MADAGASCAR COUNTRY ECONOMIC MEMORANDUM SCALING SUCCESS BUILDING A RESILIENT ECONOMY © 2020 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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ACKNOWLEDGEMENTS i Acknowledgements This report was prepared by a World Bank team led by Natasha Sharma (Senior Economist and Task Team Leader, EA1M1) and consisted of a core team including Faniry Razafimanantsoa (Economist, EA1M2), Alex Sienaert (Senior Economist, CROCR), Asif Mohammed Islam (Economist, MNACE), Carolin Geginat (EFI Program Leader, EA1DR), Roberto Echandi (Lead Private Sector Specialist, ETIRI), Gabriela Schmidt (Economist, EA1M2), Marc Stocker (Senior Economist, EA1M2), Guillermo Carlos Arena (Economist, ETIRI), John Keyser (Senior Economist, EA1M2), Gabriel Boc (FAO), Ghada Elabed (Agricultural Economist, SAGGC), Sara Nyman (Senior Economist, ETICI), Maciej Adam Drozd (Young Professional, ETICI), Neelam Verjee (Social Development Specialist, GTFSA), Cecile Giraud Kappen (Private Sector Consultant, EA1M2), Prisca Mamitiana (Consultant, EA1M2), Charlotte Keijser (IT/BPO Consultant), Lalaina Randrianarison (Agriculture Consultant, EA1F2), Ivan Crouzel (Political Economy Consultant), Lira Rajenarison (Public Sector Specialist, EA1G2) and Krishna Oolun (Telecoms Consultant). Valuable inputs were provided by the broader country team including: Eneida Fernandes (Senior Private Sector Specialist, EA1F2), Tiago Peixoto (Senior Public Sector Specialist, EA1G2), Noro Aina Andriamihaja (Senior Financial Sector Specialist, EA1F2), Djibrilla Adamou Issa (Lead Financial Sector Specialist, EMNF1), Justine White (Senior Private Sector Specialist, EA1F2), Giuseppe Fantozzi (Senior Agricultural Specialist, SAFA2), Tom Bundervoet (Senior Economist, EA1PV), Laura Rawlings (Lead Social Protection Specialist, HAFS1), Maud Juquois (Senior Health Economist, HAFH1) Voahirana Hanitriniala Rajoela (Senior Health Specialist, HAFH1), Peter Holland (Program Leader, HAFE3), Atsushi Iimi (Senior Economist, IAFT2), Erik Reed (Natural Resources Management Specialist, SAFE3), Martin Luis Alton (Financial Sector Specialist, EFNRF), Joern Huenteler (Energy Specialist, IAFE1), and Raymond Bordeaux (Program Leader, AFCS2), as well as Noro Hajalalaina Rasoloarimanana Andriamihaja (Team Assistant, AFMMG), Todimalala Volasoa Razafiarimbola (Temporary, AFMMG) and Rondro Malanto Rajaobelison (Program Assistant, AFMMG) for their administrative support. The team would like to thank the following reviewers for their advice and guidance: Antonio Nucifora (Practice Manager, ETIRI), Ian John Douglas Gillson (Lead Economist, ETIRI), Michael Joseph Ferrantino (Lead Economist, ETIRI), Dina Umali-Deininger (Practice Manager, SEAAG), Irina Schuman (Senior Agriculture Economist, SAFA2), Jean Claude Randrianarisoa (Agrifood Consulting International), Julio Revilla (Senior Economist, CROCR), Mombert Hoppe (Senior Economist, EEAM1) and Satyam Ramnauth, former IFC Head Madagascar. The team would like to express gratitude to the Government of Madagascar for helping to define the scope of work, sharing data, providing inputs and reviewing initial rounds of recommendations. Key counterpart institutions include the Ministry of Economy and Finance, the Central Bank, the Ministry of Industry and Trade, the Ministry of Telecommunications, the Ministry of Agriculture, Livestock and Fisheries, the Economic Development Board, and the Private Social Security Institution (CNaPS). The team is grateful to more than 150 private sector and embassy representatives who generously shared their time. Support to the financing of this report from the Umbrella Trust Facility for Trade is gratefully acknowledged. The report was prepared under the overall guidance and supervision of Mark Lundell (Country Director, AFCS2), Coralie Gevers (Country Manager, AFCF2), and Mathew Verghis (Practice Manager, EA1M2). The team would also like to express gratitude to Litera for translation services, Cybil Maradza for design work, and Diana Styvanley (Communications Officer, AFREC) for communications support, and Rondro Rajaobelison (Program Assistant, AFMMG) for logistics support. ii CONTENTS ACKNOWLEDGEMENTS i EXECUTIVE SUMMARY viii A. Steady economic expansion and increased political stability provides a solid context for realizing the twin goals of ending extreme poverty and boosting shared prosperity ix B. Export-oriented sectors which include the ‘bright spots’ of the economy are making important contributions to growth ix C. Scaling success requires addressing constraints related to connectivity, human capital and the business environment, while incentivizing the uptake of improved technologies to enable other sectors, such as agriculture, to realize their potential xi (i) Accelerating pipeline infrastructures and enhancing the competitiveness of service provision xi (ii) Reversing the decline in human capital so that the labor force is ready to meet the needs of an evolving private sector xiii (iii) Leveling the playing field and enhancing the institutions important for doing business xiv (iv) Incentivizing the uptake of improved technologies through addressing inefficiencies in the domestic market so that other sectors, such as agriculture, can realize their potential xv D. Conclusion and reform priorities xvii ABBREVIATIONS & ACRONYMS xxii 1 INTRODUCTION - SETTING THE STAGE 1 A. Context: declining incomes and shocks 2 B. An Economic Rebound but only Nascent Structural Transformation 5 C. Leveraging Trade and Investment to Engage in Sectors of Higher Productivity 8 D. Promoting the Productivity of the Agriculture Sector 9 E. The Importance of Levelling the Playing Field to Sustain Growth and Promote Productivity 11 F. The Madagascar Country Economic Memorandum Framework – Current Performance and Future Opportunities 11 G. Organization of the CEM and Methodology 12 2 THE LONG-TERM DETERMINANTS OF GROWTH IN MADAGASCAR: LABOR, CAPITAL AND PRODUCTIVITY 15 A. Introduction 16 B. The long-term drivers of growth: reliance on inputs (labor and capital) outstrips productivity gains 16 (i) Labor 17 (ii) Investment 26 iii Contents (iii) Productivity and innovation 34 C. The sustainability of growth 36 D. Conclusion 37 3 LEVERAGING TRADE AND INVESTMENT IN MADAGASCAR - A DEEP-DIVE INTO THREE HIGH-PERFORMING SECTORS 39 A. Introduction 40 B. Madagascar’s Trade Performance – Dominance of High-Performing Sectors 42 C. High-Performing Sectors: Explaining Growth and Leveraging Opportunities 48 (i) Focus Sector: Agribusiness 50 (ii) Focus Sector: Textiles and Apparel 54 (iii) Focus Sector: IT-BPO 57 D. Lessons Learned and Policy Recommendations 60 4 SEIZING THE OPPORTUNITIES FOR INCLUSIVE AGRICULTURE GROWTH 63 A. Introduction 64 B. Crop Production 65 C. Crop marketing and storage 66 (i) The farm level – the start of long and uncompetitive marketing chains 66 (ii) The national market level – slightly more competitive but still inefficient 67 (iii) Access to storage – a means for farmers to capture a higher share of the total value from rice, but reforms are needed 70 (iv) Contract farming can further help drive smallholder market participation and crop improvements 72 D. Crop transport and processing 74 (i) Transport costs contribute to higher overall costs and reduces competitiveness 74 E. Trade policies 76 (i) For domestic rice to compete with imported rice, efficiency improvements are needed 76 (ii) The uneven application of an export ban on rice is counterproductive 76 (iii) The ability to export ordinary rice depends on efficiency improvements 77 F. Market information 79 G. Policy and Investment Priorities for a More Inclusive Agriculture Growth Trajectory 80 5 ADDRESSING ANTI-COMPETITIVE PRACTICES 82 A. Introduction 83 B. Market Concentration and Anti-competitive Business Practices 83 C. Barriers to Competition in Key Sectors – Deep Dive Analysis 85 (i) Focus sector: Telecommunications 86 (ii) Focus sector: Petroleum 89 (iii) Focus sector: Lychee 93 (iv) Focus sector: Vanilla 95 D. Policy options and reforms to address anti-competitive behaviors 97 (i) Sector-specific reforms 97 (ii) Economy-wide reforms 98 iv Contents 6 SUMMARY OF REFORMS 100 A. Introduction 101 B. Pathways for Enhancing Inclusive Growth 101 BIBLIOGRAPHY 110 LIST OF FIGURES v Figure 1: The growth of the economy has lagged that of the population since 1960… 3 Figure 2: GDP per capita is on an overall declining trend (in constant 2011 PPP USD) 3 Figure 3: MDG one of few countries in the world with lower GDP p.c. now than in 1960 3 Figure 4: Relative to the average for SSA, GDP per capita is declining (in constant 2010 USD) 3 Figure 5: Periods of solid economic growth have been punctuated by deep downturns… 4 Figure 6: …the latest of which (2009 political crisis) generated large forgone output losses 4 Figure 7: Export-oriented sectors and services are important contributors to growth 5 Figure 8: Agriculture has absorbed the large majority of new workers… 8 Figure 9: …but other sectors have contributed much more to output growth while value-added in the agriculture sector has almost stagnated 8 Figure 10: Since 2014, net exports and investment are key contributors to gradual aggregate demand growth 9 Figure 11: The agriculture sector has a declining share in value added and volatile growth rates 10 Figure 12: Paddy production is closely linked with agricultural growth 10 Figure 13: Since 2000, growth has relied more on inputs (labor and capital) than productivity growth 17 Figure 14: Madagascar has a relatively high labor force participation rate 18 Figure 15: Pervasive informality and underemployment means that peers have higher levels of productivity compared with Madagascar 18 Figure 16: Madagascar has one of the lowest levels of remuneration levels compared with peers which both attracts investors and disincentivizes talent to stay 18 Figure 17: Madagascar has one of the lowest level of remuneration even when considering the level of productivity 19 Figure 18: Formal employment generation is led by few sectors 19 Figure 19: Sectors contributing to growth also have the fastest rate of job creation 19 Figure 20: Nightlights in 2012 20 Figure 21: Nightlights in 2018 20 Figure 22: Major changes to Madagascar’s nightlights between 2012 to 2018 and formal jobs created 21 Figure 23: Madagascar’s human capital index is amongst the lowest in the world 22 Figure 24: For Madagascar’s level of income, stunting is amongst the highest in the world 22 Figure 25: Total expenditures on health are amongst the lowest in the world 22 Figure 26: Total expenditures on education are also amongst the lowest in the world 22 Figure 27: Madagascar’s population is youthful 25 Figure 28: A declining dependency ratio indicates an opportunity to reap demographic dividend 25 Figure 29: Firms that have a female in a top position have higher labor productivity 26 Figure 30: Annual employment and labor productivity growth is also higher with females in top positions (%) 26 Figure 31: The volatility in public investment financing mirrors net official development assistance 26 Figure 32: Investment financing mirrors net official development assistance 26 Figure 33: Firms in Madagascar have amongst the highest percentage of sales lost due to outages (%) 28 v Contents Figure 34: 70 percent of paved roads are in good condition while 70 percent of unpaved roads are in poor condition 30 Figure 35: Madagascar’s Rural Access Index shows that only 11.4 percent of the population have access to a good road network 30 Figure 36: Madagascar has one of the lowest ranking scores for transport infrastructure 33 Figure 37: The perception of governance effectiveness is amongst the lowest compared with peers 4 Figure 38: Large firms have greater employment growth 35 Figure 39: Financially connected firms have higher employment growth 35 Figure 40: Madagascar’s ranking in the Global Innovation Index is on the higher end compared with peer countries 36 Figure 41: Madagascar has one of the highest rates of export growth and largest export sectors 41 Figure 42: Malagasy exports have a higher chance of survival compared with peers 41 Figure 43: Merchandise exports are under expansion, with agribusiness and apparel performing particularly well 43 Figure 44: Exports of telecommunications related services are rising at a rapid pace 43 Figure 45: FDI inflows are relatively high and are increasing 44 Figure 46: Apparel and various agribusinesses are experiencing export surges (2017) 46 Figure 47: Madagascar has a revealed comparative advantage in textiles and apparel and agribusinesses 46 Figure 48: Before 2009, Malagasy exports were largely destined to the EU and the US 48 Figure 49: Since 2009, other destination markets in Asia are gaining importance, although the EU and US still dominate 48 Figure 50: Madagascar has a challenging business climate 49 Figure 51: Getting electricity and construction permits are particularly challenging 49 Figure 52: FDI has been attracted by the availability of Madagascar’s unique inputs 51 Figure 53: But further growth is limited by poor access to electricity and governance constraints 51 Figure 54: Madagascar has one of the highest levels of participation in global value chain exports compared with SSA, but performance falls behind aspirational peers in Asia 55 Figure 55: Sources of comparative strength in the textiles sector include reduced labor costs and access to preferential markets 56 Figure 56: However, further growth is limited by political instability and high electricity costs 56 Figure 57: FDI has been attracted by the availability of affordable labor and access to broadband 58 Figure 58: But further growth is limited by high costs and labor with the right expertise 58 Figure 59: Indicative price formation of milled System of Intensive Rice sold in Antananarivo after five months of rural storage paid by collector 68 Figure 60: Average transport prices on long distance routes in Madagascar and comparator countries (US cents per ton per kilometer) 75 Figure 61: Relative to comparators, the intensity of local competition is perceived to be weak… 84 Figure 62: …and markets in Madagascar are perceived to be dominated by few businesses 84 Figure 63: The price of fixed broadband internet is relatively high in Madagascar 87 Figure 64: …while penetration and access of cellular and internet services are relatively low 87 Figure 65: Telma is present in all segments of Madagascar’s broadband value chain 87 Figure 66: The price of jet fuel oil is higher in Madagascar and is amongst the highest in Africa and other major destinations 90 Figure 67: The combined costs of transportation and storage and distribution and margins were until recently the highest in Madagascar compared with benchmark countries 90 vi Contents Figure 68: Petroleum market structure 92 Figure 69: Graphical representation of the value chain for lychee export 93 Figure 70: Value chain of export vanilla 96 LIST OF TABLES vii Table 1: Summary of Key Issues and Proposed Reforms xviii Table 2: Structural transformation in Madagascar is nascent, with increasing shares of workers outside of the agriculture sector 7 Table 3: Madagascar Selected economic and financial indicators:2008-2019 32 Table 4: Financial costs and returns from rice sold immediately after harvest 66 Table 5: Indicative value-added costs, profits, and rates of return from milled SRI rice sold in Antananarivo after five months of rural storage paid by collector during assembly (MGA per kilo milled rice) 69 Table 6: Share of total available profits from smallholder rice captured at each stage of the value chain in Madagascar and comparator countries 69 Table 7: Indicative value-added costs, profits, and rates of return from milled System of Intensive Rice sold in Antananarivo after five months of rural storage paid by farmers (MGA per kilo milled rice) 71 Table 8: Indicative regional parity calculations for ordinary Madagascar and Pakistan rice in regional export markets (US$ per ton) 78 Table 9: Summary of Key Reforms and Expected Impacts 105 LIST OF BOXES vii Box 1: Not all FDIs are the same 44 Box 2: Good practice in agribusiness: the Consortium of Cocoa Actors 53 Box 3: Boosting Investor confidence through Alternative Means of Dispute Resolution (ADR) 61 Box 4: Learning from other Country Experiences - How Senegal and Vietnam were able to realize success in domestic rice markets 73 vii EXECUTIVE SUMMARY viii Executive Summary A. Steady economic expansion subsistence agriculture dominates, absorbing and increased political stability an estimated 75 percent of the workforce, provides a solid context for who have limited opportunities to compete realizing the twin goals of ending in the market. Such a situation constrains extreme poverty and boosting the possibility of sustainably raising incomes shared prosperity and escaping poverty. Against this backdrop, the Country Economic Memorandum takes 1. Madagascar is characterized by an an evidence-based approach to informing expanding economy and a peaceful policy on how opportunities for achieving transition of power, providing a solid basis productive, inclusive and sustainable growth for achieving a more productive, inclusive can be realized.² and sustainable growth trajectory. With its Plan d’Emergence, the government has a bold B. Export-oriented sectors which vision for developing a more prosperous and include the ‘bright spots’ of the inclusive Madagascar. The economy has been economy are making important expanding for six consecutive years, with contributions to growth growth estimated at over 5 percent in 2018 and 2019. The peaceful transition of power after 3. The Malagasy economy is under transition, the 2019 Presidential elections indicates that but the formal sector needs to further expand. Madagascar has turned a corner in its political Comparing Madagascar today with the history, providing a basis for addressing deep- country in 2012, geographical areas outside rooted governance challenges. of the three largest cities have developed. The regions of Antsiranana, Mahajanga, 2. Given the vast opportunities, but also Toamasina, Antananarivo, Fianarantsoa and substantial challenges, the objective of the Toliara have been growing and jobs are being Madagascar Country Economic Memorandum created. While these developments are (CEM) is to inform the policy dialogue on how encouraging, the formal economy remains the country’s inclusive growth potential can small. At the current pace, just under one in be harnessed. Madagascar is one of the only twelve new entrants to the labor market will countries in the world to have experienced a find a job.³ Furthermore, large swathes of the long-term decline in incomes whereby the country, particularly in the south-east remain country is 41 percent poorer today than it disconnected with limited access to electricity was at independence in 1960. Unacceptably, and other basic infrastructures. an estimated 77.6 percent of the population live below the US$1.90 poverty line, at 4. Labor force participation in both the formal purchasing power parity. With high levels of and informal sectors is high, with strong informality¹ and pervasive underemployment, levels of female engagement. The level of ¹ Estimated at 93 percent in 2012, which is likely to have reduced given recent economic developments ² The report draws upon secondary data sources such as nightlights, formal employment data, the Enterprise Survey and other World Bank analytical products such as the Systematic Country Diagnostic. Primary data was collected through the administration of a survey deployed amongst high performing firms, a political economy analysis and a new competition assessment of key sectors in the economy. The scope of the work was determined through a Data Scan and consultations with various stakeholders. A benchmarking exercise was undertaken with a range of peer countries: worse-performing, structural and aspirational. ³ Data availed by the private pension body ix Executive Summary labor force participation in the formal and as agribusinesses, telecommunications, the informal economy is high compared to peer extractive industries and activities in export countries which have similar characteristics, processing zones are estimated to explain in terms of level of education and income. a third of GDP growth over the 2014-2018 Female labor force participation rates are period. In addition, export-oriented sectors high, where 86 percent of females are actively have spurred growth through linkages with engaged in the labor market compared with the domestic economy, including services to 90 percent of males. While there are fewer companies and the transportation of goods, firms that have females in top positions which are both under expansion.⁵ compared with males, private enterprises that do have women in management roles stand 7. Foreign direct investment (FDI) has also out by having greater labor productivity, as been increasing and is targeted towards well as higher annual employment and labor a range of high-performing sectors in the productivity growth. economy. Sectors such as agribusiness, textiles and apparel, and Information Technology- 5. Madagascar also has relatively high levels Business Process Outsourcing (IT-BPO) of entrepreneurship and innovation. An exemplify Madagascar’s value proposition. estimated 22 percent of the working population Key characteristics in the Malagasy economy are engaged in entrepreneurial activity, with include the availability of unique and high- the country ranking seventh out of 54, second quality natural resources (attracting natural only to Vietnam in the lower income group.⁴ resource seeking FDI), affordable labor Madagascar also has relatively high levels of (which is French-speaking, can absorb on- innovation compared with peer countries. As the-job training, has in some cases advanced the country continues to make advances in skills such as software engineers), and an the use of more sophisticated technologies, exceptionally fast download speed featuring as well as the utilization of digital financial in the global top-25 (attracting efficiency services, there is further potential to harness seeking FDI). Such performance underscores entrepreneurship and innovation. how goods and services made in Madagascar are in high demand globally, contributing to 6.Accelerating the current pace of growth one of the highest rates of export growth requires further expanding the ‘bright spots’ compared with peer countries. Moreover, of the economy, which are focused on experience of previous episodes of shocks exports and investment related activities. highlights how certain Malagasy exports have Despite Madagascar facing challenges a higher chance of survival compared with to trade as a large island economy with similar products in other countries. constrained logistics, exports are performing well. Madagascar’s export-to-GDP ratio 8. These ‘bright spots’ are creating jobs increased from 27 percent on average over at the fastest pace, are resilient to shocks the period 2010 to 2013 to 33 percent over and have linkages with other sectors of the the period 2014 to 2017, one of the highest economy. Agribusinesses, export processing in the region. Export-oriented sectors such zones (which includes textiles) and IT-BPOs are ⁴ Global Entrepreneurship Monitor’s surveyed a sample of 24,000 individuals in 2017 ⁵ Backward linkages of services to support exports is estimated at 24.8 percent while transport to support exports is estimated at 8.9 percent, UNCTAD, 2011 x Executive Summary the fastest creators of formal jobs, employing global markets is strong, as demonstrated by people in rural areas, women, and youth as well one of highest levels of participation in global as offering flexible working practices. These value chains in Africa, comparable to those sectors have also demonstrated resilience of Indonesia and India. Pipeline infrastructure to domestic shocks in the economy (such as is expected to strengthen connectivity and textiles and agribusinesses), whereby they either therefore enhance the potential for further diversified their products or markets during trade. For example, substantial external the political transition period or have recently financing for road rehabilitation is planned, established as economic operators (such as the which will connect agricultural corridors IT-BPO industry). Furthermore, these sectors throughout the country. Priority should be have strong linkages with other elements of given to improving processes for executing the economy, where for example domestic externally-financed public investments agribusinesses are helping to serve the growing according to indicative timelines need to be urban consumer demand through supplying improved. Supporting logistics infrastructure supermarket chains. Such developments are should also be planned for, including in ports encouraging for other sectors such as tourism that will be accessible through the newly that have considerable potential to further constructed roads, which may present a good contribute to growth and create jobs.⁶ case for public-private partnerships. Going further, operations and maintenance for critical C. Scaling success requires roads should also be planned for, particularly addressing constraints related given exposure to climate-related damages, to connectivity, human capital which may include reviewing the sources of and the business environment, financing for road maintenance. In addition, while incentivizing the uptake of a medium-term endeavor could consider improved technologies to enable the restructuring of the railway concession, other sectors, such as agriculture, which was at one time a less expensive and to realize their potential profitable way of transporting goods, as well as improving public transportation to facilitate (i) Accelerating pipeline infrastructures movement in urban areas. and enhancing the competitiveness of service provision 10. Reviewing competition-related arrangements in the air transport sector 9. Improving connectivity by accelerating could result in lowering costs and enhancing pipeline projects and improving the enabling the transportation of people and cargo. The policy environment could give a substantial renewal of the partial open skies agreement boost to the business environment. Despite could lead to agreement of new routes and Madagascar being a large island nation with airlines to fly in Madagascar’s airspace.⁷ The poor levels of connectivity, integration with policy framework for domestic airspace could ⁶ An in-depth study of tourism and mining was beyond the scope of this study. This study considered sectors which are already contributing to growth and have demonstrated resilience. Tourism will be studied in the Country Private Sector Diagnostic, planned for FY2020 and mining has already been studied in-depth in a separate analytical program which concluded that further improvements to governance are required to develop the sector. ⁷ Partial Open Skies agreement refers to the limited protection measures supporting Air Madagascar as part of the restructuring initiative where the airline went from being a bankrupt state-owned-enterprise to being part privatized with a financial recovery plan xi Executive Summary also be modernized, which would support which is a significant opportunity cost for the the transportation of local produce to urban economy. Achieving these objectives requires consumer markets as well as develop tourism. promoting competitive practices, such as: (i) These measures would require supporting the regulatory agency identifying actors with infrastructure in the form of domestic airports significant market power; (ii) ensuring access and logistics, which could also be developed to bottleneck facilities by third parties; (iii) through Public Private Partnerships (PPPs). ending the prohibition of investing in backbone High costs of jet fuel, which are over one-third infrastructure in areas that could compete more expensive in Madagascar compared with the incumbent; (iv) reducing the costs with Mauritius for example, are contributing of licenses; (v) the competitive assignment of to relatively elevated fares for cargo and spectrum; (vi) ensuring the Universal Services passenger transport. Addressing this situation Fund is objectively used to deliver investments in would require opening the jet fuel market to rural areas; (vii) considering possible asymmetric competition, allowing both international and regulation of interconnection rates; and (viii) domestic firms to supply fuel. These efforts improving the functionality and independence could provide a significant boost to export- of the regulatory agency. These reforms could oriented companies which use air cargo but result in lower prices of broadband and higher currently prefer routes that go via Mauritius in levels of penetration, which could contribute to view of lower costs and increased frequency growth and support industries such as IT-BPOs of flights. and the financial sector. 11. High costs of broadband and low levels 12. Given the low electrification rate and poor of penetration can be addressed through financial health of the utilities state-owned pro-competitive practices, which starts enterprise, substantial reforms are ongoing, with updating the policy framework. The which require continued momentum. The momentum from the new government to cost, quality and access to electricity is a major reform broadband connectivity to reduce impediment to growth in Madagascar. Three costs and enhance connectivity, including in out of four households have no access to rural areas should continue. High prices for electricity—one of the lowest rates in the world. broadband are an important contributor to low Electricity is supplied by the national state- penetration and access rates in Madagascar, owned utility, JIRAMA, whose operating costs xii Executive Summary of power generation are amongst the highest population is engaged in poor quality jobs in Africa, reaching over US$0.30/kWh in 2017, with low levels of productivity and one of the which is an estimated 230 percent above the lowest remuneration rates in the world. regional weighted average, largely because of poor procurement decisions and a slower 14. As the formal sector grows, investing in than expected transition to renewable energy. human capital should be prioritized if the While there have been some improvements, labor force is to be able to access quality the reliability of electricity supply remains poor, jobs to escape poverty. The private sector contributing to an estimated 13 percent loss is willing to invest in vocational training, but of sales, which is at the higher end compared for this to be meaningful, basic education with peer countries. Hydro and solar energy and health outcomes must prevail. Teachers projects are in the pipeline, which will greatly need to be selectively recruited according to increase renewable energy supply. However, their skills, which requires accelerating efforts the challenge is to ensure that these projects to develop a holistic approach to teacher are selected on a least-cost basis in line with training and career management. Although demand and ability to pay, supported by the elimination of public-school fees in the financial, social and environmental feasibility early 2000s contributed to a doubling of studies. Continuing efforts to move towards school completion rates to 73.9 percent in financial recovery of JIRAMA, including 2009, learning outcomes remain poor, as through greater transparency of the arrears teachers are not well-equipped. Notably, clearance process to suppliers, would also only 0.1 percent of teachers assessed under improve the credibility of the company as an the Service Delivery Indicators (SDI)⁸ have off-taker for private sector investments. the minimum knowledge to teach, compared with an average of 14.6 percent in comparator (ii) Reversing the decline in human capital countries.⁹ Improving the health system so that the labor force is ready to meet the requires investing in health workers as well needs of an evolving private sector as enhancing monitoring and management. Such improvements to health services could 13. Human capital in Madagascar is on a also help to address Madagascar’s high declining trend, where a Malagasy today level of stunting, while in parallel improving is 37 percent as productive as she could access to water and sanitation services and be if access to full health and education promoting positive parenting practices such was enjoyed. Over the last 20 years, the as improved nutrition. Currently, expenditures contribution that labor has made to growth on education and health in Madagascar are has been constant. Any gains from a more amongst the lowest in the world, placing a skilled and educated workforce to growth strain on out-of-pocket costs. By improving have been superseded by the population absorptive capacity and strengthening growth rate, resulting in this ‘steady state’ financial management systems, a strong case contribution of labor to growth. Furthermore, could be made to increase expenditures in while there are high levels of labor force critical human development sectors. participation rates, pervasive informality and underemployment means that the 15. Investing in human capital and female ⁸ Education Service Delivery in Madagascar, World Bank, 2016. ⁹ Comparator countries include Tanzania, Kenya, Mozambique, Nigeria, Togo and Uganda. xiii Executive Summary leadership could further strengthen the sectors of the economy. A recent challenge to possibility of Madagascar realizing a this landscape has come in the form of new ‘demographic dividend.’¹⁰ Madagascar’s entrepreneurs who have been able to navigate demographics are in its favor with a young the business environment. However, more country (41.6 percent of the population is profitable markets are concentrated among below 15 years old) and declining fertility rates, a few economic operators. Encouraging new which are lower than the average for sub- investors could involve enforcement of the Saharan Africa (SSA). Taking further steps to Trade Facilitation Agreement, identifying and reduce fertility rates could consider multiple eliminating discriminatory procedures and approaches. While informed parenthood is supporting investor aftercare programs. certainly important, increasing female labor force participation in quality jobs should also 17. The political economy context has be prioritized. Building on the demonstrated compromised productivity dynamics as well success of women in leadership (where firms as inclusive and sustainable growth. Given have higher levels of labor productivity and the weak institutional environment, firms find employment growth) further encouraging alternative ways of doing business, including females to assume top positions can have a through manipulating rules and regulations, role modelling effect for the next generation. rather than realizing success through enhancing In turn, greater female engagement and productivity. This strategy can be considered empowerment in the workforce may provide as a coping mechanism for firms attempting incentives for reducing fertility rates, which can to adapt to the business environment, as well be harnessed as the formal sector expands. as a predatory approach by incumbent firms seeking to hold on to their market dominance. (iii) Leveling the playing field and enhancing As a result, the regulatory and non-regulatory the institutions important for doing business barriers to entry are high. Such a situation can also compromise the sustainability of growth, 16. Madagascar has a challenging business whereby the ‘outsiders’ who do not have access environment, marked by the lack of a level to political elites to gain access to markets playing field. Madagascar scores 161 out of can do business because they are engaged 190 in the Doing Business index, falling behind in a new sector which does not threaten most structural peer countries. Perceptions incumbents (such as the IT-BPO industry), if of the intensity of local competition is weak they pay a high price, or if they use violence, with a few firms dominating markets. These force and intimidation.¹¹ perceptions indices reflect broader societal dynamics, where economic and political 18. Anti-competitive behaviors vary by elites are closely intertwined, similar to sector, where risks could be mitigated by an many other countries in the region. The effective regulatory framework. In certain post-independence period was followed by high-end agribusinesses such as lychees, a wave of nationalization, ensued thereafter the exporters association dominates market by privatization with the state becoming less dynamics and sets prices. In contrast, for other involved in business. Nevertheless, a group of exports such as vegetables and livestock, elites have still maintained dominance of key markets are relatively more contestable ¹⁰ Refers to growth in the economy as a result of a change in the age structure of its population. ¹¹ Political economy background paper prepared for the Country Economic Memorandum, 2019. xiv Executive Summary than in other countries. In cases where value (iv) Incentivizing the uptake of improved chains have developed in a more inclusive t e c h n o l o g i e s t h ro u g h a d d re s s i n g way, private associations with public interest inefficiencies in the domestic market so that have been important, suggesting that this other sectors, such as agriculture, can realize approach could be further supported with their potential an overarching regulatory framework. In addition, the Competition Law could be further 20. Despite Madagascar being a rice- strengthened to explicitly prohibit cartels producing and rice-eating country, the and to rule against price fixing. Successful country has not been able to produce enough implementation of economy wide and sector rice domestically to meet its consumption specific laws requires having an effective needs, and increasingly relies on imports. Competition Council and regulatory agencies Rice is a staple consumed during every meal in place that can coordinate actions, which in Madagascar. Although there are seemingly are sufficiently independent from central favorable climatic and irrigation conditions, government ministries and the influence of the country has not been able to produce private operators. enough rice for domestic consumption and has instead relied increasingly on imports to 19. Improvements to the business and justice fill the gap. It is estimated that nationwide environment are also likely to support the only about 20 percent of rice grown in lowering of interest rates, which may facilitate Madagascar is marketed for cash, with the access to finance. Amongst the characteristics rest for domestic household consumption. of firms with higher levels of labor productivity This dominance of rice in dietary habits is also are those that are connected to the financial reflected in the government’s agriculture system, meaning that they have at one stage policies, which are also focused on the rice applied for a loan, which only applies to sub-sector. 