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close this bookPrivate Sector Development in Low-Income Countries - Development in Practice (WB, 1996, 188 p.)
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


Commercial activity on the part of the ruler is harmful to his subjects and ruinous to the tax revenue...[it] crowds out competitors [and] dictates prices for materials and products which could lead to the financial ruin of many businesses. When the ruler's attacks on property are extensive and general, affecting all means of making a livelihood, the slackening of business activity too becomes general.

Ibn Khaldun, 14th century

HIS old truth is even more valid today. In a world where technological change is reducing transport costs, increasing global integration, and changing the nature of competition, firms can no longer compete on the basis of price alone. Design, quality, and timeliness of delivery are what gives today's firms a competitive edge. And for countries to compete successfully requires agile firms connected to world markets.

But firms in most low-income countries have been held back by a difficult business environment that has increased risks and transaction costs. While specific impediments vary, the consistent message is that competition is muted and firms are denied the means to respond to the changing competitive environment. They are denied by economic and political uncertainty, insecurity of economic rights, impediments to trade and investment, complex and discretionary regulations, and high costs of infrastructure and finance.

The private sector's assessment of the business environment

Several countries, often with help from the World Bank Group, have conducted surveys about how domestic and foreign private firms feel about the business environment (box 2. 1). These surveys have produced a wealth of data about the costs enterprises face in starting, operating, and expanding their businesses and about how entrepreneurs rank various impediments to doing business:

· In Cameroon, firms have identified access to finance, lack of demand, and taxes and tax administration as the three most important constraints.

· Entrepreneurs in Cote d'Ivoire note the same constraints, adding political and policy uncertainty near the top of their list.

· In Kenya, entrepreneurs are concerned about macroeconomic stability, infrastructure, regulations, and access to finance.

· In Egypt, tax administration weighs almost as heavily on firms as taxes themselves. A business may not know its actual tax liability for ten years after submitting its declaration.

· In India, firms are burdened by excessive regulations that prevent them from responding to an increasingly competitive environment.

· In Sri Lanka, firms have identified the cost of finance, the level of taxes, poor infrastructure, labor regulations, and policy uncertainty as key constraints.

To compete successfully requires agile firms connected to world markets. But firms in mast low-income countries have been held back by a difficult business environment that has increased risks and transaction costs.

Private sector assessments and firm surveys suggest that these constraints can increase the cost of doing business by as much as 30 percent over costs in other countries. The surveys also suggest that when economic and political conditions are secure, when the risks of policy reversals are low, and when the business environment is inviting, domestic entrepreneurs are forthcoming in their investments, and foreign investors come in willingly.

Institutional Investor publishes biannual country credit ratings that reflect the international financial community's perception of the economic, financial, and political health of countries (table 2.1). In most low-income countries (except China and India), country risk is still perceived as high. Some countries, such as Bangladesh, Bolivia, Sri Lanka, Uganda, and Zambia, have improved their country credit ratings considerably.


But most low-income countries need to make much greater efforts to overcome negative perceptions of country risk. In Africa, the harsh business environment has generally resulted in poorer performance of private investment than in other parts of the world. Investments were most successful in countries where the business environment was hospitable. The IFC's operations in the export-oriented oil, gas, and mining sectors have performed well—because they have been structured to be insulated to a large degree from the local economy. But the performance of its investments in the manufacturing and service industries—when measured in financial and economic rates of return, specific loss reserves, and write-off rates—has been significantly below the average of these measures for the rest countries need to make much greater efforts to overcome negative perceptions of country risk.

In collaboration with the governments and the private sector, IDA and IFC have prepared ten private sector assessments in low-income countries and are planning to complete eight more by the end of 1996. The assessments have: Documented the private sector's economic role and its relation to the public sector. Surveyed firms to improve the quality and quantity of data available regarding obstacles to private sector development—including insufficient access to credit and problems with starting, operating, and expanding a business. Clarified issues related to the nature and sequencing of reforms affecting the private sector—such as macroeconomic and political stability and the functioning of financial markets. Highlighted the high cost to business of complex regulations, poor infrastructure, and poor performance by public institutions—particularly institutions of public finance, such as customs and taxation. Reduced mutual suspicion and stimulated constructive, focused dialogue between business and government— leading to the institutionalization of private-public consultative measures. Helped the Bank Group to set priorities, define its agenda, and identify new projects in private sector development. Helped coordinate donors' strategies and support for private sector development. Based on the findings of past private sector assessments, the Bank Group is now focusing on developing standards for measuring the role of the private sector in the economy and defining constraints to private sector development arising from distorted incentives, excessive government regulations, crowding out by government, and weak support systems. Most important, private sector assessments are now being used to establish cooperative arrangements among the private sector, governments, the Bank Group, and the donor community to design reform programs acceptable to all key stakeholders.

In Africa, the harsh business environment has generally resulted in poorer performance of private investment than in other parts of the world. Investments were most successful in countries where the business environment was hospitable. The IFC's operations in the export-oriented oil, gas, and mining sectors have performed well—because they have been structured to be insulated to a large degree from the local economy. But the performance of its investments in the manufacturing and service industries—when measured in financial and economic rates of return, specific loss reserves, and write-off rates—has been significantly below the average of these measures for the rest of the Corporation's portfolio. It is this latter category of investments whose performance is directly tied to the overall economic and business environment in the local economy.

Poor performance was rooted in macroeconomic shortcomings—mainly unrealistic exchange rates and foreign exchange shortages. Further increasing costs were infrastructure inadequacies that required firms to take on functions that private firms in other parts of the world did not have to be concerned with. And weakening the performance of investments were regulatory impediments—from price controls and import restrictions to interference in product mix decisions and labor markets and delays in granting permits.

In the past few years, many African governments have taken macroeconomic measures that are reducing the cost of doing business, and many have started the long process of correcting policy and institutional weaknesses that contribute to high risk and transaction costs. But much more needs to be done to change investors' perceptions.

