottlenecks faced by exporters, retaining only what is necessary for
statistical purposes. An export promotion program will also be
established.
28/ See World Bank, World Development Report, 1985, Annex Table 10.



- 46 -
The Ghanaian Government has taken steps to remove procedural and
policy impediments to non-cocoa exports with the support of a World Bank
Industrial Adjustment Credit approved in March 1986. These steps include
removal of export permits, increased flexibility in the use of export
retentions, streamlining of import duty drawbacks and strengthening of the
Export Promotion Council.
Nigeria has introduced several reforms in the context of a Trade
Policy and Export Development Loan approved by the World Bank in 1986.
Import tariffs are being harmonized and the average level reduced.
Quantitative restrictions on imports are being removed. A scheme for
rediscounting of short-term bills for exporters is under preparation. And
a duty drawback/suspension system initiated.
There is ample scope in other African countries for similar
measures. Vigorous steps to counter the prevailing "export pessimism" in
Africa would seem to be indispensable if more rapid and better-balanced
growth is to be achieved. A competitive, dynamic private sector could
contribute the main driving force behind a new outward-oriented trade
strategy in Africa if export taxes were removed, realistic exchange rates
adopted, duty draw-back schemes introduced and administered effectively,
export credit facilities created, fiscal incentives offered to exporters
and export promotion services strengthened.



- 47 -
CHAPTER VI. THE ROLE OF AID DONORS IN PROMOTING
AFRICA'S PRIVATE SECTOR
The evidence reviewed in the previous chapters demonstrates
clearly that there is no shortfall of entrepreneurial spirit in Africa.
The most crucial limiting factor is not entrepreneurship, but weaknesses in
the physical and policy environment which inhibit effective investment.
What can aid donors do to help create more favorable investment conditions?
1. PFolicy Reforms
A fundamental prerequisite to the growth of the private sector in
Africa is a favorable policy environment. The reform of official economic
policies can remove debilitating restraints on entrepreneurial activity.
Devaluation of inflated currencies, removal of barriers to entry, liberal-
ization and diversification of financial markets, widening of the private
sector's access to foreign exchange, domestic credit and foreign capital,
the decontrol of factor and product prices, the lifting of excessive
bureaucratic procedures and requirements, an easing and more equitable
sharing of tax burdens, a reduction and harmonization of import tariffs,
removal of quantitative restrictions on trade, and creation of incentives
for labor mobility and skill formation are all difficult but essential
steps to improve the business environment. It may be necessary to imple-
ment such changes gradually so as to avoid shocks to a country's society
and economy. But without such reform, the necessary confidence among
investors will not materialize, and other more targetted measures to stimu-
late the private sector will be far less effective.
2. Involving the Private Sector in the Policy Dialogue
The reform process is underway in several countries in Africa,
such as Guinea, Ghana, Senegal and Zaire for example. Aid donors can
facilitate progress along this path in many ways. In their economic and
sector analysis work they can help to identify remaining constraints and,
through comparative, cross-country studies, draw the attention of policy
makers to measures which have been successfully applied to overcome these
constraints. Donors can strengthen both their own analytical capacity and
the national machinery for the implementation of reforms by involving the
private sector more closely in their policy dialogue with countries.
Missions to review the business environment in selected countries have
yielded some new insights because they had more extensive contacts with
representatives of the private sector than is customary in aid missions.
But if the private sector focus of aid donors were confined to special,
one-off missions their impact would be limited. The assessment of private
sector attitudes and needs could be made more systematic. Consultations
with private entrepreneurs and managers, and with representative organiza-
tions such as Chambers of Commerce, could be built into the standard sche-
dules of foreign aid missions. This would demonstrate donors' recognition
of the fact that the private sector is a vital partner with government in
the development process, and that effective reforms require its



- 48 -
collaboration and support. Participation of the private sector in policy
discussions should lead to a stronger consensus on development objectives,
a better understanding of policy options and less resistance to particular
reforms (such as import tariff and quota reductions) which the private
sector might feel to be against its interest.
3. Policy-Based Lending
The short-term political costs of reforms are minimized, and the
benefits made more immediate, if reforms are accompanied by additional
resources. This is the role of policy-based lending. Loans for structural
and sectoral adjustment are assisting a growing list of African governments
to devise economic policies and programs which are more conducive to
private sector activity. The freeing up of marketing systems, the liberal-
ization of imports, encouraging the mobilization of savings to ensure
credit availability, restructuring the financial sector, and the stimula-
tion of competition through the elimination of subsidies to state enter-
prises are some of the steps governments are taking with donor support.
There may be a need to extend the use of commercial banks as distribution
networks for the diffusion of these loans, and perhaps to change allocation
criteria and procurement methods to ensure that the private sector, partic-
ularly small firms, has adequate access to these financial resources. For
example, trading companies supplying imported equipment, materials, and
spare parts to small firms, which often lack the experience and know-how to
import directly themselves, should be eligible for credits and foreign
exchange provided by donors.
Donors could also focus more attention on policy areas which have
been somewhat neglected in past adjustment operations. Statutory monopo-
lies should be abolished and restrictions on entry by both domestic and
foreign investors lifted. Liberalized investment regimes should signal
investors of a more stable, predictable and transparent policy environment
over the long run. This will help not only to attract new foreign capital
but also to reverse the flight abroad of domestic savings. Growth-oriented
fiscal policies should be introduced, aimed at increasing incentives to
work, save and invest, mobilizing resources for productive sectors and open
legitimate activities and reducing budget deficits and public sector
borrowing requirements. Reforms of wage systems and labor market regula-
tions and institutions should promote skill formation, productivity
improvement and more rapid labor absorption in areas of comparative advan-
tage for African countries. The anti-equity biases of existing policies
should be corrected and equity market institutions strengthened. And on
the broad question of price determination, donors could encourage govern-
ments to place greater confidence in the knowledge and wisdom of market
actors when making decisions affecting their livelihood as producers and
their welfare as consumers. Rather than reinforcing government price
fixing machinery or trying to simulate market behavior in elaborate models,
prices should be left largely to the interplay of competitive market
forces.



