Cover Image
close this bookPrivate Sector Development in Low-Income Countries - Development in Practice (WB, 1996, 188 p.)
View the document(introduction...)
View the documentForeword
View the documentAcknowledgments
View the documentAcronyms and abbreviations
View the documentDefinitions and data notes
View the documentOverview
close this folderChapter 1-From state to market uneven progress
View the document(introduction...)
View the documentRecent policy reforms
View the documentFast and slow growers
View the documentThe drag of public
View the documentRegulation and barriers to competition a harsh business environment
View the documentPoor quality of physical infrastructure and human resources
View the documentThe reform agenda
close this folderChapter 2-Establishing an attractive business environment agile firms, agile institutions
View the document(introduction...)
View the documentThe private sector's assessment of the business environment
View the documentFoundations of a dynamic private sector
View the documentSecure, flexible transactions
View the documentCompetition-and simplified regulation
View the documentEnterprise development
View the documentEfficient infrastructure
View the documentThe agenda for developing an attractive yet competitive business environment
close this folderChapter 3-Reforming public enterprise farther performing and faster
View the document(introduction...)
View the documentPublic enterprises are not performing well
View the documentTurning to the private sector—slowly
View the documentThe way forward—farther and faster
close this folderChapter 4-Building robust financial systems— difficult but pressing
View the document(introduction...)
View the documentWhat went wrong?
View the documentWhat has been done?
View the documentWhat remains to be done?
View the documentThe path for reform
View the documentSelected bibliography

Competition-and simplified regulation

Competition is fundamental if firms are to court the market for profits and not the state for favors. Regulatory and competition policies have to facilitate market entry and exit, increase factor mobility, offer a level playing field, and reduce transaction costs.

Many low-income countries—especially those in Africa—have made important strides in the past four years in boosting internal and external competition. But most governments are still reluctant to relinquish discretionary latitude in their regulatory powers. They remain concerned about monopoly profits, the misuse of incentives, and the vulnerability of small, indigenous entrepreneurs. Some of these concerns are justified, insofar as they relate to unfair trade practices. But the evidence suggests that in many instances special incentives get misused. Small firms fail to benefit while larger, well-connected firms public firms get around the regulations, circumventing the competition that the rules were supposed to achieve.

BOX 2.5 LEGAL REFORM: A NEW AND GROWING BUSINESS

Member countries have increasingly sought IDA assistance to improve their legal systems. IDA adjustment credits have supported programs that included amending specific laws related to economic efficiency.

· Under a structural adjustment credit in Benin, specific legal measures were introduced to enhance loan recoveries—including reform of relevant judicial procedures, land title records, and commercial laws.

· Bolivia's structural adjustment credit supported both the enactment and enforcement of new banking laws and regulations. Investment credits and technical assistance credits have helped countries examine legal issues hindering the development of a specific sector.

· In Kenya, the Parastatal Reform and Privatization Project financed a comprehensive review of laws affecting the development of the private sector and the restructuring of public enterprises.

· Cd'lvoire's Economic Management Project enabled the Ministry of Justice to strengthen laws and judicial procedures related to commerce.

· Mozambique's Roads and Coastal Shipping Project provided assistance for the revision of laws and regulations for small ports and coastal shipping. In recent years, it has become increasingly clear that—to improve a country's ability to enact, apply, and enforce laws—legal reform needs to be comprehensive. Free-standing technical assistance credits and grant funds have been used to address major reform issues in the legal and judicial sector.

· Under the Zambia Financial and Legal Management Project, a comprehensive training program for legal and paralegal staff is being carried out within both the judiciary and government, and support is being provided for upgrading the physical infrastructure and logistic capabilities.

· In Tanzania, a Financial and Legal Management Upgrading Project is assisting the government to undertake a review of commercial laws, upgrade the attorney general's office and court libraries, undertake various legal studies, and train judges, magistrates, and administrative officers of the courts.

· In China, a free-standing legal technical assistance project is supporting legislative subprojects, legal training subprojects, and institutional support for core legal agencies.

· In Viet Nam, IDA is providing assistance in the drafting of laws governing state enterprises, bankruptcy, and land ownership.

To improve the efficiency of land markets, IDA has assisted low-income countries in rationalizing land laws, in harmonizing them with customary laws, in undertaking land surveys and in strengthening land titling, adjudication, and registration procedures. This support includes, for example, improvements in the system of recording various types of land rights in Cd'lvoire, in mapping and land conveyancing procedures and adjudication of land disputes in Ghana, and in land titling procedures in Albania.