China and India have demonstrated the value of economic reforms, particularly over the past four years. Their economic reforms have been rewarded by expanded access to international capital markets and foreign direct investment (FDI), which has brought new markets, new technologies, and muchneeded competition. In China, FDI went from negligible amounts at the beginning of the 1980s to nearly $20 billion in 1993. In India, FDI approvals went from $73 million in 1990 to more than $2 billion in 1993, and actual FDI flows increased from $165 million to $600 million. Indian firms have also raised more than $4 billion from international debt and equity markets.


































Sri Lanka

















16 4










17 6





















Sierra Leone




Source: Institutional lnvestor, September 1991 and September 1994.

Regaining the confidence of investors may take time. But once investments start, they create a virtuous cycle—investment flows increase the incentives to maintain stability and continuity, which in turn leads to more investments. The Multilateral Investment Guarantee Agency (MIGA) has been assisting low-income countries in starting this virtuous cycle by providing political risk insurance and technical assistance (box 2.2).

Foundations of a dynamic private sector

The emerging consensus of these surveys is that agile firms, which are necessary to compete in a rapidly changing environment, prosper when there is political and economic stability, when entrepreneurship and learning are rewarded, and when there is a commitment to shared growth. Creating this attractive environment requires a systematic, time-bound program formulated and implemented in collaboration with the private sector to put in place the underpinnings of a dynamic and competitive private sector (figure 2.1):

· Secure and flexible transactions, with the freedom, flexibility, and security to acquire, use, and leverage property rights (real, tangible, and intellectual).

· Nonintrusive, efficient, and respected public administration that sets widely understood rules for economic activity, enforces them uniformly and universally in a predictable manner, and changes them through transparent means.

· Competitive markets that promote mobility of products, capital, labor, and knowledge through simple, transparent, and uniformly applied incentive and regulatory systems.

· Efficient and responsive social, physical, and technological infrastructure that increases the long-term competitiveness of the economy and reduces transaction costs.

Building this structure is a difficult and time-consuming task. It implies a fundamental change in the role of the government, from owner and operator to policymaker and regulator working to develop a competitive, outward-looking economy in close partnership with the private sector. Fundamental to the success of this orientation is development of competent and agile institutions to support the rapid response of agile firms to changing market conditions.


The Multilateral Investment Guarantee Agency (MIGA) was created to facilitate private foreign investment in developing member countries. By providing long-term noncancelable investment guarantees (insurance) to foreign investors against specified noncommercial risks—including currency transfer, expropriation, and war and civil disturbance—MIGA enables commercially attractive projects to proceed in many lowincome countries. MIGA complements national and private investment insurance programs through coinsurance and reinsurance arrangements.

MlGA's guarantees, for investments as small as $150,000 and as large as $50 million in the infrastructure, mining, and financial sectors, have often been critical of the investor's decision to proceed with the project, including participating in privatization projects. As of January 1, 1995, MlGA has provided political risk insurance totaling $375 million in projects in eight low-income countries-Bangladesh, Cameroon, China, Honduras, Madagascar, Pakistan, Tanzania, and Uganda. Preliminary applications for MIGA guarantees from potential investors in lowincome countries as of that date total 350. While the vast majority of these prospective investments will not proceed for commercial reasons, the sheer number of applications is indicative of the demand for political risk insurance.

MIGA also offers technical and legal assistance to enhance the institutional capacity of host country investment promotion agencies (IPAs). Wherever possible, MIGA seeks to support promotion activities that can be organized on a multicountry or sectoral basis. For example, MIGA has provided extensive support to the promotion of foreign investment in the mining sector in Africa, including the organization of a major mining conference in June 1994 at which 18 Sub-Saharan countries showcased their mining investment opportunities to about 300 prospective investors from North America, Europe, and Asia.

New initiatives for the dissemination of information on investment opportunities in developing countries include a CD-ROM on mining sector investment opportunities in Africa and IPAnet, a global electronic information exchange and communications network on investment opportunities. This network, to be carried over the Internet, will link IPAs, business associations, financial institutions, and other intermediaries involved in the promotion or facilitation of foreign investment.

After government institutions responsible for the central role of macroeconomic management, the most important institutions are those responsible for:

· Legal and regulatory systems.

· Public finance, notably the tax and customs administrators that interact closely with the private sector.

· Trade and investment. No less important are institutions that:

Figure 2.1 Foundations of a competitive private sector

· Support technological development—universities, standards and metrology agencies, productivity centers, agricultural extension services, and research and development and labor training institutes.

· Facilitate flows of economic, business, market, and technological information.

Building partnerships

In fast-growing countries these institutions have worked closely and regularly with business and labor associations and with other civic groups to address and solve problems that affect the ability of firms to compete internally and externally. Important objectives have also been to change the attitude of the population, the media, and the administration at all levels toward entrepreneurship and legitimate profit-making—and to change the business culture from courting the government for privileges to courting competitive markets for profits.

Governments in some low-income countries have forged partnerships with their private sectors to sharpen the reform agenda and to establish the credibility of the reform program with the business community. The value of such partnerships has been demonstrated in Ghana and Senegal, where private-public consultative mechanisms are helping to bridge the gap between policymakers and the private sector in developing reform programs that enjoy broad support (box 2.3).

An important element of this partnership is the availability of timely and reliable information on economic and business activity. In most low-income countries, this information is incomplete, outdated, and not uniformly accessible—reducing transparency and accountability and increasing the opportunity for corruption. This makes it difficult for governments to formulate and monitor policies. And it limits the ability of entrepreneurs, investors, and lenders to make reasonable judgments about business opportunities and the viability of projects. Government investments in improving the information infrastructure could pay large dividends in increased transparency, greater accountability, and reduced uncertainty—if implemented in collaboration with the private sector through producers associations and chambers of commerce.

Secure, flexible transactions

One of the most important attributes of economies that foster private sector activities is that individuals are free—and believe themselves to be free—to take all actions in their economic interest that are not specifically prohibited.

The legal framework in these market economies has at least four basic economic functions:

· To define the universe of property rights in the system.

· To set a framework for exchanging those rights.

· To set the rules for the entry and exit of actors into and out of productive activities.

· To oversee market structure and behavior in ways that promote competition and protect consumers and the environment.