- 49 -
Introduction of a new lending instrument--Private Sector Develop-
ment Loans--might be the most effective means of ensuring that the foreign
exchange and credit requirements of the private sector are met at the same
time as its policy environment is improved.
4. Agricultural Development
In agriculture, where small scale enterprises have played such a
prominent role historically in Africa, adjustment lending has enabled many
governments to either decontrol or raise the prices paid to farmers and
thereby reinstate incentives long absent from the agricultural sector.
Many aid donors have emphasized the introduction of better farming prac-
tices, the dissemination of new seeds and varieties, and the development of
more efficient marketing and credit facilities. Donors are also supporting
intensive research into new agricultural technology for the African
environment and the transfer of new discoveries to the field where they can
be applied in practice by the resourceful African farmer. But perhaps
greater care should be taken in the design of agricultural projects to
ensure that the provision of inputs, and the distribution and processing of
outputs, are not dominated by subsidized public sector organizations which
preempt or undercut the opportunities for private enterprise in these
fields. Independent, competitive fertilizer and seed merchants, agricul-
tural equipment suppliers, blacksmiths, welders, and carpenters, grain
millers, small transport operators and traders of all kinds are vital
actors on the rural scene. They create new jobs for surplus agricultural
labor. They supplement farm household incomes. They mobilize rural
savings for the diversification of rural output. And they oil the wheels
of the rural economy more effectively than do centralized, bureaucratic
organizations.
5. Promotion of Small and Medium-Sized Enterprises
The encouragement of small and medium enterprises (SMEs) in both
rural and urban areas should be a high priority in Africa, not only for the
development impact of a growing indigenous private sector, but also as a
recruiting and training process for future entrepreneurs. Since the early
1970s, donors have assisted African countries in setting up development
banks which then lend to local investors, help identify projects and
provided technical a6disLafinc  tc new entrepreneurs.  In recent years, an
increasing proportion of this type of lending has supported "apex" institu-
tions, such as central banks, which have channelled credits to a larger
number of local lending institutions so as to reach a wider group of entre-
preneurs. But, the total amount of foreign aid channelled through develop-
ment banks and for SME programs has been relatively small.
Although the existence of unsatisfied demand for credit for the
private sector is not denied, African Governments and financial institu-
tions have been reluctant to expand these programs. Donors could make a
greater effort to persuade governments that subsidized credit is not the
answer. Efficient SMEs can pay the real costs of credit. But they are
being denied access to credit because of the inevitable abuses of subsi-
dized schemes. Commercial banks would be more willing participants tn the



- 50 -
programs if governments and donors recognized the higher costs and risks of
SME lending. Aid funds should be made available to these institutions at
the same cost as their other sources of funds, principally time deposits.
Deposit and lending rates should be determined by financial institutions in
response to market forces.
In the field of technical assistance to SMEs, specialized govern-
ment institutions have been wasteful and largely ineffective in Africa, and
elsewhere. Market networks, built upon commercial relationships between
suppliers and customers, are more efficient mechanisms for the dissemina-
tion of know-how and information needed by SMEs. Policy reforms of the
type discussed in this paper will strengthen this transfer mechanism by
removing price distortions and subsidies and encouraging cooperation among
firms in complementary fields, and help to fill any gaps in the provision
of services. They will also create incentives for subcontracting and
franchising relationships between large firms and SMEs which have been
shown (in Japan and Korea, for example) to be mutually supportive.
6. Restructuring of State-Owned Enterprises
The rationalization and restructuring of large state-owned enter-
prises (SOEs) is another important area where donor support benefits the
private sector. Frequently the managers of these state enterprises respond
more to official concerns than to economic ones. Short of skilled manpower
and sometimes the victims of poor planning, many such entities are found to
operate at a loss, to drain government resources, consume scarce foreign
exchange, and employ a government granted monopoly to exclude any potential
competitors. They also borrow heavily at home and abroad, using credit
which otherwise would be available to more productive borrowers.
Some SOEs are viable and perform well, but many should be
restructured, rehabilitated and managed more efficiently. Although privat-
ization of public sector holdings can be difficult to carry out in develop-
ing countries, it is an option which governments should examine closely for
a wide range of state enterprises. Donors guidance and support are likely
to be called upon increasingly in this field.
7. Infrastructure and Institutional Development
In addition to more favorable economic policies, an improved
physical and institutional environment is also essential to encourage the
development of a nascent private sector. Industrial and agricultural
entrepreneurs rely on a functioning road, rail, and port systems to obtain
essential inputs and to market their products. Power and telecommunica-
tions must also be reliable; frequent power outages not only reduce capa-
city utilization and profitability, but often cause serious damage to
costly plant and equipment. Advances in the institutional environment are
essential as well so that legal systems, accounting rules, and taxes are
uniformly applied and observed. In addition, entrepreneurs must be able to
draw upon a healthy and literate labor force--the key input in any
business.



