A W O R L D B A N K C O U N T R Y S T U D Y Afghanistan--State Building, Sustaining Growth, and Reducing Poverty THE WORLD BANK A W O R L D B A N K C O U N T R Y S T U D Y Afghanistan--State Building, Sustaining Growth, and Reducing Poverty THE WORLD BANK Washington, D.C. Copyright © 2005 The International Bank for Reconstruction and Development/The World Bank 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First Printing: February 2005 printed on recycled paper 1 2 3 4 5 07 06 05 World Bank Country Studies are among the many reports originally prepared for internal use as part of the continuing analysis by the Bank of the economic and related conditions of its developing member countries and to facilitate its dialogues with the governments. Some of the reports are published in this series with the least possible delay for the use of governments, and the academic, business, financial, and development communities. 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Contents Abstract ix Acknowledgments xi Acronyms and Abbreviations xiii Executive Summary xv 1. The Afghan Economy 1 Recent Economic Performance 2 Structure of the Economy 6 Economic Prospects 11 2. Poverty in Afghanistan: A Preliminary Analysis 15 Historical Background and Social Indicators 16 Rural Poverty Profile 20 Determinants of Rural Poverty 23 3. Toward Sustained Growth and Poverty Reduction 27 Growth and Poverty Reduction Strategy 28 Implementation Priorities and Risks 36 4. Building an Effective, Accountable Afghan State 43 The State-Building Agenda 44 Work in Progress 52 Some Key Tasks Ahead 58 The Way Forward 63 5. Encouraging and Supporting Private Sector Development 69 The Afghan Private Sector 70 Constraints to Private Sector Development 76 Government Strategy and Implementation Priorities 81 6. Agricultural Development Priorities and Prospects 91 Overview and Policy Framework 92 Priority Areas for Reform 97 Prospects for Afghan Agriculture 108 iii iv Contents 7. Understanding and Responding to the Drug Economy 111 The Opium Economy in Afghanistan 112 Lessons from Experience in Fighting Drugs 120 Government's National Drug Control Strategy 124 Options and Trade-Offs in Strategy Implementation 126 8. Delivering Basic Social Services with Gender Equity 131 Background 132 Conceptual Framework 134 Improving Basic Social Service Delivery in Key Sectors 137 9. Assisting the Poor and Vulnerable 147 Poverty, Vulnerability, and Coping Mechanisms 148 Government Strategy and Programs 153 Toward a Broad-based, Effective, Sustainable Social Protection Policy 158 10. Priorities for Action, Challenges, Prospects, and Risks 161 Statistical Appendix 165 References 185 Map LIST OF TABLES 1.1 Macroeconomic Indicators 4 2.1 Social Indicators 2003 17 3.1 National Priority Programs 29 3.2 Structural Reforms 34 3.3 Prices, Wages and Exchange Rates 40 4.1 General Pay Levels (Afs/month) 54 4.2 Examples of Accountability Mechanisms in Proposed Laws 54 4.3 SY1382 Budget Execution 57 4.4 Domestic Revenues 57 4.5 Revenues (% of GDP) 58 4.6 Economic Activities and Probable Associations with Corruption 59 4.7 Priorities for Reducing Administrative Corruption 66 4.8 Options for Enhancing Capacities within Government 67 5.1 The Enterprise Spectrum 70 Contents v 5.2 Infrastructure in Afghanistan and Selected Other Countries 84 5.3 Priority Areas for Support to the Private Sector 88 6.1 Agricultural Growth Rates (percent per annum) 92 6.2 Livestock Population Per Family 95 6.3 Regional Composition of Surface Water Resources and Irrigated Area 99 6.4 Estimated Irrigation Potential in Afghanistan 99 6.5 Estimated Rates of Return to Investment in Agricultural Research 101 7.1 Estimated Opium Cultivation, Production, and Incomes 1995­2004 114 8.1 Public Service and Social Indicators 132 8.2 Rural Households' Access to Basic Services 134 8.3 Institutions and Accountability in Selected Services in Afghanistan 145 9.1 Essential Characteristics of Three Groups of Rural Households 148 9.2 LSP Significant Achievements in 1382 (FY 2003/04) 154 A.1. Macroeconomic Indicators 169 A.2. Millennium Development Goals 171 A.3. Distribution of Characteristics Across Expenditure Quintiles, 2003 172 A.4. Determinants of Rural Poverty, 2003 175 A.5. Government Expenditures and Employment 177 A.6. Government's National Budget 178 A.7. Regional Distribution of Geographical and Arable Land, 2002 179 A.8. Cropwise Distribution of Area Cultivated, 2002 179 A.9. Area, Production and Yield of Cereals in Afghanistan: 2001­03 180 A.10. Area under Wheat and Wheat Yields by Regions in Afghanistan (1997­2003) 181 A.11. Wheat Production Across Regions, 2003 183 A.12. Average Yield and Comparative Gross Income of Horticulture Crops as Compared to Other Crops 183 LIST OF FIGURES A. The Informal Equilibrium xviii B. The Formal Equilibrium xix C. A Vicious Circle xxiv D. Strategic Framework for Breaking the Vicious Circle xxv 1.1 Afghanistan's Level of Development in International Perspective (1975­2002) 3 1.2 The Informal Economy in Different Sectors 7 1.3 The Informal Equilibrium 10 1.4 Cereal Yields 11 vi Contents 2.1 Selected Correlates of Rural Poverty (by quintiles) 21 3.1 The Formal Equilibrium 31 4.1 Afghanistan's Administrative Structure 46 4.2 De Jure and De Facto Centralization 47 5.1 Results of Enterprise Survey in Four Cities 77 5.2 When and How to Levy User Fees 85 6.1 Regional Distribution of Arable Land, 2003 93 6.2 Cropwise Distribution of Area Cultivated, 2002 93 7.1 Opium Cultivation and Production Trends, 1990-2004 112 7.2 Opium Farm-gate Prices 1994­2004 115 7.3 A Vicious Circle 120 7.4 Strategic Framework for Breaking the Vicious Circle 127 8.1 Accountability Relationships in Public Service Delivery 135 8.2 Education Enrollment Figures 140 9.1 Program Participation by Quintile (percent) 156 LIST OF BOXES 1.1 Analyzing the Informal Economy 8 1.2 Discovering Afghanistan's Growth Potential 12 2.1 Gender in Afghanistan--A Politicized Issue 18 3.1 National Program Structure 30 3.2 Refugee Return and Remittances 37 3.3 The Role of Women in Afghanistan's Reconstruction 38 4.1 State Building 45 4.2 The Berlin Security and Rule of Law Declaration 48 4.3 Improvements in the Budget 51 4.4 "Water is Muddy from the Source" 60 5.1 A Raisin Factory in Kabul 71 5.2 Non-Governmental Organizations (NGOs) 73 5.3 Construction Materials in Mazar-i-Sharif 74 5.4 Zam Zam Industries: A Small Water-pump Manufacturer 75 5.5 Characteristics of Recent Investments 76 5.6 Quality Certification for Raisins 79 5.7 Constraints Faced by a Private Mobile Telephone Operator 80 6.1 Comparative Returns from Crop Cultivation 94 6.2 Typical Regulatory Requirements of a Modern Agricultural System 96 Contents vii 6.3 Land Tenure Issues in Afghanistan 97 6.4 Outsourcing Extension Services 103 6.5 Agriculture and the Gender Division of Labor 105 7.1 The Competitive Model of the Drug Industry 117 7.2 Key Economic Linkages 118 7.3 Counter-Narcotics Experience in Afghanistan 121 7.4 Examples of Possible Innovative Approaches 124 8.1 Examples of Approaches to Improving Social Service Delivery in Afghanistan 138 9.1 Situation of Specific Vulnerable Groups 151 9.2 Safety Net Programs 155 9.3 Lessons from Oxfam's Cash for Work Program in Hazarajat 157 Abstract A fghanistan has come a long way since emerging from major conflict in late 2001. Important political milestones mandated by the Bonn Agreement (two Loya Jirgas, a new Constitution, recently the Presidential election) have been achieved. The economy has recovered strongly,growing by nearly 50 percent cumulatively in the last two years (not includ- ing drugs). Some three million internally- and externally-displaced Afghans have returned to their country/home. More than four million children, a third of them girls, are in school, and immunizationcampaignshave achievedconsiderablesuccess.TheGovernmenthassupported good economic performance by following prudent macroeconomic policies; it has begun to build capacity and has developed the nationally-led budget process and made the budget into its central instrument of reform; and it has made extraordinary efforts to develop key national programs (for example public-works employment programs and community development programs) and to revive social services like education and health. Nevertheless Afghanistan remains one of the poorest countries in the world in terms of both per capita incomes and social indicators, with large gender gaps. The difficult chal- lenge of poverty reduction is made even more difficult by continuing insecurity, weak rule of law, and narcotics. Worsening security in many parts of the country threatens to derail reconstruction, undermine state building efforts, delay parliamentary elections and adversely affect other aspects of political normalization, reduce private sector activity, and keep it in the informal/illicit economy. The burgeoning revival and spread of opium pro- duction during the last two years (opium accounted for about a third of the Afghan econ- omy and three-quarters of global illicit opium production in 2003, even more in 2004, and is now found in all 34 of Afghanistan's provinces) has fueled insecurity and funded anti- government interests. Drugs, insecurity,"capture"of large parts of the country by regional powerbrokers, and the weak capacity of the state (including difficulties in centralizing rev- enue) all contribute to a self-reinforcing"vicious circle"that would keep Afghanistan inse- cure, fragmented politically, weakly governed, poor, dominated by the informal/illicit economy, and a hostage to the drug industry. Afghanistan, with robust support from the international community, has to break out of this vicious circle--and move toward a "virtuous circle" whereby improving security, state capacity building, revenue mobilization, formal private sector development, and sen- sible, coordinated actions against drugs all reinforce each other and put Afghanistan on a path of sustained economic growth and poverty reduction. This will require simultaneous progress on several key fronts; actions in any one area alone will not be effective given the strong interests working to maintain the current status quo. On the other hand limited resources and capacity dictate that the Government prioritize core reforms that will enhance governance, focusing on the implementation of ongoing tasks rather than going for a large number of new initiatives.As the report discusses in detail, the essential elements for a breakthrough in the next one or two years include: Enhancing security and rule of law through vigorous security sector reform and capacity building (especially the Afghan National Army, police force, and justice system), combined with external security assistance including outside of Kabul. ix x Abstract State building through increasing capacity and intensifying public administration reforms, with a focus on enhancing center-periphery relations (with provincial and district administrations), revenue mobilization, and service delivery (national pro- grams, social services, basic infrastructure). Further political normalization, focused on making key institutions (cabinet, leg- islative bodies,judiciary) work effectively,with neutralization of warlords and other illegitimate powerbrokers. Maintaining economic growth with macroeconomic stability, and pro-actively pur- suing private sector development through a good enabling environment, support services, and capacity building within the private sector. Meaningful, coordinated actions against drugs, consistent with the overall state building, security, and development strategy. Enhancing the effectiveness and efficiency of international assistance, focusing on the attainment of core reforms and enhancing donor alignment with the national budget. This is a daunting agenda, which will require strong commitment, actions, and per- sistence on the part of the Government. In each area listed above sustained, coordinated assistance from the international community will be required. Moreover, the international community can support Afghanistan's state building and reconstruction agenda by (i) maximizing assistance that goes through government budget channels and moving toward programmatic support; (ii) maximizing use of coordinated Government-led technical assistance mechanisms, and coordinating pay policy with the Government; (iii) stopping payments and other support to non-legitimate regional authorities; and (iv) standing ready to respond to macroeconomic shocks (such as drought) by accelerating and adjusting assis- tance as needed. Acknowledgments T his report was prepared by a team led by William Byrd and including Deepak Ahluwalia, Christine Allison, David Atkin, Philippe Auffret, Anne Evans, Stephane Guimbert, Syed Mahmood, Nick Manning, Peter Middlebrook,Asta Olesen,Arlene Reyes, Shalini Saksena, Juliet Teodosio, and Renos Vakis. Valuable comments and advice were received from the Peer Reviewers for this task, Barnett Rubin (External Peer Reviewer) and Ian Bannon. The report benefited from guid- ance provided by Ijaz Nabi, and from comments by participants at the review meeting on the concept note, held on January 20, 2004, and at the review meeting on the draft report, held on June 24, 2004. The report was prepared under the overall supervision of Sadiq Ahmed and Alastair McKechnie. The report benefitted greatly from very useful dialog at an informal seminar with Afghan Government leaders, held in Kabul on May 27, 2004, at which some of the main themes emerging from the task were presented and discussed, and from numerous individ- ual meetings on specific topics with Government officials, whose insights and support are gratefully acknowledged. The draft report was shared and discussed with the Government, including at a high-level meeting on August 21, 2004; with donor and UN representatives; with NGO representatives; and with professors and students of Kabul University.Comments received at these meetings were taken into account in finalizing the report. More generally, the report takes as a foundation the vision for Afghanistan set forth in the Government's National Development Framework (April 2002), articulated into a detailed program of investments, policies, and reforms in the more recent Government document Securing Afghanistan's Future: Accomplishments and the Strategic Path Forward (March 2004). xi Acronyms and Abbreviations ACD Afghan Customs Department ADB Asian Development Bank AFMIS Afghan Financial Management Information System AIHRC Afghan Independent Human Rights Commission AISA Afghanistan Investment Support Agency AMF Afghanistan Militia Forces ANBP Afghanistan New Beginnings Program AREU Afghanistan Research and Evaluation Unit ARTF Afghan Reconstruction Trust Fund ASP Afghanistan Stabilisation Program BCM Billion Cubic Meters BPHS Basic Package of Health Services CAO Control and Audit Office CND Counter-Narcotics Directorate CSO Central Statistics Office DAB Da Afghanistan Bank DDR Disarmament, Demobilization, and Reintegration EC European Commission EU European Union FAO UN Food and Agriculture Programme GDP Gross Domestic Product HIPC Highly Indebted Poor Countries IARCSC Independent Administrative Reform and Civil Service Commission ICD Inland Clearance Depot IDA International Development Assistance IDP Internally Displaced Person IMF International Monetary Fund IRC International Rescue Committee ISAF International Security Assistance Force LOTFA Law and Order Trust Fund MAAH Ministry of Agriculture and Animal Husbandry MAPA Mine Action Plan for Afghanistan MDG Millennium Development Goals MISFA Micro-Finance Support Facility of Afghanistan MIWRE Ministry of Irrigation, Water Resources and Environment MoC Ministry of Commerce MoF Ministry of Finance MRRD Ministry of Rural Rehabilitation and Development MSTQ Metrology, Standards, Testing and Quality NATO North Atlantic Treaty Organisation NDB National Development Budget xiii xiv Acronyms and Abbreviations NDCS National Drugs Control Strategy NDF National Development Framework NEEP National Emergency Employment Program NSC National Security Council NSP National Solidarity Program O&M Operation and Maintenance PAREM Public Administration and Economic Management PIP Public Investment Program PMU Program Management Unit PPA Performance-based Partnership Agreement PPP Purchasing Power Parity PRR Priority Reform and Restructuring PRT Provincial Reconstruction Team PSP Provincial Stabilisation Plan SSR Security Sector Reform UNAMA United Nations Assistance Mission to Afghanistan UNDP United Nations Development Program UNEP United Nations Environment Programme UNICEF United Nations Children's Fund UNIFEM United Nations Development Fund for Women UNODC United Nations Office on Drugs and Crime WFP UN World Food Programme WSS Water Supply and Sanitation WUG Water User Group CURRENCY EQUIVALENT Currency Unit = Afghani US$1 = 49 AFN (2003/04 Average) $ refers to US dollars unless otherwise noted GOVERNMENT FISCAL YEAR March 21­March 20 2001/02 = 1380 2002/03 = 1381 2003/04 = 1382 2004/05 = 1383 Executive Summary A fghanistan is emerging from more than two decades of conflict, capped by a severe nationwide drought in 1999­2001, and faces a complex, interrelated set of political, administrative, economic, and social challenges. The energy and resilience of the Afghan people, which served them well during the conflict, is now being channeled into securing their livelihoods, rebuilding a credible state, and restoring the country's economy. Their efforts, with Government leadership and political, financial, and military support from the international community, have already borne fruit in the form of rapid economic growth, rising incomes, initial revival of public administration, and other improvements. There is near-universal popular sentiment for peace, security, and prosperity, manifested recently in the high voter turn-out for the Presidential election despite security threats. Despite the gains made, Afghanistan remains among the poorest countries in the world (average per capita GDP of around US$300 including opium), and it is a highly frag- mented society where the authority of the Government is contested. Continuation of recent positive developments is subject to serious risks--political, security, drug-related, macroeconomic, institutional, and climatic. The Government has set forth a compelling development vision in its National Development Framework (NDF), articulated into a detailed strategy and expenditure program in its recent report Securing Afghanistan's Future: Accomplishments and the Strate- gic Path Forward (SAF). The vision and strategy encompass state building, security, private sector-led growth, human development, and political and social progress, with the key national objectives of sustained broad-based economic growth and poverty reduction. This is the first Economic Report on Afghanistan by the World Bank in a quarter cen- tury. It is intended to contribute to a better understanding of the core challenges that lie ahead for the country and key strategic priorities for national reconstruction. It does not repeat the analysis and investment requirements set forth in the SAF document, but instead focuses on the conceptual frameworks, policies, and institutions that will be needed to achieve core national objectives of state building, sustained rapid, broad-based economic growth, and poverty reduction. Analysis of the Afghan economy is hindered by severe data limitations (discussed in the Statistical Appendix) and is challenged by the conflict-related economic structure and dynamics that have emerged during the past two decades. Never- theless much has been learned about how the Afghan economy functions, at least in qual- itative and institutional terms. The report also draws on the great volume of work done on individual sectors and topics by the Government and partners. This report starts with a description and analysis of the Afghan economy and its recent performance (Chapter 1), and the poverty situation (Chapter 2). Chapter 3 out- lines a strategy for growth and poverty reduction, based on the NDF/SAF, and puts for- ward key strategic priorities and directions for implementation. State building, discussed in Chapter 4, lies at the core of Afghanistan's reconstruction agenda and is essential for progress on political, security, and other fronts. Chapter 5 addresses the development of the private sector, which will have to be the engine of growth and poverty reduction in Afghanistan.Agriculture,covered in Chapter 6,comprises half of the economy and will play a crucial role. Chapter 7 examines Afghanistan's opium economy, which has some short- term economic benefits but very serious adverse effects on state building and security. xv xvi Executive Summary Chapter 8 looks at delivery of social services, a key component of the poverty reduction strategy, including the gender dimension. Social protection--strategies and programs to assist the poorest and most vulnerable members of Afghan society--is discussed in Chap- ter 9. Chapter 10 concludes with a summary of priorities for action, implementation con- straints, prospects, and risks. The Afghan Economy and Recent Performance The starting point--in late 2001 at the fall of the Taliban--for recent developments in Afghanistan was dire. The Afghan economy was reeling from protracted conflict and severe drought, with cereal grain production down by half, livestock herds decimated, orchards and vineyards destroyed by war and drought, more than five million people displaced as refugees in neighboring countries, and remaining economic activities steered in an infor- mal or illicit direction by insecurity and lack of support services. The Afghan state had become virtually non-functional in terms of policymaking and service delivery, although the structures and many staff remained. Numerous people were suffering (and still are) from low food consumption, loss of assets, lack of social services, disabilities (for example, from land-mine accidents), and dis- empowerment and insecurity. The effective Taliban ban on opium poppy cultivation, imposed in 2000, did not much affect trade in opium (apparently based on accumulated inventories) but was devastating to the livelihoods of many poor farmers and rural wage laborers, including through opium-related indebtedness. The collapse of the state virtually excluded the poor from access to services, and moreover the poor tended to be dispropor- tionately affected by insecurity,one of whose important impacts has been a very large num- ber of female-headed households. Even though the fabric of families, kinship groups, and other traditional clusters has held together rather well (demonstrated concretely by the large volume of inward remittances), the penetration of the "warlord" and "commander" culture at the local level has had deleterious effects. In sum,Afghanistan was essentially left out of the last 25 years of global development, with virtually no increase in per capita income during this period and average life expectancy of only 43 years. Afghanistan's economy has performed very strongly in the past two years, with non- drug GDP increasing cumulatively by almost 50 percent (29 percent in 2002 and 16 percent in 2003), albeit starting from a very low base. This mainly reflects the recovery of agricul- ture from the drought, revival of economic activity after major conflict ended, and the ini- tiation of reconstruction.With the improved political and economic situation,an estimated 2.4 million refugees have returned to Afghanistan, and 600,000 internally displaced people have returned to their homes. The last two years have also seen a rebound in opium pro- duction to near-record levels; the opium economy in 2003 comprised about a third of total drug-inclusive GDP and accounted for three-quarters of global illicit opium production, even more in 2004. Recent good growth performance has been supported by the Government's sound macroeconomic policies--a highly successful currency reform in late 2002, a prudent"no- overdraft" policy prohibiting domestic financing of the budget deficit, conservative mon- etary policy which has brought inflation down to around 10 percent per year, and good management of the exchange rate. Progress has also been made in mobilizing domestic rev- enue, which rose from negligible levels in 2001 to over 4 percent of GDP in 2003; in trade Executive Summary xvii reform--import duties have been rationalized and customs administration reforms are underway; and in financial sector reform, where the Central Bank has been made legally autonomous and several foreign banks have started up in Kabul. Peace and strong economic performance have been accompanied by improvements in some social indicators. Restoration and expansion of social services has been initiated, notably primary education and immunization. The end of major conflict, combined with national programs like the National Solidarity Program (NSP), has enabled communities and other groups to begin building social capital. Despite this progress, Afghanistan remains a very poor country,with extremely low social indicators (for example,infant mor- tality of 115 and under-five mortality of 172 per 1,000 live births) and very low access to most public services (such as safe drinking water). The drivers of recent growth are to a considerable extent temporary and recovery- related (such as the boost in grain output) and are running their course. In order to achieve sustained rapid growth--necessary for poverty reduction, phasing out dependence on opium, and maintaining political buy-in for reforms--other, sustainable growth drivers will be needed. Afghanistan has areas of good potential for growth, ranging from agricul- tural production and processing to mining,construction,trade,and other services.Exploit- ing Afghanistan's geographical position as a"land-bridge"between Central and South Asia also can be a source of growth--through trade, transit, and sharing and joint development of resources. Enhancing the role of women in economic life will help ensure that growth is broad-based. For these and other growth potentials to be realized, the Afghan economy will need to move beyond its present, largely "informal" character. The informal economy, which includes a range of activities in terms of legality and market orientation and accounts for some 80­90 percent of the total economy (including drugs), has been a coping mechanism for Afghans' survival during conflict and has shown considerable dynamism. It is flexible in responding to shocks and to short-term opportunities. On the other hand, the informal economy is the outcome of conflict-related insecurity, short time horizons, erosion of the rule of law, and lack of public services, which have influenced entrepreneurs' decisions toward staying informal, relatively small, and not making longer-term investments. The dominance of the informal economy is a self- reinforcing equilibrium which not only keeps most economic activity informal but also hinders revenue mobilization, state building, security, and ultimately competitiveness and growth (see Figure A). Toward Sustained Growth and Poverty Reduction The Government's SAF report puts forward an ambitious goal of 9 percent annual growth of non-opium GDP over the next 12 years, which is argued to be necessary for sustained progress in political normalization, state building, poverty reduction, and phasing out the drug economy. The SAF report is equally ambitious in targeting sharp improvements in social indicators, in line with the Millennium Development Goals. For example, the gross primary school enrollment rate is targeted to rise from 54 percent (40 for girls) at present to 100 percent for boys and girls by 2015, the under-five mortality rate to decline from 172 to 130 per 1,000 live births, the infant mortality rate from 115 to 55 per 1,000 live births, and the maternal mortality rate from an estimated 1,600 per 100,000 live births to 205. xviii Executive Summary Figure A. The Informal Equilibrium Non-state powers (warlords, commanders) Weak capacity, poor governance Limited Failed incentives government Macro instability, Weak few public goods, Rule of law revenues poor regulatory framework No incentives to go formal Informal, non taxed Informal, low activities productivity These long-term objectives constitute major challenges for the Afghan Government, the Afghan people, and the international community in support. Afghanistan faces some major constraints in sustaining recent rapid economic growth, which will have to be led by a strong, competitive private sector: (i) insecurity and lack of rule of law (fueled by the drug industry, which has a strong interest in maintaining an envi- ronment of insecurity and lawlessness); (ii) regulatory burden and corruption--although the Government has a pro-private sector policy orientation and has pursued trade and tax reforms, there is still excessive red tape in obtaining permits, land allocations, and the like; (iii) unavailability of key support services for the private sector, ranging from essential infrastructure (power--extremely important for many types of activities, roads, serviced land, water) to finance, insurance, business support services, agricultural extension and marketing, etc.; and (iv) lack of a framework and infrastructure for standards, quality assurance, weights and measures, testing, etc., which will be critical for export develop- ment. These constraints all fall within the general rubric of the "investment climate". In addition growth will be constrained by (v) human capital, both extremely scarce manage- rial and technical professionals--decimated by conflict-related "brain drain" and lack of a credible higher education system in recent years--and literate, skilled labor to work in manufacturing and services; and, related, (vi) weak capacity of the private sector itself, which despite its strong and vibrant entrepreneurship within the informal setting lacks capacity and experience in competitively bidding on international contracts, producing to international export quality standards, and other requirements for longer-term dynamism and competitiveness. Afghanistan's growth strategy must be multi-faceted to ease these constraints and enable the Afghan private sector to generate broad-based economic activity and robust Executive Summary xix Figure B. The Formal Equilibrium Government's capacity Macro stability, Government's public goods, Rule of law revenues regulatory framework Entrepreneur's productivity growth on a competitive basis (including competitiveness in exports, whose growth will be essential over the longer term to replace the eventual decline in external assistance). Sus- tained economic growth will be associated with breaking out of the"informal equilibrium" and moving toward a "formal equilibrium" whereby over time many successful and grow- ing entrepreneurs become part of the formal economy--investing, registering themselves, paying taxes, and benefiting from rule of law and availability of services (see Figure B). This does not mean that the entire economy would become formalized, let alone quickly, but rather that a sizable, dynamic formal sector would come into being. A strategy to shift incentives toward the formal equilibrium, building on the Government's NDF, would have four key elements: (i) improved security through fair and effective enforcement of law and order; (ii) maintaining macroeconomic stability; (iii) effective delivery of support services (such as power, infrastructure, and finance, and essential public goods in support of small- holder agriculture) and building the capacity of the private sector; and (iv) creation of an enabling regulatory environment for business activity through structural reforms. Progress has already been made most notably in trade and financial sector reforms, and macroeco- nomic stability has been achieved but will need to be maintained. Structural reforms will need to focus on completing those underway, on further deregulation to ease the burden of red tape and reduce vulnerability to corruption, and on new areas such as the privatiza- tion agenda. Progress in improving security and public service delivery will be crucial and will depend very much on gains in state building. Over the longer term, human resource development will be essential, requiring adequate investments in education and health, focusing on quality as well as access. In the short run, rapid economic growth can be supported, and the process of "for- malization" jump-started, by: Importing resources, including (i) aid and technical assistance, and military and police assistance; (ii) imports of goods and services; (iii) foreign direct investment; and (iv) ideas, capital, and skills from Afghans living abroad. To help promote the "formal equilibrium," xx Executive Summary external assistance going through budget channels should be maximized,contracts awarded through transparent competitive bidding, and good fiduciary practices followed. Domestic capacity building needs to be an integral part of this approach. Regional resources can sup- port this effort, e.g. importing electricity and skilled workforce. Harnessing the dynamism of the informal sector to generate growth, by (i) facilitating further growth of the informal sector, to the extent that it is legitimate--e.g. through micro-credit, targeting women who account for a large part of the informal sector, stimu- lating smallholder agriculture, developing cooperation among informal actors; and (ii) gradually shifting informal activities to the formal sector--through expanding linkages between formal and informal sectors, using donor-supported programs as a vehicle for contractors and implementation partners to move into the formal sector, encouraging small concerns to"come into the open"by exempting them from taxes, and putting in place a mining law, NGO regulatory framework, etc. Starting reforms in specific localities (Industrial Parks, Export Processing Zones, Urban Enterprise Zones, etc.), where land, security, power, and enabling regulations may be eas- ier to provide; the Government has already initiated development of Industrial Parks. Economic growth will increase opportunities for poor people--by helping them to build their assets, through their investing (and repaying debts) from their own incomes, and accumulating physical capital like livestock. Increasing opportunities for poor people will also require building their human capital, developing community asset-building pro- grams, financing assets through micro-credit, etc. Enhancing the economic role of women will support both broad-based growth and poverty reduction. To empower poor people, these approaches need to be complemented with the development of participatory insti- tutions (for example, the elected Community Development Councils established through the NSP). Finally, poor people should benefit from security improvements. Thus in addi- tion to growth, main elements of a poverty reduction strategy would include: Asset building on the part of the poor, supported by a range of well-targeted, cost- effective programs, some of which like micro-finance and agricultural development programs would support both growth and poverty reduction. Public works employ- ment programs and other income generation programs can help the poor preserve and over time build physical assets. Human capital building by the poor, primarily through adequate levels and quality of basic education and health services (see Chapter 8 and, for details of expenditure require- ments, the SAF report). Social protection (see Chapter 9) is another key element of the poverty reduction strat- egy--in particular, safety net programs for the extreme poor and those unable for various reasons (remoteness, disability, female-headed households, and so forth) to fully take advantage of opportunities created by economic growth. A final key element of a poverty reduction strategy is consultation. A good poverty reduction strategy needs to be "owned" by the poor as well as by other stakeholders. The Government is appropriately planning to engage in extensive consultations with different segments of the society as it develops its Poverty Reduction Strategy, a process that is tar- geted to reach a first stage of completion with the preparation of an Interim Poverty Reduc- tion Strategy (I-PRSP) early in 2005. Executive Summary xxi Enhancing trade, both within the region and globally, will be vital to the expansion of market opportunities, and therefore for growth and poverty reduction. Capitalizing on Afghanistan's position as a "land bridge" for trading within the region, and promoting its wider integration in the formal global economy, will require continuing policy and insti- tutional reforms, with emphasis on trade facilitation. Afghanistan has already made sig- nificant progress in reforming its trade and investment regime. Nevertheless, official regional trade flows between Afghanistan and its neighbors remain relatively small, com- prising only 11 percent of all exports in 2002, the rest being traded globally (World Bank 2004d).Informal trade flows with Pakistan and other countries are quite considerable how- ever. Currently, trade logistics remain very difficult and costly, in a difficult security envi- ronment that encourages informal and illicit trading patterns. Hence streamlining Afghanistan's transit links with both regional and non-regional trading partners would reduce transport-related trade costs and would facilitate the growth of economic activity and incomes in Afghanistan and its neighbors. Problems of market access depend not only on formal trade barriers but also on barriers to efficient trade logistics and weaknesses in the operation of market institutions. The implementation of the newly approved tariff schedule as well as enhancing the capacity of the customs service, harmonizing customs procedures, and improving customs valuation, are all vital aspects of enhanced trade facil- itation. Given its potential significance, regional trade deserves special attention in bilat- eral discussions and multilateral forums, such as the Economic Cooperation Organization (ECO), which along with Afghanistan and its neighbors includes Azerbaijan, Kazakhstan, Kyrgyz Republic, and Turkey. The March 2004 ECO Conference held in Kabul demon- strated a closer relationship between Afghanistan and other ECO members. Building an Effective, Accountable Afghan State State building forms the centerpiece of Afghanistan's reconstruction. The Government's development vision requires an effective central government that re-establishes the national unity of the country on the basis of government monopoly over the legitimate use of force, strong institutions, and rule of law. The SAF report laid out several specific goals in this regard: (i) a well functioning and well-structured security sector, based on insti- tutions that facilitate a return to normalcy in the political, economic, and social spheres; (ii) an effective public administration that is small and focused on core functions, more diverse and decentralized, better skilled, equipped and managed, more accountable, and more representative in terms of gender and ethnicity; and (iii) a budget that is affordable and sustainable on a multi-year basis and enables delegation of authority based on strong accountability mechanisms. When the post-Taliban government came into power, it found a public administra- tion (inherited from the pre-war period) that was highly centralized in terms of its struc- ture on paper, but which was denuded of infrastructure, human capacity, and financial resources, and had non-existent or very weak ties with the provinces. The bulk of revenues had been "captured" by illegitimate regional authorities, and service delivery for the most part had ceased or was handled outside government channels by NGOs. Much progress has been made since then: (i) macro control over the size of the civil service has been maintained; (ii) the national budget process has been reinstated, with the budget as the xxii Executive Summary central instrument of policy and aid management; (iii) improvements in fiduciary man- agement (procurement, financial management, audit) are increasing the Government's effectiveness and accountability in using public resources; (iv) civil service reforms are moving forward through the Priority Restructuring and Reform (PRR) process, under which core departments can reorganize themselves, build capacity, and pay qualified staff higher salaries; (v) a cabinet rationalization is being considered to reduce the number of Ministries; and (vi) a start has been made with security sector reform, although security has deteriorated in many areas. Government faces a twin challenge: it must be fully in charge of running the state-- capable of both making policy and implementing it throughout the country, but on the other hand it must not overstate its ability, and should limit its policy ambitions to its limited though growing capacity. Success will depend to a large degree on whether the Government can regain control over national policies and implementation across the country. This is made more difficult by the financial and military strength of regional warlords and local commanders. In this regard, security sector reforms have lagged far behind what is required, and the extremely limited international security assistance out- side Kabul has not been helpful. Greater attention to improving security is key to progress in state building and reconstruction. The massive amounts of donor aid largely provided off-budget, which dwarf Government budgetary resources, and the associated existence of a large and well-paid "second civil service" consisting of consultants, advisors, and employees of the United Nations and other international agencies and NGOs, comprise a second major hindrance to state building. The way forward in state building involves continuing and deepening reforms that are underway, notably public administration reforms, fiscal management improvements, and revenue mobilization; and developing momentum in other areas, including security sec- tor reform and reducing vulnerability to corruption. The ongoing political normalization process will be crucial. Donors' support for state building needs to include reducing reliance on the "second civil service" and maximizing direct budget support relative to other financing modalities. Encouraging and Supporting Private Sector Development As seen above, the Afghan private sector is at the heart of the country's growth prospects and strategy but faces some difficult constraints. The Government has been pursuing pro-private sector policies in recognition that a sound investment climate is essential for private sector development. Nevertheless there is still much to be done to improve secu- rity, ease the regulatory burden, curb corruption, and make available necessary inputs (land, finance, infrastructure, skills). The legal framework for the private sector (revised investment law, company law, etc.) will be critical. Initiatives are underway for invest- ment promotion through "one-stop shop" and Industrial Parks. Of particular impor- tance will be Government financing of "public goods"in support of private sector growth and competitiveness, for example a metrology, standards, testing, and quality (MSTQ) system, and international market information and other export promotion services. Risk mitigation (for example through MIGA) and development of the insurance industry are important ingredients of a sound investment climate as well. The private sector also very Executive Summary xxiii much needs capacity building and business support services, which can be provided by the private sector itself but with active Government support and, where necessary, financing. Infrastructure and finance will be key inputs for private sector development. While the legal framework for the financial sector has been liberalized and entry of foreign private banks has occurred,the provision of formal financial services in Afghanistan (such as credit) is still at a nascent phase and needs to be developed. At the small-scale end of the enterprise spectrum, micro-finance is being developed through the Micro-Finance Support Facility of Afghanistan (MISFA), and this could lead over time to commercially-oriented financial services to small businesses. In the case of infrastructure (notably roads, irrigation, power, water, and airports), massive investments will be required as detailed in the SAF report. It is of critical importance that appropriate institutional frameworks, accountability mecha- nisms, incentives, and financing for these services be put in place to ensure further expan- sion and sustainability as donor assistance eventually phases out. This means, in the case of public utilities, separation of the service provider from the Government and operation of the facilities concerned on an autonomous,commercially-oriented basis.In this regard,cost recovery (either direct or through indirect mechanisms like a road fund) will be necessary, not only for fiscal sustainability but also to improve incentives and enhance accountability (lifeline tariffs for the most poor should be utilized where appropriate). Agricultural Development Priorities and Prospects Agriculture, half the Afghan economy, is critical for future growth, poverty reduction, and export development. Maintaining robust agricultural growth requires adequate invest- ments and a sound enabling environment. Key priority areas include the following: Irrigation: The Government's emphasis on rehabilitation of surface irrigation facili- ties and subsequently major new investments is appropriate, but early attention is needed to ensure that water user groups (WUGs) fully participate in O&M and financing of O&M. This will require: (i) an appropriate legal framework; (ii) involving WUGs early in reha- bilitation/development works, ideally from the design stage; and (iii) developing cost esti- mates of annual O&M requirements and discussing them with WUGs. Agricultural Research and Extension: Dissemination of improved agricultural tech- niques and management practices will be essential to realize the full benefits of irrigation and other investments. Afghanistan needs to focus on adaptive research which must be demand-driven. Public and private sector roles in extension need to be clearly defined, extension services contracted out wherever possible, participatory and community-based approaches adopted, and extension focused on marketing not just production. Marketing: Investments in both "hardware" (market facilities, cold storages-- requiring electric power, roads, etc.) and "software" (grades and quality standards, market research, standards for wholesale markets, market management by market players) will be very important. Rural Credit: Micro-finance supported by MISFA is an important initiative under- way. However, over the medium term additional forms of private, deposit-taking, and xxiv Executive Summary commercially-oriented rural credit will need to develop (e.g. through contract farming and similar arrangements). Land tenure issues are widely considered to be a source of insecurity and problems for agriculture. Such issues are part of the larger governance agenda and can be complex and controversial to resolve, so it would be prudent for the Government to proceed by learning by doing through pilots and involving local communities, before scaling up. Understanding and Responding to the Opium Economy Starting from a tiny base in the late 1970s, opium has become Afghanistan's leading economic activity. Opium production (measured at farm-gate prices) generated around one-seventh of estimated total national income in 2003, and downstream trading and processing of opium into opiates generated an even greater amount of income in-country. Overall, the opium economy comprised more than a third of total national income. By 2004 opium spread to all of Afghanistan's provinces and accounted for an estimated 87 percent of global illicit opium production. The impact of the drug industry on Afghanistan's economy, polity, and society is profound, including some short-run eco- nomic benefits for the rural population and macro-economy but major adverse effects on security, political normalization, regional relations, and state building. Responding effectively to the drug economy will therefore be essential for Afghanistan's future development. The opium economy is the lynchpin of a "vicious circle" of insecurity, weak govern- ment, powerful warlords, and drug money (see Figure C)--part of the "informal equilib- rium"--which will become increasingly entrenched over time if nothing is done. The drug Figure C. A Vicious Circle Warlords Warlords undermine Protection and government other payments or capture strengthen Drug related Warlord parts of it warlords corruption militia provide undermines security for opium government economy Opium Government economy Warlords undermine Poor security Weak national creates good government security environment for unable to opium economy provide security Security Executive Summary xxv industry has a strong interest in preventing the emergence of an effective, accountable state and thus is highly inimical to the state building agenda. It has enormous financial resources to bring to bear against state building, allies or "sponsors" in the form of war- lords with military assets, increasingly entrenched ties with the rural economy, and sig- nificant penetration at all levels of government. There is also some anecdotal evidence of linkages between drug money and terrorist networks. There are no easy answers to this problem, since international experience and Afghanistan's own experience in fighting drugs have been largely unsuccessful, and more- over there is no precedent of such a large drug industry in relation to national GDP, thriv- ing in an environment of poor security, weak government, and deep poverty. To have any hope of success, a multi-pronged approach is essential, addressing each of the key elements of the vicious circle associated with the opium economy warlords (stopping payments to them, disarmament, demobilization, and reintegration of militias--DDR, etc.), insecurity (security sector reform), and weak government (state building, public administration reforms, revenue mobilization), as well as measures related to the drug industry itself (see Figure D). Experience also suggests that no single instrument of drug control alone will work well. It is the combination,timing,and sequencing of different instruments (interdiction of drug trafficking and processing, alternative livelihoods for poppy farmers and wage laborers, eradication of poppy fields) that will have better prospects of being effective. Phasing out opium production in Afghanistan will be a long-term effort requiring sustained commit- ment from the Government and international partners. While this report does not make Figure D. Strategic Framework for Breaking the Vicious Circle DDR; stopping payments and support to warlords Weakened warlords Lower cannot Warlords payments undermine weaken government Less drug resources to warlords Building bribe government Drug control government Opium strategy to Government capacity and economy reduce size of Warlords have effectiveness opium economy less ability to Stronger undermine Better security government national security is less better able to Security favorable for provide security opium economy Security sector reform and capacity building xxvi Executive Summary hard-and-fast recommendations with respect to this extremely difficult area,some key con- siderations include: Balancing Economic Measures and Law Enforcement. Both are essential--and coordi- nated international involvement will most likely be required for effective law enforcement. Careful balancing with development programs is needed, taking account of incentives and sequencing issues. The Government may want to initially give priority to interdiction over eradication, as trying to do both equally would disperse scant political capital, energy, and law enforcement capacity. Alternative livelihoods programs, and more generally measures to promote broad-based economic growth and employment generation, could be put in place, with the threat of law enforcement measures to follow. Eradication could then occur once there are credible alternatives and implementation capacity and political support are mobilized. Prioritization, Monitoring, and Evaluation. Capacity and budget constraints make prioritization essential. Giving priority to action against larger participants in the drug industry would seem to be the most cost-effective approach. A focus on new areas with little or no history of poppy cultivation could make sense. Good monitoring will be needed of implementation, based on understanding the socio-economic situation of stakeholders. Law Enforcement Capability. Clarifying institutional responsibilities and enhancing capacities with respect to law enforcement remain a priority. Legal Framework and Judicial and Penal Process. The justice system needs strengthening. Need for International and Regional Support. The Government is seeking sustained support and cooperation in its efforts against drugs, and in controlling the trade in both transit and consuming countries, both internationally and regionally. Delivering Basic Social Services and Promoting Gender Equity Delivery of basic social services--elementary education, basic health services, and water supply and sanitation--to the poor, especially to women and girls, will be a major deter- minant of Afghanistan's longer-term growth and success in poverty reduction. The coun- try inherited a highly centralized system of government social service provision, which reached only a small proportion of the population (mainly the urban elite) and was dev- astated during the war. Key issues associated with this system include, in addition to nar- row coverage and problematic quality: (i) limited human resource capacity in Afghanistan; (ii) lack of financial resources especially for O&M; (iii) de jure centralized service delivery structures and mind-sets; (iv) de facto local political autonomy; (v) lack of information and monitoring; (vi) disconnect with households and communities; and (vii) sustainability issues related to the heavy reliance on donor funding. Getting institutional relationships and incentives right for different actors (service providers, government, and service recipients), so there is meaningful accountability for performance, will be essential for effective social service delivery. In the case of education, Executive Summary xxvii schools (the units directly responsible for service delivery) need to be given a greater role in day-to-day management of their activities while enhancing their accountability to ben- eficiaries through community monitoring (perhaps through the elected Community Development Councils under the NSP). In the case of health, competitive, performance- based contracting of non-government providers is being implemented in a third of Afghanistan's provinces, strengthening accountability of providers to the Government. In both education and health, oversight of service providers needs to be de-concentrated from the center to the provincial level, and in the case of urban water supply to the municipal level. However, central oversight particularly of contracting would need to be maintained in the case of provinces that have been "captured" by regional powerbrokers. Assisting the Poor and Vulnerable An affordable, well-targeted social protection strategy is needed for poor and vulnerable Afghans who are unable to fully benefit from economic growth. Income generation and skill development are the Government's preferred vehicles for support, with pure trans- fers reserved for a minimal safety net for those unable to benefit from other programs. Existing social protection programs, notably the National Emergency Employment Pro- gram (NEEP) and other employment programs, while successful in many respects, appear not to be very well-targeted toward the poorest and most vulnerable members of the rural population. While there was a need to inject incomes into the rural economy during the drought, as there may be in the future, and targeting is understandably diffi- cult given low levels of income in most rural households and local social pressures, NEEP and other similar programs need to clarify their objectives and explore ways of improving targeting of the poor. More generally, the Government is developing a holistic social policy including a National Vulnerability Program. Many of the elements of good policy are already in place. In the near term the key is to ensure that the main national programs are effectively imple- mented, with monitoring and evaluation providing insights for improved design. It will be necessary to increasingly move beyond a fragmented project-driven approach to a system- atic national program. Conclusions The challenge that Afghanistan, with support from international partners, faces--to rebuild the state, improve security, sustain rapid, broad-based economic growth, and reduce poverty--is both complex and risk laden. In the short term, the priority is to imple- ment policy and institutional reforms already under way, focusing on the most inclusive measures that contribute to building the nation.Among the areas for action set forth in the table below, a number of key priorities stand out: Enhance Security and Rule of Law, Respond to Drugs in a Coordinated Manner: The continued existence of warlords and forces disloyal to the national government, funded in large part by drug money, undermines state building and other reconstruction agendas. Security sector reforms need to be given top priority, and administrative reforms in the xxviii Executive Summary Ministries of Defense, Interior, and Justice need to be accelerated. The Afghanistan Sta- bilization Program (ASP) will need to support improved governance of security in provinces and districts. There are no easy answers on drugs, but it is clear that actions against the opium economy must be integrated within broader national objectives and particularly the security and state building agenda in order to have any hope of success. The recent establishment of a Counter Narcotics Steering Group, chaired by the Gov- ernment and including the main domestic and external agencies, is encouraging. Pursue Political Normalization: The successful Presidential election and upcoming Parliamentary elections mark the completion of the political process mandated by the Bonn Agreement, but there is still a long way to go in political normalization. The key priority will be making Afghanistan's nascent political institutions--ranging from the new Cabinet to the new elected legislative bodies and the judiciary--fully functional and effective so they can handle their Constitutionally-mandated roles. Full implemen- tation of the security-related provisions of the Bonn Agreement, including demilita- rization of Kabul and more generally the DDR program, will facilitate political normalization. Maintain Growth with Macroeconomic Stability: This is essential but will face risks--drought, political instability, "poppy shock", "Dutch disease", etc.--as well as other challenges (e.g. fiscal pressures, limited private sector supply response). The Gov- ernment will need to monitor economic performance closely, making adjustments in response to shocks, while enhancing analytical capacity and macroeconomic policy instruments. Intensify Public Administration Reforms with Extension to the Provinces: As a critical part of the state building agenda, the Government will need to continue and accelerate cur- rent administrative and civil service reforms, including implementation of the PRR process, increasing revenue mobilization, and reducing vulnerability to corruption. It will be especially important to enable provinces to better interface with the public and deliver services, by ensuring timely payments of their employees and access to their non-salary budgets, strengthening their capacity through the ASP, and other similar initiatives. Accelerate Private Sector Development, Including Agriculture: Priority should be given to implementation of ongoing reforms: adoption of key laws (Investment, Mining, Petro- leum), acceleration of micro-credit schemes, and development of Industrial Parks. Irriga- tion, marketing, credit, and extension services need to be efficiently provided to Afghan farmers, relying on the private sector as much as possible to provide these services. Poverty Reduction, Gender, and Social Protection: The effectiveness of a poverty reduc- tion strategy will largely depend on national ownership--requiring more extensive con- sultations with different stakeholders than has occurred hitherto. Enhancing the role of women requires addressing some of their main concerns, such as poor access to education, basic health services, and credit. Building on experience, existing programs need to be improved to effectively target them to the poorest. Executive Summary xxix Main areas Priority actions For the government Security and (i) Implement security sector reform and build up well-trained, Rule of Law disciplined security forces (national police, national army) under the (Chapters 3 and 4) control of the national government; (ii) vigorously pursue DDR to mean- ingfully disarm warlords' militias; (iii) strengthen legal and judicial system; and (iv) improve security of property rights, building on existing informal arrangements. Macroeconomic (i) Maintain conservative macro-policy mix with light exchange rate man- Policies agement; (ii) monitor sources of macro risk and stand ready to intervene (Chapters 1 and 3) in face of major shocks to maintain robust, broad-based economic growth. Budget (i) Increase domestic revenues (customs, simplify income tax code); Management (ii) prepare, approve, and execute budget in timely manner; (iii) strength- (Chapter 4) en integration of ordinary and development budgets, linkages between policies and budget; and (iv) adopt and implement Procurement, Public Expenditure and Finance Management, and Audit Laws to enhance accountability and reduce vulnerability to corruption. Public (i) Implement PRR program and avoid pay increases outside PRR; Administration (ii) inject capacity on short-term contracts for key positions; (iii) ration- (Chapter 4) alize number of ministries, with clear portfolios; (iv) implement Afghanistan Stabilization Program; (v) strengthen financial management in municipal governments; and (vi) enhance accountability and reduce vulnerability to corruption (e.g. through civil service law). Public Service (i) Expand access to elementary education (and improve quality), and to Delivery basic health services; (ii) give service facilities (schools, clinics) greater (Chapters 4, 5, 8) role in day-to-day management, with government oversight de- concentrated to provincial level; (iii) promote client monitoring and greater accountability of service providers to clients; (iv) separate public utilities (power, water) from government, with management and opera- tions on commercial, financially sustainable basis; and (v) use cost recovery to enhance both accountability and fiscal sustainability. Regulatory (i) Develop and implement reform of state-owned enterprises; (ii) adopt Framework revised Investment Law and reform legal framework, finalize mining, (Chapters 3 and 5) petroleum, and other sector-specific laws; and (iii) continue to pursue structural reforms in trade/customs, financial sector, and taxation. Support Services (i) Develop Industrial Parks with adequate regulatory framework and (Chapters 3, 5, 8) private sector participation; (ii) accelerate implementation of micro- credit schemes (MISFA), with particular focus on women; (iii) implement infrastructure investment program, especially power, roads, and irrig- tion; (iv) develop a metrology, standards, testing, and quality (MSTQ) system; (v) implement political risk guarantee facility and liberalize insu- ance sector; and (vi) strengthen and reform the Export Promotion Depart- ment of the Ministry of Commerce and build its capacity with high-quality staff. Agriculture (i) Put in place appropriate legal framework and financing mechanisms, (Chapter 6) in partnership with water user groups, to guarantee proper O&M of irrig- tion schemes; (ii) develop public-private partnership-based research and extension systems to disseminate improved agricultural techniques and management practices; and (iii) develop grades and standards, market research, minimum standards for wholesale markets, market management by market players. xxx Executive Summary Main areas Priority actions For the government Opium economy (i) Take fully into account macroeconomic and poverty impacts of actions (Chapter 7) against drugs; (ii) mainstream drug policy within broader strategic frame- work for state building, security, political normalization, reconstruction, and growth; and (iii) avoid premature, single-dimension measures that will encourage a shift of production to other parts of the country or will not be sustainable. Social Protection (i) Adjust existing programs for greater effectiveness toward clarified (Chapter 9) objectives (targeting poorest, injecting income in face of shocks, or asset- building); (ii) develop well-targeted National Vulnerability Program to provide minimal safety net to those unable to benefit from growth or other programs. Gender (i) Develop monitoring mechanisms for public sector employment of women; (ii) favor female employment in social services to increase service delivery to girls/women. For the international / donor community Financial (i) Maximize assistance through Budget and Treasury and move toward Assistance programmatic support; (ii) commit assistance at beginning of or early in (Chapters 3 and 4) fiscal year to facilitate Government budget management; and (iii) be pre- pared to respond to macroeconomic shocks (e.g. by accelerating and adjusting assistance) to help maintain aggregate demand and growth. Technical (i) Ensure that all TA responds to national priorities and is under Govern- Assistance ment leadership and control (consultants reporting to Government with (Chapter 4) approved TORs); (ii) maximize use of coordinated TA mechanisms; and (iii) coordinate with Government on pay policies for consultants. Other (i) Work with Government to support effective and timely implementation (Chapters 4 and 7) of reconstruction program; (ii) support security sector reform, including through international security assistance outside Kabul; (iii) ensure that actions against drugs occur within the framework of the Government's strategy and leadership, and mindful of the broader economic and poverty context; (iv) enhance alignment of donor priorities to the national budget; and (v) improve donor coordination within and across sectors. CHAPTER 1 The Afghan Economy A fghanistan's economy has been devastated and distorted by more than two decades of protracted conflict, capped by a severe nationwide drought in 1999­2001, but has bounced back in the last two years. The strong economic recovery is attributable to the end of drought and major conflict and initiation of recon- struction, and has been supported by sound, conservative Government macroeconomic policies, a highly successful currency reform, and structural reforms most notably in trade and the financial sector. Nevertheless Afghanistan remains one of the poorest countries in the world, and numerous people suffer from low food consumption, loss of assets, lack of social services, disabilities (for example, from land-mine accidents), disempowerment, and insecurity. Moreover, daily life is still shaped by the consequences of almost a quar- ter century of conflict. One of these is "informality"--most economic activities do not follow, and are not protected by, official and legal rules and some of them, such as culti- vating opium poppy and the arms trade, are criminal. This has important implications for economic structure, policies, and reforms. This report, the first Economic Report on Afghanistan by the World Bank in a quarter century (the most recent previous report was World Bank 1978), is intended to contribute to a better understanding of the core challenges that lie ahead for the country and key strategic priorities for national reconstruction. The report reflects the development vision set forth in the Government's National Development Framework (NDF) and its recent report Securing Afghanistan's Future: Accomplishments and the Strategic Path Forward (SAF). The Economic Report does not, however, repeat the analysis and investment requirements set forth in the SAF document, but instead focuses on the conceptual frame- works, policies, and institutions that will be needed to achieve core national objectives of state building; sustained rapid, broad-based economic growth; and poverty reduction. 