These four basic functions can be loosely related to well-recognized areas of law. Property rights are defined in the constitution of a country and in more specific laws dealing with tangible and intangible property. These should give individuals the freedom, flexibility, and security to acquire, use, and leverage property rights. Exchange is covered generally by contract law. Entry is governed by company and foreign investment law, bankruptcy and exit, by liquidation laws. Finally, to promote competition and protect consumers are antimonopoly and unfair competition laws. These basic areas of law are joined by many other important ones—such as labor, taxation, and banking—in a rich and intricately woven web of laws that constitutes the complex legal framework for private sector activity in advanced market economies.


By the end of the 1980s, Ghana had undertaken major economic reform, yet had achieved little supply response in the private sector. An IDA sponsored survey of the sector identified regulations inhibiting private sector operations and found that many private entrepreneurs felt that the government was ambivalent toward them.

To address these problems the government formed a private sector advisory group (PSAG), comprising representatives from the private sector and the government, and asked it to develop a set of recommendations for the revision of business regulations. The group's final report was then discussed with private entrepreneurs, and many of its recommendations were adopted, resulting in removal of price controls and business licensing requirements and simplification of foreign direct investment regulations. Equally important, the process reduced the gulf between government and the private sector. Ghana's PSAG has been succeeded by the Business Roundtable, which holds periodic discussions with the government on issues relating to the financial sector, privatization, export promotion, and legal and judicial reforms. These efforts have facilitated privatization and encouraged both domestic and foreign investment.

In Senegal in 1994, the Bank Group sponsored an assessment of the private sector, while the government established a competitiveness review group (CRG) made up of representatives of employer associations, labor unions, and government. The CRG was to look for ways to remove obstacles to economic competitiveness and to involve both government and the private sector in formulating and carrying out economic reform. Supported by technical assistance from IDA, Senegal's CRG has assembled five commissions to poll the private sector view of reforms on important and contentious issues (including conventions specials, high transaction costs, high taxes, complex government procedures, and lack of competition policy). The commissions' work has resulted in the dismantling of most conventions specials and the simplification of business regulations supported by an IDA credit.

Important gaps in laws and rules need to be plugged, and the institutional mechanisms for implementing laws and rules need to he strengthened, streamlined, and made more efficient and responsive.

The challenge in strengthening the legal and judicial system in many low-income countries is twofold: important gaps in laws and rules need to be plugged, and the institutional mechanisms for implementing laws and rules need to be strengthened, streamlined, and made more efficient and responsive. In low-income countries that previously operated under socialist systems, the challenge is to reconstruct the basic elements of the legal and judicial system to create a regime friendly to private property rights.

Four important deficiencies in laws and their implementation are frequently cited:

Laws relating to property rights and collateral. In most low-income countries, legal restrictions or deficiencies in collateral laws limit borrowing options for enterprises, particularly for new and small firms that cannot offer unencumbered landed property. Banks' unwillingness to lend against movable and intangible property stems from the high costs of creating a loan secured by collateral, the slow and costly judicial procedures to repossess and sell collateral, and the inadequate registries for filing claims against collateral—making it difficult for lenders to publicize their security interests.

In Bolivia, the economic cost of deficiencies in collateral laws has reduced equipment investment by as much as $500 million, leading to a loss of potential output of about 2 percent of GDP (box 2.4). In most African countries lending against movable goods (and receivables) is uncommon. In many countries, the problem extends to landed property. Laws for land markets are not clear, land registries have not been updated, and establishing clear unencumbered title to land is difficult. That discourages long-term investment, reduces access to institutional finance, and mutes incentives for the greater productivity and commercialization of agriculture.


In Bolivia commercial bank lending is mainly collateralized by land or the personal guarantee of wealthy individuals. Because of inadequate property laws and legal procedures, assets such as inventory, industrial equipment, and accounts receivable are not considered acceptable collateral. And because the registries for recording security interest in property function poorly, it is hard for lenders to trace claims and identify their collateral in the eyes of the court. Repossessing collateral is made complex and time-consuming by gaps in laws that govern financial transactions. The judicial process for enforcing these laws, for instance, takes considerably longer than the times specified under law. As a consequence of these legal and administrative deficiencies, persons without real estate cannot finance equipment purchases. Only those with unencumbered fixed assets can get credit for working capital. Credit sales are discouraged. Non-bank credit is very expensive. And lenders must rely on criminal rather than civil law to enforce contracts. If deficiencies in laws governing collateral were rectified and financing were easier, demand for equipment in Bolivia could rise by more than $500 million. That in turn would increase the country's output by an estimated $150-$200 million, roughly 2 percent of GDP.

Basic business laws. Many countries have not adapted the business laws introduced by colonial powers to today's economic circumstances. Madagascar's commercial code is virtually unchanged from the French code adopted in 1867. In Sierra Leone, company law dates from 1929 and has undergone few modifications. Business laws need to provide for fuller disclosure that allows outsiders to evaluate the financial position of firms and firms to effectively leverage their assets. One of the biggest problems is inconsistency in laws relating to foreign exchange transactions, income taxes, and customs—a consequence of the failure to repeal obsolete laws and regulations and formulate new laws to reflect changes in policies. For example, despite government policy to provide duty-drawback relief to Nigerian exporters, rules for operation of the scheme have yet to be formulated and incorporated in customs regulations. In most countries, consumer protection laws also are poorly developed, and most countries still lack laws on standards allowing the public or smaller firms to challenge monopolistic behavior.

Laws governing financial transactions. Laws often do not permit full play of financial relationships and instruments. In many African countries, laws and regulations governing capital market transactions are inadequate and an underdeveloped legal framework for leasing prevents small firms from increasing their equipment investments and denies lenders a more secure method of lending to small enterprises. In Ghana, small firms improved their access to credit following introduction of leasing laws.

Most countries have neglected the legal issues of debt recovery. Inefficient adjudication has often rendered court-based remedies ineffective and encouraged willful default. In Bangladesh and India, judicial procedures relating to debt recovery can take years. Extra-judicial foreclosure arrangements—allowing lenders to exercise control rights over the security or operations of firms— are normally not available in most lowincome countries. As a result, financial intermediaries prefer to lend only to established firms. Newer and smaller firms without a track record or unencumbered real property find it difficult to get finance.