14.5 percent of firms. However, the majority 81.1percent of firms either self-finance their 21. There has been low uptake of improved operations or are discouraged from applying practices to enhance the yields of rice crops, for a loan, where one of the principal reasons as farmers need to be sure they will get a includes the high costs of finance. Reducing fair rate of return to justify higher investment risks in the business environment should in costs which is not currently the case. The turn help to lower interest rates, where key use of inputs like fertilizers and seeds, as measures could include making the credit well as better use of irrigation, strengthened registry available, adopting a law on movable land tenure security, access to credit and collateral to allow assets-based lending, extension services have all been promoted and improving the legal infrastructure and to improve the yields of crops. The utilization efficiency of the judiciary system, such as of these improved technologies and practices credit and bankruptcy proceedings. can contribute to a higher net rate of return xv Executive Summary for farmers, at an estimated 48 percent for and sell when market prices are higher, and high-intensity irrigated rice compared with 19 for traders to position their stock around the percent for high-intensity upland rice. Given country until physically needed. Cross-country these benefits, the System of Intensive Rice experience suggests that warehouse receipt (SRI) is widespread in many rice-producing systems are effective when underpinned by countries. However, in Madagascar, SRI barely improved farmer organization, for example covers 0.2 percent of irrigated land. Even if through cooperatives, which is not currently SRI is utilized at the farm production stage, the case in Madagascar. the rate of return is the lowest (at 43 percent) compared with all other stages, such as the 23. Efforts to address market inefficiencies collection (48 percent), milling and wholesale through access to information. Even in (73 percent), and retail (280 percent). In areas close to main national roads, farmers comparison, in other rice-producing countries, and sub-collectors have little knowledge of the rate of return at the farm production stage crop prices, buyer preferences, or market is much higher. Given these low rates of return, opportunities outside their immediate area under current market conditions, pursuing a of operation and so have little to no way of low cost, subsistence strategy can make good making informed production decisions and economic sense for farmers. negotiating competitive prices. Policymakers also lack information on market dynamics at 22. Connectivity challenges have contributed district level, since this is not monitored by to long marketing chains and inefficiencies the Rice Observatory. Investments in even in the domestic market. Numerous actors very simple information systems for rice and operate along the rice value chain, from other crops would be a good way to improve farmers, to sub-collectors, to town-based market efficiencies, for example through radio collectors, to wholesalers and onward to bulletins, which was previously implemented, retailers. The poor state of rural roads adds but came to an end once donor financing to transportation costs and exacerbates stopped. Going further, investments in remote the remoteness of farmers, whereby they sensing systems that help gauge crop yields have limited negotiating power. In addition, in different parts of the country enable transportation costs are raised by a lack of traders to know where surpluses exist and regional rice mills. Considering that the outturn help policymakers decide on infrastructure for milled rice from paddy is 67 percent, even investments. without investments in roads, establishment of regional rice mills could provide 33 24. Improving the efficiency of domestic percent savings in the per ton costs of long- markets could enhance competitiveness with distance transport for rice. Compared with imported rice. Madagascar allows for imported major agricultural corridors in selected peer rice to have customs duties and Value Added countries, where data is available, Madagascar Taxes (VAT) waived, and similarly, domestic rice has the highest transport costs for long- is not subject to VAT. While imported rice has distance routes. Efforts to improve physical been subject to misdeclaration at customs, this connectivity (for example through investing in policy of tax expenditures is part of a broader rural feeder roads) could be complemented by food assistance strategy, since all income groups bringing farmers figuratively closer to market, purchase imported rice. Domestic producers through the warehouse receipt system. Such enjoy a strong comparative advantage with a system would allow farmers to produce imported rice at the farm level. However, by the xvi Executive Summary time domestic rice moves through the collector main way of linking farmers with markets system to reach an urban wholesaler, this and improving access to inputs. Continued comparative advantage is largely diminished, support for contract farming arrangements and imports can easily compete with domestic is important but it is also necessary to look supply on price. for broader solutions that reach beyond the specific crops and localized production areas 25. Better functioning domestic rice markets contract operators are most interested in. could also support Madagascar’s vision Madagascar has enjoyed many successes in of becoming a rice exporter, if combined exporting high-value commodities and there with improved certainty regarding export is still scope for these to grow. With more policy. Once Madagascar is rice sufficient, secure and remunerative market access, the agriculture policy envisages the country smallholder production of rice and other becoming an exporter of rice, largely serving crops such as maize, soybeans, cassava regional markets in the Indian Ocean. Presently that are important to food security, livestock there are niche varieties of rice, such as Dista production, and agri-processing could also rice which serves markets in the US, and is be expected to grow. currently subject to an export ban,¹² unless exceptions are granted to specific private D. Conclusion and reform priorities operators. Reversing this policy stance on the export ban could encourage this niche 27. Unlocking opportunities for Madagascar variety of rice to develop and provide greater requires encouraging competitive practices. predictability in the operating environment. In Strengthening competition could help to order for ordinary white Malagasy rice to be reduce costs, enhance productivity and competitive in regional markets (Indian Ocean, promote quality. Promoting opportunities SADC and COMESA), tariff preferences are not to compete in the market through having enough; the same underlying improvements a better prepared labor force and bringing that effect the competitiveness of domestic farmers closer to markets will also contribute rice markets are also needed. to more inclusive growth. A summary of key constraints and proposed reforms are 26. With better market access, farmer outlined below, summarized as the following demand for improved seeds, fertilizers, themes: (i) connectivity; (ii) investing in human and willingness to pay for maintenance of capital; (iii) levelling the playing field; and (iv) irrigation could all be expected to improve. enhancing agricultural productivity. Reforms Thus far, contract farming has been the that are already ongoing are also indicated. ¹² The export ban was introduced in the wake of the 2008 food price hike as part of efforts for Madagascar to reach self-sufficiency in food production, but was not reversed once prices normalized. xvii Executive Summary Table 1: Summary of Key Issues and Proposed Reforms Key Issue Proposed reforms Strengthening There is a pipeline of national roads (largely • Strengthen systems to support the connectivity externally financed) but implementation has execution of externally financed not followed the expected pace investment projects (ongoing) • Consider new financing sources for O&M (such as parking, vehicle registration and inspection fees) (new) • Improve the public transportation system to facilitate access to jobs (ongoing) Air transportation is important for the • Review the partial Open Skies policy transportation of cargo and passengers, but (post-2020) to increase routes to fares are high, and routes are restricted Madagascar (partially ongoing) • Open the jet fuel market to competition to reduce costs of air passenger fares and cargo (new) Broadband speed is fast, but costs are high Reduce regulatory and non-regulatory and rural connectivity is limited barriers (there is momentum to reform the sector, but reforms are new) • The regulatory agency to identify actors with significant market power; • Ensure access to bottleneck facilities by third parties; • End the prohibition of investing in backbone infrastructure in areas that could compete with the incumbent; • Review the costs of licenses; • Promote the competitive assignment of spectrum; • Ensure the Universal Services Fund is fairly and objectively considered for all operators; • Consider possible asymmetric regulation of interconnection rates to give smaller operators a better chance; and • Improve the functionality and independence of the regulatory agency, including through greater collaboration with the Competition Council xviii Executive Summary Key Issue Proposed reforms Electrification rates are low and energy • Select hydropower projects on a least cost supply is unreliable basis supported by financial, social and environmental feasibility studies (ongoing) Continue improvements to JIRAMA, to move towards financial recovery (ongoing) • Improve revenue collection • Reduce non-technical losses • Promote greater transparency in the renegotiation of arrears • Apply a well-defined tariff policy (under preparation) Investing in The vocational training curricula does not • Public sector to promote coordinated human capital meet the needs of the private sector inputs to the vocational training curricula to avoid ad-hoc and fragmented inputs (new) Placing women in leadership positions is • Promote women in roles of increasing correlated with firms having greater labor responsibility and encourage female productivity and employment growth role models (new) Teachers lack the skills and qualifications to • Develop a holistic approach to teacher improve the learning outcomes of the next training and career management generation (ongoing) Strengthen the quality of health • Improve the training of community and service delivery nutrition health workers (ongoing in selected areas) • Increase uptake of antenatal care in the first three months of pregnancy (ongoing in selected areas) • Enhance the monitoring and management of the health system (certain interventions ongoing in selected areas such as monitoring if primary care facilities have tracer medications in stock) Reduce stunting so that citizens are healthy • Increase access to water and sanitation and productive services (ongoing) • Promote positive parenting practices (such as breastfeeding) including nutrition (ongoing) xix Executive Summary Key Issue Proposed reforms Levelling the Rules and regulations are manipulated to • Strengthen commercial justice, including playing field access and maintain access to markets use of the Center of Arbitrage and resulting in unfair business practices Mediation (ongoing but stalled momentum) • Continue to strengthen customs controls (ongoing) • Avoid ad hoc and discretionary fiscal practices through restrained used of tax expenditures including publishing the criteria for award (reforms started but tax expenditures increasing) • Support e-procurement processes and open contracting standards (reform momentum but relatively new) • Greater transparency in the recruitment of Board members for regulatory agencies and state-owned enterprises (uneven implementation) • Strengthen the Competition Law to prohibit cartelistic behaviors and to eliminate price controls (new) • Support a framework for Private Associations of Public Interest (drawing upon the cocoa example) (new) Accessing finance is important for firm’s labor • Improve the credit infrastructure, productivity but interest rates are high including the availability of a credit registry (ongoing) • Allow asset-based lending by adopting the law on movable collateral (ongoing) • Improve the legal infrastructure and efficiency of the judiciary system to reduce risks which are passed through to consumers in the form of higher interest rates (ongoing but uneven implementation) Investors face complicated procedures and • Enforce the Trade Facilitation Agreement onerous non-tariff barriers with supporting measures including greater transparency of non-tariff barriers, streamlined procedures for investors, and a comprehensive review of existing tax and regulatory incentives (ongoing but uneven implementation) • Identify and eliminate discriminatory xx Executive Summary Key Issue Proposed reforms requirements and streamline procedures for investors, including visas and expatriate work permits, as well as develop investor after-care programs (ongoing but uneven implementation) Enhancing Smallholder farmers are disconnected from • Develop feeder roles (including agricultural critical infrastructures such as feeder roads through decentralized financing productivity and transport mechanisms mechanisms) (new) • Develop regional rice mills which will reduce transportation costs and bring farmers closer to markets (stalled momentum) • Reform the warehouse receipt system to provide more flexibility in withdrawal periods and trade between crops (new) Farmers and policy-makers do not have • To enable farmers to have a greater say access to information that could support in negotiating prices, support greater better decision making access to information on prices for rice and other crops (new) • Invest in remote sensing systems to help gauge crop yields across the country (new) Uneven application of the export ban provides • Reverse the export ban for niche, high- uncertainty to exporters and discourages the end Dista rice (new) development of niche, high-end rice xxi Abbreviations & Acronyms ABBREVIATIONS & ACRONYMS ADR Alternative Dispute Resolution AGOA African Growth and Opportunities Act ARTEC Authority for Communication Technologies for Madagascar (Autorité de Régulation des Technologies de Communication Regulatory) BIANCO Anti-Corruption Agency (Bureau Indépendant Anti-Corruption) CNaPS Private Social Security Institution (Caisse Nationale de Prévoyance Sociale) CEM Country Economic Memorandum COMESA Common Market for Eastern and Southern Africa CPIA Country Policy and Institutional Assessment EAC East Africa Community FDI Foreign direct investment GDP Gross Domestic Product GEL Exporters Group for Litchi (Groupement de Exportateurs de Litchi) GPM Petroleum Group of Madagascar (Groupement Pétrolier de Madagascar) GVC Global Value Chains HCI Human Capital Index ICCO International Cocoa Organization ICT Information and Communication Technology IFC International Finance Corporation ILO International Labour Organisation IRRI International Rice Research Institute INSTAT National Statistics Office (Institut National des Statistiques) IT-BPO Information Technology-Business Process Outsourcing JIRAMA State-owned utilities company (Jiro sy rano Malagasy) OMH Office of Madagascar Hydrocarbons PPPs Public Private Partnerships ODA Official Development Assistance OdR Rice Observatory (Observatoire du Riz) SADC Southern African Development Community SAMIFIN Malagasy Financial Intelligence unit (Service de renseignement Financier Madagascar) SDI Service Delivery Indicators SIRM Systemic Investor Response Mechanism SMP Significant Market Power SOE State-Owned Enterprise SRI System of Intensive Rice SSA Sub-Saharan Africa TFP Total Factor Productivity VAT Value Added Tax WDI World Development Indicators xxii Introduction – Setting the Stage 1 Introduction - Setting the Stage | 1 The sustained rebound of economic growth over the last six years, coupled with the constitutional transfer of power following the 2018/19 Presidential elections, sets a solid basis for reversing an historical economic decline in terms of reduced GDP per capita and stagnating poverty levels, which has thus far set Madagascar apart from its peers. A. Context: declining incomes economic output has only tripled (Figure 1). Real and shocks GDP per capita has progressively fallen since independence, where the average Malagasy is 1. Madagascar is a large Indian Ocean 41 percent poorer today than in 1961. A lack of island, whose people and natural wealth are long-term robust growth has resulted in limited characterized by their uniqueness. Madagascar progress in reducing poverty: the national has a population of approximately 25.5 million poverty rate was estimated at 77.6 percent of which more than two thirds is less than in 2012, nearly the same rate as 2001. Staff 25 years of age. The country has rich natural estimates suggest that in 2019 approximately wealth in the form of unparalleled biodiversity, 75 percent of the population live on less than a pristine coastline, precious minerals, metals US$1.90 a day at purchasing power parity. and rare species, as well as untapped assets. Madagascar’s history and traditions are unique, 3. The decline in income per capita sets with diverse ethnicities and cultures. However, Madagascar apart from trends in the region multiple challenges including declining human and globally. Madagascar is one of only seven capital,¹³ poor infrastructure and connectivity, countries, out of 138 for which there are data, high levels of subsistence-based agriculture, where real per capita incomes are lower today governance failures and insularity arising than they were around 1960, and one of the from the country’s geographic isolation has only countries to have experienced declining undermined the prospects for productive, incomes in the absence of conflict (Figure 2, inclusive and sustained growth. Figure 3).¹⁴ Compared with the rest of sub- Saharan Africa, Madagascar’s income per 2. Since independence in 1960, Madagascar’s capita is on a declining trend (Figure 4). Hence, economy has been growing, but the pace not only have poverty levels stagnated, but has not been fast enough to keep up with considering the international US$1.90 poverty population growth. The population has line, Madagascar is among the poorest approximately multiplied five-fold whereas real countries in the world.¹⁵ ¹³ Madagascar’s human capital index declined from 0.39 to 0.37 between 2012 to 2017. The indicators where the country lags the most include learning outcomes and stunting [the latest data – ending in 2012 – indicates that stunting is declining; although more recent data is unavailable. ¹⁴ Most of the others are conflict-affected: Burundi, DRC, Liberia and Niger. Two are small, oil-rich high-income states (Brunei Darussalam and the United Arab Emirates). And two are small-island states: Kiribati and Comoros. ¹⁵ When using the international poverty line of US$1.90 per capita per day (in 2011 PPP), poverty is estimated at 77.6 percent in 2012. 2 1 | Introduction - Setting the Stage Figure 1: The growth of the economy has Figure 2: GDP per capita is on an overall lagged that of the population since 1960… declining trend (in constant 2011 PPP USD) GDP per capita, PPP (constant 2011 international $) 200% 1700 160% 120% 1600 80% 40% 1500 0% -40% 1400 -80% 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017 1300 Cumulative economic growth gap 1200 Cumulative population growth 1990 1995 2000 2005 2010 2015 Cumulative real GDP growth Year Source: Staff calculation based on the Word Development Indicators Sources: Staff calculations based on WDI data (WDI) data Figure 3: MDG one of few countries in the Figure 4: Relative to the average for SSA, GDP world with lower GDP p.c. now than in 1960 per capita is declining (in constant 2010 USD) 100,000 80% 70% GDP per capita (2017 or latest) Ratio of MDG's GDP per capita 60% over average for SSA 10,000 50% 40% 30% 1,000 20% 10% MDG 0% 100 100 1,000 10,000 100,000 1960 1964 1968 1972 1978 1980 1988 1992 1996 2000 2004 2008 2012 2016 GDP per capita (1960 or earliest) Notes: Sample of all countries with WDI data; GDP per capita in Sources: Staff calculations based on WDI data constant 2010 USD, scales logged to the base 10 (GDP p.c. in- creases 10x with each equal-spaced interval). Sources: Staff calculations based on WDI data 4. Growth in Madagascar has been volatile, relatively diverse and dynamic private sector where historically the country has thrived can perform well, where certain sectors during periods of political stability. Since have realized success despite a relatively independence, there have been several challenging business environment. However, periods of economic growth, each offering periods of growth have been interrupted by hope of improved livelihoods and poverty political crises. These reversals have been reduction. During politically stable times, a so deep that subsequent accelerations have 3 Introduction - Setting the Stage | 1 been insufficient to make up the lost ground isolation, for example, through the withdrawal before the next dip. of grant and concessional financing, and a revoke of privileges related to special trade 5. The stop-start nature of growth agreements such as the African Growth and underscores the vulnerability of the economy Opportunities Act. Madagascar’s climatic to domestic shocks, where political crises vulnerability can also expose the economy are particularly destabilizing. The principal to shocks; on average natural disasters are domestic shock is related to political fragility, estimated to cost the economy 1 percent of where unconstitutional regime changes and GDP each year, which is particularly devastating the risks of future crises contribute to investor for rural and agricultural based activities. uncertainty and short-termism in economic policy making. The post-independence period 7. The most recent political crisis, from 2009 has been marked by four political crises, in to 2013, highlights the devastating effects of 1972, 1991, 2001-02 and 2009-13. In each case, shocks arising from political instability. The a period of strong economic growth has been unconstitutional change of regime in 2009 interrupted by a political crisis, highlighting was associated with a 4 percent contraction the importance of political economy dynamics in GDP and slow subsequent recovery in for Madagascar’s growth trajectory. growth. Had the economy instead continued to grow at its average rate of 5.6 percent in the 6. Economic performance has also been five years preceding the 2009 political crisis, vulnerable to exogenous shocks, which it would have been larger than the actual largely stem from climate change including post-crisis economy by 37 percent by 2017. natural disasters and a cessation of access to This is an enormous loss in terms of plausible special trade agreements following political forgone output: approximately $4bn in 2010 instability. The experience from previous US dollars, or $160 per year for every Malagasy episodes of unconstitutional regime changes (compared with annual average income in highlights the costs related to economic 2010-dollar terms of $421). Figure 5: Periods of solid economic growth Figure 6: …the latest of which (2009 political have been punctuated by deep downturns… crisis) generated large forgone output losses 15 20 Hypothetical GDP at 2003-7 10 average growth rate 15 5 10 Percent GDP (2010 USD) 0 Actual real GDP 5 -5 -10 0 -15 -5 Cumulative output loss 1961 1965 1969 1973 1977 1981 1989 1993 1997 2001 2005 2009 2013 2017 -10 Real GDP growth 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 5-year moving average Sources: Staff calculations based on WDI data Sources: Staff calculations based on WDI data 4 1 | Introduction - Setting the Stage B. An Economic Rebound but only economy remains large. Industries that Nascent Structural Transformation support the export of Malagasy goods and services, such as agribusinesses, extractive 8. The return to constitutional order in 2014 industries, telecommunications and activities has seen a rebound in economic growth, within export processing zones have been once again showing that the economy can important contributors to Madagascar’s growth thrive during periods of political stability. performance (Figure 7). The expansion of these The economy has progressively gained export-related activities has supported the momentum, with growth picking up from 2.3 development of the services industry, with a percent in 2013 to an estimated 5.1 percent in growth in services provided to companies and 2018, a trend which is expected to continue the transportation of goods. In contrast to the over the medium-term. While some of this niche agribusinesses that are performing well, acceleration is a rebound associated with a the agriculture sector is broadly characterized normalization of the political situation, the by subsistence farming. Off-farm income is recent trend of positive per capita growth largely generated from non-formal enterprises, is encouraging. The economy is growing at where compensation is in-kind or through self- its fastest pace in over ten years, and in the employment.¹⁶ Available data indicates that absence of dominant megaprojects. Since the percentage of the population engaged in 2000, the only other time the economy had the informal sector increased from 72 percent comparable growth rates coincided with the in 2001 to an estimated 93 percent in 2012, development of two major mining sites, which partly due to a decline in manufacturing jobs as are currently in the extraction phase. access to preferential trade agreements were waived during the political transition period.¹⁷ 9. However, this impressive growth has The majority of informal establishments not been broad-based, and the informal operate at a subsistence level.¹⁸ Figure 7: Export-oriented sectors and services are important contributors to growth 0.6% Dark bars denote sectors that are 0.5% largely export-oriented 0.4% 0.3% 0.2% 0.1% 0.0% -0.1% -0.2% gy g t rs re es s ns ds s s s s or nie rk ice e ie in he tu on tri er tio o str wo sp h go rv pa ul Ot fis En us gz ica an du se ric m ic ed d & sin un Tr in in bl co Ag ed ish e pu m es ed ve ttl to at fin om oc Ca cti at el d ed an pr lr l of tra re ec vid cia ng - rt ale l Ex ro Te ro po an i Ag ild sp s Re Ex Fin Bu ice rv Se Source: National Statistics Office (INSTAT) and WB staff calculations ¹⁶ Madagascar Employment and Poverty Analysis, World Bank, 2016 ¹⁷ Madagascar Employment and Poverty Analysis, World Bank, 2016 ¹⁸ National Survey on Employment and the Informal Sector, Instat, November 2013 5 Introduction - Setting the Stage | 1 10. The lack of broad-based growth 11. Considering a longer-term horizon, reflects several structural challenges in available data for the period 1992 to 2015 the economy, whereby the majority of indicates that there are large productivity Malagasies living in rural areas do not have gaps across different sectors. In the agriculture access to basic infrastructure or services, sector, output per worker declined by 33 which exacerbates remoteness. Deteriorating percent, which is of concern given that the physical infrastructure has affected market sector engages approximately 75 percent of integration and the returns and endowments the working population. Meanwhile, although of poor households, as well as contributed the manufacturing sector only engages a far to higher transport costs. For example, on more modest 2.5 percent of the population, the average, over the period 2005 and 2010 the proportion of labor engaged in manufacturing cost of transporting goods to the nearest urban rose by close to 400 percent. Not only has center increased by between 36 and 80 during output per worker in the manufacturing sector the rainy season.¹⁹ It is estimated that half of increased by 24 percent, but the productivity secondary roads and two thirds of tertiary ratio is 13.5 times higher compared to the roads are classified as being in bad condition. average worker in the agriculture sector. The rural electrification rate is at 6 percent, While some caveats are needed in comparing reflecting a low national rate of 13 percent, one productivity levels between sectors (related of the lowest in the world. And while access to to the measurement of hours, different capital financial services has been improving through intensity, skills and preferences) across all the introduction of mobile banking services, an non-agricultural sectors, average output per estimated 41 percent of the population have no worker is multiples higher than in agriculture, access to a financial institution, underscoring and this gap has remained persistently high large levels of informality. since the early 1990s when the data begin. It is estimated that half of secondary roads and two thirds of tertiary roads are classified as being in bad condition. ¹⁹ Madagascar Employment and Poverty Analysis, World Bank, 2016 6 1 | Introduction - Setting the Stage Table 2: Structural transformation in Madagascar is nascent, with increasing shares of workers outside of the agriculture sector Annual output, Workers, million Output per worker, Output per worker constant 2010 US$bn (share of total) constant 2010 US$ as a ratio to that in (share of total) agriculture % % % ∆ 1992 2015 Change 1992 2015 Change 1992 2015 Change 1992 2015 Ratio Agriculture 1.99 2.79 40% 4.28 8.95 109% 465 312 -33% -- -- -- (31%) (25%) (78%) (75%) Industry (ex. 0.71 1.36 92% 0.25 0.79 216% 2,845 1,724 -39% 6.1 5.5 -0.6 Manufacturing) (11%) (12%) (5%) (7%) Manufacturing 0.21 1.28 517% 0.06 0.3 398% 3,410 4,223 24% 7.3 13.5 6.2 (3%) (11%) (1%) (3%) Market services 1.75 3.00 71% 0.42 1.17 175% 4,125 2,565 -38% 8.9 8.2 -0.7 (27%) (27%) (8%) (10%) Non-market 1.80 2.79 56% 0.45 0.8 76% 3,955 3,488 -12% 8.5 11.2 2.7 services (28%) (25%) (8%) (7%) WHOLE 6.45 11.23 74% 5.47 12.02 120% 1,180 936 -21% 8.1 8.8 0.7 ECONOMY (100%) (100%) (100%) (100%) Sources: WB staff calculations based on data from Africa’s Pulse, Office of the Chief Economist for the Africa Region, The World Bank, October 2018. 12. Madagascar’s opportunity and challenge the economy (Figure 8), but other sectors going forward will be to make growth more have contributed much more to the increase inclusive by enabling its people, to be in annual output (Figure 9). That is, annual engaged in sectors characterized by higher output in the non-agricultural sectors has productivity. The current trend suggests that increased by almost 4.5x as much as annual structural transformation – the large-scale output in agriculture, with the addition of shifting of labor resources from subsistence less than a third of all the new workers agriculture into more productive sectors available to Madagascar since 1990. This (including agricultural activities which are accords with the almost 9-fold difference more productive) – is only nascent. Since between average output per worker in 1990, agriculture has absorbed by far the agriculture vs. non-agriculture as of 2015 majority of additional workers available to (Table 2). 7 Introduction - Setting the Stage | 1 Figure 8: Agriculture has absorbed the Figure 9: ...but other sectors have contributed large majority of new workers… much more to output growth while value- added in the agriculture sector has almost (cumulative net new workers since 1990, millions) stagnated 6 (cumulative increase in annual real output since Number of workers by sector, Million 5 1990, constant 2010 US$bn) 4 4.0 Constant 2010 US$, billion Value-added by sector, 3 3.0 2 2.0 1 1.0 0 0.0 -1 -1.0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Non-market services Market services Non-market services Market services Manufacturing Industry (non-manufacturing) Manufacturing Industry (non-manufacturing) Agriculture Agriculture Sources: Staff calculations based on WDI data Sources: Staff calculations based on WDI data C. Leveraging Trade and Arms Agreement, have also contributed to the Investment to Engage in importance of trade in the economy. Sectors of Higher Productivity 14. Improved export performance and 13. International trade has historically played emerging islands of success provide an important role in Madagascar’s economy. opportunities for engaging the workforce Madagascar is a large island nation, historically in sectors of higher productivity. Since engaged in trade, being strategically placed 2014, Madagascar’s export performance has between mainland Africa and Asia. These improved. Madagascar’s export-to-GDP ratio old trading connections are reflected in has increased from 27 percent on average Madagascar’s unique make-up of ethnic and over the period 2010 to 2013 to 33 percent cultural diversity, where old Malagasy noble over the period 2014 to 2017, outshining the families, a history of colonial ties with France, performance of the SSA. Consequently, net and over the last century a mix of Indian and export demand is a key source of aggregate Chinese firms have together come to dominate demand growth (Figure 10). Further growth the spectrum of large and influential firms. of these outward-oriented sectors, which Government policies to encourage exports, for are already performing well, could present example through Export Processing Zones, and opportunities to create employment and access to preferential trade arrangements, promote productivity. Imports have been such as the African Growth and Opportunities rising since 2016 largely to support the scale- Act and the European Union’s Everything but up of public investment. 8 1 | Introduction - Setting the Stage Figure 10: Since 2014, net exports and investment are key contributors to gradual aggregate demand growth 20.0 15.0 Contribution to growth 10.0 percentage points 5.0 0.0 -5.0 -10.0 -15.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Investment Private Consumption Government Consumption Export, GNFS Imports, GNFS GDP Growth Source: INSTAT, WDI and WB staff calculations 15. Foreign direct investment (FDI) has also D. Promoting the Productivity of played an important role in the domestic the Agriculture Sector economy and for trade. Foreign-owned firms are prominently present in each of the fast- 16. Moving towards a more inclusive growth growing sectors in Madagascar , supporting model requires moving the population away exposure to new technologies and workforce from subsistence agriculture. The agriculture practices. In the mid-2000s, FDI was largely sector is dominated by subsistence farming, characterized as natural resource-seeking with a declining share in value-added of investment related to the mining megaprojects, national output and growth rates that have to support the extraction of nickel, cobalt and been highly volatile. Nevertheless, the sector other minerals. More recently, natural resource is important for livelihoods as the largest FDI is targeted towards the development of employer of the rural and poor population. niche agribusinesses. Efficiency-seeking FDI Agriculture is also important for food security is also of increasing importance, particularly and nutrition, which has a direct bearing on in the IT-BPO and textiles sector, which is worker’s productivity and health. important for enhancing exports. The more recent inflows of FDI contribute to job creation 17. Extensive analytical work undertaken with foreign-owned firms having higher in the past years has underscored how the sales and employment growth.²⁰ Enhanced low uptake of improved technologies and communication around Madagascar’s value practices has contributed to low agricultural proposition is critical for attracting and yields. While practices to improve yields are sustaining efficiency-seeking FDI. well-known such as the utilization of seeds ²⁰ WB Staff analysis using the Enterprise Survey, 2013 9 Introduction - Setting the Stage | 1 and fertilizers and increased use of irrigation agro-climatic conditions, market demand facilitated by improved water management, continues to be unmet. The performance of uptake has been low. Some commercialized the agriculture sector and paddy production agricultural activities have been successful, are closely interlinked. Rice is of important wide-scale contract farming has not been cultural significance and forms a key part of implemented, which in other countries has the diet, where Madagascar has one of the been associated with rising incomes for highest rice consumption-per-capita rates farmers. These factors are intensified by low in the world. However, the productivity of levels of human capital, high levels of financial rice is low and smallholder farmers continue exclusion, poor quality of the road network to operate at subsistence level. Market (particularly feeder roads) which constrains intermediaries capture an estimated half access to markets and enhances exposure to of the final retail price, particularly as high climatic effects. transportation costs continue to reflect poor connectivity.²¹ The low price received by 18. The rice sub-sector is particularly smallholder farmers does not motivate an important, where despite seemingly favorable increase in production levels. Figure 11: The agriculture sector has a Figure 12: Paddy production is closely declining share in value added and volatile linked with agricultural growth growth rates 20.0 20.0 50 160 45 140 15.0 15.0 Paddy productions x 100,000 Index of agriculture growth 40 10.0 10.0 120 35 (Base Yr=2000) 30 100 5.0 5.0 25 80 0.0 0.0 20 60 -5.0 -5.0 15 40 10 -10.0 -10.0 20 5 -15.0 -15.0 0 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018p 1999 2001 2003 2005 2007 2009 2011 2013 2015 Share in GDP Growth Paddy production (LHS) AG value-added index (RHS) Source: WB staff calculations based on INSTAT and WDI Source: WB staff calculations based on INSTAT and WDI 19. Despite the low levels of rice productivity, meet consumption needs. Rice imports and and Madagascar being a net importer domestically produced rice are both subject of rice, the country’s policy vision is to to VAT exemptions. For domestically produced become a rice exporter over the medium- rice to be able to compete with imported term. During the lean season, the amount of rice, it is important to address inefficiencies domestically produced rice is insufficient to in domestic markets, which contribute to ²¹ 'Madagascar: Scaling up Smallholder Inclusion in Agri-Food Value Chains; Insights from the Rice and Dairy Sectors,' 2018, World Bank: Washington DC. 10 1 | Introduction - Setting the Stage long marketing chains. Rice production is market concentration has resulted in relatively constrained by several factors including: high prices for consumers, raised costs for connectivity challenges which exacerbate the downstream firms that use upstream goods remoteness of farmers and market failures and services, and restricted connectivity whereby farmers have very limited information particularly in rural areas. In the petroleum on prices and produce, which could help market, high market concentration has inform their market participation decisions. contributed to relatively high prices and Efforts to address these challenges in the constrained access by new market entrants. rice sector would also benefit other crops, particularly staples, that are subject to long F. The Madagascar Country marketing chains, with potentially far-reaching Economic Memorandum benefits for farmer’s incomes. Framework – Current Performance and Future Opportunities E. The Importance of Levelling the Playing Field to Sustain 22. Madagascar’s current growth model Growth and Promote Productivity represents a paradox, where highly dynamic and innovative economic activity co-exists 20. The lack of a level playing field through with a persistent subsistence-oriented regulatory and non-regulatory barriers has agriculture sector. Madagascar ranks been a contributing factor to Madagascar’s relatively well compared to peer countries history of stop-start growth. Madagascar has in terms of innovation, such as innovation a complex political economy; whereby certain absorption by firms and output creativity (cf. firms have been able to gain advantages Figure 40). In recent years, Information and through by-passing formal institutions Communication Technology (ICT)-based through the manipulation of regulatory and activities are increasingly important for non-regulatory barriers. Such dynamics can economic growth and job creation. On the other result in poor contestability of markets as hand, the majority of the population remain economic operators seek to maintain their engaged in agriculture, which is dominated advantage, which hinders productivity growth, by traditional cropping methodologies rather and undermines a long-term approach to than improved technologies that could policy making and investment planning. generate higher yields. Therefore, a key challenge for Madagascar going forward is 21. The lack of competition has adverse to design policies that can encourage the c o n s e q u e n c e s fo r t h e e c o n o m y. movement of the country’s extensive labor An assessment of markets, such as force from low to higher value activities. telecommunications and petroleum which serve the domestic market, and export 23. While the economy is growing, the products such as lychee and vanilla, reveal challenge of promoting an inclusive growth that growth of these key sectors has taken model remains fundamental, to deliver on place in a vacuum of pro-competition the twin goals of poverty reduction and regulation. In the case of lychee and vanilla, shared prosperity. The sectors that are driving the lack of contestable markets can contribute the economy are concentrated, generating to lower productivity and innovation, restricted important, yet limited formal employment exports, and depressed farmers income. For opportunities. Meanwhile, the agriculture the case of telecommunications, excessive sector, which engages the majority of the 11 Introduction - Setting the Stage | 1 poor, has failed to deliver quality jobs. These of power following the 2018/19 Presidential lack of formal opportunities for structural elections, and a solid implementation of transformation is reflected in a large informal reforms (as demonstrated by a gradual economy and high levels of poverty. Moreover, increase in the Country Policy and Institutional as poverty runs deep with the average Assessment - CPIA - score²²) suggest that Malagasy consuming 32 percent less than a there is an important opportunity on the person living directly at the national poverty horizon for realizing the twin goals. The line, the risk of falling into poverty is high, final objective of the CEM is to arrive at a particularly if shocks prevail such as natural set of policy measures that are productivity disasters or political instability. enhancing, promote broad-based growth through formal job opportunities and promote 24. With the right policy and investment sustainable growth through de-risking shocks mix, the current growth model can be that have contributed to Madagascar’s stop- oriented to deliver productive, inclusive and start growth model. sustainable growth. Policy interventions can support measures to promote the movement G. Organization of the CEM of labor from less to more productive firms, and Methodology provided that the demand for such output exists through the continued expansion of the 26. The scope of the CEM was determined economy. Demographic patterns suggest that through a consultative approach, with population growth will give rise to new labor inputs from the government, World Bank market entrants, but to enable Malagasies to staff, International Finance Corporation become productive citizens, it is essential to (IFC), and development partners. The CEM invest in quality education and health services. commenced with a data scan exercise where If physical infrastructure is in place to support 20 standard macro and micro questions were connectivity by improving access to domestic explored for Madagascar. The data scan markets (particularly through road and air helped to determine areas of strengths and transport) as well as the ports, in a climate- weaknesses in Madagascar’s growth, and resilient way, transport costs may reduce, was used as the basis for discussion with and the movement of goods and people the government and other counterparts on will be facilitated. Recent advances in digital the key priorities related to pursuing a more technologies provide further opportunities to productive, inclusive and sustainable growth reap productivity gains, through diverse ways, trajectory. All vice-presidencies in the World such as potentially improving the efficiency of Bank Group and the IFC have contributed public administration, encouraging the further to this CEM, including through participating creation of jobs in the IT-outsourcing sector in the initial consultations, participating in and promoting the use of electronic payments missions, and reviewing draft reports. as a means of increasing financial inclusion. 27. The remainder of the CEM is organized 25. While Madagascar has considerable in five chapters. Chapter 2 presents the challenges ahead, the signals are positive long-term determinants of growth – labor, and encouraging. Sustained growth over capital and productivity. Chapter 3 presents the last six years, the constitutional transfer an analysis of trade and investment through ²² The CPIA increased from 3.0 in 2013 to 3.2 in 2018. 12 1 | Introduction - Setting the Stage a deep-dive analysis of growth-enabling sourced from the private social security sectors. Chapter 4 discusses how the institution (CNaPs), and nightlights data is used agriculture sector can support inclusive to estimate regional growth trends. In chapter growth. Chapter 5 assesses competition. 