- 51 -
In the vital area of infrastructure aid donors have supported
such investments as roads, ports, communications, water supply systems, and
energy installations for many years in Africa. More recently, in response
to the African economic crisis, some donors have shifted their infrastruc-
ture lending from new investments to the urgent rehabilitation and main-
tenance of existing facilities. These investments are important and should
be continued. But more innovative approaches are needed to shift some of
the burden of local cost financing from government to the private sector.
There is a growing body of experience around the world with the private
provision of infrastructural services. This experience ought to be tapped
more fully in Africa.
International legal expertise is being increasingly utilized in
the fields of SOE restructuring and privatization. Assistance could also
be extended for the drafting of new investment codes and the redesign of
commercial law.
8. Promotion of Direct Foreign Investment
Direct foreign private investment will be promoted by the estab-
lishment of the Multilateral Investment Guarantee Agency (MIGA) under the
auspices of the World Bank. MIGA will respond to the concern of foreign
investors, from developed and developing countries alike, that their
investments be protected against non-commercial risks and volatile economic
conditions in developing countries. With that protection available from
MIGA, investment conditions will be further improved in Africa. Other
steps that could be taken by donors to actively promote direct foreign
investment include:
- organization of workshops and study tours for officials of
African investment promotion agencies to facilitate a
cross-fertilization of ideas and experience;
- technical assistance for the revision of Investment Codes to
ensure non-discrimination between domestic and foreign investors
(the OECD "national treatment" principle);
- provision of funds to African investment promotion agencies to
support visits by potential foreign investors and subsequent
joint feasibility studies; to qualify, investors must demonstrate
that they are seriously interested in undertaking a project as
well as having the necessary capital and capabilities to do so;
- invitations to representative bodies of international private
enterprise (such as the International Chamber of Commerce) to
participate in economic and sector missions dealing with foreign
investment issues and policies; and
- dissemination of reports prepared by aid agencies describing and
analyzing the investment climate in African countries to organiz-
ations representing foreign investors; such reports (appro-
priately edited) could include economic and sector reports,



- 52 -
reports to consultative groups, reports on feasibility studies
undertaken by aid consultants, reports on market surveys
conducted by donor financed institutions (e.g., DFIs) and reports
on public investment programs.
9. Conclusion
In conclusion, it should be emphasized that promoting private
sector development is not an ideological necessity. It is sound policy.
A growing private sector providing a more diverse array of products and
services is a formidable force for development. Opening the economy to
more indigenous enterprises also provides increased opportunities for
African women who in many African societies have a long tradition of com-
mercial activity. For governments who have gradually realized the limits
of public sector intervention, an enhanced role for the private sector is
not a threat, but welcome relief. And the harsh rhetoric once heard in
Africa against foreign investment is being replaced by a determined compe-
tition for the capital, technology, and employment which industrial country
investors can bring to a developing country.
Attitudes and policies are changing rapidly in Africa. There is
a growing recognition that given the proper support the enterprising ener-
gies of Africa's people have enormous development potential. Aid donors,
industrial country investors, African governments, and African entre-
preneurs themselves now have the opportunity before them to engage a power-
ful engine to help drive Africa's development forward. It is an opportun-
ity which no-one can afford to ignore. Aid donors can help to create a
better environment for private enterprise in Africa in many ways. Their
existing programs make significant contributions. They should be rein-
forced by placing greater stress on the development of competitive markets,
the easing of regulatory controls and closer collaboration with the private
sector at all stages of foreign aid financed activities.



- 53 -
ANNEX
PRIVATE SECTOR DEVELOPMENT IN AFRICA
REVIEW OF CROSS-COUNTRY STUDIES
Were differences in economic performance among African countries
related to differences in the relative size and respective roles of the
government and the private sector? Five cross-country studies have
examined this question, using statistical techniques to estimate the
strength of the relationship, if any, between key economic variables and
economic growth. These variables Include the level of government expend-
iture on public services, public and private investment, taxation, the
extent of government intervention in product and factor markets, the share
of the public and private sectors in domestic credit, external public debt
and government/private sector involvement in the provision of agricultural
inputs.
1. Links Between Government Expenditure, Private Investment and Growth
The most comprehensive analysis was undertaken by Daniel
Landau.3J His data set included 65 developing countries, comprising all
countries with populations of one million or more for which data were
available for the period 1960-80. 24 countries in Sub-Saharan Africa were
included. His regressions took the rate of increase in per capita GDP as
the dependent variable and examined 37 explanatory variables grouped into
ten categories: measures of government expenditure and revenue raising;
regulation and other government impacts; the level of per capita product;
international economic conditions; human and physical capital variables;
the structure of production; historical political factors; resources and
geoclimatic factors; population; and a time trend. Separate regressions
were run for four sub-samples of the data. Two of these sub-samples were
for annual observations of the growth rate, one was for four-year periods
and one for seven-year periods. Most of the regressors were lagged values,
which avoids problems of contemporaneous correlations between regressors
and disturbance.
Landau found highly significant negative relationships between
the share in GDP of general government current expenditure (except educa-
tion and defense) and the growth of per capita GDP. In his smaller annual
sub-sample, for example, an increase of 1 percent of GDP in this category
of government expenditure was associated with a 0.25 percent lower growth
rate of per capita product. When the variables for private investment, the
share of taxes in GDP and the share of government budgetary deficits in GDP
were held constant, the coefficients for government expenditures decreased
l/ See Daniel Landau, "Government and Economic Growth in the Less
Developed Countries," in Report of the President's Task Force on
International Private Enterprise: Selected Papers (U.S. Government,
Washington, 1984).  See also Daniel Landau, "Government Expenditure and
Economic Growth: A Cross-Country Study," Southern Economic Journal,
January 1983.