The challenge for government is to create incentives firms to invest and complete for a larger market and to provide the means to do so.

Experience from developing and industrial countries alike suggests there are simpler, cheaper, and more effective ways to address these concerns. A competitive trade regime with low uniform rates of effective protection can deter monopolistic behavior. Low and uniform rates of taxation can minimize the misuse of fiscal and tax incentives. Better laws and better-functioning legal institutions can offer transparent and equitable methods of protection without distorting incentives. Firms are more likely to grow and remain competitive when trade expands, when investments can be made easily, and when regulations are simple and transparent.

The challenge for government is to create incentives for firms to invest and compete for a larger market and to provide the means to do so. Doing this implies reducing barriers to trade, encouraging domestic and foreign investment, and applying simple regulations openly and expeditiously, supported by efficient infrastructure. Many countries have made progress in reducing trade barriers. The challenge now is to reduce quickly and systematically the burden and cost of business regulation and poorly performing infrastructure while maintaining steady progress on dismantling trade barriers.

Promote external and internal competition

Most countries, often with the help of IDA, have made notable progress in reforming their exchange rates and trade regimes, with reforming African economies notable among them (box 2.6). Exchange rate reforms have eliminated large black market premiums in countries where the official exchange rate had been kept artificially low. Devaluations, leading to large real exchange rate deprecations, and reduced rationing of foreign exchange, often through auctions, have been among the biggest changes. Similarly, these countries removed most indicated its intention to phase out most quota restrictions. It also intends to unify its large domestic market by building up over the next three years with IDA assistance a comprehensive system of economic trade laws and regulations that apply uniformly across the country.

BOX 2.6 IDA SUPPORT FOR AN ATTRACTIVE BUSINESS ENVIRONMENT

IDA has worked closely with governments in low-income countries to establish an attractive business environment for the private sector. It has provided extensive financial and technical support for policy interventions that reduce distortions in the economy, remove barriers to international and domestic competition, and minimize regulatory burdens on the private sector. The nature of IDA's support has evolved over the past decade. In the 1 980s, as part of macroeconomic stabilization programs, IDA supported reforms relating to foreign exchange and trade regimes. Since then, most countries in Africa have substantially eliminated black market premiums (particularly Ghana, Uganda, Mozambique, and Zimbabwe) and reduced exchange controls. IDA also supported trade reforms that reduced tariffs (for example, in Bangladesh, Ghana, and India), eliminated quantitative restrictions (for example, in Burundi, Ghana, Senegal, and Zambia), and replaced quantitative restrictions with tariffs (for example, in Burundi, Ghana, Madagascar, and Zambia). Trade reforms aimed at further reductions in tariff and nontariff barriers continue to receive attention in IDA operations.

Since the end of the 1980s, the focus of IDA support has shifted toward structural and sectoral reforms. These include:

· Eliminating or reducing the number of products subject to price controls (as in the Central African Republic, Madagascar, Niger, Sierra Leone, Tanzania, and Uganda).

· Eliminating controls on profit margins (as in Gabon, Guinea-Bissau, and Madagascar).

· Ending parastatal monopolies in production, distribution and marketing (as in Ethiopia, Ghana, and Tanzania).

· Abolishing or easing product and sector licensing policies (as in Cd'lvoire, Ghana, India, and Senegal).

· Eliminating punitive rates of taxation, replacing turnover taxes with value-added taxes, and simplifying tax structures, administration, and quantitative restrictions and foreign exchange licensing. But most governments in Africa have adopted a gradual approach to reducing tariffs—both because of the importance of trade taxes for revenues and because of the perceived need to phase in reductions in effective protection. Progress has focused on simplifying and reducing maximum tariff rates (table 2.2). Similarly, tariff collection has improved, though in some countries average tariff collection rates remain below average statutory tariffs, largely because of discretionary exemptions.

Except in Sri Lanka, average tariffs in South Asia are still high and more dispersed relative to other regions, thereby holding back exports and muting competition in domestic markets. Quantitative restrictions still afford considerable protection to a wide range of products, particularly consumer goods. Some countries, such as Bangladesh, India, and Pakistan, have only recently accelerated their tariff reforms. China has taken steps to reduce tariffs and has compliance (as in Bangladesh, Ghana, India, and Uganda).