1 2 A World Bank Country Study Analysis of the Afghan economy is hindered by severe data limitations and is chal- lenged by the conflict-related economic structure and dynamics that have emerged and become entrenched. Nevertheless much has been learned about how the Afghan econ- omy functions, at least in qualitative and institutional terms, and there are numerous reports prepared by the Government and partners on specific sectors and topics, which have been drawn upon. This chapter provides a description and analysis of the Afghan economy and recent performance, based on available quantitative data and qualitative information. The first section reviews the state of the economy at the end of the conflict, Afghanistan's strong growth performance since then, and the drivers behind it (including supportive Government actions). The second section outlines the structure of the Afghan economy, with an emphasis on the informal economy and its linkages with conflict and insecurity. The final section summarizes the prospects for growth and areas of growth potential. Chapter 2 of this report analyzes the characteristics and determinants of poverty in Afghanistan, focusing in rural poverty based on newly available rural household survey data. Chapter 3 outlines the strategy for achieving sustained economic growth and poverty reduction, based on the NDF/SAF, and puts forward key strategic priorities and directions for implementation. State building, discussed in Chapter 4, lies at the core of Afghanistan's reconstruction agenda and is essential for progress on political, security, and other fronts. Chapter 5 addresses the development of the private sector, which will have to be the engine of growth and poverty reduction in Afghanistan. Agriculture, covered in Chapter 6, com- prises half of the economy and will play a crucial role. Chapter 7 examines Afghanistan's opium economy, which has some short-term economic benefits but serious adverse effects on state building and security. Chapter 8 looks at delivery of social services, a key component of the poverty reduction strategy, including the gender dimension. Social protection--strategies and programs to assist the poorest and most vulnerable members of Afghan society--is discussed in Chapter 9. Chapter 10 concludes with a summary of priorities for action, implementation constraints, prospects, and risks. Recent Economic Performance The Starting Point The starting point--in late 2001 at the fall of the Taliban--for recent developments in Afghanistan was dire. Protracted conflict in the 1980s and 1990s, as well as drought and other natural disasters, severely damaged the Afghan economy. Resources were diverted to conflict, and payment systems, transport, and trade were disrupted, reducing avail- able inputs as well as potential sales. Second, the conflict depleted and degraded factors of production: (i) less manpower (people joining the conflict or fleeing the country-- more than 30 percent of the population has been displaced, see Box 3.2); (ii) lower qual- ity of human capital due to lack of education and a "brain drain" as well-educated people left; (iii) destroyed or useless physical capital, such as damage to the irrigation system and road network, loss of assets of displaced persons, capital flight, and loss of livestock; and (iv) contraction of available land due to landmines. Finally, conflict also had a negative effect on "social capital," weakening governance and the rule of law, Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 3 Figure 1.1. Afghanistan's Level of Development in International Perspective (1975­2002) 9,000 World 8,000 East Asia 7,000 dollars) 6,000 (US 5,000 4,000 capita Developing per countries 3,000 Low income countries GDP2,000 Iran 1,000 Afghanistan Africa Pakistan - 35 40 45 50 55 60 65 70 75 Life expectancy at birth (years) Non-weighted average of country statistics. The non-dotted beginning of each line represents 1975, the dotted end 2002. Source: World Bank (2004f). shortening time horizons, through displacement weakening family and community links, increasing the scope for opportunistic and criminal behavior, and so forth. Women faced special difficulties and their role became increasingly restricted during the years of conflict, culminating with the Taliban regime. On the other hand, local family and community "social capital" has been central to many Afghans' coping strate- gies, and kinship and community networks have continued to function even at long distance through remittances. As important as the outright damage caused by the long conflict was the loss of oppor- tunity for Afghanistan to participate in the last 25 years of global development and to catch up, or at least maintain pace, with other countries. As shown in Figure 1.1, Afghanistan lagged far behind nearly all of the rest of the world in the 1970s, in terms of both per capita income and life expectancy (as well as other social indicators). Understandably very little progress was made on either front subsequently during the conflict, leaving the country even farther behind the rest of the world. Promising pre-war economic potentials--for example in horticultural exports (Afghanistan accounted for 60 percent of international trade in raisins) and in tourism--atrophied, and the peak level of grain production achieved in the 1970s was not equaled until 2003. In essence, more than a generation's worth of economic development was lost due to the conflict. Afghanistan is one of the poorest countries in the world. GDP in 2003, after two years of strong economic growth (see below), is estimated at around $7 billion (including $2.3 billion 4 A World Bank Country Study of illicit opiate receipts).1 With an estimated population of around 22 million, Afghanistan has a per capita GDP of $310 (including the opium economy)--one of the lowest in the world. Moreover, as detailed in Chapter 2 social indicators are among the worst in the world, with large gender gaps: gross primary school enrollment rate 54 percent (40 for girls), under-five mortality rate 172 per 1,000 live births, infant mortality rate 115 per 1,000 live births, and estimated maternal mortality rate 1,600 per 100,000 live births. The Economic Recovery Official (non-opium) GDP, starting from a very low base, has grown dramatically by 29 percent in 2002 and by 16 percent in 2003 (Table 1.1). Two-thirds of this growth came from agriculture, thanks mainly to better precipitation and better availability of seeds and fertilizers. Cereal output has strongly recovered, but opium production also has rebounded. Services are booming, mainly in major cities, in construction, and in the public sector, linked to the reconstruction effort. A strong sign of improved confidence, 2.4 million refugees have come back to Afghanistan, and 600,000 internally displaced people have returned to their homes. The end of major conflict, with associated revival of economic activity, and the end of the drought in many parts of the country, which brought sharp increases in agricultural production, are two key drivers of this dramatic economic recovery. Sound Government policies, as well as structural reforms in certain areas, have supported the recovery. Political Process. The political normalization process mandated by the Bonn Agree- ment of December 2001 has been scrupulously implemented, with important milestones like the Emergency Loya Jirga (June 2001), Constitutional Loya Jirga (December 2003­ January 2004), and Constitution achieved, and the Presidential election successfully held in October 2004 and Parliamentary elections expected in the spring of 2005 (Chapter 4). Moreover, resurgence of major conflict has been avoided, which together with the politi- cal progress has sent favorable signals to the countless Afghans setting about rebuilding their lives and livelihoods. The gains in improved security in Afghanistan have significance for the whole region (see Map at back). Macroeconomic Policies (fiscal, monetary, and exchange rate management). Another important cornerstone for the economic recovery has been macroeconomic stability-- a remarkable achievement by the Government after more than a decade of high inflation. A currency reform was completed successfully between October 2002 and January 2003. Since then, monetary policy has sought to keep inflation under control (it was 10.5 percent in the year ending March 2004), and smooth volatility in the exchange rate. Strong fiscal 1. Macroeconomic data on Afghanistan are very limited and of low reliability--both standard national accounts and even more estimates of the opium economy. Data on opium poppy cultivation from the United Nations Office on Drugs and Crime (UNODC) is based on satellite imagery as well as surveys, but estimates of yields and particularly of border prices of opiates have substantial margins of error. Population data also comprise rough estimates in the absence of a Census or other reliable sources of information. Thus, the macroeconomic data in this report should be treated with caution as the best available but inevitably still rough estimates (see the Statistical Appendix for a more detailed discussion, and UNODC 2003b on opium estimates). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 5 Table 1.1. Macroeconomic Indicators 1975 2002 2003 Official GDP (US$ billion) 2.4 4.0 4.6 Opium GDP (US$ billion) -- 2.5 2.3 Total GDP (US$ billion) 2.4 6.5 6.9 Official annual growth (%) 3.0 29 16 Total annual growth (%) 3.0 102 5 Population (million) 14.0 21.8 22.2 Official GDP per capita ($) 169 186 207 Total GDP per capita ($) 169 300 310 Inflation (%) (+) 6.6 52.3 10.5 Exchange rate (% increase) (+) .. 52.2 (3.6) Domestic currency in circulation (growth %) .. 20.1 40.9 Gross foreign exchange reserves (US$ million) .. 426 730.6 Current account (% GDP) (*) (2.7) (2.1) (0.9) Domestic revenues (% official GDP) 11.4 3.3 4.3 Ordinary expenditures (% official GDP) 9.1 8.6 9.7 Development exp. (% official GDP) (-) 6.1 13.4 31.6 (+) March to March (*) Excludes opiate exports; 1978 instead of 1975 (-) Estimate for 2003/04 2002 refers to Afghanistan's solar year 1381, from March 02 to March 03. Source: Statistical Appendix, Table A1. discipline underpins macroeconomic stability. Under the no-overdraft policy, the Govern- ment has been refraining from printing currency to finance its deficit. Considerable success has been achieved in mobilizing domestic revenues, which from negligible levels in 2001 reached more than 4 percent of official GDP in 2003. The Government is following a prudent debt policy, under which most external assistance is sought in the form of grants, and credits are taken only at highly concessional rates.2 Budget and Public Administration. Significant reforms are underway in these areas (see Chapter 4). Budget preparation and execution have markedly improved, and the budget is becoming an increasingly effective tool to implement policies and coordinate aid. Public administration reforms have been initiated, in particular the Priority Reform and Restruc- turing (PRR) scheme to reform the most critical functions of Government by allowing administrative departments to engage in organizational restructuring and place staff selected on merit basis on an elevated pay scale. 2. Currently the Government has verified close to US$200 million of debt incurred by previous administrations. The main uncertainty relates to claims from Russia. Since 2001, the Government has taken credits in the order of US$600 million (13 percent of GDP), all on concessional terms typically involving zero interest and a long grace period. 6 A World Bank Country Study Finance and Private Sector Development. The Government has also made progress in reviving the financial system and supporting private sector development (Chapter 5). New financial sector legislation (the Central Bank Law and Banking Law) was adopted in the summer of 2003 to grant the Central Bank independence and establish a modern legal framework for the banking system. Several banks have since been licensed under the new legal framework. A new Law on Domestic and Foreign Investment was enacted in September 2002, and the Afghanistan Investment Support Agency (AISA), a single-window clearance and advice center for domestic and foreign investors, was established in August 2003. Significant foreign private investment has been attracted into the telecommunications sector, with very good results in terms of expansion of private mobile telephone services across a number of cities on a competitive, cost-efficient basis. Trade Reform. The Government has implemented a number of reforms to foster trade. Customs tariffs have been rationalized (elimination of export duties; use of market exchange rate for import valuation; streamlined tariff structure--moving from 25 tariff rates of 0­150 percent to six rates between 2.5 percent and 16 percent; new, more effective broker processes). Existing trade agreements have been renewed and new agreements signed with neighboring countries. At the recent Cancun trade meeting, Government representatives pledged to build a foreign trade regime that will allow Afghanistan to easily pass the standards for World Trade Organizationaccessionoverthenextfewyears.Quantitativerestrictionsareextremelyfewand not imposed for reasons of protection. Customs administration reforms are underway. Reconstruction Process. Finally, the Government and donors have started the reconstruc- tion process. Some $1.1 billion of external assistance was disbursed in late 2001 and 2002, mainly for humanitarian purposes and not through Government channels. The Government presented its National Development Framework (NDF) in April 2002, which formed the basis of the National Development Budget. Subsequently the Securing Afghanistan's Future (SAF) report detailed medium-term investment and recurrent expenditure requirements and exter- nal financing needs and was presented at a major donor conference in Berlin in March 2004. The composition of external assistance, which increased to $2.5 billion in the 2003/04 financial year, has shifted in favor of reconstruction, with increasing Government leadership. Structure of the Economy TheAfghaneconomyisdominatedbyagriculture(32percentofestimatedtotalGDPin2003), mainly cereal crops (27 percent), and by the opium economy (an estimated 35 percent of GDP). Other sectors are relatively small (Figure 1.2), including manufacturing (9 percent)-- most of it small-scale agricultural processing and other small-scale activities, construction (3 percent), and public administration (3 percent). The striking feature of Afghanistan's economic structure is the dominance of the informal sector--not only in agriculture (not surprising) and in the drug industry (outright illegal), but also in most other sectors. A large portion of electricity supply, for example, is provided by small-scale generators in the informal sector. It is inherently difficult to estimate the size of the informal economy, except in sectors where it is dominant like agriculture and narcotics. Nevertheless, it is clear that some 80-90 percent of economic activity in Afghanistan occurs in the informal sector, which has been largely responsible for the recent economic recovery and dynamism. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 7 Figure 1.2. The Informal Economy in Different Sectors Other services 3% Public administration 100% informal 3% Transport, telecom, 90­100% informal power 50­90% informal 8% 10­50% informal Trade Opium 0­10% informal 6% 35% Construction 3% Manufacturing 9% Mining 0% Livestock 4% Cereals Other crops and 27% nonfoods 2% Note: % figures refer to share of sector in total GDP, shadings to very rough estimates of the percent- age of the informal economy in the sector. Source: CSO (2004); UNODC (2003a); staff estimates. Range of Informal Activities While the formal sector is relatively easy to delineate, the informal sector covers a range of economic activities. Being registered or paying taxes is usually viewed as a sign of "for- mality" (Box 1.1). The recorded activities of the Government, 3 percent of GDP and around 350,000 employees, are by definition mainly "formal." The formal private sector includes businesses that are registered,3 even though they may also have informal activi- ties. The formal sector also includes activities that are registered but by law are exempted from taxation, such as NGOs. "In-kind" Activities. Outside the formal world, there is a continuum of activities that are more or less legal. Many activities, labeled "in-kind," do not lead to any market trans- action or are on a barter basis. A large part of agricultural output is for household subsis- tence. In addition, sharecropping is an informal arrangement between a landowner and a farmer by which the latter receives a share of the output in kind. A range of services (for example, blacksmith, carpenter, threshers) are being paid in kind, especially in the eastern regions, in the form of a pre-defined share of the crop at harvest time. Exchange of services and products between rural households is widespread, and women perform a major part 3. Three thousand taxpayers have received a Tax Identification Number; AISA registered 84 projects between November 2003 and February 2004 (but they would involve only 4,000 jobs); 80,000 trucks are registered. 8 A World Bank Country Study Box 1.1. Analyzing the Informal Economy As suggested by the variety of names used (underground, shadow, black, etc.), the notion of the infor- mal economy is vague. A simple definition of the formal economy is that it includes activities that are measured and subject to regulations (including taxation, even if they are legally exempt). Within the many activities that fall outside this category, a distinction can be made between four groups, depending on (a) the use of market transactions; (b) the legality of the goods and services produced; and (c) the legality of the process to produce and distribute them. While the informal economy should be viewed as a continuum of activities, this classification helps clarify the analysis. Typology of Economic Activities Market Production / Registered / Activities transactions Output distribution taxable Example Formal Yes Legal Legal Yes Large private firms In-kind No Legal Legal No Subsistence agriculture Extra-legal Yes Legal Legal No Construction; hawalas Irregular Yes Legal Illegal No Smuggling; gemstones Illegal Yes Illegal Illegal No Poppy trafficking Source: Based on Thomas (1992). The informal economy is inherently difficult to measure. Direct methods include surveying activities or employment. Indirect methods focus on discrepancies between measured macro- economic indicators. Using an indirect approach, one study estimates the size of the informal economy for 69 coun- tries, mainly by comparing data on total electricity consumption and official GDP. There is a sig- nificant, negative link with GDP per capita. After correcting for GDP per capita, low revenues, weak networks (roads, telephones), and political instability tend to be more frequent in countries with a large informal sector. Finally, although the link is more ambiguous, the informal economy seems countercyclical (its growth can dampen a fall in official GDP, while it usually decreases when the official economy grows). Informal Economy and GDP Per Capital 40,000 35,000 $) 30,000 PPP 25,000 capita, 20,000 international per 15,000 GDP 10,000 (current 5,000 - - 20 40 60 80 Unofficial economy (% GDP) Source: Friedman and others (2000); World Bank (2004f). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 9 of this non-monetized work.4 Household survey data indicate that 5 percent of the rural labor force is paid in kind or is not paid (see Chapter 2). "Extra-legal" Activities. Among activities that involve market transactions, some are almost completely legal (the output is legal and the production could be legal if it was reg- istered). These "extra-legal" activities are usually small-scale, and labor is often provided casually. They include money exchange dealers, small shops, small traders, small manu- facturing, agriculture, and much construction. Many entities registered as NGOs belong to this category because they perform for-profit activities but, being registered as NGOs, they do not pay taxes. Economic activities of the nomadic Kuchis (an estimated 1.5 million people), mainly selling the products of their livestock, belong to this category. Eighty five percent of the rural labor force is either self-employed or paid casual daily wages; 81 percent work in businesses with less than five employees. Most businesses are owned by a family and employ only one or two workers (or owners). "Irregular" Activities. Moving further away from legality, production and transactions for legal output can be illegal if they do not follow the rules. Trade in illegally exploited nat- ural resources falls in this category (underground mineral resources belong to the State). Examples include: trafficking of illegally harvested timber; trafficking of emeralds from the Panjsher Valley (estimated at around $3 million per year); illegal exploitation of gravels and construction materials (up to $56 million per year); and most notably smuggling (pos- sibly as much as $1 billion per year or more). Traders have strong incentives to "go infor- mal" and thereby pay less fees and taxes. For example, because import duties are much higher in Pakistan than in Afghanistan, there is an incentive to bring goods in from other countries (including Pakistan) and then smuggle them to Pakistan. Illegal Activities. Finally, the output itself can be illegal, the main example being opium production, with as many as two million people involved (Chapter 7). Illegal activities also include usurping the privilege of the state (for example, appropriation of customs duties and illegal taxation). According to the International Organization for Migration, there are several forms of human trafficking practiced in Afghanistan including exploitation of pros- titutes, forced labor, practices similar to slavery, servitude, and removal of body organs. Illegal excavation or theft and export of valuable archeological artifacts falls in this cate- gory. The criminal economy also includes arms trafficking, land seizures, and real estate speculation based on armed force or corruptly obtained contracts. The criminal economy encompasses both a "war economy" (activities pursued to finance a war effort) and a "black economy" (activities pursued for profit). Implications of the Informal Economy Overall, most jobs in Afghanistan are in the informal economy, with most people in rural areas relying on several jobs, diversified beyond agriculture, as a coping mechanism. Infor- mal activities increase access to goods (such as food) and services (such as credit associated with opium cultivation). They also finance assets, including in the formal economy. The 4. People who do not own a house often live as so-called hamsaya ("neighbors") in return for sup- plying domestic services to the house-owner. These labor services are mainly provided by the female mem- bers of the tenant household. 10 A World Bank Country Study Figure 1.3. The Informal Equilibrium Non-state powers (warlords, commanders) Weak capacity, poor governance Limited Failed incentives government Macro instability, Weak few public goods, Rule of law revenues poor regulatory framework No incentives Informal, to go formal non taxed Informal, low activities productivity opium economy is a major source of investment in durable goods, housing, and, less frequently, working capital. The predominance of the informal economy in Afghanistan represents a self-reinforcing equilibrium,involvingfailedgovernment;other,competingpowerbases;insecurity;lackofrule of law; and a very poor investment climate for formal-sector activities (Figure 1.3). As the gov- ernmentcannotensuresecurityaroundthecountry,localpowers(warlords)takeoverthisrole, which leads to lower government revenues and thereby even lower capacity to ensure security. Local powers have limited capacity and incentives to develop infrastructure and create a strong investment climate, which in turn reduces opportunities for trade and financial services. Local powers have incentives to promote illegal, profitable activities to finance their armed forces. They may try to control markets through a monopoly of their protégés. Rule of law suffers, and entrepreneurs have no interest in going formal as doing so would not provide any security or other public goods but on the contrary would make them easy targets for predation. Most fun- damentally, this "vicious circle" creates a strong constituency--whose leading element is the drug industry--that is hostile to the strengthening of the central government. The entrenchment of the "informal equilibrium" came about through Afghanistan's historical experience. The pre-1978 Afghan economy was dualistic, with a small yet devel- oping urban economy in contrast to a large rural economy which was informal but linked to world markets through exports. The Government relied mainly on external resources to fund its development budget, obviating the need for major domestic taxation. The Soviet occupation reinforced this duality between an externally-supported State and formal econ- omy and an informal economy in non-Government controlled areas. The civil war in the early 1990s, with generalized insecurity, strengthening of local powers, no government provision of public goods, and macroeconomic instability (due to the monetization of the government deficit) greatly diminished the role of the State and formal economy, while the informal economy became the main source of livelihoods for Afghans. Incentives to develop Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 11 the informal or "war economy" were at their highest since warlords had to pay for their military spending with reduced external support. The greater security brought by the Taliban in the mid-1990s generated some growth in trade and agriculture (cereals before the drought and opium poppy before the 2000 ban), from which the Taliban took substan- tial revenues. However, they did not generate public goods, try to record and monitor eco- nomic activities, or refrain from looting, so their actions did not break the "informal circle." While the informal economy has been dynamic, it probably cannot be the "engine" of sustained long-term growth. International experience suggests that development, beyond a certain point, is accompanied by a decrease in the share of the informal sector (Box 1.1). In thecaseofAfghanistan,theadverseimpactoninstitutionsoftheillegalcomponentmostprob- ablyoutweighsthepositiveimpactoftheinformaleconomyasasourceoflivelihoodsandcop- ingmechanism.InformalactivitiesgeneratehardlyanyresourcesfortheStatebutmaysupport forces opposed to the State and provide scope for opportunism and rent seeking. Informality does not protect property rights and reduces the possibility to formalize and enforce contracts, weakening incentives to invest and opportunities for division of labor and trade. Savings tend to be channeled toward investments with lower risks (e.g. in real estate and trade) or trans- ferred outside Afghanistan. Entrepreneurs in an informal setting have an incentive to remain relatively small and to diversify their activities to manage risk, which prevents them from exploiting economies of scale and in many cases from adopting more modern technologies. Economic Prospects Some of the drivers behind the economic recovery will diminish in coming years. For example, after two years of sharp increases, Afghan cereal yields in 2003 approached those in neighboring countries (Figure 1.4). There is scope for substantial further yield increases Figure 1.4. Cereal Yields 5 highest yields in developing countries** 5 bordering countries* +16% Afghanistan +94% +209% Cereal yield 984 1,906 2,208 5,897 (kg per hectare) in 2000 in 2003 Afghanistan: 2000 and 2003; other countries: 2000­02 average * Iran, Pakistan, Tajikistan, Turkmenistan, Uzbekistan; ** Mauritius, Egypt, Croatia, Chile, China. Source: World Bank (2004f). 12 A World Bank Country Study by moving toward best-practice levels, but this will require good agricultural policies, institutions, and investments (see Chapter 6). Although significant increases in opium poppy cultivation are continuing, yields have fallen, and the large decline in farm-gate prices in 2004 (Chapter 7) suggests that income generation and the stimulus for the rest of the economy from this activity may not further increase sharply. In any case, long-term dependence on opium is undesirable and is contrary to national objectives. While con- struction and other activities associated with the reconstruction program are likely to con- tinue to boom, there is a need for other leading sectors to emerge in support of sustained rapid economic growth over the medium term. Afghanistan has areas of good potential for sustained long-term economic growth, rang- ing from agricultural production and processing to mining, construction, trade, and other services (Box 1.2). There is no certainty regarding the specific sectors where Afghanistan will grow and export: with appropriate institutions and policies, the economy itself will "discover" areas of growth potential. However, two broad areas, trade and construction, stand out for their growth potential. Trade. Exploiting Afghanistan's position as a land bridge between Central and South Asia as well as other economies can be a significant source of growth (see Map). Although as a land-locked country Afghanistan faces certain disadvantages (such countries have average transport costs 50 percent higher and trade volumes 60 percent lower than similar coastal economies), the experience of land-locked countries like Uganda and Laos demonstrates that improving trade logistics, diversifying transit routes, heavier reliance on air transport, and supporting corridor agreements can overcome this geographical disadvantage. Regional cooperation, moreover, can turn Afghanistan's geographical position into a positive advan- tage, by expanding markets, lowering costs of long-distance trade, and sharing on an efficient basis regional resources like electricity and, over the longer term, water. Processed agricul- tural products have export potential (Chapter 6), which would have strong synergies with the strategy to respond to drugs, since such exports could provide livelihoods to offset, at least in part, a drop in opium production (Chapter 7). Afghanistan could also export some natural resources (for example, copper). Achieving robust long-term growth of trade will require sus- tained effort in terms of structural reforms as well as immediate actions to foster a strong enabling environment. The latter include: (i) implementing a functioning payments system for international and domestic transfers though the formal banking system; (ii) defining and implementing regulatory conditions and terms on which foreign banks or joint venture banks will be permitted to operate in Afghanistan; (iii) making transit bonds and transport insurance available with entry of companies capable of providing coverage; (iv) developing the role of Government as a promoter and facilitator of trade and investment; (v) support- ing a larger role for a private chamber of commerce to assist in export promotion activities; and (vi) designing and implementing major capacity building programs to develop skills and professionalism in banking, insurance, and customs. Construction. The reconstruction process will sustain growth in demand for con- struction activities, from the extraction of sand and gravel to building of roads and houses. The sector is currently a good example of the costs of informality (high security costs, bar- riers at entry and lack of competition, corruption). Sustained growth in this sector requires improvements in the security and rule of law environment, as well as a regulatory frame- work that enables private sector development (Chapters 4 and 5). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 13 Box 1.2. Discovering Afghanistan's Growth Potential Today the economy of Afghanistan is still largely agriculture-based. Industries and services are mainly small businesses--upstream and downstream activities with ties to agriculture, construc- tion reflecting the housing boom and reconstruction program, and other small-scale activities. Growth potentials exist in a number of sectors. The agricultural sector (73 percent of GDP, including poppy) is largely subsistence-oriented, and cereal crops (mainly wheat) are predominant. Other crops and vegetables, such as grapes, apricots, and almonds, generate higher income yields and potentially exports. The livestock sector produces milk, meat, and wool. The main cash crop is poppy, which in 2002/03 gener- ated gross revenues of some $1 billion for farmers and $1.3 billion for traffickers (one-third of total GDP). Expansion of irrigation should raise land productivity and bring previously non- arable land under cultivation; improved techniques will also increase yields; diversification will increase average income per hectare, particularly when improved transport linkages open up new markets; and restoration of livestock herds and better husbandry will contribute to steady growth of livestock production. This growth potentially would be somewhat offset the gradual reduction of opium cultivation. Although under-exploited, Afghanistan has rich underground resources (accounting for only 1 percent of GDP in 2003/04). These include copper, coal, construction materials, gemstones, etc. There are also deposits of iron and gold, not currently exploited. There are some reserves of natural gas, which were exploited in the 1970s and 1980s, generating significant activities and public revenues. These sectors provide a good illustration of the need for the Government to create an adequate regulatory framework and security conditions, and the complementary need for sizable private sector investments. Large-scale industry is not much developed, and what little there was in the late 1970s--most of it in the public sector--has become defunct, or is poorly performing. Most industrial production (9 percent of GDP) consists of upstream (fertilizers) or downstream (mostly handicrafts) activities related to agriculture. The electric power sector has only limited capacity to import electricity and even more limited capacity to generate and distribute electricity domestically. Construction is very important at present (4 percent of GDP), and reconstruction activities are expected to continue to support its growth. The industrial sector will benefit from better infrastructure and greater supply of skilled labor due to education and training. Also, development of the financial sector--micro- credit and commercial lending--will create a climate conducive to greater investment. Among services (13 percent of GDP), trade has been very important, stimulated in large part by restrictive trade regimes in neighboring countries, which encourage unofficial trade (in par- ticular smuggling). The financial sector is almost completely in the unofficial economy, finan- cial services being provided by the hawalas. The recovery of the economy is expected to generate considerable additional demand for financial services. Out of the many products and processes that do or could exist in Afghanistan, the economy will have to discover those that are most valuable. The carpet industry is an important export that survived the conflict. Organized traders, providing advice on demand and sometimes raw material and cap- ital, have managed to continue their business throughout the last quarter-century. However past experience, while useful, cannot give investors or the Government any certainty about potential suc- cesses. For instance, dried fruits from California have taken a major part of the market in India, which Afghan products used to occupy. California has now established a technological advantage for this market (adding variety to suit Indian tastes with new treatments for dried fruit). CHAPTER 2 Poverty in Afghanistan: A Preliminary Analysis B y any measure--average per capita income (see Chapter 1), life expectancy, other social indicators, or broader indexes like the U.N. Human Development Index (HDI)--Afghanistan is one of the poorest countries in the world. In 1996, the country ranked 169th out of 174 countries in the HDI. Afghanistan was a very poor country before the war and fell further behind the rest of the world during the past quarter-century. Recent rapid economic growth and improvements in some social indicators have not yet changed this situation. In order to take on the challenge of poverty reduction and underpin the development of the Government's poverty reduc- tion strategy, it is essential to understand poverty--its dimensions, characteristics, and determinants. New household survey data, while far from perfect, represents a major advance from what was available earlier and does permit a preliminary analysis of rural poverty in Afghanistan.1 This chapter first (in the first section) provides some general background and discusses Afghanistan's social indicators, based on survey data for both urban and rural areas. The second section presents a profile of rural poverty in Afghanistan, based on rural household survey data, which identifies some of the main correlates of poverty. The third section outlines the determinants of rural poverty based on multivariate analysis. 1. The main databases are the Multi-Indicator Cluster Survey (MICS), conducted by UNICEF in 2003 and covering urban and rural areas (UNICEF and CSO, 2003), and the National Rural Vulnerability Assessment (NRVA) conducted by the Ministry of Rural Rehabilitation and Development with support from the World Food Program and the World Bank (Afghanistan Government 2003). See also World Bank (2004b). 15 16 A World Bank Country Study Historical Background and Social Indicators More than two decades of conflict, interspersed with a number of serious earthquakes, and culminating in a severe nationwide drought in 1999­2001, had dramatic impacts on the Afghan population and particularly its poorest segments, as noted in Chapter 1. First, conflict generated insecurity, with numerous adverse effects on the poor. The collapse of the state and rule of law resulted in local power-holders taking control in regions and localities, often with no check on their authority. An estimated 5.9 million AfghansleftthecountryandonemillionInternallyDisplacedPersons(IDPs)weredis- placed within Afghanistan, making one in every three Afghans a refugee or an IDP. Second, the conflict destroyed physical capital, including the small-scale traditional infrastructure which the rural poor relied on for livelihoods as well as personal assets. Third, the lack of an effective state led to collapse of public service delivery (see Chapter 8) and took a heavy toll on human capital. Under the Taliban, school attendance was low and girls were almost completely barred from attending schools. Infant and under-five mortality as well as maternal mortality were estimated to be among the highest in the world,andmalnutritionaffectedabout50percentofchildrenunderagefive.Theaver- age life expectancy was little more than 40 years, similar to the pre-conflict level. Since the fall of the Taliban regime and end of major combat, economic growth has been rapid. There has been a strong recovery, albeit from very low levels of activity (Chapter 1), accompanied by an improvement in some social indicators. In the past two years 2.5 million Afghan refugees have returned to their home country, while an additional 600,000 IDPs have moved back to their place of origin. About 40 percent of refugees have returned to Kabul and many others to urban centers across the country. School enrollment has con- tinuously increased: more than three million students were enrolled in Grades 1­12 in 2002 and 4.3 million in 2003, of which 3.9 million were in primary schools. Progress has also been made in health. A massive vaccination program led to a marked reduction in con- firmed polio cases. A measles mortality reduction campaign was conducted and reached more than 90 percent of children six months to 12 years of age, and iodized salt has been provided to 300,000 malnourished women and children. Despite the impressive economic recovery and initiation of a development strategy based on sound principles (outlined in the Government's National Development Framework), Afghanistan still ranks very poorly on all social indicators (Table 2.1). Based on a 2003 sam- ple survey, infant mortality at 115 per thousand live births and under-five mortality at 172 per thousand live births are among the highest in the world. The situation is particularly grim in rural areas where one out of five children dies before reaching five years of age. The estimated rate of maternal mortality (1,600 per 100,000 live births) is among the highest in the world. Nine out of ten births are not taking place in health facilities, and the corre- sponding figure is even higher in rural areas. Family planning is largely non-existent. Morbidity rates are extremely high: 30 percent of children under five years of age were reported to have diarrhea during the two-week period that preceded the survey and 19 percent to have suffered from severe respiratory diseases over the same period. Malnutrition is also a critical issue. Seventy percent of children do not receive timely complementary feeding (which could damage their physical and learning capacity Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 17 Table 2.1. Social Indicators 2003 Indicator Rural Urban National Survival Infant mortality (# of deaths per 1,000 infants under 1 year) 121 97 115 Under five mortality (# of deaths per 1,000 children under 5 years) 183 142 172 Morbidity (%) Diarrhea (children under 5 reporting incidence in past 15 days) 30 30 30 Increased fluid and continued feeding given during diarrhea 54 51 53 Acute Respiratory Infection (children under 5 reporting incidence in past 15 days) 19 19 19 Advice or treatment sought from hospital/HC during ARI 27 32 28 Malnutrition (%) Children that have not received timely complimentary feeding (6­9 months) 73 66 71 Households consuming non-iodized salt 90 74 85 Pregnancy (%) Births not taking place in health facility 96 68 89 Married women (<49 years) who have not heard of a method to delay pregnancy 78 55 72 Married women (<49 years) not currently using a method to delay pregnancy 94 79 90 Disability and Orphanage (%) Children 1­4 years that are disabled 2 3 3 Children 7­17 years that are disabled 3 4 3 Children with both parents dead 6 6 6 Preventive Health (%) Children 12­23 months that have received DPT 3 immunization 23 48 30 Children 12­23 months that have received Polio 3+ immunization 43 71 51 Children 9­59 months that have received Measles immunization 73 84 76 Children under 5 that have received BCG immunization 55 73 60 Access to Sanitation and Water (%) Households with drinking water from pump/protected spring 31 61 40 Households having a flush or pit toilet 59 87 67 Households with water source and latrine within 15 meters 77 60 67 Education Illiteracy rate: Male (% of pop. aged 15 and over) 64 40 57 Illiteracy rate: Female (% of pop. aged 15 and over) 92 72 86 Primary school net enrolment rate (% of 7 to 13 year olds) Male 61 81 67 Primary school net enrolment rate (% of 7 to 13 year olds) Female 30 63 40 Note: The nomad population known as "kuchi" are not included and are estimated at 1.3­1.5 million. According to CSO (2003) 22 percent of the estimated population is urban. Source: UNICEF and CSO (2003). 18 A World Bank Country Study irreversibly), and 85 percent of households consume non-iodized salt. Three percent of children are disabled and 6 percent are orphans. Preventive health is lacking as demonstrated by low vaccination rates especially in rural areas, and poor access to potable water. Routine immunization coverage (Diphtheria, Tetanus, Pertussis--DTP3) is estimated at 30 percent (23 in rural areas). Inaccessibility to health centers, hospitals, or doctors that could provide preventive and curative services, as well as lack of medicines including essential drugs, are major contributing factors to the poor state of public health. Forty percent of health facilities do not have female staff, which implies that women are very unlikely to use those facilities. Forty percent of the popula- tion report having access to safe drinking water, but this is likely to be a substantial over- estimate of actual access to safe drinking water. Illiteracy is extremely high, with stark provincial and gender disparities. Fifty-seven percent of men and 86 percent of women above 15 years of age are illiterate. Illiteracy is particularly high in rural areas. Despite progress, education is still limited. While the net enrollment ratio in major cities is as high as 80 percent, it is only 47 in rural areas. Nationally, the female net enrollment ratio is 40 percent while that of boys is 67. However, the net enrollment ratio for girls is as low as 1 percent in some provinces. Missing out on primary education generally has irreversible negative effects on well-being, as there are few "catch-up" and adult-literacy services available. The serious gender disparities in Afghanistan's social indicators reflect not only the protracted conflict and its impact on women and girls but longstanding historical patterns. A number of efforts to improve gender equity over the past century have been reversed, and the gender issue has been highly politicized, detracting from a focus on the large human and social costs resulting from poor and gender-biased social indicators. The his- torical context (discussed in Box 2.1), as well as the current political and legal situation for women, need to be fully factored into strategies to improve female social indicators. Box 2.1. Gender in Afghanistan--A Politicized Issue Throughout the 20th century, the debate on women's rights and their role in Afghan society has been closely interlinked with the national destiny. Women not only carry the burden of symboliz- ing the honor of the family, but they often are seen as embodying the national honor and aspirations as well. Gender has thus been one of the most politicized issues in Afghanistan over the past 100 years, and attempts at reform have been denounced by opponents as un-Islamic and a challenge to the sanctity of the faith and family. In 1929, the reformist King Amanullah's government was over- thrown soon after he tried to impose social reforms, including the abolition of purdah (separation and veiling of women) and establishment of coeducation. It took another 30 years before then-Prime Minister Mohammad Daoud in 1959 officially abolished purdah. Starting in the late 1970s, leaders of the Communist government pushed new reforms including abolition of the "bride-price" and forced adult education for women, fuelling the opposition to the Communist regime and Soviet occupation. When the regime finally collapsed in 1992 and a loose coalition of Mujahedin parties was installed in Kabul, decrees instructed women to observe hijab--covering of the head, arms, and legs. During the years of conflict, legitimate concerns about women's security led to the imposition of ever stricter interpretations of socially acceptable female behavior, supported by the most con- servative reading of the holy scriptures. Despite the rhetoric, women suffered from very serious human rights violations throughout the conflict. While it justified itself on the basis of protecting women, the Taliban regime's retrogressive views on gender resulted in the opposite, as women were not allowed to work or receive even basic education or medical care. (continued) Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 19 Box 2.1. Gender in Afghanistan--A Politicized Issue (Continued) While Afghan women have enjoyed Constitutional gender equality since 1964, the legal system granted differential rights to men and women, although the 1977 Civil Code introduced significant reforms. During the years of conflict and break-down of state functions, the 1977 Civil Law withered away and a largely unreformed Hanafi family law and customary law ruled in practice. The 2003 Constitution states with regard to the functioning of the Judiciary that "whenever no provision exists in the Constitution or the laws for a case under consideration, the court shall follow the provisions of the Hanafi jurisprudence within the provisions set forth in this Constitution." The legal frame- work guiding Afghan women's lives thus consists of a mixture of civil law, customary law, Islamic (Hanafi and Shia) Law, and traditions all of which stress the complementarities of male and female roles more than their equality. Religious traditions are characterized by ideals of mutual respect and dignity between female and male roles, but these normative complementarities have often been accompanied by more heavy-handed and oppressive practice, with customary law in many cases discriminating against women considerably more than Islamic law. Afghanistan has signed a number of international human rights treaties and in March 2003 rati- fied the United Nations Convention on the Elimination of all forms of Discrimination Against Women (signed in 1980), which will require new legislative and administrative measures. In the meantime, there appears to be a large degree of confusion over the exact rights of women and their legal status, and widespread violations of the most basic rights of women and girls, includ- ing physical abuse, under-age marriage, and exchange of girls to settle feuds. There is growing awareness at all levels of Afghan society that economic and social progress require contributions by all of the country's active and able human resources, including women. Yet, there are serious impediments to "gender mainstreaming" in national reconstruction and development, including limited awareness of what it means, how to apply it, and who to draw upon for support. With gender issues having been highly politicized during the past 100 years, soliciting or addressing the interests of women runs the risk, once again, of being seen as an imposed "Western" agenda running counter to local traditions. In order to garner significant public support for policies promoting gender equity, the discourse needs to be shifted from the religious to the social domain--and such policies must be seen as not running counter to Islam. This challenge can only be met through close collaboration with religious and legal experts, with professionals in line ministries and civil society organizations across the various sectors of society. The voice and initiative for making improvements needs to come from women (and men) within Afghan society. In this context it is encouraging that the Government has provided significant lead- ership roles for women, including the appointment of three women ministers, 14 percent women representatives in the first Loya Jirga, and women's participation in the constitutional drafting com- mission, the Judicial Commission, and the Electoral Body. A further important step was taken by the Constitutional Loya Jirga in December 2003, which provided for equality between women and men before the law, and allocated to women a minimum of two seats per province in the Lower House and half of the one-third membership of the Upper House selected by the President. In total this will secure for women at least a 25 percent share in the National Assembly. Women are already exer- cising their right to participate in local and national level politics, including through the National Solidarity Program where women at par with men elect (and can be elected to) Community Devel- opment Councils. As far as national politics is concerned, although voter registration was hampered by lack of security and resources (disproportionately affecting women), women nevertheless com- prised more than 40 percent of the total number of voters registered for the Presidential election and voted in large numbers, but with great regional variation. Although the size of Afghanistan's population is not known with any degree of certainty, and population growth is hard to predict, it is clearly a major concern for Afghanistan's future. By all indications the current population growth rate is well above two percent per year, which will lower the benefits to people (in terms of average per capita income) from any given level of overall economic growth, and increase the burden on social services like education and health. Population growth is likely to be accompanied by accelerated 20 A World Bank Country Study urbanization and associated needs and costs. One key driver of population growth in international experience is low female social indicators. Rural Poverty Profile The 2003 National Risk and Vulnerability Assessment (NRVA) included 1,850 rural villages and some 11,200 households surveyed between July and September 2003. Besides detailed food consumption data, the survey also collected demographic and socio- economic data such as age, education, employment, access to public goods, detailed infor- mation on agricultural activities, prevalence of shocks over the previous year, debt, remittances, and participation in social programs. Information on "essential" non-food expenditures (medicine, clothing, taxes, fuel, oil, and education) was collected for three wealth groups in each community (better-off, average, poorer), generating some 5,600 data points for non-food expenditure. While this data set has some important limitations-- most notably it covers rural areas only, and is based on a single survey done shortly after the harvest time when rural people were likely to be consuming more food than at other times of the year--nevertheless it marks a major advance in our knowledge and provides important insights into rural poverty in Afghanistan. A standard approach to identifying characteristics associated with poverty is to divide the sample of households surveyed into "quintiles"--five groups each comprising 20 percent of the sample--based on a selected indicator of welfare. Here we use total food and essential non-food expenditure per capita as the welfare indicator. Some of the most salient charac- teristics by quintile are shown in Figure 2.1 and are discussed below, while a more complete set of characteristics is listed in Table A3 in the Statistical Appendix. Expenditure. As seen in Figure 2.1, average per capita (food and basic non-food) expenditures rise from $66 per year in the first (poorest) quintile to $301 in the fifth (least poor) quintile, with an average of $165 for the sample as a whole. The biggest gap--more than 50 percent--is between the fifth and fourth quintiles. About 21 percent of households did not consume 2,100 calories per person per day--a commonly-used indicator of caloric sufficiency in food consumption. Because the survey was carried out in the summer right after a bumper harvest, it would be expected that the year-round average percentage of households in this situation would be higher. As expected, poorer families more often report difficulties in satisfying their food needs. Dietary diversity is also strongly correlated with poverty, with the households in the poorest quintile consuming a small number of food items and getting most of their calories from wheat. Welfare. On average, households do not perceive their welfare to have improved by very much over the last 12 months. This is somewhat surprising as the economy and par- ticularly agricultural production grew considerably during this period with the return of normal rainfall (Chapter 1). Households' perception of welfare improvement is positively correlated with per capita expenditures, however (see Table A3). Family size declines slightly as average per capita expenditure rises, reflecting primarily that better-off households have relatively fewer young children or elderly people in the household. Households in the high- est quintile tend to own their home more than those in the bottom quintile (93 percent versus 76). Also, the number of persons per room decreases as per capita expenditure rises. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 21 Land and Opium Poppy. The proportion of households who own some land is high and increases with per capita expenditure--from 78 percent in the lowest quintile to 92 percent in the highest quintile (Figure 2.1). The relationship between per capita expen- ditures and amount of land owned, and whether it is irrigated or rain-fed, is not very clear, however (Table A3). A significant proportion of households (4.8 percent) report cultivat- ing opium poppy, and the ratio tends to rise with per capita expenditure (Figure 2.1). However, households appear to under-report cultivating poppy. Scaled up to cover the whole population, the survey would suggest that around 103,000 households cultivate poppy on a total area of 24,000 hectares, which is below the 264,000 households reported by UNODC to cultivate poppy on 80,000 ha (see Chapter 7). Moreover, the survey does not provide data on the large number of wage laborers who work on poppy cultivation and harvesting. Figure 2.1. Selected Correlates of Rural Poverty (by quintiles) Total expenditure per yeara Own some landb Cultivate opiumb 7.8 301 92 90 300 90 85 85 7 250 6 193 80 78 4.4 4.7 200 5 151 4 3.6 3.4 150 116 70 3 100 66 2 50 60 1 0 50 0 Poorer Richer Poorer Richer Poorer Richer Illiteracyc Primary school in communityd Electricityb 27 79 80 73 71 66 25 62 0.81 0.79 0.78 60 0.8 0.74 0.76 20 16 17 14 15 40 0.7 11 10 20 0.6 5 0 0.5 0 Poorer Richer Poorer Richer Poorer Richer Female household headb Disabled household headb Migrated within countrye 9.3 9.3 7.1 7 12.3 11.3 11.8 8 6 12 6.0 5 10 6 8.1 4.7 3.9 4 8 7.1 3.9 2.8 4 3 2.0 2.4 6 2 4 2 1 2 0 0 0 Poorer Richer Poorer Richer Poorer Richer Note: Each chart shows the concerned characteristic for each quintile (20 percent) of the sample in terms of average per capita expenditure (food plus basic non-food), starting with the poorest 20 percent at left and moving up to the richest 20 percent at right. a. US$ per year; b. Percent of households; c. Percent of household heads; d. Average (0 = school more than 1 day travel away; 1 = school in village); e. Percent of household heads that have migrated within country over the past five years. Source: Statistical Appendix, Table A3. 22 A World Bank Country Study Education and Literacy. Although illiteracy is high throughout the sample (on aver- age 70 percent of household heads are illiterate), as shown in Figure 2.1 the proportion is considerably higher for the poorest quintile (79 percent) than for the highest quintile (62). While underscoring the magnitude of the task ahead, this pattern is fully consistent with the universal lesson from international experience that basic education is extremely impor- tant for development. Most households (78 percent) lived in villages with a primary school, but there is not a clear relationship between this and per capita expenditure (Figure 2.1). The same is also broadly true of health facilities (Table A3). Basic Services. A relatively small proportion of rural households report having access to electricity (17 percent), but having electricity is strongly correlated with per capita expenditures; only 11 percent of lowest-quintile households have electricity compared to 27 percent of highest-quintile households (Figure 2.1). This pattern most likely reflects that better-off households do have the option of purchasing a small generator to provide their own power. Most other basic services do not show such a clear relationship (Table A3), because access does not tend to be within the discretion of households even if they have financial resources, and may be related to other factors also correlated with income, such as proximity to an urban area. Female-headed Households. The relationship between average per capita expenditure and whether a household is female-headed is striking (Figure 2.1). The relatively high per- centage of female-headed households in the sample as a whole (6.6 percent)--which is likely to understate the real level for various reasons--reflects the direct and indirect toll of more than two decades of conflict. It is striking, however, that the proportion of female- headed households in the two poorest quintiles (9.3 percent) is more than double the level in the highest quintile (3.9). This phenomenon highlights the gender dimension of Afghanistan's development challenge and most probably reflects that female-headed households in many cases have lost or do not have a very important human asset (working- age male) and the severe restrictions against women working outside the household in many rural areas, as well as women's lower human capital (particularly education). Disabled Household Heads. Although the percentage of households reported to be led by disabled persons (3.6 percent) is lower than in the case of female-headed households, the relationship with per capita expenditure is just as striking (Figure 2.1). In the poorest quintile 7.1 percent of households are disabled-headed, whereas the figures are 2 and 2.4 for the fourth and fifth quintiles, respectively. Internal Migration. Whether the household head migrated within the country over the past five years is negatively correlated with per capita expenditure. The average for the sample as a whole is 10.1 percent, but for the poorest quintile it is 12.3 and for the richest quintile only 7.1 (Figure 2.1). Internal migration may be capturing two phenomena, both associated in different ways with poverty: (i) displacement due to conflict--Internally Displaced Persons (IDPs)--which entails a wholesale loss of assets, livelihoods, and social networks; and (ii) internal migration in search of opportunities to earn incomes elsewhere in Afghanistan. Phenomenon (i) reflects a "shock" associated with conflict that makes people poorer than they were before, whereas phenomenon (ii) may be associated with being poor in the first Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 23 place--poorer households have a strong incentive to migrate in search of labor and livelihood opportunities, as a coping mechanism. The available data do not allow us to disentangle these two possible explanatory factors. In the case of Afghan refugees who have returned from other countries over the past five years (10.5 percent of the sample), refugees from conflict have similarly been mixed together with economic migrants. However, there is no systematic relationship between this characteristic and per capita expenditure (Table A3). Remittances. The proportion of households who receive remittances increases with per capita expenditures (Table A3). Lower quintile households tend to receive remittances from neighboring Pakistan and Iran while households in the higher quintiles tend to receive them from farther away. The absolute level of remittances increases with household expenditures while the ratio to expenditure decreases with household expenditures, indicating that remit- tances are more important in relative terms for the livelihood of worse-off households. Determinants of Rural Poverty The profile of poverty in rural Afghanistan sketched out above has potentially important implications for policies and programs to reduce poverty. However, it is necessary to take the analysis further in order to derive more robust and reliable policy implications. The analysis based on quintiles is "bivariate"--whereby the relationship between each of a num- ber of different household characteristics and the poverty indicator (per capita expenditure) is looked at individually. However, it is likely that some of these characteristics are reflecting the influence of other characteristics, thereby clouding the underlying relationship (or lack thereof) between the characteristic concerned and poverty. For example, poorer house- holds tend to be disproportionately headed by females and by illiterates, as compared with the sample as a whole. However, because education and literacy levels among women in Afghanistan are much lower than for men, it is possible that the reason female-headed households tend to be poorer is not primarily because they are female-headed per se, but rather because being female is associated with a higher degree of illiteracy. Thus a "multivariate" analysis is necessary--whereby different characteristics are simultaneously compared with the poverty indicator in an effort to distill their separate effects. Based on a multivariate regression analysis,2 rural poverty in Afghanistan is clearly associated with lower levels or constrained use of key variables, including education, occu- pational activity, physical assets, basic services, and remittances, as well as with certain household characteristics (female-headed, larger households, etc.). The full results of the technical analysis are presented in the Statistical Appendix (Table A4). The main findings are summarized below: i. The data appear to show significant geographical differences in rural poverty. Other things equal, per capita expenditure in the Western region is 29 percent lower, in 2. Log of per capita expenditure is regressed on a number of key variables considered to be at least somewhat exogenous to households' decisions. It is important to note the limitations of this analysis. It is restricted to rural areas. Second, it does not capture the dynamic impact of certain causes of poverty over time. Third, the analysis is limited by the variables available at the household level from the survey. Finally, any interpretation of the included variables as having a causal effect on poverty should be treated with some caution. 24 A World Bank Country Study the Central region 16 percent lower, and in the Eastern region 12 percent lower, as compared to the Southern region. These findings need to be investigated fur- ther, as some of them (such as the relative wealth of the Northeast--indicated as the best-off region in the analysis by a slight margin over the South--and the apparent poverty in the West) do not appear to coincide with traditional patterns. It is possible that regional patterns are reflecting the location of opium poppy cultivation, which is concentrated in the South and Northeast. Further work is required before deriving significant policy implications, however. ii. Large households and those with more young children and elderly tend to be poorer. Keeping all other factors constant, the presence of one additional member decreases per capita expenditure in the household by 3 percent. Each additional child under five also decreases per capita expenditure by 3 percent, while each member over 65 years decreases per capita expenditures by 4 percent. This is sim- ilar to the bivariate patterns in the poverty profile. iii. Female-headed households tend to be poorer (but not households with a higher share of women). Per capita expenditures for female-headed households tend to be 14 percent lower than for households headed by a male (and this is separate from the impact of household head's illiteracy which is a separate variable in the analysis--see Table A4). Thus female-headed households could be used as a proxy for targeting poverty interventions. However, households with a larger presence of women do not tend to be poorer, which may suggest that with a male house- hold head, women can provide important complementary skills for income gen- eration (e.g. handicrafts which can be sold on the market by the household head) and therefore do not pay a penalty as compared to other households. iv. Domesticmigration(includinginternaldisplacement)isassociatedwithgreaterpoverty, but not return from abroad. Per capita expenditures for households whose heads have migrated within the country over the last five years tend to be 7 percent lower than for households who have not migrated. This suggests that poverty interven- tions could be designed to target this group. Households that have returned from abroad do not seem to be significantly poorer. However, a quintile regression analysis reveals that grouping all returnees from abroad together misses some important differences among them. For high-performers (those whose per capita expenditures are higher than expected given their characteristics), returning from abroad generates a higher level of expenditure, while low-performers (whose per capita expenditures are lower than expected given their other characteristics) seem negatively affected by their return. Thus programs for returnees need to be care- fully designed to reach the low-performing group. v. Education levels are closely linked with poverty. When the household head is liter- ate, per capita expenditure is 7 percent higher than when he/she is illiterate, other things equal. The education level of the household head is one of the most criti- cal factors in determining poverty status, although two-way causation may be at work (richer households may be better able to educate their children). vi. Differences in access to basic service facilities are not a strong determinant of poverty. Access to electricity is correlated with higher levels of per capita expenditure, although the direction of causality is probably reversed since most electricity in Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 25 rural areas is provided by personal generators. The presence of a secondary school is also correlated with higher expenditures, but a secondary school may serve as a proxy for closeness to urban centers. Access to other services (water, market, transport, primary school, and health facilities) is not significantly related to poverty. However, a quintile regression analysis reveals that access to clean water and a permanent food market has a positive effect on better performing house- holds and a negative effect on worse performing households. This suggests that only better performing households translate access to these basic services into higher levels of expenditure and well-being. vii. Farming characteristics are significant determinants of rural poverty. Land owner- ship has a positive impact on per capita expenditure, whereas sharecropping or agricultural wage labor tends to be associated with greater poverty. Land owner- ship and rural contractual arrangements often reflect imperfections in other markets (credit, labor, etc.). viii. Except for disease, shocks over the last 12 months have little impact on poverty. How- ever, lumping all households together hides some important differences among them. A quintile regression analysis reveals that insecurity and violence, return of refugees, and the occurrence of a drought have significant negative effects on low performing households. This suggests that actions to mitigate these shocks could be effective components of a poverty reduction strategy. ix. Poppy cultivation is correlated with higher expenditures. The possible implica- tions of this result need to be treated with caution however. Opium poppy eradication may affect negatively the livelihoods of many rural poor engaged in opium production, including the large numbers of wage laborers involved (see Chapter 7). x. Sickness of a household member has a negative impact on per capita expenditures. This suggests the need to design and implement an adequate safety net to provide affordable basic health services to the population and to the poor in particular. The counter-intuitive significant positive effect of livestock disease on per capita expenditure probably is reflecting that those who were severely affected by live- stock disease had large herds and were therefore richer families. xi. External remittances help alleviate poverty. Remittances ease households' bud- get constraints and are associated with higher per capita expenditures. About 15 percent of the rural population receive remittances, which represent about 20 percent of their expenditures on average. The percentage of recipients is lower in the lowest quintile (10 percent) but remittances represent a larger proportion of their expenditures (about 30 percent). Although these findings are preliminary and will be further developed and refined, they have policy and budgetary implications for the poverty reduction strategy that the Government will be developing (Chapter 3), and for social protection in particular (Chapter 9). Basic education and health are clearly very important for poverty reduction and (especially health) for social protection. Targeting of female-headed households, households headed by disabled persons, and IDP households in poverty reduction pro- grams appears to make good sense, whereas many (though not necessarily all) returning 26 A World Bank Country Study refugees tend to be better-off than the rest of the rural population. Further work is required to assess regional patterns of poverty and their implications for poverty reduc- tion strategy, which could be important. The role of opium in rural households' wel- fare needs to be better understood, including wage labor on poppy cultivation and harvesting which micro-level studies indicate is an important source of income for the rural poor. And the importance of remittances in the coping strategies of many rural households is confirmed. CHAPTER 3 Toward Sustained Growth and Poverty Reduction he Government has set ambitious targets for growth and human development, T reflecting the country's need to make up for a quarter of a century of conflict. Secur- ing Afghanistan's Future (SAF; Afghanistan Government 2004b) outlines a scenario with average annual growth of 9 percent for non-drug GDP during the medium term, with income per capita rising to $500 in 2015.1 This scenario is underpinned by an investment program of $25.6 billion over seven years (with external assistance requirements, including for recurrent expenditures, of $27.6 billion). The SAF report is equally ambitious in target- ing large improvements in social indicators, in line with the Millennium Development Goals. The gross primary school enrollment rate is targeted to rise from 54 percent (40 for girls) at present to 100 percent for boys and girls by 2015. The under-five mortality rate is targeted to decline from 172 to 130 per 1,000 live births, the infant mortality rate from 115 to 55 per 1,000 live births, and the maternal mortality rate from an estimated 1,600 per 100,000 live births to 205. Indeed, robust, sustained economic growth is essential for Afghanistan to secure peace and improve human development. First, it is a necessary condition to get out of deep poverty--and therefore the central element of a poverty reduction strategy. Second, growth is crucial for state building and political stabilization (Chapter 4). Economic growth impacts positively on security, by creating revenues for the Government to build police and army forces and by providing people with more of a stake in society. Economic growth 1. The scenario is based on a natural population growth rate of 1.9 percent per annum, to which was added the estimated impact of return of refugees. This may be an underestimate, and moreover the pop- ulation growth rate could further increase if health interventions are successful and begin to reduce mor- tality rates. Higher population growth and a rapid pace of urbanization would increase overall growth and investment requirements. 