- 54 -
ANNEX
in absolute values but retained their negative signs. This result led
Landau to infer that part, but not all, of the negative impact of current
expenditures on government services were due to the need to raise tax
revenue to finance this type of spending.
In the field of education, Landau compared the impact of govern-
ment educational expenditure as a share in GDP with a direct measure of
education output by weighted enrollment rates. The ccefficients for
government educational expenditure alone were positive but not statistic-
ally significant, whereas those for enrollment were both positive and
significant. The finding implies that education contributes to economic
growth, but government spending on education in the LDC's is not efficient
at producing actual education. A substantial proportion of educational
services is provided by the private sector in many LDC's but no data were
available to estimate its impact directly.
Perhaps the most important regression results concerned govern-
ment capital expenditure. The coefficients for the four sub-samples were
all negative, but only one was statistically significant. Thus, on net,
government capital expenditure seemed at best to be no help in growth and
was perhaps slightly harmful. This surprising result was explained by
introduting private investment and revenue raising variables into the
eqoation. The findings indicate that there was some return to government
investment, but the return did not cover the opportunity costs in terms of
higher taxes, larger deficits and the crowding out of private investment.
In contrast to government investment, Landau's analysis suggests
that private investment did increase the growth rate. The coefficients for
private investment were all positive and their significance levels ran from
better than 1 percent to 17 percent in the four sub-samples. While the
pay-off to private investment appeared to be much better than public
investment, it was not what one would hope. That might be explained,
Landau speculated, partly by deficiencies in the data. Many government
enterprises which operate autonomously are counted as private. An addi-
tional factor was perhaps various government policies and regulations
which, on the one hand, prevent private enterprise from entering the most
profitable and productive activities and, on the other hand, make non-
productive investment profitable. An example might be high protection of
assembly-type industries. Government distortion of prices and other incen-
tives may bring about a misdirection of genuinely private investment. A
study by Ramgopal Agarwala, discussed below, lends support to this
hypothesis.
Landau's main conclusion was that what is called development
expenditure by governments had no positive impact on growth in developing
countries during the period 1960-80. He offered a three-fold explanation:
(1) government investments are often inefficient, generating on average a
low return, (2) the taxation and borrowing needed to finance government
capital expenditure slow growth; and (3) government investment "crowds out"
private investment which does contribute to economic growth. The develop-
ment budget, he argued, is considered to be the main tool for promoting
growth in most LDCs, but the huge sums spent are not increasing growth.



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ANNEX
2. Government Intervention, Price Distortions and Growth
A large body of theoretical literature has demonstrated how price
distortions result in a loss of efficiency. Ramgopal Agarwala examined the
empirical evidence, undertaking a statistical analysis of the relationship
between price distortions and economic growth in 31 developing countries
during the 1970s.2/ These countries represented more than 75 percent of
the population of developing countries excluding China. 10 countries from
Sub-Saharan Africa were included.
Price distortions exist when the prices of goods and services, as
well as of capital and labor, do not correctly reflect their scarcity. For
goods that are internationally traded, scarcity is generally indicated by
international prices. Price distortions may be caused by monopolistic
tendencies in the private sector or by government intervention. It is
possible for government intervention, if properly designed, to correct
distortions. In most instances, however, price distortions are introduced
by government directly or indirectly in pursuit of some general or economic
objectives; sometimes deliberately, sometimes incidentally.
Agarwala's analysis concentrated on distortions in the prices of
foreign exchange, capital, labor, and infrastructural services (particular-
ly power). Distortions were not measured against some theoretical ideal,
but were practical approximations commonly used in policy analyses. For
example, the measure for foreign exchange focused on changes in real effec-
tive exchange rates from a base period, together with the effective protec-
tion or taxation of traded goods. Similarly, distortions in interest rates
were judged by how far interest rates were negative in real terms; in
wages, by movement in real wages relative to productivity adjusted for
changes in the terms of trade; in the value of money, by high and acceler-
ating inflation; and in infrastructure prices, by the rates of return in
utilities.
The study found that in many countries with a large balance of
payments deficit during the 1970s, the exchange rate was allowed to become
overvalued in relation to the purchasing power of the currency. This lack
of competitiveness became particularly serious in sub-Saharan Africa, where
the average real effective exchange rate appreciated by 44 percent between
1973 and 1981. Several African countries found that producers of tradi-
tional export crops could not be paid enough to cover their costs of
production, even though these were crops for which they have a strong
competitive advantage (cocoa in Ghana is an obvious example).
Trade restrictions (import ban's, quotas, and high tariffs) often
led to high and variable rates of protection between different manufactur-
ing industries. By contributing to an overvalued exchange rate, such
2/  See Ramgopal Agarwala, Price Distortions and Growth in Developing
Countries. World Bank Staff Working Paper No. 575, Washington, D.C.,
1983 and World Development Report 1983, Chapter 6, (Oxford University
Press, 1983).



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ANNEX
restrictions inadvertently discriminated against both exports and agricul-
ture. In several countries (such as Ghatna, Senegal and Tanzania) the bias
against exports was supplemented by export taxes or even outright restric-
tions, sometimes leading to increased agricultural imports at the expense
of domestic production. When import controls were intended to protect
infant industries, they were rarely geared to promote an industry's
long-run growth potential; nor were they reduced even after the industry
had reached adolescence. The loss of efficiency resulting from such
policies can be considerable. Apart from these losses, the system of
protection in many developing countries has been a serious administrative
burden, and by giving windfall gains to those who obtain import licenses,
often made the distribution of income more unequal as well.
Overvalued exchange rates and low tariffs on imported capital
goods encouraged capital-intensive techniques at the expense of creating
jobs. These tendencies were strengthened when interest rates charged to
borrowers (and paid to savers) fell short of the inflation rate. At
various times in the 1970s negative real interest rates were almost a
world-wide phenomenon. But they were particularly perverse and persistent
in countries such as Ghana and Nigeria.
Capital-intensive investment was also encouraged where the price
of labor was increased by unrealistic minimum wage laws and social
security taxes. In many mineral-based economies in Africa, the drive for
higher mining wages spread to other sectors. This pushed labor costs above
those of competitors, and encouraged rural people to leave land in pursuit
of the high wages paid to those lucky enough to find jobs in the urban
sector.
In his statistical analysis, Agarwala used a composite index
derived by calculating an average of,price distortions in the six price
areas covered. His regression results showed a significant relationship
between the price distortion index and economic growth in the 1970s. The
average growth rate of GDP of those developing countries with low distor-
tions was about 7 percent a year--2 percentage points higher than the over-
all average. Countries with high distortions averaged growth of about 3
percent per year, 2 percentage points lower than the overall average.
Among African countries, Malawi, Cameroon and Kenya were in the low distor-
tion, high growth category, while Senegal, Tanzania and Ghana were in the
high distortion, low growth category.
These findings suggest that Third World governments could stimu-
late economic growth by removing price distortions in three ways: (1) by
reducing direct interventions in product and factor markets in the form of
public sector monopolies and administrative and legislative controls;
(2) by encouraging competition among public and private enterprises by
lowering levels of protection from imports and allowing freedom of entry
into domestic production sectors; and (3) by leaving pricing decisions
largely to market participants subject to the laws of supply and demand.