3, a survey was deployed amongst domestic Chapter 6 summarizes the recommendations and foreign firms in the high-performing with a proposed prioritization of reforms. sectors to obtain data on how they were able A background report was also prepared on to grow and obtain evidence on linkages, Madagascar’s political economy environment, spillovers, value addition and diversification. which has informed each chapter. The findings from this data collection exercise were validated with industry leaders through 28. This CEM uses a benchmarking approach focus group discussions and the policy whereby Madagascar is compared with recommendations were discussed with aspirational peers, structural peers, and the government. To support the analysis in worst performing peers. The aspirational chapter 4, primary data on domestic trade peers are countries whose performance challenges were collected through monitoring Madagascar could strive to achieve over transactions and interviewing operators along the next five years, and include Rwanda, the four main rice corridors; in addition to field Senegal and Cote d’Ivoire, also considered missions and interviews with all stakeholders as other African countries that underwent a in the rice value chain. A formal competition period of ‘emergence’ like the ambitions of assessment was undertaken for the sectors of the current government. In the longer-term, telecommunications, lychee and vanilla value other aspirational peers are also considered chains in chapter 5. The analysis of the jet fuel such as Indonesia, Cambodia, and Mauritius market benefited from new data collected as countries that have undergone sizeable by Airport and National Airline Surveys.²³ structural transformation. Structural peers Additionally, chapter 5 uses the Exporters are those which share characteristics with Dynamic Database to determine trends in Madagascar in terms of size, income, and concentration of major exports and compares previous growth performance which includes this with available benchmarking countries. Burkina Faso, Zimbabwe, Burundi, Tanzania, Uganda and Nepal. Worst performing 30. However, there are knowledge gaps, comparators are the lowest category in and areas where the analysis mostly relied the low-income group. As political stability on secondary data. Analysis of services and has been broadly maintained since 2014, logistics to support trade was not studied in- this report does not consider Madagascar’s depth, where high levels of concentration in challenges from a fragility lens, but rather as the banking sector and possibly the trucking a low-income country which is on the pathway industry could be a further area of research. to pursuing its development objectives and The underlying drivers behind declining human requires long-term institutional reform. capital was also not studied extensively as part of this workstream, since analytical work had 29. This CEM uses new primary and secondary been carried out to support the Multiphase data. In chapter 2, data on employment is Programmatic Approach project to enhance ²³ The chapter on competition also includes the analysis from an earlier report prepared by Beicip-Franlab on the downsteam petroleum sector, as part of the reforms to the fuel subsidy, which have been supported by the Energy Sector Management Assistance Program. 13 Introduction - Setting the Stage | 1 nutrition outcomes, which has been used to growth, such an eventuality is constrained support the analysis in this report.²⁴ Finally, by poor governance practices, which were the analysis in the CEM has focused on those identified in separate analytical work. The sectors that contribute to growth and jobs, tourism sector also shows substantial potential are resilient to shocks and have substantial but has thus far not demonstrated its resilience potential to grow. An in-depth study of the to domestic shocks. Opportunities for further mining sector was not included, because while business development will be assessed in the there is the potential to further contribute to forthcoming Country Private Sector Diagnostic. ²⁴ Project P160848 was prepared in FY2017 and benefited from extensive analytical work including on the underlying causes including: (i) inadequate food and care; (ii) inadequate water, sanitation and hygiene; (iii) and inadequate health services. 14 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity INTRODUCTION 15 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 The economic recovery is having a positive effect on growth and job creation, including in regions outside of the capital. Being able to fully capitalize on these emerging opportunities requires having a labor force ready to meet the demands of an evolving private sector by reversing the decline in human capital. Further expanding formal employment opportunities requires investing in infrastructure (much of which is in the pipeline) and moreover, improving the quality of its institutions and governance environment to enable the private sector to not only grow, but to also thrive. A. Introduction productivity are assessed as well as possibilities for enhancing innovation given the recent 1. As Madagascar’s economy continues developments in digital technology. And finally, to expand, this chapter takes stock of the prospects for sustaining growth are presented long-term drivers of growth and emerging through enhancing the quality of business- trends, to assess potential transformative related institutions. economic opportunities. Long-term economic growth can be decomposed to estimate the B. The long-term drivers of contributions of labor, capital, and total factor growth: reliance on inputs productivity (TFP), a residual which captures (labor and capital) outstrips all other drivers of growth. A more inclusive productivity gains growth trajectory is characterized by salaried employment outside of subsistence agriculture, 3. Long-term growth has relied more on with greater opportunities in regions aside from inputs (labor and capital) than productivity the capital. Growing formal sector employment growth. Labor has made the most consistent opportunities requires expanding private- contribution to growth (Figure 13). The sector led growth, which in turn depends on contribution of capital accumulation to growth firms having access to enabling infrastructure has been positive but quite low, except for and a business environment that offers the period 2004-8, which coincided with large predictability and certainty. mining investments. On the other hand, TFP has been generally zero or negative. This 2. This chapter considers four issues. Firstly, means that Madagascar has not reaped any the labor contribution to growth is assessed, sustained growth dividend from increases alongside current developments in job creation in the efficiency with which existing inputs and unlocking further potential through (capital and labor) have been used to generate investing in human capital. Secondly, the output. The remainder of this section will current status of physical capital is presented present an assessment of the labor, capital with consideration of future developments and productivity contributions to growth, in the pipeline. Thirdly, indications of firm considering firm dynamics and institutions. 16 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity Figure 13: Since 2000, growth has relied more on inputs (labor and capital) than productivity growth Annual GDP growth and percentage points contribution to GDP growth 15 10 5 0 Percent -5 -10 -15 -20 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Total Factor Productivity (gA) Labor ((1-R) * gL) Capital Stock (R * gK) Real GDP (gY) Source: WDI and WB staff calculations (i) Labor reported being paid below the minimum hourly wage and 39.5 percent reported working below 4. Madagascar has one of the highest labor 35 hours per week.²⁵ Moreover, any gains to force participation rates in the world. While growth from labor have not kept up with the Madagascar’s labor force participation rate population growth rate, whereby over the is not as strong as certain aspirational peers period 2000 to 2016, the population grew on such as Rwanda and Malaysia, it is higher than average by 2.9 percent, outstripping an average other peers that have similar characteristics growth rate of 2.6 percent. in terms of level of income and education (Figure 14). Overall, 90 percent of males and 6. As the labor force is largely engaged in 86 percent of females are actively engaged low quality jobs, the value added per worker in the labor market. also pales in comparison with peer countries. The average worker in SSA contributed 3.8 5. However, the contribution that Madagascar’s percent more value added than a worker labor force makes to growth has remained in Madagascar. Rather than this finding relatively constant over time, due to the low reflecting inherently low levels of productivity quality of jobs and population growth. The in Madagascar, it is due to engagement in ‘steady state’ contribution of labor to growth economic activities which are of low value reflects high levels of informality in the added since approximately 75 percent of economy, whereby 68 percent of employment the labor force is engaged in subsistence is in the agriculture sector and 75 percent of agriculture. Salaries in Madagascar are non-farm jobs are informal. Non-farm jobs are also on the lower end compared with peer mostly self-employment in micro-enterprises. countries, which acts as a disincentive for There is also prevalent underemployment, those who are well trained and educated whereby in 2012, 44.8 percent of workers to stay in Madagascar but also encourages ²⁵ Instat, MDG survey (2012) 17 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 investors to the country (Figure 16) (see in Madagascar are low even when compared chapter 3 on Madagascar’s value proposition with peer countries that have similar levels and brain drain in the IT-BPO sector). Salaries of productivity.²⁶ Figure 14: Madagascar has a relatively high labor force participation rate Labor force participation rate (% of population aged 15-64 for each gender, avg 2000/2018) 100 80 60 40 20 0 Mauritius Mali Zambia Uganda Rwanda Malaysia Indonesia Tanzania Cambodia Burundi World Ethiopia Burkina Faso Cote d'Ivoire Senegal Chad Madagascar Cameroon Niger Kenya Zimbabwe Comoros SSA Malawi Nepal Low income Lao PDR Female Male Source : WDI, International Labour Organization (ILO) statistics, and WB staff calculation Figure 15: Pervasive informality and Figure 16: Madagascar has one of the underemployment means that peers have lowest levels of remuneration levels higher levels of productivity compared compared with peers which both attracts with Madagascar investors and disincentivizes talent to stay Ratio of productivity in Madagascar over Average monthly earnings of employees in 2012 productivity in peers (%) (otherwise indicated), constant 2011 PPP²⁷ 14 1,400 12 1,200 10 1,000 8 800 6 600 4 400 2 200 - 0 Mozambique Mauritius Ethiopia (2013) Rwanda (2014) Mali (2014) Mauritius Ethiopia Liberia Cambodia Nepal Rwanda Malawi Uganda Tanzania Zambia Uganda Cambodia Indonesia Nepal (2008) Sri Lanka (2013) Burkina Faso Tanzania Low income Niger (2011) Zimbabwe Mali Ghana Kenya Senegal Malaysia Madagascar Cote d'Ivoire Zimbabwe (2011) Lao PDR (2010) Malaysia Cote d'Ivoire Comoros SSA Source: WDI, ILO statistics and WB staff calculations Source: WDI, ILO statistics and WB staff calculations ²⁶ Productivity is measured as the value added in Madagascar as a ratio of value added in peer countries. ²⁷ The level of remuneration is measured by the Average monthly earnings of employees in 2012, expressed in constant 2011 Purchasing Power Parity, latest data available for Ethiopia (2013), Rwanda and Mali (2014), Nepal (2008), Lao PDR (2010), and Zimbabwe (2011). 18 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity Figure 17: Madagascar has one of the lowest level of remuneration even when considering the level of productivity 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 a r da da us al i a ia re l e ia R ia pa ca pi di bw PD es n ys i riti M an an Ivo io bo Ne za as al a on ba o h Ug Rw au n ag d' m La Et Ta d M Zim M ad Ca In te M Co Ratio of earning Ratio of value added MDG level Source: WDI, ILO statistics and WB staff calculations 7. The economic recovery after the return – with a high proportion in textiles) and the to constitutional order in 2014 is providing primary sector (13 percent) (Figure 18). Notably, formal sector employment opportunities. the fast- growing sectors that are contributing Between 2014 and 2018, on average an to aggregate growth, such as agribusinesses, estimated 38,200 formal jobs were created firms in the export processing zones and the each year compared to the estimated 480,000 IT-BPO sectors (see chapter 3) also have the youth entering the labor market annually.²⁸ The fast pace of job creation (Figure 19). However, tertiary sector has been the most important the challenge is to continue growing these source of employment generation (52 percent sectors to create enough jobs to absorb the – mainly in trade and the teaching profession), new entrants to the labor market, as well as the followed by the secondary sector (35 percent existing workforce currently underemployed. Figure 18: Formal employment generation Figure 19: Sectors contributing to growth is led by few sectors also have the fastest rate of job creation New formal employment by sector Employment by sector, average annual percent change, 2014-2018 40,000 30,000 25 20,000 20 10,000 15 10 0 5 2015 2016 2017 2018 0 Passenger transport Metal industry EPZ (including textiles) Energy Food industry Trade Tobacco industry Services to firms Telecommunication Agro-indsutry Extractive industries Fishery & livestock Food industry Telecommunication Construction & public works Services to firms Agriculture Trade Textile industry Administration Source: CNaPS data Source: CNaPS data ²⁸ Data availed by the private social security institution. 19 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 8. Increasingly, jobs are being created in Fianarantsoa (commerce, agribusiness), cities outside of the capital, Antananarivo. and Toliara (agribusiness and tourism) have Economic activities have traditionally been been growing. These developments are concentrated in large cities, where the capital creating jobs at the regional level (Figure 22). is an economic hub and home to over two In the East, economic activity is most likely million people. Since 2012, geographical underestimated through the nightlights areas outside of the three largest cities, data as agricultural activities may not be Antananarivo, Toamasina and Antsirabe have detected, such as cash crops in the Sava a brightening of night lights,²⁹ indicating an region, suggesting that regional growth may expansion of growth (Figure 20, Figure 21). The be higher than currently captured. There also regions of Antsiranana (wth tourism activities), remains a large part of the economy which is Mahajanga (agribusiness and tourism), disconnected, particularly in the south east of Toamasina (port, mining and agribusiness), the country (addressing challenges in lagging Antananarivo (commercial activities), areas is discussed in chapter 4). Figure 20: Nightlights in 2012 Figure 21: Nightlights in 2018 Source: Maps generated by the WBG Geospatial Operational Source: Maps generated by the WBG Geospatial Operational Sup- Support Team using nighttime lights data from NOAA’s VIIRS satellite port Team using nighttime lights data from NOAA’s VIIRS satellite ²⁹ To address the lack of subnational economic data, nightlights (which is satellite imagery from outer space) was used as a proxy for estimating economic activities at the regional level. Electrification is also the most powerful predictor of welfare than any other indicator of spatial advantage or economic density (see Shifting Fortunes and Enduring Poverty in Madagascar, Recent Findings, World Bank, 2016) 20 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity Figure 22: Major changes to Madagascar’s nightlights between 2012 to 2018 and formal jobs created³⁰ Antisiranana province, regions: Diana, Sava (34 percent increase in jobs; tourism) Mahajanga province, regions: Sofia, Boeny, Melaky, Betsi- boka, Atsimo Andrefana (fisheries, rice, tourism) Toamasina province, regions: Analanjirofo and Atsinanana (5 percent increase in jobs; port, mining and spice trade) Antananarivo province, regions: Analamanga, Bongolava, Itasy and, Vakinakaratra (14 percent increase in jobs; capi- tal city – all activities) Fianarantsoa province, regions: Haute Matsiatra and Iho- rombe (22 percent increase in jobs; trade, agribusiness, wine) Toliara province, regions: Menabe, Atsimo Andrefana, An- droy and Anosy (11 percent increase in jobs; agribusiness and tourism) Source: Maps generated by the WBG Geospatial Operational Support Team using nighttime lights data from NOAA’s VIIRS satellite 9. Being able to capitalize on the emerging 625 representing advanced attainment and employment opportunities from an expanding 300 minimum attainment).³² Stunted children economy requires having an educated and are more likely to do poorly in school, whereby healthy labor force in place. Human capital each 10 percent increase in the national rate is a key determinant of labor productivity of stunting reduces the proportion of children and plays an essential role in determining reaching the final grade of primary school by a country’s long-term development path.³¹ 7.9 percent resulting in a reduction of the From 2012 to 2017, Madagascar’s Human cognitive and productive capacity of citizens. Capital Index (HCI) declined from 0.39 to 0.37. Thus, not only is a child born today only 37 The components of the HCI where the country percent as productive when she grows up scores worst include stunting (where 49 out as she could be if she enjoyed complete of 100 children are stunted) and poor learning education and full health, but human capital outcomes (students score 351, compared with is declining. ³⁰ The jobs created refers to the period 2012 to 2016. Reliable jobs data for Mahajanga are unavailable. ³¹ Human capital is comprised of six components: survival to age 5, expected years of school, harmonized test scores, learning-adjusted years of school, adult survival rate, and not stunted rate. ³² The latest data available shows that while stunting is high it slightly decreased between 1997 and 2012. 21 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 Figure 23: Madagascar’s human capital Figure 24: For Madagascar’s level of index is amongst the lowest in the world income, stunting is amongst the highest in the world 1 60 0.9 Madagascar Fraction of kids under 5 stunted, Human Capital Index (best=1) 0.8 Madagascar 50 0.7 40 in percentage 0.6 0.5 30 0.4 0.3 20 0.2 10 0.1 0 0 500 5,000 50,000 500 5,000 50,000 Log of GDP per capita, PPP current international US$ Log of GDP per capita, PPP (constant 2011 international $) Source: WDI, JME (UNICEF, World Bank, WHO) Source: WDI, JME (UNICEF, World Bank, WHO) 10. Not only is human capital declining but it also highlights that available resources total expenditures on education and health should be well-utilized, through ensuring are amongst the lowest in the world. For that professionals in the sector are well- Madagascar’s level of income, both public qualified to provide quality services and that and externally financed expenditures are resources reach frontline service delivery low, which places a strain on out-of-pocket units. As further progress is made to improve costs for social services. While this finding the efficacy of expenditures, there will be an suggests that investments in human capital even more compelling case for increasing are relatively under-financed in Madagascar, resources to these key social sectors. Figure 25: Total expenditures on health are Figure 26: Total expenditures on education amongst the lowest in the world are also amongst the lowest in the world 6,000 12 Government expenditure on education, total (% of GDP), Current health expenditure 5,000 10 per capita, USD PPP Average 2010-2016 4,000 8 Madagascar 3,000 6 Madagascar 2,000 4 1,000 2 - - 500.0 50,000.0 500.0 5,000.0 50,000.0 Log of GDP per capita, PPP Log of GDP per capita, PPP (constant 2011 international $) (constant 2011 international $) Source: World Health Organization and WDI Source: World Health Organization and WDI 22 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity 11. Reversing the decline in human capital quality of learning. Currently, neither teachers, will require a relentless focus on learning by school principals, district supervisors, nor the government, starting with revamping the education system managers know the teaching workforce. About 30 percent of the status of learning in Malagasy classrooms. labor force has not received any education. Occasional regional assessments (PASEC), Following the elimination of public-school fees conducted every few years on a sample basis, in the early 2000s, school completion rates reveal that the level is low, and declining. But leapt from 36.7 percent in 2000 to 73.9 percent these don’t help diagnose which students in 2009. However, learning outcomes remain nor which schools are in particular need of poor, as teachers are not well-equipped, support. A properly functioning education whereby only 0.1 percent of teachers assessed system is one where learning is regularly under the Service Delivery Indicators (SDI),³³ monitored, in a robust way, such that teachers have the minimum knowledge to teach, and school principals better understand compared with 14.6 percent as the average what the system expects of their students. in other countries where an SDI has been Perhaps most importantly, this data is crucial conducted in recent years.³⁴ Since 2009, for teachers to then diagnose what parts of progress in school completion rates halted, the curricula students are struggling with, due to high levels of out-of-pocket costs, a pre-condition to instill the basic skills that challenges in accessing education facilities Madagascar needs. due to poor connectivity, and the absence of career management for teachers; factors 13. While a university education makes higher which were all intensified during the political incomes more likely, tertiary education is not transition period when the government focused to deliver skills demanded by the stopped paying salaries.³⁵ To address the lack job market. Having a university education of public teachers in rural areas, communities makes it more likely to have better incomes, often make in-kind payments for teachers particularly in urban areas.³⁶ However, the who have not received formal training. Thus, Global Competitiveness Index ranks the the quality of teaching is poor, requiring an inadequacy of an educated labor force as intensification of ongoing efforts to improve the seventh most problematic constraint the quality of teachers. (Madagascar is at 123 out of 137 countries). While there are some vocational training 12. Improving learning requires measurement activities, these are not well-targeted to the of learning, and clear signals throughout needs of the private sector, leaving firms the system that the primary function of the to invest in their own training activities (see education system in the lower grades is to chapter 3). develop basic skills, such as reading, writing, and math. Though Malagasy children spend 14. There have been some improvements about 7.5 years in school by age 18, this is to health outcomes, but large disparities reduced to 4.2 years when adjusted for the remain between urban and rural areas. ³³ World Bank. 2016. Education Service Delivery in Madagascar. ³⁴ Comparator countries include Tanzania, Kenya, Mozambique, Nigeria, Togo and Uganda. ³⁵ WB Poverty Assessment, 2016 ³⁶ WB Poverty Assessment, 2016 23 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 Access to quality health prevention and including nutrition. Expanding cash transfers, promotion services are critical for improving tied with conditionalities to increase school labor productivity. Since 2000, notably attendance and promoting positive parenting progress has been made in reducing life practices, could also have spillovers for expectancy at birth and under-5 mortality improving nutrition.³⁹ All of these interventions rates. However, there are significant disparities are currently underway in selected areas. Low between urban and rural areas. In 2012, infant coverage of cash transfers reflects limited and child mortality rates were at 39 per live domestic financing. Efforts to scale up cash births in urban area compared with 64 in rural transfer could be further complemented areas, and vaccination coverage reached with increased dietary diversification linked 77.6 percent in urban areas compared to to improved farming practices. 46.6 percent in rural areas.³⁷ The coverage of health services is also lower in rural areas with 16. Investing in human capital should only 48.6 percent of the total health workforce help to leverage Madagascar’s declining and 36.5 percent of doctors serving in rural dependency ratio to reap a demographic areas where 68 percent of the population dividend. Madagascar’s population is lives. Public financing of the health sector is estimated at 25.5 million and is remarkably also low, where for example, the public sector young with 41.6 percent of the population finances only 1 percent of products for family below 15 years old (Figure 27). Since the 1980s, planning and the remainder is covered by Madagascar has had a declining dependency donors.³⁸ Finally, the outbreak of epidemics ratio, which means that the working-age such as measles (in 2019) and the plague (in population is getting larger relative to the 2018) underscore the weakness of the overall non-working (below and above working health system. age) population. This decrease is projected to continue, at least over the next three 15. A multi-sectoral approach is required to decades to a projected 58.2 in 2055 (Figure address stunting. Addressing Madagascar’s 28).⁴⁰ As such, the country is well-poised to high level of stunting requires better access reap a demographic dividend, as the number to primary health services (maternal and of people generating output and income child), water and sanitation services, as well increases relative to the number who depend as promoting positive parenting practices, on workers’ incomes. ³⁷ Ensomd 2012. ³⁸ Budgeted National Action Plan for Family Planning in Madagascar 2016-2020 ³⁹ The Human Development Cash Transfer has proven to be effective in increasing school attendance and parenting and early childhood development activities. ⁴⁰ Under three scenarios of the UN Population Division (High, medium, and low fertility variant), the dependency ratio is projected to decline in the next three decades and start stagnating in 2055 under medium and low. 24 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity Figure 27: Madagascar’s population is Figure 28: A declining dependency youthful ratio indicates an opportunity to reap demographic dividend Age distribution by gender Child dependency ratio (%) 80+ 100 70-74 60-64 50-54 50 40-44 30-34 20-24 0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 10-14 0-4 World High-income countries 2,000 1,000 0 1,000 2,000 Upper-middle-income countries Lower-middle Female Male Low income countries income countries Madagascar Source: UN Population data Source: UN Population data 17. Crucially, the size of the demographic enhanced formal sector job creation.⁴¹ Such dividend depends on labor market dynamics measures should be complemented with amongst other factors. The quantity and efforts to increase female employment in quality of jobs which the economy is able leadership positions, which stands at 28 to generate for the rising share of working percent.⁴² Firms with women in top positions age people, as well as the speed with which have greater labor productivity, as well as the total fertility rate declines over time annual employment and labor productivity will influence the possibility of achieving growth. As women take on more responsibility a demographic dividend. Policies can also there is the chance of positively influencing play a role to address early child-bearing the next generation through female role through informed parenthood, which will also models to encourage labor force participation likely improve with higher incomes through in quality jobs. ⁴¹ In Madagascar, the total fertility rate declined from 6.1 live births per women in the early 90s to 4.4 in 2015, which implies that the fertility transition has initiated, but early childbearing remains prevalent for the poorest quintile. ⁴² Enterprise Survey, 2013 25 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 Figure 29: Firms that have a female in a Figure 30: Annual employment and labor top position have higher labor productivity productivity growth is also higher with females in top positions (%) (logs, deflated US$) 2.5 2.0 8.6 1.5 8.5 1.0 8.4 0.5 8.3 0.0 -0.5 8.2 -1.0 8.1 Annual employment Annual labor growth (%) productivity growth 8.0 Top Manager of Firm Top Manager of Firm Top Manager of Firm is Female is Female is Male Top Manager of Firm is Male Source: Enterprise Survey, 2013 Source: Enterprise Survey, 2013 (ii) Investment flows for mining, was also accompanied by an increase in public investments, supported by 18. The contribution that capital has made greater access to external financing. However, to growth has varied over time, depending as mining operations entered their exploitation on the major investment projects ongoing. phase in 2009 and 2012,⁴³ and the onset of the From 2004 to 2008, the contribution that political crisis in 2009 led to a reduction in capital stock made to growth increased. This support from the international community, the movement reflected an increase in private contribution of capital to growth also declined. capital investment flows to support two mining The implementation of new public investments, operations to extract nickel, cobalt, ilmenite and as well as operations and maintenance of other minerals. This period of increased capital existing projects, largely stalled. Figure 31: The volatility in public Figure 32: Investment financing mirrors net investment financing mirrors net official official development assistance development assistance Public investment as percent of GDP and ODA Total investment as % of GDP flows (millions) 50 10 1,000 40 Percent of GDP 8 800 Million USD 30 6 600 20 4 400 10 2 200 0 0 0 Mauritius Malawi Burkina Faso Kenya Madagascar Mali Chad Rwanda Senegal Tanzania Mozambique Cote d'Ivoire Comoros SSA Togo 2003-2008 2009-2014 2015-2018 average average average Public investment (LHS) Net official development and official aid received 2003-08 avg 2009-14 avg 2015-18 avg (million, constant 2015 US$ - RHS) Source: WDI Source: WDI ⁴³ QIT Madagascar Minerals is an ilmenite, rutile and zircon mine in Tolagnaro, in the south-east of Madagascar, which was launched in 2009. The Ambatovy Project produces nickel, cobalt and sulphate of ammonia from a mine near Moramanga, and a processing plant in Toamasina, in the east of Madagascar. The project was launched at the end of 2012. 26 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity 19. Notable deficits in infrastructure are An estimated 26 percent of Malagasy have a constraint to private sector investment access to electricity (12.4 percent grid and and growth, partly reflecting low levels 13.6 percent off-grid). To achieve universal of investment. Results from the Enterprise access to electricity, as envisaged under Survey, 2013, which were later corroborated the Sustainable Development Goals, an through consultations with the private sector, estimated 400,000 new connections would suggest that the major constraints to physical be required each year. Madagascar’s new capital contributing to growth and supporting Energy Policy, approved in 2015, has the private sector development are related target of increasing electrification rates from to (in priority order) electricity, followed the current 26 percent to 70 percent by 2030, by transport and port infrastructure. The which requires 260,000 households to be lack of infrastructure reflects low levels of connected each year. Increasing access to financing for public investments. Compared electricity is important for improving access with aspirational peer countries such as to economic opportunities to those who are Cote d’Ivoire, Senegal and Rwanda, total currently off the grid. investment financing over the period 2015- 18 has been relatively low. In Madagascar, 21. The cost and quality of electricity supply is periods of scaling-up public investment a major impediment to growth in Madagascar. have largely been financed by development Electricity is supplied by the national state- partners (official development assistance owned utility, JIRAMA. The operating costs of -ODA- flow to Madagascar are among the power generation are amongst the highest in lowest in the world). However, in line with Africa, reaching over US$0.30/kWh in 2017, political turbulences, external support has which is an estimated 230 percent above the also been stop-start in nature.⁴⁴ This finding regional weighted average, largely because underscores the need for the government of poor procurement decisions and a slower to continue enhancing fiscal space through than expected transition to renewable energy. greater domestic revenue mobilization to The full operating costs are not passed on finance investments and to crowd-in the to consumers as the cost of electricity private sector. is subsidized, which also contributes to JIRAMA’s rising quasi-fiscal deficit, where the Electricity – access, costs and reliability company’s liabilities to suppliers are estimated at 3.1 percent of GDP in 2018. Finally, while 20. Three out of four households in there have been some improvements, the Madagascar have no access to electricity— reliability of electricity supply remains poor, one of the lowest rates in the world—which contributing to an estimated 13 percent loss keeps them from participating in the of sales, which is at the higher end compared modern and increasingly digital economy. with peer countries (Figure 33). ⁴⁴ Over the period 2003-08, public investments peaked at an average of 8.4 percent of GDP, largely financed by ODA flows. The onset of the political transition period over 2009-14 saw public investments decline to 3.2 percent of GDP, in line with a reduction in external financing. Thepost-2014 period is marked by reengagement with the international community and an increase in ODA. 27 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 Figure 33: Firms in Madagascar have amongst the highest percentage of sales lost due to outages (%) 18 16 14 12 10 8 6 4 2 0 Liberia Ethiopia Zambia Indonesia Mauritius Mauritania Mozambique Rwanda Burundi Cambodia Chad Uganda Senegal World Mali Cote d'Ivoire Niger Burkina Faso Zimbabwe Kenya Malawi SSA Cameroon Madagascar Tanzania Ghana Lao PDR Togo Sierra Leone Nepal Source: World Bank Enterprise Survey and Doing Business 22. Looking ahead, Madagascar is poised about 70 percent of unpaved roads are in to make improvements to renewable poor condition. The priority is to keep the energy supply. Unlike other island countries, primary road network well maintained, which Madagascar is well-endowed in renewable supports the country’s backbone connectivity, energy sources, particularly hydropower. particularly to Antananarivo, the primary The development of two major hydro- market in Madagascar. However, the efficiency power projects are in the pipeline, in of mobility in the capital has been deteriorating Sahofika and Volobe. Undertaking these due to fragmented land management and investment projects has entailed securing poorly managed transportation systems substantial private investments. Being dominated by loosely regulated informal able to secure private investments on minibuses. The development of integrated competitive terms requires addressing the transport systems with sustainable and elevated risks which arise from JIRAMA’s resilient land management and local business precarious financial situation and currently developments could help to alleviate some of undermine its credibility as an off-taker. This these pressures. situation emphasizes the importance of all investments being procured on a least-cost 24. Poor levels of rural accessibility limits basis in line with demand and capacity to pay, farmers access to markets and is a general also to be supported by economic, social and drag on connectivity. The latest road condition environmental feasibility assessments. data translates into an accessibility of 11.4 percent (Figure 35), whereby 17 million rural Transport and logistics infrastructure people (or 68 percent of the total population) are disconnected and face high costs to 23. Primary roads, which connect with access markets and this exacerbates their Antananarivo, and the efficiency of mobility remoteness. There is significant heterogeneity in the capital are deteriorating. Madagascar across areas. While rural accessibility is owns a road network of 31,640 km. While relatively high along the RNP (for example in 70 percent of paved roads are in good or Toamasina, Antsiranana, Mahajanga, Sainte fair condition (e.g., RN2, 4, 6, 7, 34 and 35), Marie, Toliary – the cities which have shown 28 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity a brightening of nightlights and job creation), rehabilitated between the end of 2019 and other areas have minimal accessibility, for early 2023 to improve accessibility to the rice example in the North (Sofia, Analanjirofo producing region, and therefore improving Regions), West (Bongolava, Melaky), East, food security.⁴⁵ Furthermore, the rehabilitation and South (Androy, Anosy). The disconnected of a road connecting to Fort Dauphin, which areas in the south have higher levels of poverty is also home to a port, is ongoing.⁴⁶ This road where accessibility is also compromised is critical for opening up access to parts of because of climate conditions. Poorly the country which are currently unconnected, maintained unpaved roads are particularly thereby potentially unlocking new growth susceptible to heavy precipitation. corridors and facilitating access to a port outside of Toamasina.⁴⁷ In the north of the 25. Improvements to certain major road country, the RN6 from Ambanja to Diégo networks are expected, which would help will be rehabilitated, which is important for to unlock connectivity constraints. The RN44 tourism, rice and cash crop exports such as from Moramanga (between the capital and cocoa, spices, essential oils and cashew.⁴⁸ the east coast) to Vohidiala (113 km) will be Furthermore, the road from the north-east to the north-west (from Ambilobe to Vohemar) will be rehabilitated, unlocking the potential to transport cash crops and rice.⁴⁹ In the east of the country, the RN5 Soanierana Ivongo will be rehabilitated which is important for cloves and other spices, as well as access to the main port.⁵⁰ In the center of the country, key markets will be connected between Faratsiho and Sambaina unlocking the potential for food crops (rice, maize), and vegetables production and marketing.⁵¹ And in the south of the country, Analamisampy – Dabaraha (mainly rice and dry beans production regions), will be rehabilitated.⁵² In Antananarivo, several roads will be rehabilitated, which could greatly improve access and connectivity.⁵³ ⁴⁵ With support from the World Bank ⁴⁶ The EU and the AfDB are rehabilitating 50km of road at present. The WB contribution is expected to start in 2020 and be completed in 2022. ⁴⁷ RN12A will be rehabilitated with cofinancing from AFDB and EU. RN13 Ambovombe - Taolagnaro / 114km / European Investment Bank and EU. RN12A Fort Dauphin – Vangaindrano / 236km/ EU – AfDB- World Bank ⁴⁸ With support from the European Investment Bank and EU ⁴⁹ RN5A Ambilobe – Vohémar / 151km / Chinese Government ⁵⁰ With support from the Saudi Fund for Development - Kuwait Fund for Arab Economic Development - Abu Dhabi – BADEA- OFID. ⁵¹ RNS43 / 51km / BADEA and Saudi Fund for Development ⁵² With support from the AfDB ⁵³ RN at Antananarivo exit (RN1, RN2, RN3, RN4, RN7)/ 47km / EIB and Gov. Malagasy; North-east ring road between Marais Masay and Tokyo boulevard / 7.2km/ AFD – IEB – EU – Gov. Malagasy; Road Between Ambohitrimanjaka and Ambohidratrimo/ Chinese Government 29 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 Figure 34: 70 percent of paved roads are Figure 35: Madagascar’s Rural Access Index in good condition while 70 percent of shows that only 11.4 percent of the population unpaved roads are in poor condition have access to a good road network Source: Madagascar Spatial Analysis of Transport Connectivity Source: Madagascar Spatial Analysis of Transport Connectivity and Growth Potential, World Bank and Growth Potential, World Bank 26. Ports and airports are important the potential to unlock access to the port, gateways to regional and global markets, which would enable export-oriented firms but current operations are suboptimal. to capitalize on additional shipping routes. While Madagascar has 17 seaports, activities There are currently 55 airports, of which are concentrated in the Port of Toamasina, Antananarivo and Nosy Be (in the north, a which handles 65 percent of general cargo major tourist destination) are primary airports. and 85 percent of containerized cargo. Air cargo is one of the preferred methods of The current congestion of the port should transporting merchandise. However, high be alleviated through the Toamasina port costs of air cargo and passenger fares, expansion project, which should be partly which are associated with a limited number completed by 2021, and fully completed by of routes and elevated jet fuel costs are a 2026. Furthermore, the planned construction constraint to competitiveness (discussed of the road to the Port of Fort Dauphin has further in chapters 3 and 5). 