60023 Reform and Regional Africa Trade Policy Notes Integration of Professional Note #5 Services in East Africa Nora Dihel, Ana Margarida Fernandes, Aaditya Mattoo and Nicholas Strychacz August, 2010 Introduction Engineering services, encompassing Professional services matter for civil, mechanical and electronic development in East Africa. engineering, contribute to the development of infrastructure, the Even though the share of business dynamism of manufacturing and services in the GDP of East African engagement in the emerging countries is small, the sector is knowledge economy. among the most dynamic. Over the Professional services could also period 2001-2007, business services become an important avenue for have grown at 8 percent per annum export diversification by some East in Kenya, 14 percent per annum in African countries. Tanzania and nearly 18 percent per annum in Uganda. But there is a large gap between the Business services are key inputs for potential contribution these services could other sectors, and greater use of make and the meager contribution they professional services is associated make today. Policy makers in East Africa with higher labor productivity. Input- have recognized the critical importance of output tables suggest that they are developing professional services. Along among the top fifth of economic with reform of backbone services like sectors in terms of direct and indirect telecommunications, banking and transport, usage. governments are adding professional Business skills and services, such as services to their list of priorities. Improving accounting and legal services play a and expanding these services will require critical role in reducing transaction both national reform and international costs considered to be the most cooperation, including creating a more significant impediment to economic integrated regional market. growth in Africa. 1 This note presents the results of extensive information gathering and analysis of these Panel B: Number of lawyers per 100,000 inhabitants largely unexplored segments of the East Malawi 2 African economy. It shows why national Tanzania 2 markets for professionals and professional Mozambique 2 Uganda 4 services in East Africa remain Rwanda 5 underdeveloped, while regional markets are Zambia 6 fragmented by restrictive policies and Botswana 12 regulations. To turn this sector around, the Kenya 19 note calls for policy action in the four areas: Mauritius 42 South Africa 43 education, regulation of professional services, trade policy, and labor mobility. 0 20 40 60 80 100 120 Source: World Bank Survey of Providers of Striking Differences in the Level of Professional Services in East Africa, 2009. Development of Professional Services in East Africa Although professionals in East Africa receive low nominal wages relative to their There are striking differences in the level of counterparts in developed and other development of professional services across developing countries, once their wages are countries in East Africa in terms of adjusted for purchasing power, professionals availability and wages. Kenya has a relative in Kenya and Uganda are comparatively abundance of professionals, whereas in well paid ­ reflecting perhaps their scarcity Rwanda there is a relative scarcity of relative to the demand for their services. A professionals. However, per capita wage premium for professionals over the availability of professionals in each of these earnings of other workers with a university countries is only a fraction of that in more degree is evident in all East African advanced African economies, such as countries. Mauritius and South Africa (Figure 1). With the exception of accounting Figure 1: Professional Density in technicians in Kenya, East Africa faces a Africa middle-level skills vacuum. Middle-level professionals can play a crucial role in Panel A: Number of accountants per 100,000 inhabitants providing services to often underserved groups of clients. Skills mismatches seem to Mozambique 0.2 be a serious issue in all examined countries. Rwanda 0.9 Uganda 2 For example, accounting associations in Malawi 3 Tanzania and Kenya report that there are Tanzania 8 jobless accountants despite high demand for Zambia 10 qualified accounting professionals. Kenya 14 Botswana 37 South Africa High Demand for Professional Services in 48 Mauritius 110 East Africa 0 20 40 60 80 100 120 Evidence from recent firm-level surveys in East Africa suggests that a surprisingly large 2 Figure 2: Usage of Professional Services in Uganda, % Usage of Professional Services in Uganda, % 100 0 0 10 90 5 21 13 26 80 70 5 11 60 50 95 100 85 90 40 77 74 68 30 64 61 20 10 0 Accounting Legal Engineering External Usage Internal Usage Source: World Bank Survey of Users of Professional Services in East Africa, 2009. number of formal sector firms in all sectors of the pattern of service use by firms of use professional services.1 A large different size (Figure 2). proportion of the demand for accounting and auditing services seems to derive from Market structures show elements of both mandatory legal requirements, pertaining to oligopoly and competition financial reporting and taxation. The relationship between the usage of externally Accounting and auditing services are outsourced professional services and firm dominated in all countries by the large size in many cases exhibits an inverted U- affiliates of the "Big Four" multinational shape relationship: usage increases with firm firms.2 In Kenya, however, local mid-sized size until a certain point after which it accounting firms are gaining market share at declines. Whereas smaller firms rely the expense of the Big Four after initially primarily on external service providers, working as sub-contractors for them. The more than a fifth of the largest firms rely exclusively on in-house engineers and 2 The Big Four firms are Deloitte Touche Tomatsu, lawyers. Uganda is broadly representative Ernst & Young, Klynveld Peat Marwick Goerdeler, and Price Waterhouse Coopers. They retain a partnership model that relies on local members and 1 The fact that the firm-level surveys cover mostly their professionals to understand the language, rules, urban formal sector firms may help explain the high and operating procedures of the respective market usage. (World Bank, 2008). 