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ANNEX
3. Alternative Development Strategies and Growth
A subsequent study by Bela Balassa 3/ supports these conclusions
in a specifically African context. Balassa examined the performance of 19
oil-importing African countries over the period 1973-79, using two classi-
fication schemes to differentiate between the development strategies
adopted by these countries. Development strategies were defined in terms
of the extent of public intervention in product, capital,labor, and foreign
exchange markets. Balassa assigned countries according to their policies
concerning relative incentives to manufacturing and primary activities; the
determination of exchange rates; the extent of price and wage control; the
setting of interest rates, the degree of credit rationing, and the licens-
ing of private investments; the choice of public projects and their rela-
tive importance in total investments; as well as the size of the government
budget deficit. In his first classification scheme, Balassa distinguishes
between "interventionist" and "market-oriented" countries; in his second,
he adopts three categories: etatist, intermediate, and private-market
oriented. Etatist countries exhibit the most public intervention in
economic life and are characterized by a high degree of state ownership and
rapid Africanization of middle- and high-level jobs in the economy. At the
other end of the spectrum are the private-market economies, with the rest
in an intermediate group.
The results of Balassa's statistical analysis are revealing. In
1973-79, GNP growth rates averaged 6.2 percent in market-oriented countries
compared with 1.9 percent in interventionist Sub-Saharan African
countries. Private-market economies achieved a 6.8 percent rate, interme-
diate economies 3.5 percent, and etatist economies 1.5 percent. The
results of regression analysis show a positive correlation between market
orientation and the rate of economic growth, significant at the 2 percent
level. Such a result was also obtained for private market economies; the
variable for etatist countries was negative, but not significant.
Balassa suggests that differences in growth performance may be
explained by differences in incremental capital-output ratios and in domes-
tic and foreign savings ratios. During 1973-79 incremental capital-output
ratios averaged 7.8 in interventionist countries and 4.4 in market-oriented
economies. Domestic savings ratios averaged 10.1 percent in interven-
tionist countries and 21.5 percent in market-oriented countries. Finally,
foreign savings ratios (the net inflow of foreign capital expressed as a
percentage of the gross domestic product) averaged 6.3 percent in interven-
tionist countries and 5.1 percent in market-oriented countries.
The effects of the choice o'f development strategies on incre-
mental capital-output ratios, taken to represent the efficiency of using
incremental resources, and on domestic savings ratios, reflecting the
success of efforts at domestic resource mobilization, are also indicated by
3/ See Bela Balassa, "Adjustment Policies and Development Strategies in
Sub-Saharan Africa," in Moshe Syrquin, Lance Taylor and Larry E.
Westphal, (Eds.) Economic Structure and Performance (New York, Academic
Press, 1984) pp. 316-40.



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ANNEX
the results obtained in the three-way classification. In 1973-79, incre-
mental capital-output ratios averaged 23.2 in etatist countries, 4.9 in
countries of the intermediate group, and 4.3 in private-market-oriented
countries; the corresponding domestic savings ratios were 10.5, 12.2 and
21.1 percent. Finally, private-market-oriented countries experienced the
smallest inflow of foreign capital (1.8 percent of GDP), followed by
etatist countries (4.0 percent) and the countries of the intermediate group
(9.9 percent).
Balassa argues that differences in incremental capital-output
ratios and domestic savings ratios are largely explained by the policies
followed. The application of protectionist policies, aggravated by export
taxes, price controls and the large margin of parastatal trading companies
discriminated against exports and against agriculture in interventionist
countries. On the whole, discrimination increased during 1973-79 reducing
the efficiency of investment.
A review of the experiences of the 1973-79 period further indi-
cates, according to Balassa, that interventionist countries failed to
devalue along with inflation. As a result, their real exchange rates
appreciated, discriminating against both exports and imports substitution.
The licensing of private investments and the implementation of high-cost
capital-intensive public projects further reduced the efficiency of
resource allocation in interventionist-particularly etatist-countries. By
contrast, a higher degree of openness, greater price flexibility, more
realistic exchange rates, a freer choice of private investments, as well as
a smaller number and a more judicious selection of public projects favor-
ably affected the efficiency of resource allocation in market-oriented
countries.
Domestic savings ratios are affected by public and private deci-
sions. By and large, the deficit in the government budget was larger in
interventionist than in market-oriented countries, thereby reducing public
savings. In turn, private savings were affected by interest rate policy.
During 1974-78 real interest rates on the average were negative in all the
Sub-Saharan African countries, but were most negative in two interven-
tionist countries Zaire (24.3 percent) and Ghana (21.8 percent) and least
negative in two market-oriented countries, Malawi (2.5 percent and Burkina
Faso (2.3 percent). Market-oriented countries increased reliance on
foreign capital to a much smaller extent than interventionist countries,
thus avoiding increases in debt-servicing ratios, which more than doubled
between 1973 and 1978 in etatist countries.
In conclusion, Balassa notes that in Sub-Saharan African
countries incremental capital-output ratios tend to be higher while savings
ratios and GNP growth rates tend to be lower than in developing countries
outside the region. He suggests that the differences may be explained by
the fact that public Interventions are more prevalent in Sub-Saharan Africa
than elsewhere in the developing world. The findings indicate the
importance of policy choices in Sub-Saharan Africa and point to the need
for policy reforms towards greater market orientation. The conclusions
thus support the findings of Accelerated Development in Sub-Saharan Africa,
the report prepared under the direction of Elliot Berg (World Bank, 1981).