27 28 A World Bank Country Study will also generate viable alternatives to opium production (Chapter 7). Finally, economic growth creates revenue potential, which if tapped in a transparent and non-distortionary way through effective taxation, will generate the domestic fiscal resources that will enable Afghanistan over time to become financially self-sufficient and to provide effective services to its people--another key factor in poverty reduction (see Chapter 8 on social service delivery). Thus the key development challenge for Afghanistan is to put in place the insti- tutions, policies, and services that will generate sustained, broad-based economic growth. As noted in the SAF report (Afghanistan Government 2004b), in addition to the level, the quality of economic growth will be critical: The quality of growth is very important. What is needed is growth with improving social indi- cators (reflecting investments in human capital) and without a significant deterioration in income distribution. This ensures continuing broad consensus around the policies and deci- sions needed to create the enabling environment for economic growth. In the Afghan context, growth needs to be labor-intensive, sustainable macro-economically and financially, and environment-friendly and conducive to social development. Growth also needs to be reason- ably well-balanced ethnically and regionally in order to avoid exacerbating political tensions among different groups and regions. On this basis, growth will enable and fully support poverty reduction. This chapter outlines a strategy for growth and poverty reduction, based on the NDF and SAF. The first section summarizes the Government's growth and poverty reduction strategy, provides a conceptual framework, and discusses the four key elements of growth strategy and further elements of a poverty reduction strategy. The second section summa- rizes implementation priorities and risks. Growth and Poverty Reduction Strategy The Government's development strategy is presented as a development vision in the NDF, further articulated in the SAF report (Afghanistan Government 2004b), and embodied in the twelve national development programs of the NDF (Table 3.1). The NDF and SAF are anchored in three "Pillars" of development: (i) human capital and social protection; (ii) physical infrastructure and natural resources; and (iii) private sector development, including security and rule of law and public administration reform and economic man- agement. The NDF also emphasizes three cross-cutting themes: (a) governance, financial management, and administrative reform; (b) human rights, security, and rule of law; and (c) gender. The Government's holistic vision and broad development strategy provide a solid foundation for specific strategic directions and programs discussed later in this chapter, which can be organized around conceptual frameworks for poverty reduction and for growth strategy. To underpin the implementation of the NDF, the Government put forward six National Priority Programs (NPPs) in late 2002 as the "vehicle for promoting its develop- ment vision to mobilize national capacity to manage its own policies and programs in a manner accountable to the public, and in partnership with the international community." The goals of the NPPs are: (i) to unite Government, donors, the private sector, NGOs, and civil society around national policies; (ii) to create efficiency, accountability, and trans- parency in public spending; (iii) to enable resources to be allocated for large national pro- grams, as opposed to smaller and less efficient projects; (iv) to enhance the leadership and Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 29 Table 3.1. National Priority Programs Priority national program Lead ministry Six initial NPPs National Transport Program Ministry of Public Works Afghanistan Stabilisation Program Ministry of Interior National Emergency Employment Program Ministry of Rural Rehabilitation and Development National Solidarity Program Ministry of Rural Rehabilitation and Development National Irrigation and Power Program Ministry of Water and Power Feasibility Studies Unit Ministry of Finance Seven new NPPs National Agriculture Program Ministry of Agriculture and Animal Husbandry National Skills Development and Market Ministry of Education Linkages Program National Urban Program Ministry of Urban Development and Housing Private Sector Development Program Ministry of Commerce National Vulnerability Program Ministry of Martyrs and Disabled National Water Supply Program Ministry of Rural Rehabilitation and Development National Justice and Rule of Law Program Ministry of Justice ownership of Government and Ministries in the reconstruction process; and (v) to enhance provincial equity in national program execution. Progress in implementing some of the programs, notably the National Emergency Employment Program and National Solidarity Program, has been impressive. At the Berlin Conference, the Government announced an additional seven NPPs (Table 3.1). However, the current experience with implementation highlights some risks. For example, the capacity to oversee implementation of the ASP is substantially overstretched. The National Transport Program has not been implemented by the Ministry of Public Works as originally planned, but rather through an ad hoc Government and donor committee. Thus while the NPP approach has merits particularly if fully incorporated in the national budget, there are a number of concerns that need to be addressed. These include the risks related to the creation of Program Management Units (PMUs) as executive bodies reporting the relevant National Steering Committee. PMUs could become part of a second, far better-paid, and more highly-skilled civil service (see Chapter 4), which would be unsustainable, siphon away part of the limited pool of professional Afghans, work in parallel with (and thereby weaken) line ministries, and inad- vertently undermine administrative and civil service reform efforts. Conceptual Framework Opportunity, Empowerment, and Security. Poverty in Afghanistan is, as much as or even more than in other countries, multi-dimensional. As discussed in the World Development Report 2000/2001: Attacking Poverty, poverty can be broadly defined to encompass issues 30 A World Bank Country Study Box 3.1. National Program Structure Pillar 1: Human and Social Capital 1.1 Refugee and IDP Return 1.2 Education and Vocational Training 1.3 Health and Nutrition 1.4 Livelihoods and Social Protection 1.5 Cultural Heritage, Media, and Sport Pillar 2: Physical Infrastructure and Natural Resources 2.1 Transport 2.2 Energy, Mining, and Telecommunications 2.3 Natural Resource Management 2.4 Urban Management Pillar 3: Security and the Private Sector 3.1 Trade and Investment 3.2 Public Administration Reform and Economic Management 3.3 Justice 3.4 National Police, Law Enforcement, and Stabilisation 3.5 Afghan National Army (ANA) 3.6 Mine Action Program for Afghanistan (MAPA) related to opportunity, empowerment, and security (World Bank, 2001b). Insecurity in Afghanistan has a very real, physical meaning for Afghans, especially the poor--their per- sons and property are often at risk from illegitimate local power-holders. Insecurity also encompasses vulnerability to shocks ranging from natural disasters to serious health prob- lems to the ravages of conflict. Lack of empowerment has meant that the poor in Afghanistan have not only been unable to exercise political power in general (ideally in a democratic political structure) but more specifically have not been able to ensure delivery of adequate basic services to them. This is somewhat different from the situation in many other developing countries, where an existing and reasonably functional state may be unre- sponsive to, or even misused against, the poor. Thus security and empowerment for the poor are intimately linked with the state-building agenda (Chapter 4) and service delivery (Chapter 8). The third component of poverty, lack of opportunity, is at the heart of the growth agenda and also encompasses building human capital, physical assets, and livelihoods. Breaking Out of the Informal Equilibrium. Many of the most important constraints to sus- tained, broad-based economic growth in Afghanistan are part of the confluence of factors that have generated the "informal equilibrium" described in Chapter 1 (Figure 1.3). These include: (i) insecurity and lack of rule of law, one of the most serious deterrents to business growth and longer-term investments; (ii) regulatory burden and corruption--although the Government has a pro-private sector policy orientation and has pursued trade and tax reforms, there is still excessive red tape in obtaining permits of various kinds, land Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 31 allocations, and the like; (iii) unavailability of key support services for the private sector, ranging from essential infrastructure (power, roads, serviced land, water) to finance, insur- ance, business support services, agricultural extension and marketing, and so forth; and (iv) the lack of a framework and infrastructure for standards, quality assurance, measures, testing, and so forth, which will be critical for export development. All of these constraints shift incentives toward the informal sector, inhibiting the emergence of larger, efficient, and potentially internationally competitive businesses. They especially hinder export growth, international competitiveness, and productivity growth based on use of increas- ingly advanced technology--which require activities to be in the formal sector for at least part of the value chain. These constraints are compounded by the lack of skills and capac- ity, managerial as well as technical, available in Afghanistan. And in the informal equilib- rium, businesses tend not to gain the experience or build the capacity needed to operate effectively in the formal economy--one of the many self-reinforcing aspects of the infor- mal equilibrium. The "formal equilibrium" (Figure 3.1) is a convenient conceptual framework to illus- trate the changes needed to increase entrepreneurs' productivity and support sustained growth and export development. It emphasizes the importance of security and rule of law, effective state functioning in providing macroeconomic stability and essential public services, and an enabling environment for the private sector achieved through regulatory and structural reforms. Stronger capacity in the government will enable it to improve secu- rity, enforce the rule of law, and provide macroeconomic stability and public services. This in turn will provide more incentives for businesses to "go formal" and, among other things, pay taxes, enabling further strengthening of government capacity, and so on. The formal equilibrium concept does not mean that the entire economy would become formalized, let alone quickly--there would always be a sizable informal component. Yet, unlike at pre- sent, there would also be a sizable, dynamic formal sector. Going formal does not neces- sarily imply large scale--although some of the most successful enterprises would become large, Afghanistan's business landscape will continue to be dominated by small and medium- sized enterprises which need to be supported as an integral part of the private sector devel- opment strategy (see Chapter 5). Figure 3.1. The Formal Equilibrium Government's capacity Macro stability, Government's public goods, Rule of law revenues regulatory framework Entrepreneur's productivity 32 A World Bank Country Study Main Elements of Growth Strategy In essence, the Government's strategy for rapid, sustained, broad-based economic growth centers around the development of a dynamic private sector and is anchored in four key elements: (i) improving security through fair and effective enforcement of law and order and building an effective, accountable State, (ii) maintaining macroeconomic stability, (iii) delivering support services (especially infrastructure), and (iv) creating an enabling envi- ronment for business activity through regulatory and structural reforms. This strategy appropriately addresses the main constraints discussed above. The Government has already made a very good start by maintaining macroeconomic stability and initiating some important structural reforms (see Chapter 1), as well as capac- ity building in the administration (Chapter 4). These very successful and important ini- tiatives need to be complemented by capacity building and delivery of key infrastructural services, by easing the regulatory burden on the private sector (Chapter 5) and reducing vulnerability to corruption (Chapter 4), and most urgently by improving security and strengthening the rule of law (Chapter 4). Security, Rule of Law, and State Building. The first and most fundamental requirement to break out of the "informal equilibrium" is to build security, an appropriate legal frame- work and functioning judicial system, effective law enforcement mechanisms, and a capa- ble and effective state (Chapter 4). In the medium term, the stability, security, and prosperity of Afghanistan will depend on the ability of the state to raise the resources needed to fund the provision of necessary public services (Chapter 4 and 8). In the SAF report, the Govern- ment stated its intention to cover its wage bill in five to six years time, and its entire recur- rent budget in nine to eleven years time. Over the last two years, it has already achieved a significant increase in revenues. Additional progress in mobilizing resources will depend on (i) the security situation and administrative capacity of the Government, and (ii) the structure of the economy. Security sector reform is critical, and this component will also need to include reintegration of disarmed combatants. Government capacity building is underway and needs to be accelerated, on a sustainable basis. Progress in strengthening and reform of the judiciary, which has lagged, will be crucial. Building on informal institutions to create formal institutions is a promising option for moving toward a functioning legal system. Adequate property rights, for instance land titles, enhance the value of assets because, with appropriate institutions for property disputes, they can be used as collateral for credit and facilitate a longer time horizon on the part of their owners. As shown by the work of Hernando De Soto in The Mystery of Capital (De Soto 2000), existing practices can guide the formal definition of property rights. In Peru, 276,000 small entrepreneurs voluntarily recorded their business because formal regulations were adapted to informal practices. In Africa, on the contrary, attempts to impose a system of for- mal land titles failed by running into conflict with traditional arrangements: since lenders knew the new system would be opposed by communities, the expected benefits in terms of financial development did not materialize. Rural land tenure issues in Afghanistan are dis- cussed extensively in Wily (2003) and are summarized in Box 6.3 of Chapter 6. Macroeconomic Policy Framework. A stable macroeconomic framework is very important to sustain growth and shift incentives toward the formal sector. The Government intends Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 33 to sustain recent achievements in fiscal, monetary, and exchange rate management (con- servative monetary policy, light management of the exchange rate, no-overdraft rule, pru- dent debt management) and deepen budget and public administration reforms (Chapter 4). The Government is committed to develop a multi-year fiscal framework to manage effec- tively its fiscal policy. More generally, the policy framework will need to be responsive to potential shocks affecting the economy (see the discussion of macroeconomic risks at the end of this chapter). Also, in the short run a key challenge for macroeconomic manage- ment is the size of the informal economy itself. Monetary policy is weakened because the informal economy does not rely on the banking system, which suggests the need for some monitoring of the hawala system. Moreover, the policy mix can be inadequate if based on incorrect information from national accounts or employment data that poorly reflect the informal economy, which suggests that the policy mix should be very neutral. Provision of Support Services. The third element of the strategy, effective delivery of ser- vices required by the private sector, improves productivity and provides incentives for parts of the informal economy to "come out into the open." Infrastructure, business ser- vices, and research and development have significant externalities in terms of increasing entrepreneurs' productivity: i. Infrastructure services augment inputs available to entrepreneurs (more water through irrigation, more and cheaper seeds, more inputs available through roads, more power) and thus improve production efficiency. They also enlarge markets (through roads, airports, telecommunications) and therefore have a similar effect to a reduction in trade barriers. While some of these services can be used by infor- mal activities (telecom services for instance have quickly developed), others require investments or registration (for example, with the power company) that tend to self-select formal activities. A program of public investment is outlined in the Government's development budget based on the SAF report. Issues related to selected infrastructure sectors are discussed in Chapter 5. ii. A second important category of support services is business services (see Chapter 5). These are delivered by the private sector, but public policies should facilitate their development. Development of the financial sector provides important incentives for the formal sector to develop, as do mechanisms to reduce investment risks, like risk guarantees provided by MIGA. iii. A third category of public goods is research and development. For Afghanistan the priority is to adapt and adopt existing technologies (see Chapter 6 on agriculture). The rate of global technological progress is very rapid, and Afghanistan should exploit the opportunity to make use of the most efficient modern technologies suitable for the country. Enabling Regulatory Framework and Structural Reforms. A fourth element of the growth strategy seeks to improve the enabling environment to set clear rules for entrepreneurs and not require them to go through endless steps in the bureaucracy to comply with these rules. Regulatory and structural reforms can be classified in five groups (Table 3.2). Two key issues affecting all of these areas are the excessive complexity and non-transparency 34 A World Bank Country Study Table 3.2. Structural Reforms Reform area Recent reforms Issues Government's plan Labor market None Labor Code from Labor Code being the 1970s; no drafted enforcement capacity Product markets No price restrictions Large but mainly Mining and Petroleum (Chapters 5 and 6) Revision of the defunct state-owned Laws being drafted Investment Law enterprise sector Commercial Code, (including amendments Significant, disparate Trademark Law under in 2004 to eliminate tax set of laws and revision Reform of holidays) regulations state-owned enterprises Financial market No restrictions on Bank licensing process Dissolve or merge (Chapter 5) exchange rate and started and resolution state-owned banks financial flows for state-owned banks without licenses Banking Law and ongoing Strengthen Central Central Bank Law Bank's supervision passed in 2003 function Tax (Chapter 4) Tax package approved Need to increase Tax policy and revenues in an administration efficient manner reforms Trade Reform of import tariffs Customs Code Customs Code New or adjusted trade obsolete under revision agreements with Work towards Pakistan, Iran, Tajikistan, WTO accession India, US, and the EU Joined the World Customs Organization Source: Based on information provided by the Center for International Management Education (CIME); IMF (2004); World Bank (2004c). of regulations and the limited administrative capacity to provide fair and effective enforce- ment (see Chapter 4). i. The labor market is regulated by a Labor Code drafted in the 1970s, whose provisions covering hiring and firing, applicable only to firms with more than 20 employees, are rather light. Moreover, in the absence of Government capacity these provisions are not enforced. ii. Reforms in the product and financial markets are discussed in Chapter 5 (and in Chapter6foragriculture).Statedirectinterventionsintheeconomyareverylimited-- there are almost no price restrictions, virtually no controls applying to foreign exchange transactions, payments, and capital movements, and state-owned enter- prises are mainly defunct--but regulations remain numerous and potentially costly, discouraging formalization. iii. Although the Government initially focused on customs, the main source of rev- enue, broader tax reforms also have been initiated (see Chapter 4). New tax policy reforms have been enacted in 2004 (a final wage withholding tax on higher income employees, an improved income tax regime, a streamlined business establishment Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 35 tax, a tax on a limited range of services consumed by high income earners, a rent tax, a land tax, and an airport departure tax). Tax administration is being mod- ernized, which will give more clarity to taxpayers. The Ministry of Finance is cre- ating a "Large Taxpayer Office" in Kabul to focus on revenue collection from the top 100 tax-paying entities. In addition, there are plans to create units in the provinces, reporting directly to the Ministry in Kabul, for medium-sized taxpay- ers. The Government intends to modernize the tax code in 2004/05. iv. Customs reforms have been initiated with the adoption of a reform package in 2003 (see Chapter 1). Implementation of customs administration improvements is underway. The Government is now reviewing the customs code. Structural reforms, as well as other elements of the strategy outlined above, are in particular necessary to encourage growth of trade, both within the region and globally, which will be vital to the expansion of market opportunities, and therefore for growth and poverty reduc- tion. Capitalizing on Afghanistan's position as a "land bridge" for trading within the region, and promoting its wider integration in the formal global economy, will require continuing policy and institutional reforms as well as investments, with emphasis on trade facilitation. Afghanistan has already made significant progress in reforming its trade and investment regime. Nevertheless, official regional trade flows between Afghanistan and its neighbors remain relatively small, comprising only 11 percent of all exports in 2002, the rest being traded globally (World Bank 2004d). Informal trade flows with Pakistan and other countries are very large however. Currently, trade logistics remain difficult and costly, combined with a problematic security environment which encourages informal and illicit trading patterns. Hence streamlining Afghanistan's transit links with both regional and non-regional trading partners would reduce transport-related trade costs and facilitate the growth of economic activity and incomes in Afghanistan and its neighbors. Problems of market access depend not only on formal trade barriers but also on barriers to efficient trade logistics and weaknesses in the operation of market institutions. The implementation of the newly approved import tariff schedule as well as improving the capacity of the customs service, harmonizing customs procedures, and improving customs valuation, are all vital aspects of enhanced trade facili- tation. Given its potential significance, regional trade deserves special attention in bilateral discussions and multilateral forums, such as the Economic Cooperation Organization (ECO), which along with Afghanistan and its neighbors includes Azerbaijan, Kazakhstan, Kyrgyz Republic, and Turkey. The March 2004 ECO Conference held in Kabul demonstrated a closer relationship between Afghanistan and other ECO members. Some Additional Elements For A Poverty Reduction Strategy Economic growth is expected to increase opportunities for poor people. Its impact in this regard will depend on whether and to what extent growth helps the poor to build their assets, through investing (and repaying debts) from their own incomes, and accumulating physical capital like livestock. Improvements in opportunities for poor people will also require building their human capital (education, health, training), developing community asset-building programs (notably NSP), financing assets through micro-credit (the Micro- finance Support Facility of Afghanistan--MISFA), and so forth. The economic role of women should be enhanced in the interest of both broad-based growth and poverty reduction. 36 A World Bank Country Study To empower poor people, these elements need to be complemented with the development of participatory institutions (as started with the elected Community Development Coun- cils, part of the NSP). Finally, poor people should benefit from security improvements, which in any case are key to economic growth. Asset building on the part of the poor is expected to be a very important outcome of economic growth and needs to be supported by a range of well-targeted, cost-effective pro- grams, some of which like micro-finance support both growth and poverty reduction. Public works employment programs and other income generation programs can help the poor preserve and over time build physical assets, enhancing their opportunities for progress (see Chapter 9). Sector development programs, for example in agriculture, can play a sig- nificant role in this regard, both directly (for poor farmers) and indirectly (through stim- ulating demand for wage labor in agriculture and other rural activities). Human capital building by the poor, primarily through adequate levels and quality of basic education and health services, is critical for poverty reduction, as emphasized in the NDF. While the financial resource requirements for social services are detailed in the SAF report, Chapter 8 focuses on service delivery issues and ways forward to ensure adequate accountability for performance in service delivery. Social protection (Chapter 9) is another key element of a poverty reduction strat- egy--in particular safety net programs for the extreme poor and those unable for various reasons (remoteness, disability, female-headed households) to fully take advantage of opportunities created by economic growth. A final important element is consultation. A good poverty reduction strategy is not only technically and economically sound--it needs to be fully "owned" by the poor as well as by other stakeholders in the society. In this regard, the role of civil society groups, includ- ing the private sector, to identify key policy, institutional, and infrastructure constraints, as well as to suggest ways forward, will be vital to establishing a poverty reduction strategy that clearly identifies the problems that it seeks to address and builds ownership across the society. The role of both national and international NGOs in this process will be very important for enhancing ownership. The Government is planning to engage in extensive consultations with different segments of society as it develops its Poverty Reduction Strat- egy, a process targeted to reach a first stage of completion with the preparation of an Interim Poverty Reduction Strategy Paper (I-PRSP) early in 2005. Implementation Priorities and Risks Near-Term Options for Moving Forward The Government's national priority programs, presented in April 2004, include a number which will promote sustained economic growth via the formal equilibrium, directly or indirectly. For example, the Afghanistan Stabilization Program will enhance the Govern- ment's presence and capacity on the ground in provinces and districts, and the National Accountability and Rule of Law Program will encourage compliance with transparent competitive procedures, enhance fiduciary safeguards, and promote rule of law. In addi- tion, three complementary opportunities can be seized to move forward the growth agenda: (i) importing resources, (ii) harnessing the dynamism of the informal sector to generate continuing growth, and (iii) instituting reforms first in specific localities. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 37 First, importing resources is a way to overcome the lack of human, technical, and finan- cial capacity in the country in the short run. This includes: (i) aid and technical assistance, as well as military and police assistance, from bilateral donors and multilateral agencies; (ii) imports of goods and services; (iii) foreign direct investment by the private sector; and (iv) ideas, capital, and skills from Afghans living abroad. From Bonn in December 2001 to Berlin in March 2004, the international community has been responsive to this challenge. The impact of external assistance will be sustainable if it supports the Government budget (Chapter 4) and the development of formal sector activities. This entails maximizing the amount of assistance through budget channels, awarding contracts through transparent competitive bidding, and the like. In particular, the regional economy can be an important resource. Fostering regional trade is vital for Afghanistan. Importing electricity from Turkmenistan is an example of the benefits of trade in the context of low domestic generating capacity. Reconstruction activities will benefit from imports from regional countries (for example, of construction materials) and regional contracting of services. Regional investors have also expressed interest in investing in Afghanistan. If corridor agreements are developed, exports to neigh- boring countries can be expanded. Informal networks (especially those built by refugees) will support this development, even though there will be incentives for this trade to stay informal initially. Neighboring countries can also provide skilled workforce. The role of refugee return is more complex: Afghanistan would benefit from the return of more skilled refugees, but there would be an associated reduction in remittances (Box 3.2).2 There is Box 3.2. Refugee Return and Remittances During the past 25 years, more than 30 percent of the Afghan population has been externally or internally displaced. While this has taken a heavy toll in terms of human suffering and disruption, displacement has fostered a highly integrated regional labor market with remittances a substan- tial source of income for families that remain in Afghanistan. Remittances from Pakistan, Iran, North America, Europe and parts of Australasia remain a central element of Afghan households' coping strategies (Chapter 2). In 2003, 17 percent of a sample of rural Afghan households reported having a household member who had emigrated in the previous year. Although 2.4 million Afghans have now been repatriated (1.8 million from Pakistan and 600,000 from Iran) and 600,000 IDPs have returned home, an estimated 3.4 million Afghans still remain outside the country (largely in Pakistan and Iran), and approximately 200,000 IDPs remain uprooted within Afghanistan. In many provinces, security conditions are not yet sufficiently stable to expedite the return of large numbers of refugees. Many families who left Afghanistan years ago tend to seek reintegration in an urban setting, as they have become cut-off from their land and social relations. Finding solutions for the remaining refugee populations represents a complex and continuing chal- lenge. From a socio-economic point of view, there is still considerable uncertainty about the vol- ume of remittances, the economic opportunities for refugees in their host country, and economic growth in Afghanistan. From a political economy point of view, there is also uncertainty regarding stability in Afghanistan, while neighboring Pakistan and Iran are looking for near-term solutions to stabilize their own political economy. During 2005, the trilateral agreements with Pakistan and Iran will lapse, and the longer-term status of remaining refugees (probably to be given the status of economic migrants) will need to be clarified. 2. The use to which remittances are put (e.g. for investment versus consumption) also is a very impor- tant consideration. 38 A World Bank Country Study already considerable degree of integration of informal labor markets with Pakistan and Iran, which is expected to continue. Second, the existing dynamism of the informal sector can be harnessed to generate growth. Women can play an important role in this strategy (Box 3.3). Further Facilitating Growth in the Legitimate Informal Sector. A potentially impor- tant element is micro-credit. The Microfinance Investment Support Facility for Afghanistan (MISFA) has already provided assistance to nearly 20,000 clients, of which more then 90 percent are women. Greater cooperation among informal Box 3.3. The Role of Women in Afghanistan's Reconstruction The participation of women is regarded as critical in all countries. But in Afghanistan their partic- ipation will bear particular fruits. First, their participation will increase the available labor supply. Second, their participation will bring additional knowledge, techniques, and ideas, which will enhance the economy's productivity. For instance, having female staff in health facilities is neces- sary to increase women's use of these facilities, and the same is true of female teachers with respect to increasing girls' enrollment. Current Role. Women's involvement in agricultural production is considerable--in certain regions women's time input equals men's but in other regions traditions restrict their work to the house- hold where they are involved in crop processing (threshing, cleaning, drying, preserving) and also are in charge of most of the household activities (water and fuel collection, cooking, cleaning, sewing, tailoring, weaving, and child rearing). Women play an increasingly important role in poppy production (Chapter 7). Women also play a major role in livestock production and processing of dairy products. Most women's labor is non-monetized, but they make major labor contributions to a number of marketed products such as dried fruits, poppies, fuelwood, dairy products, and handicrafts. Women's contribution to pastoral livestock production both for domestic consump- tion and for domestic and international markets is high, reflected in a range of key export prod- ucts (carpets, hides, qarakul skins, wool). Even when women's domestic production such as carpet weaving forms the main income of the household, they rarely control the marketing of these prod- ucts, which is most often managed by male relatives or middlemen. Women's involvement in the formal sector has mainly been as civil servants working on health and education, where they had a sizeable presence before the conflict, which was severely disrupted by the strong restrictions on female employment during the Taliban. Currently less than 1/3 of all teachers are female while an estimated 40 percent of all basic health facilities lack female staff, which constitutes a major hin- drance to delivery of basic services (health in particular) to women (see Chapter 8). Constraints. The traditional role of women in Afghanistan is a constraint to their participation in economic activities. In particular, female wage labor is still viewed as a solution of last resort for households in desperate straits, and their wage rates are normally only half the level of men's. Women have fewer marketable skills and generally poor education, with an estimated female lit- eracy rate of 21 percent. But other constraints should not be underestimated. With a fertility rate of 6.9 and an estimated maternal mortality rate of 1,600 per 100,000 live births, reproduction and related health issues occupy much of women's time. A recent study by the International Rescue Committee (IRC) found that 40 percent of women mentioned lack of childcare as the first constraint to their participation in the labor market. The absence of many services and the need to produce agricultural products for subsistence also impose an opportunity cost for women who want to join the labor market. Women often lack ownership, control, and access to productive assets such as land, equipment, and materials, and their legal right to inheritance is usually bypassed. The lack of working capital and absence of credit reduce opportunities to start activities that require an ini- tial investment. In the carpet industry, financial constraints have been somewhat alleviated since traders often supply equipment and raw materials, but this has reduced households' control over production and marketing. These various constraints are even more acute for female-headed households (IRC estimated that 13 percent of surveyed women were widows). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 39 activities also can facilitate growth in the informal sector. In the case of horticul- ture, growers' associations could help farmers to negotiate prices, package their products in a way that preserves quality during transport, and increase market information.3 Gradually Shifting Informal Activities to the Formal Sector. Surveys in Brazil and Peru show that developing direct links with formal firms provided the needed incentives for informal suppliers to become formal themselves. Donor-supported programs, such as the National Solidarity Program, which have formal procedures in line with international guidelines, can help build the capacity of informal actors to prepare and execute contracts. By explicitly exempting them from regulations and taxation, small activities (those with few employees and small revenues) could be given access to the formal economy (public services, judicial system, trade net- work, financial services). Such a regime of "micro-enterprise" does not immedi- ately generate additional revenues, but as some of these firms grow they will naturally join the tax base. The law on NGOs will also clarify the status of these organizations and how they can access tax exempt status. Third, reforms can be started in specific localities. Within geographically narrow "Industrial Parks" or "Export Processing Zones," security, other key services, and enabling regulations may be easier to provide. The Government has already initiated development of Industrial Parks, a welcome development which should be pursued (Chapter 5). Managing Risks The implementation of the growth and poverty reduction strategy faces five major risks with economy-wide implications, which will need to be carefully managed in order to sus- tain rapid economic growth. Political and Security Risks Remain. The cost of resumption of civil war, or of delays in political normalization, would be very large. International experience suggests that a typical country at the end of a civil war faces a 44 percent risk of returning to conflict within five years. Generating sustained rapid growth and robust employment generation is the main mitigation strategy for this risk (see Chapter 1 of the SAF report). Second, there is climatic risk. While the recent four-year nationwide drought was unusually severe, droughts covering large areas of Afghanistan are estimated to happen every 9­11 years and more localized droughts every 3­5 years. The drought at the end of the 1990s reduced cereal production by 50 percent (a loss of about $700 million in fore- gone output). Regional droughts--such as the continuing drought affecting the South and parts of northern Afghanistan--would adversely affect growth and would increase demand for public expenditures (such as cash-for-work programs). External assistance would thus be critical in the face of a significant drought. 3. For example, in India dairy cooperatives in Bihar State have proved successful in federating pro- ducers and providing them with entry to markets. In Ahmedabad, also in India, the Self-Employed Women's Association provides cooperative financial, health, and childcare services to 550,000 women and helps provide a women's voice in policy circles. 40 A World Bank Country Study Table 3.3. Prices, Wages, and Exchange Rates Annual growth rate (March to March) 2001/02 2002/03 2003/04 Consumer Price Index (43.4) 52.3 10.5 Exchange rate (Afg. Per US$)a (56.9) 52.2 (3.6) Real Exchange rateab (23.8) (0.0) (12.7) Daily wage of unskilled casual labour (US$) 86.1 9.0 70.0 a. An increase represents a depreciation of the Afghani. b. Exchange rate depreciation divided by inflation (against US$, deflated only by Afghan prices) Source: CSO (2004); IMF (2003, 2004); wage data provided by WFP. Third, the combined impact of large exports of opium, inflows of foreign assistance, and remittances from abroad could have an adverse impact on growth through an exchange rate appreciation (the so-called "Dutch disease"). Aid and opium exports totaled around $4 billion in 2003/04, and remittances are hundreds of millions of dollars per year. If partly spent on non-tradable goods, these inflows would put upward pressure on domes- tic prices leading to real exchange rate appreciation. This in turn would result in a shift of labor to the non-tradable sector and opium sector, putting upward pressure on wages in terms of tradable goods (other than opium). The negative impact on competitiveness (in both exports and import substitution activities) could be harmful to growth. There is some evidence of an increase in wages, and appreciation of the real exchange rate may be occur- ring (Table 3.3). However, the overall net impact of the "Dutch disease" depends on the associated sup- ply response. If aid flows (and, in the Afghan case, opium export receipts) lead to produc- tive investments, the resulting increased capacity of the economy will ease bottlenecks and moderate inflationary pressures, and associated rising productivity will offset loss of price competitiveness. Over the longer run, aid flows would be expected to decline, and it is planned to eliminate opium production over time. This requires Afghanistan to develop a dynamic export sector to provide increasing amounts of foreign exchange. Careful exchange rate management also is called for. Fourth, a reduction in opium production would have very significant macroeconomic implications, and a reduction of poppy prices to their pre-2000 level would represent something like a $1 billion shock for the economy. Based on recent information, farm-gate prices have sharply declined since late 2003 (see Chapter 7), undoubtedly with an adverse effect on rural incomes. In addition, a fall in opium exports will: (i) adversely affect the Government's revenues through a reduction in imports currently funded by poppy income; (ii) reduce foreign exchange inflows; and (iii) dry up credit provided by the opium economy, further depressing economic activity through the equivalent of a credit crunch. This will lead to a real depreciation (with a nominal depreciation, due to lower demand for the Afghani, and deflation, due to lower demand for goods). While the depreciation will have a positive impact on price competitiveness, somewhat offsetting the depressing impact of the "poppy shock" on income, the overall impact on growth will largely depend on the response from external assistance to finance public expenditures and offset the decrease in foreign exchange inflows. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 41 Fifth, Afghanistan's heavy reliance on external assistance is potentially an additional risk. Reliance on donor funding for services could risk building in higher costs of service delivery and entrench parallel delivery mechanisms, which would be unsustainable in the long term (Chapter 8). And volatility of external assistance would constitute a significant risk for the growth and poverty reduction strategy. The Government intends to develop an adequate multi-year fiscal framework to manage this risk. Donors are encouraged to use Government systems and policies to implement their programs. The critical risk mitiga- tion strategy is in this regard is to further strengthen domestic resource mobilization. As the above discussion illustrates, the challenge for the Afghan Government, with support from the international community, is to plan for and manage these risks with sound macroeconomic policies, building fiscal and balance of payments sustainability over time, and relying on international assistance when necessary to respond effectively to shocks. In this way, and based on the structural reforms and other measures outlined ear- lier in this chapter, Afghanistan will be able to sustain its recent good growth performance and reduce poverty. CHAPTER 4 Building an Effective, Accountable Afghan State he state-building agenda is at the heart of Afghanistan's economic, political, and T social reconstruction--with strong linkages to economic growth and private sec- tor development (Chapters 3, 5, and 6), poverty reduction (Chapters 2 and 9), phasing out dependence on the drug economy (Chapter 7), and delivering public services to the Afghan people (Chapter 8 ), as well as to the all-important dimensions of security (discussed in this chapter) and political normalization. The centrality of state building has been emphasized by the Government in its National Development Framework (NDF), in Securing Afghanistan's Future (SAF), and in other public pronouncements. Considerable progress has been made during the past two years, as elaborated below, but there is a long way to go in building an effective, accountable state that meets the needs of the Afghan people. This chapter, building on analysis by the World Bank and partners,1 focuses on selected critical aspects of state building. The first section lays out the state-building agenda and strategy and accomplishments to date. The second section reviews ongoing reforms--"work in progress"--focusing on interim public administration reforms and improvements in fiscal management. The third section discusses the two key tasks of addressing corruption and improving security. The final section outlines the way forward in state building and public sector reform. 1. This chapter draws heavily on research by the World Bank and AREU on public administration in Afghanistan, including Evans and others (2004a and 2004b). It also draws on World Bank (2004c). 43 44 A World Bank Country Study The State-Building Agenda The Starting Point More than 20 years of conflict in Afghanistan resulted in the collapse of the national state as a legitimate political entity with monopoly over the legitimate use of force. Thus, the state- building agenda, including political normalization, improvements in security, administrative capacity-building, and other key components, is paramount for Afghanistan's reconstruction. State building is defined and discussed in more detail in Box 4.1. In the face of political collapse the administrative structures of the state have somewhat surprisingly survived, providing a possible entry-point for state building, which would com- plement and facilitate the fundamental political and security agenda. Afghanistan's admin- istrative arrangements are highly centralized yet provide a coherent management and accountability framework for government. The administrative practices are basically sound and understood--even if not always adhered to. Nevertheless, the government administra- tion is far from effective, and suffers from a number of systemic problems, including: i. Fragmented administrative structures, with many overlapping and unnecessary functions. ii. Lack of skilled professionals with management and administrative experience, and the Taliban's dismissal of women staff resulted in a very serious gender imbalance.2 iii. Pay and grading structures are unable to attract, retain, and motivate skilled civil servants. iv. Merit-based recruitment procedures are absent, resulting in patronage appointments. v. Mechanisms for performance management are inadequate. vi. Administrative systems are slow and cumbersome, with virtually no delegation of authority to lower ranks or to provincial departments. While progress has been made on a number of these fronts in the last two years, it will take time for meaningful capacity improvements to reach broadly across the civil service and down to the rank and file. Success will depend to a large degree on the ability of the cen- tral government to regain control over national policies and implementation across the entire country. This is made more difficult by the financial and military strength of the regional warlords (or "power-brokers") and local factional commanders, and by the mas- sive amounts of donor aid that dwarf the Government's own budget, largely provided through off-budget mechanisms. De jure and de facto State Structure. Afghanistan is a unitary state with a highly centralized government structure (Figure 4.1). Politically, all formal authority is vested in the center. Leaders at sub-national level--provincial Governors and municipal mayors, for instance--are appointed by the center. Most government services are delivered at provincial 2. Limited data are available on women in the civil service. CSO and UNIFEM estimate that in 2002 approximately 27,742 women held karmand (regular) positions within government. A further 5,753 were employed as agirs (contract employees). Women civil servants appear to be significantly less educated than their male counterparts. UNICEF surveys indicate that 27 percent of teachers are female (more than 50 percent in Kabul). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 45 Box 4.1. State-Building The state is the basic unit of political control and legitimacy in the modern world. The interna- tional system is primarily composed of states that recognize each other's sovereignty--that is, ultimate legal authority--over a demarcated territory. According to international law and norms, the exercise of this sovereignty imposes obligations to respect the rights of citizens, other people, and other states, according to the law of nations. Yet, no state can carry out these obligations unless it has certain capacities. The basic capacity that defines a state and enables it to carry out the obligations of sovereignty is a monopoly, or near monopoly, of the legitimate use of force within the territory over which it is sovereign. To merit recognition, a state is expected to use force legitimately, in accordance with law. The monopoly of the use of force is a pre-requisite for carrying out other obligations of a state, such as protecting the rights of and providing services to its citizens and other inhabitants, as well as participating in international organizations and institutions to promote and protect international security according to international law. During the past quarter-century in Afghanistan, several governments used the state to exercise violence lawlessly. In addition, the growth of numerous armed groups deprived any of them, including governments in Kabul (whether or not they received international recognition) of a monopoly of the use of force. All of these entities violated the rights of Afghans, and the ability of any of them to provide even a low level of services declined. Rather than participating in efforts to provide international security, Afghanistan became a source of international insecurity. Building a state that can protect rights, provide services, and promote security requires a num- ber of interdependent processes. At a minimum, these include: i. Demobilizing and dissolving all armed forces not controlled by the state. ii. Forming and training armed forces and police to protect international and domestic security in accordance with law. iii. Forming and training all components of a legal system, from legislators to judges and prose- cutors, to provide a legal framework for the functioning of the state and other social relations. iv. Raising revenue in accordance with law to pay for the functioning of the state. v. Creating and training an administration capable of raising revenue and providing services to citizens and other inhabitants. In a state long torn by conflict, all of these processes have to be started over, sometimes from a very low level. It is useful to make a conceptual distinction between de jure and de facto states. De jure states exist by fiat of the international community, which recognizes them as sovereign entities whether or not they have a government that can effectively control or administer their territory. De facto states actually administer a territory. States that enjoy international recognition and exercise con- trol through adequate institutions are both de jure and de facto. States may provide better services and otherwise perform better when they are democratic, but building a state is not the same as building democracy. A functioning state is the foundation on which democracy must be built. Without a state apparatus capable of providing security and rule of law, the election of office holders does not enable people to govern themselves, for those elected have no tools to govern, and the people have no instrument to hold them accountable. Hence building a state is the primary task of building sustainable peace. and district levels, but powers and responsibilities of sub-national administration are deter- mined by the center. Fiscally, Afghanistan is highly centralized. Expenditures at provincial and local levels are made through national programs carried out by provincial arms of central ministries. 46 A World Bank Country Study Figure 4.1. Afghanistan's Administrative Structure Cabinet Central administration 8 central agencies 2 constitutional 30 ministries & independent agencies bodies Elected Provincial departments of 32 provincial provincial ministries in 32 provinces municipalities overseen by councils Min. of Interior District offices of provincial Elected District municipalities departments in 355 district overseen by Min. of districts councils Interior Full authority & oversight Partial authority & oversight Advisory (as per new Constitution) No fiscal transfers as such go to sub-national levels. With almost 40 percent of the civil ser- vice workforce in Kabul, funds are concentrated at the center. Budgets of provincial depart- ments are set in Kabul, and approval from Kabul is required for even minor changes. On the revenue side, Afghan districts and provinces have no independent authority to impose taxes. The only expenditure autonomy is at municipal level. Although all tax and fee rates are set in Kabul, revenues collected by municipalities remain there and fund municipal spending. Administratively, government in Afghanistan is also highly centralized. Provincial and local governments have only a very modest formal role in decisions concerning their own structure, recruitment of senior staff, size of establishment, composition of workforce, and so forth. Such decisions are made by each ministry in Kabul, in conjunction with the Office of Administrative Affairs, and signed off by the head of the Independent Administrative Reform and Civil Service Commission (IARCSC). The ministry in Kabul or the President makes staff appointments at middle to senior grades, while the provincial Governor appoints junior staff down to district level. Despite this very high degree of de jure centralization, the de facto reality is that central control is very weak, given the strength of regional and local warlords who command sub- stantial revenues and military power, and have captured the government administration in the localities they control. Certainly in the revenue-rich provinces, Governors make resource allocation decisions except on basic salaries. Staff appointments from Kabul are often rejected in favor of those loyal to regional factions, and even Kabul-based appointments often reflect loyaltiesandethnictiesratherthanmerit.Intheseareas,wherethewarlords(andinsomecases Governors) have "captured" both strategic decision-making and overall fiscal resources, the Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 47 Figure 4.2. De Jure and De Facto Centralization de Jure de Facto · Most provinces accept that Kabul has a role to play in approving senior level Administrative Strong de jure administrative appointments, but there are significant central/provincial centralization, with virtually all departures from this for some provinces, relationships administrative decisions made particularly with regards to police. at the center. · All provinces accept the basic rules of the administrative game concerning grades and tashkeels. · Provinces do report and transfer locally Strong de jure fiscal raised revenues to the Ministry of Fiscal centralization, with no own - Finance; however, there are significant central/provincial source revenues or authority amounts of unreported (and locally relationships over expenditures at the withheld) revenues. subnational level. · All provinces accept the basic rules of the fiscal game concerning budget preparation and execution. Strong de jure political · Self-evidently, politically there is major centralization, with all de facto decentralization, with regional Political subnational political positions warlords or local commanders setting central/provincial appointed by the national policy. relationships government, and no mandatory regional representation in the national government. public sector is essentially autonomous from the central government. As shown in Figure 4.2, thedegreeofcentralizationinpracticevariesacrossadministrative,fiscal,andpoliticalspheres. Factional loyalties are strengthened by a general lack of financial support from the cen- ter. Pay levels are very low, especially for the middle-level and senior staff, and payment of salaries is often delayed. Financial support in the form of non-salary budgets has been low to non-existent for provinces and districts (see Table 4.3), and physical infrastructure (offices, desks) is lacking. Civil servants report a sense of pride in their jobs--"serving in the government is a mark of distinction, and something to be proud of"--but without ade- quate motivation, resources to do the job, or the "trappings" of their official posts, they lack influence with and respect from the populace. International Aid and the "Second Civil Service." In fiscal year 2003/04 (1382), total Government expenditures, including ordinary and development budgets, reached $2.0 billion. The international community funded all but about $208 million of this, or approximately 89 percent, and most external assistance is not channeled through the Government's Treasury (see Box 4.2). Among other implications, this has resulted in a "second civil service" consisting of NGOs, consultants, advisors, and employees of UN and other international agencies, including expatriate consultants and Afghans attracted by relatively high salaries. Not only has this second civil service taken some of the best talent from the Government, but with the relatively small share of resources at the Government's disposal, it is a constant challenge for the Government to stay "in charge" 48 A World Bank Country Study Box 4.2. The Berlin Security and Rule of Law Declaration At the March 2004 International Conference on Afghanistan, security was one of the key themes for international deliberation. The Government committed to finalizing a National Security Reform Strategy prior to the Presidential election. The plans presented were ambitious and included: Demobilization of 40 percent of Afghan militia forces (using stated troop strength as the base) by June 2004 (the previous scheduled date for presidential elections), including the decom- missioning of military units. Agreement that NATO and the Coalition deploy international military forces in support of the national police and Afghan National Army (ANA)--including to other regional cities. Extending full cooperation to the Independent Afghan Human Rights Commission (IAHRC). Strengthening Afghanistan's institutional capacity to meet its reporting obligations under the international instruments to which Afghanistan is a party. Developing human rights monitoring, documenting, and reporting mechanisms with the inter- national community. Establishing a Supreme Court according to the Constitution with the necessary capacity to ful- fill its mandate. Strengthening the administrative and financial management capacity of justice institutions. Accelerating the legislative reform process through adoption of key laws that would be com- patible with the Constitution, including laws and procedures on the organization of judicial offices, criminal, civil codes and a penitentiary law. Establishing a national legal training center. of the development agenda. There is a tendency for the various agendas of the interna- tional aid community to shape broader public policy and influence planning processes-- intentionally or not. As public administration reforms move ahead, it will be crucial for longer-term sustainability for donors to work within the existing Government adminis- tration and budget, so that they reinforce efforts to strengthen the civil service rather than inadvertently undermine it. Furthermore, as the costs of running this second civil service are significantly higher than current civil service pay levels, the sustainability of such an approach needs to be carefully assessed. The Strategy Government in Afghanistan faces a twin challenge. On the one hand, it must be fully in charge of running the state--which means that Government must be capable of both mak- ing policy and implementing it throughout the country. On the other hand, it must not overstate its ability--and should limit its policy ambitions to its still limited though growing capacity. Afghanistan's policy ambitions are laid out in the NDF, which articulates a clear vision of the role of government as limited to creating an enabling environment and providing only the most essential services. The NDF also recognizes that achieving even this focused vision will require an effective national government that re-establishes the unity of the country on the basis of strong institutions and rule of law, and through a sound national Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 49 budget. In the more recent SAF document, specific goals on the role of government are laid out, including: i. A well functioning and well structured security sector, based on institutions that facilitate a return to normalcy in the political, economic, and social spheres (Box 4.2). ii. A public administration that is small and focused on core functions; more diverse and decentralized; better skilled, equipped, and managed; more accountable; and more representative in terms of gender and ethnicity. iii. A budget that is affordable and sustainable on a multi-year basis, is used as the central policy instrument of the Government, and enables delegation of author- ity based on strong accountability mechanisms. National programs have been formulated, within the framework of the national budget, that support the overall state building strategy. The Afghanistan Stabilization Program (ASP), for example, offers an integrated strategy for addressing security, governance, and reconstruction challenges at the provincial and district levels. The ASP recognizes the inte- grated nature of the political, security, fiscal, and administrative and other reconstruction- related problems facing Afghanistan. It responds to the clear demand from the majority of Afghans for an alternative to the power of regional and local power-holders and for the establishment of a strong central government. While these wishes are often expressed in terms of a desire for a centralized state, this does not necessarily imply a centralization of operations, with all activities based in Kabul. In fact, the strategy requires some modest del- egation, although not broad-based decentralization. Key Accomplishments A number of important steps have already been taken toward the achievement of these strategic goals, in particular with respect to the Constitution, budget, economic manage- ment, and security sector reforms. These core reforms underpin the state building agenda. The New Constitution. The process to establish democratic political institutions was laid out in the 2001 Bonn Agreement. Two Loya Jirgas have been held, the first to elect a President by secret ballot, the second to ratify a new Constitution. The Constitution estab- lishes a unitary state with a strong central government, providing for a democratically elected President and for separation of powers among the judiciary, executive, and legisla- tive branches. The Government is allowed to delegate certain authorities to local adminis- trative units (provinces) in the areas of economic, social, and cultural affairs, and to increase the participation of the people in development. To this end, it establishes a role for elected provincial, district, and village level councils to work with the sub-national administration. Municipalities are to administer city affairs under the oversight of elected mayors and municipal councils. The Presidential election was successfully held in October 2004, while elections to the National Assembly have been delayed by about six months. A Joint Electoral Management Board ran the Presidential election, including the Afghanistan Interim Electoral Commission and a UN support unit. The process of voter registration was remarkably successful, with some 10.6 million voter registrations occurring in 50 A World Bank Country Study Afghanistan, more than 40 percent of them women. Despite security concerns, voter turn- out in the Presidential election was generally good. A Stronger Security Sector. To date, progress in security sector reform (SSR) has been limited, and greater efforts are required to extend the rule of law beyond Kabul into major regional cities and the provinces. There have however been some modest achievements. As of early 1383 (mid-2004): (i) DDR had been initiated and over 10,925 former soldiers disarmed and demobilized; (ii) the Counter Narcotics Directorate and Counter-Narcotics Police had been established and a National Drugs Control Strategy adopted; (iii) 7­8,000 police had been fully trained with police academies established in Kabul, Gardez, Kandahar, Kunduz, and Mazar-i-Sharif; (iv) reforms had been initi- ated with respect to the staffing and structure of the Ministry of Defense; (v) 9,500 sol- diers had been recruited to the ANA; and (vi) some early judicial reforms had been initiated. Despite these actions, the security situation across much of the country has deteriorated, interfering with the Government's state-building agenda. Further, the demilitarization of Kabul, mandated by the Bonn Agreement, has not yet been fully implemented. A strong commitment to security sector reform was made at the Berlin International Conference (see Box 4.2 and Afghanistan Government 2004c). Currency Reform and Monetary Policy. A major early achievement was the introduc- tion of a new currency within the first six months of the Transitional Administration. Since then, monetary policy has been restrained, supported by adherence to strong fiscal disci- pline and a "no overdraft" rule that prohibits Central Bank financing of the deficit. Revenue and Customs Collection. Domestic revenues have increased significantly dur- ing the past two years, reaching $163 million in 2002/03, a level higher than expected in part because of exceptional revenues such as telecom licenses. As targeted, revenues reached $208 million in 2003/04, largely as a result of the Government's political will to start effectively controlling revenues collected in the provinces. The Budget as a Policy Instrument and Aid Coordination Tool. Since it came into office, the Government stated its intention to use the budget as a policy instrument and an aid coordination tool. After a first, rudimentary budget in 2002/03 and a much improved budget process in 2003/04, the most recent budget, for 2004/05, has been underpinned by a better analytical base and a more participatory process in the Cabinet. The 2004/05 budget signals, or confirms, that a number of key policy decisions have been taken (see Box 4.3). These include a significant effort to increase revenues, continuing the "no over- draft" commitment (to refrain from domestic deficit financing) as well as a substantial budget increase in education to recruit teachers. Furthermore, a new policy to deliver health services by contracting their provision to NGOs (basic package of health services, funded through the development budget) has been put in place. The ongoing commitment to pay and administrative reforms (with a $34 million provision for PRR departments, discussed below) has been confirmed, and the PRR process is now fully operational and has made considerable progress. On the security side, the Government has sought to increase the size of security forces (police and army) and finance their cost directly through the budget. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 51 Box 4.3. Improvements in the Budget The national budget has two components (see the figure below). The core budget includes all funds flowing through the Treasury, while donors directly execute the external budget. For the first time in 2004/05, The definition of a core budget unifies the budget flowing through the Trea- sury, with total expenditures fully funded by domestic revenues and external assistance (fast dis- bursing loans, project loans and grants, and reimbursements from ARTF and LOTFA). Within the core budget, operating expenditures include the wage bill, most non-salary recurrent costs, and some capital expenditures. Development expenditures include all technical assistance, most cap- ital expenditures, and some recurrent costs (for example, health services contracted out). Oper- ating expenditures are structured around ministries, while development expenditures are composed of projects structured around development programs (from the National Development Framework and the National Priority Programs). All projects in the core budget have an identified source of financing, while some projects in the external budget are partially funded. The Government expects that it will mobilize more resources than budgeted expenditures: the expected additional funding is set aside for the National Prior- ity Programs and for co-financing existing projects and will be allocated during the fiscal year. Further progress toward an integrated budget involves securing funding for projects earlier in the year so that more projects are included in the original core budget (which requires projects to be at an advanced stage of design), and channeling a higher share of external assistance through the Treasury so that monitoring and reporting processes are standardized. Further integration of the budget also requires that ordinary expenditures match some of the features of development expenditures, including having a multi-year horizon and program basis. 1382 Expenditure Structure and Financing External budget Ordinary expenditures 453 190 Core budget (643) Financing sources for expenditures through treasury 600 2,183 182 500 Other(*) 400 ARTF and 253 Development 300 LOTFA expenditures (2,373) 200 Domestic revenues (*) includes expenditures funded from external grants and credits 100 208 (which are lower than disbursements), and changes in GoA's accounts at DAB. 0 These are estimates as accounts have not yet been finalized. Source: Ministry of Finance, Staff estimates. 