· Revising and streamlining investment codes (as in Benin, Ghana, Guinea Bissau, Mauritania, and Uganda).

· Simplifying regulations governing enterprise creation and operation (as in Burundi, Central African Republic, and Ghana).

· Enacting new labor legislation (as in Burkina Faso and Gabon).

· Reducing restrictions on hiring and discharging labor (as in Benin, Burundi, Lao People's Democratic Republic, and Zimbabwe).

· Establishing safety nets for retrenched labor (as in Bangladesh, Cape Verde, and India).

Between fiscal years 1988 and 1994, IDA's average annual lending in support of favorable yet competitive business environments was $1.6 billion—about 28 percent of IDA average annual lending. The number of projects with explicit reform components averaged 29 each year. Reforms have been supported through a wide range of sectors and lending instruments. In Africa, structural and sector adjustment operations have been used as effective and comprehensive instruments for improving the business environment. Between 1988 and 1994, trade reforms were supported in 18 adjustment operations, price reforms in 39, reforms in regulations and regulatory institutions relating to customs, taxes, and investments in 37, reform of sector-specific investment policies in 22, and reforms of labor markets in 23. In addition, sector-specific investment operations in agriculture, infrastructure, mining, energy, and industrial sectors have been used in all IDA eligible low-income countries to address specific impediments to private investment. Finally, through a significant program of economic and sector work, IDA has worked closely with governments and the private sector to identify critical constraints and institutional deficiencies in the incentive and regulatory framework.

The major impact of liberalizing trade has been to give firms easier access to technology, capital, and intermediate goods and critical raw materials. Tariff reform increases internal competition, reduces production costs, improves product range and quality, and increases the incentive to export. In India, the reduction in inventory costs alone probably amounts to several percentage points of total cost. Recent surveys in Africa also show that industry and services have gained because of increased access to production inputs, with important gains for informal sector activities and the smaller businesses in the formal sector. In the reforming economies of Sub-Saharan Africa, industry grew by 4.3 percent a year during 1987-93 after falling by 3.0 percent a year during 1981-86.

TABLE 2.2 TARIFF RATES IN SELECTED LOW-INCOME COUNTRIES

Country

Average unweighted tariff rates (percent)

Quantitative restrictions (QRs)

China (1992)

43

Up to 50% of imports covered by QRs

Viet Nam (1991)

11

Nearly all QRs were replaced by tariffs in 1994

Bangladesh (1994)

30

Less than 10% of tariff lines are covered by QRs

India (1994)

53

38% of tariff lines are covered by QRs

Pakistan (1994)

50

The negative list has been reduced from 215 categories to 75, and the restricted list has been removed

Sri Lanka (1994)

25

All QRs have been removed

Cameroon (1994)

16

All QRs have been removed

Cd'lvoire (1994)

19

Up to 50% of QRs were removed in 1994, and 90% of nonoil imports will be free by January 1996

Ghana (1991)

17

All QRs have been removed

Kenya (1994)

26

No significant QRs

Nigeria (1990)

33

20% of industrial production and 30% of agricultural



production were covered by QRs in 1994

Senegal (1994)

a

QRs eliminated, except for items agreed with specific firms prior to 1987. These will be replaced by a 20% import surcharge

Tanzania (1992)

33

QRs to be eliminated as part of the reform program

Zambia (1994)

25

No significant QRs

a. Tariff rates range between 10 percent and 45 percent. Luxury items are subject to an additional 20 percent import duty

Source: World Bank data.

Similar accelerations in growth and exports were found in services and agriculture between the two periods as firms, particularly smaller firms, successfully adapted to new incentives by changing the product mix, inventory, and labor costs under their control. New labor-intensive and export-oriented businesses also emerged in agriculture and services in response to the altered incentive structure. And evidence from several African countries suggests that these firms tend to be more robust than their predecessors—more oriented to global markets and with better educated entrepreneurs.

One of the best ways to acquire technology and increase the capacity to respond and compete is through trade. Imports of capital goods, equipment, and inputs embody years of acquired knowledge. The technical support services that generally accompany these imports are also a major source of knowhow for improving production capabilities. So are buyers of a country's manufactured exports. Then, through domestic trade and labor mobility, this know-how gets widely diffused throughout the economy.