3 engineering and legal sectors are dominated though large, is too scattered to meet by domestic providers, which are often demand for large, possibly more small firms and microenterprises. The sophisticated, projects. combined capacity of these small firms, Limited Trade in Professional Services Explaining Skills Shortages and Skill Mismatches in Professional Services in The heterogeneity of professional East Africa ­ Weakness in Education endowments and the earnings differentials across countries for each profession suggest First, professional education is expensive in that there is substantive scope for trade in all East African countries. While skills professional services in East Africa. Foreign premia for professionals exist and internal professionals and foreign professional firms rates of return to education are high in the could help address the underdevelopment of region, the median cost to become a the sectors and the unmet demands in East professional worker ranges from USD Africa. However, data on the presence of 14,000 to USD 26,000. This makes attaining foreign professionals in East Africa suggests professional qualification unaffordable for that in Kenya, Tanzania, and Uganda, the majority of the population in these foreign professionals represent less than 10 countries, especially given the percent of the total number of professionals underdeveloped nature of the markets for in accounting and engineering. In Rwanda, educational loans. in contrast, foreign professionals account for more than 60 percent of the total number of Second, the weaknesses in secondary professionals. In legal services, there are education across East African countries limit virtually no foreign professionals in any of the ability of students to acquire professional the East African countries. skills. The general erosion of mathematical skills in all countries explains the declining Similarly, in terms of commercial presence, number of applicants in science, there is only a limited presence of foreign engineering, and technology courses, engineering firms and there is an almost leading to shortages in the engineering complete absence of foreign legal services sector. firms. Evidence from World Bank- supported civil works procurement contracts Third, the capacity and quality of since 1994 reflects the lack of integration of professional education institutions are the East African market for engineering limited. In several East African countries, services. Domestic companies generally institutions that offer specialized post- win most of the contracts, except in energy graduate courses, as well as institutions that and mining and transportation where non- offer academic and professional training African companies have the lion's share. courses for middle-level professionals are There is virtually no intra-East African entirely absent. foreign firm participation in these contracts, with the limited exception of Kenyan firms Fourth, there is an absence of links between in a few Tanzanian and Ugandan projects educational systems, employers, and users and Ugandan firms in a few Rwandan of services. This absence leads to the projects. production of nominally qualified but effectively unemployable professionals. Stakeholders from the private sector 4 Figure 3: Restrictiveness of Regulation in East Africa - Top Constraints by Sector Top constraints by sector 3.5 Accounting Legal Engineering 3 2.5 2 1.5 1 0.5 0 Source: World Bank Survey of Providers of Professional Services in East Africa, 2009. emphasize the severe lack of coordination sectors in East Africa. Kenya, Tanzania and between employers, professional Uganda seem to impose particularly severe associations, and education institutions with entry restrictions in engineering and legal regards to the content of educational services. Rwanda remains on the light side programs for accountants and engineers and in all three sectors. Each country grants accountants. exclusive rights to certain professions over certain activities. Licensing and educational Explaining the Underdevelopment of requirements and quantitative constraints Professional Services in East Africa ­ also inhibit competition. Regulation Domestic Regulation affecting operations of legal and engineering providers (conduct regulation) include Domestic regulation on the entry and on the restrictions on prices and fees, advertising, operations of professional services firms form of business, and inter-professional often undermines competition and constrains cooperation, are particularly heavy when the growth of strong professional services 5 compared to those in emerging economies by different types of restrictions across and in OECD countries. countries in East Africa. The entry of foreign law firms is not permitted in Kenya Firm-level surveys of private providers of or Tanzania. Local members of international professionals services in East Africa reveal law networks face restrictions in Kenya, that restrictions on multidisciplinary Tanzania, and Uganda on using the activities are an important constraint in the network's brand name. The restrictions accounting sector, while regulations on fees imposed on accounting firms are even more and prices are the major constraints in the stringent, with branches of foreign firms engineering and legal sectors. Non- being prohibited in Kenya, Uganda, and transparent procurement procedures also even the more liberal Rwanda. Kenya and hurt accounting and engineering services Tanzania also prohibit ownership or