52 A World Bank Country Study Using the national budget to coordinate aid is sensible but complex. Unified planning, management, and control of expenditures--whether funded from domestic resources or external assistance--makes sense. Yet, the budget thereby includes projects over which the Government has little control with its announced policies. Also, earmarking donor funds for specific projects undermines the scope and possibility for Government prioritizing between programs and projects. Priority Reform and Restructuring Decree. On July 10, 2003, the Government passed the Priority Reform and Restructuring (PRR) Decree, creating the primary vehicle for reforming and modernizing the most critical functions of government. The PRR process permits ministries and agencies or functions within them to place key staff on an elevated pay scale for a fixed term, and provides funds to obtain technical assistance for restructur- ing and re-engineering. Work in Progress Key Responsibilities Overall responsibility for public administration reform (PAR) rests with the IARCSC, established in June 2003 with responsibility for appointments and appeals, civil service management, and administrative reform. It is now staffed at one-third of its projected complement. The IARCSC is pivotal to achieving significant improvements throughout the civil service, especially in human resources management, and specifically in embedding the principle and practice of merit-based recruitment and promotion. Therefore, getting the IARCSC fully staffed and effective is an urgent priority. The Ministerial Advisory Committee (MAC) on Public Administration Reform sup- ports the Chair of the IARCSC. Its role is to provide advice on reform proposals--for exam- ple approval of PRR applications--and on dealing with problems and issues that may hamper progress. Members of the MAC include all the core central Ministries and, on a rotat- ing basis, line ministries at the forefront of reform. The Committee therefore provides an important degree of political legitimacy for the difficult choices that must inevitably be made. The Ministry of Finance (MoF) is central for fiscal and economic management reform. It has adopted the PRR framework on a department-by-department basis, focusing first on the departments responsible for key reforms. Almost all key functions in Kabul have now obtained PRR status. As the next step, the Ministry plans to extend PRR to the provincial Mustoufiats (finance departments). The aim is to bring the whole of the Ministry within the PRR framework soon. This will achieve the following objectives: (i) improved admin- istration and management of all key departments; (ii) significant downsizing with surplus staff redeployed; (iii) strengthened middle and senior management capacity across the departments; and (iv) confirmation of actual employment and resolution of problems with ghost workers, and multiple payments of salaries. Ongoing Reforms A number of reform initiatives are well underway, largely under the framework of the PAR program, covering seven major components: civil service legal framework; person- nel management, institutional and functional streamlining and development; financial Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 53 management and machinery of government; administrative efficiency; and improvement of government physical infrastructure. Some of the more significant reforms are discussed below. PRR Program. This is the Government's central vehicle for reforming key functions. As of October 2004, 66 functions in eleven ministries, one department in Kabul Munici- pality, Da Afghanistan Bank (the Central Bank), the Central Statistics Office, and the IARCSC had received stage two approvals. A further 37 functions in sixteen ministries and one department in the Office of the President had received stage one approvals. A moni- toring tool is being developed which will enable the IARCSC and the MAC to take stock at regular intervals of the impact of PRR. Looking forward, the rollout of the PRR process to the provinces is a critical next step. Some initial forays have begun, in the Offices of the Governors in five provinces, and in provincial departments of the Ministry of Public Health. But this also presents a major challenge. In particular, there is a risk of political capture of the PRR process by regional and local warlords given the lack of presence of the IARCSC at the provincial level and the difficulty in effective monitoring outside of Kabul. Nevertheless, the PRR process will continue to be an important vehicle for building capac- ity within the Government. A major issue in civil service reform is the very low public sector salaries, especially at middle and senior levels, exacerbated by competition for local staff from international aid agencies and NGOs. There have been strong arguments to increase salaries at all levels, as well as to decompress the salary scale, all within the context of very limited fiscal resources. During 1382 the Government made a series of decisions to increase pay levels for teachers, police, and other civil servants. The pay increase for general civil servants, shown in Table 4.1, provides for some decompression of the wage scale. In addition, a new "Interim Additional Allowance" has been established as part of the PRR program. By the end of October 2004, 7,900 posts had received PRR approval for the new pay scale. Some 10,000 posts could real- istically be approved by the end of 1383 with adequate technical assistance, perhaps as many as 15,000. The IARCSC is introducing merit-based recruitment at the senior levels, and is launching a comprehensive pay and grading review, which will likely lead to a decompressed pay scale patterned on the additional pay awards provided under the PRR. A key challenge for the IARCSC will be to manage comprehensive pay reform within the context of the higher paid "second civil service." To meet critical capacity gaps in the civil service, the Government has approved the Afghan Expatriate Program under the ARTF, which enables the recruitment of professional and technical Afghans from the diaspora to take up advisory positions. The Lateral Entry Program opens a window through which to inject professional and technically qualified Afghans into line government positions for 1­2 years at salary levels that are comparable to those in the NGO and international agency labor market in Afghanistan and the regional labor market, especially Pakistan and Iran. These two windows complement the PRR initiative. Accountability mechanisms comprise two principal components: enforcing individual compliance to fiduciary standards and ensuring transparency and public access to infor- mation (Table 4.2). The Government has begun to put in place elements of a legal frame- work to ensure that civil servants are accountable for the execution of their duties. The proposed Public Finance and Expenditure Management Law provides specific penalties to be applied by a civil court to any civil servant who uses his or her position for material gain 54 A World Bank Country Study Table 4.1. General Pay Levels (Afs/Month) General civil servants PRR reformed depts.1 Total pay before Total pay after Grade pay rise2 pay rise PRR scale PRR total pay "beyond" 2,019 3,279 A 13,417 "above" 1,955 2,975 B 11,893 1 1,908 2,688 C 10,486 2 1,888 2,548 D 9,056 3 1,873 2,443 D 9,041 4 1,856 2,324 E 7,614 5 1,848 2,268 E 7,606 6 1,840 2,212 F 6,188 7 1,835 2,177 F 6,183 8 1,829 2,135 F 6,177 9 1,824 2,100 U 1,824 10 1,818 2,058 U 1,818 Notes: 1. The distribution of PRR grades shown is illustrative. There is intentionally no simple mapping of PRR grades onto the existing pay scales as staff should be considered individually as new job descriptions are prepared. 2. A general pay rise was approved in the eighth month of SY1382. Excludes teachers and police. Source: Evans and other (2004a). Table 4.2. Examples of Accountability Mechanisms in Proposed Laws Collective accountability: Individual accountability: Transparency and public access to Laws Enforce penalties on individuals information: Civil service law Code of conduct to deal with IARCSC reports on the quality of conflict of interest. recruitment processes. Public finance and Penalties for civil servants who use Public release of reports on budget expenditure their position for material gain. execution; mandatory use of Management law Treasury Single Account; mandatory external audit. Procurement law Penalties for civil servants who use Open, competitive, transparent their position for material gain. bidding process (with public notice Exclusion of contractors from ex ante and ex post). bidding process after misconduct is proved. Audit law Code of ethics for external auditor. Independence of the external auditor; guaranteed access to information for external auditor; mandatory external audit released to public; mandatory response from the Government. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 55 or otherwise abuses the position. The proposed Procurement Law is expected to have sim- ilar provisions. The draft Civil Service Law will include a code of conduct with conflict of interest rules and other provisions. Reforms to the Auditor General's Office and Attorney General's Office need greater support. Enforcement will depend on the establishment of effective mechanisms within IARCSC and Ministry of Finance. Accountability is not just an issue for civil servants; ultimately ministers are account- able for the actions of their departments, and for executing their responsibilities with hon- esty, integrity, and impartiality. A draft Ministerial Code of Conduct is soon to be adopted. Ensuring that reports of the independent auditor and the Cabinet's responses are available to the National Assembly is an important part of the accountability framework. The Con- stitution also calls for the wealth of the President, vice presidents, ministers, members of the Supreme Court, and the Attorney General to be registered and monitored. This is not a simple provision to implement, but a review of mechanisms that could be suitable for Afghanistan would be useful. The Afghanistan Stabilization Program (ASP). This is a major new initiative, intended to bring together both existing and new efforts to improve security and governance throughout the country, targeted first at the most sensitive locations. The ASP is the first major effort to build capacity at the provincial level, and is somewhat reflective of the selec- tive approach adopted by the PRR. It is also a significant departure from more traditional donor-centered project delivery mechanisms. It will use coordinating mechanisms to bring together Government and donors, but implementation of most of the specific components will be done through ministries. While funding will be managed separately from the Government's ordinary budget, the intention is to pool donor funds and work through local administration, such as the Mustoufiats, as much as possible. In fact, an important aspect of the program will be to build financial and administrative capacity at the local level through hands-on involvement. In particular, the Provincial Reconstruction and Devel- opment Fund will be managed out of the provincial Governor's office, providing an oppor- tunity to build capacity for managing small projects. Rationalization of Ministries. The Government is planning to reduce the number of ministries (currently 29) in order to focus on the core functions of government, eliminate the current overlap and duplication between ministries, and optimize the use of scarce skills and resources. Although no decision has been announced at time of writing, the number of ministries could be significantly reduced in the short run, go down to 20 later, and possibly even be reduced to 15 in the longer run. Although the process of implementing a realign- ment of ministries is not a simple one, it offers an important opportunity to push the PRR process further, and use it to ensure that the new organizations are more effective. Coordinating Aid. Managing aid flows is a daunting task in a post-conflict context, for at least three reasons. First, their magnitude is very high (about 37 percent of non-drug GDP disbursed in 2003/04, more than 150 percent of GDP pledged in the Berlin Conference for the next three years). Second, they are delivered through various channels (including at least direct bilateral assistance, grants to multilateral trust funds, and grants and con- cessional lending from development banks). Third, they rely on heterogeneous allocation 56 A World Bank Country Study mechanisms (different budget timing, diverse country priorities and interests). The Gov- ernment has taken a phased approach to coordinating aid. It started by recording all pro- posed and on-going projects in its development budget. Then it linked the development budget to its development strategy (initially formulated in the NDF and refined in the SAF report). As an additional step, in 2004/05 the core budget has been defined to include only funds flowing through the Treasury: in the core budget, all development expenditures have adequate financing. Thus the development budget has moved from little more than an aggregation of what donors are planning to do ("project shopping list") to a demand- driven expenditure program ("prioritized project list"). Improving Budget Implementation. The budget can be a useful policy tool only if it is properly implemented. Significant progress has been made developing institutions and sys- tems to raise fiduciary standards, including implementation of the Afghanistan Financial Management Information System in Treasury; creation of the Central Procurement Facility; and initial preparation of procurement, public finance and expenditure management, and audit laws. Moving forward, the proposed reforms to strengthen accountability mecha- nisms (see above) will develop institutions and systems that give civil servants the incen- tives and tools to use public resources effectively. These reforms will also reduce corruption, and give comfort to donors to channel their assistance through the Treasury and through budget support. The quality of expenditures in provinces, in particular, is critical both to deliver pub- lic services and to give the state an effective and accountable face. Progress has been made in paying salaries with smaller delays, but much remains to be done to certify the legiti- macy of all paid employees. While centralization of payroll processes after the fall of the Taliban was an important step to start payroll payments, the re-decentralization to provinces should address the issues of delays and legitimacy. Progress on non-salary pay- ments has been uneven. In an effort to improve cash management, the Government replaced all provincial accounts with a single revenue and an expenditure account in 2003. Without the right to spend directly the revenues they collected, provinces were fully depen- dent on Kabul to make non-salary payments. Since then, a system of cash advance has been set up to expedite these payments. However, there are apparently still constraints, and provinces collecting large revenues have been able to spend more on non-salary items than others (Table 4.3). In 2004/05, the Government is committed to ease another constraint-- the low level of allotments for non-salary expenditures in provinces. The Afghanistan Sta- bilization Program will also facilitate expenditures outside Kabul. Increasing Domestic Revenue Mobilization. If Afghanistan is to have a fiscally sustain- able budget, it will need to greatly increase domestic revenue. The SAF target is for domes- tic revenues to cover the Government wage bill by 2008/09. In the short run, additional revenues will reduce transaction costs from heavy aid dependence: even with better aid coordination and budget systems, external financing will remain fragmented, uncertain, and often inflexible. Domestic revenues have increased from $132 million in 2002/03 to almost $208 million in 2003/04 (Table 4.4), with a stretch target of $300 million for 2004/05. Much remains to be done to augment the revenue base and ensure that all rev- enues due are collected and remitted to the center. Special efforts are required in provinces collecting most of the revenues, which may have been "captured" by regional powerbrokers. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 57 Table 4.3. SY1382 Budget Execution Revenues Allotment Expenditures % non Non % non Total % total Total salary Salary salary Total salary US$ US$ US$ US$ US$ million % million % million million million % Centre 73 35 280 55 115 124 239 52 Provinces 135 65 185 28 118 72 189 38 Heart 84 40 15 25 12 33 45 74 4 other provinces 41 20 55 31 36 19 54 34 with large revenues Other provinces 10 5 115 28 71 20 90 22 Total 208 100 465 45 233 196 429 46 Source: Information provided by Ministry of Finance, Government of Afghanistan; staff estimates. Table 4.4. Domestic Revenues 2003/04 Revenue (est.) (US$ million) (% total) Import duties 111 54 Other Tax Revenues 20 9 Tax Revenues 131 63 Administrative fees 37 18 Sales 31 15 Other Non Tax Revenues 9 4 Non Tax Revenues 77 37 Total 208 100 Source: Information provided by Ministry of Finance, Government of Afghanistan; staff estimates. A key element in the effort to raise revenues is the Customs reforms adopted in 2003 (use of market exchange rates for import valuation and streamlined tariff structure--moving from 25 tariff rates of 0­150 percent to six rates ranging between 2.5 percent and 16 percent). Combined with better compliance at border posts, this reform is expected to generate $26 million in additional revenue in 2004/05. New tax policy reforms enacted in 2004 (a final wage withholding tax on higher income employees, an improved income tax regime, a streamlined business establishment tax, a tax on a limited range of services consumed by high income earners, a rent tax, a land tax, and an airport departure tax) are expected to gen- erate an additional $14 million. The Ministry of Finance is creating a "Large Taxpayer Office" in Kabul to focus on rev- enue collection from the top 100 tax-paying entities. In addition, there are plans to create units in the provinces for medium-sized taxpayers, reporting directly to the Ministry in Kabul. 58 A World Bank Country Study Table 4.5. Revenues (Percent of GDP) Afghanistan Post-conflict countries 1975 2003 Y1-3 after conflict Y3-5 after conflict Taxes 7.1 2.4 11.2 12.6 Of which direct taxes 1.1 0.1 n/a n/a Of which import duties 5.5 2.9 n/a n/a Non tax revenues 3.3 1.7 3.8 5.8 Total revenues 10.4 4.6 14.9 18.4 Source: Information provided by Ministry of Finance, Government of Afghanistan; World Bank (1978 and 2004f). Turning to the longer term, based on Afghanistan's history and a comparison with other post-conflict countries, a target of 12.5 percent of GDP, as indicated in the SAF report, is plausible (Table 4.5). The critical question is the pace at which Afghanistan can mobilize additional resources. International evidence suggests that continual significant yearly increases in revenue to GDP ratios are difficult to achieve over a long period of time. In the case of Afghanistan, two factors will be critical. i. Security and administrative capacity. As discussed above, the first priority is for the Government to fully regain control of the existing revenue base. Assessing and col- lecting taxes throughout the country requires strong administrative capacity, includ- ing buildings, enforcement capacity, information systems, and skills. In particular, further growth in Customs revenues will be predicated on greater Government abil- ity to control its borders. Focusing on large taxpayers and on the main provinces in terms of revenue collection should provide quick results, but significantly scaling up resource mobilization will require considerable administrative efforts. ii. Nature of economic growth. The structure of the economy also will be critical (see Chapter 1). The informal sector is difficult to tax, although the existing presump- tive taxes (e.g. on shops, mills, buses), while probably too complex, provide a means to tax informal businesses. Agricultural taxation can also be considered (for exam- ple, taxing the largest landlords), but its administration costs tend to be very high. The nature of economic growth also matters because promising taxes could vanish (import duties if trade is reduced by trade policy decisions in neighboring coun- tries) or materialize very slowly (mineral taxation) if a sector does not grow rapidly. Some Key Tasks Ahead Controlling corruption and enhancing security and the rule of law are among the key tasks ahead. The positive impact of these factors on growth is analyzed in Chapter 1, and they are critical as well for poverty reduction, state building, and building popular loyalty toward the state. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 59 Addressing Corruption In the short run corruption--defined as the abuse of public position for private gain-- undermines the nascent institutions of state, rule of law, and democracy and justice. Over the longer term corruption will also jeopardize the attainment of broad-based and sus- tainable economic development objectives. Corruption is one of the major constraints to private enterprise, particularly in South Asia where nearly two-thirds of firms report mak- ing "irregular payments" to get things done, and for smaller firms. Of notable concern in Afghanistan are the close links between corruption and the drug industry and other crim- inal activities. A Typology of Corruption. Building on the classification of economic activities in Chapter 1, Table 4.6 provides an overview of the likely linkages between different types of economic activity and associated corruption. While Afghanistan is a de jure unitary state, the national government maintains only marginal control over many provinces. With the adoption of the 2004 Afghan Constitution, any provincial Governor or other Table 4.6. Economic Activities and Probable Associations with Corruption Recognized by law/ Market Production/ regulated/ Key actors Associated Activities transaction Output distribution taxable (examples) corruption Formal Yes Legal Legal Yes Small, medium Probably high: and large officials paid to private firms avoid tax, for licensing and/ planning appli- cations, etc. Extra-legal Yes Legal Legal No Construction Probably low-- companies; nothing to bribe sector hawalas to obtain Irregular Yes Legal Illegal No Smugglers Probably Private moderate--e.g. bribes paid to customs staff Illegal Yes Illegal Illegal No Poppy, arms Probably high-- and human bribes paid to traffickers provincial officials and police. Constitu- Some Legal Legal Yes "Official" Probably high in tional Government procurement, in bodies ghost employ- ment, and in patronage pos- sector tions. Extensive theft of public Public resources in past. "Captured" Some Legal Legal Partly Autonomized Variable, but provinces like could be high in Herart and some cases. Balkh. Source: Based on Thomas (1992); Box 1.1. 60 A World Bank Country Study power-holder using political or military force to maintain power, status, or wealth must officially be viewed as illegitimate. In the current transitional situation, such parallel (or autonomous) governance structures are perhaps best described as the "captured" public sector. There are differing views as to whether such autonomous structures are likely to be involved in high levels of administrative corruption, but anecdotal evidence suggests that this is likely. Toward a Strategy. Public sector corruption associated with private sector activities is the product of either unenforceable or weak regulations, so re-regulating activities or deregulation to match weak enforcement capacity is called for. For the public sector, actions required include enforcing penalties on individuals for corruption, improving transparency and public access to information, and simplifying processes to deter collu- sive relationships. In March 2004 President Karzai, aware that levels of corruption were damaging public perceptions of the Government, ordered the establishment of an anti- corruption department. Private Sector Regulation. The formal private sector is made up of small, medium, and large companies, which pay bribes to central, provincial, and municipal government officials (see Box 4.4 for some examples) to avoid payment of taxes and get around certain regulations--many of which are archaic. Anecdotal evidence indicates that bribes are paid by larger companies to ministry and municipal staff to gain planning approval, to obtain investment licenses, and to smooth the importation of goods and their smuggling to other countries. Irregular private sector activities involve illegal mechanisms of production or distrib- ution and so provide great incentives for corruption, as officials must be persuaded to turn a blind eye. The most notable example is smuggling, including re-export of imported goods to Pakistan, import of petroleum products, and export of lumber to Pakistan and north- ern neighbors of Afghanistan. Bribes to smooth the way in making transactions are probably very common. The most prominent example of corruption associated with the Box 4.4. "Water is Muddy from the Source" This Afghan saying refers to corruption, which is endemic and often seen as a normal require- ment for business. Bribery is widely considered to be common among the police force, within the judiciary, in public utilities, and in public enterprises. Below are some examples: A resident of east Kabul said he had to pay $500 in bribes before he could begin reconstruc- tion of his family's house, $260 to the local police and $240 to city planning officials. A Supreme Court deputy acknowledges that bribery exists among the judiciary. By way of jus- tification, he said that judges in other countries are paid high salaries to discourage them from resorting to accepting bribes. A senior official of the anti-crime department at the Ministry of Interior all but concedes that corruption is rampant in Afghanistan. "We have information that bribery is common within government and that bribery takes place in all government institutions." A petrol station owner says he paid $4,000 dollars in bribes to city and police officials when he was setting up his business. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 61 illegal private sector relates to the opium economy, where systematic bribery, concealment, and money laundering are required among producers, local officials, and drug traffickers (see Chapter 7). The Hawala system is a good example of extra-legal private sector eco- nomic activity. Associated public sector corruption is probably low as there are no licenses or permissions that a briber needs to obtain. The challenge is to regulate private sector activities only to the extent that is strictly necessary for economic or security reasons, and only to the degree that the regulators are able to match with enforcement. Unenforceable regulations will simply redefine extra-legal activities as irregular--and thereby increase corruption. Public Sector Activities. Administrative corruption is doubtless found across the public sector, and any strategy needs to involve a twin-track approach of re-regulating and de-regulating private sector activities to reduce incentives and opportunities for corruption, while simultaneously increasing public sector staff accountability through enforcing penal- ties on individuals for corruption and improving transparency and public access to infor- mation (see Table 4.2 above). Theft of public resources--both cash and other assets-- undoubtedly has been a significant problem. Improving accountability and simplifying and automating business processes will assist in removing opportunities for collusive relation- ships between officials and members of the public, and between officials responsible for releasing funds.3 In the "captured" public sector, pending political normalization under the Constitution a primary focus should be on building the legitimacy of municipalities as hon- est service providers, as a counterbalance to de facto provincial authorities and "captured" provincial administrations. Enhancing Security and the Rule of Law4 Insecurity, in all its forms, is an extremely serious problem in Afghanistan. The almost total absence of well-trained and accountable police and judiciary services has led to a cul- ture of security violations and impunity. The existence of tribal militias, security forces loyal to regional power brokers, drug mafias, and terrorist bands fosters insecurity and leads to tensions between these forces and the modest security forces loyal to the Gov- ernment. Other aspects of insecurity include uncertainties about land tenure (see Box 6.3 in Chapter 6) and lack of a supportive legal system for enforcing property rights. Improv- ing security is a critical element of the growth strategy (Chapter 1), and the recent mini investment climate survey heard from investors that, in places like Mazar-i-Sharif, secu- rity remains the major constraint to expansion of businesses (Chapter 5). In this context, achievements in security sector reform have lagged far behind what is required to con- solidate the early gains made in state building. Many provinces remain largely autonomous from the Government, and efforts to disarm militias, in sequence with the creation of a national army and police force, must be substantially stepped up if insecu- rity is to be substantially reduced. Outside Kabul, different powerbrokers and non- Constitutional authorities have varying degrees of power and loyalty to Kabul, and are in 3. For example, business re-engineering within the Ministry of Finance reportedly has significantly reduced levels of corruption, particularly in the Treasury. 4. This section draws mainly from Afghanistan Government (2004b, Chapter 6; and 2004c). 62 A World Bank Country Study competition with each other. A broad assessment of the current writ of the national gov- ernment across the provinces and border areas highlights the lack of formal state control and the continued co-existence of opposing military forces in the south (elements of the former Taliban) and to a lesser extent in the north. Enhancing security and the rule of law requires two main thrusts. First, and probably most essential, hearts and minds must be won to achieve a reasonable degree of consensus on the authority of the national government. This requires gaining political, civil servant, and citizen loyalty to Kabul. Second, enforcement capacity must be adequate with a work- able judiciary and police force (with military back-up). The current co-existence of formal and informal justice arrangements across Afghanistan is a manifestation of the fragmen- tation of security, and the critical need for reforms to reclaim popular and national own- ership of judiciary services, thereby reducing the prevalence of rough justice under the control of warlords and commanders. Reform efforts need to focus on building core capa- bilities of judiciary services through legal reforms, capacity building, and new recruitment. Winning Loyalty. Lack of loyalty to Kabul by some provincial Governors and regional powerbrokers, whose militia forces maintain only a semblance of security while being involved at least indirectly in permitting extortion, criminal activities, and drug smuggling, has a significant impact on all segments of society--rich and poor. In the past year alone, thousands of security incidents have taken place across the country, claiming the lives of nearly 1,000 civilians, peace keepers, and aid workers. Human rights abuses, including rape and human trafficking (of women and children), have gone unpunished. Criminal acts do not reach the courts. Moreover, the existence of warlords and militia alongside the national government creates disunity, allows crimes to go unpunished, and encourages illegal activities. Some of the political interests resisting re-imposition of national authority have deep roots and need to be dealt with accordingly. Yet, weaknesses in fiscal and administrative arrangements contribute to the problematic politics. Delays in payment of civil servants' salaries, under-provision of non-salary budgets, and a high-handed central administration provide provinces with an excuse to not remit revenues to the central Treasury. This con- tributes to inequalities between provinces, and allows the Governors or local powerhold- ers in resource-rich provinces to claim credit for services with funds diverted from the Government Exchequer. Ill-equipped, poorly paid, and ineffective provincial and district administrations suffer from poor morale and undermine the image of the national gov- ernment in the eyes of the people. They cannot do their jobs, or are forced to depend on local commanders or other local political elites who provide funds, thereby further entrenching the power of these interests. Getting funds out to the provinces and districts is therefore critical for the national government, not only to improve service delivery but also to shore up weak loyalties to Kabul. Poll research suggests that there is strong public attachment to the idea of central government--even though citizens are aware of its lim- ited capacity. However, lack of evident Government functionality at provincial and local levels and slow visible progress in reconstruction are doubtless eroding this. Weak government administration thus contributes to a vicious circle, further eroding loyalty to Kabul with adverse effects on the enforcement of rule of law and revenue collec- tion. Not only are senior police officers usually appointed by local commanders, but police forces are being weakened by the accommodation of large numbers of former combatants Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 63 in them. These demobilized forces are usually untrained, often unqualified, and therefore lack the capacity to function as professional police. The lack of professional security forces loyal to the center increases the reliance of administrators on local commanders for secu- rity. Timely expansion of international forces into the major cities, as well as the further expansion of PRTs and the ASP, will also be very important. Building Enforcement Capacity. The SAF report suggests that building the capacity of the police has, to date, been limited by poor coordination between the main stakeholders in the police reform process. In addition, military support for the police, whether in the form of PRTs or a detachment of the International Security Assistance Force (ISAF), has been inadequate to provide a secure environment for police reform and capacity-building (the expansion of ISAF out of Kabul to other major urban locations has been extremely limited so far). There are reported to be capacity problems in the Ministry of Interior, as well as difficulties in the chain of command and its perceived legitimacy given ethnic imbalances in staffing. Funding shortfalls, affecting both the major security programs and the Interior Ministry's recurrent budget, also have hindered the reform process. For the judiciary, key steps include basic infrastructure in the main provincial capitals and districts, with adequate security for magistrates. Revision of rules and procedures for appointment, promotion, disciplinary action, and transfer of magistrates to ensure their independence, basic databases of caseload and court decisions, and reconstruction and capacity building in correctional facilities are needed. The Way Forward Continue and Deepen Ongoing Core Reforms Public Administration. Considerable progress has been made in public administration reform, including the creation of the IARCSC and the PRR program. Beginning to address pay issues through PRR has had an important incentive effect. The introduction of merit- based recruitment through the IARCSC will be an important next step. In order to develop a professional civil service, one of the key challenges for the IARCSC is to develop a top management group, working together to lead and manage the implementation of civil service reform. Developing such a top management cadre requires that employees with potential to rise to the top are identified early, and tested in a series of challenging positions during the course of their careers. Major, long-term investments are required to meet these needs, including the establishment of a permanent training institu- tion. In the short run a sizeable injection will be required of competent staff on short-term contracts who can be placed in key positions where they are able to play a pivotal and authoritative role. It will take time for reforms to have a significant impact at the sub-national level, where services are actually being delivered. In addition, civil service reforms need to go beyond basic capacity building, so that the roles, responsibilities, and accountability structures among central units and local administration better reflect the Government's service deliv- ery model (see Chapter 8). While recognizing that the pace of change has to be realistic, del- egation of more administrative decision-making closer to where services are being delivered is needed. The ASP offers a vehicle for this, in a way that responds to needs and readiness. 64 A World Bank Country Study The rationalization of the Cabinet's structure also provides an opportunity to clarify roles and accountabilities. National Security. Post-conflict experience suggests that security sector reform--includ- ing international security provision--is the key investment in the early post-conflict years (see World Bank 2003a). Progress will need to occur within the following broad framework: i. A Unified Security Framework: Greater international support is needed for a uni- fied security framework, where national and international stakeholders adopt a clear reform plan, based on national consensus and national institutions. Cur- rently, security objectives are not fully shared between domestic stakeholders (internecine conflict) and international partners (fight against terrorism). Efforts to bring all security spending within the national budget framework are also needed to make it more accountable. ii. Ownership in Building Center-Periphery Relations: Enhanced national ownership of the reform process is needed, including a focus on strengthening center-periphery relations. iii. DDR: DDR objectives need to be realigned as there is neither a standing army to disarm, nor an adequate national army in existence to fill the security vacuum cre- ated; there needs to be a focus on demobilization of commanders, not just their troops--otherwise DDR may not prove sustainable. iv. Priority Reforms and Restructuring: Administrative reform within the Ministries of Interior, Defense and Justice is of the highest priority, and the PRR program should be stepped up in these institutions. v. Justice: Reforms in the area of Justice are critical for sustained economic growth, private sector development, combating drugs, and resolving land disputes. Progress with strengthening and reform of the justice sector has lagged so far, however. Given the multiplicity of justice arrangements, it is necessary to install new capac- ities at central and sub-national levels, and more generally to establish a sound for- mal justice system. The traditional informal justice system, although widely used and having some advantages, becomes highly inequitable and vulnerable to cor- ruption where it is controlled by warlords and factional commanders. vi. Army and Police: Training of the new national army and police needs to proceed on a fast track, but in line with building such capacities, provincial and district gov- ernment capacities will need to be strengthened around the provincial Governor's office, including through the ASP. Fiscal Management. Over the medium term, cautious budget management is required to prepare for the eventual decline in external aid. It is necessary to properly cost proposed policies, integrate the ordinary and development budgets, and develop a multi-year fiscal framework: i. Health and Education. In education the multi-year implications of recruiting large numbers of teachers should be costed, taking into account the impact on the wage bill and needs for training and equipment. For health, integrating the ordi- nary and development budgets in a multi-year framework is required to assess the Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 65 medium-term affordability of health services (currently mainly financed by donors through the development budget). ii. Security Costs. The affordability of large security forces, currently financed by exter- nal assistance, should be assessed against the Government's multi-year framework. iii. Operation and Maintenance Costs. A critical goal of the integration of the ordi- nary and development budgets is to plan for operating and maintenance costs of the reconstruction program and to give adequate consideration to cost recovery (see Chapter 5). iv. Salary and Pensions. As pressures to increase salaries and pensions continue, pay reforms should be costed and should remain in line with the Government's multi- year fiscal framework. v. State-Owned Enterprises (SOEs). Decisions on SOEs (currently mainly defunct) should be based on a detailed analysis of the fiscal implications of their activities. vi. Debt Management. Uncertainties about the level of debt (related to debates about claims on previous regimes) should be clarified so that the Government builds its multi-year budget framework on a sustainable debt scenario. Develop Momentum in Priority Areas Reduce Vulnerability to Corruption. The fight against corruption is best mainstreamed as part of the broader public administration reform program. Anti-corruption bodies estab- lished in other countries have often been largely ineffective in curbing corruption. A num- ber of priority corrective measures have been identified (Table 4.7). Reduce Reliance on the Second Civil Service. The "second civil service" in Afghanistan will continue to exist for some time, along with significant donor assistance and while Gov- ernment capacity remains weak. The incentives for donors to pay high rates to consultants and staff to maximize the prospects for effective project implementation are well-known, and although these can be moderated by strong expressions of concern by the Government, the problem will remain. As outlined above, the Government is moving in key areas to strengthen the capacity of its civil service, in particular through the PRR program, as well as more comprehensive pay reform. To maximize the benefits of these reforms, donors and aid agencies will need to make every effort to control their use of salary top-ups and not recruit people at pay levels far above what can be reasonably offered by Government, or at a minimum coordinate their pay policies with the Government. Government also needs to maintain tight discipline on compensation levels that it pays to individual consultants and that it approves in firm contracts. There is now a comprehensive menu of options for enhancing capacity within the Government (Table 4.8), which should assist the Govern- ment in setting rates for consultants that it contracts, and should also provide a baseline for donor agencies' compensation policies. Further Integrate External Assistance within the National Budget. External assistance needs to further strengthen rather than undermine the budget processes. The Govern- ment's efforts to integrate the development program and the ordinary budget (Box 4.3) need to be supported. Donors should support only projects that are in the budget (that have gone through the decision-making process that leads to inclusion in the budget) 66 A World Bank Country Study Table 4.7. Priorities for Reducing Administrative Corruption Activities Specific priorities Overall strategy Formal Adopt the draft private investment law, draft Re-regulating and approve new laws regulating the activities where establishment and functioning of foreign and appropriate or domestic companies. deregulating Developing the enabling legislative, institutional, activities to match and regulatory framework for implementing weak enforcement investment policy (Chapter 5). capacities. Strengthen the MoF office of taxation and revenue departments, the Judiciary and Attorney Generals Office. Conduct a review of national NGOs, their activities and accounts, to identify those that are profit seeking. sector Refine the current NGO code of conduct to include a minimum requirement for independent audit and the annual publication of accounts, including Private identifying the names of Board Members. Irregular Reform the customs service (as under the Customs Modernization Program). Provide tighter border controls through better trained and motivated border guards. Illegal Strengthen the counter-narcotics institutional framework and law enforcement capacity (e.g., counter-narcotics police), while ensuring that broader economic and poverty aspects are fully taken into account in counter-narcotics drugs strategy (see Chapter 7). Extra-legal Regulate hawalas cautiously. Constitutional Adopt and implement the draft Procurement, Enforcing Public Finance and Expenditure Management, penalties on Civil Service, and Investment laws. individuals for Adopt the draft Ministerial Code of Conduct corruption. and introduce asset declarations. Improving transparency and Support reforms to the Auditor General's Office public access to and Attorney General's Office. sector information. Introduce awareness of the anti-corruption Simplifying dimension into core civil service training business Public modules for existing and new recruits. processes to deter collusive relationships. "Captured" Support for Municipal governments, with a focus on service delivery not on rent extraction. Prioritize municipal reform programs. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 67 Table 4.8. Options for Enhancing Capacities within Government Interim additional ARTF allowances PRR expatriate Lateral entry under PRR super-scale window TAFSU program Parameters Key officials Restricted In exceptional Short term Key positions in PRR to key circumstances consultants where in each agency officials in where the case the need is clearly ministry PRR is clearly made justified and a terms through basic agencies and exceptional of reference capacity candidate submitted to assessment available TAFSU Salary range Upto $300 Up to $2000 $3000­$5000 $200­$700 per day $1000­$2000 per month per month per month and DSA at UN rates per month and in exceptional circumstances higher and should progressively channel more of their assistance through the Government Treasury. Over time external assistance should move toward programmatic support. This requires further building the Government's capacity, raising fiduciary standards (see accountability mechanisms above), and developing sector-wide strategies and pro- grams. The ARTF is already largely programmatic (through its support to the ordinary budget), and its support is conditioned on fiduciary standards monitored by an inter- national firm. Donors should have increasing comfort to move more assistance through Treasury channels as the Government is establishing a track record through compliance with benchmarks in the IMF's staff monitored program and a World Bank budget sup- port operation (World Bank 2004c). CHAPTER 5 Encouraging and Supporting Private Sector Development A dynamic private sector will be essential for Afghanistan to achieve the robust, sus- tained economic growth that is necessary for national poverty reduction, state building, and other reconstruction objectives. Tremendous entrepreneurial talents exist in Afghanistan, but in order to be the "engine of growth" the private sector must be able and encouraged to move beyond the bounds of the informal economy (see Chapter 3). While Afghanistan will continue to have a great many small, household and family-based businesses in agriculture, handicrafts, trade, and other services, some enterprises need to grow into medium or even large firms, thereby becoming a source of competitiveness for Afghanistan. The challenge for the Government in encouraging and supporting private sector development is: (i) to support through macroeconomic policies a strong demand environment for the private sector, by maintaining robust economic growth (Chapter 1); (ii) to create a structural and regulatory enabling environment in which private enterprises can compete and grow; (iii) to ensure that key infrastructure services (power, roads, water, telecommunication) are efficiently provided to the private sector; and (iv) to help the pri- vate sector build capacity (including through financial services and business support ser- vices) so that it will be able to respond effectively to opportunities. The SAF report outlines a number of key characteristics of the Afghan investment environment that will need to be taken into account in the private sector support strategy: i. Afghanistan is a land-locked country, with porous borders and surrounded by neighbors with different trade and investment policies, in many cases quite restrictive. ii. The Afghan economy is largely informal and undocumented, with the informal eco- nomy including most importantly the illegal drug industry (see Chapters 1 and 7). 69 70 A World Bank Country Study iii. Insecurity severely constrains the most productive private sector development and channels it into shorter-term activities. iv. Infrastructure constraints, nationally and in the region, undermine the cost effi- ciency of trade and transit and thereby adversely affect private sector production and profitability. v. Afghanistan's rich underground resources are under-exploited, and large-scale industry is still in its infancy. vi. Afghanistan's labor market is already highly integrated into the regional economy, as a result of the large numbers of refugees and economic migrants. The first section of this chapter pieces together a picture of Afghanistan's non-agricultural private sector (agriculture is covered in Chapter 6), based on available information. The second section discusses the constraints affecting private sector activities. The third section summarizes the Government's strategy for private sector development and outlines prior- ities for moving forward. The Afghan Private Sector The Enterprise Spectrum At the core of private sector development are business enterprises. Different types of enter- prises have different roles in stimulating economic activity, growth, and poverty reduction. They also differ in the constraints they face. While some policies will have effects across the board, others may affect different enterprises differently. Table 5.1 summarizes the enter- prise spectrum--consisting of formal enterprises plus those that have potential to become formal. At one end of the spectrum are large enterprises (generally defined as those with over 250 employees), which are extremely few in Afghanistan at present although a number of Table 5.1. The Enterprise Spectrum Catalytic impact on other firms Direct and on overall Direct impact impact on efficiency Enterprise size Examples on growth employment in economy Large AWCC, Roshan, Moderate Low High Hyatt Regency Low Moderate Low Hotel Medium Karizma High High Moderate Construction Small (dynamic) Import / Moderate High Low to Export Firms to high moderate Other small and micro Carpet Makers Low High Low Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 71 larger companies are beginning operations. Examples include the two telecommunications providers (AWCC and Roshan; see below), Coca Cola, and the new Hyatt Regency hotel. Many large firms are funded by foreign investments, but as they are likely to be small in number this group will not make a major direct contribution to employment. Their main contributions are likely to be as: (i) efficient providers of critical services, such as mobile telecommunication or distribution networks, or products, such as cement and fuel, with downstream effects on other enterprises; (ii) major vehicles of foreign investment, whose success will have an important signaling effect; (iii) catalysts for introduction of modern technology, methods of management, and enterprise operation that may have a demon- stration effect on other firms; (iv) incubators of newer, smaller, enterprises; and (v) providers of much needed Government revenue. Medium-sized enterprises typically have 50­250 employees. They are likely to be found in construction and scattered in other services, but would also be expected to emerge in manufacturing. The bulk of their investment is domestic, but with support provided in many cases by expatriate Afghans. This group of enterprises would be expected to be a major source of employment and a base of industrial development and private sector development in Afghanistan. Small and micro enterprises will be an important source of employment and incomes for the poor, and hence a driver of poverty reduction. Their importance in aggregate means that they will also contribute to overall economic growth. However, relatively few small enter- prises will be dynamic and a significant source of efficiency gains in the economy. Such enter- prises may graduate into medium scale and some might become large enterprises over time. The extent to which this happens will depend on the degree to which the business environ- ment in Afghanistan encourages successful entrepreneurs to shift into the formal sector. Finally, a number of private businesses (especially construction contractors) are reg- istered as NGOs, reflecting the peculiarities of the situation in Afghanistan (Box 5.1). While inappropriately registered and benefiting from their non-profit, tax-exempt status, Box 5.1. A Raisin Factory in Kabul There were eight raisin processing factories in Kabul in the 1980s. Currently only one of them is operational, which on the day visited was processing raisins for export to Russia. The equipment is old, bought in 1964 from California, and has worked continuously since then, all the way through the war. Raisins are shoveled onto the conveyor manually. They are washed and winnowed, and then paraffin is sprayed on them. After that, women and boys manually sort the raisins and remove the remaining cap stems, before they are loaded into 12 kg cardboard boxes. Approximately 1/2 of the process requires manual labor. The line can process 4­5 metric tons per hour. The factory manager claimed to have 250 employees. However, there were only around 30 peo- ple working at the time of visit, about 2/3 women and children and 1/3 men. At busy times of the year the factory operates double shifts. The factory operates all year around except for 15­20 days when it is shut for plant maintenance. The factory processes raisins for 15 to 20 exporters during a year. Usually the exporting company pays for everything including labor wages, and the factory owner charges Afs 500 per metric ton of raisins processed. A representative from the Raisin Export Promotion Institute visits to ensure the quality of raisins for export. The factory also has its own small laboratory. Source: AREU 2004. 72 A World Bank Country Study these enterprises constitute an important reservoir of technical and management capac- ity, and could be moved formally into the private sector and thereby become a source of dynamism. Current Private Sector Activities Afghanistan possesses a rudimentary manufacturing base with most factories in Kabul and a few major cities such as Herat and Mazar-i-Sharif. A significant component of current manufacturing is in traditional activities, such as carpet weaving, dried fruit production and processing, and other small-scale activities. Transportation services and construction are two major traditional private sector service activities. Private entrepreneurship has recently ventured into a number of areas that are non-traditional in the sense that they either did not exist before in Afghanistan (mobile phones) or were reserved for the public sector (airlines and banks). Examples of Traditional Activities: Carpets and Raisins. The bulk of Afghanistan's car- pets are produced in villages, by women weavers. These find their way to export mar- kets through a network of domestic markets and traders. During the conflict many carpet weavers and traders migrated to Pakistan, mostly to Peshawar. As a result, a large proportion of carpet exports in Pakistan's trade statistics are attributable to the Afghan carpet industry--in Afghanistan, or displaced in Pakistan. Raisins, once the most success- ful Afghan export, have been hampered by damage to orchards and processing plants, although the recent preferential trade agreement with India has seen Afghan dried fruit exports back in fourth position in that market in 2003--a major recovery. If traditional activities, such as carpets or dried fruits, are to contribute significantly to broad-based growth, it will be important not only to revive production but also to ensure that the smaller players, especially producers, benefit more from these activities. Recent studies of carpet and raisin markets indicate that producers get only a small share of the price paid by the final consumers,1 for example, 8­15 percent of the final price in the case of carpet weavers. Revival will not necessarily mean going back to old methods of production, pro- cessing, and marketing; for some activities, particularly agro-processing, there is much greater premium on quality assurance than 20 years ago. Construction is booming in Afghanistan and is expected to continue to be an impor- tant driver of private sector activity. Most construction of roads and new schools and clin- ics is being implemented by private firms (many registered as NGOs; see Box 5.2), in the case of roads largely by international contractors. Afghan companies generally do not have sufficient experience, skilled personnel, or equipment to handle larger contracts, although larger Afghan contractors based in Peshawar and Quetta could be encouraged to return. However, many Afghan companies have successfully completed contracts for primary roads and, as sub-contractors to international companies, are increasingly becoming eligible for 1. Studies of the carpet and raisin markets suggest that traditional informal markets are characterized by some non-competitive features. A relatively small group of businessmen may dominate major trad- ing activities, excluding new entrants in various ways including price manipulation, possession of capital (when credit is unavailable to others), political influence, and high levels of vertical integration at the top of the chain (AREU 2004). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 73 Box 5.2. Non-Governmental Organizations (NGOs) In the absence of an effective state, NGOs have fulfilled a major role in the delivery of both relief and development services in Afghanistan. The centrality of their role was heightened by donors' desire to bypass direct support for the Taliban regime by channeling resources via the U.N. sys- tem, or through international and national NGOs. As a result, there are now more than 2,000 NGOs registered in Afghanistan, and a number of international NGOs have over 10,000 employ- ees, working largely in the areas of health and education and provision of humanitarian services. In many ways, NGOs took on de facto the state's role in service delivery. Currently NGOs are operating across Afghanistan in activities as varied as education, health, humanitarian relief services, water supply, refugee return, etc. Initial estimates indicate that in both 1382 and 1383, on the order of $300­500 million per year was being channeled through NGOs. The legal environment, legal texts, codes, legislation, and decrees do not adequately address the expansion of civil society in Afghanistan. The lack of regulation has also led to a plethora of for- profit organization masquerading as non-for-profit organizations--undermining the legitimacy of the formal economy and displacing the private sector. The Government's development strat- egy requires greater differentiation between economic and civil society actors. In 2003 the Ministry of Planning, responsible for registration of NGOs, drafted new legislation that would oversee the work of both national and international NGOs. While not yet promulgated, the law foresees the establishment of a Commission to evaluate NGO capability, quality, and account- ability. In principle, existing legislation is currently being enforced by the Ministry of Planning, but in practice capacities are too weak for it to be effective. The Ministry of Planning believes that a large number of NGOs would probably have their status changed because they do not conform with the new definition. The 2004 mini investment climate survey conducted by the World Bank in Kabul, Mazar-i-Sharif, Kunduz, and Jalalabad found that a number of private companies were registered as not-for-profit organizations. While the new law needs to protect the rights of legitimate not-for-profit organizations so as to enhance their effectiveness and more generally facilitate a flourishing civil society, it must clearly differentiate between NGOs and contractors--many of which are involved in the construction industry. The law needs to increase the accountability of NGOs through clear management struc- tures, the publishing of annual reports, public access to accounts, and external audit. Profit-seek- ing organizations should formally register as such, with the Ministry of Commerce and the Afghan Investment Support Agency (AISA). Taking the poor regulatory capacity of the Government into consideration, an NGO Code of Conduct to allow for self-regulation and increased transparency would seem a workable option. In the longer term the economy will benefit significantly if the large number of de facto private concerns currently registered as NGOs are formally incorporated into the private sector. contracts for secondary road contracts too. The Afghan-owned construction industry is growing rapidly. It is estimated that there are approximately 20­30 medium sized compa- nies with turnover of $1 million or more and another 30­40 companies with turnover of between $200,000 and $1 million. Some donors are trying to ensure greater participation by Afghan companies through policies such as local content requirements. Construction Materials. The construction boom has led to high demand for con- struction materials, such as cement and cement blocks, wood, steel and steel products, bricks, aggregate and sand, plumbing products and sanitary fixtures, and glass (Box 5.3). Most demand is met through imports (mainly from Pakistan, Iran, Russia, and to a lesser extent the United Arab Emirates and China), since there is very little manufacturing 74 A World Bank Country Study Box 5.3. Construction Materials in Mazar-i-Sharif Mazar-i-Sharif is the economic hub of Balkh province. The province borders Uzbekistan, which connects Afghanistan with the main import routes from Russia and other former Soviet Union countries. The city of Mazar is located 90 km south of Hairatan port on the Afghan-Uzbek border. It is the main commercial center in the north and both a primary market and a distribution point for construction materials imported from Russia. The regional customs office is located in Mazar. Dozens of trucks with imported wood and steel are always parked in the compound of the cus- toms office waiting for paperwork to be completed and duties to be paid before they move on. Drivers usually spend 1­2 days there. The "bazaars" in construction materials are booming. There are four big markets in the city as well as numerous small shops in the central part of the city. There is some price difference between goods in Mazar and those in other cities. Usually materials imported from Russia are cheaper here than in Kabul or any other city in Afghanistan. Smuggled goods from Pakistan, such as plywood, also reach the markets of Mazar, which is home to many large importing companies. Barakat Construction is among the largest. It has been trading for 45 years and mostly imports steel and wood from Russia and exports raisins to Moscow (AREU, 2004). capacity in Afghanistan. There are three basic trade patterns: (i) large contractors import materials for their own use; (ii) import/export companies buy from manufacturers and sell to wholesalers, who in turn sell to retailers and large consumers; and (iii) manufacturers export directly and sell to Afghan wholesalers (relatively rare). Some barriers to entry exist at the lower end of the commodity chain. Lack of credit, and vertical integration of the top end of the business, make it difficult for small and medium-sized businesses to expand. Corruption appears to be endemic, and bribes to municipalities, police and, judicial ser- vices act as a disincentive to market engagement. The industry currently lacks quality reg- ulations to protect against low-quality materials which often come into the market, and sub-standard construction is common. Transport. This was an important activity during the conflict, and private transport companies have expanded rapidly since the end of the war. There are a number of flour- ishing freight and passenger transport companies (the government truck fleet has stopped working). Estimates of the total size of the private truck fleet in Afghanistan range from 47,500 to 80,000. There are 165 registered bus companies with approximately 14,000 buses (the majority of these are minibuses and vans), and the number of registered taxis rose from 17,000 in 2000 to 33,500 in 2002. The Government-owned Millie bus company oper- ates 963 vehicles, mainly in Kabul, and the balance are privately owned and operated. The costs of entry into the market are not high. Infrastructure. The largest private investment in infrastructure has been in telecom- munications. While very modest fixed-line telecom services are provided by the public sec- tor, there are two private mobile operators. The first, AWCC, offers pre-paid GSM services in four major cities. It is a joint venture 20 percent owned by the Ministry of Telecom- munications and 80 percent by Telephone Systems International, which is controlled by an Afghan investor providing management. An international competitive tender process in 2002 resulted in the award of a second mobile license in January 2003, to Roshan, owned by a consortium led by the Aga Khan Fund for Economic Development (51 percent), Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 75 Monaco Telecom International (35), MCT Corporation (9), and Alcatel (5). Total invest- ment in the two mobile networks is reported at over $180 million, representing most direct foreign investment in the country. The number of connections has increased from 57,000 in 2000 to at least 200,000 by December 2003 (including both mobile subscribers and fixed lines). Total tele-density has increased from 2 per 1000 to at least 8 per 1000, mostly due to Roshan and AWCC. Competition between the two privately owned mobile networks has resulted in prices consistent with international norms. Currently there is very little involvement of the private sector in the main electricity generation, transmission, and distribution system. However, there are thousands of gener- ators in operation which are privately supplied and maintained. These range from house- hold usage of very small generators to workshops and small businesses using diesel-powered generators of a significant size. Since the end of major conflict in Afghanistan, a private water and sanitation industry has emerged. International agencies typically use either private con- tractors or a combination of private contractors and their own implementation operations to construct wells, manufacture hand-pumps, and install systems. There are a number of Afghan hand-pump suppliers operating (see Box 5.4 for an example), which provide an illustration of how public sector demand, in this case from international aid agencies, can stimulate Afghan private enterprise. The growing importance of the construction industry as an area of investment and its potential for the future are reflected in the composition of new investment projects. Box 5.5 discusses recent investment projects benefiting from services provided by AISA. Construction accounts for 25 percent of projects and more than half of expected invest- ment volume. The primary group of potential foreign investors for Afghanistan currently consists of returning Afghan nationals who left the country as many as 25 years ago for Europe, Australia, North America, and countries in the region. There are also interested investors from countries that have traditionally had trade ties with Afghanistan, such as India, Iran, Pakistan, Turkey, and Uzbekistan, as well from U.S. and European companies. Some for- eign investors view Afghanistan as a central business "hub" and vital trade route, where the Middle East meets Southern, Central, and East Asia. In addition, some businesses are striv- ing for "first mover advantage" in establishing a presence in Afghanistan. Moderate inter- est has been expressed by potential investors in power, telecommunications and internet Box 5.4. Zam Zam Industries: A Small Water-pump Manufacturer Zam Zam Industries is a hand-pump manufacturing and metal fabrication business. It was set up in Pakistan four years ago by four former employees of an international NGO and relocated to Kabul in the fall of 2003. It now has 25 employees, including 4 engineers and 10 skilled craftsmen. The factory is currently producing approximately 300­400 pumps per month which sell for between Afs 7,000 and Afs 12,000 ($140­240). The company has two sales channels. Approximately 60 percent of the company's output is made to order for NGOs and international organizations. The remainder of its output is sold to private buyers through a network of eight shops around the country. Zam Zam's competition comes from both Afghan and foreign com- panies. Zam Zam is diversifying into new products. It is currently working on an order for an international construction company and is also negotiating an order for doors and windows for an international aid agency. 