Sustained growth will require large infusions of capital, much more than entrepreneurs can get from their own resources or from friends and relatives. And expanding access to outside finance—from banks and institutional investors—will require comprehensive revision of laws relating to the creation, trading, and enforcement of security interests.

Laws for arbitration and other dispute resolution mechanisms. In many countries, such laws and mechanisms are not responsive to changing commercial needs. In the absence of quicker alternative dispute resolution mechanisms, firms must rely on tedious court procedures, increasing the costs and risks of market transactions and squelching the opportunities to expand markets.

Specialized institutions, such as law reform commissions, can improve the relevance of laws and provide a mechanism for gradually revising laws on a consensual basis in harmony with existing social and legal traditions. In many low-income countries, these institutions either do not exist or have become moribund, as in Sierra Leone. Strengthening institutional mechanisms for law reform is particularly important for privatization programs, for the private provision of infrastructure services, for attracting foreign investment, and for protecting the interests of small and new enterprises.

Equally important is strengthening public awareness of laws and legal decisions. When the substance and applicability of laws are known only to a few, uncertainty rises for all business decisions. Poor law reporting arrangements, outdated legal indexes, and delayed gazette notifications are the main culprits. In Ghana, there is a considerable backlog of law reporting—and until recently, even summaries of court decisions were unavailable. In Sierra Leone, the last available law reports date back to 1984.

The efficacy of laws depends on disposing of court cases expeditiously. In most low-income countries, adjudication is cumbersome and unreliable. Serving summons, filing suits, obtaining judgments, and executing decrees are all time-consuming. Efficiency is impeded by limited knowledge of economic laws and severe shortages of trained court clerks, process servers, transcribers, and bailiffs. Further handicapping the functioning of the legal and judicial system is the poor state of the physical, logistical, and informational infrastructure. In many low-income countries—such as Bangladesh, Ghana, Sierra Leone, and Tanzania—the facilities for recording court proceedings are rudimentary. Judges often have to record the proceedings manually, so delays in completing cases are common.

In many Sub-Saharan African countries and formerly socialist economies, government agencies are ill-equipped to convert legislative proposals and government intent into coherent legislation. Legislation, rules, regulations, and public notices fail to keep pace with government policy announcements and decisions, particularly in matters relating to investments, foreign exchange, customs, taxes, and finance. That naturally hurts the credibility and timeliness of reforms. The result is confusing and inconsistent legislation that allows civil servants wide latitude in interpretation—thus denying predictability, flexibility, and security for property transactions.

Efforts to improve the quality of legal drafting and analysis can pay large dividends in private investment. Witness the mining sectors in many African countries, where the private sector responded positively to clear, revised mining codes. The Bank Group has been helping low-income countries to address specific deficiencies in laws through technical assistance directed at improving institutional and infrastructure capacity (box 2.5). These efforts are collaborative undertakings by governments, the judiciary, and the private sector, with IDA's support. They are creating a broad consensus about reform and the most effective way of implementing it—to strengthen the legal and regulatory system in low-income countries.

The objective of this effort is to establish, visibly, a rule-based economic system in which the rules governing economic activity are generally available and understood by the population. Those rules are to be enforced uniformly and universally, with a stable, predictable pattern over time. And they are to be changed through transparent means. Such open processes have special merit for countries that have experienced gradual breakdowns in their judicial system—and where the expropriation of private property in the 1 960s and 1 970s left many private companies, particularly foreign ones, doubtful about the wisdom of continuing to invest.

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.


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.


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.



Average unweighted tariff rates (percent)

Quantitative restrictions (QRs)

China (1992)


Up to 50% of imports covered by QRs

Viet Nam (1991)


Nearly all QRs were replaced by tariffs in 1994

Bangladesh (1994)


Less than 10% of tariff lines are covered by QRs

India (1994)


38% of tariff lines are covered by QRs

Pakistan (1994)


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

Sri Lanka (1994)


All QRs have been removed

Cameroon (1994)


All QRs have been removed

Cd'lvoire (1994)


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

Ghana (1991)


All QRs have been removed

Kenya (1994)


No significant QRs

Nigeria (1990)


20% of industrial production and 30% of agricultural

production were covered by QRs in 1994

Senegal (1994)


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

Tanzania (1992)


QRs to be eliminated as part of the reform program

Zambia (1994)


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.



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.


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.


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.


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.


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


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.


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.

Enterprise development

In Africa and the smaller low-income countries, the larger firms are either public enterprises or foreign firms. Most indigenous entrepreneurs operate microenterprises in the informal sector, mainly in services in urban and rural areas.

The population of medium-size firms is small—hence the term "missing middle"—firms that elsewhere have been most dynamic in generating employment and increasing wages.

Informal sector

Information on the size of the informal sector is often difficult to obtain. But surveys suggest that in most low-income countries informal sector firms play a significant role, employing as much as 60 percent of the urban labor force. In Burkina Faso, the informal sector accounted for 32 percent of GDP according to the official 1985 census; in Chad, it accounts for 75 percent of employment in the capital city of N' Djamena; in Guinea, about 62 percent of GDP; and in South Africa, about 30-50 percent of the work force.

The informal sector performs vital functions—both for equity and growth. By providing employment and means of income stabilization, the sector acts as a safety valve, especially during difficult economic times. It helps stem rural to urban migration and absorbs social pressures generated by such migration. Largely relying on women, the sector enhances their economic and social status. Most important, the-informal sector is the seedbed for entrepreneurial development—in many countries, up to 50 percent of all small firms started out in the informal sector. Characterized by high rates of exit and entry, it is the most dynamic sector. This chumming-up process, besides being a constant source of new employment, makes it possible for at least a few entrepreneurs to move up the business ladder.

Firms in the informal sector benefit from economic liberalization, which gives them easier access to inputs at more reasonable prices. But the sector still faces constraints. In many countries, the high cost of complying with regulations often inhibits growth of informal firms and slows their transition into the formal sector—and the attendant benefits of better technology, bigger markets, and greater economies of scale. It also condemns them to low-productivity activities and prevents labor from being utilized more productively. Removing the burdensome regulations identified in the preceding sections will help make the fullest use of the economic functions performed by firms in the informal sector. And giving those firms better access to water, roads, power, and telecommunications will also help raise their productivity and earnings.