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ANNEX
4. Credit Allocation and Growth
A study by Keith Marsden throws further light on the performance
of 17 countries in Africa and East Asia over the period 1962-82.4/ The
countries are Cameroon, Ethiopia, Ghana, Ivory Coast, Kenya, Korea,
Madagascar, Malawi, Malaysia, Mali, Philippines, Senegal, Sudan, Tanzania,
Thailand, Zaire and Zambia. They constitute all countries in East Asia and
Sub-Saharan Africa for which financial data are available, with the excep-
tion of OPEC members (Indonesia and Nigeria, which are special cases) and
countries with populations of less than 5 million. Their economic struc-
tures (predominantly agricultural) and income levels were similar at the
beginning of the period. The study uses data on domestic credit provided
by the monetary authorities and banks to government and public enterprises
on the one hand and to the private sector on the other. Data on external
public debt, that is, medium and long-term foreign loans to governments (or
guaranteed by them) are also analyzed. The countries are classified into
four groups--high growth, medium growth, low growth and negative growth of
GNP per head. The table below summarizes the findings.
Table 1
aREDIT AND GROWIH
Average Anumal   Share of Private
Growth of QCP   Sector in Domestic   Private D1bestic    Ecternal Public
Countries        Per Head(%)       Credit (%)      Credit (% of GNP)   Debt (% of GNP)
1962-82      1962      1982     1962      1982     1970     1982
High Growth          4.5           65        85       13       41       14       22
Madium Growth        2.3           92        65      13        28       22       46
LowGrowth            0.9           89       31       13        16       29       47
Negative Growth     -0.9           68        26       8         13      22       51
Source: IMF International Financial Statistics Yearbook, 1984 and Supplement on Output
Statistics, No. 8, 1984: World Bank,. World Development Report, 1984.
The results are striking. Regression analysis showed that
economic growth was strongly correlated with growth of domestic credit to
the private sector. A 1% increase in the real rate of growth of private
credit was associated with an increase in growth of GNP per head of 0.34%.
-~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
4/ See Keith Marsden, "Private Enterprise Boosts Growth" in Journal of
Economic Growth, Vol. 1, No. 1, 1986, and Keith Marsden, "Why Asia
0Boomed and Africa Busted" in The Wall Street Journal, June 3, 1985.



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ANNEX
The estimate is significant at the 99% confidence level. Economic growth
was also positively related to the shares of private sector credit in total
domestic credit and GNP. This suggests that the private sector used its
financial resources more efficiently than the public sector. Countries
which mobilized savings through financial intermediaries effectively, and
ensured ample access to credit by the private sector over the twenty year
period, achieved higher levels of gross domeacic saving in relation to
GNP. Saving ratios dropped sharply wherever governments came to dominate
the demand for domestic credit. This was true for Africa as well as Asia.
The differences among countries seem to be more related to differences in
policy than to inherent characteristics of the two regions.
Marsden found that economic performance was not significantly
correlated with financial flows from abroad. Foreign lending to African
governments was generally substantially higher in relation to GNP than for
their East Asian counterparts. But in most cases it failed to boost
growth.  In fact, the level of external public debt had a negative rela-
tionship with economic growth, although the association was statistically
weak. This indicates that foreign loans do not, by themselves, guarantee
higher output and may sometimes have an adverse impact. The risk is
greatest when governments raise taxes or borrow heavily in the domestic
capital markets to pay the local counterpart costs of foreign funded
activities within the public sector, or to cover the operating losses of
those financed from abroad in the past. However, the experience of the
higher growth countries suggests that moderate foreign borrowing by
governments can contribute to progress in the following circumstances.
First, the projects are well selected.   Second, the public sector's
managerial capacity is not over-extended. Third, the policy environment is
conducive to efficiency. Fourth, the debt can be serviced readily out of
export earnings. And fifth, the private sector is given adequate incen-
tives and opportunities to harness and develop domestic resources.
Another important finding is that, with one exception (Zaire),
all countries began the period with active private sectors and domestic
credit markets geared to their needs. The level of credit outstanding to
the private sector was relatively low as a proportion of GNP, but was
surprisingly uniform across country groups (8-13%). Africa and East Asia
started off on a similar footing. It was only over the next twenty years
that their paths diverged. But not all African countries took the same
route. This can be shown by a closer examination of the country groups.
In the high growth group (Korea, Thailand, Malaysia and
Cameroon), per capita incomes rose at an average annual rate of 4.5%. The
share of the private sector in total domestic credit went up from 65% to
85%. Outstanding loans to the private sector increased from 13% to 41% of
GNP. By adopting sound monetary and interest rate policies and by creating
an economic climate which fostered private initiative, these countries
raised their domestic savings rapidly and induced individuals and firms to
deposit their savings in financial instruments and financial inter-
mediaries. Private entrepreneurs in all sectors (including farmers) were
assured continued access to investment and working capital funds because
domestic borrowing by the government and public enterprises was kept at
moderate levels.