The importance of trade in acquiring technology through imports of capital goods, equipment, and inputs is demonstrated by the growth of export-oriented garment industries in Bangladesh, cut flowers in Colombia and Kenya, and diamond cutting in India, as well as by the high growth in the coastal regions of China, where tariff barriers were almost totally eliminated.

Further reform efforts have been slowed because of concerns expressed by governments and the private sector that rapid liberalization will lead to deindustrialization, decimate small and medium-size industries, and retard the growth of nascent domestic entrepreneurship. True, firms suffer when incentives change, especially capital-intensive public enterprises that have developed behind tariff barriers or under the umbrella of public protection and whose domestic market may shrink as they face import competition. But this is seldom the case in low-income countries. Exemptions and quantitative restrictions abound, particularly in Asia. And tariffs remain high—it is not uncommon to find effective rates of protection between 40 and 60 percent. This distorts the markets, mutes competition, and inhibits exports.

In many countries, however, a good part of effective protection is eroded by the high cost of doing business stemming from inefficient public enterprises and utilities, onerous regulatory requirements, poor quality and high cost of supply from public sector, and heavy financing costs. Increasing tariff and nontariff protection is self-defeating because it limits the firms' ability to obtain the inputs necessary to compete both internally and externally. Similarly, selective and temporary protection, as applied in East Asia, requires a capable and honest civil service that can administer, monitor, and adapt these incentives quickly to market conditions. In most low-income countries, there is little domestic competition, and civil services are weak. So, the emphasis has to be on the systematic reduction of the heavy costs of excessive economic and administrative regulation, one of the root causes of the problem. This reduction complements the continuing efforts to lower effective rates of protection, reduce tariff dispersion, eliminate quantitative restrictions, and remove impediments to internal trade. The following sections deal with various aspects of the regulatory environment.

Eliminate preferential treatment of the public sector

A major obstacle to making markets competitive is the dominance of state owned enterprises in key sectors of the economy (see chapter 1). In many countries, the high cost and poor quality of inputs provided by state-owned enterprises (utilities and others) increase production cost by as much as 30 percent and deprive firms of opportunities both inside and outside the country. In Africa, state monopolies for agricultural commodity exports have held back growth of the private sector.

Costly monopoly marketing arrangements involving state-owned marketing enterprises have reduced returns to farmers and muted the impact of trade and exchange rate reforms intended to improve incentives for farmers. A desire to tap an easy source of revenue to feed hungry government coffers has been one of the main reasons for continuing to control commodity exports. Even where state marketing boards have been abolished, de facto monopolies stir] thrive. Private entry has been restricted through licensing arrangements, transport restrictions, and control over processing and storage facilities. And in many instances, state marketing boards enjoy privileged access to financing from state-owned commercial banks.

One argument for government intervention in agricultural markets is to prevent the exploitation of farmers and consumers by marketing middlemen. Yet in many instances the entry of private traders has had a positive impact (box 2.7). Traders provide credit and technical advice to farmers. And by investing in vehicles and collection points for moving inputs and outputs, traders strengthen rural infrastructure and connect farmers to bigger markets.

BOX 2.7 THE AGRICULTURE SECTOR RESPONDS TO MARKET REFORMS

Tanzania.

In 1990, all restrictions on private grain purchases were removed at the farm level. And despite many remaining legal, regulatory, and infrastructure obstacles, private traders have managed to improve farmers' access to markets, increase food supplies, and stabilize food prices in urban areas. Free entry has also increased competition, reduced profit margins in private trading, and contributed to the revival of the cashew nut sector. With farmers now having their crops collected early and being paid promptly, production went from 29,000 tons in 1990-91 to 41,000 tons in 1992-93. Cashew farmers are beginning to rehabilitate their farms and plant new trees.

Malawi.

Following a series of reforms, private participation in domestic maize marketing has increased considerably. Despite unfair competition from the state-owned marketing agency, private producers have managed to capture a considerable share of the domestic market by paying farmers substantially higher prices than the state-owned agency.

India.

A host of regulations prevented domestic private companies from participating in the seed industry until the early 1980s, when these polices were liberalized. By 1990, the private sector's share in the value of commercial seed sales reached roughly 70 percent, with growth being most rapid in sorghum, pearl millet, cotton, and vegetables. Older companies spun off numerous new companies, considerably increasing competition and offering farmers greater choice in their seed purchases.