control providers while inappropriate standards hurt of foreign accounting and auditing firms by accounting services providers (Figure 3). non-locally licensed professionals. Foreign firms providing engineering services face fewer restrictions in East Africa. Explaining the Segmentation of Markets for Professional Services in East Africa ­ All East African countries restrict cross- Trade Barriers border trade (mode 1 in GATS) in certain types of professional services, such as Trade barriers limit competition and the advice on matters relating to domestic law, efficiency of professional service providers audits, as well as tax representation and tax in East Africa. Countries in the region differ advice. in terms of their openness to trade: Kenya and Tanzania generally exhibit the most Reforming Markets for Professional restrictive policies on trade in professional Services services while Uganda is relatively open and Rwanda much more so. The East African regional market for professionals remains generally Trade in professional services through the underdeveloped and fragmented by movement of natural persons (mode 4 in restrictive policies and regulatory GATS) across national borders is restricted heterogeneity. Given these limitations and in East Africa by explicit trade barriers, constraints, policy reform is necessary to regulatory requirements, and immigration allow the market for these professions to policies. Chief among them are develop. An effective reform agenda will discretionary limits through labor market require policy action in four areas: tests on the entry of any type of foreign education, regulation of professional professionals in Kenya, Tanzania, and services, trade policy and labor mobility at Uganda, de jure or de facto nationality both the national and the international level. requirements to practice domestic law in Kenya and Tanzania, limited recognition of Reforms at the National Level foreign-licensed professionals and work permit issues in most East African countries. Reforms at the national level should focus on the development of framework Trade in professional services through the conditions that address skills shortages and establishment of foreign commercial skills mismatches and attempt to facilitate presence (mode 3 in GATS) is also limited the growth of professional services. 6 adequate quality can be provided at a Reforms related to education should focus lower cost by middle-level professionals. on the following issues: Disproportionate restrictions on Financial constraints prevent individuals competition should be eliminated. from acquiring a professional education, o Price regulations are supported by so developing new and expanded means the East African countries' of financing higher education such as professional associations which student loans schemes should be a claim that they are useful tools to priority. prevent adverse selection problems. Weaknesses in African education East African countries could adopt systems mean that students are ill- less restrictive mechanisms such as equipped to acquire professional skills, increased access to information on so enhancing the quality of and capacity services and services providers to of schools, especially in mathematics, accomplish the same goals at lower sciences, and technical studies, should economic cost. be a key item on the policy agenda. o East African countries impose Given the capacity constraints and restrictions on the ownership quality limitations of professional structure of professional services education institutions, improving firms, the scope of collaboration existing institutions and encouraging the within the profession and with other creation of new ones is necessary. professions, and, in some cases, the Policy action to encourage closer opening of branches, franchises, or collaboration and consultation between chains. East African countries should employers, professional associations, eliminate regulations that are clearly and education institutions could help anti-competitive and may harm professionals acquire the job-market consumers by preventing providers relevant skills and the crucial practical from developing new services or training. cost-efficient business models. o Advertising prohibitions are imposed Reforms should also focus on incremental, by most East African countries to qualitative improvements in domestic many of their professional services regulation. sectors. East African countries should allow advertising of Disproportionate cumulative entry professional services that facilitates requirements should be relaxed. For competition by informing consumers example, narrowing the scope of about different products and that can exclusive tasks in certain professions be used as a competitive tool for new would contribute to accomplishing this firms entering the market. goal. The argument in favor of exclusive rights is that they can lead to increased Reforms at the International Level specialization and guarantee a higher quality of service. But exclusive rights The fragmentation of regional markets for that create monopolies can have adverse professional services and professional price and allocation effects, especially if education in East Africa by restrictive they are granted for services for which policies and regulatory heterogeneity prevent countries from taking advantage of 7 gains from trade based on comparative benefits in that a larger regional market is advantage, as well as gains from enhanced able to attract greater domestic and foreign competition and economies of scale. Policy investment, and regionalization may help to action is required in the following key areas. take advantage of scale economies in regulation, particularly where national Steps must be taken to relax the explicit agencies face technical skills or capacity trade barriers applied by East African constraints. Regulatory cooperation to countries to