76 A World Bank Country Study Box 5.5. Characteristics of Recent Investments According to information submitted to AISA on 84 recent investment proposals, these enter- prises together expected an initial investment of about US $120 million and total employment of about 4,000. About a quarter (22) of these projects are in construction, accounting for more than half the total expected investment ($69.3 million, or 58 percent), and half of the total expected employment in the 84 projects (2,000 jobs). Next in importance are 26 manufactur- ing projects, covering a wide range of activities, with an expected investment of $21 million and employment of about 1,150. Three banks and two hotels account for another $20 million in initial investment but only 140 jobs. The remaining investment proposals comprise a number of service-oriented enterprises and other miscellaneous activities. Only five projects show an initial investment of $5 million or above; these include two construction projects, two banks, and one beverage manufacturing project. Another 17 show an initial expected investment of between $1 million to $5 million. About 50 projects have an investment of $100,000 or less. Only 12 projects are expected to employ more than 100 people; another 11 are expected to employ between 50 and 100 people. A little more than half (58 percent) of the projects, accounting for 24 percent of the investment value, are sponsored by Afghan investors. Sources of foreign investments include Germany (6), Pakistan (4), the UK (4), Iran (3), and the USA (2). services, banking, business hotels, housing and related infrastructure, agro-business, tex- tiles, steel, and the oil and gas industry. The potential for sizable foreign investments to materialize if conditions are right is illustrated by nine investments newly registered by AISA, which have a total expected investment value of $388 million and an estimated employment once operational of 9,215 people. However, both domestic and foreign investment are severely hampered by a number of serious constraints. Constraints to Private Sector Development A rigorous investment climate survey has not been done for Afghanistan. However, a sim- ple survey carried out recently by the World Bank helps identify the major constraints faced by private enterprises. The survey covered about 150 business firms in Kabul, Mazar-i-Sharif, Jalalabad, and Kunduz. Enterprises were provided a list of possible con- straints (derived from the World Bank's core investment climate survey questionnaire) and asked to identify if these were severe, moderate, minor, or not constraints on their business operations. The results are summarized in Figure 5.1, indicating the top five investment constraints as: (i) access to land, (ii) lack of water, (iii) lack of electricity, (iv) poor com- munication facilities, and (v) transportation. Investors were also asked to identify on their own the three most important constraints they faced. Poor security and access to finance were cited as among the three most important problems in all four cities, but security is the number one problem in Mazar and only the number three problem in the other three cities. Transportation and access to roads is among the top five problems in Kabul, Kunduz, and Jalalabad but not in Mazar. Difficulties in getting visas is among the five most serious problems in Mazar and Kunduz but not in Kabul and Jalalabad. Results also differed by sector (not captured in Figure 5.1). Traders most frequently complained about lack of finance, transportation, non-existent banking services, and visa facilities. Construction companies referred to lack of security and supply of inputs as the Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 77 Figure 5.1. Results of Enterprise Survey in Four Cities 100% 80% constraint 60% 40% investment of 20% Severity 0% s land tion rates to Water e-mail space markets workers disorder Electricityfax, Tax financing instabilityfinancing regulations of to resolu businesses authorities of uncertainty Corruption regulation and office Access Transportation administration to trade Cost other Tax dispute policy available Labor theft Access political of Telephone, and by availability es and Access or crime, Macro-economicsystem, to Economic Customs practic education Legal Security, government Access unfair and or to Skills Access Anti-competitive Major problem Moderate problem Minor problem No problem Don't know key constraints. Corruption was not seen as a major constraint as investors appear to have classified this as a normal and necessary business transaction. A number of specific con- straints faced by the private sector are discussed below. Land. The scarcity of serviced land, as well as unclear ownership of land, is a major constraint to investment in Afghanistan. Land titling is difficult, and often multiple docu- ments exist for the same piece of land. The return of refugees is compounding the prob- lem, with disputes being common. The scope for resolving disputes through the court system is limited given inadequate court and judicial capacities, lack of necessary legal expertise, and insufficient guidance provided by law (there is no formal company law). Property rights are thus unclear and insecure. Land cannot be collateralized easily and hence cannot be used to generate financial resources or to set up small businesses. To over- come land and other constraints, the Ministry of Commerce (MoC) is establishing an industrial park outside of Kabul. Electric Power. As in many developing countries, inadequate and unreliable power sup- ply (discussed at length later in this chapter) is a major constraint on private sector activity in Afghanistan--particularly in the industrial sector. Due to a combination of the direct effects of war, lack of maintenance, and theft of spare parts and equipment, power supply is 78 A World Bank Country Study erratic and unreliable. In addition to generation problems, Afghanistan has no national grid and suffers from severe transmission and distribution limitations. Lack of adequate power supply increases costs for private firms who are forced to make alternative arrangements. Access to Finance. Banking services in Afghanistan remain severely limited. The pas- sage of the Central Banking Law and the Commercial Banking Law in September 2003 and the entry of several commercial banks marks significant progress. Yet, much must be done before financial services are restored to the level required for meaningful trade and invest- ment activities. State financial institutions are largely non-functional. The new private banks have not yet started lending to industry, and it appears that at least some of them will not be inclined to do so in the near future. Local enterprises suffer from a shortage of capital, and trading activity and industrial development have been adversely affected. The absence of a functional formal banking system also prevents the development of a bond- ing or monetary guarantee system for vehicles or cargo in transit. Security. This remains a major problem for private enterprises in Afghanistan, although the severity of insecurity may differ across locations. Poor security increases the risks of investment, raises transactions costs, and thereby deters investors, particularly for- eign investors who have other places to invest. Poor security also raises the costs for exist- ing businesses, for example, through the need to hire security guards (on the Kabul/ Kandahar highway the international contractor employed over 1,000 security guards just to protect the workforce and equipment). It also raises transport costs in general by impos- ing limitations on operating hours, restricting the flexibility of truck operations, and some- times requiring the use of convoy systems. Risk Mitigation. Insecurity as well as other factors increase the perceived political risk of doing business in Afghanistan. The Government strongly encourages foreign direct investment, but without political risk insurance many investors may take a "wait-and-see" approach.2 Domestically as well, Afghanistan is acutely underinsured. The Afghan National Insurance Company (ANIC), the sole insurance company operating in the country and holding a monopoly on insurance functions, lacks trained staff and has a poor track record in paying out on legitimate claims. Lack of insurance has a significant effect on private sector activity. Most international shipping lines do not allow their containers into the country. Within Afghanistan, cargo moves under either owners' risk or carriers' liability (at much higher freight rates), discouraging trade. Transport and Trade Logistics. Transit-related trade costs are high in Afghanistan due to inefficiencies in the present transit system, including: (i) non-existent or poor state of trade and transit infrastructure,3 (ii) very poor condition of the road network, (iii) short 2. Afghanistan is now a member of the Multilateral Investment Guarantee Agency (MIGA), although the total volume of political risk insurance so far provided to foreign investors has been small. 3. Border facilities are mostly run-down, congested, or in many cases only partially functional. Almost all border facilities have no external communication links or IT setups, and have mostly unreliable power supply. Inadequate physical infrastructure also constrains operations at nearly all Inland Clearance Depots (ICDs). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 79 Box 5.6. Quality Certification for Raisins There are no gazetted grades or standards, cleanliness rules, or public health inspections. The Afghan Raisin Export and Other Dry Fruit Export Promotion Institute, a non-profit body under MoC, has offices in Kabul, which are equipped with a small lab recently fitted out by the Japanese gov- ernment, as well as offices in Kandahar, Mazar, and Jalalabad. Its role is to provide services to pro- ducers and regulate the quality of exports. It issues a certificate of "quality control" after carrying out laboratory tests, a procedure for which they charge Afs 50 per metric ton. Provincial departments of the Ministry of Agriculture and Animal Husbandry (MAAH) also provide a certification service to exporters of raisins. But such certification is rarely based on laboratory testing. internal hauls on transit routes, (iv) insecurity, and (v) numerous checkpoints along the routes. With the limited exception of some direct road transport from Karachi to Kabul, all of Afghanistan's foreign trade is transshipped, which raises costs directly (handling charges) and indirectly (loss and damage). Because international shipping lines do not allow their containers into the country, most cargo, subjected to multiple handling, is thus break bulk cargo, vulnerable to handling loss and damage. Coordination between trans- porters in Afghanistan and transit countries, and between shippers and customs officials, is poor because of the lack of professional transit agents and poor communications. A local freight-forwarding industry was very active prior to 1975 but is non-existent today. There are no norms of accreditation for freight-forwarders. Quality and Standards. Afghanistan has no metrology, standards, testing, and quality (MSTQ) infrastructure; as a result the country is often a dumping ground for sub-standard goods. Export development also is inhibited given the high quality standards demanded by international markets, especially for agro-based products. Without a proper MSTQ sys- tem, enterprises are unable to access information on standards, calibration, and product testing facilities. Existing limited arrangements for quality control are generally ineffective (see Box 5.6). Regulatory Burden. Although there have been improvements in the regulatory regime, including streamlining business registration, customs procedures, and trade licensing sys- tems, there are still numerous excessive regulatory burdens. For example, the transaction costs of transporting goods within Afghanistan are raised directly by multiple fees and taxes, and indirectly by delays and uncertainties due to multiple checkpoints along the routes. Provincial agencies interfere by imposing informal procedural requirements. Deal- ing with municipalities remains a big hassle. (See Box 5.7 on the regulatory problems faced by Roshan, a private mobile telephone operator, which pre-date recent improvements.) While business registration and overall trade licensing have been streamlined, obtaining specific licenses (for example, for operating in certain sectors such as pharmaceuticals) may still take considerable time. Corruption by public sector employees is considered a major constraint to business (see Chapter 4). Private sector operators state that bribery to police, judicial services, municipal, and other sector Ministry staff is almost a daily affair--and often $3­4,000 is paid in bribes to municipal staff just to gain access to land. Anecdotal evidence 80 A World Bank Country Study Box 5.7. Constraints Faced by a Private Mobile Telephone Operator Despite its success Roshan, one of the two private mobile telephone operators in Afghanistan, encountered many obstacles along the way, ranging from poor physical infrastructure to insecu- rity and excessive Government bureaucracy. While not unexpected, these constraints added to the time and cost of doing business for the company. Infrastructure. Establishing a mobile telecommunications operation throughout Afghanistan requires significant amounts of personnel and equipment to be transported around the country. The poor state and lack of security on the roads and unreliable local air service meant that Roshan found it necessary to lease a plane to transport its staff and equipment within the country. The lack of reliable electricity supply in Afghanistan has been a source of difficulties for Roshan. The company had to install power generators at all of its sites. Every base-station has two 16kW generators, and there are pairs of larger 250kW and 350kW generators at its major switch and con- trol center sites. To date, Roshan has spent $3 million on generators as a result of the unreliable electricity supply. By the end of 2004, the company expects to have 220 sites operational in Afghanistan, by which time the annual maintenance costs of Roshan's electricity generation capacity will exceed $1 million. In order to reduce the cost of generation, Roshan is considering solar power solutions for its base sites. Bureaucracy. Dealing with the Government bureaucracy has been a challenge in some respects. For example, three licenses were required from the Government before Roshan could begin oper- ations--an investment license, a trading license, and a telecommunications license. The invest- ment license required 19 signatures of Government Ministers and officials, and it took 18 months to obtain a trading license. A similarly laborious process was involved in registering the "Roshan" name, which also required 19 signatures. The company has also had to deal extensively with municipal authorities for everything from general permission to operate in a town to specific authorization to carry out even very simple civil works such as repairing drainage channels. In Jalalabad, for example, Roshan found that permission was required from the municipal authority to operate in the city. Roshan's experience provides clear evidence of improvements over time, however. Customs clear- ance delays have been reduced considerably, for example. More generally, Roshan's interactions with various Government agencies appear to have led to improvements in policies and processes, improving the business climate and demonstrating the value of private sector feedback. suggests that municipal Construction Commissions are involved in corruption and bribery. Labor. Because of low literacy levels and the lack of training facilities, qualified man- agement and service staff are scarcely available, and most labor training takes place on the job. The lack of qualified employees is exacerbated by the barriers against women being employed in certain jobs, as well as a dysfunctional education system in terms of prepar- ing students to exploit future labor market opportunities. Since formal employment opportunities are very limited, further skill enhancement does not occur to any significant extent. Legal Framework for Private Sector Development. Afghanistan has inherited many laws, regulations, and procedures that inhibit trade and investment instead of encouraging it. A legal framework that allows businesses to start up easily, to function efficiently while they are in operation, and to exit the market in a timely and efficient manner is needed. An active program of legal reforms is currently underway in Afghanistan with donor support, Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 81 although the proposed investment law has faced considerable delays in gaining approval. The adaptation of foreign laws to the Afghan context and translations of English drafts are important challenges to legislative reform in Afghanistan.4 Assets Locked Up in State-Owned Enterprises (SOEs). Afghanistan has about 70 SOEs, many of which are defunct and none are operating at full capacity. Most SOEs lack resources to carry out major restructuring. Moreover, many are overstaffed and lack man- agement capability to increase capacity utilization. Many SOEs have considerable surplus land attached to them that is not required for their operations. Government Strategy and Implementation Priorities The Government has placed the private sector at the center of its development strategy. Two of the three Pillars of the NDF relate to the private sector--one directly as private sec- tor development itself and the other indirectly in terms of infrastructure for private sector development. Beyond general pronouncements and strategy documents, the Government has been actively pursuing pro-private sector policies and has generally avoided actions which would adversely affect the private sector, such as resurrecting state-owned enter- prises or restoring public sector procurement and trade in certain commodities. On the structural reform front, good progress has been made in trade reform and in liberalizing the financial sector. Nevertheless there is a long way to go in improving the investment environment and in providing more adequate infrastructure for the private sector, two key prerequisites for strong private sector development, and in shifting incentives in favor of the formal economy in the interest of greater competitiveness, efficiency, and growth. Improving the Investment Climate The Government recognizes that a sound investment climate is essential if private enterprise is to be the driving force for broad-based and sustainable growth in Afghanistan. Key ele- ments include: (i) security and law and order (see Chapter 4); (ii) macroeconomic stability (see Chapter 3); (iii) the policy, legal, and institutional framework; and (iv) availability of critical production inputs (for example, land, labor, and infrastructure--discussed in the following section). Private sector development requires an enabling policy framework that is clear and predictable. The Government has made a strong commitment to such policies and has taken a number of steps in this regard. A conducive legal framework and a fair and effective judicial system--to settle disputes, enforce contracts, and protect property rights and investments--is required, and a program of legal reforms is currently underway with donor support. Non-viable state-owned enterprises need to privatized or liquidated. The Government is involved in preparation of a privatization program, which needs to be based on an appropriate legal framework and handled in a transparent manner with due consid- eration to the social implications of privatization. 4. Several important pieces of legislation relevant for private sector development are at an advanced stage of preparation: the Foreign Investment Law; the Decree on the Transfer of Government Property; the draft Decree on Corporatization of Telecommunications; the draft Company Law; and sectoral laws such as those on telecommunications, petroleum, and mining. 82 A World Bank Country Study The Government is looking to the High Commission for Investment to provide improved coordination across the different Ministries and agencies. The Government also established the Afghanistan Investment Support Agency (AISA) with a mandate to pro- mote foreign investment and facilitate business. Operational since August 2003, AISA helps investors secure necessary permits, licenses, and clearances; provides general information on investment opportunities, regulations, and standards; and provides support in the acquisition/leasing of land. A draft Presidential decree on the transfer of government prop- erty gives the High Commission the authority to allocate government land earmarked for industrial use to private investors. The High Commission will need strengthening in order to fulfill the roles assigned to it. An institutionalized mechanism for obtaining regular feedback from the private sec- tor about the constraints that it faces would be very desirable, conducted through an effec- tive, regular dialogue with private sector associations. The Afghan Chamber of Commerce, which has existed for many years, is essentially a government agency with several regula- tory functions. A number of independent private sector collective bodies have emerged and are active, including the Afghan-American Chamber of Commerce (AACC) and the Afghanistan Traders and Industrialists Center (ATIC). There are plans to consolidate these and a number of other private sector associations into the Afghanistan International Chamber of Commerce (AICC). The future role of the Afghanistan Chamber of Com- merce will need to be delineated, given that many of its functions as a quasi-government entity no longer exist or should be abolished. The Government is considering streamlin- ing its functions and converting it into a truly private sector chamber. Greater export orientation is a very important aspect of the Government's private sec- tor development vision. This will require a successful export promotion effort with col- laboration between the public and private sectors. It will also require development of an effective quality and standards system. The Export Promotion Department in MoC has an explicit mandate to promote and facilitate exports. However, it suffers from weak capac- ity, including lack of many basic skills, and has lost contacts in developed countries after the shift in trade flows away from these countries since the mid-1970s. The Government is seriously considering revamping its export promotion efforts and is starting to establish a quality and standards system. The Government's export promotion efforts should focus on activities of a public good nature. This will require adoption of an appropriate policy and regulatory framework and institutional structure, with adequate capacity. While the Government may take the lead in setting up this system, important parts of it, such as lab- oratories, would be private sector activities. The Government is planning to set up Industrial Parks to provide access to serviced land and other critical basic services. There are currently plans to set up three small indus- trial parks in Kandahar, Mazar-e-Sharif, and Bagram. Another 19 potential sites have been identified. The Government is developing an institutional framework to oversee the devel- opment of industrial parks. Options being considered include an independent agency or a department within AISA. Private participation in the development and management of industrial parks is envisaged. Industrial parks, with an appropriate policy, legal, and regu- latory framework, can be a powerful instrument to encourage entrepreneurs to shift into the formal sector. They are only a partial solution to the land access problem, however. Over the medium term, appropriate actions will need to be taken to clarify and strengthen property rights, especially in land. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 83 Expanding Infrastructure on a Sustainable Basis Infrastructure is a critical input for the private sector, and Afghanistan's basic infrastruc- ture, such as existed prior to the war, was badly damaged by the conflict itself and severely run down due to lack of maintenance. As emphasized in Chapter 3 of the SAF report, indi- cators of infrastructure availability in Afghanistan are in most respects the worst in the world, well below the corresponding figures for Sub-Saharan Africa (Table 5.2). The Government, fully recognizing the centrality of infrastructure for growth, has developed a major investment program most notably in roads, but also in electric power and urban water supply. Just as important as the investments and the mechanics of infra- structure provision will be the institutional and policy framework, which will be essential for appropriate incentives and accountability for performance, and for financial sustain- ability (see the model of accountability for public services presented in Chapter 8, based on World Bank 2004g). Key directions for reform, starting from the highly centralized model of government service delivery that Afghanistan has inherited, include (i) separa- tion of the service provider (public utility) from the government and its operation on an autonomous, commercial basis with accountability for performance; (ii) business-like rela- tionship between service provider and service recipient, with a service orientation on the part of the former; and (iii) financially sound and sustainable operations, based on cost recovery. Particular attention should be given to cost recovery from service recipients, which is not necessary only for financial sustainability and demand containment (the reasons usu- ally cited). Paying for services changes the incentives of both clients (increased stake and vig- ilance and making better choices) and service providers (better provider behavior, increased and sustained supplies). Thus cost recovery, with appropriate lifeline tariffs or other mech- anisms to ensure access for the poor, can be an effective instrument for accountability and sustainability objectives. Given the public good dimension and targeting issues relating to the poor, cost recovery is not possible or desirable in all cases. Figure 5.2 presents guidance on this issue based on the inherent characteristics of a service, its usage by the poor, and ability to target the poor. These guidelines need to be tempered by consideration of the costs and distortions arising from government funding of a service (for example, through taxation), if cost recovery is not resorted to. Institutional and service delivery issues for two key infrastructure sectors--electric power and highways--are discussed below. Detailed investment requirements for major infrastructure sectors were presented in the SAF report (Afghanistan Government 2004, Chapter 3). Electric Power Sector Situation. Very limited quantity (only 6 percent of the population has access to power from the grid) and poor quality (low voltage, intermittent supply, black-outs) of electric power supplies are severely constraining Afghanistan's economic development. This dire situation reflects lack of investment, insufficient maintenance, and loss/damage of infrastructure due to conflict, looting, etc. In addition to grossly insufficient generation capacity (which is being augmented by imports of power from neighboring countries), the system is plagued by inadequate transmission, poor distribution, and lack of back-up 84 A World Bank Country Study to 53 85 31 66 72 61 83 68 12 2000 100 100 Access sanitation water 97 51 84 88 76 18 88 83 58 85 85 13 Access 2000 to 1,000 4 7 8 32 31 21 1.6 22 41 36 82 67 18 people 152 104 Telephones per capita kwh 98 84 74 12.16 957 379 345 321 255 944 894 1750 2163 1650 Electricity per consumption 1,000 5 94 1 81 4 8 52 8 43 41 Motor vehicles people 2000 per Countries of Other 69 29 9 01 71 64 74 13 34 59 38 18 78 84 61 road paved Percent Selected sq and kms per area 2000 0.531 0.287 1.441 0.037 0.124 1.010 0.180 0.090 0.320 1.465 0.194 0.049 0.183 0.047 0.032 Total km road Afghanistan in (2004b). GNP 2000 520 600 370 570 450 450 570 240 440 850 180 750 360 460 186 per/cap Government Infrastructure 2003)( 5.2. Republic Afghanistan Lanka Table Armenia Azerbaijan Bangladesh Congo Guinea India Indonesia Nepal Pakistan Sri Tajikistan Turkmenistán Uzbekistán Zimbabwe Afghanistan Source: Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 85 Figure 5.2. When and How to Levy User Fees Note: Numbers for Boxes and Figures refer to those in the World Development Report 2004. Source: World Bank (2004g), Box 4.4, p. 71. equipment, which results in losses. Most of the equipment in the power sector is old, dilap- idated, and failing. Although the population demonstrates willingness to pay for power supplies when the costs are transparent (imported power or diesel generation), in Kabul and some other large cities like Kandahar electricity is priced at levels far too low to recover the costs of O&M--overall the average cost recovery rate (ratio of power tariff to cost of supply) is estimated at just over 50 percent. Organizational Structure. The Ministry of Water and Power is in charge of the power sector in Afghanistan, which it operates through a number of departments and public 86 A World Bank Country Study enterprises--the latter function as parts of the ministry however. The state power utility, Da Afghanistan Breshna Moassesa (DABM), is in charge of generation, transmission, and distribution of electricity and has nearly 7,000 employees, most of whom are in some 14 regional electricity departments responsible for running electricity facilities in different parts of the country. DABM has neither an appropriate governance structure nor financial resources to improve electricity services. Until recently its staff were paid from the min- istry's budget, and funds for maintenance, fuel, spare parts, etc. are lacking. Government Strategy. The Government's key objective is to expand coverage of elec- tric power supply while improving quality, through rehabilitation of existing facilities and expansion (including in the short run power imports where appropriate). The goal is to increase coverage of the electricity grid in urban areas to 90 percent by 2015, which trans- lates into an overall national electricity access ratio of 33 percent, compared with an esti- mated 6 percent at present. The capacity of the Ministry of Water and Power will be enhanced, and a program management approach will be taken with establishment of a Pro- ject Implementation Support Unit within the ministry. DABM is to be corporatized as a first step toward transforming it into an autonomous, commercially-oriented business entity with special focus on power distribution. Emphasis will be given to improving billing and collections, and a process of tariff enhancement has begun in Kabul. Improving Service Delivery. While major investments will be required to achieve power sector objectives, institutional and policy changes that improve incentives and enhance accountability of service providers also will be essential. i. An early focus on improving billing and collection is necessary. ii. A relatively ambitious power tariff reform could be embarked upon as the quality of power supply is improved and the network is expanded. While this is essential for covering O&M costs and thereby ensuring the financial sustainability of the sys- tem, it will also yield dividends in terms of the power utility's incentives to provide good service and consumers' incentives to restrain their own power usage and demand good service. iii. As power tariffs are rationalized, consumer protection mechanisms and feedback channels need to be developed to help ensure that there are adequate levels of service. iv. Corporatization of DABM is an essential first step, but it will need to be accompa- nied by appointing a new Board of Directors and commercially-oriented managers, building capacity, instilling a more business-like corporate culture, and better com- mercial cash management and pricing practices, among others. Highway Network Sector Situation. Afghanistan's pre-war paved highway network, although of limited length (some 2,000 km) was excellent in terms of quality in relation to the relatively low traffic levels, reflecting large investments in main roads funded by aid from the USSR and USA. Protracted conflict and lack of maintenance left this network largely dilapidated--road trips that took hours 30 years ago took days by the end of the war. Secondary, tertiary, and Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 87 farm-to-market roads were neglected in the pre-war period with for the most part no improvements subsequently. Rehabilitating the road network has been a top priority for the Government during the past 21/2 years, and despite delays work is well underway, with concomitant improvements in travel times already beginning to materialize. Widespread efforts also have been made to repair and improve smaller roads, primarily through pub- lic works employment programs (most notably NEEP). Nevertheless there is still a long way to go in rehabilitating the highway system and completing its segments including the remaining "ring" connection in Northwest Afghanistan. Organizational Structure. The Ministry of Public Works is responsible for the national highway system, with a centralized administrative structure. Although the ministry tradi- tionally was supposed to handle construction and maintenance, capacity and equipment for the former are lacking, and maintenance has suffered greatly from grossly inadequate financial resources. Technical and managerial capacity are very weak, making it difficult to oversee and coordinate the major donor-funded road investment program underway, and to prepare and evaluate bankable major road projects for future investments. Key Sector Issues. In addition to the deteriorated road network and centralized orga- nizational structure described above, the highway sector faces a number of serious problems: i. Security is an important constraint adversely affecting the pace and cost of road construction and rehabilitation. ii. The financing of recurrent costs of the road sector is far from adequate, and funding mechanisms for cost recovery are undeveloped. Toll collection is irregular, unsu- pervised, and un-audited, and much of the revenue does not go to the Government. iii. There is little effective regulation of road use, and freight loads exceeding appro- priate weight limits damage roads and shorten their usable life. iv. Road maintenance appears to be to a large extent reactive to significant deteriora- tion, with insufficient attention to routine maintenance which is more cost-effective. v. The Afghan private sector is growing but still lacks capacity to handle sizable road construction projects, although it handles smaller roads and often is subcontractor in major road projects. Thus capacity building in the private sector is extremely important. Government Strategy. The Government has developed a large investment program for major highways, including rehabilitation of the existing network, completion of the net- work, and, over time, construction of new roads. The Government plans to establish a Pro- gram Management Unit in the Ministry of Public Works to support implementation of this program. The role of the ministry will shift away from direct responsibility for con- structing and maintaining roads to setting policies, network planning, setting and enforc- ing standards and regulations, and overseeing the major highways (for which construction and rehabilitation works would be contracted out). Over the longer term, the Government envisions that: (i) major roads will be overseen by an autonomous road agency; (ii) the preservation and further development of the highway network will be financed by road user charges, through some form of "road fund"; (iii) road construction and maintenance 88 A World Bank Country Study will be undertaken primarily by private contractors contracted on a competitive basis; and (v) donor assistance would be directed mainly at rural roads. Improving Service Delivery. Key priorities from the accountability standpoint include: i. Phasing out the ministry's direct involvement in road construction and mainte- nance will focus its role on sector policies and oversight, competitive contracting to the private sector, sector planning, and so forth. This change will avoid conflict of interest between these roles and the ministry's existing (not well-fulfilled) role in construction and maintenance. ii. Developing appropriate financing mechanisms whereby road users directly (via registration fees, tolls, and so on) and indirectly (through a fuel charge or similar levy) pay for their usage of roads will be critical for the sustainability of road invest- ments. Good governance arrangements will be crucial for the success of a road fund. iii. In addition, participation by user groups (truckers' associations, vehicle owners) in oversight and monitoring of road management can enhance accountability for services. Conclusions The Government views private sector-led development as the key to Afghanistan's longer- term economic development and poverty reduction. Concerted efforts will be needed to create a suitable enabling environment for the private sector and to push forward with public sector reforms redefining the State as the regulator of the private sector--not its Table 5.3. Priority Areas for Support to the Private Sector Description Priority action Clear role of Clearly define the mandate, roles, and responsibilities of key min- public and istries, bringing them into line with the new economic policy of private the Government. institutions Establish an institutional framework to oversee the privatization and liquidation of non-viable state-owned enterprises. Establish a mechanism for regular and effective dialogue between Government and the private sector. Legal and Judicial Pass the draft Investment Law. framework Framework Review the legal framework for private sector development in order to identify areas where gaps, inconsistencies (between dif- Policy ferent laws), and contradictions (between the overall government approach and provisions of specific laws) exist. Develop a company law. NGO Registration Conduct a thorough review and re-registration of NGOs. Trade Continue trade policy improvements, and support for trade facili- tation, and provide export promotion services. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 89 Table 5.3. Priority Areas for Support to the Private Sector (Continued) Description Priority action Governance Strengthen the High Commission for Investment. Strengthen capacity in Government to provide research and policy support. Regulation and Continue the simplification of business registration processes Certification and the streamlining of customs clearance procedures. Develop a metrology, standards, testing and quality (MSTQ) system. Access to Factors Reform/privatize the state-owned commercial banking system. of Production Develop collateral systems to increase the incentives for banks to provide loans. Conduct an assessment of the prospects of micro-finance institu- framework tions to scale up and serve small enterprises. Capacity Building Develop a strategy for the effective provision of capacity of the Private building services to the private sector. Sector Work toward market-oriented provision of capacity building Institutional services to ensure they reflect the needs of private firms. Export Promotion Strengthen and reform the Export Promotion Department of MoC and ensure it has high-quality staff--perhaps through the PRR process. Adopt an appropriate policy and regulatory framework and institutional structure for export promotion development. Taxation Continue registration of major companies for tax purposes and provide further support for revenue collection. Enhance the capabilities of the MoF Large Taxpayers Office. Security and Risk Expansion of ISAF into regional cities. Mitigation Focus on measures which can help mitigate perceived risks aris- ing from both political and non-political sources. Further development of investment guarantee facilities (MIGA etc.) to provide political risk insurance to foreign investors. Develop the insurance industry to provide insurance coverage on a commercial basis. Other Utilities Continue the expansion of power and water utilities. Provide investment support for reform of Municipalities to develop their role as a service provider. Develop a clear and consistent policy framework for private sec- tor participation in provision of utilities. Land Develop a policy, regulatory, and institutional framework for development of Industrial Parks with private sector participation. competitor. The goal is a dynamic and well-regulated economy with a substantial formal component. It is clear that trade, both within the region and more globally, will need to be a dri- ving force in Afghanistan's economy over the medium to longer term (see Chapter 3). Afghanistan has joined the World Customs Organization. Development of the financial sector will be critical; on September 15, 2003 the Government approved new laws for 90 A World Bank Country Study central banking and the regulation of all other banks. The Government is further devel- oping the legal framework, with new laws on investment, trade in goods and services, and economic governance (including bankruptcy, competition, and land use). The Government, with support from the international community will need to focus on overcoming the many constraints faced by the private sector, among which the chal- lenges of continued insecurity and lack of infrastructure remain key. A focus on institu- tional capacity building for both public and private sectors; improved public sector management; formulation of a sound enabling regulatory framework for businesses; devel- opment of banking and insurance services; introducing standards, metrology testing, and quality certification services; labor market training and skill enhancement; land titling; infrastructure development for trade and investment; trade, transit, and transport facilita- tion; and private sector capacity building are vital if high growth rates are to be sustained (Table 5.3). CHAPTER 6 Agricultural Development Priorities and Prospects C ontributing an estimated 53 percent to GDP (excluding drugs) and 67 percent to the labor force in 2003, agriculture (crops, livestock, forestry, and fishery) is cen- tral to the Afghan economy. Agricultural performance strongly influences over- all economic growth, evident in the recent recovery after three years of drought. With most poor people living in rural areas, many depending either directly or indirectly on agriculture, improved agricultural performance would have major impacts on poverty reduction through direct effects on producer incomes, indirect effects on consumer welfare through changes in food prices, employment and wage effects, and growth- induced effects throughout the economy.1 Agriculture and related activities are a major vehicle for women's participation in the economy. Agricultural development is part of the Government's core program of promoting efficient and sustainable use of natural resources, promulgated in the NDF and reiterated in the SAF report. The first section of this chapter provides an overview of agricultural performance, structure, policy frame- work, and key issues. Reform priorities in four key areas--irrigation, research and exten- sion, marketing, and credit--are then discussed in the second section. The chapter ends with a look at agricultural prospects. 1. This is not to downplay the contribution of the rural non-farm economy which will also be impor- tant in combating rural poverty and improving livelihoods. However, agriculture continues to be a pri- mary occupation in rural areas and is a catalyst for rural non-farm activities. 91 92 A World Bank Country Study Overview and Policy Framework Recent Performance Afghan agriculture has suffered badly for nearly 25 years. Main drivers of agricultural growth and rural poverty reduction--technology, roads, irrigation, education--have all suffered extensive deterioration due to conflict, lack of maintenance, and most recently the severe drought. Trend growth in agricultural output, as measured by an index which includes all crop and livestock products (but not opium poppy), slowed dramatically from 2.2 percent per year in the pre-conflict period of 1961­78 to 0.2 percent during 1978­2001. Cereal output actually declined by 2.0 percent per year between 1978 and 2001, after grow- ing at 1.3 percent annually during 1961­1978 (Table 6.1). Since 2002 there has been a strong recovery Table 6.1. Agricultural Growth Rates with the return of normal precip- (percent per annum) itation in much of the country 1961­1978 1978­2001 and improved availability of seeds Agricultural 2.2 0.2 and fertilizers. Total cereal pro- Production Index duction (primarily wheat) incre- Cereals production 1.3 -2.0 ased by 82 percent in 2002 and by a further 50 percent in 2003, reach- Note: Growth rates are trend rates calculated using a log lin- ing 5.4 million tons--roughly the ear regression. aggregate level Afghanistan needs Source: Staff estimates using data from FAOSTAT (2003); to meet its foodgrain consumption ADB (2003a). needs. Production of fruits and vegetables and livestock products has also increased in the past two years but will take longer to reach pre-conflict levels given the sharp reduction in livestock herds and destruc- tion of orchards in recent years. Cereal production growth is expected to slow down from its accelerated pace of the last two years, since the area under cereals has probably reached its upper limit within the current capacity.2 It is extremely important, however, that agriculture continue to grow at an average rate of at least 5 percent per year over the next decade to enable faster overall economic growth and to make a substantial dent in rural poverty. Developing a facilitat- ing environment for this to be achieved with the right mix of public policies, institutions, and investments is a major challenge. Main Structural Features Although Afghanistan's economy is primarily agricultural, only 12 percent or 7.9 million hectares of the country's total land area is classified as arable (FAO/WFP 2003). Geographically, nearly 75 percent of the arable area is concentrated in three of the eight 2. While area increase was responsible for only 9 percent of increased cereal production in 2002, it was responsible for 55 percent of increased production in 2003 ­ virtually all land left fallow during the drought was brought back into production. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 93 agricultural planning regions of the country--north, northeast, and west Figure 6.1. Regional Distribution of Arable (Figure 6.1). Of the total arable area, Land, 2003 not more than half is actually culti- vated annually, mainly because of West-Central 3% water availability problems. West The agriculture sector is com- 17% Northeast Central posed mainly of cereal crops which 21% 3% account for an estimated 75 percent South 6% of agricultural value added, non- cereal crops 15 percent, and livestock North East 2% 10 percent. These numbers should 36% be treated with caution as they are Southwest subject to revision. 12% Cereals. Wheat is the main Source: Maletta and Favre (2003). cereal crop, covering about 2.4 million hectares or 68 percent of total cultivated area in 2002 (Figure 6.2). It is grown by most Figure 6.2. Cropwise Distribution of Area Cultivated, 2002 farmers, largely for subsistence and animal fodder, on irrigated Other cereals as well as rain-fed land. Most (barley, rice, (75­80 percent) wheat produc- maize, millet) tion is from irrigated land, with 16% Pulses rain-fed wheat area (and yield) 2% Oilseeds varying with climatic condi- 2% tions. Nearly 70 percent of wheat Cotton is produced in the three main Wheat 0.5% 68% Clover (fodder) arable regions (north, northeast, 4% and west) of the country. Other Fruits 2% cereals cultivated include rice, maize, and barley. Vegetables Others Poppy 2% 2% 2% Non-Cereals. The impor- tant non-cereals are pulses, oil- seeds, fruits, vegetables, fodder, Source: Staff estimates using data from Maletta and Favre (2003); Afghanistan Government (2004b), UNODC (2003b). and opium poppy. Area under poppy has risen sharply since 2001, reaching an estimated 80,000 ha in 2003, about 2 percent of cultivated area or 1 percent of arable area (Chapter 7). Financial returns to cultivating poppy appear to have been mar- ginally higher than for the most lucrative alternatives in the late 1990s (Box 6.1), but rose dramatically following the Taliban ban in 2000/01. Among other non-cereal crops, fruits and vegetables are important because of their past significance and potential future prospects. The fruits sub-sector (grapes, almonds, apples, apricots, pomegranates, and so forth), which in the 1970s was a significant part of the Afghan economy contributing over 94 A World Bank Country Study Box 6.1. Comparative Returns from Crop Cultivation Assessing relative profitability of different crops in Afghanistan is hampered by lack of reliable and representative data. Apart from some recent farm-level estimates of costs and returns to wheat cultivation, there is little information available on costs of production for the other main crops. Estimates from 2000 are available on the gross value of output per hectare for different crops (ICARDA, 2003, shown in Chart), but since the costs per hectare are not known, it is difficult to draw any conclusions about relative profitability Nevertheless, available information suggests that, first, opium poppy has the highest gross value of output per ha. In 2000 it was estimated at eight times that of wheat, but by 2003 with the steep increase in the farm-gate price of poppy it had risen to 28 times that of wheat. Even after adjusting for higher production costs, the difference in profits per ha is enormous. Second, most important fruits (almonds, apples, grapes, pomegranates) and vegetables (potatoes, onions, tomatoes) also offered better gross revenue per hectare in 2000 compared to wheat, but not poppy. Third, in 2003 the gross value of output per ha from wheat cultivation increased substantially as a result of improved yields, from around $450­500 per ha to $700 per ha. Index of gross value of output per hectare for different crops in 2000 (wheat = 100) 900 800 700 600 500 400 300 200 100 0 Rice Wheat Maize Cotton Melon Onion Apple Tomato Apricot Grape Potato Poppy Almonds Watermelon Pomegranate 40 percent of export earnings (with a large share of the world market), at present covers only about 2 percent of cultivated area. The decline in the area of fruit orchards in recent years was mainly due to drought and conflict. Most fruits are now for domestic con- sumption, with exports limited due to lack of market access arising mainly from weak post-harvest management practices, lack of quality control, and lack of finance. Vegeta- bles, increasingly preferred because of their short growing cycle in an uncertain environ- ment, also cover about 2 percent of cultivated area; the main products are melons, watermelons, potatoes, onions, and tomatoes. Fruits and vegetables are major cash crops, with marketed proportions in the range of 50­70 percent of production. Cotton, signifi- cant in the 1970s, has declined to negligible levels with the collapse of the domestic cot- ton textile industry. Livestock is a major source of food and income for Afghan farmers, traditionally being an integral part of most farming systems in the country. Range pasture land covering Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 95 about 45 percent of the total land area has traditionally supported a Table 6.2. Livestock Population Per Family large livestock population, with 1995 1998 2003 animals being the only source of Cattle 3.7 2.5 1.2 income for some groups like the Sheep 21.9 14.2 2.9 Kuchi nomads. The livestock popu- Goats 9.4 5.8 2.4 lation declined in the 1980s but had Donkeys 1.1 0.7 0.5 recovered to pre-war levels by the Camels 0.4 0.2 0.1 mid-1990s. However, the drought years of 1999­2001 had a devas- Poultry 11.6 6.8 4.0 tating impact. As per a 2003 census the estimated livestock popula- Source: FAO (2003b). tion is about 34 million (including 12 million poultry), a major decline from the 1990s. The number of cattle and poultry per family had fallen to one-third of the 1995 figure, with numbers of sheep and goats per family suffering an even steeper decline. Input Use. According to a farmer survey covering 30 provinces in 2002/03, use of improved seeds, fertilizers, and tractors in Afghanistan is significant. Nearly 54 percent of wheat area in 2003 was sown with improved seed released in the last 10 years (through FAO and other sources), while the rest was sown with local seeds or improved seeds introduced more than 10 years ago. There are regional variations, however, with less than 30 percent wheat area using improved seeds in the southwest and southern regions but over 75 percent in the east and northeast. Fertilizer use is also substantial, with a national average of about 180 kg/ha for irrigated wheat and regional variations ranging from an average of 345 kg/ha in the central region to 80 kg/ha in the southwest. Fertilizer is also commonly used for fruits, vegetables, and other crops. Use of tractors is also significant, and in 2002/03 about 46 percent of land was cultivated using a tractor compared to 39 percent in 2001/02. This increased use may have been partly prompted by the decrease in the number of oxen due to the prolonged drought, although significant income for many farmers from opium (e.g. in Helmand where more than 98 percent of land was cul- tivated using tractors) is also a factor contributing to increased use of tractors. There is a large degree of unanimity on the main constraints facing agriculture in Afghanistan, based on recent studies and farmer surveys. These include: i. lack of assured and timely irrigation; ii. inadequate knowledge of improved production and post-production technologies; iii. access to markets; iv. access to credit; and v. weak institutional capacity in both public and private sectors. Policy and Institutional Framework Unlike in many other countries, Afghanistan's agricultural sector does not suffer from major price distortions arising from input subsidies or price support policies. The trade environ- ment is relatively undistorted--without high import tariffs, quantitative restrictions, or 96 A World Bank Country Study Box 6.2. Typical Regulatory Requirements of a Modern Agricultural System Legal and business regulation (with low costs of compliance for doing business), transparency, adjudication of contract disputes, contract enforcement, market regulation. Food safety regulations and standards (especially in processing facilities), and testing for con- tamination (including microbial) and chemical residues. Natural/environmental and common property resource (waterways, forests, air, fauna) pro- tection, and land and water use management including tenure administration. Intellectual property rights (IPR) regulations to provide incentives for innovation, enforcement of IPR laws and patents, balancing security of property rights with technology accessibility for smallholders. Verification and certification of seeds and plant propagation materials and registration and regulation of agrochemical use. Inspection services and issuance of phytosanitary certificates, and verification and certifica- tion of products for satisfying relevant grades and standards. Labeling requirements and their enforcement. Source: World Bank (2004a). export subsidies. In sum, the incentive structure is largely market driven, and furthermore, the Government is committed to keeping it this way. The main challenges to developing Afghan agriculture are institutional. Public and private institutions are ill-equipped in terms of physical infrastructure, regulatory frame- work, human skills, or concrete knowledge of what a modern and competitive agricultural sector looks like (Box 6.2). Three core ministries have been involved in agriculture and nat- ural resource management--the Ministry of Agriculture and Animal Husbandry (MAAH), the Ministry of Irrigation, Water Resources, and Environment (MIWRE), and the Ministry of Rural Rehabilitation and Development (MRRD). Water-related issues have been entrusted to MIWRE, agricultural research and extension to MAAH, and rural develop- ment/employment/poverty programs to MRRD. Within this broad division of labor, areas of overlap/gap are being identified and addressed. At the farm level, water, technology, and livelihoods are inextricably linked, so effective coordination between the three ministries is critical for efficient delivery of public investments and support services in rural areas. The agricultural sector may be affected by consolidation of ministries, which is under con- sideration (mentioned in Chapter 4). The structure of the ministries also reflects a centralized form of administration inconsistent with current rural development thinking which calls for decentralized decision making and implementation. At present more than one-third of the roughly 13,500 staff employed in the three ministries are located at headquarters in Kabul. Also, the long period of conflict has weakened all government institutions--buildings and equipment have been destroyed, existing staff are poorly paid, they lack appropriate technical and managerial skills, and ministries generally lack the capacity to effectively carry out their functions. The PRR, an interim public administration reform program which includes capacity building, higher pay, and staff retraining, has been initiated in some ministries. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 97 Although there is as yet no formal national agricultural policy or strategy, a draft Policy and Strategic Framework (PSF) for the Agriculture and Natural Resources Sector has recently been prepared by MAAH in consultation with MIWRE, MRRD, and major devel- opment partners. It identifies the main issues and problems to be addressed, outlines a broad sectoral vision with strategic objectives, lists major interventions needed, and pre- scribes following NDF principles for developing detailed sub-sectoral policies and programs to guide future sector development. The PSF represents an encouraging beginning, partic- ularly in its adoption of the NDF division of roles and responsibilities between the public and private sectors. The next step is to prepare a set of detailed sub-sectoral policies and strategies. These should address, inter alia, roles of public and private sectors (including NGOs) in performing particular functions, appropriate regulation to foster development of a modern food and agricultural system, institutional reform and inter-ministerial collabo- ration, and development of human resources. Priority Areas for Reform While there is a large degree of consensus on the main problems and constraints in agri- culture, what is less clear is a road map to effectively address these constraints within underlying boundaries of fiscal sustainability, environmental sustainability, and politi- cal acceptance. The rest of this chapter discusses four priority areas where immediate Government action is necessary to accelerate agricultural growth: rehabilitation and man- agement of water resources; effective generation and dissemination of agricultural tech- nology; facilitation of modern post-harvest handling and marketing systems; and enhanced access to rural finance. One other constraint that has been identified as very seri- ous is land tenure insecurity (Box 6.3). While recognized as important, this is part of a larger governance agenda, not only related to agriculture. Experiences elsewhere suggest that resolving land tenure issues can be complex and controversial, and for this reason it may be prudent to carry out more research in the area and for the Government to adopt an incremental and learning by doing approach that involves local communities, before scaling up. International experience suggests that building on the best traditional practices can be an effective way to move forward (De Soto 2000). Water Resources Water is central to Afghanistan's agriculture. Lack of assured and timely irrigation water supply at the farm level is perhaps the most important constraint to agricultural growth. Irrigation infrastructure, as well as many supporting community-based and government institutions, have seriously deteriorated or broken down due to years of conflict, lack of main- tenance, and more recently drought. Addressing irrigation problems is high on the Govern- ment's agenda. Present Status of Irrigation Systems. Traditional surface systems, with intakes from rivers and streams, account for about 80 percent of the irrigated area. While these systems have generally survived, their community-based mechanisms for water management and 98 A World Bank Country Study Box 6.3. Land Tenure Issues in Afghanistan Information about how rural land is distributed and under what conditions is incomplete, but there are important regional differences. Disturbed settlements and tenure insecurity render informa- tion unreliable beyond the short term. High rates of sharecropping by both landowners and land- less and the ambivalent status of mortgaged plots make precise definition of owners difficult. Years of conflict have seriously disturbed land relations, de-securing farm and pasture rights in some areas, and jeopardizing the ability of administrators or courts to manage or uphold rights fairly. Landlessness and indebtedness in the farming sector have been longstanding features of Afghan agriculture. Population growth and land shortages, opium poppy production, ethnic tension, insecurity, and more recently the drought remain potent drivers to land grabbing, landlessness, and destitution. Pasture land is a principal source of conflict. Competition over this valuable resource engenders conflict among settled and nomadic land users and ethnic and territorial interests. Issues of com- mon property rights also arise. A plural legal basis to land rights exists, in the form of customary, religious, and state law, and with a great deal of overlap, some inconsistency, and much uncertainty as to norms in each body of law. Landowners variously use custom, Shariat, or evidence from the land register to demonstrate their rights. A clear system for land tenure administration does not exist. Administration (such as the formal- ization of routine transfer of rights) falls, by default, to judges. There is currently no institutional focus for dealing with land tenure. The main discernible land policy of the Government is to restore land to those who owned the land in 1978. However, adop- tion of this strategy without addressing underlying grievances associated with how land was acquired will not provide a lasting resolution. A second main policy is to pursue registration and entitlement, mainly to encourage investment. This deserves more thought in light of the failure of registration approaches to deliver tenure security. Source: Wily (2003). maintenance have been adversely affected by local commanders who frequently have not respected water rights or the authority of the farmer elected and employed mirabs (water masters). This has had a significant impact on water distribution, both within some of these systems, and across irrigation systems along the same river. Next in importance are larger modern irrigation systems, accounting for about 10 percent of irrigated area. Managed in the past by parastatal agencies, these have been gravely affected during the past twenty years as maintenance was neglected due to lack of staff, equipment, and finances. Consequently only the upstream parts of the roughly 325,000 hectares of their command areas now receive proper irrigation. Karezes (a traditional irrigation system using underground tun- nels), accounting for roughly 5 percent of irrigated area, have also suffered due to the war; some were deliberately destroyed, sabotaged, or mined to make rehabilitation difficult. The recent drought, coupled with a gradual disintegration of community responsibility, has led to indiscriminate groundwater pumping by some farmers, leading to declines in ground- water levels in some areas and jeopardizing traditional springs and kareze fed supplies. Springs and wells constitute the remaining types of irrigation systems. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 99 Water Availability and Use. Recent estimates indicate that Afghanistan has about 70 billion cubic meters (BCM) of annual water resources, of which 55 BCM is surface water and 15 BCM is groundwater. Annual water use, of which over 95 percent is for irrigation, is estimated at about 20 BCM, which means that not more than 30 percent of water resources are being utilized. Actual irrigated area has been considerably lower in recent years than ear- lier. It is roughly estimated that 1.3 million ha were intensively irrigated in 2003, with a slightly larger area under "intermittent irrigation." There is also considerable regional vari- ation in water availability and use, with the north, northeast, west, and southwest regions accounting for Table 6.3. Regional Composition of Surface about half of estimated surface water Water Resources and Irrigated Area resources and three-fourths of irri- Percent distribution of gated area (Table 6.3). Surface water Irrigated area Region resources (FAO satellite maps) Government Strategy. There is substantial scope for improving the North 6 21 quality (timely delivery) and expand- North East 25 12 ing the quantity (area under assured West 10 15 irrigation) of irrigation, thereby South West 11 25 reducing vulnerability to droughts West Central 6 3 and increasing yields in Afghanistan. Central 20 15 Recognizing the centrality of water, South 4 5 the Government plans to invest East 18 5 about $2.35 billion between 2004 and Total 100 100 2015 in four sub-programs related to water resources and irrigated agricul- Source: Sheladia Associates (2004). ture (Table 6.4). On the investment Table 6.4. Estimated Irrigation Potential in Afghanistan Hectares (`000) Area irrigated before the war to be brought back to permanent irrigation 240 through rehabilitation works Area under irrigation that require potentially improvement/rehabilitation 1,310 works to allow more intensive cultivation Area under intermittent irrigation that can be brought to intensive irrigation 953 mainly through development of storage infrastructure Area never irrigated that could be brought to intensive irrigation through 1,035 development of new irrigation schemes Total 3,538 Source: Afghanistan Government (2004b). 100 A World Bank Country Study side, it is estimated that a total of 3.54 million hectares of irrigation potential could be developed through rehabilitation and development of new infrastructure such as storage. Projects currently funded by external assistance focus on the first three categories and pro- vide funds to rehabilitate infrastructure serving about 0.43 to 0.55 million ha. Another 0.5 million ha., mainly in the third and fourth categories, is planned to be developed by 2015 under the National Long Term Irrigation and Power Program. On the policy and institutional front, the proposed strategy contains three main ele- ments. First is the adoption of a river basin approach to manage water resources. Two pilot river basin management organizations are to be established by the end of 2004, and three more by 2006. These will be autonomous bodies that will administer all water resources related matters within their boundaries, including water allocation to different subsectors (such as drinking water, irrigation, and industry). Second, as part of the Priority Reform and Restructuring (PRR) program underway in most ministries, MIWRE is to be restruc- tured, with retraining of all staff by 2008, reduction (about 40 percent planned by 2006) and redeployment (from Kabul to the provinces) of staff, and privatization/liquidation of Helmand Construction Company, Deep Wells Drilling Department, and Metal Works by 2006. Third is the adoption of a participatory approach involving water user groups in rehabilitation and O&M of all irrigation schemes in the future. Recommendations for Consideration. Overall, the irrigation strategy appears to be on the right track, although there are significant implementation issues. Given conditions pre- vailing in Afghanistan, the initial focus on rehabilitation of irrigation infrastructure is appropriate. There is a risk, however, that MIWRE's efforts may become so focused on rehabilitation/development that other critical aspects with potentially large multiplier effects in terms of delivering sustainable growth outcomes may be neglected. Selected rec- ommendations include: i. Attention to operation and maintenance (O&M) and cost recovery. International experience demonstrates that while creating assets can be relatively easy, ensuring timely and adequate O&M is much more difficult. Although the MIWRE plan is that water user groups (WUGs) will be involved in O&M of irrigation systems, a number of actions are needed to ensure that this happens. First is appropriate leg- islation that formalizes the roles and responsibilities of WUGs, MIWRE, and other stakeholders. While the traditional mirab system worked well without written rules and agreements, there are increasing reports of challenges to it from local commanders and the system breaking down as a result, so providing legal protec- tion to resolve disputes is essential. Second, WUGs need to be involved as early as possible in rehabilitation/development work, ideally from the design stage, which creates ownership and facilitates smooth handover of O&M. Third, cost estimates of annual O&M requirements should be prepared early and discussed with WUGs prior to any significant capital investment. While detailed project-wise estimates of rehabilitation costs are available with MIWRE, there is relatively little informa- tion available on expected O&M costs. ii. Dissemination of improved agricultural techniques and management practices. Productivity and income effects of irrigation can be fully realized only by adopting improved agricultural technologies. Because agricultural technology is primarily Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 101 an MAAH responsibility, efforts need to focus on: (i) revitalizing MAAH's capacity for technology generation and transfer; (ii) incentives for effective field-level coor- dination between MIWRE, MAAH, and other government/NGO staff; and (iii) using WUGs and other forms of farmer groups as a cost-effective instrument of technology transfer. iii. Environmental considerations. While MIWRE is currently focusing on surface water irrigation, groundwater resources need to be looked at closely and their indiscriminate exploitation curbed. Groundwater tables need to be regularly monitored, especially in vulnerable areas, and appropriate actions taken if neces- sary, through pricing and other instruments. While enacting regulations on groundwater extraction is an option, implementing such regulations would be difficult, especially in the prevailing situation of insecurity. International experi- ence suggests that community participation and peer pressure can often be more effective in managing groundwater resources than policing by government staff. Attention also needs to be paid to integrating watershed development with irri- gation improvement (little work has been done on integrated watershed devel- opment in Afghanistan). Research and Extension Productivity growth in agriculture is based largely on application of science, technology, and information. Studies consistently show high returns to investments in agricultural research in developing countries, averaging over 40 percent (Table 6.5). A recent paper on comparative returns to Table 6.5. Estimated Rates of Return to Investment in Agricultural Research public investments in R&D, irriga- tion, roads, education, and electric- Number of Median rate of ity in China and India showed that Region estimates return (%) public investment in R&D con- Africa 188 34 tributed the most to promoting agri- Asia 222 50 cultural growth in both countries Latin America 262 43 (Fan, Zhang, and Zhang 2002). Middle East/ 11 36 While complementary investments North Africa in infrastructure are necessary, All Developing 683 43 investment in agricultural research Countries and extension is a key element in All Developed 990 46 Countries enhancing a country's competitive All 1772 44 advantage by reducing production costs, improving product quality, and generally increasing efficiency Source: Alston and others (1998), cited in World Bank (2004a). along the commodity chain. Present Status. Prior to the conflict Afghanistan had a substantial agricultural research system which, at its peak, carried out its functions through 24 research stations and over 1,000 staff, of whom 25 percent were technical research staff. This system is now largely 102 A World Bank Country Study dysfunctional as a result of widespread infrastructure destruction and loss of skilled staff. The agricultural extension system, which used to operate through about 400 extension units spread across the nation, is in a similar state of disrepair. Although there are still large numbers of staff on the MAAH payroll (about 10,000), most have little exposure to mod- ern agricultural management practices. Capacity building efforts need to focus on updat- ing technical skills but also on developing new skills related to management, monitoring and evaluation, participatory approaches, and marketing. Government Strategy. Part of the problem with revitalizing the agricultural research and extension system is that there appears to be little consensus on the way forward. Opting for an army of centrally controlled staff who also double as input supply agents is neither a desirable norasustainableoption.Increasinglyglobaltrendsaretowardpublic-privatepartnershipsand decentralized systems that can identify and respond nimbly to changing farmer demands. The Government's strategy for revamping agricultural research and extension is less developed than in the case of irrigation. The initial step in strategy development is a review planned for 2004 of the policies and institutional structure needed to establish and oper- ate an efficient agricultural research and technology transfer system that will respond to farmers' identified priorities and to future farming needs. This exercise could be the basis for a national research strategy and a national extension strategy, which is a recommended second step. In this context it should be noted that policy planning and analysis in MAAH needs to be strengthened. Recommendations for Consideration. Establishing an effective and sustainable research and extension system is a high priority. Key directions on the research side include: i. Focus on adaptive research, not basic research. There are many new technologies available internationally from which Afghan agriculture could benefit--including not just new varieties but also improved practices in nutrient management, pest management, water management, conservation farming, and integrated crop- livestock production. Efforts should be made to form partnerships with regional research institutions/systems to access these technologies, validate them in local conditions with the help of the domestic research system, adapt as necessary, and then spread them to farmers through the extension system. ii. Strengthen demand for research products. Past investments in research have mostly focused on supply of research products rather than farmer demand. Research systems need to be responsive and accountable to client demands. This can be fostered by encouraging farmer participation in priority setting, execution, and evaluation of research programs through rapid appraisals and participatory on-farm research, farmer representation on research governing bodies and advisory panels, decentral- izing/deconcentrating research, and linking research to demand-driven extension. iii. Align research priorities to needs. While research priorities will emerge from devel- opment strategies and client demand, likely priority areas include: (i) post-harvest research, product quality, and food safety--horticultural exports, for instance, have good potential but will require substantial adaptive research to meet international quality standards; (ii) environmental conservation; and (iii) social science and pol- icy research. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 103 On the extension side the following considerations are important: i. Define public and private sector roles. Because there is frequently a mix of public and private elements in an extension system, it is important to delineate the roles of the public and private sectors in provision of specific services. For instance, generic farm advisory services, market price information through mass media, advice on environmental conservation practices, and control of major contagious diseases are legitimate public sector responsibilities. Establishing and enforcing quality parameters for agricultural inputs also is a public sector responsibility, that needs to be handled through appropriate regulation. However, supply of inputs such as seeds or fertilizers or farm equipment, apart from demonstrations, should be left to the private sector. ii. Contract out extension services where possible. There is growing recognition inter- nationally that even in situations where public financing of extension is justified, private service delivery is often the more efficient way to serve clients (Box 6.4). Good-practice examples of contracting out extension include Chile (introduced in 1978), Bangladesh, and India. Contracting out extension programs works best when community or producer organizations are closely involved in selecting extension agents, evaluating services, determining program content, and deciding how services are allocated. iii. Adopt participatory approaches. Extension strategy needs to emphasize develop- ment of capacity for farmers to express their demand for services and increase their influence over programs, strengthening accountability for service delivery (see Chapter 8 for a conceptual framework in this regard). International experi- ence confirms that working with client groups makes extension services more accessible to small farmers by exploiting economies of scale in service delivery and by providing a mechanism for producers to express their demand for services. Box 6.4. Outsourcing Extension Services Advantages: Reduces permanent staff requirements and allows deployment of resources to high-priority areas. Allows for accessing providers with special skills to provide specific services. Promotes partnerships and working relationships with other providers. Enhances flexibility in responding to special needs of diverse clientele. Tests innovative and higher risk "new" systems. Increases provider accountability and forces more attention to financial management. Disadvantages: Institutional memory may be lost; some private providers may not pass on new skills and lessons learned. Increases the need for skills of contract negotiation, supervision, and monitoring performance. High initial costs (if not offset by staff reductions). Source: Rivera, Zijp, and Alex (2000). 104 A World Bank Country Study Two concrete lessons emerging from these approaches are: (i) working with exist- ing groups is often more successful than starting new ones--in Afghanistan the elected village Community Development Councils (CDCs) being established under the National Solidarity Program (NSP) could provide an appropriate entry point, eventually paving the way for specific farmer interest groups to emerge and farmer-to-farmer extension to take root; and (ii) promoting farmer groups requires specialized skills which are often lacking in traditionally trained public extension workers--calling for appropriate training, but also extensive use of pri- vate community facilitators (including NGOs) to fill the gap. iv. Decentralize/de-concentrate agricultural extension services. User participation and response to local needs can be facilitated by decentralizing governance, admin- istration, and management of extension programs. Extension systems in indus- trialized countries have long been decentralized, with responsibility devolved to local governments, often in conjunction with local producer organizations. This approach is now spreading to many developing countries. However, decentral- ization raises complex political and administrative issues, and would be prema- ture in Afghanistan given the governance environment in many parts of the country. Nevertheless, in preparing for the future, there are a few salient lessons. First, decentralizing extension will work best when it is part of an overall public sector reform program transferring responsibilities from national to local gov- ernments. Second, de-concentration is nearly always the first and necessary step, which puts staff from centralized administrations in closer contact with local people and problems, although it does not change the central line of authority and control. There should be adequate central support, especially for capacity development, monitoring and evaluation, establishing quality control systems, training, subject matter specialists, and production of extension materials. v. Reach out to women. Women play an extremely important role in all dimensions of agricultural production (Box 6.5), yet they have not figured prominently enough in agricultural policies and past extension initiatives. As part of a demand- driven and community-based approach, women should be explicitly targeted which will reap major benefits in terms of agricultural production and incomes. vi. Expand the scope of extension services beyond production. While re-establishing an effective extension system, care should be taken that it is not restricted to pro- duction as has traditionally been the case. Advice to farmers would be particularly important, especially for horticultural crops. This could include guidance on mar- ket acceptability, post-harvest handling techniques, marketing methods, and cal- culation of marketing costs. vii. Develop sustainable financing mechanisms. The planned MAAH review of the agri- cultural research and technology transfer system should look closely at staff and skill requirements and at levels of salary and non-salary expenditures that can be supported over the long term, and take appropriate decisions on staff levels. Agricultural Marketing Well-functioning agricultural markets improve competitiveness and increase incomes to farmers, laborers, and entrepreneurs. In Afghanistan, prospects for a sustained horticultural Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 105 Box 6.5. Agriculture and the Gender Division of Labor Recent research highlights the extent to which land tenure arrangements, ownership, and the social dimensions of production in Afghanistan need to inform the agricultural development strategy (see Wily 2003 and Maletta 2003). As the recent NRVA results highlight (see Chapter 9), female-headed households are among the poorest members of society. Security of tenure and security of other social and economic assets for women are most often less than those for other groups. It is therefore vital to understand the extent to which gender aspects impact on ownership, cultivation patterns, division of labor, post-harvest processing, livestock raising, and dairy production. Future extension work should acknowledge women's input at various stages of cultivation (with regional variations), and their significant responsibilities in post-harvest processing of crops. Moreover, livestock extension must focus on women as far as veterinary services are concerned. While there are no exhaustive surveys of the division of labor within rural households nor of women's contribution to the agricultural economy, evidence from a number of scattered local surveys highlights that women's and girls' contribution is very significant but remains largely Main Characteristics of Villages Village A Village B Village C (mainly Pashtun) (Pashtun) (Pashtare) Household activities, Women's Household farmingfarm labor, Household activities, production activities--cheese, migration wood collection, farming, activities embroidery, sewing (piecework/farm labor) farm labor Women Men Women Men Women Men Crop planting x x X xx x x Crop Main-tenance (mainly weeding) x x Xx xx x xx Irrigation xx X x xx Crop Harvest x xx Xx xx xx xx Crop Process x x X Wild Plant x x X x xxx x Collection Fodder xxx x Xx x xxx Management Livestock xxx x Management Shepherd x x x Farm Labor x X x x Non-Farm Labor x x x Transport x x Other xxx Xx x xx x: less than 10% of positive respones; xx: 10% or more positive respones; xxx: more than 25% positive respones Source: Kerr-Wilson and Pain, 2003: Table 1, p. 8 and Table 11, p. 16. (continued) 106 A World Bank Country Study Box 6.5. Agriculture and the Gender Division of Labor (Continued) unrecorded and un-monetized. A significant portion of households in all surveys are female- headed. Women and girls undertake a wide range of farm-based activities ranging from seed bed preparation, weeding, horticulture, and fruit cultivation to a wide range of post-harvest crop pro- cessing activities such as cleaning and drying vegetables, fruits, and nuts for domestic use and for marketing. The chart at right, showing three villages with different conditions, demonstrates the centrality of women's involvement in all stages of the production of crops and livestock. Better applied research, a more focused policy that acknowledges women's central contribution to agri- culture, and associated investment instruments geared toward women are therefore needed. revival, in particular, depend to a large extent on improving market efficiency and an envi- ronment that encourages greater private sector investment. Present Status. Agricultural markets and support services are not well developed in the Afghanistan. The most serious constraint has been the absence of a well-maintained road network, although fears about security, poor market facilities, and telecommunica- tions also are important issues. Wholesale market infrastructure, even in major urban centers, is sub-standard, lacking in many cases basic services such as water, electricity, and sewage. There is no organized management of these markets, most of which are on land nominally owned by municipalities, as a result of which trading is done in unhygienic conditions and no money is spent on maintenance. Facilities for sorting, cooling, pack- aging, and storage are poor or non-existent (and cold storages will require reliable sup- plies of electricity). Support services like market information systems do not exist. Food safety regulations, grades and standards, quality control, and testing and certification services are lacking or weak. Government Strategy. While investments in roads and other market-related infra- structure will help address the "hardware" side of market development, capacity in MAAH and the Ministry of Commerce to support the equally if not more important "software" side is lacking. Not enough attention is being paid to strengthening this aspect, despite a general consensus that addressing marketing constraints is essential for accelerated and sustainable agricultural growth. This could have adverse consequences for development of an export-led horticulture sector. Recommendations for Consideration. Strategically, and to keep the task manageable, it would be appropriate to focus in the short term on improving market prospects for horti- cultural products. Afghanistan has a long tradition in horticulture, so most Afghan farm- ers and traders are already familiar with many horticulture crops and are likely to be receptive to measures that improve product quality and marketability. Second, some of the high-value horticultural commodities, if properly marketed, could generate large farm- level profits and employment. These could include spices (small amounts of saffron and cumin are already being exported), medicinal herbs, flowers, fragrances (like rose oil), and the more traditional dried fruits and nuts. Third, fuelled by rising consumer incomes, international demand for income-elastic horticultural products is growing rapidly, notably in Russia, Eastern Europe, India, and East Asia. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 107 International markets for horticultural products are very competitive and demanding in terms of quality. The challenge for Afghanistan is to stimulate private sector-led initia- tives, backed by public investment in critical infrastructure and an appropriate regulatory environment (such as for sanitary and phyto-sanitary measures). Actions to stimulate pri- vate investment economy-wide are discussed in Chapter 5. Establishing an appropriate regulatory environment and support services for modernizing horticultural markets would include: i. Public investments in roads, including those linking farms to markets, and availabil- ity of other basic infrastructure like electric power to run cold storages and other mar- keting facilities. ii. Establishing minimum standards for different wholesale agricultural markets to provide basic amenities and marketing facilities, and developing a system for man- agement and operation of these markets by elected representatives of the main market players (farmers, traders, processors, and so forth) that is financially sus- tainable through collection of marketing fees, with Government oversight limited to ensuring fair trading practices. iii. Developing and enforcing a grades and standards system that reflects market requirements. Private stakeholders need to take a lead role in the development of these standards, with Government facilitation and enforcement of an agreed sys- tem. Information on sanitary and phyto-sanitary standards in different countries is needed. iv. Supporting strategic market research to assist the Government in deciding which crops should be supported in terms of research, extension and other facilities. v. Emphasizing marketing issues in agricultural extension to: (i) help farmers and others better understand markets and become more commercially numerate; and (ii) link farmers to agribusiness. Adoption of a farmer group approach to agricul- tural extension will also facilitate group marketing, which can significantly enhance the negotiating power of farmers and the prices they receive for their produce. vi. Piloting a publicly funded market information system to test its usefulness and cost effectiveness; if successful the model can be scaled up with private funding/ partnership. Rural Credit A functional rural financial system is necessary to enable farmers to better manage their activities, improve technologies, and increase productivity. Based on the lessons of inter- national experience with directed lending to agriculture through publicly-owned institu- tions, and in line with current development thinking, the Government has decided to dissolve the state-owned Agricultural Development Bank. Currently, traditional sources (moneylenders, traders, family, friends) are the main source of agricultural credit, together with various NGO-led micro-finance initiatives. The Micro-Finance Support Facility of Afghanistan (MISFA) is seen as the primary apex facility for micro-finance, with a target of reaching 80,000 people in its 18-month pilot phase. The program has started well and by March 2004 had an estimated 25,000 clients. At this early stage the main issue is related 108 A World Bank Country Study to cost-effectiveness--administrative costs in the first year of operation have been high, reportedly as much as 1:1 for each dollar lent as substantial expenditures went into estab- lishing new facilities. The lower population density in Afghanistan's rural area as compared with the cities and with many other countries also affects costs. Administrative costs have to be controlled for financial sustainability of the program. Establishing a viable rural financial system in Afghanistan should be seen as a medium- term objective rather than a short-term goal. Creative solutions for filling the gap between micro-finance at the low end and nascent larger-scale commercial lending need to be explored, in order to respond effectively to farmers' credit requirements. This will be espe- cially important in the case of marketed horticultural products and exports. Rural credit also needs to be seen as part of a wider financial systems approach within which financing for agriculture is viewed as part of the broader rural finance market. Key priorities put for- ward in a recent World Bank report on this subject include the following: i. In the short term, establish an effective system of NGO and micro-finance regis- tration and monitoring, and facilitate entry and expand outreach. ii. Adopt new NGO legislation that encompasses micro-finance activities and other savings and credit associations; encourage larger, well managed institutions to expand their range of products, including deposit taking among members. iii. Eventually consider transformation of some of the larger micro finance entities into banks or non-bank financial institutions. Prospects for Afghan Agriculture Future agricultural prospects in Afghanistan depend to a large extent on how speedily and effectively public and private institutions can respond to challenges and provide an appro- priate environment that can stimulate market-driven agricultural growth. The last two years have seen a strong recovery from the drought of 1999­2001. Sustaining and further build- ing on this recovery in the medium term will depend on weather and security conditions but also on investments and institutional strengthening in the key areas discussed above. Expanding the scope and effectiveness of irrigation is the best option to raise yields and reduce the vulnerability of the agricultural economy to drought. However, benefits from irrigation investments could be modest if agricultural technology and market-related ser- vices are not strengthened concurrently. These are critical gaps in the current strategy. On purely economic grounds, opium poppy is the most profitable crop and is likely to remain so (Box 6.1). Poppy cultivation in Afghanistan in many respects represents a model of contract farming--inputs, extension advice, and credit are provided to farmers under a firm buyback arrangement at an attractive price. Finding alternative crops to match these arrangements will be difficult if not impossible. Thus a combination of agricultural and rural development with effective law enforcement will be necessary (Chapter 7). Wheat will continue to be the most widely grown crop in Afghanistan for some time, partly for subsistence reasons and partly because diversification will take time to materialize to a substantial degree. Prior to 2003 wheat yields in Afghanistan were much lower than in neighboring countries. In 2003 irrigated wheat yields in Afghanistan increased significantly to an average of 2.8 tons/hectare, close to levels in neighboring countries, based on good precipitation and improved availability of seeds. Rainfed wheat yields rose to an average Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 109 1.1 tons/ha, also comparable to yields in neighboring countries. However, there is no struc- tural reason for wheat yields (and incomes) to be trapped at these levels. In the medium term, national average irrigated wheat yields of 3.0 to 3.5 tons/ha and rainfed yields of around 1.5 tons/ha would be feasible with improved on-farm management and appropri- ate inputs. Already in 2003, average irrigated yields of more than 3.5 tons/ha were recorded in four wheat producing provinces. Among horticultural crops, raisins, apricots, pistachios, almonds, melons, and pome- granates appear to have relatively greater economic potential. Less is known about some of the spices, medicinal herbs, fragrances, and flowers, although some of them (such as saffron, roses) may have very good potential. Key challenges relate to improving product quality and access to export markets. In addition to investments in roads and other infra- structure, steps to modernize research, extension, and marketing will be critical in addressing issues related to varietal improvement, improved post-harvest practices, and export market access. In the livestock sector, restoring the size of animal populations, severely affected by the drought, is the priority. This requires investments and institutional strengthening in animal health services and in meeting animal nutrition demands. Even so, recovery in the livestock sector is likely to be gradual.3 In the longer run, breed improvement is likely to become a focal area for which national level data on different breeds, currently unavail- able, will be a prerequisite. Given its nature and scale and the many challenges faced, the process of rebuilding the agricultural sector in Afghanistan will take time. Success will also require coordina- tion between Government ministries, a large and varied donor community, the private sector, and the farming community. With the right leadership, commitment, and sus- tained prioritization of agriculture, there is no reason why the challenges cannot be suc- cessfully met. 3. According to one estimate, based on a return to normal weather patterns and technical assump- tions about fertility/mortality levels, it could take five years for small ruminants to return to pre-dought levels and up to 10 years for cattle numbers to recover. CHAPTER 7 Understanding and Responding to the Drug Economy1 H eroin, made from opium, is an extremely dangerous drug, with some 15 mil- lion addicts worldwide and strong links to HIV/AIDS and crime. Global out- put of opium shot up from 1,000 tons in 1979 to some 4,500 tons in 2002 (equivalent to about 450 tons of heroin). Afghanistan currently produces the bulk of the world's illicit opium. The impact of the drug industry on Afghanistan's economy, polity, and society is profound, including some short-run economic benefits for the rural pop- ulation and macro-economy but major adverse effects on security, political normaliza- tion, and state building. Hence responding effectively to the drug economy will be essential. This chapter first describes and analyzes Afghanistan's opium economy and its key economic and other implications. Lessons from international and Afghan experience with efforts to curb the drug industry are discussed, and the Government's National Drug Control Strategy is then summarized. The main options and instruments for strat- egy implementation are outlined and their respective advantages and drawbacks assessed. Given the magnitude, complexity, and profound implications of the drug indus- try in Afghanistan, the emphasis is not on hard-and-fast solutions but rather on gaining a better understanding of the issues and trade-offs. 1. This chapter, which consolidates recent analysis by the World Bank, draws on the excellent work of UNODC (in particular UNODC 2003b), and on micro-level fieldwork by the UK and others. However, it should be emphasized that quantitative data on the drug economy are by their nature rough estimates and hence should be used with caution. 111 112 A World Bank Country Study The Opium Economy in Afghanistan Growth and Spread of Production In conditions of lawlessness and impoverishment, and starting from a tiny base in the late 1970s, opium has become Afghanistan's leading economic activity, having now spread to all of Afghanistan's 34 provinces. Opium production (measured at farm-gate prices) is esti- mated to have generated close to one-sixth of total national income in 2003, and the sub- sequent trade and processing of opium into opiates (heroin and morphine) generated a somewhat greater amount of income within Afghanistan. The proportion of opium refined in-country appears to be continuing to rise, and reportedly most recent drug seizures at Afghanistan's borders have been of opiates. As can be seen from Figure 7.1, growth of opium cultivation and production was substantial in the 1990s and was interrupted for only a single year by the effective ban imposed by the Taliban. Although the proportion of Afghanistan's land and labor resources used for opium production is relatively small--only about 7 percent of total irrigated land area even after a large increase in opium poppy cultivation in 2004, as many as two million people are involved in opium production, earning higher incomes than in other activities. In 2003 the Figure 7.1. Opium Cultivation and Production Trends, 1990­2004 140,000 7,000 130,000 6,500 120,000 6,000 110,000 5,500 100,000 5,000 90,000 4,500 80,000 4,000 70,000 3,500 60,000 3,000 50,000 2,500 40,000 2,000 30,000 1,500 20,000 1,000 10,000 500 0 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Opium poppy cultivation (hectares) Opium production (metric tons) Note: Data for the earlier years up to 1994 are considered less reliable than data for more recent years. Source: UNODC (2003a, 2003b, 2004). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 113 average gross income per hectare from opium cultivation exceeded that of wheat, the main alternative crop, by as much as 27 times. In some parts of the country where poppy culti- vation is concentrated, wage rates of as much as $11­12 per day for opium harvesting work have been reported, five times the market wage rate for rural unskilled labor. Although incomes declined in 2004, they remain far higher than those in other agricultural activities. The rapid growth of the opium economy in the past two decades demonstrates that it is very attractive to farmers--a durable commodity commanding a high price, having a guaranteed market, with credit and other inputs available from traffickers, easy to trans- port, and non-perishable. The phenomenal rise of the opium economy can be in addition attributed to: i. Exit of other suppliers and growing world demand. Three opium producers (Iran, Pakistan, Turkey) stopped opium cultivation, opening up a supply gap in the world market that Afghanistan could fill. Growth of demand in neighboring countries, especially Pakistan, and in Europe starting in the mid-1980s further enhanced growth prospects for Afghanistan's opium production. ii. Collapse of governance and law enforcement. During the conflict Afghan govern- ments effectively lost control of the countryside, and there was no credible law enforcement. iii. Drugs and arms. Drugs provided a ready source of cash to pay for arms, and an opium for arms trade arose which various actors involved in successive conflicts encouraged. iv. Rural pauperization. The conflict led to extreme rural impoverishment--more than half of Afghanistan's villages were bombed, livestock numbers dwindled, irri- gation networks were destroyed or run down, and over a third of land went out of production. A modest agricultural recovery in the mid-1990s was wiped out by the severe drought of 1999­2001. Under these dire circumstances, and despite religious and cultural aversion, opium production came to be widely accepted as a coping mechanism and livelihood strategy. v. Comparative advantage. Based on its natural conditions, weak security environ- ment, and experience with large-scale production, Afghanistan now has a strong comparative advantage in opium production. vi. Market development. Market organization is excellent, well adapted to the charac- teristics of the product and to the nature and intensity of risks. Markets extend from the farm gate to the frontier and beyond, and there is working capital financ- ing available at all stages, as well as credit and other inputs for producers. Given the small share of Afghanistan's land and labor resources now devoted to opium, modest requirements for other inputs, and the level of know-how and market organiza- tion, there is ample potential for further increases in production. Price declines (resulting from market saturation), wage increases for skilled labor used in opium harvesting, disease resulting from overextension of production, and changing expectations with respect to law enforcement could moderate further growth of the opium economy. However, the most recent UNODC survey indicated that farmers planned to further increase the area under poppy cultivation for the 2004 crop, and in the event there was an estimated 64 percent increase in the total poppy area (Table 7.1). 114 A World Bank Country Study Table 7.1. Estimated Opium Cultivation, Production, and Incomes 1995­2004 1995 2000 2001 2002 2003 2004 Production (tons) 2,300 3,300 185 3,400 3,600 4,200 World Market share (%) 52 70 11 74 76 87 Number of provinces n/a 23 11 24 28 34 producing opium Area under poppy prod (ha) 54,000 82,000 8,000 74,000 80,000 131,000 Area under poppy/Area 2.0 3.2 n/a 3.2 2.8 5.9 under cereals (%) Gross farm income per 1,000 1,100 7,400 16,200 12,700 4,600 ha (US$) Value of opiate exports n/a 850 N/a 2,500 2,300 2,800 (million US$) Gross farm income from 50 90 60 1,200 1,000 600 opium (million US$) Gross downstream domestic N/a 760 N/a 1,300 1,300 2,200 income (million US$) Note: Estimates have considerable margins of error; there have been some changes in estimation methods over time. Source: Afghanistan Government (2004b, Table 1.2); UNODC (2003a, 2003b, 2004). Prices and Incomes Farm-gate prices of opium were low in the 1990s, but a nearly ten-fold rise occurred when the Taliban banned opium production in 2000 (Figure 7.2). High prices of $300/kg or above were maintained in 2002­03 despite the recovery of opium output, but prices declined in late 2003 and have fallen more sharply in 2004, to an average of around $90/kg by late summer before a modest recovery post-harvest. It is clear that margins between farm-gate prices and border prices of opiates are very large, on the order of dou- ble in 2002/03 and well over four times in 2004 (based on the gross income estimates in Table 7.1). The lion's share of opium income in the 1990s went to traffickers rather than farmers, and several other crops were financially competitive with opium. This pattern changed dra- matically after the Taliban ban, and close to half of annual gross income from the opium economy appears to have gone to the farm level in recent years, although this share has declined as farm-gate prices fell in 2004. The share of opium output refined within Afghanistan appears to have been rising, leading to higher domestic value added accruing to traders and processors. The following groups benefit from the opium economy: i. Better-off farmers (characterized by significant landholdings and capital resources), cultivating poppy on their own land (typically as part of a diversified cropping pat- tern including other food crops and cash crops) and in many cases letting out part Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 115 Figure 7.2. Opium Farm-gate Prices 1994­2004 400 350 300 250 200 150 100 50 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Average farm gale price of fresh opium (US dollars) Source: UNODC (2003a, 2003b, 2004). of their land to sharecroppers and getting part of the poppy crop in return. These farmers have been major beneficiaries of the opium boom and many of them have become rich. ii. Poor farmers (probably most of the roughly 350,000 farm households estimated to be involved in poppy cultivation), typically with little or no land and often bur- dened with debt, cultivating opium poppy on tiny amounts of their own land or as sharecroppers (with opium cultivation normally required by the landlord). For these farmers, the benefits of high opium prices in recent years may have been to a large extent dissipated by servicing high-interest debts and by unfavorable share- cropping arrangements. iii. Rural wage laborers, as many as half a million, the bulk of them poor, who harvest the poppy crop which is a highly labor-intensive activity. Large numbers of itiner- ant laborers move seasonally following the poppy harvest in different areas. Wage laborers have benefited from the opium boom, although many of them also may be mired in debt. iv. Small opium traders, very roughly estimated by UNODC (2003b) at around 15,000, who buy and sell raw opium at the farm gate and at "opium bazaars," and typically handle small volumes (as little as 100 kg per year or less) and in many cases are often involved in the trade on a part-time basis. v. Wholesalers and refiners, much smaller in number, who trade in large quantities, organize processing, move product across the border, and so forth. vi. Local warlords and commanders, who receive "protection payments" and in turn employ substantial numbers of militia fighters, and may "sponsor" processing facilities. vii. Government officials, at various levels, who receive bribes from the drug industry in return for favors in law enforcement or other aspects. 116 A World Bank Country Study The gender dimension of the opium boom also is noteworthy. Women play a very im- portant role in poppy cultivation in northern and eastern Afghanistan, being involved in planting and weeding; thinning; lancing the capsules; collecting the opium; clearing the fields; breaking the capsules and removing the seeds; cleaning the seeds; and processing by-products like oil and soap. In the southern, generally more conservative region, women do not participate directly in opium poppy cultivation but rather indirectly by preparing meals for hired laborers. Although women's labor in poppy cultivation traditionally has been unpaid, local labor shortages in some areas have led to women in Badakhshan and Takhar provinces, often for the first time, being paid wages. This is in addition to women's traditional right in many areas to make a final pass at already harvested opium fields and glean what is left. Tragically, daughters are often used to settle opium-denominated debts. Drug Industry Structure and Market Organization What we know about the opium business in Afghanistan suggests that it more closely resembles a competitive market than a criminal cartel. Entry and exit seem to be relatively easy for both production and trafficking, and the number of participants is high. Opium is openly bought and sold on various markets. Parts of the drug industry are more con- centrated, with relatively few and more powerful actors involved in opium refining and cross-border trading. There is, however, evidence of new entrants joining even at these stages of the business, and the existence of a number of trading routes going out of Afghanistan to the North, West, South, and East facilitates competition nationally if not necessarily locally. Increasing refining of opium into heroin within Afghanistan, to the extent that it is occurring, may be accompanied by drug industry consolidation. Opium production has been responsive to prices and has shifted locations in response to erad- ication campaigns, demonstrating that it is "footloose." Prices have been flexible at the micro level.2 Some implications of a competitive drug industry are explored in Box 7.1. In addition the criminal nature of the drug business--and consequent ability and tendency to use armed force in the conduct of business--needs to be taken into account. In the Afghan context where government military power and law enforcement have been weak, and where local conflict is conducted mainly with small arms, entry into the military sphere by small actors with limited resources would be easy. Moreover, it would be difficult for one or a few actors to dominate militarily on a sustained basis. Under such circumstances a fragmented, competitive drug industry could emerge, leading to fragmented capture of the state apparatus at the local level by drug interests, which would be inimical to the emer- gence of an effective, unified state. 2. The maintenance of opiate exports apparently at near normal levels during the year of the Taliban ban, and then the persistence of high farm-gate prices for two years after large-scale opium production was restored, may be explained by the existence of large inventories in the late 1990s, which were sold off to maintain supply during the year of very low production and then were rebuilt when production resumed. The recent sharp decline in farm-gate prices reflects the impact of oversupply in the face of already high inventories by the end of 2003. But more work is needed to better understand opium price trends. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 117 Box 7.1. The Competitive Model of the Drug Industry If the number of actors in the drug industry is great enough that there is no opportunity for strate- gic behavior, or if anti-competitive behavior is deterred (at least over time) by new entry or its threat, a competitive model of the drug industry may be applicable to Afghanistan. This would have the following implications: i. Opium prices would adjust to the point where marginal cost is equated with demand (as opposed to marginal revenue in the case of a monopoly producer). Thus prices would be lower than in a monopoly situation, and production in a static sense would be higher, unless demand is completely price inelastic. ii. Over time the supply curve would adjust through expansion, new entry, etc. to the point where "excess profits" in the drug industry are eliminated. This does not mean no prof- its, just a normal level of profits competitive with what can be earned in other sectors (factoring in a risk premium and the cost of avoiding law enforcement). iii. Production could increase quite sharply (at least from season to season) in response to foreign demand. iv. Once there is full adjustment to the perfectly competitive equilibrium, further growth of total opium production would tend to track world demand rather closely. v. Thus the nightmare scenario under the competitive model is one of an efficient, com- petitive drug industry increasingly embedded in Afghan society and with low opium prices stimulating world demand. Heroin demand is growing slowly in Western European mar- kets but very rapidly in Asia and the former USSR. The perfectly competitive model suggests that resources for political influence and destabilization would be under fragmented control. Hence there would likely be a pattern of fragmented capture of the state apparatus at the local level and exercise of power by illegitimate drug-financed local and regional authorities. Economic and Poverty Implications The sheer size of the opium economy means that it has very important economic implications andlinkages(Box7.2).Itisakeypartofthe"informalequilibrium"oftheeconomyasawhole, discussed in Chapter 1. From a macroeconomic perspective, the opium economy stimulates aggregate demand and has a positive effect on Afghanistan's balance of payments but does not contribute to government taxes except indirectly, for example through Customs duties on imports financed by drug proceeds. The very large size and potential volatility of the opium economy constitute a significant risk for the Afghan economy as a whole (Chapter 1). The impact of Afghanistan's drug economy on household incomes is of central impor- tance from a poverty perspective. In recent years Afghan farmers have received in the range of half a billion dollars annually from opium production, with another several hundred million dollars probably going to wage laborers (see Ward 2004, Table 1). This constitutes an enormous injection of income into Afghanistan's battered rural economy. Income from opium appears to be unevenly distributed. For the better-off it has been a source of wealth creation, for the poor it has been a coping mechanism for survival and in many cases for gaining access to credit and land, albeit on unfavorable terms. In sum, the opium boom in recent years appears to have been a potent force in generating incomes in rural areas. 118 A World Bank Country Study Box 7.2. Key Economic Linkages Income: The income accruing to the Afghan population from both production and trade in opium is quite high in relation to the GDP of a very poor country. This income is allocated to a very large number of participants in the farm and trading sector, and also through protection payments to others. Consumption: Even allowing for leakages from expatriation of opium revenues, it is clear that a large share of drug receipts is spent in Afghanistan, mostly on consumption expenditures for goods and services. Domestic production: A substantial percentage of consumption expenditures from drug receipts would appear to be on domestically-produced goods and services. This is especially true of farm and wage incomes. Investment: A significant part of drug receipts goes into re-investment, since the drug business itself absorbs working capital and fixed investment in processing and transport facilities. Surplus funds may be invested mainly in building construction (helping finance building booms in Kabul and other cities), transport, and trade. Balance of payments: It is likely that a considerable share of gross drug proceeds (roughly estimated at $2.3 billion in 2003) stays in Afghanistan. Although estimates are highly uncertain, taking into account the propensity to import from drug industry proceeds (e.g. for durable goods like vehicles and televisions), the net positive effect on Afghanistan's balance of payments could be in the range of $1 billion annually. Fiscal linkages: Opium revenues largely escape the official tax net. It is reported that opium farm- ers pay the ushr tithe, which in some regions may be paid to the local mullah, in others to the local administration or commander. More important, a large share of opium farm gate receipts and downstream income goes into levies of various kinds by local interests, outside the budget. (For example, the most recent UNODC Farmer Intentions Survey reported that farmers pay local com- manders between 10 and 40 percent of the opium harvest, and that in some areas opium traders pay local commanders for the right to enter producing villages and purchase opium there.) An indi- rect fiscal linkage is that Customs duties are levied on many imported goods paid for with drug receipts. Asset prices: The real estate market in Kabul and in other large cities is booming, and rural land prices also appear to be on the rise. This may reflect to some extent an influx of drug money. Wage rates: The drug economy also appears to be driving up rural wage rates. Wage rates have gone up to peaks of $11­12 a day for a skilled worker during the harvest period. Rural unskilled wages in the winter of 2003/04 were in the range $2.50­3.00 per day, compared to $1.50­1.75 in the pre- vious winter. There are signs of insufficient labor coming forward for government public works pro- grams at the offered wage of $2 per day. However, wages may moderate with the recent decline in the farm-gate price of opium. Finance and credit: The opium economy provides considerable amounts of credit to the rural econ- omy, which is attractive to farmers who often have no other sources of credit. However, implicit interest rates are very high, and advances tend to be denominated in opium, exacerbating the long- term dependency of farmers on opium. An understanding as to why farmers grow poppy is essential for design of effective strategies to respond to the drug economy. Available information suggests the following: i. Poppy cultivation is an important element in poppy farmers' strategies for crop mix and risk management, with some farmers specializing in opium (particularly highly indebted small farmers) but many cultivating poppy as one among several crops. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 119 ii. For most poor rural households wage income is more important than farm income. Thus they benefit from high demand for labor for poppy cultivation and harvesting. iii. The majority of households have to buy most of their food from the market. Opium production or associated wage labor provides assured cash with which to purchase food. iv. High levels of risk associated with opium production encourage landowners to sharecrop out some of their land for poppy cultivation, which spreads risk and at the same time provides access to land and water (and often credit) for the poor through sharecropping. v. Many poorer farmers report that they are obliged to cultivate poppy, even if they have misgivings about doing so, due to high debts or sharecropping requirements. vi. There is variation among regions, and even among communities in a local area, in the mix of rich and poor opium farmers, the relative importance of farming and wage labor, land tenure arrangements, and access to opium markets. These stylized facts provide an indication of the complexity of farmer and household motivations and of the rural livelihood impacts of opium. Poppy has enabled some peo- ple, not necessarily poor in the first place, to grow rich, but for many more people the opium economy has become an important source of income enabling them to cope better with the poverty and vulnerability that they remain mired in. Abrupt shrinkage of the opium economy or falling opium prices without new means of livelihood would signifi- cantly worsen rural poverty. Finally, although the rate of addiction to opiates in Afghanistan is believed to be relatively low it is likely to be rising, facilitated by the increas- ing trend of refining opium into heroin in-country and the return of heroin-addicted refugees from neighboring countries. Security and Political Implications The opium economy has profound adverse implications for security, politics, and state building in Afghanistan. It contributes to a vicious circle whereby the drug industry finan- cially supports warlords and their militias, who in turn undermine the Government-- which is also corrupted and captured at different levels by bribes from the drug industry. As a result the state remains ineffective and security weak, thereby perpetuating an envi- ronment in which the drug industry can continue to thrive. The linkages between drugs, warlords, and insecurity add up to a vicious circle of mutually-reinforcing problems, shown in Figure 7.3 (see also Chapters 1 and 4). There is also some anecdotal evidence of linkages between drug money and terrorist networks. Warlords, drug interests, and terrorists work together to promote insecurity and weaken the state, even if their interests do not coincide in other respects. In fact many war- lords and local commanders directly sponsor or are otherwise involved in the drug indus- try, and the same may be true of some terrorist groups. All in all, the security and political implications of Afghanistan's opium economy present a grave danger to the country's entire state building and reconstruction agenda. 120 A World Bank Country Study Figure 7.3. A Vicious Circle Warlords Warlords undermine Protection and government other payments or capture strengthen parts of it Drug related Warlord corruption militia provide warlords undermines security for government opium economy Opium Government economy Warlords undermine national Poor security Weak security creates good government environment for unable to Security opium economy provide security Lessons from Experience in Fighting Drugs International Experience Drug consuming nations have invested heavily in drug control, but success has been elu- sive. Law enforcement and interdiction of international drug shipments have raised the risks associated with drugs, increased prices, and interrupted supply. Demand-side inter- ventions such as treatments can mitigate some of the adverse effects of drugs, including crime and HIV/AIDS. But there has been no large, sustained reduction in global con- sumption of illicit narcotics. There is also rich international experience with supply-side interventions to reduce drug production, primarily eradication of poppy fields. A key lesson is that eradication alone will not work and is likely to be counterproductive, resulting in perverse incentives for farmers to grow more drugs (for example, in Colombia), displacement of production to more remote areas, and fueling of violence and insecurity (Peru, Bolivia, Colombia), which in several cases forced the eradication policy to be reversed and led to adverse political outcomes. Neither does the approach of making eradication a condition for devel- opment assistance work--without alternative livelihoods already in place, premature erad- ication damages the environment for rural development. The most successful case of speedy and sustained drug eradication was in Iran, where the Khomeini government quickly brought down opium poppy cultivation from 33,000 ha prior to 1979 to zero. However, there arose a major problem with transit of drugs pro- duced in Afghanistan through Iran, and the country's strong interdiction efforts have been responded to with violence and terror--since 1979 more than 3,000 Iranian law enforce- ment officers have been killed in confrontations with heavily armed drug traffickers. Moreover, Iran has been left with the highest opiate addiction rate in the world--nearly Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 121 2 percent of the population are regular drug abusers. Mexico succeeded in eradicating poppy by spraying in the mid-1970s, but the drug industry responded by dispersing culti- vation to smaller fields hidden in remote areas, and by the early 1980s Mexico was supply- ing as much heroin to the US market as before eradication. Thailand and Pakistan succeeded in eliminating opium production on a sustainable basis. Their approach has been gradual, taking decades rather than months or years. In both cases, eradication was undertaken only following the implementation of compre- hensive alternative development programs which raised incomes in the target areas through development of profitable cash crops. In both cases, poppy cultivation was local- ized and constituted a small percentage of total national economic activity. Moreover, opium production boomed in neighboring countries (Myanmar in the case of Thailand and Afghanistan in the case of Pakistan), suggesting that the drug industry moved its activ- ities elsewhere rather than shutting down. Afghanistan's Experience Afghanistan has had more than a decade of experience with efforts to reduce opium pro- duction. All of these initiatives failed to achieve their objectives (Box 7.3), except for the Taliban ban which succeeded in drastically reducing opium production for a year--but with questionable sustainability, worsening poverty, and no apparent effect on the flow of Box 7.3. Counter-Narcotics Experience in Afghanistan Since the early 1990s, there has been a series of attempts to control opium production in Afghanistan, each of which has been in its own way unsuccessful. Alternative development without security and political support: Starting in 1989 several projects were initiated following the model of "alternative development" used in Pakistan and the Andean region. These projects were in areas where opium production was entrenched and there was inse- curity and lack of political support. Benefits were offered to communities (through their councils of elders or shuras) in return for a commitment to phase out opium cultivation, but there was no impact on production. An evaluation concluded that the shuras were unrepresentative, there was too little connection between project benefits and farmer motivations and constraints, the better- off captured the benefits, and offering benefits with "conditionality" created perverse incentives. A simple ban vigorously applied: In 2000 the Taliban imposed a complete ban on opium cultiva- tion, severely enforced, which resulted in production in Taliban-controlled areas falling to negli- gible levels. No restrictions were imposed on trade, however, and the flow of opium out of Afghanistan did not much diminish. Border and consumer prices remained high, while farm-gate prices shot up, suggesting that operators may have maintained turnover by running down large inventories. The eradication campaign pauperized many farmers, requiring them to incur debts which they are still repaying. The ban also promoted a shift in cultivation to northern areas out- side the Taliban's control, and shifted trade to the northern trafficking route through Tajikistan. Eradication with promised cash compensation: The post-Taliban government quickly banned the cul- tivation, production, abuse, and trafficking of drugs, and in the spring of 2002 an eradication cam- paign was carried out on about 17,500 ha. Compensation was offered but apparently only actually paid to one tenth of the farmers whose crops had been destroyed. In many areas eradication seems to have involved opportunistic local power plays, with factions trying to destroy the economic power base of other factions. Failure to honor promises of compensation impoverished smaller and highly- indebted farmers and harmed the credibility of the program. Only 12 percent of respondents to a UNODC survey said that the eradication campaign would deter them from planting. (continued) 122 A World Bank Country Study Box 7.3. Counter-Narcotics Experience in Afghanistan (Continued) Eradication with promise of reconstruction support: In 2003 more than 21,000 ha of opium was reportedly "eradicated," and opium production was "foregone" through persuasion on 5,000 ha more. Some was eradicated by local authorities who promised that rural development assistance would follow, but this has come slowly if at all. Although there were marked reductions in poppy area in Helmand and Kandahar provinces, elsewhere production grew and spread to new districts and provinces, and the total poppy area increased by 8 percent to 80,000 ha. opiates into consumer markets. Moreover, the Taliban ban resulted in a sharp rise in the farm-gate price of opium and stimulated a multi-fold increase in opium production in areas outside the Taliban's control. After the Taliban were removed total national output rebounded to near-record levels. Recently a new approach has been developed--"alternative livelihoods"--which takes a holistic rural development perspective in implementing projects intended to enable those whose livelihoods currently depend on poppy production to find other, sustainable liveli- hoods (through a combination of on-farm and off-farm activities). Some relatively small projects have already been initiated and are generating valuable experience with this con- cept. Except in that it may be associated with law enforcement measures, the alternative livelihoods concept resembles any good integrated rural development project and in that sense is not controversial. There are however some important issues. First, no matter how well designed and implemented, relatively small interventions cannot be expected to make much of a dent in the enormous opium economy. What is really needed is generalized eco- nomic growth and rural development--"alternative livelihoods for Afghanistan as a whole"--which can only be accomplished through reforms, policies, and substantial pro- grams implemented nationwide. Thus the alternative livelihoods approach needs to be integrated into the national rural development and poverty reduction strategy. Second, the sequencing of alternative livelihoods initiatives with law enforcement actions is extremely important for the effectiveness of both and needs delicate management. Some General Lessons Perverse Incentives Associated with Targeting. Providing development assistance in return for a locality's commitment to stop opium production, paying farmers compensation for destruction of poppy fields, and implementing alternative livelihoods projects or other development projects in poppy-growing localities--all involve targeting of farmers or localities currently cultivating poppy and providing them with benefits for stopping. This can generate perverse incentives for others, not currently producing opium, to get into the business in order to be eligible for benefits. In order to minimize the risk of perverse incen- tives, assistance should not be targeted solely or primarily at farmers and localities currently cultivating poppy. Price Effects. Eradication and other actions to reduce the supply of opium (including successful alternative livelihood projects) will likely result in higher farm-gate prices, increasing incentives for farmers to cultivate poppy. The very large, lasting price rise after the Taliban ban on opium cultivation is a notable example. Such price effects need to be Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 123 taken into account and may influence the mix and sequencing of actions. For example, interdiction against trafficking and refining, by disrupting downstream stages and at least temporarily reducing demand for opium at the farm gate, may have a lesser (or even neg- ative) impact on farm-gate prices. Short-term versus Longer-term Implications. Experience has shown that the short-term and longer-term effects of actions against drugs can be quite different, making sustainable success elusive. For example, eradication even if successful tends to result in shifting of opium production elsewhere, so the outcome over the medium term is that total produc- tion has not been much affected but is now dispersed in more remote areas where it is more difficult to root out. Prioritization and Sequencing. The impact of different actions against drugs can depend very much on how they are combined with other actions and how they are sequenced. For example, eradication in the absence of alternative livelihoods being available does not work, and eradication followed by assistance does not seem to work well, yet eradication (and its threat) can help reinforce alternative livelihoods development if the former fol- lows the latter. Effects of Poor Security and Governance. Implementation of development programs and law enforcement in conditions of poor security and weak governance is extremely difficult, and distortions inevitably emerge. The credibility and effectiveness of recent eradication campaigns have been weakened by local responsibility for implementation and associated perceptions of factional bias, corruption, and favoritism in the selection of which fields to eradicate. Anecdotal evidence suggests that the poor have been disproportionately affected by eradication. Strategic Interactions. From a dynamic perspective the drug industry, which has very large interests at stake, can be expected to respond vigorously to efforts to curb opium production, refining, and trade. The more effective the Government's actions, the more vigorous the likely response from the drug industry. It has a formidable arsenal of instru- ments, including: (i) pricing--given the huge margins beyond the farm gate there is scope for the drug industry to raise prices almost to any level necessary to provide adequate incentives to opium cultivators; (ii) location--the drug industry is "footloose" in shifting the location of refining, trade routes, and cultivation; (iii) inputs and extension services-- these contribute to the attractiveness of opium cultivation; (iv) corruption--the resources of the drug industry can be used for bribery on a massive scale to undermine efforts against drugs; and (v) armed violence against the authorities, and against others (for example, coer- cion of farmers). Need for Innovative Approaches. Limited success in past experience with fighting drugs does not give much ground for optimism, especially in view of the unique aspects of the opium economy in Afghanistan (most notably its sheer size). No single approach is likely to be effec- tive and sustainable; a combination of different measures, well-designed and well-sequenced, will be essential to have any hope of success. There is also a need to think "outside the box" and explore innovative approaches. Some illustrative examples are listed in Box 7.4. 124 A World Bank Country Study Box 7.4. Examples of Possible Innovative Approaches A broader approach to alternative livelihoods. The alternative livelihoods approach as implemented so far runs the risk of being ineffective due to the small size of interventions and offsetting responses by the drug industry. Blanketing the entire country with alternative livelihoods projects in theory could deal with these problems but is not feasible and in any case underlines the need to get away from a project focus. What is really needed is sustained growth of the rural economy as a whole--both agriculture and off-farm activities--which will generate livelihoods that those displaced by the shrinking of the opium economy can take up. Using cost-benefit and/or cost-effectiveness criteria for prioritizing actions. Although such assess- ments inevitably would be crude and subject to margins of error, they would nevertheless be use- ful in addressing questions like whether to devote limited law enforcement resources more toward interdiction or toward eradication. A strong public communications campaign, enlisting support of religious leaders and others respected by rural communities, could be an important part of the national effort against drugs if backed up by other actions. This is called for in the National Drug Control Strategy but so far appears not to been fully exploited. Going after abusive behavior by the drug industry, for example credit at extremely high effective interest rates (over 100 percent) and denominated in opium. Legal and practical approaches to cancellation of opium-related debts could be explored, although it should be recognized that the tradition of advances carrying very high implicit interest rates is well-entrenched in Afghanistan's rural areas, and other forms of rural credit would need to be available. Interdicting shipments of chemical precursors into Afghanistan. It takes about four liters of acetic anhydride to yield a kilogram of heroin, so large amounts of precursor chemicals are currently being imported into the country. Combining anti-money laundering efforts with "grandfathering" of assets from past drug revenues. This could help co-opt parts of the drug economy that are already shifting into other businesses and give them a stake in the legitimate economy. The obvious risk of perverse incentives would need to be taken into account. Preventing spread of opium cultivation to new areas. Past eradication campaigns focused on the provinces with the highest levels of opium production, where the greatest reduction in production could be achieved in the short run. The dynamic effect, however, has been the growth and spread of opium cultivation in other provinces--making it more difficult to attack subsequently and spreading the adverse political and security impacts into additional parts of the country. A strat- egy of containing opium production in traditionally important areas and giving high priority to preventing its spreading into new areas could be explored. Tactical uncertainty and incomplete information. Strategic considerations suggest that maintaining some degree of uncertainty vis-ŕ-vis the major actors in the drug industry--about the Govern- ment's plans as well as about next moves and specific actions--may be useful. Government's National Drug Control Strategy Institutional Framework. The Government established the Counter Narcotics Directorate (CND), which reports to the National Security Council, in October 2002. CND is respon- sible for counter-narcotics strategy development and coordination but not for implemen- tation, which is the responsibility of line agencies. The main tasks of CND are to: (i) develop the national counter narcotics strategy; (ii) coordinate counter-narcotics activ- ities in the Government including budgets and programs; (iii) liaise with internal and external partners; (iv) coordinate drug interdiction programs with neighboring countries; (v) act as a clearing house for projects related to drug control; and (vi) set benchmarks and timeframes and monitor progress. CND has about 50 staff in total. Present activities Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 125 include policy and strategy development, demand reduction and public awareness activi- ties, legal and judicial reform (including drafting the new Anti-Narcotics Law that was adopted in 2003), coordination of alternative livelihoods efforts (with the Ministry of Rural Development), and coordination on law enforcement with the Interior Ministry. Further strengthening of the counter-narcotics institutional structure is under consideration. National Drugs Control Strategy (NDCS). Promulgated in May 2003, the NDCS sets a cautious and gradualist tone: the approach "should be realistic" and "take account of the economic and social causes of illegal cultivation." "Attention is first needed to establish security and the rule of law, and to create a stable environment to accelerate reconstruc- tion and build institutions." There is also awareness of the political risks--"in carrying out law enforcement interactions it will be important to balance the political risk of instability caused by counter-narcotics measures with the political desirability of projecting central authority over the entire country and of eliminating the cultivation and production of nar- cotic drugs." On the other hand, the NDCS sets ambitious goals: (i) a 70 percent reduction in opium poppy cultivation by 1386 (five years) with total elimination by 1391 (ten years); (ii) interdiction and prosecution of trafficking, processing, and distribution of narcotics and precursors; (iii) forfeiture of drug-generated assets and checking money laundering; and (iv) enhancing regional and international cooperation. The alternative livelihoods concept is central to the NDCS and is considered as an essential condition for eradication. It is seen as part of a broad-based economic and social development strategy, to proceed pari passu with "phased law enforcement." A poppy cul- tivation ban will be enforced where "rural reconstruction has already produced tangible results and alternative livelihoods are sufficiently available." The NDCS includes an imple- mentation plan, which has been translated into five action plans for judicial reform, law enforcement, alternative livelihoods, drug demand reduction and treatment, and public awareness, approved at an international conference on counter-narcotics strategy in February 2004. Some Questions. The NDCS provides a good strategic framework for action. It acknowl- edges the difficulties and proposes many sound and necessary actions. It has provisions for action plans, coordination, monitoring etc. The proposals (such as on alternative liveli- hoods) link to existing activities and programs rather than proposing yet more initiatives for an already overloaded system. Moreover, the purpose of the NDCS is not to put for- ward a detailed blueprint for all actions but rather to present a coordinated framework including key principles and strategic elements. Some questions that arise related to the strategy are posed below. i. Ownership and implementation: The Government is embarking on an important process of generating broad-based ownership through conferences, publications, etc. But questions remain about ownership and implementation capacity for the NDCS. ii. Strategic targets: The targets are ambitious, in contrast with the cautious language in much of the document. Are the targets realistic? Are the measures as ambitious as the targets? The strategy lists numerous steps that appear to add up to a broad and integrated attack on the drug problem, yet many of them are already ongoing 126 A World Bank Country Study and have not made an impact. Is much greater concentration of resources and effort needed? In the light of experience, are the measures proposed the right ones, or is a "paradigm shift" needed? iii. Institutional architecture and capacity: The role assigned to CND of coordinating and catalyzing other institutions rather than implementing programs itself seems appropriate. But does the architecture provide for adequate high-level decision tak- ing? In Thailand, for example, the Cabinet meets once a year on drugs, deputy min- isters meet quarterly, and the directors of all concerned departments and institutions meet monthly. A second, practical question relates to the capacity of the CND. iv. Legal framework and law enforcement: Law enforcement for both eradication and interdiction is problematic. Despite the recent law, the legal framework is unclear, institutional responsibilities are confused, and implementation capacity is in its infancy. v. Judicial and penal process: There are questions about the judicial and penal process for drug criminals. The strategy does not discuss the key steps of prosecution and punishment, or measures to get a working judiciary and penal system established. vi. Focus on production or trafficking: Actions against production, processing, and traf- ficking are included in the NDCS, but there is no discussion of prioritization. Should limited law enforcement capability be directed toward eradication or toward interdiction? vii. International support. Will direct international involvement in law enforcement be necessary, particularly in the short run while domestic capacities are being built? viii. Alternative livelihoods concept: The alternative livelihoods concept that is so promi- nent in the strategy is left vague and general and is not clearly defined. ix. Priority areas for alternative livelihoods: The NDCS states that priority will be given to poppy growing areas because the farmers are poor, and to source areas for poppy labor. However, as discussed earlier "favoring" poppy areas may generate perverse incentives. x. Sequencing of alternative livelihoods programs and eradication: There appears to be a lack of consensus about the appropriate pace and phasing of alternative liveli- hoods and eradication. The NDCS appears to endorse the "alternative livelihoods first" approach. Yet there is pressure on the Government to vigorously pursue erad- ication quickly. xi. Controlling financial flows: The question of controlling the monetary proceeds of the drug trade, which are transferred through the informal hawala financial sys- tem, is important. The subject is mentioned in the strategy but no specific actions are proposed. Options and Trade-offs in Strategy Implementation Broader Strategic Framework Breaking the vicious circle of drugs, warlords, and insecurity, which is so inimical to Afghanistan's state-building and reconstruction agenda, requires a multi-pronged ap- proach. Drug control measures alone will not be effective. Thus the response to the drug Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 127 Figure 7.4. Strategic Framework for Breaking the Vicious Circle DDR; stopping payments and support to warlords Weakened warlords cannot Warlords Lower undermine payments government Less drug weaken resources to Drug Building warlords bribe control government government strategy to capacity Government Opium economy reduce and size of Warlords effectiveness opium have less ability to economy Stronger undermine national security Better security government is less better able to Security favorable for provide security opium economy Security sector reform and capacity building economy must occur within a broader strategic framework including state building and improving security as well as curbing warlords, similar to the strategy for breaking out of the "informal equilibrium (Chapter 3). As shown in Figure 7.4, in addition to drug mea- sures this framework includes (1) curbing warlords' power by stopping payments and other support to them, DDR to take away their militias, co-opting them into the Govern- ment where appropriate, etc.; (2) building state capacity and resources; and (3) security sector reform and capacity-building. All this needs to happen in an environment of rapid economic growth which allows the drug economy and other forms of illegal activity to be eventually replaced by legitimate economic activities. The rest of this chapter focuses on the right-most part of Figure 7.4 relating directly to the opium economy. Strategic Objectives, Implementation Options, and Trade-offs The overall strategic objective of the NDCS is to progressively reduce the size of Afghanistan's opium economy and eventually eliminate it. This challenging and ambitious goal needs to be accomplished in a way that (1) is technically feasible and sustainable and builds required capacity; (2) does not increase rural poverty; (3) avoids pushing the Afghan economy into a recession and handles any macroeconomic fall-out--for example a wors- ening of the balance of payments; (4) manages the political risks associated with fighting drugs; and (5) takes into account the dynamic longer-term implications and strategic responses by the drug industry. Capacity and resource constraints mean that it is not possible to do everything, which brings issues of prioritization and sequencing to the fore. Different options need to be 128 A World Bank Country Study assessed on the basis of the above criteria and in light of the lessons of experience, and choices made. Four options involving the three main counter-narcotics instruments are reviewed below. Option 1: Interdiction. This would involve pursuing drug traffickers and seizing their product, enforcing closure of opium bazaars, and destroying processing facilities. It might also involve sanctions against officials who condone and benefit from the drug trade, seizure of drug-related assets, and legal action against drug money balances and flows. The technical rationale for interdiction is strong, as the trafficking and processing business is more concentrated, more evidently criminal, and has fewer participants than the produc- tion stage. Interdiction also does not result directly in rural impoverishment, at least not to the same degree as actions against resource-poor farmers. It is likely that some propor- tion of the drug trade will be suppressed; risk premia will increase sharply; and the drug business will become increasingly aggressive and well organized in its response. The costs of trafficking and processing could be expected to increase. This will increase the border price of opiates, and it may lower farm-gate prices at least temporarily due to disruptions in the downstream supply chain. In sum interdiction, if vigorously pursued, has the likely economic advantage of reducing the trade and decreasing its profitability (after risk premia are taken into account) and disrupting the supply chain; it has the moral advantage of attacking what is more evidently criminality; it has the technical advantage of focusing on a much smaller number of actors than eradication; and it has the political advantage of directly addressing the nexus of drugs and illegitimate political and military power Three issues arise with respect to implementation. Enforcement requires political will, adequate money, and institutional changes (reinforcement and reorganization of the inter- diction forces, judicial reform). The effectiveness of this approach has its limits: neighbor- ing Iran--a well organized, affluent, and committed state with a well-functioning police force and judicial system--has struggled for years in a bloody war on trafficking. Even with this caveat, vigorous interdiction would certainly make a difference. Political risk is signifi- cant, given that so many people at every level benefit from the drug trade. Thus if the Government opts for an interdiction-led strategy, political consensus would be required, and sustained external support would be essential. The likelihood that the drug industry will respond aggressively with violence and political manipulations has to be anticipated, and the risks and responses taken into account. Option 2: Eradication. Eradication, involving destruction of opium growing in the fields and sanctions against poppy farmers, attacks the problem where it starts and destroys the most visible evidence of illegality. While eradication can reduce opium output locally, production can quickly shift to other producing areas and spread to new areas quickly (stimulated by the higher farm-gate prices caused by eradication), and cultivation can resume in eradicated areas in the following year if there is no follow up. Moreover, the gov- ernance and poverty impact of eradication can be problematic. The fairness and consis- tency of recent eradication campaigns in Afghanistan has been questioned, and poorer farmers appear to have been disproportionately affected (the better off may escape eradi- cation by means of political connections and/or bribes). Total national production has not fallen as a result of eradication, and a UNODC survey indicates no difference in planting intentions between areas where eradication took place and those where it did not. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 129 Overall, an eradication-led strategy could face severe problems with implementation, poverty impacts, and political damage. Implementation is very difficult where the authority of the central government is fragile, and experience indicates that it will lead only to changes in the location of opium production. Poverty impacts will be negative, given the dependence of large numbers of poor people on opium for their livelihood as well as the distortions in implementation noted above. Political risk is daunting, but in a different way than for inter- diction. The Government wants to win over the rural poor through inclusive development processes, not aggressive destruction of their livelihoods. Existing rural development and governance initiatives in the countryside, which comprise an important part of the state- building agenda, may be compromised. Finally, there is a moral, political and economic case for having alternative livelihoods programs in place before commencing eradication. Option 3: Alternative Livelihoods. Alternative livelihoods programs, which have a cen- tral place in the NDCS, include components of comprehensive rural development, farm- ing, and off-farm income generation. Whatever their impact on drug production, they should contribute to development and poverty alleviation (through creation of assets, mar- kets, and livelihoods) and are non-confrontational. But important issues remain to be resolved. Conducting alternative livelihoods programs only or mainly in areas currently growing poppy runs the risk that poppy cultivation will move elsewhere, encouraged by perverse incentives. Implementing these programs first in areas currently not growing poppy would have an appropriate incentive effect (for both opium cultivating and non- opium cultivating farmers) but would require programs of a different order of magnitude given that poppy currently is not grown on 93 percent of Afghanistan's irrigated area. Or programs could be targeted toward areas "at risk" of getting involved in poppy cultivation, but how should such areas be defined? More generally, alternative livelihoods initiatives cannot be separated from the broad-based rural economic growth and income generation that will be critical in phasing out Afghanistan's dependence on the opium economy. Alternative livelihoods approaches are attractive, but as the primary instrument of a drug reduction strategy they suffer from critical weaknesses in time, scale, cost, and effec- tiveness. Completing such programs will take many years and large resources, without vis- ible reduction of drug production in the interim. Moreover, opium would remain the crop of choice particularly for resource-rich farmers, and poorer farmers may continue to be bound to the opium economy by debt and their need to access land and credit. Thus sole reliance on persuasion through alternative livelihoods approaches would not succeed in reducing drug production. Option 4: Alternative Livelihoods Programs Coordinated with Eradication. The weak- nesses of stand-alone eradication and alternative livelihoods programs suggest that the two approaches need to be pursued together. This is consistent with the national strategy, where broad economic and social development is to take place in tandem with "phased law enforcement." The key issue with such a combined approach is the need for appropriate sequencing. Eradicating first runs the risk of alienating farmers and reducing their recep- tivity to rural development efforts in general (including alternative livelihoods programs). On the other hand, implementing alternative development programs first means a delay in eradication, which at the extreme could be quite long. Yet there is pressure on the Government for quick results. 130 A World Bank Country Study Strategic Trade-offs. The following discussion is intended to pose questions and sug- gest options rather than to make hard-and-fast recommendations. i. Balancing economic measures and law enforcement. Both are essential, and close coordination is needed between law enforcement and development instruments, taking into account incentives and sequencing issues. ii. Interdiction, eradication, alternative livelihoods. The Government may want to ini- tially give priority to interdiction over eradication, as trying to do both equally would disperse scant political capital, energy, and capacity. Alternative livelihoods programs--and more generally measures to promote broad-based economic growth and employment generation--could be put in place, with the threat of law enforcement measures to follow in due course. Eradication measures could then be planned once implementation capability and political support are mobilized. It is the combination and phasing of the three elements that will be most effective. iii. Prioritization. Given capacity and budget constraints, prioritization is essential. The possibility of using a cost-benefit tool to analyze different options was discussed above. In the immediate future, giving priority to action against larger participants in the drug industry would seem to be the most cost-effective approach, and also would have potential for a strong positive public reaction. A focus on new areas with little or no history of poppy cultivation could make sense, as it is easier to roll back the practice where the technology and networks are not yet entrenched. iv. Monitoring progress and impacts and adjusting plans. The NDCS emphasizes the need for good monitoring, and there needs to be a thorough assessment of the economic and social situation of opium farmers and wage laborers. v. Law enforcement capability. Clarifying institutional responsibilities with respect to law enforcement is a priority. Exceptional measures are needed to strengthen capacity. vi. Legal framework and judicial and penal process. The justice system as it relates to drugs needs strengthening. The legal framework is under review. Consideration could be given to devising a fair but easily implementable legal, judicial, and penal process for drug offenders, perhaps including special mobile courts dedicated to narcotics cases. vii. Need for international support. The Government is seeking sustained international support and cooperation in its efforts against drugs, and in controlling the trade in both transit and consuming countries. CHAPTER 8 Delivering Basic Social Services with Gender Equity I n 2001, levels of basic services and social indicators in Afghanistan were among the worst in the world, reflecting very limited coverage pre-war and the effects of protracted conflict. Considerable progress has been made in the past three years, but Afghanistan still lags far behind other poor countries in terms of basic social services (education, health, water supply), and quality is problematic. Delivering public services is critically important for Afghanistan because: i. Services contribute to economic growth by augmenting human capital, and to a lesser extent by directly contributing to total GDP (see Chapters 1 and 3). ii. Public services improve human welfare, especially that of the poor who cannot afford expensive alternatives. iii. Delivery of public services helps reduce poverty, through both of these channels. iv. Effective service delivery enhances the Government's credibility and legitimacy in the eyes of the public, thereby strengthening public support for the Govern- ment and facilitating political progress and necessary reforms (see Chapter 4).1 This chapter analyzes issues and constraints faced by Afghanistan in expanding the cover- age and improving the quality of basic social services, and puts forward some approaches and strategies in line with the Government's development vision and policy framework. The chapter focuses on accountability relationships, incentives, and the institutional 1. As noted in the National Development Framework (Afghanistan Government 2002), this does not mean that government can or should deliver all services itself, but the government does bear ultimate responsibility for service delivery outcomes and in that sense must be "in charge," whether or not it is directly involved in financing or provision. 131 132 A World Bank Country Study framework--without which financial and human resources and technical solutions alone will not deliver the desired results on a sustainable basis. The pre-war situation, the impact of the conflict, and recent progress are first briefly reviewed in the first section. The second section presents a conceptual framework for analyzing public service delivery, highlight- ing key issues and general recommendations for Afghanistan. The final section focuses on specific sectors including education, health, and water supply and sanitation. Background Pre-War Situation and Impact of Conflict In the late 1970s, Afghanistan had a highly centralized system of social service delivery by government organizations, primarily for a small elite group of the urban population. Most Afghans, who lived in rural areas, were not beneficiaries of any public services. The bulk of people did not have telephones, electricity, or piped water, and most were not reached by modern education and health facilities. Afghanistan's pre-war social indicators not surpris- ingly were very low, reflecting the extremely limited coverage of public services. Table 8.1 Table 8.1. Public Service and Social Indicators 1999 or Target Pre-war Year 2000a 2003 2015 Primary education (gross enrollment %) 30 1974 15 54 100 Primary for girls (gross enrollment %) 9 1974 0b 40 100 Primary for boys (gross enrollment %) 51 1974 29 68 100 Access to basic health services (% population) 24.1c 1974 n/a 40 95 Immunization, DPT (% of children under 4 1980 35 30 n/a 12 months) Immunization, measles (% of children under 11 1980 40 n/a n/a 12 months) Maternal mortality ratio (modeled estimate, N/a n/a 1600 205 per 100,000 live births) Infant mortality rate (per 1,000 live births) 190.5 1975 165 115 55 Under-5 mortality rate (per 1,000 live births) 300 1975 267 172 130 Life expectancy at birth, total (years) 39 1975 43 43 n/a Improved water source (% of population 5d 1977 13 13e 80f with access) Improved water source, rural (% of rural n/a 11 n/a n/a population with access) Improved water source, urban (% of urban n/a 19 n/a n/a population with access) a. Data quality during the conflict is weaker. b. Some girls were enrolled in schools in areas not controlled by the Taliban and in rural areas. c. percent of population with access to Basic Health Centers. d. percent of population with potential access to public water supply systems. e. No updated data available. f. For Kabul. Source: World Bank (2004f); UNICEF and CSO (2003); Afghanistan Government (2004b); staff estimates. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 133 presents rough estimates of service availability and social indicators for Afghanistan in the late 1970s, 1999­2000, 2003, and targets for 2015. Afghanistan's social services were gravely damaged by the long conflict and associated flight of human capital, lack of funding, and neglect of maintenance. While the govern- ment structure remained in place along with many public servants, actual service delivery to a large extent ceased, and where activities continued quality deteriorated. Rural social service provision was largely wiped out (rural schools destroyed, teachers killed or driven away); urban social services bore the brunt of Taliban retrogressive social policies in the late 1990s, with many facilities closed, girls forbidden to go to school, and female profes- sionals dismissed except to some extent in Health. Salaries of public sector service providers became so eroded by inflation as to be nearly meaningless. There were some positive developments however. Millions of Afghans became refugees or were displaced to cities in Afghanistan (and thereby exposed to urban envi- ronments), helping kindle demand for social services, education in particular. NGOs stepped in with limited humanitarian funding, helping some failing public facilities to stay in operation with salary supplements (especially in the Health sector) and non- salary support. Thus while government capacity sharply deteriorated, some capacity was maintained in the NGO sector, which had been virtually non-existent before the war. In a few cases like rural drinking water supply in many areas and girls' primary education in rural Pashtun areas, the coverage of services most probably was greater than before the war. These modest achievements under very difficult conditions had a limited impact quantitatively and could not offset the deterioration in government service delivery. All in all, in terms of service delivery outcomes Afghanistan was essentially left out of a quarter-century of development (Table 8.1). Recent Progress Inheriting a dire situation with public services largely non-functional, the Government emphasized in its NDF in April 2002 the critical importance of ensuring adequate basic social services for the population. Remarkable progress has been made in a number of areas during the past three years. For example, through extraordinary efforts supported by inter- national partners, more than three million children were enrolled in school in 2002 and more than four million in 2003, one third of them girls. This far exceeds past peak levels and rates of school enrollment. Another notable example is immunization, which had been pursued with limited resources and great difficulty during the conflict but which achieved considerable success during the past two years, with positive outcomes like the number of reported new polio cases dwindling to near zero. Despite these achievements, coverage of most services remains very low (Table 8.1), and serious quality problems are evident. Afghanistan still lags well behind other countries at similar levels of development in school enrollment, literacy rates are very low, and large gender disparities persist especially in rural areas. The Basic Package of Health Services (BPHS) is estimated to cover only 40 percent of the rural population, and effective cover- age is much less than that due to capacity and resource constraints. The bulk of Afghans still do not have reliable electric power supply and clean water. Thus the situation that pre- vailed in the 1970s and during the long period of conflict--basic social services not 134 A World Bank Country Study Table 8.2. Rural Households' Access to Basic Services Access to basic % of Service facilities % of infrastructure households in community households Electricity 16 Primary school 48 Non-traditional lightinga 10 Secondary School 13 Non-traditional cookingb 0.1 Health facility 9 Covered drinking waterc 24 Public transportation 34 Adequate toilet facility 7 Food market 5 a. Electricity, generator, gas. b. Kerosene, gas, electricity. c. Handpump. Source: Afghanistan Government (2003). reaching most of Afghanistan's people--has not yet been fundamentally changed with the partial exception of primary education. This is illustrated by the National Rural Vulnera- bility Assessment (NRVA), which collected rural household survey data on access to vari- ous basic services, some of them privately-provided (see Table 8.2). International experience demonstrates that achieving better social service delivery on a sustainable basis, especially to the poor, requires more than just human and financial resources and good technical solutions. The key actors that relate to public service provi- sion need to be accountable to each other, which requires appropriate incentives and institutional relationships. Conceptual Framework A conceptual framework for analyzing public service delivery issues is provided in the World Bank's World Development Report 2004: Making Services Work for Poor People (World Bank, 2004g). The main actors associated with public service delivery can be cate- gorized in three groups: the public (with particular focus on the poor) in their dual roles as citizens and clients; the government (at different levels in sizable countries) in political and policymaking guises; and the service delivery organizations themselves, including manage- ment and the front-line professionals directly providing services (teachers, public health providers, utility technicians, etc.). The accountability relationships between these actors form an "accountability trian- gle" (Figure 8.1). The "long route" of accountability includes two stages, whereby service providers are supposed to be accountable to government policymakers (through explicit contracts or other forms of "compact") and the government in turn is supposed to be politically accountable to the people as citizens (through the electoral process and other political mechanisms). The "short route" of accountability is directly from service providers to service recipients (clients), whereby through choice of providers (if possible) and participation (monitoring and other activities), clients seek to make service providers more accountable directly to them. This framework can be used to analyze service Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 135 Figure 8.1. Accountability Relationships in Public Service Delivery Source: World Bank (2004g), Table 3.2, p. 49. delivery breakdowns and actions to make services work better, depending on different political contexts and characteristics of the public services concerned. Key dimensions include whether the clients are heterogeneous or homogeneous and whether the public service is easier or more difficult to monitor. Services that are both transactions-intensive and discretionary on the part of the frontline service provider--such as education--tend to be more difficult to monitor than those which do not have one or both of these characteristics. This framework implies that there is often scope to improve public service delivery by enhancing the accountability of service providers directly to clients (including the poor)-- the "short route" of accountability. In the context of Afghanistan, the long route of accountability also is very important as it can help build citizens' loyalty to the Govern- ment (Chapter 4). This conceptual framework also sheds light on the financing of public services. The financial flows are similar to the accountability arrows in Figure 8.1--that is, payments from clients to service providers (cost recovery); from citizens to government (taxes and levies); and from government to service provider (subsidies or, if the service is provided by a gov- ernment department, budget expenditures). Financing is critical for long-term sustainabil- ity of social service delivery. In the case of elementary education, and only to a slightly lesser extent for basic health services, cost recovery (discussed in Chapter 4) is not an option due to the intended poverty impact of the services (and major externalities in the case of immu- nization and certain communicable disease programs). However, community contribu- tions, for example to construction or maintenance of rural school buildings, can be pursued both on grounds of financial cost-effectiveness and to promote community ownership of the service. In any case, it is essential to program adequate budget allocations for recurrent expenditures in social sectors, especially the non-salary portion which is chronically neglected in many countries (see Chapter 4). 136 A World Bank Country Study Key Issues for Afghanistan This framework helps in understanding the key issues that affect basic social services in Afghanistan and lead to gaps and quality problems in service delivery. These include over- all human and financial resource constraints, institutional weaknesses, inadequate financ- ing mechanisms, and weak accountability relationships. Limited Human Resource Capacity in Afghanistan. While constraints are most salient in the public sector due to low salaries and loss of professionals during the war, Afghanistan overall is very short of educated, skilled, and professional human resources, reflecting the breakdown of the education system and other effects of conflict. Competition among different actors (Government, NGOs, private sector, international agencies) for this very limited pool tends to bid up wages without eliciting additional supply from domestic sources (see Chapter 4 on the "second civil service"). Capacity constraints affect both the state and providers and are especially severe at management levels. There is also a very seri- ous gender imbalance, reflecting mainly the disproportionately low supply of educated women, aggravated by the Taliban's dismissal of the bulk of female civil servants, many of whom have not returned. Financial Resources and Sustainability Issues. Social services have been starved of funds for a long time, and domestic fiscal resources are still much lower than in other countries despite recent revenue mobilization efforts (see Chapter 4). This situation is expected to improve, but demands on limited domestic revenues will continue to be large and growing, necessitating difficult trade-offs. De jure Highly-Centralized Government Service Delivery Structures and Mindsets. The existing system in Afghanistan is based on the view that the state itself has to deliver ser- vices. Management of service delivery and policymaking are combined within the same central ministries. The first instinct when Afghanistan emerged from conflict, in the gov- ernment bureaucracy but also among many others, was to restore centralized government service delivery, without consideration of the implications, costs, and sustainability of this approach in the context of the required quantum leap in the coverage of public services. Moreover, the geographic and bureaucratic "distance" between frontline service delivery personnel and departmental management in Kabul is often very great, so the managerial relationship tends to be weak and easily can break down altogether. The lack of separation of service delivery management from government policymaking also makes it more diffi- cult for the Government to hold service delivery organizations accountable for their work, and leads to patronage which detracts from the necessary focus on service delivery. De facto Local Political Control. In many areas, the national government has relatively weak control in practice (Chapter 4). This reflects difficulties in communicating between Kabul and provinces (poor security, lack of roads and telecommunications), as well as a tendency on the part of the center to neglect liaison with the provinces, lack of availability of approved non-salary budget allocations, and delays in salary payments to provincial officials. The weakness of central authority also reflects the political power structure--in Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 137 particular the "capture" of some provincial administrations by regional powerbrokers. In general, local powers have very limited direct accountability to the clients, and therefore local control does not lead to better service delivery. In particular women tend to be com- pletely excluded from political influence at the local level, and have a limited presence at national level. Lack of Information and Monitoring. Information flows can promote accountability and better service delivery. However, good information on service delivery was not gener- ated in the past but rather bureaucratic reporting within the government hierarchy. Even these information flows to a large extent broke down during the conflict. While the report- ing system from government service providers to government policymakers (and then onward to citizens) can be difficult to make work well, there are ways to promote infor- mation flows between service providers and clients in support of the short route of accountability. Disconnect with Households and Communities. The centralized service delivery enti- ties did not interact closely with the people and communities they were intended to serve. The approach was top-down and one-size-fits-all, with little client feedback or provider responsiveness to client needs and preferences. "Client power," the short route of account- ability, was very weak as a result. While such an approach may not have worked too badly in urban areas prior to the war, its shortcomings are obvious in trying to scale up and expand coverage throughout a far-flung country with difficult logistics and communica- tions, particularly in view of the high expectations among the rural population as a result of their contacts with NGOs. Sustainability Issues Related to Heavy Reliance on Donor Funding.2 Most funding for social service delivery in Afghanistan today comes from external assistance. In addi- tion to the need for domestic resource mobilization to replace donor funding over time (see Chapter 4), there are concerns that the heavy reliance on external assistance in the short run will: i. Build in higher costs of delivery that will turn out to be unsustainable in the long term when donor funding tapers off and the burden has to be taken up by domestic resources. ii. Entrench parallel networks and capacity that will prove difficult to integrate into national programs and delivery mechanisms. iii. Postpone and render more difficult the hard trade-offs that need to be made in the interest of cost-effective service delivery in a fiscally constrained environment. 2. These concerns relate especially to external assistance outside budget channels and without transparent cost control incentives such as competitive contracting. Recent Government initiatives try to address many of these issues. 138 A World Bank Country Study Improving Basic Social Service Delivery in Key Sectors From a medium-term perspective, getting institutional relationships and incentives for different actors right so there is meaningful accountability will be critical for effective social service delivery in Afghanistan. This is true despite the imperative to respond to enormous problems of narrow coverage, problematic quality, insufficient human resource capacity, and limited funding. In sectors where there has already been a signifi- cant degree of success in expanding coverage of services (e.g. primary education), address- ing institutional and policy issues is all the more urgent because they will be a major determinant of service quality, whether people continue to utilize the services or drop out, sustainability, etc. Where the expansion of service delivery has not yet gotten very far, it is important to build in considerations of institutional relationships, incentives, and accountability from the start. Box 8.1 has examples of options for improving service deliv- ery, grouped in five general categories--improving management, strengthening account- ability, better use of information, financial incentives and fiscal sustainability, and donor engagement. The focus is on doable options in the Afghan context which do not entail drastic changes in the structure of government. The remainder of this chapter discusses selected social services including elementary education, basic public health services, and urban water supply and sanitation. There are major capacity and investment requirements in each sector, as well as recurrent expendi- ture needs, all of which are discussed in Securing Afghanistan's Future (Afghanistan Government 2004b). Here the focus is on the institutional, policy, and financing arrange- ments that will help enable the resources and capacity in these sectors to work effectively in delivering services, especially to the poor. Elementary Education Sector Situation and Key Issues. Great success has been achieved in bringing primary school enrollments (including for girls) up to unprecedented levels not seen before in the history of Afghanistan (Figure 8.2). Over four million children are now in school, one-third of them girls, but this still represents only a little more than half of school-age children and 40 per- cent of girls. Moreover, these figures hide dramatic regional disparities, with girls repre- senting less than 15 percent of total enrollment in nine provinces in the east and south. Besides gender disparities, such figures also reflect the persistent huge urban-rural dispar- ity. The challenge will be to sustain and further expand enrollments and progress toward universal primary education, in line with the national objective of reaching 100 percent gross primary school enrollment (including for girls) by 2015 (see Table 8.1). A critical prerequisite both to keep children in school, notably girls who have higher drop-out rates than boys, and to further expand enrollment is adequate content and quality of education, which are in urgent need of improvement. Obstacles to expansion of education and better quality include (i) constraints on numbers and skill levels of teachers, particularly in under-served rural areas where it is difficult to deploy female teachers; (ii) poor or non-existent school infrastructure, with many classes held in tents; (iii) outdated curricula--including in their portrayal of gender roles--and shortages of teaching materials; (iv) a variety of constraints affecting Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 139 Box 8.1. Examples of Approaches to Improving Social Service Delivery in Afghanistan Improving Management 1. De-concentration within the government departments responsible for overseeing service delivery, i.e. enhancing the role of provincial and district government officials. Local governments as they build capacity will be in a better position to oversee and monitor front-line providers, which is impossible to do effectively from the center. 2. Enhancing the management role and autonomy of service provision facilities where appropri- ate, e.g. in the case of hospitals and educational institutions. This will permit the managers of these facilities to act more like managers as opposed to bureaucrats in a long chain of admin- istrative hierarchy. Strengthening Accountability 1. Clients (individually or through their communities) monitoring local service delivery facilities and providing feedback on their performance. This needs to be built into programs. 2. Organizing service-specific beneficiary groups to provide monitoring and feedback, e.g. parents' associations in the case of elementary schools, transport associations in the case of roads, water or power user groups, etc. 3. Giving the Community Development Councils that are part of the National Solidarity Program a broader role in monitoring local service delivery and giving voice to communities' concerns and priorities. 4. Ensure female beneficiary involvement in monitoring and feedback on service delivery, partic- ularly in the health, education, and water supply and sanitation sectors. Using Information to Improve Management and Strengthen Accountability 1. Radio. 2. Posting resource allocations, which was done in the Kabul University Block Grant project, sup- ported by IDA. 3. Use of local languages to improve outreach to clients/beneficiaries, especially women. Financial Incentives and Fiscal Sustainability 1. Pushing out the non-salary budget so that provincial and district governments can function, with further installments contingent on proper accounting and reporting of initial installments. The Government intends to implement such a mechanism in the current financial year (1383). 2. Modest enhancement of spending discretion (within the budget) at lower levels of government administration. 3. Maintaining a hard budget constraint for lower levels of administration through observance of budget allocations and standards (with flexibility for reallocations within categories as noted above). Donor Engagement 1. Move assistance through the government budget, thereby strengthening budget accountabil- ity channels. 2. Reinforce service providers' domestic accountability relationships and avoid trying to duplicate them. 3. Maximize consistency of approaches across donors. 4. Coordinate TA and build domestic capacity, avoid "enclave" approaches. 140 A World Bank Country Study Figure 8.2. Education Enrollment Figures 5,000,000 4,500,000 4,000,000 3,500,000 3,000,000 students of 2,500,000 2,000,000 1,500,000 Number 1,000,000 500,000 0 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1993 1999 2002 2003 Year Source: Afghanistan Government (2004b). access to education in remote areas and especially for girls, such as distance, lack of security, and lack of toilets at schools; (v) low retention rates especially for girls; and (vi) financial resource constraints. Organizational Structure for Service Delivery. Education, before the war and recently, has been delivered mainly through a highly centralized government apparatus in the Ministry of Education. As noted recently: "Almost all key decisions are made in Kabul. Even the provincial and district offices have very limited decision-making author- ity...With few exceptions, a culture of dependency on the center pervades the education sector in Afghanistan" (Evans and others 2004a, p.116). Another prominent feature has been the past emphasis of the Ministry of Education on its role as primary, even sole provider of educational services and inputs, including school construction and textbook production. This approach is beginning to change for non-educational activities. But overall, unlike in the case of other post-conflict countries where the collapse of the state and of government-provided education led quickly to local and community-based schooling, in Afghanistan the main thrust has been to revive and expand the centralized government system. Given experience, the ability of this approach to deliver the cover- age, quality, and sustainability needed in order to achieve universal primary education in Afghan conditions is questionable. Government Strategy. The Government's vision is good-quality education for all, regardless of gender, ethnicity, language, religion, or location. This objective, which amounts to achieving the MDGs for Education, has been translated into a development program emphasizing (i) teacher development (increasing the numbers of teachers and improving their qualifications); (ii) infrastructure investments (school repairs and Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 141 construction); (iii) curriculum and textbook development and provision; and (iv) special measures to increase and maintain enrollment of girls. Deployment of more male and female teachers in rural areas is of particular importance. Improving Service Delivery. The Government recognizes that modifications in the tra- ditional centralized, government dominated approach to providing education will be required: "The goal is to gradually put in place systems of mutual accountability between levels of government and communities for ensuring well performing schools. An accom- panying goal is to incrementally delegate greater decision making and spending authority to districts, communities and schools" (Afghanistan Government 2004b, Education Annex). This implies several concrete reform directions: i. Getting the Ministry of Education at the central level out of direct provision of education and production of inputs, and focusing on its role of policymak- ing, regulating and monitoring service delivery, facilitating others' work, and contracting for goods/services. ii. Delegating (de-concentrating) decision making authority and management roles vis-ŕ-vis schools and teachers to provincial and district levels of govern- ment, which will entail building the capacity of Provincial Education Depart- ments and District officials. iii. Giving schools more flexibility in day-to-day management and authority over non-wage O&M resources at the school level. iv. Involving communities (parents' associations or Community Development Councils) in monitoring and overseeing schools and holding them accountable for performance. A special effort to involve mothers in parents' association could positively impact on girls' enrollment and retention. Innovations like community contracting of NGO education providers are being tried out. v. Greater roles for schools and communities will not work unless the Govern- ment delivers on its obligations. This means paying salaries on time, provid- ing funds for non-wage O&M, providing necessary teaching materials, etc. vi. Better information flows at the local level also will be very important. Basic Health Services Sector Situation and Key Issues. Afghanistan's health indicators are among the worst in the world with large gender gaps--under-five mortality rate of 172, infant mortality rate of 115, and estimated maternal mortality rate of 16 (all per 1,000 live births); rate of chronic malnutrition (moderate or severe stunting) around 50 percent; and very high rates of dis- ability due to polio, cerebral palsy, and conflict (including landmines). Recent surveys have revealed that almost half of all deaths among women of reproductive age are a result of preg- nancy and childbirth--and that more than three-quarters of these deaths are preventable. Among children diarrhea, acute respiratory infections, and vaccine preventable illnesses likely account for 60 percent of deaths, and among adults tuberculosis results in an esti- mated 15,000 deaths per year, with 70 percent of detected cases being among women. Life expectancy is estimated at 43 years. Only something like 40 percent of the rural population is in the coverage areas of basic health facilities, and moreover these are inadequately staffed 142 A World Bank Country Study with female health personnel in particularly short supply. With the prevalent reluctance of women to seek medical assistance from male health workers, the lack of female staff greatly obstructs women's use of health facilities. Only 9 percent of rural households surveyed in 2003 reported a health facility in their village (Table 8.2), although it is possible that a larger percentage may have had a health facility in the locality. While immunization coverage has expanded including for measles and polio (only seven confirmed polio cases reported in 2003), routine immunization coverage (DPT3) is estimated to be only 30 percent. Key issues include, in addition to financial resource constraints, (i) inadequate num- bers of skilled health staff in rural areas, particularly women; (ii) lack of managerial capac- ity especially at provincial level; and (iii) managerial and organizational structures that do not provide incentives or accountability for results. Many health professionals (doctors, nurses, technicians, immunizers, etc.) get incentive payments or "top-ups" from NGOs and donor agencies. While helping retain such staff, these payments, especially their ad- hoc nature, raise concerns about sustainability and also that staff may become more responsive to their financiers than to the Government. Planned standardization of top-ups should help reduce this latter tendency. Organizational Structure for Service Delivery. In the pre-war period the Health sector had a centralized mode of government service delivery management similar to that of Education. There have been significant changes during the conflict and more recently, however. Government health services were gravely affected by conflict, flight of talent, and lack of funding. In the 1990s, NGOs using humanitarian funding came on the scene and provided modest levels of service in some areas. They also became the repository of most of the remaining professional capacity in the Afghan health sector, through employment of these professionals or through top-ups for those who remained in gov- ernment service. This pattern of NGO and NGO-supported service delivery has contin- ued since 2001, as has the heavy reliance on donor funding. Government Strategy. With the ultimate objective of improving health outcomes for all Afghans and achieving corresponding progress toward health MDGs, the Government has developed a Basic Package of Health Services (BPHS), including maternal and new- born health, child health and immunization, public nutrition, and communicable disease control. The goal is to deliver the BPHS to 90 percent of the population within seven years and 95 percent within 12 years. In addition, the Government will continue to strengthen vertical programs to achieve blanket coverage of simple yet effective interventions such as salt iodization, polio, measles, and tetanus immunization, and vitamin A distribution. The Government intends to ensure that every health facility in the country has sufficient female staff, and that all staff are properly trained and independently certified to have the required skills and knowledge. Finally, organizational and managerial reforms to improve health service delivery will be implemented and management capacity built up within the Government, particularly at the provincial level. The Government is pursuing different ways of generating incentives and accountability for results, including working with the private sector and NGOs. One example is Performance-Based Partnership Agreements (PPAs), whereby service providers are contracted on a competitive basis to deliver the BPHS in a province, with per capita cost an important consideration and independent monitoring of performance. So far PPAs are in effect for seven provinces. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 143 Improving Service Delivery. The PPA approach has potential to provide an appropri- ate accountability relationship between Government and service providers, with incentives for cost-effective service provision. The Government is keeping its options open as to whether this will be the dominant mode of delivery of basic health services or whether the government service delivery network will be rebuilt, depending on experience with differ- ent modes of service delivery. Irrespective of this choice, strengthening the management and oversight capacity of provincial health departments, part of the reform plan, will be critical for success. Options for enhancing the role of service recipients and communities in promoting accountability of service providers for results also should be explored. Spe- cial efforts should be made to involve female service recipients, as women and children comprise by far the largest number of potential health beneficiaries. This is particularly important for non-standardized services provided to individuals at basic health facilities. Options for augmenting outreach, for example training for traditional birth attendants, could be explored. Some health services lend themselves to standardized delivery to easily identified target groups (e.g. children), with effective top-down monitoring. Examples include immunization, vitamin A supplementation, certain types of screening, etc., which are handled through vertical programs in many countries including Afghanistan. Urban Water Supply and Sanitation Sector Situation. The proportion of Afghanistan's urban population that has access to mod- ern water supply systems is estimated at less than 20 percent, the lowest figure in the world. This reflects minimal investment in urban water supply and sanitation (WSS) for decades and running down of systems through damage and lack of maintenance, aggravated by sharp increases in urban population in recent years. A large majority of urban residents draws water from wells or traditional canals and streams, which is at great risk of contami- nation from sewage and other pollutants. (According to recent surveys, 50­70 percent of the tube wells tested in Kabul were unsafe.) The situation with respect to sanitation is even worse, with virtually none of the urban population served by modern sewerage systems, and much solid waste not collected or properly disposed of. There are serious adverse impli- cations for health and risk of epidemics. Continuing rapid urbanization and massive building (re)construction in urban areas (which generates large amounts of rubble and debris) further aggravate the crisis of urban sanitation. Organizational Structure for Service Delivery. The Central Authority for Water Supply and Sewerage (CAWSS) is responsible for urban water supply and piped sewerage. It was previously part of the Ministry of Public Works but is now under the Ministry of Urban Development and Housing. CAWSS was established in 1978 as a quasi-autonomous government-owned company, but its present legal status is not clear and it has not been operated on a commercial basis. CAWSS manages the water supply system in Kabul and has networks in 12 other cities. Communications and other difficulties during the conflict gave rise to de-facto regional management of urban water supply in several parts of the country. Solid waste collection and disposal is the responsibility of municipal governments. Key Sector Issues. Beyond severely limited coverage, poor quality of supply, and major funding requirements, the urban WSS sector faces difficult institutional and policy 144 A World Bank Country Study issues: (1) lack of institutional capacity for sector policymaking; (2) lack of a clear legal and regulatory framework; (3) grossly insufficient cost-recovery in relation to O&M requirements--for example in Kabul the ratio is about 15 percent--and lack of a tariff policy including subsidy mechanisms; and (4) over-centralization of CAWSS formal responsibilities with respect to cities other than Kabul. Government Strategy. The Government's short-run strategy has been to focus on rehabilitation and revival of existing water supply and sanitation services while initiating capacity building, institutional strengthening, and developing plans for system expansion. It is recognized that as the system is restored and expanded, managerial and technical capacity will need to be sharply augmented to run operations. The Government has also initiated increases in user charges--it is estimated that the O&M costs of running the reha- bilitated and expanded urban water supply system over the next seven years will be some $65 million, and the funding of these expenditures needs to be put on a sustainable basis. Improving Service Delivery. The large investments required for WSS need to be com- plemented by institutional and policy changes to ensure actual delivery of services, adequate quality, and financial sustainability. Donor support for urban WSS cannot be expected to continue indefinitely, and budgetary resources also will be constrained, so sustainable sources of financing for O&M and eventually for investments need to be found. The fol- lowing actions would enhance incentives for good service delivery by strengthening accountability: i. Corporatization of CAWSS so that it can be run on an autonomous, com- mercial basis. ii. Establishment of autonomous, commercially-oriented water supply entities in other cities, in a gradual, phased manner as their capacity and operations expand. iii. Phased decentralization of government oversight of urban WSS to munici- palities, while getting the central government out of direct involvement in operations. iv. Increasing reliance on cost recovery, which will promote financial sustainabil- ity, encourage a more commercial orientation on the part of the provider, con- tain demand, and give users more of an incentive to hold providers accountable. v. Ensuring convenient access to safe water for the urban poor, through well- located and well-maintained standpipes. Solid waste disposal is a municipal function and presents different issues. Contracting out of garbage collection and disposal functions is already occurring and can be expanded, with municipal governments playing a monitoring and regulatory role. There is scope for greater community participation in and monitoring of solid waste disposal, to enhance accountability. Water supply, sanitation, and solid waste disposal all require strategies which specifically address and involve the female members of communities and house- holds, with women and children in urban and rural areas being the primary water collec- tors. Community participation in sanitation and solid waste disposal would also need to focus on women in particular. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 145 Conclusions The above discussion highlights that each sector has its own specific characteristics which influence and constrain choices with respect to institutional relationships and account- ability mechanisms. Table 8.3 below brings out some of the key dimensions of variation. In sectors where there is relatively more emphasis on the "long route" of accountability, the contractual relationship or other arrangements between Government and service provider are of great importance. On the other hand, the mechanisms for client participa- tion and monitoring vis-ŕ-vis service providers are important for strengthening the "short route" of accountability, and to be effective will require female involvement at community level. In both cases service delivery units need to be given greater scope and capacity to manage themselves, within an appropriate accountability framework. Finally, the desirable level of government oversight is at the sub-national level rather than in the central gov- ernment. However, where contractual arrangements are being used to strengthen the long route of accountability (for example, for basic public health services), national government oversight of contracting is required in the case of provinces that have been "captured" by local interests and are not responsive to Government guidance. Table 8.3. Institutions and Accountability in Selected Services in Afghanistan Public service Elementary Basic health Water Supply and Solid waste education services sanitation disposal Main type of service Government Non-profit Public sector Private provider organizations corporations contractors Main direction of Short Route Long Route Long Route Short Route accountability reforms Desirable level of Province Provincial oversight Municipality Municipality government oversight of contracts (*) Government-service Supervision Competitive Regulatory Contractual/ provider relationship and contracting Regulatory management Role of cost recovery No No (minimal fees Yes (with lifeline to ration demand) tariffs for poor) Yes (*) With central government contracting for "autonomous provinces" (chapter 3). CHAPTER 9 Assisting the Poor and Vulnerable A very large number of Afghanistan's people are poor by any reasonable definition (see Chapter 2), and some are extremely poor. Afghan households have been severely affected by drought, political and security instability, conflict, and natural disasters. These shocks have often led to deepening poverty or have reduced chances of escaping poverty. Furthermore, even non-poor households have experienced and con- tinue to face multiple shocks, and are also vulnerable to fall into poverty as they deplete their assets--physical, human, social, and financial--to help smooth consumption. Divesting or mortgaging assets simply to survive, and also foregoing the building of assets (such as education), can have adverse implications for future productivity and broad- based economic growth, which are essential for sustained poverty reduction. Yet, the people of Afghanistan are not on the brink of starvation, nor have they been in recent history, due mainly to widespread personal and private initiative. Afghans are a resourceful, resilient, creative, opportunity-seeking, and entrepreneurial people (as wit- nessed by the high incidence of labor migration, entrepreneurial activity wherever they are located, trading networks, and remittances). Their achievements in the face of adversity are noteworthy. Building on the analysis of poverty in Chapter 2 and drawing on a forthcoming World Bank report (World Bank 2004b) which is based on the Government's recent household survey (Afghanistan Government 2003), this chapter focuses on issues and options related to social protection--the best way to help those among the poor who are least well- equipped and least likely to benefit directly and immediately from a growing economy (Chapters 1 and 3). Social protection is also intimately related to the capacity of the state (Chapter 4) and its delivery of services to the people (Chapter 8). The first section discusses the characteristics of the poor and vulnerable--key target groups, how people are coping 147 148 A World Bank Country Study through traditional mechanisms and private initiative, and the implications of these cop- ing mechanisms. The second section assesses the Government's present approach and social protection programs. The final section puts forward key elements of a broad-based, effective, and sustainable social protection policy, which the Government is developing. Poverty, Vulnerability, and Coping Mechanisms Poverty and Vulnerability in Afghanistan Building on the National Rural Vulnerability Assessment (NRVA; see Afghanistan Govern- ment 2003) and what is known about urban areas (see also Chapter 2), the following broad characterization of the population in terms of poverty and vulnerability seems appropriate. Around one-fifth of rural households (the lowest quintile) appear to be extremely poor. Roughly 50­60 percent of rural households (the middle three quintiles) are doing a little better, but most are still poor and vulnerable to falling deeper into poverty. The remaining households, the top quintile, while generally better off, in some cases do remain at risk of becoming poor in the event of being hit by shocks. It appears that the profile of the urban population is broadly similar. The essential characteristics of the three population groups, based on the NRVA data, are presented below and in more detail in Table 9.1. Table 9.1. Essential Characteristics of Three Groups of Rural Households The moderately poor or those at risk of The extreme poor becoming poorer The better off Share in NRVA sample (%) +/-20 50­60 20­30 Adequate calorific intake No Yes Yes Problems meeting food Yes Sometimes Rarely needs year round Share of cereals (wheat ) 70 60 50 in diet (%) Approximate % of hhs 13 6­7 4 formally headed by women Approximate % of households 18 24 32 with literate hh head Incidence of disability 22 12 9 (% households) Land ownership High incidence Some landlessness Mostly of landlessness (20­25%), some landowners of (40%); some with land irrigated land; sharecropping (including engage irrigated) sharecroppers Role of poppy Grow own and Grow own and Grow, employ provide labor provide labor to laborers to others others Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 149 Table 9.1. Essential Characteristics of Three Groups of Rural Households (Continued) The moderately poor or those at risk of The extreme poor becoming poorer The better off Employment patterns On- and non Waged labor as Self-employed farm unskilled well as farming & business, labor, daily self-employed and regular wages (farm and wage based non farm) employment (some public sector) Labor migration Some, both Most prevalent, Some, domestic and domestic and predominantly abroad, but abroad abroad mainly reliant on short term opportunistic movements within provincial locality Access to electricity 11 14 25 (% households) Access to potable water, Rare Rare Rare modern sanitation Access to primary school About 50% of About 50% of About 50% of (within village) households households households Use of health provider Occasionally, most Occasionally, most Often (but not when sick likely traditional often traditional always), most healer, rarely healer and health likely to use health center or center but private private doctor private doctor doctor for some but also traditional healer Coping strategies--what Reduce food intake, Reduce food intake, Reduce quality households do when a opt for cheaper opt for cheaper of diet, reduce "shock" occurs calories; informal calories; mortgage other networks for food and sale of assets; expenditures. and credit; informal credit; Sale of assets, migration; migration; poppy poppy poppy labor cultivation cultivation Approximate number of 3.5 million 10.5 million 3.5 million people (based on very rough estimate of total rural population) Source: Afghanistan Government (2003) and staff estimates. i. The extreme poor, who are food insecure all year round, and whose diet is primarily cereals, roots, and edible oil. These are often landless or very land-poor households, whose primary asset is their human capital and for whom wage employment (farm and non-farm, mainly informal sector) is central to their livelihood strategies. 150 A World Bank Country Study Some may enter into share-cropping arrangements with landowners, which provide access to land and sometimes credit but can be highly exploitative. In some cases the extreme poor actually reside in the homes of landowners and provide labor services in return for accommodations and/or food. Children are less likely to attend school and often make an important income contribution. Households without members able to engage in gainful employment may have little choice but to depend on the charitable support of relatives and informal social networks. Extremely poor house- holdsarehighlyvulnerabletosicknessandprematuredeathbutdon'thavethemeans to seek medical care when sick. They face volatile employment opportunities and are potentially at risk from fluctuating food prices. Years of shocks have eroded the asset base of these households, and they are reduced to daily survival strategies, living in a vicious cycle of indebtedness, very low wages, and exploitative relationships. ii. The moderately poor and those vulnerable to poverty. These constitute the bulk of the rural and urban population and despite many differences, have a similar propen- sity to move up and down the welfare ladder. These households tend to have the most diverse livelihood patterns, often engaging in half a dozen or more activities through the employment of different household members. They are engaged in agriculture (their own small landholdings as well as laboring for others), non-farm wage employment, and labor migration. Their diverse portfolios can serve well as a buffer against the impact of any one shock but at the same time limit the scope for major gains. These households generally manage to maintain adequate calorific intake although chronic malnutrition is common due to poor dietary diversity, high incidence of water-borne disease, and improper feeding practices of young children. Much of the time, they are able to manage risks and shocks without hav- ing to resort to extreme and degrading coping strategies. Welfare indicators for this category of households are better than for the extreme poor, but not by a large mar- gin. The absence of schools, health facilities, potable water, electricity, and roads has an equally negative impact on the welfare of these households. iii. The better-off (relatively speaking). These households enjoy greater stability in their consumption and are more likely to be food secure, both in calorific and nutritional terms. Consumption smoothing is possible due to household involve- ment in higher-value activities and their ability to divest assets when needed, as evident during the 1999­2001 drought. These households are typically land owners (85 percent), having access to irrigation water, capital to buy the necessary inputs, and employing outside labor. However, non-farm earnings (from wages or self-owned enterprises) represent a more significant form of employment than farm management. Remittances from family members working abroad may add to household income and asset accumulation. Services that can be procured pri- vately, such as electricity from a generator and health services from private providers, are enjoyed by the better-off households. But these households remain exposed to many of the same risks and vulnerabilities as other rural households. Another way of identifying the poor and vulnerable is by specific characteristics, such as people with physical disabilities, female-headed households, the nomadic kuchi, IDPs, returning refugees, and households farming only rain-fed lands. The NRVA collected information related to such groups (summarized in Box 9.1). These patterns confirm that Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 151 Box 9.1. Situation of Specific Vulnerable Groups Returned refugees and IDPs have a slightly higher incidence of poverty compared to the overall NRVA sample, and the calorie intake gap is slightly higher, but all other indicators for this group are similar to the rural average. In fact, it is slightly better off in terms of land ownership, access to irrigated land, and literacy of household heads. Data on refugees and IDPs who have returned to urban locations rather than to their original rural homes (the majority) further confirm that these households are no worse off than others. Many returnees arrive with assets, including edu- cation and skills, existing social networks, and able-bodied men, and are well positioned to engage in economic activity and benefit from a growing economy. Households with disabled people are visibly among the poorest along a number of dimensions: they have higher poverty rates and food gaps than average, and less land ownership and access to irrigated land. There is also a higher incidence of female headed households in this category. How- ever, by no means are all households with disabled people poor. Depending upon the severity of the disability, how this impacts on both the individual as well as the household as a larger entity, the activities of non-disabled household members, and existing household assets including social capital, there is considerable variation in household well-being. Female-headed households have the highest incidence of poverty of all vulnerable categories. They also have a high calorie intake gap (though the gap is less than for some other categories), sug- gesting that perhaps these households do better than some in meeting basic food requirement. This may well reflect targeting of female-headed households in humanitarian programs as well as intra-community charitable arrangements. Female-headed households also have a higher than average presence of disabled members. They are more likely to be landless, not to have access to irrigated land, and to have lower ownership of other assets, such as livestock. Female-headed households tend to have (i) restricted mobility outside the domestic compound and (ii) restricted formal entitlements/control with regard to productive assets. Landless households have a high incidence of poverty, a very high calorie intake gap, and the low- est average daily calorie intake, suggesting a significant food insecurity problem. Owning no land (often the result of having to sell their land during the drought years) and little livestock, they are much more dependent on agricultural and non-agricultural labor, which are low-paid and pre- carious. A higher than average proportion of landless households are female headed (15%, nearly double the ratio for the sample as a whole), which may reflect the loss of formal asset entitlements by women to male relatives, after the loss of a husband. Households farming only rainfed lands have the second highest poverty rate, although their food consumption patterns are about average. This may reflect significant livestock holdings for these households and extensive engagement in share-cropping and/or agricultural and non-agricultural labor. Households residing in rainfed zones are more likely to be female-headed and to include disabled persons. female-headed households, some households with disabled members, the landless, and those farming small plots dependent on rainfall are indeed among the poorest and most vulnerable in rural Afghanistan. These groups are also less capable of protecting themselves against adverse shocks and are more likely to remain trapped in extreme poverty. While this is not an exhaustive list--there are, for example, extremely poor urban households and perhaps significant vulnerable elements within the Kuchi population--designing appro- priate mechanisms to allow such groups to increase their income generating potential wherever possible and considering direct transfers as a measure of last resort are called for as an important policy direction. However, returned refugees appear not to be necessarily poorer or more vulnerable than other households. With respect to the geographical location of the poorest and most vulnerable, insights from the NRVA and other information sources suggest that there is some regional variation, 152 A World Bank Country Study such as a greater concentration of the extreme poor in the west and north-west of the coun- try, and less poverty in the north-east. However, there is significant heterogeneity in house- hold welfare both within communities and across communities throughout the country. This poses a particular challenge for any form of geographical program targeting. By contrast, in urban areas location of residential area (insofar as it conditions employment opportunities, services, access to shelter, environmental, and sanitary conditions) is an important factor in identifying the poor and vulnerable. Stability of income source, social capital, and status of housing (owned or rented) are other proxy indicators of urban poverty/vulnerability. Less is known about poverty and vulnerability in urban Afghanistan, but urban poverty is clearly as much a multi-dimensional phenomenon as rural poverty. The urban poor suf- fer from similar deprivations as their rural counterparts, such as lack of access to employ- ment, adequate housing, and services. Personal security appears to be a greater concern in urban areas than in rural areas, although this could also be a reflection of the more qualita- tive assessments and enhanced intra-household research conducted with urban communi- ties. The nationwide 2003 Multiple Indicator Cluster Survey (UNICEF and CSO 2003) collected information in both rural and urban areas and provides some interesting com- parisons (shown in Table 2.1). The data show significant levels of poverty and vulnerability in both urban and rural Afghanistan. For several indicators, mainly relating to access to basic services, such as birth delivery in health facility, literacy and school enrollment (particularly for girls), access to safe drinking water and sanitation facilities, the situation in urban areas is slightly better than in the rural areas. While infant and child mortality rates not surpris- ingly are around 20 percent lower in urban areas than in rural areas, there is no significant variation as between urban and rural areas in diarrhea prevalence, the proportion of dis- abled children, the incidence of child labor, orphans, and fertility rates. Traditional Safety Nets: How Well are They Faring? As noted above, the remarkable resilience, responsiveness, and strength of the Afghan peo- ple is confirmed by the absence of any large-scale famine in the face of adverse circumstances over the last twenty five years. This would appear to be borne out by nutritional data from different parts of the country.1 A key contributing factor is undoubtedly the diversity of eco- nomic activities across Afghanistan, within communities and even within most households, facilitating a wide range of private and informal risk management instruments, utilized by Afghans in the face of adversity.2 Undoubtedly the rich fabric of community-based networks and institutions has also played a significant role in supporting households and individuals. When faced with a multitude of risks and shocks, rural households in Afghanistan have for decades relied mostly on informal and private risk management instruments. 