By simplifying regulations for private entry and privatizing financial systems to expand access to credit beyond government agencies and a handful of privileged traders, governments can foster considerable competition in rural marketing. And by increasing public investments in rural infrastructure such as roads and market facilities, governments can reduce entry costs and spur competition.

Simplify regulations to reduce the cost of doing business

One of the biggest complaints of firms in low-income countries relates to the complex maze of opaque, restrictive, and highly discretionary regulations for investments, business operations, fiscal incentives, customs, and taxes. These regulations thwart competition, segment markets, increase the cost of doing business, and discourage foreign direct investment. They have encouraged rent-seeking strategies where larger profits can be made by manipulating rules and excluding competition than by improving competitive capabilities.

Many countries have undertaken systematic efforts to reduce the burden of excessive regulation. When these reform efforts are viewed as credible, firms react positively, as in India (box 2.8). The challenge for governments is to reduce trade and investment impediments, reduce barriers to entry and exit' increase labor mobility, simplify regulatory tax administration, and implement regulations through responsive and accountable public institutions.

Even many countries that have simplified investment licensing still have discretionary business licensing to grant special privileges and monopolies to some firms at considerable cost to the rest of the economy. In India, layers of federal and state policies continue to inhibit interstate commerce, depriving entrepreneurs from economies of scale and scope. Product reservation, licensing, and industrial location policies have segmented markets, increased prices for consumers, and removed incentives for efficiency and productivity improvements. As a result, it is not unusual to see inefficient firms operating at a fraction of installed capacity for extended periods, while maintaining the same market share as efficient firms.

In Senegal, favored firms received such special long-term concessions as tax incentives, production and distribution monopolies, import protection, and price guarantees. A domestic sugar monopoly has cost the economy some $55 million a year, $7 million of it in direct subsidies. This arrangement has also prevented another local firm from selling sugar cubes in the domestic market at half the monopoly's price. Having imposed considerable costs on the rest of the economy—and reduced competition—these concessions are now being progressively removed.

BOX 2.8 INDIA: CREDIBLE REFORMS LEAD TO STRONG SUPPLY RESPONSE

Since 1991, India has been implementing economic reforms that have been moving its private sector to the lead in its development strategy. Investment deregulation, trade liberalization, financial reforms, and tax reforms have transformed the environment for private investment. The government has deregulated and opened most areas of the economy to the private sector, reduced tariffs and quantitative restrictions, and opened the financial sector to private competition.

· In manufacturing, licensing requirements now apply to only 15 listed industries.

· In mining, 13 minerals previously reserved for the public sector are now open to the private sector.

· In some areas of infrastructure, private participation is now possible and encouraged—in the power sector private entry is unrestricted, with up to 100 percent foreign ownership. Private airlines compete with the state airline on domestic routes. The private sector can enter the railways sector through "own your wagon" schemes.

Coastal shipping has been completely deregulated.

Even in sectors that are still reserved for the public sector, such as telecommunications, petroleum, coal, and postal services, the government has taken a liberal stance toward private investments. Private operators can provide value-added services in telecommunications. Private courier services can compete with government postal services. And more private investment is being sought in the petroleum sector.

Maximum tariffs have been slashed from 400 percent in 199091 to 65 percent in 1994-95. Average tariffs have declined from 128 percent in 1990-91 to 53 percent in 1994-95. Import licensing for capital and intermediate goods has been eliminated, and customs duties have been rationalized to lower capital and input costs. Export controls on agricultural commodities have also been reduced.

In the financial sector, interest rates have been partially liberalized. International standards on prudential lending norms and capital adequacy guidelines have been adopted. Government financial institutions have been encouraged to raise equity. And private entry in the banking system has been allowed. The government is also considering new private entry in the insurance sector.

Laws and regulations for foreign investment have been made more flexible and less discretionary. Automatic approval for 51 percent foreign equity participation is allowed in 34 "high priority" industries. New rules for foreign portfolio investments have been instituted to attract foreign capital in the stock markets.

A comprehensive program of tax reforms is being implemented. Corporate income taxes have been reduced. The excise system is being simplified and converted into a value-added tax system with fewer different rates. Invoices are used for the determination of value.

Reforms at the federal level are being accompanied by state initiatives to simplify investment and business regulations. In Gujarat, private participation has been allowed in the development of ports and in power generation. In Kerala, a green-channel scheme has been introduced to expedite industrial clearance. In Uttar Pradesh, inspections by various government agencies are being simplified. And in Andhra Pradesh and Orissa, power purchase agreements with private suppliers have been signed.

