60113 The Business Environment in Southern Africa: Issues Africa Trade Policy Notes in Trade and Market Integration Note #12 Taye Mengistae November, 2010 The Southern Africa Development Community (SADC) is an association of This policy note1 examines the role of states promoting economic integration differences in business environments in among the following countries: Angola, impeding cross-border trade flows between Botswana, the Democratic Republic of Southern African countries. It also Congo (DRC), Lesotho, Madagascar, considers the cross-border integration of Malawi, Mauritius, Mozambique, Namibia, credit and labor markets based on the Seychelles, South Africa, Swaziland, microeconomic data on firms and Tanzania, Zambia, and Zimbabwe. The households. The aim of the assessment is to SADC has been a free trade area since 2008 help inform the policy and business and has an ambitious regional integration environment harmonization agenda of the agenda that includes the establishment of a Community. customs union by 2012. The free trade area Trends in trade integration provides for the elimination of import tariffs and nontariff barriers to trade among SADC economies are far more integrated members and aims for, among other things, today within the region and with the global the harmonization of customs procedures economy than they were in the mid-1990s. and technical standards, and the Most Favored Nation (MFN) tariffs have liberalization of trade in services within the been reduced, intraregional trade flows have free trade area. Since 2006, the SADC has increased, and trade has risen as a share of also had a Finance and Investment Protocol GDP. On average, SADC countries export (FIP) that seeks to harmonize the policies of and import as much as would be expected member countries in the areas of investment promotion, labor codes, and immigration 1 This policy note is based on a larger report by a task laws, with the ultimate goal of developing team led by Taye Mengistae, The Business the region into an SADC Investment Environment in Southern Africa: Issues in Trade and Zone. Market Integration, The World Bank, 2010. 1 relative to their income and distance from many face problems of high unemployment international and regional markets. Further, and widespread poverty. To successfully intra-SADC trade is relatively high in grow out of these problems many need to relation to what intraregional incomes and diversify production and exports into labor- distance would predict. However, much of intensive industries in manufacturing and the increase in intraregional and extra services. Future progress in further trade regional trade occurred in the 1990s, and all integration within the region will indeed indications are that progress has halted in largely depend on how far member countries recent years. In addition, substantial succeed in this type of diversification. imbalances in trade flows persist. The South African Customs Union (SACU) continues Business environment and trade to dominate intraregional trade flows, as integration both a destination for other SADC member exports and a source of their imports. Trade The cross-country differences in flows among non-SACU countries in the manufacturing productivity and exports that SADC area remain low. we observe today among SADC members have a great deal to do with differences in Another feature of the nature of integration business environment. Specifically, more to date, posing a major policy challenge, is successful exporters of manufactures and that, excluding South Africa, SADC exports services are, on average, more open to trade; to the rest of the world and within the SADC have lower trade costs on account of more are comprised mainly of primary products, conducive geography and lower transport although Mauritius, Malawi, Swaziland, and and regulatory costs; have lower regulatory Lesotho also export clothing and textile barriers to business formation; provide products. The high concentration in better access to long-term finance; and have commodity-based exports has limited intra- more reliable public utilities and better industry trade flows and the productivity governance in the sense of having less gains associated with the economies of scale corruption in government agencies. Above and the diffusion of innovation that such all, more successful exporters of flows facilitate. To realize productivity gains manufactures and services suffer far less from intra-regional trade, many member from allocative inefficiency resulting from countries need to diversify into disparities in access to long-term finance, nontraditional exports, including public utilities, and to government services manufactured and service exports. Trade in among sectors, business size groups, and manufactured goods and services is more entry cohorts, as they provide a more level sensitive to trade barriers and other cross- playing field to everyone on those key border transaction costs than the current dimensions of the business environment. trade in resource-based products. Its development in the region would therefore The top exporters of manufactures and require greater openness to trade of member services in the region currently are South countries and significant reforms of the Africa, Mauritius, Lesotho, Namibia, business environment within the region. Swaziland, and Malawi. These are also among the most open to trade. All except Adding to the urgency of diversifying Lesotho owe their exporting status to the members' exports is that most SADC higher productivity of their manufacturing countries are