30 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity Figure 36: Madagascar has one of the lowest ranking scores for transport infrastructure Global Competitiveness Index - Transport Infrastructure (best score = 7) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Indonesia Mauritius Malaysia Rwanda Ethiopia Cambodia Zambia Mozambique Mali Guinea Liberia Uganda Burundi Kenya Tanzania Lao PDR Zimbabwe Madagascar Cameroon Burkina Faso Nepal Malawi Chad Cote d'Ivoire Senegal SSA average Sierra Leone Source: Global Competitiveness Index Dataset 2007-2017, World Economic Forum Addressing the investment gap finance investments. (See Table 3 for selected economic and financial indicators from 2008 27. To address the poor quality of to 2018.) infrastructure, the government has been taking steps to increase domestic sources 28. These domestic sources of financing of fiscal space. Coming out of the political are being complemented by debt transition period in 2014, Madagascar had financing, largely on concessional terms. one of the lowest tax-to-GDP ratios in SSA at As reengagement with the international 9.9 percent, which was insufficient to cover community in 2014 paved the way for current expenditures at 10.8 percent of GDP. the government to access financing on Furthermore, there was great scope to improve concessional terms, debt financing for the quality of public expenditures, whereby infrastructure has risen. The public and nearly one third of current expenditures were publicly guaranteed debt-to-GDP ratio channeled to regressive areas of expenditures, has increased from 24.4 percent in 2014 to such as transfers to inefficient state-owned a projected 35.7 percent in 2019, of which enterprises. Seeking to remedy this situation, close to 96 percent is on concessional the government embarked on a successive terms. Bilateral partners currently provide series of reforms, whereby projections for only limited financing, which may be both 2019 indicate that the tax-to-GDP ratio should on concessional and grant terms. PPPs are increase to 12.2 percent of GDP, regressive increasingly being explored, in sectors such transfers will reduce, and capital expenditures as transport (Antananarivo airport), roads, will increase from 3.5 percent in 2015 to 6.6 energy, e-government and finance. However, percent of GDP. Therefore, steady progress the institutional capacity for managing PPPs is being made to increase revenues and is still weak, and so this option should be improve the composition of expenditures to treated with caution. 31 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 Table 3: Madagascar Selected economic and financial indicators:2008-2019 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Actual Est. Proj. Real sector GDP 16,081 16,726 18,245 20,034 21,774 23,397 25,775 28,585 31,634 35,729 40,032 44,241 (billions of Ariary) Real GDP 7.2 -4.7 0.3 1.5 3 2.3 3.3 3.1 4.2 4.3 5.1 4.7 (annual % change) GDP per capita 472 417 424 467 455 473 463 412 409 459 467 477 (current USD) Real GDP per capita 4.4 -7.5 -2.5 -1.3 0.2 -0.5 0.5 0.4 1.4 1.5 2.3 2.0 (annual % change) Public Finance (%GDP) Total revenue 15.9 11.5 13.2 11.7 10.8 10.9 12.4 11.8 14.8 14.8 14.6 15.0 and grants o/w: Tax 11.8 9.4 9.8 9.5 9.1 9.3 9.9 10.1 11.0 11.5 11.8 12.2 Revenues 17.9 14.1 14 14.1 13.4 14.9 14.7 15.1 16.1 17.2 17.1 17.5 Total spending (commitment basis) o/w: Capital 7.7 4.9 5 4.2 2.7 3.1 3.9 3.5 5.2 5.5 6.1 6.6 spending Overall balance -2.2 -2.5 -1.1 -1.6 -1.4 -2 -2.4 -3.3 -1.3 -2.4 -2.5 -2.5 (commitment basis) Total public debt 31.5 33.7 31.7 32.2 33 33.9 34.7 41.3 47.1 46.0 45.7 45.9 o/w: External 24.2 26 24.1 24 23.5 22.8 24.4 28.4 29.6 29.5 30.5 31.7 External sector (%GDP) Exports of goods, 14 12.4 13.4 14.9 15.3 18.1 20.6 21 21.7 24.4 25.0 25.5 f.o.b. Imports of goods 40.1 37.4 28.9 29.4 31.2 30.7 30.2 28.7 28.7 31.5 28.9 29.6 c.i.f Current account -18.9 -21.1 -10.2 -7 -7.6 -5.9 -0.3 -1.9 0.6 -0.5 0.8 -0.8 balance Foreign Direct 6.9 8.1 3.9 7.8 7.8 5.2 2.9 4.5 4.5 3.1 4.1 3.2 Investment Foreign Reserves 2.5 2.9 2.9 3.7 3.3 2.2 2.5 2.9 3.9 4 4.3 … (months of imports) Terms of Trade -8.8 0.8 10 -0.4 -6.5 -0.3 -0.9 -0.9 0.1 22.3 -1.2 -0.8 (percent change) Exchange Rate 1,708.4 1,956.2 2,090.0 2,025.1 2,195.0 2,206.9 2,414.8 2,933.5 3,176.5 3,116.1 3,333.6 LCU/USD(average) Source: Malagasy authorities and WB staff calculations, October 2019. Figures and ratio use the 1984-based national accounts 29. To capitalize on the opportunities developed, there is a new legal framework for increased infrastructure financing, for Public-Private Partnerships (PPP), and the government has been taking steps the transparency of public investments and to improve the institutional framework the sources of financing have improved, for for public investment management, but example through publishing information on capacity remains weak. For example, a loans with medium-term debt projections. new Public Investment Strategy has been However, despite these efforts, the ability of 32 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity the government to effectively plan, select, business environment, which would help to sequence, execute and monitor public increase predictability and reduce risks. These investments remains very weak. Therefore, long-term reforms in the business environment increasing public resources for investments would not only help to encourage private should continue in parallel with efforts to sector investment but would also help to build improve public investment management the resilience of the economy to move towards capacity. Furthermore, efforts are needed to a more sustainable growth path. improve the execution of externally financed investment projects, by addressing key 31. The business environment in Madagascar bottlenecks on the side of the government is characterized by key weaknesses related to to ensure timely delivery. the perception of governance effectiveness and rule of law. The quality of governance 30. As part of a long-term strategy, it is critical serves to undermine investor confidence in to continue crowding-in investments from the public administration, as well as the ease of doing private sector, which requires strengthening business. This situation reflects the domination the business environment. Certain elements of of the economic and political spheres by a small the private sector have already demonstrated elite, some of which have used their influence commitment to investing in Madagascar, to exclude new players and opponents. This comprising of both domestic and foreign modus operandi is a legacy of the pre and post- investors. For example, during the Donors independence period, when the economy was and Investors Conference in 2016, the private controlled by a handful of well-connected and sector confirmed investments of US$1.9 billion influential families. Today the composition of the in sectors such as energy, infrastructure, private sector has evolved, and the economy agribusiness and the financial sector. To is more open and accessible than in the years further leverage long-term investments from following independence, allowing some the private sector, it is critical to improve the measures of upward mobility. Figure 37: The perception of governance effectiveness is amongst the lowest compared with peers Percentile rank among all countries (ranges from 0 (lowest) to 100 (highest) rank) 100 80 60 40 20 0 Chad Liberia Burundi Uganda Comoros Sierra Leone Madagascar Mali Mozambique Mauritania Ethiopia Cambodia Tanzania Zambia Niger Malawi Burkina Faso Zimbabwe Nepal Lao PDR Senegal Togo Cameroon Côte d'Ivoire Source: World Governance Indicators, 2017 33 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 32. Given the weaknesses in institutions, investment could be exponential (discussed private operators have relied upon political further in chapter 3). connections to protect their business. Reliance on connections and alliances (iii) Productivity and innovation has diminished incentives to strengthen governance, transparency, and accountability 34. Firms with higher levels of labor and oversight mechanisms. Breaking the elite productivity share the characteristics of: capture system requires a strong public sector (i) being connected within the financial reform program and strengthened rule of law system; and (ii) having greater exposure to improve investor confidence. However, to international know-how.⁵⁴ Firms which the incentives for strengthening institutions are connected to the financial system, for will need to address potential resistance to example through accessing a bank loan, reform. Firms that have been able to grow, and are likely to have higher levels of labor moreover survive the turbulences resulting productivity (measured as sales per worker from the political crises, have maintained growth), which only accounts for 20 percent privileged access to the factors of production, of firms, as reliance on self-financing is such as land (which is prohibited for non- more common. Firms that have access to Malagasies) and the ability to negotiate credit financial resources that enable them to hire on more favorable terms (including access to external talent also have higher levels of labor supplier credit). These findings suggest the productivity. Medium-sized firms have the importance of promoting a more level playing highest level of labor productivity growth, but (discussed in chapter 5) as well as encouraging employment growth is higher for large firms. and protecting investors (chapter 3). On the other hand, small-sized firms (which accounts for employment of 60 percent of 33. The more recent arrival of new economic the non-agricultural sector) are characterized operators, in emerging sectors such as by negligible employment growth and low IT-BPOs for example, demonstrates that annual labor productivity growth. connections are not always a prerequisite for doing business in Madagascar. New economic 35. There have been recent improvements to entrants – either domestic or foreign – can be financial inclusion which are encouraging. At accommodated in niche and emerging sectors the household level, there have been some that are relatively open and unprotected, or improvements to financial inclusion, where in sectors where established companies do for example, between 2011 and 2017, the not have a prior claim or interest. While these percentage of Malagasies with a financial examples are limited, they demonstrate that institution account increased from 6 percent newcomers can effectively do business in to 10 percent. While this increase marks good Madagascar, and moreover in sectors that progress, it still falls far behind the average generate employment. These examples for SSA at 33 percent.⁵⁵ Lending to the private further indicate that if the barriers to doing sector is on the upside, but credits are largely business were alleviated, prospects for further short-term in nature, limiting opportunities to ⁵⁴ Findings based on analysis from the Madagascar Enterprise Survey, World Bank, 2013 ⁵⁵ The improvements to financial inclusion have been supported by legislative improvements to the financial sector, including the formalization of electronic money payments and the private credit bureaus, which can be used to enhance the assessment of a potential creditor’s risks. 34 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity commit to long-term investments. in the region, at 43 percent in 2018.⁵⁶ Broader improvements to the business environment, 36. However, further progress is required to again through improving commercial justice, address weak financial intermediation. The as well as through increased use of land Malagasy banking sector is overall profitable, certificates as collateral for accessing credit and the system is liquid. However, credit costs could help to reduce risks, and in turn lower are high due to portfolio risks associated with interest rates. In addition, there has been overall institutional weaknesses which are limited regulation in fees for financial services, being transferred to consumers. Madagascar which is a further area of reform to be pursued also has one of the highest interest rate spreads by the regulatory agency. Figure 38: Large firms have greater Figure 39: Financially connected firms have employment growth higher employment growth Firm size based on the number of employments Annual employment growth (%) 10.0 8.7 15 8.0 6.0 10 4.0 2.0 5 0.0 -2.0 0 -1.4 -4.0 -3.6 -6.0 -5 All sizes Small Medium Large Connected Firms Disconnected Discouraged Firms (5-19) (20-99) (100+) (Applied for a loan) Firms (Sufficient (Unfavorable capital, no loan terms) Annual employment growth (%) needed) Annual labor productivity growth (%) Source: Enterprise Survey, 2013 Source: Enterprise Survey, 2013 37. Enhancing access to finance is is viewed as a good career choice but is particularly important for encouraging largely concentrated in the informal sector, entrepreneurial activity, which is currently dominated by small-sized firms. Further concentrated in the informal sector. developing formal entrepreneurship An estimated 22 percent of the working activity requires facilitating access to population is engaged in entrepreneurial finance, for example through soft loans activity, with the country ranking seventh and leasing, as well as providing training; out of 54, second only to Vietnam in the initiatives which have all started under the lower income group.⁵⁷ Entrepreneurship new government’s program.⁵⁸ ⁵⁶ Interest rate spreads are explained by four main factors. 1) Cost of resources: the interest rate paid on deposits and the ability of banks to list on the stock market and expected returns from equity investments. 2) Risk pricing; 3) Intermediation costs which are driven by the efficiency of banks; 4) Profit margins that banks make which depends on competition in the financial sector. ⁵⁷ Global Entrepreneurship Monitor’s surveyed a sample of 24,000 individuals in 2017 ⁵⁸ The government has established a new entrepreneurship program, Fihariana to provide technical and financial support to entrepreneurship 35 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 38. Recent advances in technology suggest activities are ongoing, which could spur that there may be other avenues for innovation over the long term. Compared with enhancing innovation. Investments in digital other countries, Madagascar has relatively technologies have resulted in Madagascar high levels of innovation, greater than certain having the fastest download speed in Africa aspirational peer countries such as Cote and featuring in the global top-25.⁵⁹ These d’Ivoire, but falling behind others such as technological developments are being Rwanda and Senegal. Such developments leveraged by the private sector to further could also help to improve productivity over business development, where for example, the medium to long-term and could help to more advanced software development improve long-term productivity. Figure 40: Madagascar’s ranking in the Global Innovation Index is on the higher end compared with peer countries Global innovation index overall score - 2018 35 30 25 20 15 10 5 0 Mauritius Zambia Mozambique Malawi Zimbabwe Mali Uganda Senegal Burkina Faso Nepal Rwanda Tanzania Madagascar Kenya Togo Côte d'Ivoire Niger Cameroon Source: World Intellectual Property Organization and WDI C. The sustainability of growth for doing business through clear, consistent, and predictable implementation of relevant 39. Encouraging the growth momentum to regulation. Reforms to commercial justice are continue while de-risking shocks, requires required. In the short-term, the utilization of the restoring confidence in the formal institutions recently established arbitration center could for doing business. The risks to political be encouraged. Over the long-term, reforms stability are related to the country’s political are needed to assure private operators of a economy dynamics, whereby weak institutions free and fair trial, through for example, ensuring have in some cases contributed to firms that cases are not pre-assigned to judges and bypassing formal mechanisms. Addressing that undue delays are avoided. The same this situation will require long-term reforms to recommendations apply to the penal justice restore confidence in the formal mechanisms to reverse the increasing prevalence of crime 36 2 | The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity and theft observed over the past decade that may not have the necessary infrastructure undermines the business environment.⁶⁰ in place and requires measures to address resettlements in areas prone to flooding and 40. Checks and balances related to government / or landslides. Climate-related disasters are effectiveness should also be strengthened. For estimated to cost on average, 1 percent of example, the anti-corruption agency, BIANCO, GDP per year, which is a substantial contingent and the anti-money laundering institution, liability. Planning for future costs could involve SAMIFIN, could be strengthened to provide implementing a contingency fund (regulation greater incentives to prevent wrongdoing. already in place), as well as contingent credit Concretely, the adoption of the law related to and sovereign insurance. the recovery of illicit assets would strengthen the anti-corruption framework and result in D. Conclusion Madagascar not being gray-listed by the Financial Action Task Force; which would 42. While progress has already started in also be an important signaling mechanism for bringing growth outside of the three major new investors that the environment for doing cities, which is accompanied by job creation, business is improving. further efforts are needed to invest in the quality of human capital. For Madagascar 41. Climate change and natural disaster- to reap the benefits from expanding job related shocks also pose a risk to the creation opportunities, it is critical to continue economic sustainability and particularly reforms to accelerate improvements in human affects the poorest. The unmitigated impacts capital. In the education sector, this involves of climate change affect the security of rural implementing a holistic teacher reform livelihoods due to high dependence on process, with strong political leadership from rain-fed agriculture, chronic food insecurity, the highest level. Efforts have already begun physical isolation and the lack of access in earnest to address high levels of stunting, to social safety nets. Addressing these including through increasing the uptake risks could involve strengthening early of health services and promoting positive intervention in case of disasters, improving parenting practices. In health, there is scope mitigating measures, as well as reforming to improve the quality of service delivery social safety nets so that they are further through developing in-service training tools, expanded and can be used more flexibly in improving the pre-service training of qualified times of emergency, for example through health workers to match the needs of the cash for works. Given the impact that climate health system (some of which is already related shocks have on physical infrastructure, ongoing), and to strengthen monitoring and mitigating measures could include regular management of the health system, to avoid maintenance of infrastructure. The loss of epidemics. While progress has started on livelihoods in climate affected areas can place these fronts, tangible results which will be pressure on migration to areas less affected possible over the medium to long-term, would by climate related shocks or changes, which provide a solid argument for also increasing ⁶⁰ Security in Madagascar has been rated 4.06 (on a scale of 1 to 7) in the 2008-2009 Global Competitiveness Index and 3.65 in the 2017-2018 edition, ranking Madagascar at 118 over 137 countries. Crime and theft is cited as the 6th most problematic factors for doing business in the GCR 2017-2018. 37 The Long-Term Determinants of Growth in Madagascar: Labor, Capital and Productivity | 2 Going further, infrastructure improvements should consider access to ports and airports the level of resources allocated to the social private sector. Going further, infrastructure sectors, which should be complemented improvements should consider access to ports with improved accountability mechanisms. and airports, including rehabilitation where Ensuring that there is a strong foundation in necessary, which may also be strategically human capital, will enable the labor force to supported with PPPs. be market ready to respond to the emerging opportunities from higher growth. 44. Improving firm productivity, innovation and growth of the private sector requires 43. Pipeline developments suggest that improving access to credit and the business physical road infrastructure will improve over climate. Indicators of productivity suggest the next five year, but to be fully leveraged, that firms that are connected to the financial this needs to be accompanied by reliable system, seeking loans instead of financial electricity supply, access to ports, and services have higher sales per worker growth. complemented with alternative methods of However, the level of financial intermediation transport. There are important infrastructure is low, with firms largely accessing short-term developments in the pipeline, which will help credit, rather than long-term sources needed to unlock connectivity to strategic areas with to invest. Furthermore, high levels of interest economic potential. Ensuring these projects rates deter firms from seeking financing to are implemented on time and according to expand their operations. Addressing these plan is a priority through the strengthening the challenges requires improving the business overall public investment management system, environment, and specifically commercial and specifically procedures involving external justice, so that high levels of risk are not financing. Continuing these infrastructure inadvertently passed to consumers. Efforts improvements should involve brining access to enhance competition in the business to both on and off-grid electricity. Again, there climate could encourage firms to innovate are pipeline developments, with two large and increase productivity rather than the hydro-power dams in the pipeline. For these current practice of manipulating legislation developments to have positive economic gains, to gain an edge over rivals. Strengthening projects must be well selected and procured checks and balances in the institutional on a least-cost basis in line with demand and environment could help in this regard, as well capacity to pay. Improving the governance of as approving the law on illicit assets recovery, JIRAMA, the national utilities company, which which would send a strong signal that there is undergoing financial restructuring will help is commitment at the highest level to wide- to improve the credibility of the company reaching improvements to the financial and as a viable off-taker for investments by the business environment. 38 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High- Performing Sectors 26 39 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 Madagascar’s trade and investment recovery since the return of constitutional order in 2014 has been driven by a strong value proposition and clear comparative advantages, despite an unfavorable business climate, high trade costs, and deficient infrastructures. Madagascar’s competitiveness mainly stems from the affordability and quality of labor, unique natural resources, high-end branding in some niche markets, and fast internet connection. As a result, sectors such as agribusiness, textiles and apparel, and business processing outsourcing are expanding rapidly, creating jobs, developing regions outside of the capital, and fostering positive spillovers to the rest of the economy. The continuation of these trends could support the diversification of products in goods or services of higher value-added, and expansion into new markets, including those within the region. This would contribute to income generation to boost domestic demand and move Madagascar towards a more inclusive and sustainable development path. Realizing these opportunities requires addressing cross-cutting constraints related to trade and investment policies, a lack of connectivity, skills, energy, and effective dispute resolution system. These must be complemented by sector-specific initiatives, including better structured and more competitive value chains, improved quality controls, R&D and training activities. A. Introduction the African Growth and Opportunities Act - AGOA), a shift towards higher value-added 1. Despite Madagascar being a large island goods and services exports, as well as a rise nation with logistical challenges to trade, in foreign direct investment (FDI). the country’s integration in the global economy has been pivotal to its economic 2. Trade and foreign direct investment flows revival in recent years. Madagascar’s trade are driven by a limited number of high- performance is strong, with exports increasing performing sectors, which can be leveraged from 22 percent of GDP in 2009 to 35 percent to foster more productive, sustainable and of GDP in 2017, which is superior to most inclusive growth. Key export-oriented sectors peer countries (Figure 41).⁶¹ Reengagement such as textiles and agribusiness have shown with the international community in 2014 elements of resilience to economic shocks (for supported increased access to markets example during the 2009 to 2013 downturn) (including special trade agreements such as and recovered strongly during periods of ⁶¹ Considering possible distortions that may arise from the vanilla price spike initiated in 2012, Madagascar’s export performance against its benchmark was also evaluated in constant prices. Based on GDP and total export values expressed in constant 2010 USD sourced from WDI, Madagascar’s share of exports in GDP jumped from 24 percent in 2009 to 40 percent in 2016 (the latest year with available data), which is higher than equivalent shares for the World (30 percent), SSA excl. high income countries (29 percent) and all structural and aspirational peers except for Malaysia (71 percent) – no comparable data is available for Burkina Faso and Ethiopia. Malagasy exports also maintain high dynamism when expressed in constant prices, growing by 10% annually since 2009, which is faster than annual growth of exports by the World (5 percent) and Sub-Saharan Africa excluding high income countries (3 percent), as well as growth by all structural and aspirational peers except Zimbabwe (who grew at 14% annually in the same period). 40 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors economic and political stability.⁶² Exports of at a slower pace) even during the political metals have seen a large expansion since the transition period, outshining the performance coming on stream of nickel, cobalt, titanium of most peer countries, SSA and global and zirconium, with their share jumping to 19 averages. Such performance demonstrates percent of total merchandise exports in 2013 a strong value proposition associated with from less than 2 percent in all preceding years, affordable labor and unique agriculture and thus making an important contribution to the natural resources. The emergence of newer country’s export revenues in recent years.⁶³ sectors like IT-BPO (Information Technology Malagasy exports have shown a higher and Business Process Outsourcing) also rate of survival than most peer countries illustrates the benefit of past investments in (Figure 42); and therefore continued (albeit broadband internet. Figure 41: Madagascar has one of the Figure 42: Malagasy exports have a higher highest rates of export growth and largest chance of survival compared with peers⁶⁴ export sectors Probability of survival (0-1) over time (years) Exports of goods and services (% of GDP) and growth of exports (US$) .4 45% 40% 35% .3 30% 25% Probability 20% 15% .2 10% 5% 0% World SSA (excl. high incomes) Indonesia Mozambique Burundi Nepal Haiti Ethiopia Uganda Mali India Zimbabwe Niger Malaysia Cameroon Madagascar Burkina Faso .1 0 0 10 20 30 Analysis Time Exports of goods and services 2017 (% of GDP) AFG BFA CMR MDG MLI MOZ Growth of Exports of Goods and Services in current USD (2009-2017) NPL NER RWA UGA ZWE Source: WB staff calculations based on UN Comtrade data Source: WB staff calculations based on UN Comtrade data ⁶² Even after deflating the export values of vanilla to exclude any distortions that may arise from rapidly increasing prices since 2012, agribusiness still accounts for the largest or second largest share of total merchandise exports throughout the whole period of analysis, in alternance with textiles and apparel, except in 2015 when it comes third with a share of 26 percent after metals (29 percent) and textiles and apparel (28 percent). In particular, agribusiness accounts the largest share in overall merchandise exports to the World between 2011 and 2014 as well as in 2017, and the sector’s exports still increased by 5.8% yearly between 2014 and 2017, faster than any other product category, even when taking vanilla in constant 2012 prices and despite the decrease observed in export volumes of such commodity, indicating that this result is not driven by the price spike in vanilla, but rather other agribusiness are growing strongly. ⁶³ Metals exports continued to grow in 2014 and 2015, accounting for 24 and 26 percent of overall merchandise exports, respectively (the shares rise to 26 and 29 percent when vanilla exports are expressed in constant 2012 prices). Metals exports were moderately lower in the last two years of the analysis, bringing their share in overall merchandise exports down to 15 percent in 2017 (21 percent when vanilla exports are expressed in constant 2012 prices). ⁶⁴ Every passing year some export flows die, but at different rates for the different countries in the comparators group. Most export flows end soon after they start, and the longer they survive, the higher their chance to keep surviving. At every point in time, Malagasy exports have a higher survival probability than exports by nearly all structural peers. Rwanda and Comoros were excluded for lack of comparable data. 41 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 3. This chapter focuses on resilient and fast- sectors. Fourth, cross-cutting as well as growing sectors and their potential to foster sector-specific policy recommendations are higher and more inclusive growth. Resilience presented. to shocks, a strong export growth, and job creation were among the key criteria for the B. Madagascar’s Trade selection of high performing sectors. These Performance – Dominance were identified as agribusiness, textiles and of High-Performing Sectors apparel and IT-BPO. Two other sectors that show potential but were not included in the 4. Madagascar’s economic recovery has scope of the analysis are: (i) tourism which been associated with an increase in both has shown less resilience to shocks and merchandise and services exports, which has not fully recovered from the political were supported by a few dynamic sectors, transition period; and (ii) mining, which including agribusiness, textiles, metals has already been studied in-depth through and IT-BPO. Merchandise exports have a separate analytical workstream, where demonstrated rapid growth, increasing by further growth of the sector is subject to 75 percent in nominal values from the period improved governance, with progress thus far 2009-13 to 2014-18. This performance has being limited.⁶⁵ The chapter is organized in been dominated by agribusiness, textiles four sections. First, the country’s overall trade and metals, including nickel and cobalt. In and investment performance is presented, particular, the average share of Agribusiness including a description of key export-oriented exports (38 percent on average in 2005-17) sectors. Second, the chapter reviews the is considerably larger than that of most factors that have enabled success of those structural peers, with only Zimbabwe and sectors despite the country’s challenging Rwanda matching it, and Uganda exceeding business environment. Third, opportunities it.⁶⁶ Even though travel and transport account for leveraging further growth, job creation, for the largest share of services exports, IT- linkages, and value addition are presented. BPO are the fastest growing services exports, This analysis is based on a deep-dive survey expanding by 73 percent over the period that was administered among the selected 2014-17. ⁶⁵ Tourism has an average share in total exports of goods and services of about 20 percent and mining of metals and minerals (HS chapters 25-27 and 72-83) of about 10 percent over the period 2005-2017. ⁶⁶ Cameroon 22 percent, Nepal 21 percent, Mozambique 17 percent, Burkina Faso 11 percent, Niger 10 percent, Mali 8 percent. 42 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors Figure 43: Merchandise exports are under Figure 44: Exports of telecommunications expansion, with agribusiness and apparel related services are rising at a rapid pace performing particularly well⁶⁷ Malagasy Exports of Commercial Services excl. Malagasy Merchandise Exports (Millions USD) Travel & Transport and other business services 4,000 (Millions USD) 140 3,000 120 100 2,000 80 60 1,000 40 20 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 All Other Products Metals Minerals Personal, cultural, and recreational services Apparel and Textiles Telecommunications, computer, and information services Agribusiness (with Vanilla in current USD) Charges for the use of intellectual property n.i.e Agribusiness (with Vanilla in constant 2012 USD) Financial services Insurance and pension services Total Merchandise Exports (with Vanilla in constant 2012 USD) Construction Goods-related services Source: WB staff calculations based on data from UN Comtrade Source: WB staff calculations based on data from UN Comtrade on WITS and UNCTAD. on WITS and UNCTAD. 5. The development of these fast-growing in niche higher value-added foodstuffs. The sectors has been supported by foreign direct textiles industry and IT-BPOs have attracted investment. Understanding their drivers is efficiency-seeking FDI, underscoring important for maintaining and encouraging Madagascar’s competitiveness based on future FDIs (see Box 1). Madagascar’s the availability of relatively affordable labor, natural resources such as nickel, cobalt which is French speaking and receptive to and other minerals, as well as a breadth on-the-job training. Thus, despite substantial of agribusinesses such as vanilla, cloves, constraints to Madagascar’s business seafood and other products, have attracted environment, the country remains attractive natural resource-seeking FDI to export to foreign investment, which is relatively high products that in many instances do not compared with other non-natural resource exist elsewhere. Contrary to the experience peer countries. The top investor to the country in most developing countries, resource- is France, which is trailed by other countries driven FDI in Madagascar is concentrated such as India and Mauritius.⁶⁸ ⁶⁷ The agribusiness products include HS chapters 01 to 24 comprising animal and vegetable products and foodstuffs. Apparel and Textiles comprise HS chapters 50 to 63. Minerals and Metals comprise HS chapters 25 to 27 and 72 to 83. ⁶⁸ Financial Times fDi Markets, data extracted November 2018 43 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 Figure 45: FDI inflows are relatively high and are increasing Foreign direct investment, net inflows (% of GDP) 15.0 10.0 5.0 - Burundi Nepal Kenya Zimbabwe Senegal Indonesia Mali World Ethiopia Rwanda Uganda Comoros Côte d'Ivoire SSA Burkina Faso Malaysia Tanzania Cameroon Lao PDR Madagascar Niger Cambodia Low income Seirra Leone Average 2000-2009 Average 2010-2017 Source: WDI Box 1: Not all FDIs are the same Developing countries tend to attract three different types of FDI, each one rooted in different characteristics of the host country acting as “pull” factors for investors. Each type of FDI has different impacts on trade patterns and varying socio-economic and environmental effects: • Resource-seeking FDI is motivated by the quantity and quality of agricultural and natural resources with which the host country is endowed. This type of FDI generates exports of raw materials, such as mining and foodstuffs. While this can lead to sizable government revenues and, in the case of agriculture, contractual and income-generating employment, the resulting exports are typically of relatively low ‘sophistication’. In Madagascar, resource-seeking FDI has been associated with the extraction of nickel and minerals, certain key products such as vanilla and lychees and increasingly new niche-agribusiness and seafood products. • Domestic Market-seeking FDI is motivated by the size and potential growth of the host country’s domestic market. This type of FDI does not generate exports, as investors seek to serve the domestic market, but be associated with better and cheaper availability of goods and services consumed by the population or used as inputs by other firms. Given the limited purchasing power of the Malagasy population, market- seeking FDI is not widespread, being dominated in certain services sectors such as banking, telecommunications and wholesale. • Efficiency-seeking FDI is attracted by the capacity of host countries to enable foreign firms to compete in international markets. It is the main vehicle for countries to join Global Value Chains (GVCs) and off-shoring of certain production stages to the host 44 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors country. These are greenfield FDIs that generate exports and are net job creators. This type of FDI is often seen as a means of technological leapfrogging that can lead to the creation of more productive jobs and more sophisticated exports. In Madagascar, efficiency-seeking FDI has been directed to the textile industry and more recently, to IT-BPOs. Madagascar has a good mix of FDI types, which has contributed to islands of successes and resilience in recent years. Besides, FDI in agribusinesses tend to mobilize local actors more than the traditional resource seeking investments (for example in mining), supporting producers, middlemen, transport providers, and light manufacturers along the value chain. In the case of efficiency seeking FDIs, even though some of the most successful export products have also pursued a niche strategy based on high-quality labor inputs (such as cashmere sweaters, high-quality niche within IT-BPO), as the country has low labor costs combined with preferential market access. Assuming labor costs may rise over the medium term, maintaining profitability will require skills upgrade and the development of opportunities for domestic market-seeking FDIs. 6. The selected sectors driving Madagascar’s share of the country’s total exports in the latest trade performance are experiencing ‘export year) include apparel/textiles, agribusinesses surges’ or ‘hits’, which underscore the country’s (broadly defined to comprise cash crops, competitiveness. Merchandise that experienced vegetable and animal products including export surges (defined as significant increases fishing, and food preparations), and metals/ in export growth sustained over several years, precious stones (Figure 46).⁶⁹ Madagascar beyond what can be attributed to trend, in has revealed comparative advantage in these products accounting for a relatively large products, meaning that the country exports ⁶⁹ Building on the work of Freund and Pierola (2012) and Cadot et al (2015), exports surges are characterized by: (a) a product that has experienced average export growth higher than 6 percent yearly between 2014 and 2017 (“the take-off phase”), (b) this rate is at least 30 percent higher than average export growth between 2010 and 2013 (growth acceleration), (c) export value in 2017 is in the top decile, averaged over 2015-2017 (significant size), (d) the minimum export value during 2015-2017 is at least as large as the maximum export value during 2011-2013 (stability), and (e) average growth between 2014 and 2017, excluding the strongest year of growth, is greater than average growth between 2010 and 2013 (exclusion of single-year spurts). The application of criteria (a)-(e) yields a total of 21 products that have undergone an export surge (products are aggregated in broader categories for ease of interpretation of results). Given the pronounced spike in vanilla prices starting in 2012, going from 18.4 USD per kg in that year to 425.9 USD per kg in 2017 (a more than 23-fold increase), the export surge analysis is performed with the export value of vanilla expressed in 2012 constant USD to avoid capturing a purely price-driven surge. When following this approach, vanilla is not found among the Malagasy products undergoing export surges in 2017. A caveat must also be acknowledged in the case of apparel products, as part of the observed surge in exports in that sector was associated with renewed access to U.S. markets after the reinstatement of the AGOA in December of 2014. However, most of the apparel products undergoing surges experienced positive average growth during the AGOA suspension from January 2010 to December 2014, and half of them also had positive growth between 2010 and 2013 (before the decision to reinstate the AGOA was made), which confirms evidence obtained from interviews and surveys suggesting that firms began to target new export markets during that period, and these exports have continued to grow rapidly after preferential access to the U.S. market was regained. 45 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 them more intensively than the world (Figure fabrics) and agribusiness (jams and cooked 47).⁷⁰ The three sectors with highest revealed fruit), as well as fertilizers (both mineral and comparative advantage together account for organic) and several metals.⁷¹ While IT-BPOs 73 percent of the country’s total merchandise do not yet show comparative advantage, they exports on average over the period 2014-17, are nevertheless a high growth sector, and and new “emerging champions”, products in the fastest growing services exports. Indeed, which Madagascar did not have a comparative FDIs tend to transform the export structure of advantage ten years ago but does at present, host countries and can reshape comparative have recently appeared in textiles (woven advantages in developing countries.