The growth of the informal sector is also constrained by limited access to finance. Traditional financial institutions and directed credit programs run by governments have been largely unsuccessful in servicing the needs of this sector. But in many countries—such as Bangladesh, Bolivia, Kenya, and South Africa—community-based institutions have managed to provide a broad range of financial services and technical assistance, as discussed in chapter 4.

Small and medium-size enterprises

The technological and organizational revolution now under way in the global economy is not driven by large, capital-intensive industrial firms. It is driven instead by small and medium-size enterprises (SMEs)—labor intensive in nature, with quick start-up times and agile responses to rapidly shifting markets and technologies. Typically, SMEs are the firms that create the greatest employment opportunities at increasing wages. But they face constraints (box 2.12), so governments often have special programs of subsidies, tax exemptions, and product reservations to support them. These programs have done less to promote a competitive private sector than have policies emphasizing growth—supplemented by programs that address the specific needs of small enterprises for production technology, for easier access to markets, and for credit, management, and labor training services.

Consider India's experience. Small enterprises there operate under product reservation policies that restrict competition from larger firms. Small firms enjoy tax concessions and access to credit on concessional terms from the banking system. These protectionist policies have increased the number of small firms, but reduced their productivity and competitiveness. A significant number of these firms are sick and in need of modernization.

Beyond policy reforms

By contrast, governments in Indonesia, Korea, Taiwan (China), and Thailand have made special efforts to remove impediments to trade and investment and eased the regulatory burdens on SMEs. Freed from these constraints, SMEs have benefited from subcontracting activities with larger firms and from contacts with suppliers and buyers that provide them with manufacturing know-how. In addition, these governments supported SMEs through innovative use of public investment programs, and through strengthening technology and training institutions, in active collaboration with small industry and farmers associations. This support supplemented but did not substitute for what the firms could provide either individually or collectively. It gave them the necessary infrastructure and easier access to credit and technological support from productivity centers. Governments also made a special effort to help exporting firms by facilitating access to inputs at world prices, access to export credit, export market development, and promotion of export-oriented ventures (box 2.13).


Throughout the developing world, small and medium-size enterprises (SMEs) are condemned to a cycle of low productivity, stunted growth, and unstable incomes. Here are the reasons:

Restricted access to institutional financial services. Companies that lack collateral are frequently denied access to necessary financing. While financial intermediaries are often reluctant to lend to SMEs for sound financial reasons (such as the high transaction cost of monitoring), badly functioning financial systems, ineffective laws on collateral, and poor enforcement of financial contracts also limit access to credit.

Lack of access to markets. SMEs' failure to find markets for their products and services often results from inadequate physical infrastructure, high transport costs, and inadequate information about markets.

Lack of access to inputs. Difficulty in getting physical inputs largely stems from input markets that function badly—including those controlled by large parastatals that have preferential access to inputs.

Inadequate technical skills. Unlike large enterprises, SMEs lack the financial and time resources needed to train workers—who often have little formal education. They also have neither the resources to obtain appropriate technology, nor sufficient access to information on it. The combination of rudimentary technology and poor skills makes for low-quality, uncompetitive products.

Restrictive policies and regulations. While SMEs generally regard policy and regulation as less problematic than credit or physical inputs, excessive bureaucratic procedures and the lack of clear-cut regulatory norms impose high transaction costs that deter them from expanding. Indeed, it is often argued that the scarcity of medium-size enterprises in Africa is largely the result of a highly restrictive regulatory environment.

Distorted incentives for growth. Special support programs to promote SME growth distort the overall incentive system and are thus more harmful than beneficial, both to SMEs and to economic development. In India, such programs encouraged SMEs to become dependent on subsidies and inhibited their growth.

Policies that favor large firms. Many low-income countries continue to protect large public enterprise sectors despite the fact that these often crowd out private ventures and monopolize markets. Public policies can also protect large private enterprises by restricting competition and by imposing barriers to entry, subsidies and tax exemptions. In Senegal special exemptions restrict entry, while high effective rates of protection limit competition.

Government technological support came through institutions dealing with standards and quality control and from productivity centers and extension services that help firms adapt existing technologies and improve production and management routines, as in Hong Kong and Taiwan (China) (box 2.14). This is now being successfully tried in India under a technology development project, supported by the Bank Group, to redirect the activities of government research institutes from expensive basic or applied research development to activities of more direct operational relevance to businesses.

A similar approach is being adopted in the agricultural sector. Successful research and extension programs focus on services that the private sector is unable to supply, such as those relating to staple food crops and basic fanning techniques, and on activities that encourage private input suppliers and agro-processing companies, often the best source of specialized advice, particularly for cash crops.

Extension services have benefited from the involvement of producers cooperatives in service delivery. One model of public-private cooperation is the IDA-supported initiative by the National Federation of Central African Livestock Producers, a herders' association that was assisted in taking over the delivery of livestock services. The sale of veterinary drugs increased fivefold, reaching 80 percent of the target population. And the herders association has been transformed into a major service organization—a driving force for livestock development. Similar approaches in other agro-based industries could significantly improve the productivity and earnings capacity of most rural activities, while freeing government resources for use in other areas, such as strengthening the rural roads network.

The quality of the labor force also affects enterprise development. A welltrained labor force increases productivity, makes the shift into new areas of economic activity, and increases the pace of technology assimilation. In many countries, public training systems are overextended and divorced from the needs of the private sector. The most successful programs combine government resources and strengths in analyzing economywide information with better private capacity in managing specific programs to make training systems more responsive to the needs of the economy (box 2.15). Many countries could benefit from modernizing the technology curriculums in secondary schools and helping individuals and fines acquire specialized training abroad.