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ANNEX
Two factors in particular explain this moderation. First, rela-
tively low tax rates stimulated economic incentives and economic growth.
A rapid broadening and deepening of the tax base generated higher tax
revenues to pay for essential government services. Second, these high
growth countries were able to obtain external finance, often on conces-
sional terms from development agencies like the World Bank, to build up
their basic infrastructures. Again moderation was shown in this borrow-
ing. Their external public debt increased from 14% of GNP in 1970 to only
22% in 1982. Market oriented trade policies boosted exports and brought in
ample foreign exchange to service this debt. Exports averaged 36% of GDP
in the high growth group in 1982. Average annual growth of exports ranged
from 4% to 20% over the period 1962-82.
The medium growth countries (Kenya, Philippines, Malawi, and
Ivory Coast) achieved an average annual rate of increase of GNP per head of
2.3%. Their financial systems were particularly private sector-oriented in
1962, with governments acting as net lenders in three cases. Over the next
two decades, the volume of domestic credit channelled to private enterprise
rose significantly, in both absolute terms and in relation to GNP. But
governments absorbed a growing proportion of domestic financial resources,
and the private sector's share dropped to 65% on the average. Governments'
demands for foreign loans also increased dramatically. External public
debt reached 46% of GNP in 1982 compared with 22% in 1970. The private
sector retained sufficient access to financial resources to maintain a
reasonably buoyant level of economic activity overall, but economic growth
slowed considerably during the second,half of the period. The shift was
most abrupt in Malawi. Its budget deficit soared to 15% of GDP in 1980/81
and the government took 92% of the incremental credit extended by the
banks. Income per head actually declined over the last five years.
The presence of four African countries alongside four East Asian
countries in the medium and high growth categories demonstrates that
entrepreneurship is not lacking in either region. Their private sectors
have responded to incentives and opportunities created by appropriate
policies and have generally used their resources effectively. But their
experience also indicates that, even where private ente2prise is well
rooted, economic performance can be adversely affected if governments'
fiscal and financial appetites grow immoderately and if government controls
over prices, interest rates and foreign exchange allocations cause
market distortions which provoke inefficient resource utilization in all
sectors, public and private.
The risks of excessive government intervention are illustrated
vividly in the low growth group (Ethiopia, Tanzania, Mali, Senegal and
Sudan) and negative growth countries (Zambia, Zaire, Madagascar, and
Ghana). Economic stagnation or decline coincided with a massive extension
of government control over domestic funds. The private sector's share of
domestic credit fell to 31% and 26% in the two groups respectively.
External public indebtedness also increased sharply. Foreign loans were
often used to increase public investment and to cover the current deficits
of public enterprises in the main economic sectors, not just in infrastruc-
ture. But loss of confidence among foreign creditors in the domestic
policies adopted by these countries restricted their access to overseas
capital markets towards the end of the period.



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ANNEX
The study also examined two other variables which are often cited
to explain the poor performance of many African countries. The first is a
deterioration in their terms of trade. This undoubtedly added to their
difficulties. But apart from Ethiopia, Zambia and Zaire, the low/negative
growth countries fared no worse than did the high/medium growth countries
over the period 1970-82.
A second factor is said to be a growing dependency on imported
foodstuffs, thus tying-up scarce foreign exchange. Periodic drought has
affected agricultural output in Africa, but so have defective pricing,
exchange rate and marketing policies. Long-run economic growth does not
appear to be negatively linked to the level of food imports. In fact, the
two countries with the highest levels of cereal imports per capita in 1982,
Korea and Malaysia, are both in the high growth category. By promoting
exports and diversifying their economies, they had no difficulty in paying
for imported food.
Korea and Ghana provide the sharpest contrast in performance
among the countries reviewed. In 1962 their incomes per head were almost
identical, $491 and $490 in 1980 U.S. dollars. They also had other charac-
teristics in common. 64% of Ghana's labor force was engaged in agriculture
in 1962 compared with 66% in Korea. 90% of Ghana's exports were primary
products compared with 86% of Korea's. Yet just twenty years later, the
average Korean enjoyed an income five times that of the average Ghanaian.
Korea did begin with higher levels of adult literacy, but Ghana's human
resources were among the most developed in Africa in 1962. So, this factor
alone does not explain the subsequent disparities. 90% of Korea's exports
were manufactured goods in 1982 and it had become a major force in world
markets in such fields as shipbuilding. Exports represented 39% of GDP.
Private sector credit amounted to 49% of GNP and 87% of total domestic
finance. Public enterprises contributed only 6% of GDP and they maintained
a current account surplus. The total tax/GDP ratio averaged 14.2 percent
during the 1970s. The burden of direct taxes on the top three income
deciles (from which most entrepreneurs are drawn) averaged only 1.8 per-
cent, 3.6 percent and 11.7 percent of their total incomes.
Ghana's rudimentary industry on the other hand, was working at
below 25% of capacity because of inadequate demand and scarcity of foreign
exchange for imported inputs. The entrepreneurial skills and resources of
the Ghanaian cocoa farmer, which had produced one of the highest living
standards in Africa at the time of independence, had been drained by state
marketing boards to finance ill-conceived public investment and to maintain
an inflated bureaucracy. By 1982 the private sector was so squeezed, and
the public sector so inefficient, that tax revenue had fallen to 4% of
GDP. Exports accounted for only 2% of GDP, down from 28% in 1962. Private
sector credit was also merely 2% of GNP.
There is some evidence that official data may exaggerate the
extent of Ghana's economic decline. Entrepreneurial energies have been
channelled into an underground" economy and a parallel market. Never-
theless, the Ghanaian authorities now recognize that the government's role
had become too pervasive and had undermined a critical asset, the sptrit of
enterprise of its people. Ghana has recently embarked on a program of



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ANNEX
reforms to strengthen market mechanisms and to restore personal
incentives.
In conclusion, the record of the seventeen countries covered in
this study, as well as broader international experience, supports the view
that mobilization of domestic savings and access by the private sector to
credit are key elements in development. The record also shows that rich
countries can make important contributions to Third World progress in two
ways. First, they can assist governments in their crucial functions--
strengthening the infrastructure, diffusing technology and know-how and,
above all, creating a policy environment conducive to enterprise and
initiative. Second, continued access to developed country markets is vital
if developing countries are to climb from poverty largely by their own
efforts. International cooperation in these forms should prove to be more
than enlightened self-interest for all parties.
5. Provision of Agricultural Inputs and Growth of Agriculture
Finally, in this review of cross-country empirical studies which
examine the impact of government and the private sector from different
perspectives, attention is drawn to the work of Richard Vengroff and
Ali Farah who focus their analysis on agriculture.5/ The main question
examined is the relationship between government involvement in the rural
sector, particularly by the provision of inputs, and agricultural moderni-
zation and productivity. The authors use data on 39 Sub-Saharan African
countries. The independent variables chosen fall into two categories. The
first concern the supply of agricultural inputs: (i) fertilizer,
(ii) seeds, (iii) chemicals, and (iv) farm equipment. For each country,
each input is classified as being provided entirely by the private sector,
or by government, or by a combination of both. For each of these farm
inputs, a 1 is assigned for private, a 2 for private-public and a 3 for
government distribution. These values are then totalled for each nation,
the result being a scale ranging from 4, indicating agricultural inputs
provided completely by the private sector, to 12 for those nations in which
all four agricultural inputs are provided by the state.
The second independent factor, government commitment to agricul-
ture, is measured by two variables: the percentage of (i) the central
government's functional expenditures allocated to agriculture (1978) and
(ii) the share of the increase in the central government's expenditure
going to agriculture (1972-78). These provide a good indication of the
relative importance of agriculture compared to other areas of government
spending and also whether the share devoted to agriculture is increasing or
decreasing.
Three types of dependent variables were taken: (i) the first
measures the growth in agricultural production (food, non-food and total),
food production per capita and growth in agriculture production per capita;
5/ See Richard Vengroff and Ali Farah, State Intervention and Agricultural
Development in Africa: A Cross-National Study, The Journal of Modern
African Studies, 23. I (1985) pp. 75-85.