1. While the nutritional situation in Afghanistan is characterized by very high prevalence of chronic malnutrition (stunting), estimated at 45­59 percent, levels of acute malnutrition (wasting) remain rela- tively low, estimated at 6­10 percent. While severe stunting often is associated with a high incidence of chronic poverty characterized by food insecurity and poor health etc., low wasting may imply less prob- ability of nutritional deterioration as a result of rapid shocks. 2. Analysis of a particular economic crisis resulting from a blockade by the Taliban in 1997/98 com- bined with a severe winter and rising grain prices concludes that households averted famine by employ- ing a range of complex livelihood strategies including sale of livestock, increased labor migration, growing indebtedness, use of social support mechanisms, and access to distress foods. The overall impact of this severe shock was heightened impoverishment for many households, but not outright famine. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 153 During the drought of 1999­2001, the worst drought in living memory, households adopted a number of ex post risk management strategies. These included the sale of assets (livestock, land, farm tools, and in the most extreme cases family members--for example, under-age child marriage), generation of additional household incomes through migra- tion strategies, increased reliance on the labor of women and children, employment with local militias, and informal credit (both in cash and in kind). As reported in the NRVA, almost 40 percent of the rural households affected by drought reduced food consumption, another 25 percent decreased overall expenditure, 17 percent sold assets (such as livestock), while 9 percent relied on informal coping instruments (such as borrowing from family and friends). Similar patterns emerge in response to other shocks, such as health shocks. While preventing starvation, the majority of the coping strategies employed by rural households have long-run adverse implications. Particularly when utilized by poorer house- holds, decreasing food consumption lowers productivity in the short run and in the longer run has adverse health/nutritional consequences among children. Similarly, while asset depletion may be an appropriate smoothing mechanism for households that are relatively rich in assets, this may have major adverse implications for the ability of poorer households to generate income in the future. In addition to food consumption reductions, poorer households may have to rely on support from family and friends in the form of informal borrowing or transfers. This is frequently reported by rural households as a potentially dam- aging dis-investment in social capital and can incur a significant burden for household members (and may give rise to increased personal and psychological insecurity). Opium poppy cultivation, and associated wage labor involving as many as two million people altogether, have emerged as a major mechanism helping poor rural households recover from the asset losses and other ill-effects of the drought. However, the burgeoning opium economy is profoundly damaging to state building, security improvements, political normal- ization, and other critical components of national reconstruction (see Chapter 7). Moreover, many of the rural poor have become increasingly mired in opium-denominated debt. While the most severe coping mechanisms such as child labor, indentured labor, and giv- ing up under-age daughters in marriage are less frequent in the NRVA sample, their utilization by some households reveals destitution and absolute lack of better risk management instru- ments. Such practices by all accounts continue, with tragic social consequences for children-- a very vulnerable segment of the poor--and there are reports of sale or theft of children for organ transplant purposes as well. These extreme coping mechanisms which some of the poor are forced to resort to underline the critical importance of developing a broad-based social protection strategy focused on the extreme poor, to prevent such tragic outcomes. Government Strategy and Programs The Livelihoods and Social Protection Program As discussed earlier in this report, poverty reduction through broad-based economic growth is at the core of the National Development Framework (NDF). Investments in physical infrastructure (especially roads, water systems, and electricity), agriculture, secur- ing land and property arrangements, creating a healthy business climate with access to skills and capital, good governance, health, and education, will all be parts of a sound poverty reduction strategy. 154 A World Bank Country Study The Livelihoods and Social Protection Public Investment Program (LSP PIP), part of the first pillar of the NDF, has been developed with a view to ensuring that the needs of poor and vulnerable people are addressed through both their direct (self-reliance) and indirect (targeted public transfers) inclusion in national development. The stated purpose of the LSP PIP is "to empower and support the poor and most vulnerable people in Afghanistan, thereby assisting individuals, households, and communities to better man- age risks through both support to sustainable livelihood strategies and direct provision where people are unable to help themselves" (Afghanistan Government 2004b, LSP Tech- nical Annex). The budget for the LSP PIP outlined six sub-programs, each consisting of a coherent set of priority interventions, including many not directly implemented by the Government. The total investment budget for 1382 was $250 million, 14 percent of the National Development Budget. In addition, food aid programs (300,000 million tons of food) costing around $150 million were planned for the same period. Significant achieve- ments of 1382 are highlighted in Table 9.2, including major progress in implementation of the National Emergency Employment Program (NEEP), which generated more than eight million labor days of labor-intensive public works employment. Table 9.2. LSP Significant Achievements in 1382 (FY 2003/04) National Emergency The NEEP generated 8 million labour days through establishment of a Employment nationwide employment based safety net for the construction of rural Program (NEEP) infrastructure (including 5,000 km of rural roads) using mainly cash payments National Solidarity The NSP, Afghanistan's flagship intervention for community Program (NSP) empowerment, provided resources through block grants for community managed small-scale reconstruction and development in rural areas, and promoted more participatory and inclusive decision making and governance at the village level. The target is to cover the country's approximately 20,000 villages over a four year period. As of May 2004, 4,600 village level community development councils had been elected, 3,400 village development councils completed, and 2,350 sub-projects submitted to approval. Comprehensive The delivery of services to 30,000 disabled people in Herat, Farah, Disabled Afghan's Kandahar, Ghazni, Mazar and Takhar. Program (CDAP) Community Based The construction of over 12,000 water points across the country with Rural Water Supply prioritization given to areas where pressure on host communities and Sanitation resulting from returning refugees and IDPs has resulted in particularly Program (CBRWSS) acute needs for safe water and sanitation facilities. National Area Based The formulation and implementation of immediate recovery and Development development projects in areas where the local economy has been Program (NABDP) particularly damaged, based on local resources and existing/historical skills and productive enterprises. Micro-Finance The establishment of MISFA following a National Micro-Finance Work Support Facility shop in February 2003 to provide funds for the competitive of Afghanistan contracting of specialist professional agencies to sustainably deliver (MISFA) financial services to poor Afghans. As of May 2004, 30,000 loans had been disbursed to clients (90% of whom are women), and the repayment rate is 98%. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 155 The Performance of Safety Net Programs The Government introduced its support for labor-intensive public works (LIPW) programs as part of the LSP PIP in 2002. These interventions, most notably NEEP, are generally designed to (i) generate additional employment opportunities in rural areas at a minimum wage, as a safety net to as many people and in as short a time as feasible; and (ii) rehabilitate Afghanistan's basic infrastructure (rural roads and irrigation channels). In addition to several multi-agency "cash for work" initiatives, the largest single LIPW initiative, the NEEP, was operational by the time the NRVA was carried out in the summer of 2003. The NRVA collected information on participation in cash-based LIPW initiatives (lumping together NEEP with other programs), and separately for two other programs: (i) food for work and (ii) relief food aid. Food-for-work, like cash-for-work programs (including NEEP), is designed with the dual objectives of creating rural infrastructure and providing short-term employment for some of the poor and vulnerable. Relief food aid, administered mainly by the World Food Program, has the objective of reaching food- insecure households. Further details on all three programs can be found in Box 9.2. Box 9.2. Safety Net Programs Labor Intensive Public Works Program (NEEP) (cash based): The total value of these initiatives, which were largely nationwide by March 2003, was estimated at over $130 million. Within provinces, the criteria for selection of project sites included areas of intense IDPs and returnee activity; drought-affected areas; areas severely affected by war; areas where existing NGO programs (often food-for-work) could be scaled up quickly; areas where few alternative employment oppor- tunities existed; kuchi areas; and areas sufficiently stable and secure to be able to undertake works. Participation in the program was self-selected, predicated on the assumption that at a low wage of $2/day only the poor and needy would want to participate. In practice, work was spread fairly evenly among all those who wanted work, typically a wide cross-section of any community. Over time, however, at $2/day labor became scarce during the summer months while remaining plen- tiful during the winter months. Some barriers to participation of the extreme poor and vulnerable have been identified and include distance to project site, share-cropping and other arrangements binding labor to landlords, and traditional values vis-ŕ-vis women's work. Food for work/food for asset creation programs. These programs are similar to cash-for-work pro- grams, except that payment is made in food commodities (wheat, flour, cooking oil). The main cri- terion for FFW targeting is areas of acute and very high food insecurity where households meet less than 50 percent of caloric requirements, as assessed by the WFP's vulnerability assessment method- ology. Wages are set below casual labor rates so that FFW should be largely self-targeting and does not compete with other work. FFW activities involve community participation, allowing villagers, including women, to agree on projects to be supported and to determine who should participate. Food for work programs have been a feature of life in rural Afghanistan for many years. Relief food aid, also under the umbrella of the WFP, consists of various programs to assist food- insecure households to meet basic food requirements, with particular attention to the most vul- nerable (returning refugees, IDPs, malnourished children, TB patients). Major programs in 2002/03 included: (i) returning refugees--150 kg of wheat per family provided at place of return, with follow-on support for three months; (ii) IDPs--support for both returning to their homes (150 kg of wheat) as well as those remaining in camps; (iii) vulnerable rural households--house- holds living in FFW communities but unable to participate, such as widows, orphans, households headed by elderly or disabled person, and households without income earners (rations provided for five months per year); and (iv) Assistance to TB patients and their families, mainly women (food rations for eight months per year). In 2002/03, Food for Work and relief food aid combined cov- ered around 10 million people. 156 A World Bank Country Study Figure 9.1. Program Participation by Quintile (percent) Food for work Cash for work Relief food 40 40 36 40 40 33 30 30 26 30 30 21 20 21 21 20 20 17 16 20 14 12 9 9 10 10 10 0 0 0 Poorer Richer Poorer Richer Poorer Richer Note: Quintiles are based on per capita food expenditure. Source: Afghanistan Government (2003). The participation rates in these programs are quite high. More than one-third of rural households in the NRVA sample had participated in food-for-work in the year preceding the survey, almost 20 percent of households in cash-for-work programs, and 13 percent had received relief food aid. Turning to the participation of different categories of rural households (extreme poor, moderately poor--further subdivided into the middle three quintiles of the sam- ple--and better-off), of the three programs only relief food aid appears to be highly pro- gressive in targeting the extreme poor households (see Figure 9.1). Food for work appears to be modestly progressive, and LIPW (cash-for-work) programs are reaching only slightly more of the extreme poor than of the rest of the rural population. Moreover, many of the extremely poor households are excluded from these programs altogether. On the other hand, households in the "better-off" category participate in all three programs, especially cash-for-work programs. While it is possible that some of these people were less well-off at the time of participating in the program (the data refer to the year preceding the survey) and may have been more eligible beneficiaries at that time, this seems unlikely. Indeed, insights gained from qualitative reviews of the LIPW programs suggest that at the community level the work is divided fairly evenly among all those in the community who are able to work. Thus, there is an issue of targeting, especially in LIPW programs, and a considerable share of the resources devoted to all three types of programs seem to be going to relatively better-off rural households. These issues also relate to the objectives of the programs, in par- ticular whether they are seen primarily as: (i) social protection mechanisms to alleviate the situation of the extreme poor; (ii) programs designed to inject purchasing power (in the form of cash or food) more generally into the rural economy, for example in the face of a massive shock like a drought; or (iii) rural infrastructure programs to build or repair phys- ical assets that are of use to the poor, such as rural roads and small-scale irrigation facilities. The balance between these different objectives affects the importance of targeting issues. Finally, in making comparisons between the three categories of programs, cost-effectiveness 3. The payment of a monthly stipend to more than 250,000 war-related disabled persons and their fam- ilies is an additional program on the operating budget of the government. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 157 should be a primary consideration. For example, although as discussed above cash-for-work programs appear to be less well-targeted at the extreme poor, this would most probably be more than offset by the much higher overhead costs (especially food transport and handling costs) of food-for-work and relief food aid programs. Thus the total program costs required for LIPW programs to put a dollar into the hands of someone in the poorest 20 percent of the rural population might well be considerably less than in the case of the other two pro- grams because of the much more reasonable overhead costs involved, even if food-for-work and especially relief food aid are somewhat better targeted at the poor. In conclusion, additional information not collected in the NRVA is needed to fully evaluate these programs. The patterns outlined above, however, suggest that the programs are not proving very effective in reaching the poorest and most vulnerable. Steps need to be taken to improve targeting and selection criteria, and to help restructure and redesign some of the objectives and goals of existing and potential new programs. The detailed eval- uation of one cash-for-work program (in Hazarajat; see Box 9.3) suggests some pointers for successful labor-intensive public works programs: Box 9.3. Lessons from Oxfam's Cash for Work Program in Hazarajat Background: The Oxfam cash for work program was funded by ECHO at a project site where Oxfam had been present since 1991. The intervention was focused on livelihood protection over the win- ter period when employment opportunities are reduced and to ensure avoidance of damaging cop- ing mechanisms such as distress migration. Cash-based transfers were chosen since food-based transfers were frequently re-distributed, were often not perceived as a development activity for asset building by communities, and to minimize the potential adverse impact on agricultural activities. Targeting and Activities: Targeting mechanisms were facilitated through the introduction of Oxfam developed criteria, but managed by communities to the extent possible. Where greater investment in shura/community participation had taken place, targeting problems were minimalized. Com- munities had clear ideas regarding the identification of the most vulnerable households including homeless; landless; small landowners; widows; and people with disabilities. Cash for work activi- ties included construction of water reservoirs and river protection walls, protection against ero- sion, safeguarding irrigation channels, tree planting, vegetative propagation, fodder collection, and planting. A women's embroidery project component was also introduced, and Oxfam acknowl- edged that the identification of acceptable work for Hazara women was a challenge, given the inap- propriateness of external manual labor. Traditional community safety net instruments were reinforced through the contribution by participants of cash transfers to the non-able bodied. Payment: Half of the cash payments were distributed before winter and the other half at the end of winter, which coincided with the communities' greatest need for cash. Wage levels were around $2/day for unskilled labor and $4/day for skilled labor. Interestingly, although community repre- sentatives argued that other agencies were paying higher rates, local government supported the principle of greater self targeting through lower payments. Monitoring confirmed that participat- ing households accessed 70 days work and that around 90 percent of wages were spent on food, much of it stocks for the winter season. Market traders responded well with additional food sup- plies. Despite the existence of high debts, money was not spent on debt repayment. Impact: The household impact of the intervention included increased purchasing power; preven- tion of migration and distress asset sales; and creation of new community assets. Communities appeared most interested in the overall and longer-term impact of the infrastructure on livelihoods (particularly when these were located within the local vicinity) rather than the more immediate impact of the cash receipts on household well being. The quality of outputs, design, materials etc. was considered very important. 158 A World Bank Country Study i. Seasonality--more activities in winter months when other income generating activities are fewer, with before winter and end winter payments (the most cash- needy times); ii. Types of activities--activities which the extreme poor and vulnerable can help with (a particular challenge with regard to the inclusion of different groups of women and people with disabilities)--and location of activities, in or near to the village; iii. Duration of employment--long enough to provide a significant cash injection and to provide a meaningful alternative to other less desirable short-term livelihood strategies; iv. Create quality and durable infrastructure--this outcome should be considered as a more important objective of LIPW programs; v. Mode of payment--preference for cash-for-work over food-for-work projects; and vi. Support traditional distribution mechanisms--support communities to generate transfer instruments for less-able bodied households. Toward a Broad-based, Effective, Sustainable Social Protection Policy The challenge for Afghanistan's social protection strategy lies in effectively reaching the poorest and most vulnerable people in the short run while supporting effective risk man- agement for the broader population over the medium term, all at an acceptable, sustain- able fiscal cost. Thus far, social protection has proven more effective in reaching the broad population, and programs that were intended for the extreme poor have not been as suc- cessful in reaching them directly. This is not an unusual outcome--countries around the world that have much more institutional capacity than Afghanistan and better data on the poorest have great difficulty in reaching them through programs with low inclusion and exclusion errors (relatively few better-off people included in the programs, and relatively few of the poorest left out of them). Many of the elements of good policy are already in place in Afghanistan's social pro- tection strategy. These include favoring productive safety nets such as labor intensive pub- lic works and other labor-based activities over entitlement programs, strengthening livelihoods through skills development and micro-credit, and working with and through communities. In the immediate future the focus should be on ensuring that key programs are effectively implemented, with meaningful monitoring and evaluation providing insights for improved design. Above all, the challenge is to increasingly move beyond a fragmented project-driven approach to a more systematic national program, effectively drawing on analysis of poverty and vulnerability and carefully monitoring the impacts of interventions on different groups. Implementation can remain dispersed and in the hands of NGOs, local communities, and private individuals, if transparently and competitively conducted within the national social protection framework. Governmentpolicywillneedtobuildonandcomplementprivateandinformallivelihood strategies and self-protection arrangements, revitalizing and supporting informal risk man- agement instruments. The emphasis should be on productive and inclusive programs that: i. Focus on the extreme poor in both rural and urban areas, but create safety nets for them only as a last resort; ii. Take a labor-based approach to investments in rural infrastructure wherever pos- sible (NEEP); Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 159 iii. Operate through communities and empower communities to manage their own resources (NSP); iv. Promote sustainable financial service delivery to the poor through micro-finance (Microfinance Support Facility of Afghanistan--MISFA); v. Promote sustainable provision of enterprise support (e.g. business development services); vi. Enhance the health of rural and urban communities (National Water Supply and Sanitation Program); vii. Provide rural and urban communities with services and infrastructure; and viii. Further develop emergency response interventions which are also important for risk management (National Disaster Risk Management Program). Direct social transfers (cash, in-kind) will be limited to the extremely poor and vulnerable who are not able to participate in asset-creating, income-generating programs. These include disabled people with the more debilitating disabilities; poor female-headed house- holds; and destitute and displaced families (as identified in Chapter 2). The new National Vulnerability Program (NVP) will attempt to address the needs of these groups. However, the lack of formal institutions in Afghanistan, weak institutional capacity, and very limited fiscal resources, coupled with the fact that the extreme poor are scattered throughout a vast country with difficult physical access, mean that formal and market based options will be limited in the immediate future. In conclusion, even if strong economic growth is sustained, the need for continued support for the extreme poor and most vulnerable groups in Afghanistan is clear. In many cases household assets of the poor have been depleted, employment opportunities remain limited, and land fragmentation and high population growth present challenges to both the rural and urban economy. The social protection strategy selected and associated national programs must be fiscally sustainable in the longer term. Hence, continuing research on the nature of vulnerability, linking findings to enhanced targeting of programs, will be key to increasing the efficiency and effectiveness of limited resources in a difficult delivery environment. Moreover, an important aspect of enhancing budget execution in the area of social protection is increased institutional capacity for both public and not-for- profit organizations. Priority civil service reforms also are required in key central Ministries and sub-national departments responsible for social protection. CHAPTER 10 Priorities for Action, Challenges, Prospects, and Risks A fghanistan has come a long way since emerging from major conflict in late 2001. As detailed in the earlier chapters of this report, good progress has been made in economic recovery, political normalization, macroeconomic stability, revival and initial reform of public administration, expansion of primary education, initiation of reconstruction, and structural reforms in trade and the financial sector as well as in other areas. Perhaps most important, the energy and initiative of the Afghan people, demon- strated under duress during the more than two decades of conflict, are now being chan- neled to securing livelihoods, rebuilding assets, restoring a credible state, and more generally reinvigorating the economy. Their efforts have been supported by Government leadership and by major assistance from the international community. The challenge for the Afghan people, their Government, and international partners is to turn the recent economic recovery, and the promising progress in other respects, into sustained growth, poverty reduction, and social progress over the medium term, while building the state, improving security, and continuing to move forward with political nor- malization. As indicated in Chapter 1 and elaborated in the SAF report, the Afghan econ- omy does have sources of growth potential, which can be unlocked to sustain growth through a good investment climate and availability of infrastructure and other support services for the private sector. Equally important, especially over the medium term, will be further unlocking the potential of the Afghan people through human resource development. This challenge is complex and risk-laden. Adverse trends on the security and narcotics fronts constitute the most serious threats to the national vision of economic, political, and social development articulated in the National Development Framework and other Government documents. Worsening security in many parts of the country threatens to derail reconstruction, undermine state-building efforts, adversely affect elections and other 161 162 A World Bank Country Study political normalization, reduce private sector activity, and keep it in the informal/illicit economy. Closely related to insecurity is the problem of drugs--the burgeoning recovery of opium production during the past three years is an important driver of insecurity and funds interests strongly opposed to state building. Drugs, insecurity, "capture" of large parts of the country by illegitimate regional powerbrokers, and the weak capacity of the state all contribute to a self-reinforcing "vicious circle" that would keep the country inse- cure, fragmented politically, weakly governed, poor, dominated by the informal/illicit economy, and a hostage to the drug industry. Breaking out of this vicious circle and moving toward a "virtuous circle" of state build- ing, security, dynamic formal-sector economic activity, sustained growth and poverty reduction, and escaping from the opium economy will require simultaneous progress on several key fronts. Actions in any one area alone are unlikely to be effective given the forces at work to maintain the informal equilibrium. On the other hand, the Government has limited political capital and capacity and must focus on those aspects which really matter. There also needs to be a premium on implementing and completing reforms already underway rather than devising and starting new initiatives, which will use up limited capacity and high-quality human resources in the Government without achieving as much in the way of results. With these considerations in mind, key priorities for action over the coming 1­2 years include: i. Enhance Security and Rule of Law, Respond to Drugs in a Coordinated Manner: The continued existence of warlords and forces disloyal to the central government, funded in large part by drug money, undermines state building and other recon- struction agendas. Security sector reforms need to be given top priority, and administrative reforms in the Ministries of Defense, Interior, and Justice need to be urgently stepped up. The Afghanistan Stabilization Program (ASP) will need to support improved governance of security in provinces and districts. There are no easy answers on drugs, but it is clear that actions against the opium economy must be integrated within broader national objectives and particularly the security and state-building agenda to have any hope of success. The recent establishment of a Counter Narcotics Steering Group, chaired by the Government and including the main government and external agencies involved, is encouraging in this regard. ii. Pursue Political Normalization: The upcoming Parliamentary elections will mark the completion of the political process mandated by the Bonn Agreement, but there is still a long way to go before the political landscape in Afghanistan approaches full normality. The key priority will be making Afghanistan's nascent political institutions--ranging from the new Cabinet to the new elected legislative bodies and the judiciary--fully functional and effective so that they can take on their Constitutionally-mandated roles. iii. Maintain Growth with Macroeconomic Stability: This is essential but will face risks--drought, political instability, "poppy shock," "Dutch disease," and so forth--as well as other challenges (fiscal pressures, limited private sector supply response). The Government will need to monitor economic performance closely and make adjustments in response to shocks, while developing over time analyt- ical capacity and conventional macroeconomic policy instruments. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 163 iv. Intensify Public Administration Reforms with Extension to the Provinces: This is a critical part of the state-building agenda, and the Government will need to con- tinue and accelerate current administrative and civil service reforms, including implementation of the PRR process, increasing revenue mobilization, and reduc- ing vulnerability to corruption. It will be especially important to enable provinces to better interface with the public and deliver services, by ensuring timely payments of their employees and access to their non-salary budgets, strengthening their capacity through the ASP, and so forth. v. Accelerate Private Sector Development, Including Agriculture: Priority should be given to implementation of ongoing reforms: adoption of key laws (Investment, Mining, and Petroleum Laws), acceleration of micro-credit schemes, and develop- ment of Industrial Parks. Irrigation, marketing, credit, and extension services need to be efficiently provided to Afghan farmers, relying on the private sector as much as possible to provide these services. vi. Poverty Reduction, Gender, and Social Protection: The effectiveness of a poverty reduction strategy will largely depend on national ownership--requiring more extensive consultations with different stakeholders than has occurred hitherto. Enhancing the role of women requires addressing some of their main concerns, such as poor access to education, basic health services, and credit. Building on experience, the Government needs to continually improve existing programs to effectively target them at the poorest. This is a daunting agenda, and in each area listed above strong, sustained, and well- coordinated assistance from the international community will be required. International security assistance will continue to be needed in the coming several years, and its further expansion outside Kabul would have a high pay-off. Maximizing assistance provided through budget channels is very important, so that Government institutions have a chance to work. Payments to non-legitimate authorities should be stopped. Technical Assistance can support the reconstruction agenda but needs to be coordinated and fully under Government leadership and supervision, with sensitivity to the problems created by the "second civil service." The international community needs to be prepared to respond to major shocks like a drought, by adjusting and accelerating assistance as needed to support appropriate macroeconomic policy responses. Although Afghanistan's path forward will undoubtedly contain numerous pitfalls and detours, the experience so far gives ground for hope. Despite serious problems and risks, Afghanistan's position and prospects today far exceed what reasonably could have been expected in late 2001, let alone earlier during the protracted conflict. This is a tribute to the energy, initiative, and entrepreneurship of the Afghan people. The vast majority of them have demonstrated by their actions their keen desire for peace and prosperity, most recently manifested in the high voter turn-out for the Presidential election despite security threats. The Government has navigated a very difficult situation remarkably well in most respect. The international community has demonstrated its unity, commitment, and stay- ing power with respect to Afghanistan. This all bodes well for concerted, sustained efforts in the future to tackle the most important constraints hindering further progress in national reconstruction. Statistical Appendix Data Availability and Quality The analysis of the Afghan economy and of poverty in Afghanistan is hindered by severe data limitations: statistics on Afghanistan remain "wild guesses based on inadequate data," as Louis Dupree (1980) described them. But much has been learned about how the Afghan economy functions, and this report draws on the best available estimates, prepared, inter alia, by the Central Statistics Office (CSO), the Ministry of Rural Rehabilitation and Devel- opment (MRRD), the Ministry of Finance, the Central Bank, FAO, the IMF, UNICEF, and the World Bank. Institutional Structure and Reform Program Currently, the core of the statistical system in Afghanistan is the CSO, with branches in all provinces. In addition, there are statistical units in line ministries (and other agencies such as Da Afghanistan Bank) collecting data from administrative sources. The organizational structure and methods used emphasize central planning: CSO continues to use many statistical methods that are inappropriate and inherited from the previous era, and the organization focuses on collecting data for sectors relevant for planning on a complete enumeration basis. CSO and other Ministries and agencies responsible for the compilation of administrative and other data at the sector level have suffered greatly from the conflict and are confronted by serious human resource, material, and physical constraints. In the last two years, a number of NGOs and international agencies have mounted ad hoc data collection efforts, but with no or limited involvement of CSO. A Statistical Master Plan has been prepared to develop the Government's statistical capacity and coordinate donor support (Chandar 2003). The Government is expected to 165 166 A World Bank Country Study gradually strengthen its institutional capacity to monitor and evaluate its development strategy, including public expenditures. According to this plan, a National Statistical Council will be constituted, with a large membership (statistics producers and users), to set priorities and review progress. The plan also involves reform of CSO (including preparation and implementation of the Priority Reform and Restructuring scheme for CSO). It programs improvements in most areas, including the design, implementation, and analysis of regular households surveys. National Accounts The official GDP estimate of $4 billion for 2002/03 produced by CSO, is based on expen- diture categories (Table A.1). The traditional method, compiling value-added for different sectors and aggregating the sectoral figures, is simply not workable in the short term in Afghanistan. Government consumption was easily estimated from the national budget. Investment was based on an estimate of investment in construction and imports of machinery and equipment (mainly for transportation). Exports included recorded exports (about $100 million), plus an estimate of $1.2 billion for opium exports, smuggling, and re-exports, and $300 million of non-factor services (expenditures by foreign embassies in Kabul and non- residents including foreign military, UN, NGOs, and other international consultants and missions). To recorded imports of $2.3 billion were added smuggling and some non-factor services (Afghan embassies abroad, Afghans visiting abroad especially Pakistan, students, and so on). Household consumption was based on a very rough survey of a few households in Kabul (consumption was estimated at 4,500 Afghanis per month per household, or approximately $200 per year per capita). From this total estimate, CSO derived sectoral value added estimates by updating sec- toral shares from estimates of the "Net Material Product" (a concept used for planning purposes in Soviet-style economic systems, with six main branches evaluated at constant 1978 prices). The GDP estimate used in this report is based on the assumption used in the Govern- ment's SAF report, namely that the total income of the economy is calculated as the sum of the official GDP estimate and the value of opium production. Indeed, even though some opium exports appear to be included in the official data,1 a large part of the opium econ- omy is probably excluded and needs to be added to the official estimate. Agriculture and Opium Most estimates of agriculture production, by UNODC for drugs and by FAO/WFP for the rest, rely on satellite images to measure cultivated surfaces (Tables A.7­10). It is also necessary to estimate yields, which are based on surveys with possibly significant margins of error due to heterogeneity throughout the country. Very little agricultural price data is available, which makes the value of production difficult to measure. 1. In the CSO estimate, only $1.2 billion is included for opium exports (including smuggling and net value of re-exports), while the value of opium/opiate exports is estimated by UNODC at $2.5 billion. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 167 For opium, surveying farm-gate prices combined with production estimates can be used to derive and estimate of the value of opium production at the farm level (estimated at $1.2 billion in 2002/03). But the total income from opium for Afghanistan should be eval- uated at border prices, which are far more difficult to measure. UNODC roughly estimated total opium-related income at around $2.5 billion in 2002/03 (the base year for the national accounts estimates). Household Data The main source of household data is the National Risk and Vulnerability Assessment (NRVA), carried out in July-September 2003 by MRRD. It surveyed 1,850 rural villages in almost all districts in the country and collected data at the village, (subjective) "wealth group," and household levels (11,227 households). The survey estimated average rural expenditures at $165 per year per capita (as discussed at the end of the Statistical Appendix). UNICEF conducted a Multi-Indicator Cluster Survey in 2003 (Table A.2). The survey covered more than 20,000 households and focused on health, education, and access to related facilities (including water and sanitation). Another source of data is the labor market information survey conducted by IRC (2003). Although the sample design is rudimentary, this survey provides information on incomes, employment, and business constraints based on questionnaires completed by 992 families, 637 local businesses, and 77 local shuras (councils of village elders). Government Finances The Government has implemented an information system (Afghanistan Financial Man- agement Information System). Even though there are still issues of quality, notably with regard to data from provinces, this system provides rich information on Government finances (Table A.3). Data on the civil service are difficult to interpret in the absence of a nominal roll, however. Data on projects directly implemented by donors (not through Treasury) suffer from inaccuracies. As a result, an integrated view of the budget (with financing) is subject to uncertainties (Table A.4). Other Data A Kabul Consumer Price Index (CPI) and foreign exchange rates are now officially recorded on a monthly basis (Table A.1). Price data collection has expanded from 50 to 202 items surveyed in four markets in Kabul. Plans are in place to extend the CPI to five other cities. However, the weights for the CPI are problematic, and this weakness is unlikely to be overcome until a full-scale household expenditure survey is completed. The CSO, in collaboration with the IMF, has made an attempt to estimate the balance of payments. However, many flows (including smuggling and remittances, among others) are not adequately recorded. Finally, population data also comprise rough estimates in the absence of a full Census or other reliable sources of information. The official estimate from CSO is 22.2 million in 2003, based on the preliminary phase of the Census conducted as part of the electoral process. 168 A World Bank Country Study Analysis of Household Data The analysis in Chapter 2, detailed in Tables A.3 and A.4, is based on a measure of welfare that was obtained as follows. A vector of food consumption for 11,227 households was obtained from the NRVA household survey. This was then multiplied by a fixed vector of prices (a national median) to obtain a measure of expenditure on food that is the closest approximation to money metric utility available. Non-food expenditure on education, medicine, clothing, taxes, fuel, and oil was obtained from 5,559 wealth group surveys within villages. This was an estimate of the typical amount a household in one of three wealth groups in that village would spend on these items and was estimated by a gathering of household members from that wealth group (who for convenience were often later chosen as sample households). Therefore there were between two and three data points which had the same non-food expenditures in each village. A total expenditure measure was then calculated by sum- ming food and non-food expenditure. This was found to be the best measure when compared to food expenditures alone and expenditures calculated using locally weighted price indices. The method used was ascer- taining which measure better fit (in R-squared terms) various dependent variables that are either strong indicators of poverty or are in themselves factors in poverty (for example, dietary diversity, troubles satisfying food need, and village wealth group). Almost all the results shown are derived from data reported at the household level. Sometimes this is data for the household head only (for example occupation), which is clearly stated. The exceptions are debts and remittances and the priorities for the Afghan Government, which are obtained, as in the case of non-food expenditure, at the wealth group level. Due to the lack of a comprehensive Afghan census, the weightings used only scale the results up to the sample population. The quintiles are weighted by individual as are all individual statements, while household statements are weighted by household weights. For the regression analysis in Table A.4, data points containing missing observations were dropped and the top and bottom 5 percent tails were dropped to avoid the results being contaminated by clear outliers (for example, some individuals were apparently con- suming more than 10,000 calories a day). The quintile regressions were done using STATA code, with standard errors being obtained from bootstrapping. Significance levels are likely to understate the significance for the normal regressions as the fact that the survey was implicitly stratified into wealth groups will tend to reduce variance although not to an eas- ily quantifiable degree. This is not true of the quintile regression where the programming has not yet been developed to carry out such techniques taking into account survey factors such as clusters and strata. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 169 ) 25 22 52 62 11 17 27 38 -- income 16.8 39.0 430 3.2 52.8 (11) 12.9 b 1,617 countries Low continued( (2002) 7.1 27 23 51 69 14 19 30 41 -- 15.8 446 3.0 48.5 (12) 14.7 countries Africa 2,050 Sub-Saharan Other 17 20 62 52 10 22 29 31 (2) -- 36.8 49.4 746 7.6 8.8 66.3 3,200 Neighbors a 4­6 6 -- -- -- -- -- -- -- -- -- -- 20 27 41 13 -- (14) countries Year 1­3 9 -- -- -- -- -- -- -- -- -- -- 17 21 41 -- (20) 179 Post-conflict Year 9 4.6 -- 16 -- 47 21 29 38 12 69 36 18 2003 22.2 207 110 (56) c 8 c -- 29 53 25 22 20 3 38 (9) 2002 4.0 21.8 186 43.2 107 (35) (29) Afghanistan 6 2.4 -- 51 16 34 86 92 13 14 (2) -- 1975 14.0 169 3.0 6.6 39.4 Indicators GDP) (% (%) services services ($) formation billion) Economy and and increase) ($) PPP growth (% (US$ (million) the consumption capital Macroeconomic of goods goods rate Development GDP capita capita, annual of of (%) of consumption A.1. per fixed per expectancy trade Level Official Population GDP GNI Official Life Structure Agriculture Industry Services Household Public Gross Exports Imports Net Prices Inflation Exchange Table I. II. III. 170 A World Bank Country Study 5 0.2 49 -- -- 14 19 14 income Morocco, b countries Low (2002) Liberia, 5 ended. 68 -- -- 18 21 16 (0.0) countries Africa Lebanon,, Sub-Saharan onflictc Other the Georgia year 3 0.8 26 -- -- 16 19 16 the Ethiopia, is Neighbors 1 Year a 4­6 Salvador, -- -- -- -- 18 23 -- El Yemen. budget. countries Year Rep., and Dem. 1­3 -- -- -- -- 15 21 -- ---- Uganda, Post-conflict Year Congo development= d d Rep., -- 2003 (0.0) 40.9 731 4.5 71.7 Tajikistan, 10.0 61.7 Congo expenditures d d -- Serbia, 2002 (0.1) 20.1 426 3.3 22.0 8.6 13.4 capital Afghanistan Cambodia, Leone, ) d d and -- -- -- 1975 (0.1) 11.4 15.2 9.1 6.1 Sierra budget Myanmar, Continued( %) Rwanda, million) ordinary= (growth (US$ GDP) GDP) Herzegovina, Indicators GDP) GDP) Philippines, and reserves official (2004f). official billion) circulation official statistics. (% official (% Peru, expenditures in (% Bosnia Bank (US$ GDP) (% (% country opium. exchange Finances of of current World Macroeconomic Indicators Balance currency Nicaragua, account debt revenues expenditures expenditures Azerbaijan, foreign expenditures export (2004); A.1. average CSO External Current External Monetary Domestic Gross Government Current Total Current Capital Afghanistan, Table IV. V. VI. Countries: Mozambique, Simple excludes For a. b. c. d. Source: Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 171 of 0%2 avail- level n/a not 1 are water: deaths minimum based, per/year 8 1000 100,000 0 risk consumption: drinking be 100% education: 100% below per per 1000 high safe Polio: would energy 130 205 at 100,000; to (total): 50% primary per ts in rate: 55 per 56% enrollment: ratio: access 450 targe Population dietary net share: boys rate: per/year cases 20% rate: to population ($): 48 MDG (indicators) enrollment of mortality cases without n/a n/a net girls mortality GDP): 0 2015 primary 8% capita Literacy of mortality of Enrollment 100,000 (% per Target Poverty: Hunger: Primary Adult Female Girls Ratios Under-five Infant Maternal Measles: Malaria: Tuberculosis: per Population ODA GDP corresponding which Billion on of 68%, 3.7 0.52 100,000 reports. cases/year 87% per level n/a US($): estimates, (female (1990): million water: agencies' GDP 54% cases/year 3 deaths 91 poverty minimum 68% 1000 100,000 10 risk, Total drinking education consumption: (total): per per 1000 Polio: high available. below safe Official at 100,000; international Rate 172 per to Billion not 1,600 energy primary per line. enrollment: in rate: 115 170 other 36% ratio: per/year access cases Population dietary gross boys rate: women) and population 48% (US$): poverty estimates (indicators) Enrollment rate: to cases of 321 are UN mortality without on n/a n/a level girls mortality GDP): 718 16% capita official a b Gross primary Goals 40%) Literacy of cases mortality of national of (% per on drawing Current Poverty: Hunger: Primary male Adult Female Ratios Under-five Infant Maternal Measles: Malaria: Tuberculosis: (65% Population ODA GDP based population; (2004b), Development total to in and poverty Primary Health Equality partnership (percentage) Women diseases Access Mortality water hungry Government Millennium MDGs extreme global the Universal Gender Child Maternal HIV/AIDS other a poverty Environmental of of A.2. hunger Empower drinking development present. at Afghanistan Eradicate and Achieve Education Promote and Reduce Improve Combat Malaria, Ensure Sustainability/ safe sanitation Develop for Table 1. 2. 3. 4. 5. 6. 7. 8. Incidence able Percentage a. b. Source: 172 A World Bank Country Study Table A.3. Distribution of Characteristics Across Expenditure Quintiles, 2003 Q1 (Poorer) Q2 Q3 Q4 Q5 (Richer) Total Welfare (per capita) Total expenditure per year (US$) 66 116 151 193 301 165 Food expenditure per year (US$) 48 91 122 160 262 137 Non-food expenditure per year (US$)1 18 25 29 33 38 29 Overall situation compared to last year 0.44 0.47 0.51 0.56 0.59 0.52 (worse = 0, same = .5, better = 1) Household Characteristics Number of household members 8.2 8.1 8.1 8 7.5 8 Ages 0 to 5 1.2 1 0.9 0.9 0.8 1 Ages 65 and above 0.3 0.3 0.3 0.3 0.2 0.3 Female household head (%) 9.3 9.3 6 4.7 3.9 6.6 Disabled household head (%) 7.1 3.9 2.8 2 2.4 3.6 Migrated within country over last five 12.3 11.3 11.8 8.1 7.1 10.1 years (household, head, %) Returnees from abroad over last five 8 11.6 10.8 11.4 10.5 10.5 years (household head, %) Kuchi household (%) 5 3.3 6.2 4.4 3.6 4.5 Food and Nutrition Calories per day (minimum caloric 1,834 2,290 2,626 3,044 3,996 2,802 requirement = 2100) Problems satisfying food need 0.62 0.59 0.49 0.4 0.34 0.49 (never = 0, always = 1) Dietary diversity (number of food 7.2 12.4 14.7 17.1 21.2 14.5 items consumed) Calories from wheat (%) 69 63 59 55 48 58 Education Household head attended school (%) 20 24 27 33 37 28 Illiteracy of household head (%) 79 73 71 66 62 70 Housing Owns house (%) 76 83 85 91 93 86 Persons per room 3.8 3.5 3.1 2.6 2.3 3.1 Public Goods Electricity (%) 11 14 16 17 27 17 Access to: (more than 1 day travel = 0, in the community = 1) Drinking water 0.96 0.97 0.97 0.98 0.98 0.97 Permanent food market 0.62 0.65 0.68 0.67 0.69 0.66 Public transport 0.65 0.72 0.77 0.75 0.76 0.73 Primary school 0.74 0.79 0.78 0.76 0.81 0.78 Secondary school 0.35 0.47 0.48 0.51 0.55 0.47 Health facility 0.53 0.59 0.63 0.61 0.65 0.6 Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 173 Table A.3. Distribution of Characteristics Across Expenditure Quintiles, 2003 (Continued) Q1 (Poorer) Q2 Q3 Q4 Q5 (Richer) Total Employment (%) Employment rate for household head 78 83 85 82 82 82 Number of jobs held by household head 2.12 2.09 2.06 2.05 2.11 2.08 Self-employed household head 60 63 69 71 70 67 in main occupation Main occupation (16­64 year old): Agriculture 61 58 56 56 56 57 Construction 13 19 19 17 13 16 Trade 3 4 7 9 10 7 Manufacturing (textiles, crafts) 9 6 4 4 3 5 Transport 3 4 4 4 4 4 Education and Health 4 3 4 5 5 4 Administration 1 2 3 2 5 3 Others (Mining, industry, hunting and gathering) 5 4 3 3 4 4 Total 100 100 100 100 100 100 Method of payment in main occupation (16­64 year old): Self-employed 37 43 48 52 54 47 Casual daily wage 49 43 40 35 30 39 Regular salary 8 9 10 11 14 10 Payment in kind 6 5 2 2 1 3 Unpaid work 1 1 0 1 1 1 Total 100 100 100 100 100 100 Farming and Livestock Own some land (%) 78 85 85 90 92 86 Irrigated land owned (ha) 1.38 1.32 0.76 1.45 1.01 1.18 Rainfed land owned (ha) 0.66 0.43 0.39 0.42 0.54 0.48 Engaged in sharecropping (%) 22 16 10 8 6 12 Livestock owned (US$) 538 542 636 783 1358 769 Poppy Cultivation Cultivate opium (%) 3.6 3.4 4.4 4.7 7.8 4.8 Area of opium cultivated (ha) 0.16 0.20 0.24 0.25 0.31 0.24 Farming Constraints: (% reporting as one of top 3 constraints) Lack of irrigation water 53 61 65 69 63 62 Lack of seeds 53 54 58 60 59 57 Lack of fertilizers 42 47 51 55 54 50 Lack of oxen/traction power 50 36 33 30 32 36 Lack of farming land 35 34 32 23 26 30 (continued) 174 A World Bank Country Study Table A.3. Distribution of Characteristics Across Expenditure Quintiles, 2003 (Continued) Q1 (Poorer) Q2 Q3 Q4 Q5 (Richer) Total Lack of credit/cash 31 30 25 21 18 25 Lack of rainfall 20 25 24 26 24 24 Lack of farm labour 3 3 3 5 12 5 Reduced access due to landmines 1 1 1 1 1 1 Conflict and insecurity 1 1 1 2 2 1 Shocks (% suffering in last 12 months) Insecurity/violence 6 4 4 5 7 5 Influx of returnees 4 5 4 3 3 4 Human disease 41 30 27 30 23 30 Reduced water 58 58 59 60 54 58 Crop disease 42 37 38 40 38 39 Livestock disease 38 34 35 40 39 37 Late frosts 34 27 28 27 30 29 Debts and Remittances Household food debt (kg wheat) 55.2 51.7 48.4 33.9 28.6 45 Household cash debt (US$) 97 125 118 105 90 108 Households receiving remittances 10.5 10.1 12.8 18.3 23.2 15.2 (%) from: Pakistan/Iran (%) 35 32 32 28 27 31 Other (%) 65 68 68 72 73 69 Amount of remittances per capita 19 28 33 38 47 34 (receiving households, US$) Participation in Social Programs: (%) Food-for-work 39 34 33 31 26 32 Cash-for-work 19 22 20 18 16 19 Food relief 17 13 11 9 8 12 Demand for Development Projects (% reporting as one of top 3 priorities) Health facility 63 68 73 74 69 70 Education facility 50 53 55 55 62 55 Rehabilitation of irrigation system 37 45 47 46 46 44 Improved drinking water quality/ 36 34 34 35 35 35 quantity Construction or repair of rural roads 19 19 20 24 26 22 Micro-credit schemes 31 24 21 17 15 21 Employment opportunities 26 22 18 14 11 18 Others 32 31 30 32 33 32 1. Non-food expenditure includes spending on medicine, education, clothes, taxation, fuel and oil. Note: Local prices in Afghans converted at exchange rate of Afs 45/US$1. Source: Afghanistan Government (2003). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 175 Table A.4. Determinants of Rural Poverty, 20031 Variables Coefficient t-statistic Household Characteristics Numbers of household members ­0.032*** ­7.69 Ages 0 to 5 ­0.028*** ­4.63 Ages 65 and above ­0.042*** ­3.47 Female household head ­0.135*** ­4.88 Numbers of household members ­0.018 ­1.55 disabled Age of household head 0 0.32 Number of female members/ 0.028 0.6 household size Internally displaced over last ­0.066*** ­3.14 five years Returnees from abroad over last ­0.013 ­0.72 five years Kuchi household 0.149*** 3.05 Education Literate household head 0.072*** 4.86 Public Goods Electricity (yes = 1) 0.036** 2.19 Access to: (more than 1 day travel = 0, in the community = 1) Clean water 0.004 0.05 Food market ­0.018 ­0.47 Public transport 0.038 1.44 Primary school ­0.033 ­1.35 Secondary school 0.085*** 4.57 Health facility ­0.004 ­0.16 Employment (household head) Employed ­0.04* ­1.83 Self-employed in main occupation 0.027 1.63 Main activity of employed: (Agriculture omitted) Construction ­0.11*** ­5.38 Trade 0.067*** 2.87 Education and health 0.047 1.3 Administration 0.039 1.11 Farming and Livestock Own some land 0.083*** 4.17 Engaged in sharecropping ­0.137*** ­7.03 Agricultural laborer (main job of household head) ­0.116*** ­7.43 Cultivate opium 0.078*** 2.9 (continued) 176 A World Bank Country Study Table A.4. Determinants of Rural Poverty, 20031 (Continued) Variables Coefficient t-statistic Shocks from: (suffering in last 12 months) Insecurity/violence ­0.037 ­1.15 Influx of returnees 0.013 0.29 Human disease ­0.031** ­2.07 Reduced water ­0.006 ­0.49 Crop disease 0.017 0.94 Livestock disease 0.065*** 3.71 Late frosts ­0.012 ­0.75 Debts and Remittances Probability of receiving remittances 0.093*** 7.08 Region (Southern Region omitted) Central ­0.162*** ­3.87 East-Central ­0.074*** ­3.61 Eastern ­0.115*** ­6.14 North-Eastern 0.022 0.66 Northern ­0.054** ­2.09 Western ­0.287*** ­10.14 Memo: Number of observations2 5916 R-Square 0.189 Note: Regression also includes a constant and a date of household interview variable (not reported). * significant (difference from 0) at 10% level, ** significant at 5% level, *** significant at 1% level. 1. Dependent variable: Log of per capita total expenditure. 2. Missing observations and the 5% tails of the distributions dropped. Source: Afghanistan Government (2003); staff analysis and estimates. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 177 Table A.5. Government Expenditures and Employment 2002/03 2003/04 2004/05 Solar yeara Budget Estimate Budget Estimate Budget Ordinary Budget (US$ million) Locationb Center 193.1 391.7 269.7 418.4 Provinces 155.8 158.3 183.1 190.2 Total 460.3 348.9 550.0 452.9 608.6 Economic classificationc Wages 190.4 274.8 243.5 348.8 Pensions 15.6 1.1 3.6 14.5 Debt service 6.6 6.7 4.4 5.6 Goods and services 131.0 179.1 125.0 144.3 Transfers 4.0 22.4 15.0 22.5 Contingencies 74.1 28.3 -- 27.8 Capital expenditures 38.7 37.5 61.3 45.1 Total 460.3 348.9 550.0 452.9 608.6 Functional classification General Public Services 14.2 42.2 46.2 34.1 Defense 115.5 128.5 122.3 119.1 Public Order and Safety 93.5 82.0 111.0 124.9 Economic Affairs 61.2 41.0 45.3 58.7 Housing and Communal Services 0.4 1.3 2.5 1.3 Health 27.9 28.0 21.7 25.3 Recreation, culture, and religion 16.0 13.4 10.0 12.5 Education 61.6 133.0 77.0 127.3 Social Protection 4.9 7.2 16.9 8.5 Reserves 65.1 73.4 -- 97.0 Total 460.3 348.9 550.0 452.9 608.6 Development Budget (US$ million)d General Public Services 7.2 120.0 158.8 517.2 Defense 129.6 445.8 694.1 678.8 Public Order and Safety 77.7 173.6 190.5 494.9 Economic Affairs 109.2 403.7 591.3 1,315.3 Housing and Communal Services 2.9 35.5 89.8 78.3 Health 7.2 212.9 153.5 289.4 Recreation, culture, and religion 18.6 30.0 19.0 34.3 Education 3.5 84.7 109.9 277.0 Social Protection 185.6 448.4 365.8 539.6 Reserves 299.5 Total 541.5 1,954.5 2,372.7 4,524.3 (continued) 178 A World Bank Country Study Table A.5. Government Expenditures and Employment (Continued) 2002/03 2003/04 2004/05 Solar yeara Budget Estimate Budget Estimate Budget Employment (`000)e General Public Services 11.5 9.3 9.9 Defense 100.0 100.0 66.7 Public Order and Safety 78.7 77.2 88.3 Economic Affairs 43.1 29.7 34.4 Housing and Communal Services 1.1 0.8 1.0 Health 26.3 18.9 20.6 Recreation, culture, and religion 16.3 11.9 12.5 Education 172.2 129.9 166.9 Social Protection 6.1 5.5 5.9 Total 455.3 383.2 406.1 Memorandum Item Exchange rate (Af/US$) 34.0 44.5 44.8 49.0 49.8 a. Afghan solar year 2002/03 = March 21, 2002­March 20, 2003. b. 2002/03 based on IMF report. 2003/04 budget: based on first quarter allotment. c. Based on GoA's chart of accounts (differs from IMF's GFS). Wages include PRR allocation. d. 2002/03 and 2003/04 estimates = disbursement estimate. e. Budget = employment ceilings. 2003/04 Actuals = Mid-Year Review. Source: Data provided by Ministry of Finance, Government of Afghanistan. Table A.6. Government's National Budget 2002/03 2003/04 A. Domestic Revenues 163 208 B. Expenditures (B1+B2) 891 1,514 B. 1. Ordinary Expenditures 349 452 B. 2. Development Expenditures 542 1,062 Through Treasury -- 190 Directly by Donorsa -- 872 C. Budget Deficit (A-B) ­728 ­1,306 D. Financing (D1+D2+D3) 728 1,306 D. 1. External Assistance through Treasury 709 463 ARTF 79 217 LOTFA 17 36 Other Grants and Loans 207 210 D. 2. External Assistance Outside Treasury 511 872 D. 3. Other Financingb ­86 ­29 a. Disbursements. b. Other financing reflects changes in the balance of GoA's account at DAB. Note: These are estimates as the Government's accounts have not been finalized. Source: Data and estimates provided by Ministry of Finance; staff estimates. Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 179 Table A.7. Regional Distribution of Geographical and Arable Land, 2002 Percentage Percentage distribution of distribution of Percent arable land to Region geographical area arable land geographical area North 12 35 35 Northeast 12 21 21 West 20 17 10 West-Central 9 3 5 Central 4 3 11 South 8 6 9 East 4 2 6 Southwest 31 12 5 Total 100 100 12 Source: Maletta and Favre (2003); Afghan Web Directory (www.afghana.com) Table A.8. Cropwise Distribution of Area Cultivated, 2002 Crop Area cultivated (ha) Percent area cultivated Wheat 2,486,730 68.3 Other cereals (Barley, Rice, 573,470 15.7 Maize, Millet) Pulses 69,377 1.9 Oilseeds 68,787 1.9 Cotton 17,509 0.5 Clover (fodder) 137,073 3.8 Fruits 80,000 2.2 Vegetables 73,000 2.0 Poppy 74,000 2.0 Others 62,401 1.7 Total Area Cultivated 3,642,347 100 Source: Maletta and Favre (2003); Afghanistan Government (2004b); UNODC (2003b). 180 A World Bank Country Study Table A.9. Area, Production and Yield of Cereals in Afghanistan: 2001­03 Area (`000 ha) Production (`000 tonnes) Yield (Kg/ha) Regions 2001 2002 2003 2001 2002 2003 2001 2002 2003 North 608 1,034 355 753 1,367 1,239 1,322 North-East 565 716 419 958 1,576 1,696 2,200 West 406 409 218 630 722 1,551 1,765 East-Central 106 95 19 150 102 1,415 1,074 Central 120 139 115 281 467 2,342 3,360 South 48 105 156 93 325 1,938 3,095 East 106 114 289 243 267 2,294 2,344 South-West 254 206 397 482 547 1,898 2,656 Total Cereals 2067 2,213 2,819 1,968 3,589 5,372 951 1,622 1,906 Note: Cereals consist of Wheat, Barley, Maize and Milled Rice; Regional break-up for Area and Yield in 2001 is not available. Source: FAO/WFP (2001, 2003). Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 181 0 ) 2003 2525 3263 2554 3598 2238 3117 2765 1829 2849 907 1535 1137 800 1000 462 1089 0 2002 1727 2216 2106 2405 2193 1977 2011 1740 2019 669 950 944 800 886 268 continued( 2001 929 1491 1057 1520 2156 1568 1400 536 1310 102 199 99 333 500 125 100 333 133 (Kg/ha) 2000 1102 1101 1000 1247 1803 905 1099 1104 1118 200 200 100 333 250 125 109 200 167 Yield 1999 1401 1600 1902 1600 2097 1402 1900 1091 1662 702 500 800 200 400 400 500 200 616 1998 1500 1600 1900 1696 1707 1505 1700 1309 1637 900 700 1000 900 900 810 900 700 558 1997 1599 1701 1798 2000 1901 1495 1799 1197 1699 700 600 800 800 800 800 800 500 701 (1997­2003) 5 0 1 3 2003 217 224 139 107 63 103 170 35 1059 670 314 204 39 1235 3 0 0 Afghanistan 2002 260 204 170 74 57 44 186 50 1045 269 180 180 30 35 697 in 3 4 8 2001 254 173 174 75 77 95 280 28 1156 245 156 142 50 15 623 Regions ha) by 3 4 8 (`000 2000 265 188 176 77 66 95 274 48 1189 260 250 220 55 40 840 Yields Area 5 5 Wheat 1999 274 200 184 70 72 92 260 44 1196 225 260 220 10 66 40 318 and 1998 280 200 190 69 75 95 270 55 1234 250 260 230 20 10 42 90 50 952 Wheat under 1997 292 197 183 71 71 95 254 61 1224 220 260 210 20 10 40 90 50 900 Area A.10. Irrigated Rainfed Table Region Wheat North North-East West Central East South South-West West-Central Total Wheat North North-East West Central East South South-West West-Central Total 182 A World Bank Country Study 2003 1303 2255 1711 3473 2238 3096 2717 1108 1901 Paktika, 2002 1189 1622 1509 2312 2193 1977 1843 1388 1542 Takhar, (Paktya, 2001 523 878 627 1474 2074 1456 1203 465 898 South Kunduz, (Kg/ha) 2000 655 587 500 1213 1714 845 933 693 725 Wardak); (Bughlan, Yield Ghazni, ) 1999 1086 978 1302 1507 1987 1304 1617 667 1233 Northeast Logar, Uruzgan). and Continued( 1998 1217 1091 1407 1517 1612 1292 1500 1019 1296 Kapisa, Samangan); Nimroz 1997 1213 1074 1265 1736 1765 1289 1538 883 1276 Parwan, Balkh, Zabul, (1997­2003) 2003 887 538 343 112 63 104 173 74 2294 (Kabul, Sar-i-pol, Helmand, Central Afghanistan 2002 529 384 350 77 57 44 216 85 1742 in Juzjan, (Kandahar, Bamyan); 2001 499 329 316 78 81 103 330 43 1779 (Faryab, Regions ha) by (Ghor, North Southwest (`000 2000 525 438 396 80 70 103 329 88 2029 Yields Area follows-- Wheat 1999 499 460 404 75 77 102 326 84 2027 as West-Central Nooristan); are and 1998 530 460 420 89 85 137 360 105 Badghis); 2186 Laghman, Wheat provinces of Farah, Kunar, under 1997 512 457 393 91 81 135 344 111 2003). 2124 (Herat, Area (2002, groupings West (Nangarhar, A.10. East FAO/WFP Wheat Regional Table Region All North North-East West Central East South South-West West-Central Total Note: Badakhshan); Khost); Source: Afghanistan--State Building, Sustaining Growth, and Reducing Poverty 183 Table A.11. Wheat Production across Regions, 2003 Production Percent Region (`000 tonnes) production (%) North 1156 27 North-East 1214 28 West 587 13 Central 389 9 East 141 3 South 322 7 South-West 470 11 East-Central 82 2 Total 4361 100 Source: FAO/WFP (2003). Table A.12. Average Yield and Comparative Gross Income of Horticulture Crops as Compared to Other Crops Average yield Average gross income Comparative income Crop (Kg/ha) (USD/ha) wheat = 100 Wheat 2170 440 100 Maize 3360 517 118 Rice 2275 792 180 Cotton 1645 642 146 Almonds 2415 3179 723 Apple 10325 1814 412 Apricot 8890 1423 323 Grape 9065 1628 370 Pomegranate 9730 1424 324 Melon 11690 725 165 Onion 12845 1109 252 Potato 14175 1943 442 Tomato 10710 1024 233 Watermelon 14350 792 180 Opium poppy 70 3535 803 Source: ICARDA (2003). References Afghanistan Government. 2002. National Development Framework. ------. 2003. National Risk and Vulnerability Assessment (NRVA). ------. 2004a. Constitution of Afghanistan. ------. 2004b. Securing Afghanistan's Future: Accomplishments and the Strategic Path Forward. Transitional Islamic State of Afghanistan and international agencies. http://www.af/recosting/index.html ------. 2004c. Security Sector Reform in Afghanistan. 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IBRD 33584 ° ° ° ° 40 35 80 30 Bank. ° 80 eH rld o the by W tnakraY Ganges The colors, of produced Unit was boundaries, map Design The Delhi This Map CHINA New INDIA ° . 75 ° 75 REP Bishkek (Frunze) KYRGYZ AN Islamabad AN AJIKISTT Jalalabad AKISTP ° 70 AN ashkentT sudnI ° 70 Kabul Dushanbe Kunduz ay'radryS KAZAKHST Mazar-i Sharif AN AN ° Kandahar 65 UZBEKIST ya Dar ° Amu AFGHANIST dnamleH ° 65 40 AN Herat TURKMENIST 500 ALS ° AND 60 400 CAPIT AN ASIA TIONAL ° 300 60 TIONAL TOWNS NA RIVERS INTERNA BOUNDARIES 200 KILOMETERS CENTRAL IRAN 100 ISLAMIC AFGHANIST REPUBLIC OF 0 ° 55 OMAN ° ° ° 35 30 55 AUGUST 2004 Afghanistan--State Building, Sustaining Growth, and Reducing Poverty is part of the World Bank Country Study series. These reports are published with the approval of the subject government to communicate the results of the Bank's work on the economic and related conditions of member coun- tries to governments and to the development community. Afghanistan has come a long way since emerging from major conflict in late 2001. Nevertheles, it remains one of the poorest countries in the world in terms of both income and social indi- cators, and has large gender gaps. The challenge of poverty reduction is made even more difficult by continuing insecurity, weak rule of law, and narcotics. With robust support from the international community, Afghanistan must seek to break out of the self-reinforcing "vicious circle" that would keep the country insecure, fragmented politically, weakly governed, poor, dominated by the informal economy, and a hostage to the drug industry. The path to sustained economic growth and poverty reduction requires simultaneous progress on several key fronts, as dis- cussed in detail in this report: enhancing security and the rule of law; state building; further political normalization; main- taining economic growth; pro-actively pursuing private sector development; meaningful, coordinated actions against drugs; and enhancing the effectiveness and efficiency of internation- al assistance. This daunting agenda will require strong com- mitment, actions, and persistence on the part of the Government, and sustained, coordinated assistance from the international community. World Bank Country Studies are available individually or by subscription, both in print and online. ISBN 0-8213-6095-7 TMxHSKIMBy360958zv,:':!:*:; THE WORLD BANK 1818 H Street, NW Washington, DC 20433 USA Telephone: 202 473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org