Results have been significant. Foreign direct investment rose from $165 million in 1990 to more than $600 million in 1993-94. Portfolio investment went from nearly nothing in 1991-92 to more than $4 billion in 1993-94. Exports grew by 20 percent in 199394. Private air operators have captured 40 percent of domestic air traffic business and spurred the state airline to improve its customer services. Some 87 independent power project proposals (total capacity of about 50,000 megawatts) have been submitted. Ten new private banks have received banking licenses, and eight new foreign banks have established branch operations.

When fiscal incentives are provided case-by-case, protracted negotiations with government agencies are common. Firms lacking political clout are usually blocked out. In the Philippines, the Board of Investments approves tax and duty exemptions on imported capital equipment and on investments in "pioneer" sectors for individual companies. Large firms oriented toward domestic markets enjoy most of the benefits—to the exclusion of small and medium-size firms that are important for exports.

There is growing acceptance of the principle that licensing should serve to register and monitor enterprises and not to restrict entry. The existence of productive capacity is no longer a criterion for denying new licenses in Ghana. The licensing of new industries has recently been simplified or removed from ministerial discretion in Zambia and Zimbabwe. Some countries have tried to streamline investment applications through "one-stop shops," which have had mixed results. In Mali and Senegal, the Guichet Unique undertakes regulatory and fiscal formalities for applicants, but entrepreneurs complain that they have to provide excessive documentation and must often still pursue approvals from various ministries.

The costs of all this for doing business are clear and documented. Business licenses cost formal Kenyan firms an estimated 5 percent of sales. And Bolivian enterprises have to complete as many as 86 registers and records, a time-consuming process that can reduce before-tax profit of 25 percent to as little as 5 percent.

Solving these problems begins at the top—with a conviction that reducing the interference and hostility to business at the working level is a top priority. Part of the problem in many countries is that the commitment to liberalization at the highest levels of government has not yet reached the middle and lower levels of government, where hostility and corruption are often compounded by poorly trained civil servants. Beyond that are technical issues of streamlining regulations and their administration and aggressively promoting investment opportunities.

Promote labor mobility

Labor reform is another area of increasing concern, particularly in large organized sectors. Though detailed information on labor markets is not available for many lowincome countries, government regulation generally reduces labor mobility. Large firms bear the brunt of rigid labor laws that constrain them from restructuring their operations, force smaller capacity expansions than otherwise, and reduce employment creation by encouraging capital-intensive modes of production.

Rigid labor laws have also slowed the pace of economic reforms, privatization, and state enterprise reforms. In India, where the organized industrial sector accounts for 80 percent of industrial value added, constraints on rationalizing the labor force are a heavy drag on industrial growth. In China, the competitiveness of the state-owned sector has been crimped by the need to maintain high employment and provide workers with housing, medical care, schools, transport, and other social services not usually provided by other firms. Their labor costs are more than twice those of collectively-owned enterprises.

The challenge is to unbundle these services and transfer them to municipalities or commercial entities so that firms can operate on a commercial basis and labor is free to seek opportunities elsewhere.

Simplify customs and tax structures and administration

Customs and tax institutions also take a heavy toll. Fully one-third of the time required to ship freight between landlocked Mali and neighboring ports in Lome and Abidjan is for customs clearances. Few Sub-Saharan countries have an effective system of rebating domestic taxes on exports. Duty drawback and bonded warehouse systems are not well developed or widely publicized. Firms have to engage in extensive negotiations to take advantage of export programs, incurring delays and reduced competitiveness in the process.

In many countries, tax agencies have considerable latitude in the content and timing of their decisions. In Egypt, a business may not know its tax liability forten years after submitting its declaration. Cumbersome sales tax and excise duty procedures hinder the operations of firms and encourage tax evasion in many countries. Bangladesh and India are gradually replacing these taxes with a value-added tax (VAT) and simplifying tax administration while maintaining the buoyancy of revenues. Ghana is also considering a VAT to replace its sales tax. To overhaul a complex and fragmented tax system, and to overcome deficiencies that inject considerable uncertainty into business operations, China has initiated a tax reform program covering tax structure, tax administration, and revenue sharing between the center and the provinces.