Access to inputs at world prices. Import restrictions, relatively high import tariffs, and taxes on domestic inputs often handicap exporters in lowincome countries from competing with exporters from other economies who do not face similar restrictions and costs. These cost disadvantages are normally overcome through duty drawback, duty exemption, and tax rebate mechanisms. In China, a welladministered duty exemption system has assisted exporters in maintaining cost competitiveness by allowing easy access to imported inputs-exports under duty exemption arrangements accounted for 27 percent of total exports in 1991. In most African countries streamlining and adequately funding such programs to significantly reduce the costs incurred by exporters will increase export competitiveness.

Easy access to export credit. In most African countries, access to export finance would be facilitated if there were automatic access to export credit and rediscounting facilities for export orders backed by letters of credit; if export credit risk and commercial risk insurance were easily available; and if restrictions on issue and negotiability of trade financing instruments, such as bankers' and governments' trade acceptances, were eliminated to spur growth of market-based trade-financing mechanisms. By allowing exporters to retain all foreign exchange earnings and thus earn the full scarcity premium on foreign exchange, the cost of export finance can be reduced.

Market and product development. Most firms in low-income countries need but cannot fully afford specialized services relating to export market identification, product and process adaptation, and compliance with ISO 9000 standards. In India, IDA assisted firms in acquiring specialized services and in implementing export market development strategies. The assistance, on a cost-sharing basis, enabled beneficiary firms to register average export growth of more than 50 percent. A recent study by IDA—Africa Can Compete—-has shown that poor product quality and production technologies are important constraints preventing African firms from exploiting U.S. demand for Afrocentric textiles and home products estimated at around $200 million annually. A product and technology development program of the type used in India could assist African firms.

Export-oriented joint ventures. Export trading companies in many East Asian countries have provided critical logistical, marketing, sales, technology, and financial services to producers selling to overseas buyers. Enabling the establishment and operation of joint-venture or wholly foreignowned trading companies could help Africa's new entrepreneurs gain access to foreign markets being opened by reform. In addition, export-oriented joint ventures could be facilitated by eliminating investment restrictions and by offering special export incentives. In some instances, export-processing zones have proved effective as interim arrangements for providing exporters with reliable infrastructure and for establishing the credibility of government policies.


In the late 1 960s the Taiwanese (China) bicycle industry was facing difficulties in competing in export markets. Indeed a number of companies went out of business. The Taiwanese government entrusted MIRL (Metallurgical and Industrial Research Laboratory), a nonprofit, government-supported research institution, with developing and implementing a modernization program in collaboration with producers and the industry association. MIRL identified problems in materials, manufacturing, design, and standards. It then assisted the bicycle plants in three areas. Engineering modifications were made to improve product specifications, to standardize material utilization, and to raise quality control procedures. Production changes were introduced to increase the efficiency of manufacturing and assembly procedures and the interchangeability of components. And greater efforts were made to market the higher quality and safety standards of the bicycles in the United States.

The technology upgrading program, implemented in close collaboration with manufacturers, cut manufacturing time by as much as 40 percent, complied with safety regulations set by the U.S. Consumer Products Safety Commission, and shifted production to lightframe bikes. Bicycle exports grew from less than $3 million in 1970 to close to $200 million by the end of the decade.

Since then Taiwanese firms have maintained their export competitiveness and have moved upmarket. At present, bicycle exports are more than $2 billion.

In contrast, Indian producers, who were bigger exporters than the Taiwanese in the 1 960s, failed to upgrade their technologies. They continued to produce basic models, which were losing appeal in international markets. They lacked a technological support system. And they were unable to combine low labor costs with technology and product upgrading. As a result, India has lost market share. Bicycle exports languish at less than $100 million, even though India is one of the largest producers of bicycles in the world.

This example suggests that technology support can play a critical rote in enhancing the competitiveness of firms. To be effective, however, it must be based on clearly identified and strong needs, quick government recognition of the need, a technologically competent and commercially oriented research and development institution, a wellintegrated action plan that focuses on specific process and design problems of a large number of producers, and continuous interaction and feedback from producers, with industry associations playing an important coordinating role.

In general, government procurement policies can be designed to promote small and medium-size firms. Ten West African countries are using their public investment program to help their budding contracting industry—often the launching pad of large companies—by combining technical assistance and a prompt payment system with contracting out infrastructure maintenance and investments that were previously carried out by the public sector. These efforts have also succeeded in providing, in a cost-effective way, infrastructure services to undeserved small—rural and urban—localities. This program provides a model that many countries could replicate on a large scale (box 2. 16).

The telecommunications sector has considerable potential for developing modern small and medium-size enterprises. New technologies allow telecommunication services to be unbundled. Such value-added services as paging, electronic mail, and database information services can be provided through franchising arrangements without substantial capital requirements. Even in basic telephone services, independent operators can compete with existing operators in such services as pay phones. In India, pay phones have been franchised to small private operators, who have substantially improved access to telephone services and boosted the collection rate for the utility.


Until 1 99O, both public and private training programs in Togo were rigidly administered and inadequately financed. Both quality and efficiency were low. In 1 990, the government reformed its policies on training and institutional development, aiming to build a flexible private-public training system that would be responsive to the country's economic demands, provide more practical training, and strengthen the theoretical content imparted during apprenticeship. By upgrading skills, the government hopes to attract foreign investment in labor-intensive light manufacturing and thereby reduce the economy's dependence on subsistence agriculture and on cocoa, cotton, and coffee. The reform includes:

Strengthening government's capacity to monitor and analyze labor markets in both the public and private sector, formal and informal, by analyzing existing data and conducting household surveys, periodic censuses in the urban and rural sectors, and profession-specific studies. The information generated would be analyzed and widely disseminated to schools, training centers, and employers.

"Twinning" managers and instructors with overseas training institutes.

Establishing a national training fund, administered by a private-public management committee, to allocate financial resources to public and private training projects that meet predetermined criteria.

Efficient infrastructure

The quality and adequacy of infrastructure services are important determinants of how successful firms are in delivering products and services of high quality, at low prices, and in the shortest possible time. Poor public infrastructure increases private costs and is a drag on market efficiency—by increasing investment and transactions costs, increasing barriers to entry, reducing competitiveness, and restricting access to domestic and international markets. Small and informal enterprises, particularly in rural areas, are hurt most by the failure of public infrastructure. Unlike bigger firms, they cannot afford private investments needed to compensate for public failure.