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ANINEX
(ii) the second measures the adoption of modern agricultural inputs,
notably fertilizer and consists of average fertilizer consumption, use per
hectare of arable land and growth in fertilizer consumption; and (iii) the
final set measures food self-reliance/dependency by total and per capita
food aid imports, and food as a percentage share of merchandise imports and
exports.
Vengroff's and Farah's findings are instructive. In many African
states agricultural inputs tend to be provided by governments. Speci-
fically, as many as 64 percent and 61 percent supply fertilizer and seed,
respectively. In only four out of the 36 states on which data are avail-
able are either of these two inputs provided entirely by the private
sector. Chemicals are provided by the government in just under half (47
percent) of the sample. The comparable figure for farm equipment is
slightly lower (42 percent), with the number of countries relying entirely
on the private sector (22 percent) being higher than for any of the other
agricultural inputs.
When the authors examined the rank correlation between their
overall scale as regards the source of agricultural inputs and the measures
of productivity they found that the relationships were negative in all nine
instances and significant in five.  The growth in food production, both
total and per capita, and in agricultural production are all strongly and
negatively associated with government involvement in the provision of agri-
cultural inputs. That is, the more the government is involved, the lower
the productivity.
Turning to fertilizer utilization, as an indicator of the adop-
tion of modern techniques, the authors found evidence that the supply and
distribution of fertilizer are more efficiently handled by the private
sector. The countries that relied on the private sector used more than ten
times as much fertilizer per hectare of arable land as did those that used
a system of mixed public-private distribution, and 20 times more than those
relying on government distribution.
Vengroff and Farah looked next at the degree to which government
commitment to agriculture is related to productivity. The relationship
between increases in a government budgetary allocation for agriculture, the
percentage of total government expenditures devoted to agriculture and the
measures of agricultural productivity were all negative although only one
out of the 18 coefficients was significant at the 0.05 percent level.
Hence, it seems that additional government support does not necessarily
have a positive impact on agricultural productivity.
Finally, the study revealed a strong positive relationship
between government inputs and food-aid imports. That is, the more govern-
ment inputs in agriculture the greater the dependence on foreign food aid.
However, the authors advised caution in interpreting the findings. The
heavy government involvement in agriculture may be a strategy adopted by
certain nations to help overcome their shortages rather than a cause of
their food dependency. Nevertheless, they concluded by suggesting that
several inferences could be drawn from their data:



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ANNEX
1.   The utilization of government services to distribute agricultural
inputs in Africa, and hence to stimulate increased productivity, seem to
have failed. Much of the blame can probably be attributed to the inade-
quate management of these resources by the public sector, and to many of
the pathologies associated with third-world bureaucracies. Problems
ranging from inadequate resources to poorly trained extension agents have
also contributed to this failure.
2.   Political factors have also played a significant role.  Resources
which have consistently been siphoned off from government-controlled agri-
cultural inputs and marketing systems have rarely been reinvested in agri-
cultural development or returned to the producers as profits.
3.   Not only has government management of agricultural inputs proved
to be less adequate than either private or mixed management, but it is also
less effective in promoting the adoption of modern techniques. This may be
tied to the difficult environmental conditions experienced by farmers in
many African countries where the private sector is not well developed.
4.   Those nations relying on governmental systems for the distribu-
tion of agricultural inputs appear to be more rather than less dependent on
foreign food aid than those that use either a mixed or a private format.
The temptations for governments to rely on foreign donors at the expense of
local food production are immense and work against the long-ra1ige interests
of food self-sufficiency.
5.   Finally, it seems that many African governments are somewhat
remiss in exploring the possibilities of stimulating private sector
suppliers of inputs as a more efficient means of promoting their agri-
cultural development.
6. Conclusions from Empirical Studies
The most constructive interpretation of the findings of these
studies is that policies matter and do work in Africa in the same way as
elsewhere. African economies have performed better when markets have been
allowed to function relatively freely. Entrepreneurs do exist in Africa
and have responded well to appropriate incentives in some countries, but
have been repressed or discouraged in others. This is not theory, or
hypothesis, or ideology. Real life experience lies behind these dry
statistics.
The findings do not imply, of course, that governments should
abandon their important functions of building basic infrastructures,
providing social services, ensuring adequate security and justice for their
citizens and correcting market imperfections through laws and regulations.
The evidence does suggest, however, that many African governments have
(i) overextended their financial, managerial and administrative resources
by trying to do too much, particularly through direct public investment and
state ownership in economic sectors where private entrepreneurship would be
forthcoming and be more effective; and (ii) created market rigidities and
distortions and discouraged private resource mobilization by excessive
intervention in areas where decisions and choices could be left to
producers and consumers.



- 66 -
ANNEX
The broad lessons that may be drawn for future strategy are that
African governments could accelerate progress towards their national
economic and social goals by doing fewer things better themselves, while at
the same time widening the scope for private enterprise by removing
barriers and constraints to private initiative and fostering open,
competitive markets.



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