Regulation and barriers to competition a harsh business environment

Although reforming countries have taken significant steps to improve the business environment, private sector development in many low-income countries is still discouraged by a harsh business environment that increases the cost and risk of doing business—often hitting small and medium-size firms the hardest. Even informal sector firms are not exempt, for they benefit from freedom from regulation at the cost of being excluded from opportunities participation in the formal sector could bring. And despite considerable progress in trade liberalization, further progress is still required. True, many low-income countries have reduced the coverage of nontariff barriers and rationalized tariff codes. But many have not yet introduced low or moderate tariffs, in part because of the continuing importance of tariffs for government revenues.

The result is a continuing bias against exports and a high cost for inputs. Making things worse, marketing boards continue to be heavily involved in agricultural exports in most African countries.

Further trade reform must be accompanied by legal, regulatory, and institutional reforms. Increasingly, the emphasis on improving the business environment needs to swing toward the wide range of legal, regulatory, and institutional deficiencies that are only now being addressed in most countries' reform programs.

In many low-income countries, internal competition—and thus the capacity of domestic firms to respond to external competition—has been limited by incomplete price liberalization, licensing requirements, and special concessions. These policies create barriers to the entry of private sector firms and insulate firms from competitive pressures to innovate, reduce costs, and seek new markets. Such policies also tend to preserve the rents received by privileged firms, discriminating in particular against small and medium-size enterprises.

One major obstacle to creating competitive markets is the presence of public enterprises in key sectors of the economy. Public enterprises tend to deter private entry, in part because they enjoy privileges not available to private firms, such as tax exemptions, access to government contracts, immunity from normal commercial law, and so on. The small markets in many low-income countries mean that public enterprises may enjoy a monopoly, particularly in nontraded goods industries. Even where such state monopolies have been abolished, state enterprises often retain privileges that deter private producers and traders.

In addition to improving the capacity of the private sector to respond to improvements in incentives for production and investment, deregulation of the economy in turn has an important impact on the public sector. It reduces the administrative burden on public services and redirects the efforts of government toward areas that help firms to exploit market opportunities and develop technological, management, and marketing skills to improve their productivity. Issues relating to improvement of the business environment are discussed in chapter 2.