Under the Agences d'Execution des Travaux d'lnteret Public (AGETIP) model of contract management—first used in a Bank-sponsored project in Senegal-subprojects on large public works are carried out by small, dynamic firms in the private sector, rather than by (largely) inefficient public agencies. An added benefit is liberating project managers from much red tape.

AGETIP is a private, not-for-profit company that does general contracting for municipalities, ministries, and other public entities. It hires consultants to prepare designs and bidding documents and supervise works. It issues calls for bids, evaluates them, and signs the contracts. It also evaluates a project's progress, promptly pays contractors, and oversees the final reception of the works, adhering throughout to a set manual of procedures. In its first year of operation in Senegal, AGETIP executed $8 million of works through 119 subprojects, used 78 (mainly small or medium-size) contractors, and created almost 2,000 person-years of employment.

AGETIP owes its success first and foremost to its efficient private sector management team. This team takes pride in paying contractors in ten days rather than the 30 allowed or the months taken by 'public entities. AGETIP is also able to hold its overhead low by contracting for engineering consultants and others only as needed. Moreover, its legal status as a private company exempts it from the many and cumbersome bureaucratic procedures imposed on the public sector.

Because AGETIP hires local contractors, it has stimulated the development of local consulting industries. On its roster are 680 local contractors and 160 local consultants. Its success has spurred other agencies to improve their performance. In the public sector, the Senegalese minister of public works is considering setting up an AGETIP within his ministry, and the mayor of Dakar has contracted with AGETIP to execute projects financed from his own budget.

AGETIP's success in Senegal has led to the creation of similar agencies under World Bank projects in ten countries, including Benin, Burkina Faso, Mali, Niger, and Mauritania. The Mauritanian project proposes to disseminate information to local communities in order to increase their sense of responsibility toward project works and improve communication between the grassroots and local authorities. Before projects are presented for funding, affected communities will be consulted, particularly when projects concern such issues as garbage collection or sewer cleaning, where grassroots participation can make a large difference.

As documented extensively in the World Bank's World Development Report 1994, low-income countries have improved the coverage of their infrastructure. But they are slipping behind middle-income countries and need to do much more—and quickly—if their firms are to compete in international markets (table 2.3). Unmet infrastructure needs are still considerable. Electric power has yet to reach most people. Demand for telecommunications to modernize production and integrate into global markets is far outstripping supply. And in rural areas, transport, water, sanitation, and education facilities are still poor-specially for women and children. Often past investments in infrastructure have not had the expected development impact because of inefficient and inappropriate investments by the public sector. Surveys of private firms consistently highlight infrastructure as a critical constraint to investment and profitability—and as an important variable in the investment decisions of foreign firms.

In Africa, the poor state of infrastructure continues to retard growth of the private sector and impose high transaction costs. Telecommunications coverage in Sub-Saharan Africa is among the lowest in the world—averaging 0.4 lines per 100 inhabitants compared with 4 in Asia and 6 in Latin America. And government-owned telephone companies lack the resources to deliver the massive increases in telephone lines needed to accelerate growth and expand exports. Besides capacity constraints, poor service reliability imposes a burden on firms and results in lost opportunities. In Kenya, it has been estimated that unreliable telephone and telex services reduce foreign exchange earnings by 1-2 percent.

Performance in the power sector is also mixed. Some countries—such as Ghana, Malawi, and Togo—have managed to rapidly increase output. But others—such as Tanzania and Guinea—have had their power output stagnate.


Low- income countries

Middle - income countries






Power-generating capacity
(thousand kilowatts per million persons)





(main lines per thousand persona)





Paved roads
(kilometers per million persons)





Source: World Bank 1994e.

The share of households with electricity in Sub-Saharan Africa—only 5 percent of all households—remains among the lowest in the world.

Failures to achieve high generating efficiency and control system losses have combined with budget constraints to reduce access to electricity. It has been estimated that by spending $1 million to reduce line losses, many countries could save $12 million in generating capacity. For private firms, the cost of unreliable power and chronic shortages has been considerable. In Nigeria, because of poor reliability of publicly supplied power, most private firms have to invest in electricity generators—adding 1025 percent to their machinery and equipment budgets.

National transportation systems also often fail to deliver the logistical support necessary for private firms to reach new markets. In Zambia, it has been estimated that poorly maintained roads add 17 percent to freight costs. As a result of poor operating efficiency of the rail system, freight rates in Africa are on average twice as high as those in Asia, and one and a half times those in Latin America. Despite high returns on road maintenance investments, neglect of maintenance in Sub-Saharan Africa has eroded almost $13 billion worth of roads—one-third of those built in the past 20 years. The high cost of sea and air freight services undermines the competitiveness of exports from Sub-Saharan Africa. For example, a container costs $200 to pass through Abidjan's port, compared with $120 in Antwerp, and much less in East Asia. The cost of air transportation in Africa is also much higher than in East Asia—often four times as much. The performance of national airlines has been dismal. With the exception of such carriers as Ethiopian Airlines and Air Zimbabwe, national carriers (Zambia Airways, Cameroon Air, Kenya Airways, and Nigeria Airways) continue to rack up large deficits.

The agenda for developing an attractive yet competitive business environment

In China and India, the demand for infrastructure services outstrips supply, constraining fresh domestic and foreign investments. Delays in the delivery of coal cost China an estimated $70 billion in 1992. To maintain its planned economic growth, China will need to spend more than $100 billion by 2000 to upgrade its overburdened transport system. In India, chronic power shortages often cripple industrial production and cause production costs to soar, while frequent voltage fluctuations or sudden disruptions in supply damage equipment. In 1992-93, power shortages, estimated at 18 percent of peak capacity requirements, resulted in low capacity utilization and substantial production losses. Equally disruptive is the inefficient management of transport services, which often raises operating and inventory carrying costs. Poor management of ports in India, for example, adds $80 to each container of Indian exports.