Promote foreign direct investment

In most low-income countries, the small enterprise sector has the greatest need for technology and market access—and could benefit most from a larger presence by foreign firms. FDI plays a powerful role in stimulating competition and the growth of the domestic private sector. In addition to providing capital, foreign firms transfer technologies and management skills and give domestic firms access to export markets. Domestic and foreign trading companies have been particularly important in international product and information markets and have provided logistical and trade financing support that has been especially valuable to smaller firms.

In 1993, worldwide FDI flows were $200 billion, with the developing country share around $65 billion. Most of this FDI was concentrated in Latin America, East Asia, and China, though there was a significant increase in India and Pakistan. Sub Saharan Africa had only limited success, attracting only $700 million in 1993, mainly in petroleum and mining where special efforts had been made to attract foreign investment (box 2.9). In other sectors Sub Saharan countries experienced disinvestment and exodus by foreign firms due to the uncertain political and economic conditions and the high cost of doing business. A recent study indicates that over the past decade or so more than half the British companies that had investments in Sub-Saharan Africa have subsequently disinvested from the area (Bennell 1995). Similar trends appear to be prevalent among- firms from other countries, particularly France, Germany, and the United States.

Special efforts of the type initiated for mining and oil sectors may be necessary for reversing the exodus of foreign firms and for stimulating new foreign investment in the manufacturing and service sectors. The powerful impact of FDI on the domestic private sector and exports is vividly demonstrated by the garments industry in Bangladesh, where links between Korean firms created a new class of local entrepreneurs and are helping Bangladesh reduce its dependence on jute exports (box 2. 10). In Africa too, foreign investors could play a vital role in overcoming problems of small domestic markets and weak global linkages.

BOX 2.9 PROMOTING FDI IN THE PETROLEUM SECTOR

Starting in the late 1970s the World Bank undertook a series of 45 petroleum exploration promotion projects, of which 20 were in IDA-eligible countries—mainly in Africa. The objective was to attract the private sector into oil and gas exploration and production. The government's role changed from that of primary risk-taker to that of policymakerand regulator, with the private sector taking the exploration and subsequent production risk. These projects provided assistance to low-income countries in:

· Assessing their national oil and gas resource endowment.

· Establishing a modern technical data repository.

· Developing a promotion strategy based on a modern petroleum law, standard oil contracts, fair taxation legislation, and access to the government's technical database.

· Negotiating contracts with international oil companies.

· Developing a contract compliance and regulatory agency.

These promotions were successful in obtaining about $500 million in investment by the international oil industry. And they made the private sector the financial risktaker while strengthening the government's role as policymaker and regulator. The same approach holds promise for promoting private participation in infrastructure, which involves many similar elements.

In addition to improving their business environments, low-income countries can benefit from active promotion efforts and marketing their countries aggressively, particularly to attract employment-generating and skillsenhancing joint ventures. Doing this will take changes in FDI laws and approval processes (single windows for private investment). Also important are simplified procedures for employing foreign experts, assurances for transfers of profits and capital, and less discrimination between foreign firms and the domestic business sector. In this context, the Foreign Investment Advisory Service (FIAS) has been assisting low-income countries to develop more effective investment regimes, often in conjunction with IDA (box 2. 11). Countries can also benefit from taking part in international conventions, institutions, and forums that govern trade and investment and provide predictable and credible systems for dispute resolution and settlement.

Promote regional integration

Bureaucratic restrictions and uncoordinated policies inhibit the free movement of goods, capital, and people between countries in Sub-Saharan Africa. The result: limited official foreign trade, considerable smuggling, and small markets. In recognition of the need to promote freer movement of goods, capital, and people, many countries are starting to coordinate and harmonize tariffs, border controls, payments arrangements, taxation, investments, and business regulations. Currently, three such initiatives exist: first, economic integration arrangements between countries in Eastem and Southem Africa and the Indian Ocean; second, the Union Monetaire Ouest Africaine (UMOA), designed to convert the monetary union among seven West African countries into a full economic union; and third, the Union Douaniere des Etats de L'Afrique Centrale (UDEAC), designed to facilitate cross-border movement of goods in six Central African countries.