labor-surplus economies, and sectors. On the other hand, Angola, the DRC, and Zambia have manufacturing and 2 Figure 2.8: Figure 1: Index of technical efficiencyAverage within-firm TFP (log units)- countries in Southern Africa (manufacturing and services) for Enterprise Surveys MAURITIUS SWAZILAND NAMIBIA SOUTH AFRICA BOTSWANA MALAWI TANZANIA CONGO, DEM. REP. ANGOLA ZAMBIA MADAGASCAR 0.000 0.500 1.000 1.500 2.000 Source for figures 1 and 2: World Bank Enterprise Surveys service sectors that are the least productive in the group of successful exporters--a and least export-oriented in the region. One reflection of the lower allocative efficiency major source of the productivity gap that characterizes industry in the non- between the two extremes of successful exporting group (figure 2). Allocative exporters of manufactures and services efficiency measures how efficiently an (South Africa, Mauritius, Namibia, economy allocates available resources for Swaziland, and Malawi), and non-exporters production; a higher score in figure 2 shows of the same (DRC, Angola, and Zambia), is higher efficiency. differences in technical efficiency (figure 1). Technical efficiency measures how The relatively lower allocative efficiency of efficiently an economy uses a given set of industries in the non-exporting group in inputs; a higher score in figure 1 shows turn is partly caused by the fact that there is higher efficiency. greater in-country disparity of business environment in those countries than there is A second source of the manufacturing and within the more successful exporters, where services productivity gap between the two the playing field is more level for all firms groups of countries is that, within the typical regardless of how large they are, how long domestic industry, low productivity firms they have been in business, and where in the tend to have higher market shares in the country and in which sector they are non-exporting group than they would have operating. Figure 2.9: Manuacturing industry allocative efficiency Figure 2: Index of allocative efficiency(manufacturing and services) for countries in Southern Africa index -Enteprise Survey Sample BOTSWANA TANZANIA MALAWI SOUTH AFRICA NAMIBIA MAURITIUS SWAZILAND MADAGASCAR ANGOLA CONGO, DEM. REP. ZAMBIA 0.000 0.100 0.200 0.300 0.400 0.500 0.600 0.700 0.800 3 Business environment reforms and FDI Cross-country differences in the business Mozambique, Swaziland, and Namibia environment have also been a major factor should have attracted far more FDI than they in recent trends in inward foreign direct actually did, while Angola, DRC, and investment (FDI) in the region and in its Zambia are unlikely to sustain current levels allocation among member countries. In of FDI as these far exceed those warranted recent years SADC has attracted higher FDI by expected rates of return shown on the on a per capita basis than most other dashed line in figure 3. Sustaining high developing regions (figure 3). Though most levels of FDI in the second group and of the inflow has been to mining, resource- raising levels in the first group will require poor countries have also attracted more than significant improvements in the countries' their share of FDI. In almost every case, FDI business environments. The type of inflows have financed large shares of improvements needed differ among domestic savings and helped improve countries, however. In at least one country productivity, without which growth rates (DRC), what is needed is reduction of would have been significantly lower than investment risk through greater political they turned out to be. stability. In almost all the others, there is an urgent need for reducing corruption and However, given cross-country patterns in business start-up costs. expected rates of return, Tanzania, Malawi, Figure 3: FDI inflows and the marginal productivity of capital Figure 3.12: FDI inflows and marginal productivity of capital Average annual FDI as % of GDP (2002-08) 10 CONGO, DEM. REP. 8 ANGOLA ZAMBIA 6 MADAGASCAR 4 BOTSWANA SOUTH AFRICA TANZANIA NAMIBIA 2 MALAWI MOZAMBIQUE MAURITIUS SWAZILAND ** But t I 0 0 .1 .2 .3 .4 Marginal revenue productivity of capital, lastest Enterprise Survey estimates, 4 In the recent past, reforms that lowered start- Issues in financial market integration up costs in Madagascar, Mauritius, and Mozambique have had drastically positive Greater financial integration in the SADC and visible impacts on FDI flows, while should help improve the allocation of FDI greater political stability in Zambia and and capital more generally within the region. Mauritius has had a similar effect in those It should also help promote trade countries. On the other hand, major declines integration. Some of the influence of in the control of corruption seem to have led business environment on investment and to a sharp fall in FDI in Namibia and trade integration therefore occurs as an Swaziland in the early 2000s. One effect on financial integration and financial indication of the scope for positive changes development. in these business environment factors is that start-up costs have steadily declined in At this point the level of financial nearly all resource-poor countries to integration is quite low, an indicator of converge with or to a lower point than the which is the large variance in real interest South African norm, while start-up costs are rates among member countries: some have very high and have generally remained excessively high rates (Mozambique, unchanged in most resource-rich countries. Tanzania, and Zambia), while others report negative rates (DRC, Botswana, DRC and Zimbabwe aside, the trend in the Madagascar, and Angola). Countries also SADC as a whole has been one of members' vary hugely in terms availability of financial convergence towards greater political products and their accessibility to different stability, with steady improvements in every sectors of the economy. country's score on the stability index. Botswana, Mauritius, and Namibia are the One major impediment to greater financial most politically stable members; the larger integration is that institutions of contract countries--South Africa, Mozambique, enforcement are weak in many member Malawi, and Zambia--converge around countries. The SADC scores lowest among something of a normal (or mean) score for all regions on time to enforce contracts, with the region. Angola, Mozambique, Botswana, and Swaziland recording the longest times. On the other hand, there is not much Another barrier is that credit information is evidence of convergence over time among lacking in several countries, including DRC, SADC members in terms of control of Lesotho, Madagascar, Malawi, Tanzania, corruption. Indeed, countries in the region and Zambia. Capital controls constitute the fall into three distinct groups: relatively third impediment. The SADC region has the corruption free members, namely, most restrictions on capital flows, both in de Botswana, Mauritius, Namibia, Madagascar, jure measures of capital account restrictions and Lesotho; those with moderate and in de facto measures of actual capital corruption, namely, Zambia, Malawi, flows during the past few years. Mozambique, and Swaziland; and those where corruption is a serious problem-- Employment regulation and labor market Angola, DRC, and Zimbabwe. integration Compared to other regions, employment contracts are not heavily regulated in the SADC. Seven countries have an overall 5 Doing Business employment rigidity index An evaluation of the extent of labor market that is well below the OECD average. The integration involves measuring the speed same index is below Sub-Saharan Africa's with which wages in one country respond to average for three other members. However, shocks to the labor market in the rest of the there is enormous variation in the degree of region. The general rule for interpreting this employment regulation within the region measurement is that a faster adjustment itself. Angola, DRC, Zimbabwe, Botswana, indicates a more regionally integrated and Madagascar regulate the labor market market. Such an evaluation shows that the most heavily. In Lesotho, Malawi, although South Africa has broadly Mauritius, Swaziland, Namibia, and Zambia, integrated its labor market with others in the employment contracts are the least region, the depth of integration is still rather regulated. low. This reflects the fact that both trade and capital flows are far more restricted in the These differences in the intensity of labor region than in places where there is greater regulation have significant implications for cross-border labor market integration. cross-country differences in employment and earnings, and for cross-country One such place is the U.S.­Mexican border, differences in trade integration. It is not by where a study showed that wages in coincidence that the countries where Mexican border towns fully adjusted to employment is least regulated have attracted wage shocks in the US in around one month. more FDI per capita and have more export- This is 3.6 times shorter than the time it oriented manufacturing and service sectors takes for wages in the BNS to fully adjust to than other member countries. Intraregional wage shocks to the South African labor differences in empoyment regulation also market. As would be expected, adjustments generate differences in the price of labor to the shock would take even longer as we and in labor market integration. move further away from South Africa's border. For example, it takes 5.5 months for The reason for this linkage is that a country Tanzanian wages and 11 months for wages cannot sustain wage rates that exceed a in Mauritius to adjust to the same shock to global or regional norm unless it somehow South African wages. restricts the flow of goods, services, capital, and people across its borders. Even where Policy Recommendations trade is restricted, labor market integration can be driven by the flow of capital among The key harmonization issues emerging countries. When FDI is driven by a positive from the diagnostics of the report concern wage shock in the sending country labor import tariffs and nontariff barriers, market, it creates a link with the recipient competition policy, transport and other country's labor markets. For example, FDI significant components of trade costs, from South Africa to Zambia, motivated by provision of infrastructure, control of a sudden rise in wages in South Africa, corruption and access to finance. increases the demand for labor and, Harmonizing import tariffs and reducing ultimately, wages in Zambia. International nontariff barriers to trade migration is another mechanism linking wages and labor markets across countries. Although average tariff rates are now quite modest in the region, the structure of MFN tariff rates vary significantly within the 6 region, effective protection rates are quite effectively enforced, and regionally high with a built-in anti export bias, many harmonized competition policies will help nontariff barriers remain in place within the safeguard against such an outcome. At the FTA, and customs procedures have yet to be moment South Africa is the only member