The problems of infrastructure detailed above stem from poorly specified goals, lack of managerial autonomy and accountability, chronic financial distress, price controls, insufficient competition, and wage and labor problems. As a result, governments in many low-income countries are increasingly taking a fresh, pragmatic look at expanding the menu of options for delivery of infrastructure services.

At the heart of these new approaches is greater involvement of the private sector, more decentralized and participatory approaches to public infrastructure investments and maintenance, and stronger capacity of the public sector to oversee and regulate private sector involvement. Governments recognize that technological, institutional, and regulatory innovations now allow competitive private delivery of many services. They are increasingly unbundling infrastructure services and applying a range of market options to increase efficiency, competition, and private investment.

The menu of options ranges from management contracts, leases, and concessions to outright sales of assets. These approaches are increasing competition from substitutes (for example, natural gas for coal). They are also increasing competition in and for the market. In many Sub-Saharan African countries, such port activities as stevedoring, tugboat services, dredging,

Perhaps the greatest lasting benefit of private participation in infrastructure e is that governments can increase the allocation of resources to areas crucial to the long-term growth of the private sector and piloting are being handed over to the private sector. Viet Nam and Pakistan are considering leasing container terminals to private operators. In the water sector, concessions and leases to private operators are working well in Guinea and Cote d'Ivoire. In Sri Lanka and India, urban transportation has been deregulated to allow profitable operation of small vehicles by entrepreneurs. Private toll-road operations are planned in Ghana, India, and Pakistan. In countries as diverse as China, Ghana, Sri Lanka, and India, large parts of the telecommunications sector are being opened to private operators. In Sri Lanka, by 1993 four private cellular operators had been licensed—and competition between these operators has produced tariffs among the lowest in the world.

The power sector, particularly power generation, also has been opened to private participation in many countries. In Ghana and Guinea Bissau efforts are under way to bring in private firms under performance-based contracts, while in Tanzania and Cd'lvoire new projects will involve private investment. In Pakistan and India, private power generation in the form of independent power production is actively promoted and will contribute both to increasing efficiency and reducing the financial burden on governments. To stimulate this flow of private capital and management, many countries are revising their regulatory regimes and examining options for providing financial assurances to investors and lenders, often with help from IDA.

Besides new private investments, privatization of existing infrastructure utilities is an option available to low-income countries, particularly where the need to control persistent budget deficits leaves the public sector with limited resources for maintaining and expanding infrastructure capacity. In many middle-income countries, particularly in Latin America, privatization of infrastructure has been pursued to relieve overextended government budgets, improve operating efficiency, increase capacity, and reduce the cost of services to private firms. Infrastructure privatizations in developing countries mobilized about $25.4 billion between 1988 and 1993, of which $5.2 billion were raised through bond and equity sales in international markets (World Bank 1994e). The privatizations were mainly in the telecommunications and power sectors with Latin America, followed by East Asia. accounting for most of them (table 2.4).

Few low-income countries have yet pursued the privatization of infrastructure aggressively. In light of rapid changes in the infrastructure sectors in middle-income countries, low-income countries will have to step up their efforts to maintain the competitiveness of domestic firms and increase their access to international markets. True, the privatization of infrastructure in lowincome countries poses special problems—embryonic domestic capital markets, limited domestic entrepreneurial capacity, weak regulatory mechanisms.















Latin America







East Asia

















































Total (billions of dollars)







Note: Privatizations include sales in local markets and exclude airlines, shipping, and road transport.

Source: World sank 1994d, e: Sader 1993.

But options to overcome these problems are being applied in some countries. These issues are discussed in detail in chapter 3.

Perhaps the greatest lasting benefit of private participation in infrastructure is that governments can increase the allocation of resources to areas crucial to the long-term growth of the private sector, but where private participation is often difficult. One is rural infrastructure, an area of considerable underinvestment in most low-income countries.

In Sub-Saharan Africa, the neglect of rural roads, education facilities, small-scale irrigation facilities, and telephone and power connections often cuts farmers and processors off from urban markets and from export markets. It also cuts them off from access to improved inputs, equipment, and technology. On average, road density is 34 miles per square kilometer in Africa, compared with more than 500 in India. In Cameroon, more than 80 percent of the unpaved road network—predominantly in rural areas—is in need of complete reconstruction and compaction. In India, it has been estimated that the decline in public investment in rural infrastructure during the 1980s led to a decline in the growth of private rural investment, from 2.8 percent a year in the 1970s to 1.9 percent in the 1980s.

Several low-income countries are attempting to redress the imbalance in infrastructure investment between rural and urban areas. In this effort, they are decentralizing implementation and relying more on community-based approaches to rural infrastructure development and maintenance—approaches that lead to better project effectiveness and resource mobilization. Ghana, for instance, has set aside 25 percent of its road funds for rural roads. In Ethiopia, a community organization, Gurage Road Construction, has mobilized resources for maintaining and improving more than 350 kilometers of roads. In Sierra Leone, Tanzania, and Zambia, district councils are taking on the responsibility for road maintenance.

These approaches, in tandem with greater private sector involvement, will permit increased spending on education at the primary and secondary levels and on primary health services—areas in which public investment in real terms has yet to climb back to levels of the 1 970s. They will also permit governments in South Asia to tackle, the massive problem of rural illiteracy.

In sum, the growth of a dynamic private sector requires a business environment that:

· Encourages and welcomes private entrepreneurship and reduces uncertainty and risks through continuity and consistency of policies.

· Encourages market relationships through legal and judicial systems that protect property rights and provide a framework for their exchange.

· Fosters competition through open, neutral, and nondiscriminatory policies for trade, regulatory, and investment.

· Reduces transaction costs through simple regulations, well-managed institutions of public finance, and well-functioning infrastructure.

· Commits governments to support enterprises through facilitation of trade and investment, innovative use of public investment programs, and investments in technology and skills development.

· Forges lasting partnerships between governments and the private sector—with a view to overcoming private sector concerns about policy reversals and systematically eliminating impediments that the private sector views as most onerous.

Countries that have achieved this business-friendly competitive environment have done so through a determined effort by the government to develop competent and responsive institutions that work closely with private firms, labor organizations, and civic societies. The financial and technical assistance of the donor community can do much to support what must remain a local initiative and effort.