⁷² Figure 46: Apparel and various agribusinesses Figure 47: Madagascar has a revealed are experiencing export surges (2017) comparative advantage in textiles and apparel and agribusinesses 14 140 14 35% Number of Exports Surges 12 120 12 30% Million current USD Percentage share 10 100 10 25% RCA Index 8 80 8 20% 6 60 6 15% 4 40 4 10% 2 20 2 5% 0 0 0 0% Metals/precious Agribusiness Apparel Pearls, previous Live animals and animal products Metals Textiles and apparel Vegetables Food stuffs stones, jewelry stones (and products there of) Number of products characterized by "Export Surges" within Malagasy Competitive Sectors Broad Containing Category Total Export Value in 2017 of products undergoing "export RCAI, avg. 2014-2017 surges" within Broad Containing Category % of Malagasy Total Merchandise Exports, avg. 2014-2017 Source: WB staff calculations based on mirror data from UN Source: WB staff calculations based on mirror data from UN Comtrade on WITS. Comtrade on WITS. 7. Malagasy exports have gained market to 2009, Malagasy exports were largely shares and are expanding to new destinations, destined to France and the USA, where the including towards emerging markets. Prior latter was supported by the African Growth ⁷⁰ Revealed comparative advantage indices (RCA) use the trade pattern to identify the sectors in which an economy has a comparative advantage, by comparing the country of interests’ trade profile with the world average. The RCA index is defined as the ratio of two shares. The numerator is the share of a country’s total exports of the commodity of interest in its total exports. The denominator is share of world exports of the same commodity in total world exports. The RCA index takes a value between 0 and +∞, and a country is said to have a revealed comparative advantage if the value exceeds unity. ⁷¹ The identification of products with traditional and emerging comparative advantage is based on the product space methodology developed by Hidalgo et al. (2007). ⁷² Freund and Moran, 2017, “Multinational Investors as Export Superstars: How Emerging-Market Governments Can Reshape Comparative Advantage,” Peterson Institute for International Economics (PIIE), Washington D.C. 46 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors and Opportunity Act (AGOA).⁷³ As access to agricultural, forestry and fishing exports account AGOA was interrupted from 2010 to 2014 for the largest share of direct labor value added due to political instability, firms particularly (24.1 percent), whereas food processing has the in the textiles industry, adapted to the new highest share of indirect labor value-added in environment by expanding to new export overall exports (21.3 percent).⁷⁵ Relatively high destinations such as South Africa, India contributions to export value-added generation and Japan. Exports to China, another non- are also found in textiles and apparel, as well traditional destination show continued growth as in ICT and other business services (which since the early 2000s, outpacing world exports comprises IT-BPO), but less pronounced than to the same destination. in agribusiness.⁷⁶ These sectors’ exports also embody relatively large shares of domestic 8. The selected high-performing sectors value added generated economy-wide.⁷⁷ are also characterized by significant value- Agribusiness has the highest forward linkages chain linkages with the rest of the economy, to domestic value-added generation in particularly agribusiness. The latter, which economy-wide production, contributing more includes both primary and food processing than 50 percent when considering primary activities, contributes the most to value- activities, food processing, as well as beverages added generation embedded in exports.⁷⁴ and tobacco.⁷⁸ ICT and other business services, Agribusiness exports are also important for job as well as textile and apparel both contribute creation, both directly and indirectly. Indeed, less than 5 percent each.⁷⁹ ⁷³ AGOA was enacted in 2000 with the objective of expanding U.S. trade and investment with Sub-Saharan Africa, to stimulate economic growth. AGOA allows duty-free access to the U.S. market for over 1,800 products, in addition to the more than 5,000 products that are eligible for duty-free access under the Generalized System of Preferences (GSP) program. For Madagascar, AGOA provides duty-free market access for apparel and textiles products, which are not included under the GSP program, provided adherence with the rules of origin. In Madagascar’s case, fabrics can be sourced from anywhere in the world and still qualify for duty-free treatment in the US. AGOA has been renewed several times since its inception and it is currently set to expire in 2025. ⁷⁴ According to WB EVAD data for 2011, agribusiness contributes the largest value-added to Malagasy exports, jointly accounting for 30.5 percent of domestic value-added in exports based on forward linkages (16.7 percent from agricultural, 10.8 percent from non-agricultural exploitations, and 3 percent from food processing). ⁷⁵ Based on backward linkages using 2011 data from WB LACEX database. Direct labor value added is computed as the total wages paid directly to produce a sector’s exports, whereas indirect value added is calculated as the wages paid indirectly via the production of economy-wide inputs for the sector's exports. ⁷⁶ Textiles and clothing together account for 8.2 percent of value addition to exports, whereas ICT and other business services account for 5.5 percent. ⁷⁷ Wearing apparel and textiles embody 15.1 percent of all domestic value-added that Madagascar exports, and other private services, which includes IT-BPO, embodies 11.6 percent. ⁷⁸ Based on WB EVAD data for 2011, primary and food processing activities contributes to 45.3 percent of value-added generation in economy-wide domestic production. 6.4 additional percentage points are accounted for by beverages and tobacco. ⁷⁹ ICT and other business services contribute 3.6 percent to value-added generation in economy-wide domestic production. Textiles and apparel jointly account for 2.1 percent of overall domestic production value added based on forward linkages, and 3.3 percent based on backward linkages, but these low percentages are largely explained by intra-sectoral value addition, whereas linkages with other sectors of the domestic economy are relatively low in both directions. 47 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 Figure 48: Before 2009, Malagasy exports Figure 49: Since 2009, other destination were largely destined to the EU and the US markets in Asia are gaining importance, although the EU and US still dominate CHN MDG : CAGR of Exports 2009 - 2017 (%) MDG : CAGR of Exports 2000-2008 (%) 30 60 KOR IDN 20 40 USA NLD 10 JPN GBR DEU IND ITA ZAF CHN FRA ESP 20 USA 0 DEU SGP FRA SGP -10 0 5 10 15 20 25 2 4 6 8 WLD : CAGR of Exports 2000 - 2008 (%) WLD : CAGR of Exports 2009 - 2017 (%) Madagascar's growth (2000-2008) World growth (2000-2008) Madagascar's growth (2009-2017) World growth (2009-2017) Source: WB staff calculations based on mirror data from UN Source: WB staff calculations based on mirror data from UN Comtrade on WITS. Comtrade on WITS. C. High-Performing Sectors: against foreign investors through special tax Explaining Growth and treatment, access to licenses or approvals. Leveraging Opportunities However, foreign investors are not permitted to own land, which has been overcome in 9. Madagascar has a challenging business sectors such as agribusiness through contract environment, characterized by recurring farming and the use of intermediaries who political instability and governance can source produce. Overall, the weak legal problems. The country ranked 161th out of and judicial environments, as well as the lack 190 countries in the World Bank’s 2019 Doing of transparency which are subject to political Business, behind most comparator countries corruption, are major barriers to investment. In in SADC and only ahead of Comoros (164th), fact, Madagascar ranks towards the bottom of Angola (174th), and the Democratic Republic World Bank governance indicators, including of Congo (184th) (Figure 50). Madagascar ranks in perception of corruption, government below the average of countries in SSA in each effectiveness, and rule of law. The poor area of the Doing Business index, except for environment for commercial justice has been starting a business (rank 81) and trading across particularly problematic for encouraging new borders (rank 138). It performs particularly investment, with low levels of confidence in the poorly in terms of getting electricity (185) and current system. The recent peaceful outcome construction permits (rank 183) in which the of the Presidential elections is likely to bode country is ranked in the bottom 5 per cent of well for investor sentiment, particularly since all countries assessed (Figure 51). the President has also been actively promoting Madagascar as an investment destination, 10. While Madagascar is open to foreign including from nearby Mauritius, which is home investment, in practice, the lack of a strong to many foreign investors into the country. institutional environment acts as a serious barrier. Officially there is no mandatory screening 11. High trade costs and deteriorating of foreign investment, with no discrimination logistics performance are hampering 48 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors competitiveness. High average tariffs (12.2 Improved trade facilitation and simplification percent in 2018) and the prevalence of of administrative requirements remain key elevated non-tariff barriers have resulted in priorities to boost export competitiveness stubbornly high trade costs in Madagascar, in Madagascar. However, poor domestic contrasting with trend declines among connectivity seems to account for the bulk key competitors (including Cambodia, of trade costs in the country,⁸⁰ with logistics Bangladesh, and Vietnam in the textile and performance on a downward trend over apparel sector). These high trade costs reduce the last decade.⁸¹ Policies that reduce high access to imported intermediate inputs “within the border” trade costs and improve at competitive prices, increase domestic logistics performance could generate firms’ production costs, and negatively significant opportunities to increase trade affect competitiveness in export markets. and attract new investments. Figure 50: Madagascar has a challenging Figure 51: Getting electricity and construction business climate permits are particularly challenging Ease of Doing Business ranking, 2019 (best = 1) Doing Business Classification in Madagascar, 2019 (best = 1) 180 160 Starting a Business (81) 140 200 Construction Permits Resolving Insolvency 120 (183) (136) 150 100 100 Enforcing Contracts Getting Electricity 80 50 (85) (150) 60 0 40 Trading across Registering Property 20 Borders (138) (162) 0 Paying Taxes (132) Getting Credit (124) Mauritius Malaysia Rwanda Indonesia Kenya Nepal Uganda Mozambique Cambodia Tanzania Mali Ethiopia Burundi Chad Côte d'Ivoire Senegal Niger Burkina Faso Zimbabwe Madagascar Comoros Cameroon Protecting Minority Investors (99) Madagascar Sub-saharan Africa Source: Doing Business 2019. Source: Doing Business 2019. 12. Despite binding constraints to trade, to the US through AGOA, and to the European certain exports continue to grow and perform Union market through the Cotonou agreement well, in part supported by preferential trade and the Economic Partnership Agreement agreements and other policies. In the 2000s, since 2007. These policy initiatives encouraged the government actively sought to promote an initial wave of investors to Madagascar, exports by creating Export Processing Zones, who in many instances continued to operate to attract foreign investors. Furthermore, despite the challenges related to the business Madagascar benefits from preferential access environment and the suspension of AGOA, ⁸⁰ Ali and Milner (2016). ⁸¹ Most components of the Logistics Performance Index (LPI) worsened with several components (customs performance, infrastructure, and international shipments) dropping more than ten spots in rankings between 2007 and 2018. Only two of the main components, logistics competence and the ability to track and trace consignments, improved over this period. 49 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 since they have long-term investments in of market differentiations, with a high the country.⁸² However, the importance of potential for territorial inclusiveness and the incentives pales compared with other aspects development of contract farming; such as the of the country’s competitiveness such as case of cacao, special honeys, and essential the availability of affordable labor, unique oils, (iii) Other niche-high quality exports such agriculture products, and fast internet speed. as crustaceans and exotic tropical fruits, which are based in specific regions and require 13. To distill the opportunities for further specialized logistics related to the cold leveraging growth from high-performing chain; and (iv) Emerging domestic market sectors, the following section will present oriented agribusiness, such as poultry, beef the results of a deep-dive analysis of the and domestic rice, which are relatively more three selected sectors. The results are based contestable and therefore open to investors. on a survey that was administered amongst domestic and foreign firms to understand the 15. The main driver for agribusiness investors motivations behind investment, how linkages is Madagascar’s unique agriculture resources, could be fostered, the types of jobs that are high-quality branding, and competitive currently being created and how employment costs. Malagasy products, particularly in the and value added generation can be further premium market segment, such as vanilla, supported.⁸³ The results of the survey were cocoa and certain types of exotic honeys, are validated through focus group discussions, part of the country’s unique value proposition where policy recommendations were and crucial for attracting resource-seeking discussed with both private and public sectors. FDI. The availability of distinctive agricultural inputs and competitive labor costs have (i) Focus Sector: Agribusiness allowed sufficiently high margins in these markets to cover for challenging business 14. Madagascar’s agribusiness sector is conditions, deficient infrastructures, and diverse and has developed around key poor governance. Firms have exploited the niche markets. Four different sub-sectors potential from these products by developing of agribusiness have been identified, each a high-quality marketing strategy, supported with its own dynamics: (i) “Traditional” by labelling such as “organic,” ISO certification, agribusiness with significant levels of “fair trade” and denomination of origin quality resilience and potential, but with high degree label such as the classification as 100 percent of concentration and risks of cartelization; fine cocoa for Madagascar exports, which has that is the case of the vanilla and lychees been the first agricultural product of Africa to sectors; (ii) “New” high value agribusiness be granted denomination or origin recognition niches using Madagascar-origin as a source since 2016 (see Box 2). ⁸² Consultations with business leaders undertaken for the Madagascar CEM in May 2019. ⁸³ Findings based on survey administered amongst 24 IT-BPO companies (out of 37 reachable companies) 22 textiles firms (out of 55 reachable companies) and 22 agribusiness firms out of 47 reachable companies. The survey was based on a methodology used by Farole and Winkler for the book ‘Making FDI work for SSA,’ World Bank. 50 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors Figure 52: FDI has been attracted by the Figure 53: But further growth is limited by availability of Madagascar’s unique inputs poor access to electricity and governance constraints Percent of firms citing factor as reason to begin operation in Madagascar Obstacles to firm’s development, % of firms affected Access to local skills 9% Competition from informal sector 27% Work environment 14% Low levels of skills 27% Reduced labor costs 14% Transport 32% Preferential access to export markets 18% Political instability 32% Access to fiscal incentives 18% Physical insecurity 32% Access to land 27% Corruption 36% Access to inputs 73% Electricity 36% 0% 50% 100% 0% 10% 20% 30% 40% Source: Deep-dive surveys. Source: Deep-dive surveys. 16. The continued expansion of the develops. The agribusiness sector has the agribusiness sector has the potential to potential to develop in a number of regions support inclusive growth largely through depending on specific endowments and job creation. Over the period 2014-18, formal climate conditions and can therefore help employment generation in the agribusiness reinforce territorial cohesion. Planned sector increased by 17 percent.⁸⁴ Firms infrastructure improvements, including to benefiting from FDI have more than double Fort Dauphin which also has a port in the the number of employees as non-FDI firms, south-east of the country (see chapter 2), both permanent and seasonal. However, could open new agribusiness corridors income and margins of smallholder famers including sugarcane, livestock (which has are compressed by low productivity, poor already started to develop in the south of logistics, limited access to finance and Madagascar) and pepper. The potential for fertilizers, and high margins of intermediaries further investment in these sectors, which (see chapter 5). When foreign investors are have high levels of market contestability, allowed to enter markets, they can help could make inroads in developing lagging overcome these constraints and contribute regions (including the south-east) and offer to improved practices, labor standards, and employment opportunities of higher value for quality controls in some cases.⁸⁵ the rural population. 17. Agribusiness can also support the 18. Agribusinesses are also important for development of regions that are lagging, creating linkages within the domestic particularly as planned infrastructure economy. Both domestic and foreign-owned ⁸⁴ Compound annual growth rate of job creation based on data from CNaPs, the private pension body. ⁸⁵ Close to 60 percent of agribusiness firms surveyed received a technical audit from a client and over 40 percent received requests to make subsequent improvements. 51 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 agribusinesses help to develop backward there is a preference for in-house training linkages, for example through the purchase activities. Another challenge is the difficulty of seeds, fertilizers, chemicals and other of responding to stringent health, security, inputs. Because many rural farmers do not environmental or social norms for niche have their own transport means, someone exports to high-end markets. To address this must deliver advanced inputs, and go and challenge, firms are seeking to increase their pick up their produce. The presence of own production or source directly from local agribusinesses, especially those that are producers, instead of using intermediaries, input suppliers, i.e. collectors, processors which could contribute to higher incomes and and exporters, has been shown to stimulate margins for producers. agricultural production more broadly (Iimi et al. (2017). Moreover, the rise in domestic 20. Common challenges experienced by demand is supporting the creation of forward agribusinesses include access to land linkages and indirect job creation. Over two- (particularly for new entrants) and physical thirds of domestic Malagasy firms already capital. Since foreign ownership of land is sell in both the domestic and export market, prohibited, investors engaged in agribusiness using a variety of distribution channels such as are pursuing contract farming. However, retailers, wholesalers and supermarkets. With successful contract farming depends on the economy under expansion, and urban contractual procedures related to land demand for good quality produce increasing, leasing being followed. In the absence there has been a rising number of international of appropriate governance procedures, and domestic supermarket stores opening in new investors usually work with local Madagascar, as another example of market- intermediaries, which can raise the cost of seeking FDI. Firms currently benefiting from doing business. New market entrants also FDI are pursuing export-oriented strategy face challenges related to the organization (applies to close to 75 percent of firms), but of the supply chain. Agribusiness firms also this could gradually change over time. report common challenges to doing business related to physical infrastructure and are 19. Key constraints to further developing willing to use the “ristournes” system to agribusinesses include the capacity of earmark funding for local infrastructure.⁸⁷ local producers and the ability to meet quality control standards. The largest 21. The way a value chain is organized can obstacle to local sourcing is the capacity present both opportunities and constraints, of local producers, to which agrobusiness depending on the niche market. In certain firms respond to by providing financial and cases, the organization of firms operating in a technical assistance, inputs and equipment.⁸⁶ particular supply chain as private associations The lack of well-designed training facilities with public interest has facilitated coordinated for agricultural workers exacerbates the engagement with both suppliers and challenge of low productive capacity, where importers, while improving their branding. ⁸⁶ A similar finding in Limi, Atsushi; You, Liangzhi; Wood-Sichra, Ulrike. 2018. Crop production, transport infrastructure, and agrobusiness nexus: evidence from Madagascar (English). Policy Research working paper; no. WPS 8486. Washington, D.C.: World Bank Group. ⁸⁷ Ristournes are levies collected by municipalities on selected products for the domestic market and exports, including agricultural produce 52 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors For instance, the creation of consortium of agribusinesses may be excluded (see the case stakeholders in the cocoa value chain and of lychees in chapter 5). Therefore, the creation subsequent increase in the share of cocoa of private associations which could promote production meeting international quality collective quality control, marketing, R&D and standards led to a surge in exports and technical support for small farmers may offer foreign investments in the sector in recent great opportunities but should also be carefully years. However, there is a risk that qualified monitored to avoid risks of cartelization. Box 2: Good practice in agribusiness: the Consortium of Cocoa Actors In the past, the cocoa value chain presented several weaknesses, including ageing orchards, low yields, multiplication of inefficient varieties, and a lack of coordination of key value chain players. With the aim of better structuring the sector, the government, private sector and financial and technical partners started coming together in 2015 within the framework of a public-private dialogue. This resulted in the creation of the Consortium of Cocoa Actors (GACM) in April 2015, which comprised producers, chocolate makers and operators/exporters. Madagascar also joined the International Cocoa Organization (ICCO) in 2016. Shortly after, its production was labeled 100 percent fine cocoa. Since then, with support from the World Bank-financed Integrated Growth Poles and Corridor project, several activities have been undertaken to improve quality, traceability and standards for sustainability in the sector. Around 5,000 producers and 200 cocoa preparators have received training and support, a modern facility has been developed in Ambanja, the capital of cocoa, to produce certified plants, while R&D activities have been coordinated between the private and public sectors to improve quality and productivity. Between 2015 and 2018, export volume increased by almost 60 percent to reach nearly 12,000MT, with more than 90 percent of the production meeting international standards (from 14 percent in 2014). National standards - more stringent than international ones -have been established and an independent analysis and control center for export products was also established in Ambanja. The sector is attracting new investments in cocoa processing units and the country is currently presiding the ICCO. The National Cocoa Plan validated in 2018 is now guiding all activities targeting value chain sustainability. For several other high-value products such as vanilla, lychee, spices, cloves or essential oils, similar initiatives to structure production value chains and develop tight quality controls could also have positive effects in terms of market openings, export volumes, and opportunities to raise income and profitability for smallholder farmers. However, in contrast to the geographically concentrated production of Cocoa, many of these other export-oriented value chains have plantations spread throughout the country, complicating dialogue between stakeholders and the identification of common priorities. For instance, lychee or spice producers can face different agronomic conditions, logistic challenges, and market opportunities across various regions. An additional complication in the lychee value chain is the fact that harvests last at most two weeks for export markets. Cash-constrained 53 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 and poorly equipped producers have no other option than selling their products as quickly as possible to avoid rots, reducing their bargaining power and limiting their role in value chains. Common initiatives could be taken to improve production processes, overcome export limitations, and increase the bargaining power of smallholder producers. The public sector can also help unleashing the potential of high-value export markets in the agribusiness. In addition to its prerogatives in industry regulation, the public sector can support the private sector through investments in public and semi-public goods, including R&D or agrologistics, that meet the upstream and downstream needs of these markets. Source: World Bank staff 22. Looking ahead, there may be opportunities dry beans, and high-value seafood such as to attract resource-seeking FDI to develop lobster and prawns, providing other avenues agribusiness products of higher value within for enhanced regional integration.⁸⁸ Madagascar and increase trade within the region. For products such as essential oils and (ii) Focus Sector: Textiles and Apparel juices, the first stage of product transformation is done in Madagascar (for example fruit 23. The Malagasy textiles and apparel sector to puree), which is then often exported to has different niches. Madagascar has a niche in be transformed outside of Madagascar. exporting high-value apparel such as cashmere Transforming these products domestically and wool knitted garments. Smaller niche would enable greater profit retention in the sectors are also developing in the fast-fashion country but would require changes to the sector, encouraging new efficiency-seeking distribution value chain, which is unlikely to FDI from Mauritius. The competitive edge of happen over the short-term. Under current the latter relies on just-on-time competitive market conditions, firms that supply the delivery of branded garments to wholesalers domestic market with processed goods are and retailers managing low inventories, as more likely to grow their operations and well as low labor costs. They are interested expand to other products. The emergence of in agglomeration in industrial parks where products such as special honeys which are predictability of operation of the value chain currently exported to Mauritius for marketing can be ensured. and branding, and then sold to other high- end markets also offers growth potential. 24. Madagascar’s textile and apparel Other Malagasy exports that could serve industry is well-integrated in global value the markets of Mauritius and the Seychelles chains (GVCs).⁸⁹ Indeed, Madagascar has one include pulses such as pigeon peas and of the highest levels of participation in GVCs ⁸⁸ Mauritius: Strengthening Regional Agriculture Imports of Mauritius and Seychelles from APEI Countries, draft report, World Bank, 2019 ⁸⁹ Participation in a GVC means that a country, sector, or firm produces (at least) one stage in a global value chain. Madagascar’s participation is both backward (meaning that inputs from other countries are imported to produce goods and services) and forward (through exports to other countries). 54 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors in SSA, comparable to those of Indonesia and percent of demand in Germany (its main India.⁹⁰ For example, Madagascar accounts destination market). This participation in GVCs for almost 15 percent of global imports is encouraging as it contributes to income of cashmere wool, which sources almost generation, and related spillovers in the entirely from China, while its production of domestic market, but still falls significantly cashmere knitted garments meet around short of aspirational peers in Asia such as 5 percent of global demand, and up to 25 Nepal and Malaysia.⁹¹ Figure 54: Madagascar has one of the highest levels of participation in global value chain exports compared with SSA, but performance falls behind aspirational peers in Asia⁹² 60% 12,000 50% 10,000 Per Capita GDP 8,000 GVC exports 40% 30% 6,000 20% 4,000 10% 2,000 0% 0 Mozambique Uganda Niger Zimbabwe Mali Rwanda Ethiopia Burundi Indonesia India Comoros Burkina Faso Cameroon Madagascar Nepal Malaysia GVC Exports as a share of Total Exports (2017) Per Capita GDP in current USD (2017) Source: WB staff calculations based on MC-GVC database on WITS 25. The textiles and apparel sector has less important, compared with other factors attracted efficiency-seeking FDI, reflecting such as the availability of affordable labor and the country’s key competitive advantages preferential access to markets. The recent such as the availability of affordable labor political stability is encouraging new investors and access to preferential markets. Over to consider Madagascar as an investment time, the fiscal incentives offered through destination. For example, Mauritian textiles the Export Processing Zones have become and apparel firms are increasingly investing in ⁹⁰ With GVC exports accounting for only 5.3 percent of total regional exports in 2017, Sub-Saharan Africa is the world region with the lowest integration into global value chains, even without excluding high-income countries (South Africa accounted for 78% of the region’s total GVC exports in the same year). ⁹¹ World Development Report 2020, Global Value Chains: Trading for Development, World Bank. ⁹² The source dataset (WB MC-GVC) covers four “classic” or “archetypal” GVCs which are characterized by a lead-firm network structure and have been much studied: apparel/textile, footwear, electronics and motor vehicles (Ferrantino and Schmidt, 2018). Since the underlying data source is UN Comtrade merchandise trade statistics, country coverage is very good, especially among developing countries. The similarities and differences in the organization of these four distinct GVCs are a useful entry point into an understanding of GVC trade and been used to analyze the response of developing-country GVC participants in the crisis of 2008-2009 (Cattaneo, Gereffi, and Staritz 2010). The share of total global merchandise exports accounted for by these four GVCs has fluctuated between around 14 percent and 36 percent since 1990, with the weight of classic GVC trade in total merchandise trade tending to be higher when the price of oil is low, and vice versa. 55 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 the ‘fast fashion’ niche where the availability of intermediaries bundle large orders from global affordable labor is a strong incentive. A strong buyers and then source them from Madagascar relationship already exists between Malagasy among other countries, thus linking smaller and and Mauritian textile and apparel firms, whereby often domestically owned firms to GVCs. Figure 55: Sources of comparative strength Figure 56: However, further growth is in the textiles sector include reduced labor limited by political instability and high costs and access to preferential markets electricity costs Percent of firms citing each factor as comparative Obstacles to firm’s development, % of firms affected strength Other reduced costs 9% Road infrastructure 23% Access to inputs 14% Work regulations 23% Access to land 23% Commercial and customs 23% regulations Access to fiscal incentives 23% Physical insecurity 36% Work environment 27% Corruption 36% Preferential access to export markets 41% Electricity costs 45% Reduced labor costs 64% Political instability 45% 0% 10% 20% 30% 40% 50% 60% 0% 10% 20% 30% 40% 50% Source: Deep dive survey results Source: Deep dive survey results 26. The textiles and apparel sector related to the availability of social services and is important for the creation of jobs, the possibility of unionization of employees. On particularly for females. On average, an the other hand, other investors, for example estimated 70 percent of the workforce is those who are currently based in Mauritius made up of female recruits. Therefore, from an would welcome the possibility of investing in a inclusion angle, the textiles and apparel sector new special economic zone, if concerns related is an important creator of female employment, to political instability are addressed and there with opportunities opening up in other parts of are improvements to transport logistics, such the country. Plans are underway to develop a as more competitively priced air cargo fees, second industrial zone in Moramanga,⁹³ which which is an important means of transportation could help foster employment opportunities and seen as a feasible alternative to shipping. outside of the current zones (in the capital and Addressing infrastructure gaps, improving Antsirabe). However. there is resistance from investment protection and governance would certain incumbent firms to group together help reduce the need for ad hoc tax incentives in special economic zones due to concerns to attract foreign investors. ⁹³ The government las recently approved a Special Economic Zone law to support a new Textile City project, to be located on the future highway connecting Antananarivo and the Toamasina port. The site is planned to be built on an area of 100 to 600 hectares and able to accommodate more than 100 production plants in a totally integrated zone that will offer all logistic administrative customs, banks, a single window for investors, as well as residential and commercial infrastructure. It is expected that the electrical connectivity will be good as the energy source is just close to this area. 56 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors 27. The integration of Madagascar’s textiles for higher-value products and managerial and apparel sector in GVCs has encouraged positions. While local training centers do suppliers to demand higher standards, exist, there is a mismatch between the which has positive spillover effects in the curriculum content and sector demands, domestic economy. More than half of all with most firms preferring to provide training firms received an audit from a client firm, with in house. In addition, an overall constraint is requests to make improvements related to related to trade and transport infrastructure product quality, labor standards, timing and and logistics, for example at the port, related volume of production. In turn, nearly a third to air transportation, customs and trade of foreign-owned firms provide assistance to facilitation. Finally, with destinations such as Malagasy firms through technical support to China and Mauritius continuing to grow, there enhance quality as well as financial support. is significant scope for Madagascar to meet In general, foreign-owned firms work well the demands from the textiles and apparel with Malagasy firms, where motivations for industry, in light of its competitive advantage collaboration include undertaking research in affordable labor. and development activities jointly. Backward linkages have been developed with firms (iii) Focus Sector: IT-BPO specializing in packaging but otherwise there is limited use of inputs from domestic 29. Over the last decade, a robust IT-BPO suppliers. Looking ahead, the creation of the sector has emerged. While IT-BPO activities textiles industrial park could foster forward are to a large extent focused on lower value- linkages through the development of public added services such as call centers and back- services and infrastructure. office activities, in recent years a small higher value-added niche focused on IT, software 28. Overall firms in the textiles and development and artificial intelligence has apparel sector have a positive view for started to develop, with well-qualified local the development of the sector, including software developers.⁹⁴ Activities in the IT- developing products of higher value added, BPO sector are largely oriented towards the if certain key constraints could be lifted. The export of service sales, where France is the most important deterrent for foreign investors main destination, capturing 75 percent of in textiles and apparel is related to poor firms’ sales, followed by the US, Switzerland, governance and infrastructure. Challenges and Belgium. The organization of the sector is related to electricity services provision, being consolidated through the establishment including high costs and poor reliability of an industry association, where collaboration are also key constraints. Many firms are efforts include obtaining better input prices developing local solutions to these challenges and conducting joint training for employees. including the installation of standalone solar panel systems, where there is scope to work 30. Madagascar’s IT-BPO sector continues with the national utilities company, JIRAMA, to attract efficiency-seeking FDI, reflecting to develop storage solutions and sell excess the country’s unique value proposition. energy back to the grid. A further challenge Investments in the sector are being driven is related to skills development, particularly by the low cost of labor in combination with ⁹⁴ Digital Moonshot, World Bank, forthcoming, 2019 57 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 fast broadband internet availability, a French sector on the continent, the country has a unique speaking population perceived as having a value proposition due to comparatively low clear accent, and a convenient time zone for labor costs and fast broadband speed, making the operation of call centers servicing the the sector not only fast growing but also more Francophone market in Europe.⁹⁵ Although competitive compared with other francophone Madagascar does not have the largest IT-BPO countries such as Morocco, Tunisia and Senegal. Figure 57: FDI has been attracted by the Figure 58: But further growth is limited by availability of affordable labor and access high costs and labor with the right expertise to broadband Key constraints to further growth, % of firms affected Key reasons for investing in Madagascar, % of firms Ease of doing business 17% citing each factor as attraction Average commute for workers 21% Follow our competitors 8% Telecommunications services Other reduced costs 29% 13% and costs Access to fiscal incentives 21% Access to urban transport 33% Access to competences 25% Electricity costs 38% Access to a pool of labor fluent in French 38% Availability of competences 58% Access to a broadband connection 46% Internet costs 75% Reduced labor costs 54% 0% 20% 40% 60% 80% Source: WB estimates based on deep-dive survey results Source: WB estimates based on deep-dive survey results 31. The expansion of the IT-BPO sector based at home, offering greater flexibility, which continues to offer opportunities to support is also encouraging new female recruits.⁹⁷ inclusive growth, through employment Industry leaders have started expansion of generation (including for female workers activities, particularly call centers, outside and the youth) and expansion in areas outside of Antananarivo in areas such as Tamatave, of the capital. Over the period 2014-18, jobs Morandava and Diego, where benefits include increased by 11.4 percent in the IT-BPO sector.⁹⁶ reduced overheads and improved logistics for Female workers occupy close to 50 percent employees. However, the further development of entry level jobs and nearly 40 percent of of regional call centers would depend on the management positions. Furthermore, the successful expansion of internet connectivity sector is expanding to allow individuals to be throughout the country. ⁹⁵ According to the EDBM, 200 IT-BPO companies were created in Madagascar between the period of 2005-2017. A growth spurt is observed since 2010, coinciding with the arrival of fiber optic cables connecting the Island to fast broadband, where Madagascar has both the East African Submarine System (EASSy), an undersea fiber optic cable that stretches from Sudan to South Africa and the Lower Indian Ocean Network (LION). ⁹⁶ Compound Annual Growth Rate using data obtained from CNaPS. ⁹⁷ Interviews with the IT-BPOs business leaders indicated that they view the flexible, home-based work as an area of further growth. Individuals would be hired on a consultancy basis and will be provided with a data stick to work from home. 58 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors 32.While the activities of the IT-BPO sector are negligible. In the higher value-added segment, oriented towards external markets, linkages there is an increasing risk of “brain drain,” to with domestic firms are evident, and client countries such as France⁹⁸ and Canada. Across relationships are contributing to capability both niches, there are challenges in filling building and upgrading. In addition to the use managerial positions, mainly related to a lack of internet services provided by Malagasy firms, of competencies. While training facilities do two-thirds of firms report using other goods exist, these are used by only an estimated 20 and services acquired from Malagasy suppliers, percent of firms, largely because the curricula such as equipment and machinery, business do not reflect the needs of the job market, with services, and technical services amongst a preference to undertake internal training. As others. These linkages have developed due the IT-BPO industry body strengthens, joint to the quality of products and their proximity training activities are increasing (currently allowing firms to establish a better relationship close to 40 percent of firms, which is set to with their supplier. There are emerging grow). Based on an emerging talent pool in knowledge transfers and spillover effects Madagascar, industry leaders expressed that through working with local suppliers, through further skills development, for which they are for example providing quality assurance or willing to contribute, should help to support training of workers. Furthermore, close to 60 the diversification of the sector into other percent of firms have been requested by the niches, such as Artificial Intelligence and firm that has outsourced its services (the Client) applications development. to make improvements, such as investments in new equipment or technology, improving 34. Constraints related to physical capital, product quality, and training employees, with including fast but expensive internet and nearly 40 percent of firms receiving assistance unreliable electricity also affect growth for this upgrading. prospects. While Madagascar has a fast download speed, featuring amongst the 33. While there is great potential for further global top-25, costs are still relatively high growth in the sector, particularly in the higher- compared with competitors such as Morocco end value market, a lack of available and and Mauritius. The poor quality of electricity relevant skills is a key constraint. In the call service provision means that alternative center segment, there are concerns related sources of energy need to be in place, such to the deterioration of the French speaking as generators. Maintaining quality services has capacity of the newer generations, which resulted in firms paying multiple operators for is the result of low pedagogical capacity of both broadband and electricity services, which teachers associated with a poor approach increases costs (see chapter 5 for a discussion for the introduction of French language of competition in the telecommunications in classrooms. The risks of automation sector). Addressing these constraints is critical replacing core business activities in the for expansion of the sector, and particularly so call center segment were considered as in cities outside of the capital. ⁹⁸ For example, there is a new French tech Visa that fast-tracks the recruitment of international digital talent for French companies, which holds regular recruitment initiatives in Madagascar. 