harmonized. As a result, the growth in country that has an internationally well regional and extra regional trade has slowed regarded competition policy regime. down in recent years. There is thus an However, even it needs further competition unfinished agenda for tariff reforms that policy reforms. should include the harmonization of MFN tariffs among SADC members and reduction Reducing trade costs of effective protection rates. Perhaps the most prominent reason that Developing and harmonizing competition intraregional and extra regional trade in the policies SADC are not growing is that trade costs also remain high for reasons that are not As member countries liberalize intra necessarily related to trade policy. Trade regional trade and capital flows, care needs costs are high, particularly in Angola, DRC, to be taken that first arrivals on the domestic Zambia, Botswana, and Zimbabwe (figure scene from other parts of the region do not 4). High transport costs are often the main erect barriers to entry to domestic markets part of the problem, but problems with and domestic industries by design or customs administration and regulatory costs otherwise. Combined with regionally of cross border transactions, and activities in harmonized trade policies, well crafted, general, are often major contributors. Figure 4: Trade costs --cost of exporting Doing Business Standard Cargo to the US (US$)- 2010 Figure 2.14: Doing business trade costs-exports 2010 3500 3280 3000 2810 2500 2000 1531 1500 1000 737 500 0 7 Reducing start-up costs, particularly in In many countries, burdensome customs and resource-rich countries trade regulations have added significantly to trade costs. In such countries there is a need Although nearly all resource-poor countries to streamline clearance procedures as an have tried to lower business start-up costs, important means of facilitating trade. these costs as well as the time it takes to set Nearly everywhere there is a need to reduce up a company remain excessively high in all transport costs by improving roads, railways resource-rich countries. Governments should and port services, although the specific therefore carry out the administrative means of achieving these differ from reforms needed to bring business start-up country to country. costs and set-up times down to international and regional norms. Improving power supply Promoting financial development and After freight transport and port facilities, financial integration power supply is the most important infrastructural obstacle to export diversification in many countries within the At the moment financial integration in the SADC. Power shortages are holding back SADC is impeded by capital controls that manufacturing productivity and exports, are more stringent than in many other parts particularly in Madagascar, Malawi, Angola, of the world, the lack of credit information and Zambia. In each of these countries, in several member countries, and huge start-ups can wait for months to be disparities in the quality of contract connected to the public grid while enforcement institutions among member established businesses report significant countries. Improving availability of credit losses of revenue due to frequent outages. information, opening capital accounts, The proximate cause of the shortages in all opening the banking industry to greater of these cases is years of underinvestment in competition, and improving the quality of the power sector. As a result, governments contract enforcement institutions are thus have sought to promote large investments in potentially important instruments for maintenance and additional generating and promoting financial development and transmission capacity. financial integration in the region. Monitoring market integration The root causes of the shortages also include the deliberate under pricing of electricity, the failure of poorly managed state-owned In most SADC countries, government operators to collect payments, and the statistical agencies collect price data and absence of a workable legal and regulatory household and labor force survey data with framework for private sector investment. variable degrees of regularity and quality Instituting cost recovery tariffs, establishing standards. Unfortunately, in many cases, the efficient billing and collection, and limiting quality of data is so poor that they cannot be transmission and distribution losses are also used to monitor the integration of regional among the measures that some governments goods markets or labor markets. And yet, in the region are being advised to take. well designed and disaggregated product price data are usually a more effective means of monitoring trade integration than are trade flows, and measures of labor 8 market integration provide an indirect but About the Author quite powerful and indispensable indicators of barriers to trade and investment flows. Taye Mengistae is a Senior Economist in the Much effort has been expended by policy Africa Financial and Private Sector makers of member countries in negotiating Development unit (AFTFP). This work is mechanisms for achieving integration. To funded by the Multi-Donor Trust Fund for monitor these, sufficient investment needs to Trade and Development supported by the be made on collecting the price and labor governments of the United Kingdom, market data needed to monitor integration in Finland, Sweden and Norway. The views all member countries. expressed in this paper reflect solely those of the authors and not necessarily the views of the funders, the World Bank Group or its Executive Directors. 9