The major benefits will come from removing restrictions that impede flows of people, capital, and goods—and that segment geographically contiguous markets. In addition, there is considerable untapped potential for regional cooperation in power, transportation, and distribution (particularly petroleum products), which would reduce the costs of doing business. Also providing a strong impetus for regional integration, as in other parts of the world, is the development of regional growth poles—such as South Africa and

BOX 2.10 THE CATALYTIC ROLE OF FDI IN BANGLADESH

Despite low wages and the absence of import quotas during the late 1970s, Bangladesh's garment export industry failed to emerge because it lacked both production technology and access to world markets. Then Noorul Quader, a retired government official who had started the Desh Garment Company, signed a collaboration agreement with Korea's Daewoo. Daewoo was to train Desh workers, identify and install machinery, start up production, and market Desh's output. Daewoo and Desh Garments also worked with government officials to establish, for the first time in Bangladesh, official freetrade status for garment factories that were entirely export-oriented. And the government instituted a special bonded warehouse scheme.

This collaboration enabled Desh to enter foreign markets, and between fiscal 1980 and 1987 garment exports went from $55,000 to $5.2 million.

Observing the success of Desh Garments, Desh employees went on to establish their own garment assembly units.

The success of the collaboration encouraged other Korean garment exporters to use Bangladesh as an export platform and take advantage of the favorable treatment accorded to Bangladesh under the Multi-Fibre Agreement. Private investment in the garment sector and production and marketing know-how increased rapidly. The number of garment assembly units increased from 21 in 1983 to 1,630 in 1993, and garment exports skyrocketed to $1.2 billion in 1992-93, when they accounted for 52 percent of Bangladesh's total exports. The creation of an entirely new export industry enabled Bangladesh to reduce its reliance on jute exports and provided gainful employment to a large number of semiskilled female workers.

BOX 2.11 FIAS PAVES THE WAY FOR FOREIGN DIRECT INVESTMENT

The Foreign Investment Advisory Service (FIAS) helps developing countries shape policies and institutions conducive to foreign direct investment. FIAS advises governments about policies and regulations, relationships with foreign investors, and institutional strengthening. It promotes openness, ease of establishment, transparency in decisionmaking, and no discrimination between foreign and domestic investors. Advice on institutional arrangements emphasizes investment promotion, objective criteria for approvals, and reducing the complexity of approval procedures. To strengthen institutions, governments are advised to specify the characteristics of investment promotion agencies, define their relationships with government ministries and institutions, specify their organizational structure, and identify their training needs.

Between 1991 and 1993, FIAS provided policy and institutional advice to 29 low-income countries. Particularly in Africa, this advice often was part of IDA-sponsored structural adjustment programs. Combining FlAS's expertise with the implementation mechanisms of IDA credits has speeded the pace of policy and institutional reform. Now, lowincome, countries are increasingly seeking FIAS advice on their own.

In fostering investor-friendly environments, FiAS's impact has been significant. In Asia, nearly every country has followed at least part of the FIAS recommendations. In Bangladesh, FIAS suggestions led to an improvement of the legal frame work regulating foreign and domestic private investors and a Board of Investment was set up to promote investment. In Viet Nam, FIAS helped the government adopt a new investment law.

In Africa, FIAS has worked in 26 countries since 1986, of which 18 are IDA-eligible countries.

· Based on an FIAS diagnostic review, Burkina Faso's government abolished most price controls and relaxed trade regulations.

· In Ghana, FIAS helped develop a new and more liberal investment code, which has now been adopted and helped the Ghana Investment Promotion Center develop a new organizational plan and investment promotion program.

· In Guinea Bissau, FIAS helped devise a liberalized investment regime.

· As part of an IDA structural credit in Mauritania, FIAS recommended new laws regarding investments, foreign exchange allocation to investors, and investment approvals, which are now being implemented.

· Under another IDA credit, Lesotho has adopted FIAS recommendations relating to an investment promotion agency and strategy.

Between 1991 and 1993 FIAS also achieved considerable success in institutional development. FIAS helped seven low-income countries establish investment organizations, four devoted exclusively to investment promotion. And FIAS helped four countries restructure investment bodies to emphasize investment promotion.

Zimbabwe in the south, Cote d'Ivoire, Ghana, and Nigeria in the west, and Kenya, Tanzania, and Uganda in the east. They could have an important pull effect on growth throughout Africa if the impediments to local and foreign investors and to movements of goods, people, and capital are removed. They could also help promote FDI through enlarging markets. Such regional cooperation and integration should be seen not as a substitute for opening up to the global economy, but as a way of assisting firms to connect to global markets at lower cost.