59 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 D. Lessons Learned and Policy presence and distribution channels). Policies Recommendations geared toward improving consistency and dependability through the development of 35. The business value proposition of the skills, strategic infrastructure, such as the cold “bright spots” is strong enough to offset chain and signaling capacity, such as quality domestic constraints. Most of the success compliance accreditation, could help attract FDI stories are found in export products that are to other sectors with latent potential and expand of premium quality and/or niche in terms of possible exposure to critical factors of success. market penetration strategy, thus avoiding engaging in direct competition with leading 38. Policies that could help release the world players and overcoming the virtual untapped potential from high-performing non-existence of a domestic market for these sectors would also benefit the rest of the products/services to serve as an anchor. If economy. Key policy priorities include progress existing constraints could be lifted or reduced, in trade and investment facilitation, measures the threshold for profitability would become to improve dispute resolution mechanisms, lower thus enabling more activities willing connectivity, access to skills and energy. to pursue a similar strategy to emerge, as well as higher growth to expand the current • Ambitious trade and investment successful niches. Measures encouraging the facilitation package. Trade facilitation development of an incipient domestic market solutions need to be enhanced through for some of these products would also help greater transparency of non-tariff barriers, support their development. streamlined procedures for investors, and a comprehensive review of existing tax 36. The adaptability of exporting firms and and regulatory incentives. As a first step, historical relations with destination markets the existing Trade Facilitation Agreement were key factors of success. The adaptability should be fully enforced, and the role of of firms operating in the “bright spots” is National Trade Facilitation Committee evidenced by the textiles sector response to should be strengthened. Over time, the suspension of AGOA in 2010-14 and by the coordination of government agencies capacity to seize market opportunities as operating at the border should be they emerge (IT-BPO, fast fashion and some reinforced and fees and charges should agribusiness such as cocoa and honey). be consolidated and reduced. The Longtime established relationships with foreign investment promotion agency EBDM could investors and markets arising from geography, help identify and eliminate discriminatory historical events and cultural links also appear requirements and streamline procedures as a key factor in all successful sectors. for investors, including visas and expatriate work permits. This agency can also help 37. Foreign investors in “bright spots” brought develop aftercare and linkages programs capital, but also know-how and market to fully leverage positive externalities from access. Common factors that contributed to FDI. In order to better leverage existing success stories were the benefit of foreign free trade agreements and the benefit of direct investments, not only in terms of physical the upcoming African Continental Free capital and technological improvements, but Trade Agreement, private sector advisors also know-how (both technical and marketing) could provide counsel the government on and links with destination markets (established trade and investment policies. 60 3 | Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors • Improved business climate and dispute means of dispute resolution could be resolution. The predictability of the important first steps (see Box 3). The business environment for private investors establishment of a Systemic Investment could be improved through strengthening Response Mechanism (SIRM) with direct the commercial justice system (including links to the Prime Minister’s office could through reducing costs related to judicial be another important initiative. Over fees) and ensuring that final awards can in the long run, the justice system and its practice be swiftly enforced. Encouraging administration will need to be reformed arbitration mechanisms and alternative and modernized. Box 3: Boosting Investor confidence through Alternative Means of Dispute Resolution (ADR) As strengthening the Court System may be a long-term endeavor, given the importance that improving investors’ confidence entails for development, many countries have opted to promote Alternative Dispute Resolution (ADR) mechanisms, which may be deployed to address this challenge in shorter time frames. Countries have enacted legislation enabling the use of ADR techniques to resolve disputes arising not only among private subjects but also between private investors and public authorities. ADR techniques include arbitration, mediation, early neutral evaluation and fact finding among others. A key point is that in the case of arbitration, for this ADR to be effective, it is critical that the arbitration decision is final, without appeal before domestic courts. Further, to ensure the use of ADR, many countries set up diffusion and capacity building programs to make private and public sector users alike become familiar with these types of procedures, as often they are not well known in many countries. Another alternative to foster investors’ confidence, beyond using arbitration and other legal means, has been to establish informal conflict management systems, that can enable governments to identify, track, and manage grievances arising between investors and public agencies as early as possible, well before the aggrieved investor considers or even submits a legal claim. An early warning and tracking mechanism to identify and resolve complaints and issues that arise from government conduct could help fill this gap, ultimately preventing legal disputes and facilitating harmonious relations between investors and governments. This mechanism, called a Systemic Investor Response Mechanism (SIRM) and initiated by the WBG, enables countries to collect data and helps identify patterns in government-generated grievances affecting investments. Furthermore, SIRM quantifies investment retained or expanded as a consequence of addressing grievances, as well as investment lost as a consequence of not addressing them. SIRMs have been already been recommended as part of the G20 Compact with Africa and have been successfully piloted in many countries, and Madagascar could one another one where this tool could be deployed. 61 Leveraging Trade and Investment in Madagascar – A Deep-Dive into Three High-Performing Sectors | 3 • Better connectivity. Road transport chains is limited. This represents a missed should be enhanced, as currently planned, opportunity to scale up skills availability in order to improve connectivity between with positive spillover effects for other populated rural areas, major urban areas, actors in the sector and at economy-wide and ports (see Chapter 2). Given that level. This justifies effective public policies the road to Fort Dauphin will soon be to support vocational training. To respond constructed, efforts could already start to market demands, curricula in vocational to negotiate access to its port, which centers should be developed by, or in could accommodate larger cargo ships collaboration with, the private sector. and is closer to major shipping lanes than Tamatave. Reforms to air connectivity • Enhanced access to affordable and have started through the Open Skies reliable energy. Beyond plans to reform Policy, which will be revisited in 2020, the energy sector and increase power and could consider reducing air cargo generation capabilities (see chapter 2), fees.⁹⁹ An overhaul of the domestic approving a new regulatory framework market segment, for example through to support off-grid renewable energy the rationalization of security procedures generation and storage by the private and equipment of air caravans would sector could be a quick win.¹⁰⁰ This support the transportation of goods, measure could potentially alleviate and there would be positive spillovers supply constraints and further encourage to the tourism industry. This should go the private sector to invest in alternative hand in hand with increased competition means of energy supply, including solar. in the jet fuel market (see Chapter 5). Finally, constraints related to high • Better organized value chains. Regulatory internet costs could be addressed measures could be taken to institutionalize through encouraging competition and private associations of public interest incentivizing investments in connectivity, between small producers in order including for rural areas (see in chapter 5). to foster quality enhancement, R&D, training, and global market positioning. • Better alignment of skills’ supply and The recently established Consortium demand. Improved provision of basic of Cocoa actors is a good example of education and vocational training is successful coordination. For other high- considered by the private sector to be value agribusinesses, such as lychee and one the most important priorities to vanilla, a denomination of origin could help boost both external competitiveness increase market opportunities, if labels and domestic growth opportunities in are credibly managed and enforced. At Madagascar. Regarding basic education, the same time, risks of cartelization need improved teacher qualification, selection, to be addressed, enforcing market rules and promotion criteria are particularly to promote competitive neutrality and important. Regarding vocational training, ensuring balanced relationships between firms invest individually but coordination at producers, collectors, and exporters (See sector-wide level or vertically along value Chapter 5 on the lychee example). ⁹⁹ This reform was included in the Diagnostic Trade Integration Study (DTIS), 2016. ¹⁰⁰ Such a measure would have to follow the PPP framework for Independent Power Producers, as indicated in the DTIS. 62 Seizing the opportunities for inclusive agriculture growth 63 Seizing the opportunities for inclusive agriculture growth | 4 While selected cash crops perform well for export markets, the production of staple crops, particularly rice, for the domestic market has failed to meet local demand. The efficiency of rice value chains is compromised by farmers’ remoteness, which contributes to the existence of numerous intermediaries, as well as high transport costs from the farm area to a main road. Improving the competitiveness of the rice value chain requires: (i) investing rural connectivity; (ii) increasing access to information on price and demand for produce; (iii) promoting commercialization of the warehouse receipt system; (iv) encouraging farmers to adopt collective behaviors; (v) investing in regional rice mills; and (vi) reversing the ban on rice exports. A. Introduction 2. This chapter explores the constraints to competitiveness in the rice value chain. The 1. The agriculture sector, dominated chapter focuses on rice, since this crop is the by subsistence activities, supports the focus of government policy¹⁰⁴ and dominates livelihoods of an estimated 75 percent of domestic production and consumption. the population. While Madagascar is a large Addressing the constraints in the rice value exporter of various high-value agriculture chain would also benefit other staple crops commodities,¹⁰¹ most rural households such as maize, soybeans, and various bulk are engaged in low-income subsistence commodities that are traded through similar production with household food security collector networks as rice and are important being a consistent concern. Poverty is to the growth of livestock production and concentrated in rural areas, where 85 percent food processing. The analysis is structured of the rural population are poor, compared according to how the value chain is built up: with 40 percent in urban areas.¹⁰² Rice is the (i) crop production; (ii) crop marketing and main staple food, but production has not kept storage; and (iii) transport and processing. pace with population growth. Nationwide, There is then a discussion of trade policies and only about 20 percent of the rice grown in the role of market information. The analysis in Madagascar is marketed for cash and, even in this chapter is based on a survey of available Toamasina, the “rice granary,” just 15 percent of literature and fieldwork that was conducted rice is marketed commercially.¹⁰³ This situation in March 2019 in the central highlands around is leading to rising food imports and declining Vakinankaratra and Itasy which are large rice- levels of national food self-sufficiency. growing areas.¹⁰⁵ ¹⁰¹ For example, bourbon vanilla, cloves, lychee, spices, gourmet honey, fresh vegetables, farmed prawns, dried beans and other shelled legumes, which are discussed in-depth in chapter 3. Between 2012 and 2017, agribusinesses accounted for 38 percent of merchandise export, with an annual average value of US$982.3 million. ¹⁰² Calculations estimated using the international poverty line using the 2012 poverty line. ¹⁰³ INSTAT, 2013 ¹⁰⁴ NDR, 2016; Ministry of Agriculture and Livestock, and Fisheries, 2017 ¹⁰⁵ Meetings were held with public institutions, technical and financial partners, large and small commodity collectors, individual smallholder farmers, and groups of smallholder farmers. Additionally, primary data on transport costs were collected through a survey of vehicle operators along four major corridors that are important to rice and other major commodities: Alaotra-Antananarivo, Alaotra-Toamasina, Itasy-Antananarivo, and Mahajanga-Maroavoay-Antananarivo. 64 4 | Seizing the opportunities for inclusive agriculture growth B. Crop Production higher-yield system. Despite long-standing efforts to promote the System of Intensive 3. There are many well-known opportunities Rice Cultivation (SRI) in Madagascar,¹⁰⁸ such to improve crop yields through production practices cover barely 0.2 percent of irrigated techniques. The National Center for Applied land, compared with widespread use in over Research in Rural Development (FOFIFA/ 50 other rice-producing countries.¹⁰⁹ Farmers CENRADERU), for instance, has shown that the who had been introduced to SRI practices adoption of improved seeds could enhance through development projects later switched rice yields from two to four tons per hectare back to conventional techniques when the for irrigated rice and from one to three tons project came to an end because of the high per hectare for upland rice.¹⁰⁶ Recent analysis costs of the SRI system and uncertain market suggests that agricultural growth can be prospects for surplus rice.¹¹⁰ As shown in enhanced through: (i) greater use of improved Table 4, the SRI and irrigated methods of rice inputs, including fertilizers; (ii) improving land production are the most profitable, but also tenure security to increase incentives for require significantly more cash expenditure agricultural investment and access to credit; than low-intensity rice. Moreover, estimates of and (iii) fostering linkages between agricultural household consumption needs indicate that production and nutrition to improve the health farmers can rely on the low-intensity upland status and productivity of agricultural labor.¹⁰⁷ rice which is the least expensive system.¹¹¹ Therefore, SRI practices will only be attractive 4. However, farmers face a lack of market if farmers can be sure to sell their surplus at certainty that rice surplus can be sold at an adequate price to cover costs and the risk a remunerative price to justify use of a of investing to produce at that level. The SRI and irrigated methods of rice production are the most profitable, but also require significantly more cash expenditure than low-intensity rice. ¹⁰⁶ Razakamiaramanana and Rakotoson, 2014. ¹⁰⁷ World Bank, 2016 ¹⁰⁸ Almost 40 years ago, FOFIFA/CENRADERU (an innovation platform for facilitating the adoption of new technologies) developed a set of recommendations for introducing SRI which is a system of low water, labor-intensive rice to improve yields. ¹⁰⁹ World Bank, 2016; Ministry of Agriculture, Livestock and Fisheries, 2006 ¹¹⁰ Interviews with farmers during the field mission. ¹¹¹ Estimations assume that an illustrative family of five only needs to produce around 880 kilos of paddy annually which can be done by cultivating just 0.44 hectares of low-intensity upland rice which is the least expensive system. 65 Seizing the opportunities for inclusive agriculture growth | 4 Table 4: Financial costs and returns from rice sold immediately after harvest Yield Farmer's Gross Purchased Family Total Cash Cash Total Net profit Net (paddy) price Revenue Inputs labor & Costs costs as costs costs (gross revenue - rate of (paddy) (cash other non- % total pe rkg per kg total costs) return costs) cash costs (Kg/ha) (MGA/kg) (MGA/ha) (MGA/ha) (MGA/ha) (MGA/ha) (MGA/kg) (MGA/kg) (MGA/ha) (US$/ha) Upland rice Low- 2,000 550 1,100,000 390,900 564,400 955,300 41% 195 478 144,700 43.85 0.15 intensity High- 3,000 550 1,650,000 822,100 564,400 1,386,500 59% 274 462 263,500 79.85 0.19 intensity Irrigated Low- 3,000 550 1,650,000 619,100 564,400 1,183,500 52% 206 395 466,500 141.36 0.39 intensity High- 4,500 550 2,475,000 1,104,100 564,400 1,668,500 66% 245 371 806,500 244.39 0.48 intensity (SRI) Notes: 1mt paddy = 670kg polished rice. Assume 20% of labor is hired for cash. Net rate of return = net profit/total costs. Source: Author's calculations based on data from Gergely and Kanatiah, 2017. C. Crop marketing and storage and sub-collectors have little knowledge of prices in other villages or towns even 20-40 (i) The farm level – the start of long and kilometers away. uncompetitive marketing chains 6. The most competitive market outlet is on 5. Most farmers engage the market through market days when town-based collectors a village-based sub-collector. Sub-collectors and/or sub-collectors venture into are typically residents of the farm area with neighboring villages. This is most common social ties to the community, and work directly in irrigated areas or other locations near a under a larger, town-based collector who national road where collectors believe that sets the price he or she is willing to pay for sizable volumes of rice or other crops will crops delivered to their warehouse or other be available for sale. In these circumstances, assembly point. Town-based collectors often outside collectors may arrive in the market provide sub-collectors cash to buy from with a small truck, tractor, or cart. Because farmers and have several sub-collectors they do not live in the immediate village, working under them in different locations. farmers report that prices sometimes rise Sometimes the collector provides transport by 20 percent or more by the end of day from the farm area and pays a commission to as the buyer seeks to secure a full load. the sub-collector for the crops they buy while Therefore, finding ways to bring farmers others leave it to the sub-collector to arrange closer to regional collectors and otherwise transport and make their profits entirely facilitate competition at the farm gate level from whatever price they negotiate with the could be a direct way to incentivize the producer. Both farmers and sub-collectors uptake of improved technologies to enhance have limited negotiating power, facing fixed yields. Even if sub-collectors cannot be fully prices by town-based collectors, largely based bypassed, producers would benefit from on historical price trends. Further, due to a lack greater competition at the farm gate and of market information systems, both farmers improved access to market information. 66 4 | Seizing the opportunities for inclusive agriculture growth (ii) The national market level – slightly more capacity mills are not available in the main rice competitive but still inefficient growing areas, the collector has to transport paddy rather than milled rice. As the milling 7. Collectors in district towns and regional outturn for rice is around 67 percent, an centers are slightly more competitive, additional 33 percent of weight and volume is having access to capital, warehouse storage transported around the country in the form of facilities, and transport. Most collectors have husk and bran adding substantially to costs.¹¹² access to capital from other businesses to Investments in good quality industrial mills finance the purchase of farm commodities. in the main rice growing areas, therefore, Certain collectors have warehouses to store could greatly improve the competitiveness rice and other non-perishable crops until of domestic rice with imports and provide new prices peak. In some cases, community value to be shared up and down the chain. warehouses are also used for storage to deposit rice and obtain a bankable warehouse 9. Given these value chain dynamics, the receipt to finance further purchases. Well farmer receives a small share of total value in established collectors often operate a small the rice chain. Figure 59 shows the indicative fleet of trucks for long-distance and local price build-up for SRI practices (since this is transport. They may operate small milling the model Madagascar is recommended to businesses to serve the local market and/or follow) based on the typical arrangements sell paddy to other nearby mills. whereby the farmer sells soon after harvest and the collector stores for several months. 8. Regional collectors are in a better All values have been converted to milled rice negotiating position, with access to equivalent with crop storage paid by collectors wholesalers who provide market information, and milling done in Antananarivo. Because although the payment and transportation the division of responsibilities between sub- processes are inefficient. With access to collectors and collectors vary, costs and several large wholesalers, regional collectors profits at this stage in the chain have been obtain information on prices and selling merged to one stage called crop assembly. opportunities. Prices are agreed through This approach has the further advantage of negotiation between the collector who allowing for a comparison of the value chain travels to the urban market outlet with the costs in Madagascar with other countries load, and the wholesaler, who pays in cash. where similar analysis of the price build up Due to poor road conditions, a truck can for rice has been carried out (see below). In carry only ten tons, and so the journey must Figure 59, the percentages are a share of the be repeated several times, implying not final retail price. When other variations of rice only additional transportation costs but also are considered, such as low-intensity upland security-related concerns due to travelling rice and low-input irrigated rice, farmer profits with large amounts of cash; an issue which as a share of the final traded value are much could be addressed through electronic money smaller, at an estimated 4 percent and 11 payments. Furthermore, since modern, high- percent respectively. ¹¹² There is only one modern mill in the Lake Alaotra which has recently opened for business and there are no modern mills in Itasy. More specifically, about 28 percent husk and 5 percent bran. 67 Seizing the opportunities for inclusive agriculture growth | 4 Figure 59: Indicative price formation of milled System of Intensive Rice sold in Antananarivo after five months of rural storage paid by collector Farm production Crop assembly Rural transport (incl delivery to warehouse National transport to and final assembly TNR mill/wholesaler, point), 9% 9% Cash costs, 19% Profits from Warehouse and collection, 13% finance, 9% Milling and Retail Re- wholesale tail- er's Retailer's profits, costs, Family labor and Milling 3% 1% other imputed costs, Wholesaler's Wholesaler's costs, Farmer's profits, 12% profits, 5% costs, 4% Taxes on paddy and 9% 3% milled rice, 2% Notes: Based on costs for the 2018/19 season and final retail price of MGA 2,000/kg in Antananarivo and six months of storage paid by collector. Standard definitions of value chain stages were applied to allow comparison with data for other countries. Source: Authors’ calculations based key informant interviews in Vakinankaratra and Itasy plus Gergely and Kanatiah 2017, and World Bank 2018a. 10. An assessment of value-added costs kilo are more critical than for others further (defined as new costs that arise at each along in the chain. The current assessment stage excluding the cost of crop purchases) of value-added costs thus shows how a low- shows that farmers have the lowest rate of input subsistence strategy can make good return and that collection is an expensive economic sense. Value added costs at the stage. Farmers bear the highest total costs assembly stage include costs related to and receive the lowest rate of return in finance, rural transport, storage, and transport per kilo terms (Table 4). Moreover, farmers to Antananarivo. Reducing these costs through mostly produce just a few tons per year as improved market efficiencies, therefore, opposed to collectors who handle several could also be of major benefit to improving hundred tons and wholesalers who handle Madagascar’s overall competitiveness in crop several thousand tons. For farmers to earn production and market-based agriculture a living wage, therefore, profits from each more generally. 68 4 | Seizing the opportunities for inclusive agriculture growth Table 5: Indicative value-added costs, profits, and rates of return from milled SRI rice sold in Antananarivo after five months of rural storage paid by collector during assembly (MGA per kilo milled rice) Value chain stage Value added costs Profits Rate of return Farm production 573 247 43% Crop assembly 541 259 48% Milling & wholesale 145 105 73% Retail 25 70 280% Source: Authors’ calculations from data in Figure 59. 11. Comparison with value chain data producers improves from 36 to 45 percent for other countries shows that farmers in but still compares poorly with Madagascar’s Madagascar receive a much lower share international competitors. At the assembly of the total profits, while collectors at the stage, the data equally show that crop assembly stage receive a much higher collectors in Madagascar capture from 31 to share (Table 6). This is particularly so when 38 percent of total available profits compared the results for Madagascar are compared to with just five to 18 percent in the comparator Thailand which is a world leader in rice. When countries. These findings further underscore farmers in Madagascar store their crop before the need to improve financial incentives for selling, the share of total profits captured by farmers to engage in market participation. Table 6: Share of total available profits from smallholder rice captured at each stage of the value chain in Madagascar and comparator countries Farm Production Crop Assembly Milling & Wholesale Distribution & Retail Madagascar (sell immediately) 36% 38% 15% 10% Madagascar (farmer stores mos.) 45% 31% 13% 9% Malawi 66% 8% 11% 15% Mozambique 47% 17% 16% 20% Nigeria 71% 18% 7% 5% Zambia 57% 11% 17% 15% Thailand 89% 5% 4% 2% Source: Authors’ calculations from data in Tables 4 and 5 for Madagascar; Tchale and Keyser, 2010 for Malawi; and World Bank 2007 for Mozambique, Nigeria, Zambia, and Thailand. 69 Seizing the opportunities for inclusive agriculture growth | 4 (iii) Access to storage – a means for farmers community granaries and other storage to capture a higher share of the total value places have become a place for individuals from rice, but reforms are needed to collateralize crops for obtaining seasonal finance. Micro-finance institutions (MFIs) such 12. With large seasonal price cycles for as CECAM¹¹³ (Caisses d'Epargne et de Crédit most crops, the ability to store is a major Agricole Mutuels), OTIV (Société Coopérative determinant of who benefits from crop d’épargne et de credit), and others have taken marketing. In rural areas, paddy prices in the on joint “key rights” to the village warehouses same location were reported to range from alongside community organizers. In this MGA 550 per kilo (US$0.16) immediately after arrangement, community organizers and a harvest to MGA 800 per kilo (US$0.22) or more representative of the MFI sign a storage receipt five or six months later. For onions, farmers that the depositor can use to obtain a loan for said prices can swing from MGA 500 per kilo up to 75 percent of the crop’s market value (US$0.14) at harvest to MGA 1,000 (US$0.28) at the time of deposit. Under the CECAM when supplies are scarce. For soybeans, program, depositors are charged three percent prices went from MGA 750/kg (US$0.21) at monthly interest for a minimum of five months. harvest to MGA 3,000/kg (US$0.83) or more To withdraw the crop from storage, the loan just four months later. must be repaid in full. If the crop is withdrawn before the minimum storage period, five 13. However, smallholders face multiple months of interest is still due. The crop must pressures to sell immediately after harvest. be withdrawn at the end of the tenth month. Physical access to safe and dry storage space Storage receipts are non-transferrable and at current production levels is only one part of non-divisible meaning a depositor must be the problem. For many households, the amount physically present to make a withdraw and of surplus rice available for cash sale presently can only withdraw the full amount at one time. may be no more than 200 kilos which can easily Upon withdrawal, the depositor is meant to be stored at home. Rather, the main problem receive the same grain bags they put into is that farmers face multiple pressures to sell storage minus any losses that may have immediately after harvest both for family needs occurred to their specific grain due to pest and to raise cash for the next production cycle. infestation, water damage, or other cause. Improving the returns from market participation therefore requires a combination of changes 15. Table 5 provides results of a hypothetical that promote competition and provide flexible value chain analysis in which the farmer opportunities for farmers to monetize their sells six months after harvest using CECAM crops as prices rise. storage. As shown, storage can be highly beneficial as way for both farmers and traders 14. To help farmers with immediate cash to earn higher rates of return and thereby needs benefit from seasonal price cycles, minimize the risks of market participation. ¹¹³ CECAM is the leading micro-finance institution in Madagascar with 223 branches and over 210,000 members. It is privately owned and has a 60 percent share in the rural credit market (http://www.cecam.mg/). 70 4 | Seizing the opportunities for inclusive agriculture growth Table 7: Indicative value-added costs, profits, and rates of return from milled System of Intensive Rice sold in Antananarivo after five months of rural storage paid by farmers (MGA per kilo milled rice) Value chain stage Value added costs Profits Rate of return Farm production & storage 741 340 46% Crop assembly 301 238 79% Milling & wholesale 145 105 73% Retail 25 70 280% Source: Authors’ calculations from data used for Figure 59 with farmer’s paying storage. 16. Presently, however, community and negotiated by the leaders when prices warehouses are seldom used by farmers, are high. Individual depositors would not be due to high interest charges and penalties allowed withdraw early or to use the crop as for early withdrawal. Rather large farmers collateral. While this approach would remove and collectors are the main users of the the problem of high interest and risk of long- warehouse credit system. As one collector term indebtedness, it would not address the explained his operating strategy, the aim need for seasonal credit or risk of tying up the is to buy, deposit, get a loan, and buy even farmer’s commodity in case it is needed for more.¹¹⁴ Small farmers, on the other hand, an emergency. face significant obstacles in obtaining credit through community warehouses including risk 18. Relevant experiences in East Africa and of storage losses, impossibility of withdrawing southeast Asia suggest that reforming the small amounts when needed, and having to warehouse receipt system on commercial pay interest for a minimum of five months. lines would benefit both farmers and With limited cash reserves and no market collectors. In Madagascar, credit terms information, small farmers said they feared are unfavorable to small farmers, and the if they did take a loan, they would have to go warehouse receipt system lacks flexibility as to a sub-collector for an advance payment it is only negotiable as collateral, rather than to settle the credit and get the crop out from being used for onward trade. In contrast, the storage thus opening a route to long-term warehouse receipt system being developed indebtedness. in East Africa by the East Africa Grain Council together with governments and regional 17. To avoid this outcome, certain community traders, allows warehouse receipts to be fully leaders are advocating for farmers to tradable as collateral or selling to a trader. deposit their rice in the community store While work is still ongoing to get this system without taking a loan.¹¹⁵ Sales of deposited off the ground, the vision is for traders to commodities they said would be group based assemble commodities virtually without taking ¹¹⁴ Field interviews with CECAM loan officers and others in Itasy and Vakinankaratra ¹¹⁵ These preferences were expressed by community leaders participating in the “village rice platform.” 71 Seizing the opportunities for inclusive agriculture growth | 4 physical delivery until they are needed for use. raw material they need.¹¹⁶ Already there are digital platforms in East Africa that provide traders and farmers real 20. There are some emerging successes of time information on the quantity and type of contract farming for crops related to food stocks being held in patriating warehouses. To security, including rice. In recent years ensure the receipts are genuine and that the Groupe SOCOTA (originally a cotton company grain meets the buyer’s quality expectations, that has diversified into many other areas of warehouse receipts must be issued by export agriculture) and STOI Trading (another warehouses that meet minimum criteria for commodity exporter) have been contracting storage and grading capacity. Similarly, in small farmers to produce blackeye peas, southeast Asia, medium-size warehouses white kidney beans, and other pulses for managed by trader associations have become export and domestic sale. Through contract a type of small wholesale market where farming, STOI has been improved the quality farmers observe demand and price trends. and uniformity of the beans that it trades These practices for warehouse receipting in making the product more competitive in East Africa and southeast Asia are playing a domestic and international markets. STOI is direct role in improving market linkages. also providing farmers with uniform rice seed to improve rice crop yields and milling outturn (iv) Contract farming can further help drive while also reducing the share of broken grain. smallholder market participation and crop Under these contract farming arrangements, improvements the repayment of crop loans for beans is 97 percent, largely due to close monitoring 19. Contract farming has been successful of producers by extension agents and the in Madagascar for promoting non-food attractiveness to producers of continuing cash crops. Details of contracts vary, but with the program. While the rice program is smallholders involved with these programs just one year old, STOI says initial results are are generally provided with inputs such as promising with excellent repayment rates. seeds, fertilizer, agri-chemicals, and extension Buying prices match local prices at harvest advice needed to grow the target commodity time so the program does not provide a way in exchange for a promise to sell the crop back to benefit from seasonal price cycles but does to the firm after harvest. Contracts may specify at least ensure market access together with minimum quality requirements and specify input and extension support. upper limits on the amount of product the firm is willing to buy. There are many large 21. While support for expansion of contract and small firms involved with contract farming farming to new areas and new crops in different parts of Madagascar with most could make an important contribution to firms targeting crops used for agri-processing agriculture growth in Madagascar, this model and for export. Several processors targeting also has inherent limitations. According to the international market such as Lecofruit Randrianarison and others (2009) and World (export vegetables), Bionexx (artemisia), and Bank (2016), households involved with contract Sopral (fruits, spices, and essential oils) were farming tend to the best equipped in terms of established under the free export processing production factors. Because of management zone system and use contracts to secure the requirements, contract programs also tend to ¹¹⁶ World Bank, 2016 72 4 | Seizing the opportunities for inclusive agriculture growth be highly localized and concentrated on areas today few cooperatives are operating in the near an all-weather road. On the other hand, rice sector. In the 2000s, the most active recent successes demonstrate that contract ones operated in the niche of specialty rice farming can be used to build market linkages by exporting a distinct pink variety. The for staple foods not just high-value exports. National Rice Development Strategy 2017 Efforts to forge new productive alliances for states that the evolution of the Water Users rice, beans, cassava, as well as for maize and Associations and Federations into Rice soybeans that are demanded for stock feed Cooperatives will be decisive for the future could therefore make a strong contribution to of the sector. Furthermore, the recently sector growth. adopted National Cooperative Development Strategy (SNDCoop 2019-2028) provides a 22. While the cooperative model based on framework for reviving the cooperative model groups could also allow producers to be in Madagascar. Therefore, while there may be better integrated into domestic markets, some emerging leadership to move towards experience so far has not been successful. cooperative farming, further efforts will be Agricultural producers’ experience with needed to demonstrate that the new wave of cooperatives in Madagascar was marked cooperative farming is different to the last one. by the wave of politicization of agricultural Nevertheless, if efforts were to be successful, cooperatives in the 1970s and 1980s, where experiences in other rice-producing countries they were used by successive governments such as Senegal and Vietnam suggest to dominate or even exploit rural households, improved farmer organization is a critical contributing to a reluctance of households factor in strengthening yields, food security to participate in such entities.