the movement of natural overcome regulatory heterogeneity within persons, establishment of commercial the EAC would be particularly useful in the presence, and cross-border supply of following areas: professional services, as well as through discriminatory procurement. Examples of East African Community countries have possible reforms are: articulating the taken the first steps towards mutual economic and social motivation for recognition of qualifications and nationality and residency requirements; licensing in professional services in the developing transparent criteria and adoption of the Common Market procedures for applying any quantitative Protocol in 2009. While some progress restrictions on the movement of on mutual recognition has been made in professionals such as economic needs tests; accountancy, EAC countries should minimizing restrictions on the forms of continue to work towards implementing establishment allowed; developing a a regional framework for mutual transparent and consistent framework for recognition in other professional services accepting professionals with foreign even if the process is lengthy and qualifications. The reduction of explicit difficult. trade barriers should be complemented with the reform of immigration laws. Inappropriate standards can stifle demand for services. The development of Trade liberalization should be coordinated an appropriate standard may be with regulatory cooperation at the regional desirable at a regional rather than level. Trade barriers would ideally be national level in order to exploit liberalized on a most favored nation (MFN) economies in regulatory expertise, or non-preferential basis since that would prevent fragmentation of the market by generate the largest welfare gains. But such differences in standards, and limit the liberalization may not always be technically scope for regulatory capture. Common feasible or politically acceptable, especially regional standards would reduce the when impediments arise from differences in costs to market participants of operating regulatory requirements. Deeper regional across national borders. A framework for integration through regulatory cooperation regional cooperation on accounting and with neighboring partners, which have auditing standards already exists in the similar regulatory preferences, can usefully form of the Eastern Central and Southern complement non-preferential trade African Federation of Accountants liberalization. Regional integration would (ECSAFA). All countries could benefit also enhance competition between services from the development of the ECSAFA providers, allow these providers to exploit Guide on Accounting for SMEs and economies of scale in professional from common training standards for education, and produce a wider variety of accounting technicians such as the services. Regional integration brings further Occupational Standards for Accounting 8 Technicians in the ECSAFA Region or While the economic benefits of regional the accounting technician scheme integration are evident, the pace of recently introduced by the Association integration is largely dependent upon of Accountancy Bodies in West Africa member countries' political motivation and (ABWA). conviction that the various reforms are beneficial to their domestic constituencies. Regional cooperation on the removal of So far, East African countries have restrictions on the free movement of committed themselves, at least in principle, labor including visa and immigration to liberalization and deeper regional laws is crucial for East Africa. The integration in a number of services sectors. mobility of business people is a key However, much more work is needed to factor in the promotion of free and open accomplish this goal. The policy discussion trade. Through the Common Market and recommendations presented here are Protocol, East African economies have intended to facilitate more informed policy committed themselves to enhancing choices, which could lead to a reformed and labor mobility by streamlining dynamic professional services sector that immigration and temporary residence contributes to East African development. processes for foreign workers but these commitments need to be implemented in practice. About the Authors Regional cooperation to improve the Nora Dihel is Trade Specialist with the Africa Poverty Reduction and Economic Management unit. financing and capacity of professional Ana Margarida Fernandes is Economist in the education is desirable. Cooperation Development Research Group - Trade and among countries in terms of sharing Integration. Aaditya Mattoo is Research Manager, information and experiences to increase Development Research Group - Trade and the recovery rate of student loans while Integration. Nicholas Strychacz is a Consultant in the Africa Poverty Reduction and Economic increasing students' access to higher Management unit. This work is funded by the Multi- education could improve the impact of Donor Trust Fund for Trade and Development educational loan schemes in East Africa. supported by the governments of the United In general, the fragmentation of the Kingdom, Finland, Sweden and Norway and the Bank regional market for education by Netherlands Partnership Program (BNPP). The views expressed in this paper reflect solely those of differences in regulation can prevent the the authors and not necessarily the views of the emergence of regional hubs for higher funders, the World Bank Group or its Executive education, so smoothing these regulatory Directors. differences can lead to a greater variety of higher education services becoming available at lower costs for students in East Africa. The Inter-University Council for East Africa (IUCEA), a regional inter-governmental organization established in 1980 with the aim of facilitating contact between the universities of East Africa, already provides a forum to address these issues. 9