¹¹⁷ As a result, and agricultural growth (see Box). Box 4: Learning from other Country Experiences – How Senegal and Vietnam were able to realize success in domestic rice markets As part of its Emerging Senegal Plan adopted in 2012, the Senegalese government vowed to modernize its agricultural sector with the aim of increasing food security and boosting job creation. Investments in rural roads, irrigation, and promotion of farmer cooperatives led to a significant transformation of the rice sector, with a near doubling of rice production since 2014, to reach 1.2 million tons in 2018. Prior to reform efforts, the most important hurdles to modern farming in Senegal were a shortage of irrigated lands, poor road connectivity, disorganized supply chains, limited access to credit, and an archaic land administration system. Key to improving the organization of supply chains is the emergence of large cooperatives that serve smallholder farmer interests through input procurement, milling and storage, and quality control. Private-sector-led initiatives helped the development of thriving agribusinesses and job creation along the value chain. Access to credit has improved through new financing facilities and local lending to smallholders. The outstanding amount of loans contracted by rice farmers nearly doubled since 2012 while default rates declined with better farming practices, better irrigation, and increased rice quality. Like Madagascar, Senegal is a net rice importer. Another example of successful transformation in the rice sector comes from Vietnam (a ¹¹⁷ WorldBank, 2011 73 Seizing the opportunities for inclusive agriculture growth | 4 large net exporter of rice) where small landowners have come together to form large- scale production units under the leadership of rice marketing companies. Under these systems, participating farmers pool their land into a consolidated (large-scale) field in exchange for mechanization services, extension support, and a pre-negotiated price from the marketing company. Through forward negotiations with rice buyers, these companies pay higher prices to farmers who, in turn, enjoy better economies of scale and produce more yield per hectare as a result of the timely delivery of inputs and extension support provided by the company. These systems are important for promoting quality upgrades and the introduction of aromatic varieties for export. In cases where farmers are not linked to an outgrower company, it has been very difficult to persuade farmers to organize themselves in groups merely for the supposed benefits of improved economies of scale. D. Crop transport and processing surplus rice for market sale. More commodities travel along national roads than small feeder (i) Transport costs contribute to higher overall roads but initial transport from the farm area costs and reduces competitiveness to town accounts for a greater share of final value compared to long-distance transport 23. At the next stage of the value chain, from town to the urban wholesale market. transport costs represent a major block Improving rural feeder roads is important but in the price formation for rice and have a expensive and other measures that enhance major impact on producer margins. In Itasy rural connectivity can also lead to greater and Vakinankaratra transport costs from the competition between collectors and sub- production area to a town-based assembly collectors and incentivize farmers to produce point were reported to range from MGA 1,260 surplus crops for market sale. Even in very to MGA 2,280 per ton per kilometer (US$ 0.35 distant areas investments in market information to $0.80) in the dry season. Over a relatively systems that work by text messaging or modest distance of just 40km, therefore, rural by radio as well as the establishment of transport can amount to MGA 50.40 to 115.20 publicly available warehouse registries, and per kilogram or nearly 10 to 20 percent of eventually, tradeable warehouse receipts, the farm gate price. In more remote areas, could significantly improve negotiating power transport costs will of course be higher and of small farmers and competitiveness of the farm gate prices lower. On the input side, rice sector overall. the price of moving fertilizer and other bulky inputs to the farm area can easily be the same 25. The cost of long-distance transport or even more if transport is done after the start along national corridors are far higher in of the rains. In the rainy season, transport Madagascar compared with other countries. prices were said to double. While transport conditions were said to be highly competitive in Madagascar with 24. Investments in rural connectivity could many independent operators and larger therefore have a major impact on the transport companies vying for business, incentives for small farmers to produce most national highways tend to be little 74 4 | Seizing the opportunities for inclusive agriculture growth more than narrow, windy roads and the increasingly being the subject of banditry trucks involved in agriculture transport are when they get stuck. Since most sales in usually small with a maximum load of just urban areas are transacted in cash, collectors 10 to 15 tons at most. Because of these poor said that they are especially vulnerable conditions, transporters say they budget up when returning from the city. Long-distance to 10 percent of their trip costs for repairs and transport costs in Madagascar therefore helping hands when trucks get stuck along tend to be much higher compared with other the way. Poor security on national routes countries, particularly Pakistan which is a was also identified as a problem with trucks large rice exporter to East Africa. Figure 60: Average transport prices on long distance routes in Madagascar and comparator countries (US cents per ton per kilometer)¹¹⁸ 16.0 14.0 14.0 US cents per ton per km 12.0 11.0 10.0 8.0 8.0 7.0 6.0 6.0 5.0 5.0 3.5 4.0 4.0 2.0 2.0 0.0 Africa: Durban-Lusaka Pakistan Africa: Mombasa-Kampala Brazil United States China Africa: Douala-N'Djamena Madagascar: national routes France Africa: Lomé-Ouagadougou Source: Authors’ calculations from transport survey for Madagascar;¹¹⁹ Teravaninthorn and Raballand, 2009 for all others. 26. Further savings on transport costs the western outskirts of Antananarivo, for could be realized through investments instance, was identified as a major wholesale in regional rice mills. Un-milled paddy is and milling center for rice from many parts about 33 percent husk yet apart from some of Madagascar. Further developing regional industrial mills in regional centers such rice mills in major producing areas therefore as Amparafaravola around Lake Alaotra, could provide an immediate 33 percent most commercial milling is done in urban saving in the per ton costs of long-distance and peri-urban locations far from the main transport making domestic rice much more rice growing areas. Imerintsiatosika, on competitive with imports. ¹¹⁸ The data is from the latest available year in each country. ¹¹⁹ Primary data on transport costs were collected along four major corridors that are important to rice and other major commodities: Alaotra-Antananarivo, Alaotra-Toamasina, Itasy-Antananarivo, and Mahajanga-Maroavoay-Antananarivo. 75 Seizing the opportunities for inclusive agriculture growth | 4 E. Trade policies profit margins to the wholesale level in Antananarivo are MGA1,259 per kilo (US$0.35) (i) For domestic rice to compete with imported which compares favorably with the estimated rice, efficiency improvements are needed import parity price for Pakistani rice delivered to an Antananarivo wholesaler of MGA 1,738 27. Imported rice, similar to domestic rice, per kilo (US$ 0.48).¹²³ However, once farmer is not subject to duties or value added and collector profits are taken into account, tax. Since the international food price crisis the warehouse price of domestic rice jumps of 2008, imported rice has not been taxed to MGA1,870 per kilo (US$0.52), motivating as part of efforts to enhance food security. large wholesalers to trade in imported rice Previously, imports were taxed on the order at certain times of the year. of 32-38 percent. Imports have been growing and now account for about 40 percent of all (ii) The uneven application of an export ban commercially traded rice in the country.¹²⁰ On on rice is counterproductive balance, Madagascar likely produces around 92 percent of its total requirements, but 29. Around the same time that import only 15 to 20 percent of this rice is marketed duties and VAT were abolished on imports, commercially leaving a large deficit in towns government also instituted a ban on rice and urban areas.¹²¹ exports ostensibly to protect food security. Until that time, Madagascar had done very 28. In principle, tax-free imports should well in exporting small amounts of a specialty encourage efficiency in domestic markets; variety of pink rice, known as “Dista rice” to the but this requires addressing bottlenecks United States and other developed country in farm level marketing, warehousing, and markets.¹²⁴ Exporters have sometimes been rural connectivity. Domestic producers able negotiate ad hoc exceptions to the ban enjoy a strong comparative advantage with on grounds that Dista rice is not the type of imported rice at the farm level.¹²² By the time rice needed for domestic food security. domestic rice moves through the collector system to reach an urban wholesaler, 30. These exceptions aside, the ban has however, this comparative advantage created great uncertainty for exporters and is largely diminished to the point where given rise to many negative consequences imports can often compete with domestic for the rice sector. From 2005 to 2007, for supply on price. In the illustrative value chain example, Madagascar exported an average analysis for milled SRI rice sold through a of 766 tons of Dista rice annually. In 2008, typical collector arrangement (Figure 59 and however, exports dropped to just 51 tons and Table 4), total value-added costs excluding has since averaged only 29 tons per year from ¹²⁰ Authors’ extrapolations from five-year production estimates reported by Ministry of Agriculture and Livestock allowing for 15 percent post-harvest losses, INSTAT estimates of the share of national production marketed commercially, and import figures reported by Ministry of Agriculture and Livestock and Ministry of Trade. ¹²¹ INSTAT, 2013. ¹²² Gergely and Kanatiah, 2017 ¹²³ Based on US$360/ton fob Karachi plus US$58/ton freight, insurance, and port/clearing charges to Toamasina and US$65/ton road transport to Antananarivo. Freight charges are from: https:/ /www.freightos.com/freight-tools/ freight-rate-calculator-free-tool/?utm_expid=.z9z58OKARtaw92XYtNF_KQ.1&utm_referrer= ¹²⁴ Dista rice, named for the farmer who discovered the variety, is cultivated mainly in Toamasina province near Lake Alaotra. The rice has a pale pink color and a natural scent of cinnamon, cloves, and nutmeg. 76 4 | Seizing the opportunities for inclusive agriculture growth 2009 to 2015 with exports in some years being annually and Seychelles imports around as low as just four tons.¹²⁵ Like many other 6,000 tons but these imports are of high- agri-food exports from Madagascar, Dista value aromatic varieties with a low share rice is a very high-value specialty product of broken grain so is not the type of bulk largely irrelevant to national food security. rice produced in Madagascar. According to More than harm niche exports, export bans Mauritius Customs data, the average landed adversely impact the functioning of market- price in Port Louis is over US$1,000 per ton based mechanisms needed to promote indicating that substantial investments in high food security including the development of quality seed of select varieties and modern warehouse receipts systems and contract milling infrastructure would be needed to farming arrangements. Ultimately, food meet buyer requirements. Similarly, despite security requires encouraging more trade, prices being highly attractive in Reunion including through adopting a more open trade Island, the value chain in Madagascar is not regime; avoiding the use of export restrictions; sufficiently developed in terms of seed supply, promoting more effective regional integration; processing, or certification capacity to meet and improving logistics. buyer demands.¹²⁷ (iii) The ability to export ordinary rice depends 33. While Madagascar would enjoy tariff on efficiency improvements preferences for bulk exports of ordinary rice to neighboring countries in mainland Africa, 31. In the long-term, the stated objective for inefficiencies undermining competitiveness the Government is to become a regional rice in domestic markets remain an issue. As a exporter. According to government policy, as member of the Common Market for Eastern soon as the country is self-sufficient in rice, and Southern Africa (COMESA) and the neighboring Indian Ocean and African countries Southern Africa Development Community represent the first target for rice exports.¹²⁶ (SADC), Madagascar benefits from tariff Exporting a bulk commodity on the global preferences against other global suppliers market, however, is a very different business in mainland African markets. While quality from niche sales of high-value specialty specifications may not be as high in mainland foods that Madagascar mostly exports at Africa as in Mauritius, Seychelles, or Reunion present. Export bans on rice notwithstanding, Island, price in mainland markets is critical. Madagascar’s ability to supply global or With Madagascar barely able to compete with even regional markets at competitive prices imports in its own domestic market, therefore, depends on overcoming the same challenges tariff preferences are unlikely to be enough to that currently undermine the competitiveness ensure a competitive place in mainland Africa with imports in domestic markets. without efficiency improvements at home. 32. Buyer requirements in neighboring Indian 34. To illustrate this point, Table 7 summarizes Ocean countries are very high. Mauritius, a set of regional parity price calculations for imports around 36,000 tons of milled rice deliveries to Kenya and Mozambique which ¹²⁵ Ministry of Agriculture, Livestock, and Fisheries, 2017 ¹²⁶ Ministry of Agriculture, Livestock, and Fisheries, 2017 ¹²⁷ IFAD; and Gloanec, Cazal, and Prophyre, 2011 77 Seizing the opportunities for inclusive agriculture growth | 4 are large rice importers. In this analysis, the fob Community (EAC) which imposes a 75 percent price of US$470 per ton for Madagascar rice is common external tariff on rice imports but has derived from the value chain data discussed negotiated a preferential 35 percent tariff with above (Figure 59 and Table 4) up to the Pakistan which is a longstanding and major rice wholesale level, which in this case is assumed supplier to Kenya. As a member of COMESA, to be Toamasina rather than Antananarivo. The Madagascar could supply to Kenya duty free. analysis further assumes that exports are done Similarly, Mozambique levies 7.5 percent duty immediately after harvest so exclude the costs on imported rice, but as a member of SADC, of storage.¹²⁸ Kenya is part of the East Africa rice from Madagascar would have zero duty. Table 8: Indicative regional parity calculations for ordinary Madagascar and Pakistan rice in regional export markets (US$ per ton) Madagascar supply Pakistan supply Kenya Imports Milled rice, foo 470 360 Freight and insurance 85 55 cif Mombassa 555 415 Duty 0% - 35% 145 Total landed price 555 560 Mozambique imports Milled rice, foo 470 360 Freight and insurance 80 60 cif Maputo 550 420 Duty 0% - 7.5% 32 Total landed price 550 452 Source: Authors’ calculations from data used for Figure 59 and Table 4 excluding storage costs for Madagascar. Pakistan price information from hasrice.com (http://www.hasrice.com/pakistan-rice-prices/). International shipping costs from freightos.com https://www.freightos. com/freight-tools/freight-rate-calculator-free-tool/?utm_expid=.z9z58OKARtaw92XYtNF_KQ.1&utm_referrer=). 35. Even with regional tariff preferences, these 36. These results underscore the importance calculations show that ordinary rice from of improving the efficiency of domestic value Madagascar would not be price competitive chains. Increasing farm level production to in regional markets. Even with substantial the point of having a surplus is likely not tariff protection Madagascar could barely sufficient for Madagascar to be a competitive land rice in Mombasa for less than Pakistan. rice exporter. Rather, investments in rural In Mozambique, where tariff protection is 7.5 connectivity, storage, and seed supply, percent, Malagasy rice would cost about 18 together with reforms around warehouse percent more than rice from Pakistan. receipt and other aspects of crop marketing ¹²⁸ Total value-added costs and profits up to the wholesale level excluding storage converted to US$ per ton. With storage costs, the fob price would be higher. 78 4 | Seizing the opportunities for inclusive agriculture growth that bring farmers closer to the market both by donors, which explains the fluctuating literally with improved roads and figuratively performance in data collection, analysis, through improved trading systems are and dissemination. In addition, by focusing needed to ensure a competitive place in the on markets at district level, OdR is missing global market. important information on market dynamics between producers and their immediate F. Market information buyers. At the national level, OdR provides decisionmakers with a descriptive overview 37. To improve the efficiency of value chain of price information but the analytical processes and quality of policy decisions, content is limited. Dissemination activities public and private stakeholders need are also limited and not geared to a wide better market information. Even in areas public audience. Furthermore, the outdated close to main national roads, farmers and agricultural census (2005/05) also constrains sub-collectors have little knowledge of effective decision making. crop prices, buyer preferences, or market opportunities outside their immediate area 39. Investments in even very simple of operation, constraining the ability to make information systems for rice and other crops informed production decisions and negotiate would be a good way to improve market competitive prices. Although collectors make efficiencies. Authorities in one part of Itasy, said it their business to monitor production and that there used to be weekly radio bulletins market opportunities through their network with price announcements and extension of sub-collectors and wholesalers these advice. Although they claimed that farmers agents also have little information beyond and collectors responded well, the activity their individual sphere of influence. Apart from was donor financed and came to an end contract farming, therefore, most agriculture when the project stopped. Resurrecting, and transactions are based entirely on spot even expanding such systems in partnership market conditions with little or no account of with OdR could be one very practical way to underlying trends and future opportunities. improve market conditions. 38. Policymakers are also left to cope with 40. Investments in remote sensing systems a lack of reliable information on which to that help gauge crop yields in different parts base major policy and investment decisions. of the country could also be of significant The Rice Observatory (Observatoire du Riz or benefit to policymakers and private OdR) is mandated as the rice sector market investors. The International Rice Research information system, yet its coverage of the Institute (IRRI), for example, has been testing value chain is limited. Set up in 2005, the various technologies for remote monitoring of OdR collects price data from 110 districts more than 15 million hectares of rice fields in for paddy, milled and imported rice, and Thailand, India, Vietnam, Cambodia, Indonesia, for maize, cassava, and sweet potato, and the Philippines. Through its RIICE Project, although full data collection is not always IRRI and its partners have shown that remote done. The activity of the Rice Observatory sensing data and smartphone-based surveys has been heavily dependent on financing can be used to map estimated planting dates, 79 Seizing the opportunities for inclusive agriculture growth | 4 crop areas, crop rice yields, and even how 43. The analysis shows there are other natural disasters are likely to impact yield.¹²⁹ ways to improve rural connectivity and Access to this type of information would provide farmers the incentives they need enable traders to know where surpluses to produce marketable surpluses of rice exist and help policymakers decide on and other staple crop even in hard to reach infrastructure investments and trade policies areas. A market information system that to enhance market efficiencies. broadcasts current prices in different parts of the country would be relatively inexpensive G. Policy and Investment to set up and operate yet would enable Priorities for a More Inclusive farmers and collectors everywhere to make Agriculture Growth Trajectory better informed decisions about what to sell and what to plant or trade. Short messaging 41. Inefficiencies and unpredictability in services (SMS) are widely used in other domestic agricultural markets important developing countries and radio bulletins, that for food security is a major disincentive to have been successful in Madagascar in the improving production, whereby farmers past, could also be revived. Similarly, creation get a small share of the profits. With limited of a publicly available registry of deposits in competition at the farm gate and multiple community warehouses would be a good way intermediaries who stand between the farmer to improve market efficiencies and promote and the final market, producers receive only group marketing of surplus commodities. With a small share of the available profits from smart phones and other modern technology, commercial agriculture so have little incentive it would be relatively easy to build a system to produce beyond the subsistence level. for warehouse operators to create a real-time These factors are a drag to domestic rice record of current deposits that could then be markets and other crops that are important transmitted nationally. for food security. 44. Efforts to reform the warehouse receipt 42. Reforming the current situation requires system are also important. An immediate bringing farmers closer to markets, both first step would be to allow more flexible physically and figuratively. To reduce long credit terms that permit farmers to withdraw marketing chains, investments in rural their crop whenever needed and to settle connectivity are important. In physical terms, their debt without the burden of five months feeder roads are mostly in a dilapidated state minimum interest. Longer-term investments and have received little investments over that help Madagascar transition to a system the recent years. Upgrading of rural roads where warehouse receipts are fully tradable is therefore an obvious, and critical, area for would also be of major strategic benefit. investment. Linking all rice areas with decent Work to formulate practical standards for roads, however, is major undertaking that product grading and warehouse certification, will require considerable time and financial for example, would provide Madagascar a resources to complete and maintain. roadmap for the commercialization of rice Investing in feeder roads will also require trade. Developing such a system, as the EAC planners to make hard choices on which has been working to do, will take time but areas to service first. would be of significant benefit by allowing ¹²⁹ Remote-sensing Information and Insurance for Crops in Emerging Economies (RIICE): http://www.riice.org/ 80 4 | Seizing the opportunities for inclusive agriculture growth traders to position stocks around the country rice a competitive edge over imported and only take physical delivery when needed. rice, and eventually enhance prospects This would greatly reduce the dependence on for exports to neighboring markets. The rural feeder roads in difficult times of the year. country’s vision is to become a rice exporter once domestic food self-sufficiency needs 45. Addressing market inefficiencies further have been met. Achieving such a goal requires requires encouraging cooperative behavior inefficiencies in domestic markets to be and opportunities for contract farming. Given addressed by reducing the long marketing small plot sizes for rice, efforts to encourage chain and lowering costs, particularly those group marketing and other types of cooperative related to transport. The uneven application of behavior are needed to support development of the export ban on specialty niche rice should the warehouse receipt system and commercial be lifted to provide a broader signaling effect market development more generally. Given of enhanced market certainty. that cooperative behaviors are currently not the societal norm outside of family networks, 47. Ultimately, with better market access, particularly for food crops, a more feasible farmer demand for improved seeds, fertilizers, option in the near-term could be to leverage willingness to pay for maintenance of the initial successes of the STOI model of irrigation, and demand for farmers extension contract farming. for rice and other staple crops services could all be expected to improve. to see how it can be replicated further. Going Madagascar has enjoyed many successes in further, investments in regional rice mills could exporting high-value commodities and there is reduce the overall cost of transporting rice by still scope for these to grow. With more secure up to a third so would significantly enhance the and remunerative market access, smallholder competitiveness of local farmers in domestic production of rice and other crops such as and potential export market. maize, soybeans, cassava that are important to food security, livestock production, and 46. Improving efficiencies in domestic agri-processing could also develop, to move markets could help give locally produced towards a more sustainable growth trajectory. 81 Addressing Anti-Competitive Practices 49 82 5 | Addressing Anti-Competitive Practices A lack of market competition in key sectors of the economy is a major constraint to productive, inclusive and sustainable growth in Madagascar. This chapter presents an overview of regulatory and non-regulatory barriers to competition, including business practices that can exclude some firms from the market or create a level playing field, and ways of overcoming them, with a focus on four specific sectors. Telecommunications and petroleum sectors, which are tightly interconnected with the rest of the economy, illustrate the pervasive effects of insufficient competition in key input markets. The case of lychee and vanilla shows how limited competition in key export markets can concentrate gains in the hands of a few actors and reduce opportunities for smallholder farmers. The chapter presents both market-specific and economy-wide recommendations to open markets, improve competition policies and strengthen their enforcement. A. Introduction an overview of competition in Madagascar, and some of the features of market conditions 1. Market competition is a key driver of that have resulted in uncompetitive business productivity and innovation.¹³⁰ Empirical practices. The second section presents the evidence suggests that competition promotes four case studies of telecommunications, a reallocation of resources from low to high petroleum, lychee and vanilla, where the de productivity firms,¹³¹ helps upgrade quality,¹³² jure, de facto and enforcement challenges boosts export competitiveness, and stimulates are considered. The third section considers innovation. Welfare gains for consumers can cross-cutting solutions related to improving be significant, as they benefit from lower prices policy frameworks, including pro-competition and opportunities for more and better paying regulations, measures to promote a level jobs. However, in Madagascar, markets are playing field between incumbents and characterized by a high level of concentration new entrants, and better enforcement of and low levels of competition in key sectors. competition laws. This reflects regulations and policies that restrict access to markets, preferential B. Market Concentration treatment of incumbent companies, and lack and Anti-competitive of enforcement of competition policies. Business Practices 2. This chapter assesses the competitive 3. Overall, the intensity of local competition is landscape in Madagascar by considering perceived to be weak with markets dominated three key issues. The first section provides by a few businesses. A wave of privatization ¹³⁰ Arnold et al., 2011 ¹³¹ As an example of this channel, Carlin et al. (2004) show, using a dataset of about 4,000 firms in 24 transition countries, that firms facing between one and three competitors saw real sales grow by almost 11 percent on average over three years, while monopolists suffered from a 1 percent decline in real sales. Similarly, Nickell (1996) found that a 10 percent increase in price markups resulted on average in a 1.3–1.6 percent loss in total factor productivity growth. ¹³² Barone and Cingano (2011) show that in OECD countries, pro-competition reforms in input services sectors (telecommunication, transport, energy and professional services) increase value added, productivity and export growth of downstream service-intensive sectors. 83 Addressing Anti-Competitive Practices | 5 reforms took place in the 1980s and 1990s, exploit the weak institutional environment. reversing an earlier wave of nationalization. Once firms have successfully penetrated During the privatization period, state-led markets, particularly in highly profitable monopolies and oligopolies were replaced with sectors, incumbents seek to maintain a first privately-owned companies.¹³³ However, these or second mover advantage by supporting private actors were broadly drawn from the anti-competitive behaviors. Key sectors in political elite and families close to them, with the economy such as telecommunications, economic power largely concentrated in the petroleum, banking, mining, real estate, and hands of a few, the Grandes Familles. Over time, high-end agribusinesses are concentrated, a new wave of entrepreneurs has been able to and firms often develop vertically integrated successfully do business in Madagascar, as they or conglomerate structures which can further have been able to navigate and, in some cases, entrench market power.¹³⁴ Figure 61: Relative to comparators, the Figure 62: …and markets in Madagascar intensity of local competition is perceived are perceived to be dominated by few to be weak… businesses Intensity of Local Competition (best rank = 7) Extent of Market Dominance (best rank = 7) 6.0 6.0 4.8 5.0 5.0 4.0 4.0 3.4 3.0 3.0 2.0 2.0 1.0 1.0 0.0 0.0 Uganda Mauritius Burundi Indonesia Mauritius Ethiopia Mozambqie Tanzania Mozambique Mali Rwanda Senegal Malaysia Kenya Chad Uganda Burundi Tanzania Ethiopia Chad Rwanda Zimbabwe Cambodia Nepal Madagascar Cameroon Nepal Zimbabwe Madagascar Cambodia Kenya Senegal Mali Indonesia Malaysia SSA SSA Cameroon Source: WEF GCR 2017/18. Note: Values from 1 (competition not Source: WEF GCR 2017/18. Note: Values from 1 (market intense at all) to 7 (competition extremely intense) dominated by few business groups) to 7 (market power spread among many firms) 4. Rather than firms growing through justified tax expenditures, unfair practices productivity improvements, upgrading related to procurement, preferential and diversification, economic operators treatment in the award of licenses, control seek to gain a competitive edge through of state-owned enterprises (such as JIRAMA manipulating rules and regulations. Examples through Board appointments or supplier of such practices include the arbitrary use of contracts which gives firms significant commercial lawsuits, avoiding customs duties, leverage) and holding political power to the imposition of fiscal penalties and poorly benefit from immunity. Going further, in ¹³³ Jütersonke and Kartas 2010. ¹³⁴ See for example, Gerschenkron (1962) and Grossman and Hart (1986) for global evidence. A background paper on Madagascar’s Political Economy for the CEM, undertaken in February 2019 provides evidence for Madagascar. 84 5 | Addressing Anti-Competitive Practices some cases, firms have operated in concert have substantial potential to be developed in through the potential establishment of cartels Madagascar based on calculations of relative to secure and maintain their market power. comparative advantage, have been easier to penetrate outsiders. Taking further steps to 5. These anti-competitive behaviors place improve the business climate and levelling high non-regulatory barriers to accessing the playing field, as already signaled by the markets, undermining both the inclusiveness current administration can make substantial and sustainability of growth.¹³⁵ Newcomers inroads in encouraging new investment to may enter markets if they do not encroach on the country. the business practices of incumbents (such as the IT-BPO sector), they pay a high price in areas C. Barriers to Competition in Key where operators already exist, or violence and Sectors – Deep Dive Analysis intimidation is used, which has in the past contributed to political instability thereby 7. This section presents a comprehensive compromising the sustainability of growth. review of barriers to market entry and Furthermore, these types of non-regulatory competition in four major sectors of barriers undermine the inclusiveness of the Malagasy economy.¹³⁶ Two of those, growth, whereby rules and regulations telecommunications and petroleum, supply are manipulated through connections and key inputs to the rest of economy. More alliances between economic and political competition in these tightly integrated operators, a domain which is inaccessible input sectors could generate large welfare to outsiders, unless intermediaries are used, gains by reducing costs for other sectors, which raises the cost of doing business. optimizing the use of existing infrastructures, and stimulating new investments in the 6. Nevertheless, it is important to note that economy. At the time of preparing this study, levels of market concentration vary by sector. discussions were ongoing at the highest level Using export data as a proxy for estimating of government to initiate reforms to both the market concentration and contestability, telecommunications and petroleum sectors, highly specialized export sectors such as which includes minimizing regulatory and mining which are usually characterized by non-regulatory barriers to enter these markets. high levels of concentration, bear this trend to The other two sectors, vanilla and lychee, are a greater extent in Madagascar compared with export-oriented agribusinesses that generate peer countries. However, for less premium significant export revenues and have a large markets such as animal products, vegetable potential for greater productivity along the products and pharma/medical products, value chain and income gains for smallholder export concentration levels are relatively farmers if barriers to competition can be low. The implication is that certain sectors addressed. Moreover, analyzing how anti- such as vegetables and livestock, which competitive behaviors prevail in these high- ¹³⁵ Information drawn from a Political Economy assessment prepared as a background paper for the Country Economic Memorandum, 2019 ¹³⁶ The assessment is based on the Markets and Competition Policy Assessment Toolkit (MCPAT). The MCPAT methodology allows for the identification of market characteristics that shape dynamics and government interventions that restrict competition by: i) restricting entry; ii) facilitating collusion; or iii) creating an unlevel playing field), and consideration of solutions that can achieve policy objectives and address market failures while minimizing market distortions. 85 Addressing Anti-Competitive Practices | 5 end agribusinesses can help to inform policy- high-performing sectors, including the IT- making for other value chains, particularly as BPO industry, as well as retail, banking, and pipeline road infrastructures will help unlock services to enterprises. access to important commodities over the next three to five years. 9. Despite improvements in the sector, prices remain high and penetration is low. The cost (i) Focus sector: Telecommunications of fixed broadband internet services is higher than peer countries (Figure 63).¹³⁹ Penetration 8. The telecommunications sector plays a key rates are also well below those of comparators role in the services industry. Investments in (Figure 64), with a significant proportion of the submarine fiber optic cables LION¹³⁷ and the population still unconnected to mobile EASSy in 2009 and 2010 ended the country’s network (65.9 percent). High prices are an dependence on satellites for international important contributor to low penetration connections, improving access and reducing and access rates in Madagascar, which is a the cost of international bandwidth. More significant opportunity cost for the economy. recently, Telma (Telecom Malagasy),¹³⁸ If fixed broadband subscriptions were to rise has been laying a national fiber backbone to levels of peers in Rwanda and Cameroon connecting major cities contributing to the (i.e. from 10 percent currently, to 18 percent), availability of relatively high-speed internet growth could be raised by more than 1 across urban areas. Madagascar has now one percentage point.¹⁴⁰ Over time, it could also of the fastest download speeds in sub-Saharan stimulate new investments and accelerate the Africa. This has helped the emergence of new digitalization of the economy. The cost of fixed broadband internet services is higher than peer countries ¹³⁷ The Eastern Africa Submarine Cable System (EASSy), an undersea fibre optic cable system connecting countries in Eastern Africa to the rest of the world. Lower Indian Ocean Network (LION) is a submarine communications cable network that connects Madagascar, Réunion, and Mauritius. ¹³⁸ Telecom Malagasy (Telma) is a former state-owned enterprise. During the privatization phase, Telma was acquired by the Axian Group, with the government maintaining a 19 percent share. ¹³⁹ The ITU defines a mobile-cellular basket as consisting of 51 minutes of mobile voice call and 100 SMS ¹⁴⁰ This calculation is based on the assumption that in low income countries, an increase of broadband subscriptions by 10 percentage points can lead to up to 1.4 percentage point increase in growth rates, which is the finding of the report: World Development Report (2016), Exploring the relations between the broadband and economic growth, http://pubdocs.worldbank.org/en/391452529895999/WDR16-BP-Exploring-the-Relationship-between-Broadband- and-Economic-Growth-Minges.pdf 86 5 | Addressing Anti-Competitive Practices Figure 63: The price of fixed broadband Figure 64: …while penetration and access internet is relatively high in Madagascar of cellular and internet services are relatively low Prices in US$ purchasing power parity Indicators of penetration (%) Fixed-broadband prices (PPP$) 200 150 Mobile-broadband prices, 1GB (PPP$) 100 50 0 Mobile-broadband prices, 500MB (PPP$) Indonesia Mauritius Ethiopia Malaysia Nepal Mali Cambodia Senegal Burkina Faso Kenya Zambia Tanzania Uganda Liberia Chad Malawi Niger Madagascar Côte d'Ivoire Zimbabwe Cameroon Comoros Mobile-cellular prices (PPP$) 0 50 100 150 200 250 Madagascar LDCs World Mobile-cellular subscriptions per 100 inhabitants % of individuals using the internet Source: ITU, accessed at https://www.itu.int/en/ITU-D/Statistics/ Pages/publictions/mis2017.aspx Source: ITU, accessed at https://www.itu.int/en/ITU-D/Statistics/ Pages/publictions/mis2017.aspx 10. Investments in the telecommunications in Telma, at 19.9 percent. Discussions are ongoing sector by new and existing operators has been to allow other operators to invest in areas where limited by both regulatory and non-regulatory Telma already has infrastructure in place, which barriers. There are four major operators in the is currently prohibited, but if opened up, would telecommunications market: Telma, Orange, allow for greater price competition.¹⁴¹ Currently, Airtel and Gulfsat (Blueline). The incumbent the cost of access to international bandwidth firm, Telma has made significant investments in is more than three times higher than in other backbone infrastructure in the past, including African countries, limiting penetration. Foreign during the political transition period when other investment in telecommunication companies is operators largely shied away from making long- also restricted to two thirds of a company’s shares, term investments, although this was partly with the further requirement for at least one of financed by the Universal Services Fund. The the directors to reside in Madagascar,¹⁴² which government currently maintains shareholdings limits opportunities for further development. Figure 65: Telma is present in all segments of Madagascar’s broadband value chain International Core network Middle mile Access network connectivity National backbone Backhaul Last mile EASSy: Telma Fiber optic: Telma Fixed services: LION: Orange Copper lines: Telma Fixed wireline (ADSL and fiber): Telma Fixed wireless (WiMAX, WiFi): Telma, Gulfast (Blueline), other ISPs Mobile services: Market shares as at 2019 Share of 3G Share of 4G Airtel 16.9% 5.7% Orange 19.6% 5.4% Telma 63.5% 12.2% Gulfsat (Blueline) - 76.7% Source: Authors’ own elaboration. Market shares only available for mobile services, GSMA 2019 ¹⁴¹ Decree No 2014-1652. Discussions ongoing in May and June 2019. ¹⁴² Madagascar Investment Law 2007 -036 87 Addressing Anti-Competitive Practices | 5 11. Regulation currently in place does not of remote areas.¹⁴⁶ A Universal Access Fund support access to shared infrastructure has been created to finance such network or manage interconnection charges in a extensions, where investments would way that could gradually reduce tariffs.¹⁴³ otherwise be unviable, but the mode of Regulation of the telecommunications sector administration has been opaque. To support should strive to balance the incentives for a level playing field, a Universal Access incumbents to continue investing over time, Fund should have clear selection criteria while also encouraging new players to invest, on which projects should be financed as which is currently not the case in Madagascar. well as competitive neutrality principles to Regulatory lapses include the lack of an ensure the operators have been justifiably enforceable obligation for the Regulatory selected. In practice, it appears that the Authority for Communication Technologies for incumbent has benefited from the Fund to Madagascar (ARTEC) to determine whether recoup part of the costs for the deployment operators have Significant Market Power of the national backbone network, where (SMP). The failure to publish a list of operators the process followed by ARTEC and considered to have significant influence in the the Ministry of Telecommunications for market has persisted despite this requirement disbursement is unclear. being included in its founding statute (Law 2005-023) nearly 15 years ago. Unlike other 13. Allocative efficiency of available spectrum countries, the regulatory agency has not is also being compromised by current determined interconnection charges, while practices related to spectrum assignment. in countries like Kenya, Rwanda and Tanzania, Spectrum allocation has so far been assigned regulators have introduced glide paths¹⁴⁴ for on a first come first served basis, rather than the reduction of such charges, with positive through a competitive and transparent basis. In impacts on final tariffs.¹⁴⁵ addition, it appears that the incumbent has been granted some advantages in its assignment 12. Investments in rural areas (last mile of spectrum, through access to a contiguous infrastructure) are also being constrained by block of frequencies while rivals have scattered both regulatory and non-regulatory barriers. blocks, allowing the incumbent to operate at a In areas without existing backbone, the cost lower cost.¹⁴⁷ Addressing this situation requires of a license to lay such infrastructure has developing a modern spectrum assignment been reported to be prohibitive, hindering policy, including competitive and transparent investment in last mile services and access assignment mechanisms. ¹⁴³ There are no provisions to implement an essential facilities doctrine. OECD specifies the ‘Essential facilities doctrine’ as when the owner(s) of an “essential” or “bottleneck” facility must provide access to that facility, at a reasonable price. http://www.oecd.org/competition/abuse/1920021.pdf. ¹⁴⁴ A glide path is a prescribed price path over time, so companies are given proper signals for future cost containment and investments. ¹⁴⁵ World Bank. 2015. Unlocking growth potential in Kenya: dismantling regulatory obstacles to competition (English). Washington, D.C. : World Bank Group. http:/ /documents.worldbank.org/curated/en/946191481707622675/ Unlocking-growth-potential-in-Kenya-dismantling-regulatory-obstacles-to-competition pg. 42 ¹⁴⁶ Mission findings revealed that mobile operators other than the incumbent were not able to put up their own fiber infrastructure under their current license arrangements. Acquiring permission to construct infrastructure requires obtaining a new license, where costs are relatively high. ¹⁴⁷ Aide Memoire: “Mission d’étude de l’environnement règlementaire et de la concurrence du secteur des TICs à Madagascar”, 18-22 February 2019 88 5 | Addressing Anti-Competitive Practices 14. Enforcement of competition laws and markets. The incumbent is part of a larger policies is also weak due to governance conglomerate which is active in sectors that challenges. Anticompetitive practices by utilize ICT services, such as financial services. firms (such as abuse of dominance and Telma’s significant market position in segments cartelization) can be prosecuted ex post under such as fixed internet services which are key the sector-specific regulation and under the inputs for firms in downstream sectors, raises competition law.¹⁴⁸ However, ARTEC has not the risk of exclusionary behavior through refusal exercised these provisions and the activities to deal with its parent company’s downstream of Madagascar’s Competition Council have competitors. Such behavior could be dealt been limited to date. As the activities of the with through proper enforcement of abuse of Competition Council grow, it will also be dominance provisions in the competition law. important to manage the concurrency of powers between ARTEC and the Competition (ii) Focus sector: Petroleum Council to maximize the benefits of ex post competition enforcement. This could involve 16. The petroleum sector plays a key role in incorporating a collaboration framework access to electricity and related goods and between the two bodies to facilitate case services, but low levels of purchasing power referrals, investigations, and sanctions. means that consumption is limited to the Finally, the governance structure of ARTEC, better off. Fuel is used as an input for producing including selection of board members and a range of goods, such as processed foods, and accountability, does not ensure sufficient services such as electricity and transportation; a independence and decision-making ability. situation which is likely to continue in the short- While individuals appointed to the board term as the transition to renewable energy cannot be employees of an entity licensed supply is underway. However, the price of fuel by ARTEC, their affiliation can sometimes is currently inaccessible for the majority of the hinder their independence. Furthermore, population. Only the wealthiest 20 percent ARTEC is accountable to two ministers, the consume gasoline and diesel, and account Minister for Telecommunications and ITC for 85 percent of electricity consumption. The and the Minister of Economy and Finance, richest 40 percent account for close to 90 and its independence may be limited by the percent of public transport utilization, and the unusually prominent role that these ministers wealthiest 60 percent consume over 80 percent play with regards to ARTEC’s strategy and of processed foods. Low levels of consumption workplan, which both require approval from by the majority of the population reflect limited both ministers, contrary to good practices purchasing power. For the specific case of jet observed in other countries.¹⁴⁹ fuel, the price is higher in Madagascar than other comparator destinations, which is passed 15. There is a risk of exclusionary behavior through to consumers in the form of fares for by dominant telecoms players in adjacent passenger tickets and cargo. ¹⁴⁸ The new Madagascan Competition Law No. 2018 – 020 on the recasting of the Competition Law (repeals the Competition Law No. 2005 – 020 of October 17th, 2005) lays out the establishment, functions, and institutional arrangement of the Competition Council. The Competition Council was fully constituted in 2015 but has not been very active in regulation competition, investigating and sanctioning anticompetitive practices. Article 37 of the Act provides for collaboration between the Ministry of Trade, which also has a competition mandate, and other specialized agencies ¹⁴⁹ Law 2005 – 023 and Decree 2006 -213, articles 13 and 30 89 Addressing Anti-Competitive Practices | 5 17. Prior to recent reforms, the fixed cost 18. To reduce the final retail price of fuel, elements of the final price of fuel in without reverting to a universal price subsidy, Madagascar have been higher than other the government started negotiations with countries. Changes in global oil prices as petroleum companies in January 2018. well as costs related to importing fuel to the Following several rounds of negotiations, country, storage and transportation of fuel petroleum companies agreed, in June 2019, to within Madagascar and taxes all contribute reduce the price per liter of fuel and decrease to the final retail price of fuel. These different the maritime freight cost.¹⁵¹ Furthermore, elements of fuel prices should be calculated companies agreed for these measures to using a formula. However, in practice, prices be applied retroactively starting on January have been changed on an ad-hoc basis, as 1, 2019, allowing the government to use the the government has hesitated in passing cost savings over the first six months of the through changes to global oil prices to year to pay off the accumulated arrears due consumers. An assessment of the formula to petroleum companies. Such an outcome for determining the final price of fuel demonstrates that the government has revealed that the margins maintained by the capacity to determine policies even in petroleum companies related to storage and concentrated markets, as well as marking distribution were higher in Madagascar than a more permanent solution to reducing the in comparator countries, thereby contributing price of fuel without reverting to a regressive to an elevated final price.¹⁵⁰ universal price subsidy. Figure 66: The price of jet fuel oil is higher Figure 67: The combined costs of in Madagascar and is amongst the highest transportation and storage and distribution in Africa and other major destinations and margins were until recently the highest in Madagascar compared with Jet fuel prices, in US$ per liter benchmark countries 1.40 Costs in each country as a percentage of average 1.20 costs for the sample countries 1.00 0.80 350% 300% 0.60 250% 200% 0.40 150% 0.20 100% 50% 0.00 0% Marseille (MRS) Paris (CDG) Saint Denis (RUN) Guangzhou (CAN) Johannesburg (JBN) Port Lous (MRU) Victoria (SEZ) Mauritania Tanzania Antananarivo (TNR) Moroni (HAH) Dzaoudzì (DZA) Senegal Reunion Burkina Togo Kenya Ivory Coast Guinea Conakry Mali Madagascar Transportation & storage Distribution & margins Source: Airline data obtained by Airport and National Airline surveys (2018) Source: Beicip-Franlab Industry Assessment ¹⁵⁰ Study of the reference calculated price undertaken between November 2016 to May 2017 by Beicip-Franlab and financed by the Energy Sector Management Assistance Program of the World Bank. ¹⁵¹ The cost of fuel per litre decreased by 100 Ariary for gasoline (2.4%), 150 Ariary for diesel (4.2%) and 500 Ariary (19%) for kerosene. The maritime freight cost decreased from 65$/metric ton to 40$/metric ton. 90 5 | Addressing Anti-Competitive Practices 19. The organizational set up of the that the petroleum companies maintain petroleum and jet fuel markets result in significant market power. the private sector having significant market power. There are four major players in the 20. Furthermore, the state maintains a dual import and distribution of petroleum,¹⁵² role of being a shareholder in petroleum two companies involved in the storage and companies and seeking to regulate the transportation of petroleum,¹⁵³ and only one sector, which are arguably incompatible. As in the case of the jet fuel market. As such, a shareholder, the state has the objective of the petroleum fuel market is characterized increasing the profitability of the petroleum by a high degree of concentration,¹⁵⁴ while sector. Even though the state sold its majority the jet fuel market operates as a monopoly. shareholding during the privatization wave in Fu r t h e r m o re , l i n k s b e t we e n t h e s e the 2000s, shareholding rights are maintained, companies are strong and they appear to which the government views as being important act in concert with each other on strategic for accessing information on the sector and matters, such as price, through the industry having Board representation. However, in association, Groupement Pétrolier de practice, the government has not been able Madagascar (GPM) which is highly influential to leverage this opportunity and has limited in the regulation of the sector.¹⁵⁵ Another access to information. At the same time, the example of coordinated behavior includes regulatory authority, the Office of Madagascar joint shipment to minimize marine transport Hydrocarbons (OMH) is tasked with ensuring costs and realize economies of scale given that fixed costs are reasonable as per industry the relatively small market. While this can standards; a role which it has not been able to lead to efficiency gains it can also facilitate effectively play thus far. The OMH also relies collusion. The sector’s market structure, with on technical and financial information from the common ownership and vertical integration industry body (GPM) which may lead to risks of of storage and transport facilities means capture or conflict of interest. ¹⁵² Jovena (a subsidiary of Axian Group, also the majority owned of Telma) having the largest market share); Galana (part of the Rubis group); Vivo Energy; Total Madagascar. ¹⁵³ Galana Refinery in Tamatave (GRT) owned by Rubis; Petroleum Logistics Company (LPSA), owned by Total and Vivo (see Figure 68 for an illustration of market structure). ¹⁵⁴ Market concentration can be measured through the Herfindahl-Hirschman index (HHI), which considers the number of firms and the market share they account for. Madagascar’s petroleum sector has an HHI of 0.27. A market with an HHI above 0.18 is generally considered concentrated, while less than 0.1 is generally considered unconcentrated. Kojima, M., Matthews, W., & Sexsmith, F. (2010). 'Petroleum Markets in Sub-Saharan Africa'. Washington DC: World Bank. ¹⁵⁵ Madagascar Economic Update (Spring 2019) ‘Managing Fuel Pricing’ 91 Addressing Anti-Competitive Practices | 5 Figure 68: Petroleum market structure Galana Jovena Vivo Energy Total Groupement distribution Import & New Entrant Petrolier de GoM: 10% GoM: 6.4% GoM: 20% GoM: 20.6% Madagascar (GPM) Ownership Common Potential ownership for refusal Storage & transport to deal GRT LPSA from incumbents GoM: 10% GoM: 31% Source: Beicip-Franlab Industry Assessment; Madagascar Economic Update Spring 2019; Note: % shows government shareholding in each company. Government of Madagascar holdings in each of the companies is shown in yellow. 21. Currently, there is no price competition 22. The fixing of petroleum prices has taken for petroleum products. As per the law, the advantage of a provision in the Competition price of petroleum must be the same in all Law but has not been accompanied by regions of the country. However, there is no collaboration between OMH and the price competition between firms, despite Competiton Council to assess the economic their operating costs being different. Prior to basis for the fixed price. The Competition Law the political transition period, one petroleum contains a provision for price fixing in certain company did lower prices in order to increase strategic sectors, contrary to the principles market share. However, this company of competition. However, the fixing of prices was not able to successfully procure fuel has not evolved in consultation with the afterwards, given the joint transportation and Competition Council, where there has been storage arrangements, which was one of the no full assessment of whether the conditions contributing factors behind its transition out of that jusitfy price controls are present, as would the Malagasy market. To date, the regulatory be required under the law. authority has made minimal attempts to encourage price competition amongst 23. There are both regulatory and non- petroleum companies. Allowing companies regulatory barriers for new players to to access common infrastructures regardless access the petroleum market. While the of whether they compete in price should be Law 2004-003 on the liberalization of the encouraged through the Competition Law and downstream petroleum sector includes the promoted by the Competition Council as well objective to encourage new entry, in practice as the regulatory agency. For the case of jet there has been limited penetration by new fuel, the price is determined by the supplier actors. To the contrary, legal provisions such who has the monopoly of the market. Due as requiring new firms to have a minimum to higher prices of jet fuel in Madagascar coverage in all eight petroleum zones, compared with other destinations, international including in geographical areas where airline companies aim to refuel elsewhere while markets are small with limited profitability, domestic airlines have no other choice, which requires significant investment costs and compromises their overall competitiveness. is a deterrent for new operators.¹⁵⁶ High ¹⁵⁶ Law No 99-010 of 17 April 1999, revised by Law No2004-003 of 24 June 2004 and Decree No2004-669. 92 5 | Addressing Anti-Competitive Practices costs to obtain and comply with licensing export revenues and income for smallholder procedures have also restricted entry into farmers. Lychees are a source of income for various sections of the petroleum value chain more than 100,000 farmers and seasonal resulting in concentration and increased costs. workers in Madagascar with most of the While new entry is unlikely to solve all issues potential of the sector stemming from in the sector, it is important to encourage an export markets.¹⁵⁷ Production of lychees environment where entry is possible to allow is primarily done by smallholder farmers, for some market contestability and prevent bought at farmgate by collectors, and sold potential cartelistic behavior. In the case of to exporters who operate sulfur treatment the jet fuel market, only one company has plants (Malagasy lychees are generally the license to supply the market, which has sulfur-treated for preservation during been justified on the grounds of the high initial transport) or other processing facilities (see investment costs. Such a situation where there Figure 69). Exporters are also responsible for are limited options for new players to enter the the packing, storing and transport of lychees market and fix prices contributes to market to the airplane or boat. Export revenues dominance by a limited number of companies are estimated to account for more than 80 and limits incentives to improve quality and percent of all revenues from sales of fresh innovate to gain market share. and processed lychees in Madagascar.¹⁵⁸ Around 90 per cent of Malagasy lychees are (iii) Focus sector: Lychee exported to Europe, although other export destinations include Russia, the Middle East, 24. Lychees are an important source of and East Asia. Figure 69: Graphical representation of the value chain for lychee export Export of early lychees by air Cash advances Lychee Collection & Export of sulfur-treated production Transport Treatment lychees (by sea) Planet production Export of processed lychee Processing (by sea) Input supply Production Collection Processing & Export Functions Treatment - Collectors/processors - ~30,000 smallholder - Producers for first - Exporters equipped - Exporters ~29 firms Actors (financing) farmers packing with sulfur-treatment - ~25,000 seasonal - Exporters (financing) - Industrial plantations - Approx. 280 collectors in and packing station workers, including - CTHT and tree nurseries - ~45,000 seasonal the region of Tamatave - Processors-exporters processing by exporters (plantlets production) workers for export - Processing industries (pulp, puree, juice) - ~4,000 seasonal workers Source: WBG Markets and Competition Policy Team. Given the central role of exports, this diagram and analysis in this section focuses on the value chain for exports of fresh and processed lychees. ¹⁵⁷ Lychees are grown by 30,000 smallholders in the Tamatave, Manajary, Manakara and Forth Dauphin regions along the east coast of Madagascar. In addition, 75,000 seasonal workers are involved in the harvesting, collection, processing and packing of lychees. See ILO (2017) Chaîne d’approvisionnement du litchi de Madagascar: Facteurs incitatifs et contraintes pour l’amélioration de la sécurité et de la santé au travail. ¹⁵⁸ Assuming a domestic retail price of 500 Ariary per kilogram, an export price of 2000 Ariary per kilogram, and equal sales volume in domestic and international markets. 93 Addressing Anti-Competitive Practices | 5 25. Despite Madagascar’s privileged divided between GEL members. One of the position in dominating the European market functions of GEL is to maintain their exclusive over winter, less than half of the harvest relationship with the two European importers, is commercialized resulting in a missed which is facilitated through enforcing the quota opportunity to raise incomes for farmers on lychee exports. Part of the explanation and create jobs. Madagascar dominates behind the organizational practices of GEL the international market for lychees and its relationship with the two importers is between December and February in Europe, related to challenges in maritime transport, representing approximately 80 percent of which is expensive and requires advance produce during this period.¹⁵⁹ However, this financing by the importers. position is not maximized, whereby of the 70,000-100,000 tons of lychees harvested 27. In cases where new investors may wish in Madagascar only 30,000-40,000 tons are to enter the lychee market and collaborate typically commercialized. Market participants with other importers, access is limited by estimate that about half of the sold produce high barriers to entry. Regulatory barriers reaches international consumers and the include the need for exporters to have a other half domestic consumers.¹⁶⁰ Such a sulphur treatment plant that meets minimum situation results in missed opportunities to standards. However, this restriction prevents create better jobs for farmers and to increase entry by exporters who do not need to export revenues. engage in sulfarization, and moreover, the regulations do not state the minimum 26. Decisions over the quantities to be standards, leaving substantial room for the sold are determined by the exporters’ discretionary granting of licenses. Members association, which works with importers who are not part of the GEL, or members that and the government, to set export quotas. have attempted to exceed their official quotas The exporters’ association, Groupement de have reportedly been blocked from shipping Exportateurs de Litchi (GEL), exports over 90 at the port. Furthermore, a lack of competition percent of Madagascar’s lychees (by volume) enforcement means that risks of potentially to two European importers, who are meant to collusive behavior (in the market for buying be selected by the government in a tendering lychees and in export) are not monitored. procedure every two years. However, in practice, a new call for proposals among 28. In addition to the exports of lychee being European importers has not been initiated restricted, farmers also have limited options since 2013, which prevents competition to negotiate prices. Lychees are highly among importers and therefore the potential perishable, which means that sales from to boost export opportunities. The export the farm are constrained to local markets. volume is agreed between GEL and the two In many lychee growing areas, farmers do importers, Greenyard Group and Novagrim not have access to roads, which reduces (currently capped at 17,500 tonnes), which is their negotiating power with collectors who ¹⁵⁹ Background report by Henri Michael Tsimisanda. Madagascar’s production is estimated at 70,000-100,000 tons p.a. See also Houbin, Chen, Xuming Hang (2012). Overview of litchi production in the world. 4th International Symposium on Lychee, Longan and other Sapindaceae Fruits. White River, South Africa. Acta Horticulturae, International Society for Horticultural Science. ¹⁶⁰ Interviews with lychee exporters in March 2019. 94 5 | Addressing Anti-Competitive Practices have the transportation means to reach the global exports since 2014.¹⁶¹ Vanilla exports farmgate. Furthermore, smallholders have accounted for 26 percent of Madagascar’s limited access to information about prices export revenue in 2017¹⁶² and contributed in other locations, which constrains their around 6.8 percent to national GDP. The sector decisions on where and when to sell lychees. supports more than 80,000 farmer households Farmer’s weak bargaining power related to and over 6,000 intermediaries. Along with poor connectivity is exacerbated by low levels seasonal employment, vanilla generates of access to credit and limited yields per around 200,000 direct jobs, mainly in the Sava farm due to small plot size, which is cross- region (North East coast), which produces 85- cutting for other value chains, such as rice (see 90 percent of Malagasy vanilla.¹⁶³ Increasing chapter 4). These factors combined contribute vanilla exports, mainly by improving quality, to farmers being disconnected from markets has been a key aim of the government. and have limited negotiating power. 31. However, smallholder farmers are not 29. Going further along the value chain, taking the bulk share of the final price. collectors of lychees face fixed prices, Vanilla farmers typically sell their beans restricting competition in buying markets. In to intermediaries before any processing. turn, the collectors of lychees generally work Unprocessed or green vanilla cannot be stored exclusively for one exporter, where a set price without deterioration in its quality and therefore is agreed in advance. All exporters agree the must be sold shortly after harvest. While most same price for lychees from the collectors. sales occur on an informal spot market, mostly The collective fixing of buying prices among at farm gate or the street, official local wholesale exporters is likely to restrict competition markets are also used for sales. In the case of in buying markets and therefore is to be green vanilla, collectors (who are often hired detrimental to farmer incomes. In addition, and financed by preparators or exporters) buy for the small portion of lychees that are vanilla from different farmers or from smaller exported outside of EU markets, the GEL has collectors. Figure 70 gives an overview of the autonomy to set reference prices, thereby functions, activities and actors along the chain. also limiting price competition, without a While reports suggest that some farmers have substantial socio-economic justification. been able to benefit from recent high prices,¹⁶⁴ most farmers are not involved in value-adding (iv) Focus sector: Vanilla activities downstream, such as curing, which could significantly increase farmers’ selling 30. Vanilla is experiencing a global price power by allowing them to store the dried, surge, and Madagascar is the leading non-perishable product. Barriers to curing by exporter. Low labor costs and a well-suited farmers include technical know-how, space climate have allowed Madagascar to develop and labor constraints, cash needs at the a dominant position in the international vanilla beginning of the season, as well as minimum market, accounting for more than half of capacity requirements for curing. ¹⁶¹ FAOStat, 2018. ¹⁶² Observatory of Economic Complexity, 2017, https://atlas.media.mit.edu/en/profile/country/mdg/ ¹⁶³ International Labor Organization, 2011. ¹⁶⁴ Interview (2019) 95 Addressing Anti-Competitive Practices | 5 Figure 70: Value chain of export vanilla Export of black vanilla Cash advances Vanilla Collection & Export of Production Transport Curing & Packing red vanilla (EU/US) Vanilla seedlings Processing & Export of Farmgate sales Packing vanilla extract Functions Input supply Production Collection Processing Export - Loan provision - Growing (planting, - Collection of green - Sorting - Packing Activities - Technical assistance pruning, pollination) beans from farms - Traditional curing - Transport to port/airport - Vanilla seedlings - Harvesting - Transport to (70% or less) - Storage - Vanilla vines and tutor - Curing (20% of processing plants - Quick curing (20 - 30%) - Brokerage trees producers cure vanilla) - Secondary processing Actors - Exporters (technical - Independent - Collectors (approx. 3,000, - Farmers and - Exporters (123 licensed in assistance to <10,000 smallholder 10% formal) and agents préparateurs 2018, 15 main/trusted) farmers and loans) farmers (60,000+) working with collectors (traditional hand curing) - Symrise has 70% market - Microcredit institutions: - Cooperatives/ (mandataires) - Commission agents share in vanilla extract loans producers' - Commission agents - Collectors - Four export companies - Commission agents/ associations linked - Processors - Exporters (e.g. QCP) acount for about 50% of collectors (flower to exporters - Exporters beans (Somava, contracts) - Industrial plantations Authentic Products - NGO (seedlings) M/CAR, Origines/Symrise, Planifolia - Traders and brokers Source: Prepared by the Markets and Competition Policy Team of the WBG 32. The vanilla chain is highly controlled registration process is managed by an industry and regulated, protecting vested interests board that is composed, among others, of and limiting entry and growth of collectors, representatives of incumbents (including processors and exporters. There are collectors, preparators, exporters and farmers) requirements on the minimum and maximum raising a possible conflict of interest that may size of operations and other restrictive entry hinder the entry of new operators. rules. For instance, preparators wishing to buy or sell green vanilla in official markets 33. Government interventions in the sector are required to demonstrate the capacity to have also resulted in limiting options of cure at least five tons of produce. Collectors producers. The government requires sales are not allowed to employ more than five of green vanilla in official markets (marchés agents. Exporters are required to renew their contrôlés) to maintain quality control, protect license on an annual basis. All buyers and farmers and limit incentives for theft – but sellers in official markets for green vanilla these markets may also hinder alternative need to be registered. According to regulation, commercialization options for farmers (such the Regional Directorate for Trade provides as contract farming). Government prohibited an opinion on the registration of collectors, vacuum packaging in 2016 (agreed by the preparators and exporters, while the Regional Ministry of Commerce in collaboration with Directorate for Rural Development opines the National Vanilla Platform which represents on registration of planters. Meanwhile, the the main exporters) to safeguard against 96 5 | Addressing Anti-Competitive Practices reputational risks given issues with buyers assessing the quality of vacuum-packed D. Policy options and reforms vanilla on purchase,¹⁶⁵ as well as to limit to address anti-competitive premature harvests. However, the ban can behaviors limit selling options by encouraging players to sell produce immediately to avoid product (i) Sector-specific reforms deterioration and may prevent volumes from responding to price signals. Overall, the 35. In the telecommunications market, market regulations have reduced the price reforms could result in lower prices of elasticity of supply, which can exacerbate broadband and higher levels of penetration, price volatility. which would also contribute to growth and support industries such as IT-BPOs and 34. Facilitating the entry of new players the financial sector. Key reforms include: into the local vanilla market could help (i) the regulatory agency identifying actors Madagascar preserve its global market with significant market power; (ii) ensuring position while benefiting a greater share access to bottleneck facilities by third parties; of the population. With vanilla prices (iii) ending the prohibition of investing in high, more farmers are likely to enter the backbone infrastructure in areas that could market in Madagascar as well as competitor compete with the incumbent; (iv) reducing destinations, which should in the medium- the costs of licenses; (v) the competitive term help to bring prices down. Madagascar assignment of spectrum; (vi) ensuring the currently holds 80 percent of the world Universal Services Fund is objectively used market for vanilla. Vanilla is a very labor- to deliver investments in rural areas; (vii) intensive commodity, because it requires considering possible asymmetric regulation that vanilla plants are pollinated manually. of interconnection rates; and (viii) improving However, at a price that represents five the functionality and independence of the times the price three years ago, Madagascar’ regulatory agency. comparative advantage of low labor costs is getting eroded as other countries with 36. In the petroleum market, addressing higher labor costs like Uganda are now able anti-competitive practices could result in to invest in the vanilla production.¹⁶⁶ Similarly, increased price competition and a reduction the current price makes investments in better in jet fuel prices. Key reforms include: synthetic alternatives attractive.¹⁶⁷ These new (i) enforcing the requirement for OMH to players will ultimately drive prices down and obtain greater access to firm’s operating will result in Madagascar losing market share. information including details on actual costs; A strategy that would promote domestic (ii) encouraging price competition for retail competition would also result in lower fuel prices through the monitoring of price prices but would not lead to a loss in export fixing / market division by the Competition revenues and would promote employment Council; (iii) reducing barriers to entry for in Madagascar rather than abroad. new firms including access to transport and ¹⁶⁵ Potentially due to failure to enforce original regulation of vanillin and moisture content of vacuum-packed vanilla. ¹⁶⁶ https://www.bloomberg.com/news/articles/2018-03-07/vanilla-production-in-uganda-surges-as-farmers- battle-thieves ¹⁶⁷ https://www.ft.com/content/f16d8766-ee13-11e6-930f-061b01e23655 97 Addressing Anti-Competitive Practices | 5 storage infrastructure; (iv) applying gradual the lychee example, for international firms asymmetric regulation on the minimum to undertake audits of the value chain; and coverage requirement; (v) allow other firms in (v) for the government to limit interference the jet fuel market to access licenses; and (vi) in markets and allow for contract farming or encourage consumer groups to monitor prices other forms of value chain organization such and engage in advocacy-related activities. as Public Associations with Private Interest. 37. In the lychee market, reforms to open (ii) Economy-wide reforms the export market could result in higher market demand for farmer’s produce, 39. Institutional reforms should help to which could create jobs and encourage address economy-wide anti-competitive further production. Key reforms include: practices, building on what is already (i) remove the export quota; (ii) streamline working and expanding, or leveraging requirements for licenses including removing experiences from other countries in similar the requirement to own a sulphur treatment situations. In the case of commercial justice, plant and clarifying minimum standards to some cases could benefit from alternative avoid discretion in interpretation; (iii) review mediation which could be set up building on the role of GEL, under a new framework for experiences in other countries.¹⁶⁸ To avoid private associations with public interest; and the manipulation of fiscal administration, (iv) build coalitions between international well-designed performance-based measures organisations, NGOs, civil society and should continue which have had proven governments to encourage buyers/importers success in the area of customs.¹⁶⁹ While to undertake value chain audits in line with Madagascar took a first step in publishing Corporate Social Responsibility requirements. tax expenditure statements, further progress can be made through making transparent the 38. In the vanilla market, reducing barriers criteria used to justify the award, to enhance to entry and government regulation could public scrutiny.¹⁷⁰ Similarly, open contracting result in more farmers being able to principles could be gradually applied to participate in the value chain. Key reforms procurement and the award of licenses.¹⁷¹ include: (i) removing an arbitrary ban on vacuum packing in favour of better labelling, 40. The institutional basis for competition traceability and stronger enforcement; (ii) should be strengthened by improving the lifting restrictive regulatory barriers such as content of the competition law. Recent the cap on the number of agents that can amendments to strengthen the law include work with a supplier; (iii) the Competition clarifying considerations in determining Council to monitor examples of price setting dominance, amending the provision on and other collusive behaviors; (iv) similar to monopolies such that the abuse of monopoly ¹⁶⁸ http://pubdocs.worldbank.org/en/952171510251453291/IPP-Tools-booklet.pdf. Examples include: Bosnia & Herzegovina, Dominican Republic and Georgia, as well as more recent pilots in Albania, Colombia, Kyrgyz Republic and Mongolia ¹⁶⁹ http://documents.worldbank.org/curated/en/714611506078407127/Customs-reform-and-performance-contracts- early-results-from-Madagascar ¹⁷⁰ http://documents.worldbank.org/curated/en/970941498201633115/pdf/116658-PUB-Date-6-16-2017-PUBLIC.pdf ¹⁷¹ https://openprocurement.io/en/cases/prozorro. See for example: Ukraininan ProZorro system – used open contracting standards 98 5 | Addressing Anti-Competitive Practices power is prohibited, including penalties for most In addition, in other countries, a leniency anticompetitive practices, and strengthening program¹⁷² has been developed, to encourage the financial and administrative framework firms to come forward and provide evidence for the Competition Council. However, there of cartels. Ensuring the effectiveness of the is further scope to improve the law, to include Competition Council requires implementing the per se prohibition of hardcore cartels. safeguards for its independence, particularly Furthermore, the competition law also provides in sectors which are dominated by politically for price controls, which may build on requests connected operators. Going forward, the from private operators for sectors characterized Council should be provided with sufficient by a monopoly or “difficulty in supply”, thus not resources, to enable the institution to undertake limiting the use of price controls to cases where independent inquiries and investigations. In there is a clear market failure. Addressing these addition, the Council should collaborate with shortcomings in the law may merit the approval regulatory agencies on sector specific issues of secondary legislation. to interpret the application of the Competition Law to sector specific practices. 41. Weaknesses in the Competition Council are amongst the constraints to the effective 42. For regulatory agencies to enhance their implementation of the competition law effectiveness, it is important to improve since 2005. Across all the sectors reviewed appointment procedures to enhance in this chapter, there is ample scope for the independence. For example, in the case of Competition Council to increase monitoring the telecommunications regulatory agency, and sanctioning of anticompetitive behavior, while individuals appointed to the board to estimate quantitative impacts of a lack of cannot be employees of an entity licensed by competition, and to communicate the results ARTEC, their affiliation can sometimes hinder to the public and policy-makers. However, their independence. Learning from other these activities are not being undertaken to a countries, Board members could be hired significant degree. To enhance the deterrence following an open and competitive hiring effect of the law on anticompetitive behavior, process, and in some cases, international the Council needs to build a credible threat of expertise could also be sought, particularly enforcement action with sufficient penalties. in the early phase of a regulatory agency Developing a framework for settlements will undergoing reform to provide practical also help increase efficiency of enforcement. guidance on effective regulation. ¹⁷² Leniency can be described as a system of immunity and reduction of fines and sanctions that would otherwise be applicable to a cartel participant in exchange for reporting on illegal anticompetitive activities and supplying information or evidence. More than 50 jurisdictions have adopted a leniency program including: Australia, Brazil, China, Germany, India, Korea, Malaysia, Mexico, Russia, Singapore, South Africa, UK and USA; and the EU. 99 UNDERSTANDING COMOROS' Summary of Reforms LOW GROWTH PERFORMANCE 67 100 6 | Summary of Reforms This chapter summarizes key reforms from the Madagascar Country Economic Memorandum: Scaling Success: Building a Resilient Economy. The reforms consider how improvements could be made to connectivity, labor productivity and human capital, doing business institutions, as well as incentives to encourage the use of improved technologies in the agriculture sector. A. Introduction place, timely execution is undermined by the poor public investment management 1. This chapter presents the priority reforms practices, particularly for projects that identified from previous chapters, to facilitate are externally financed. Addressing productive, inclusive and sustainable growth these constraints could help to unlock in Madagascar. The recommendations of the infrastructure that could facilitate trade CEM build on the successes of the sectors along major agricultural corridors within that have driven growth over the past six the country, and also further support years, to distill the lessons learned and integration with major trading partners. alleviate constraints that could help to realize Efforts to develop new infrastructure exponential growth. Three types of reforms can should be considered alongside planning be identified: (i) areas reforms and investment for operations and maintenance of the plans are ongoing; (ii) areas where there is existing infrastructure stock. emerging momentum for reform; and (ii) areas where progress has been much more limited. • Extend the open skies agreement and The priority areas in the General Policy of the reform the domestic air transportation Government, were also carefully considered, segment. While Madagascar has started where there is close alignment with the the process of moving towards an open themes in this report, such as promoting skies agreement, there is scope to much decent employment for all, enhancing human further through the opening of new capital through health and education services routes and allowing new airlines to fly and improving physical infrastructure. into the country’s airspace. The domestic air transportation sector could also be B. Pathways for Enhancing strengthened, which would require both Inclusive Growth policy reforms and new infrastructure, including enhanced competition in the 2. The priority reforms are grouped by the jet fuel market. pathways most important for enhancing inclusive growth including: strengthening • S t re n g t h e n c o m p e t i t i ve n e s s of connectivity, developing human capital, the telecommunications industry. levelling the playing field, and enhancing S u b s t a n t i a l i nve s t m e n t s i n t h e agricultural productivity (Table 9). telecommunications sector have resulted in Madagascar having exceptionally 3. Strengthening connectivity fast broadband speed, although high • Improve execution of pipeline road costs relative to incomes means transport projects. While there are that penetration rates are low. The several pipeline infrastructure projects in momentum to strengthen competition 101 Summary of Reforms | 6 of the telecommunications sector could of making renewable energy affordable be concretized by strengthening the role is reforming the state-owned utilities of the regulatory agency to: (i) identify company, JIRAMA, so that it is a credible actors with significant market power; (ii) off-taker for privately financed projects. to determine the objective allocation of the Universal Services Fund; (iii) to 4. Human capital and labor allow for the competitive assignment of • Strengthen basic public services spectrum; and (iv) to consider possible through multi-faceted interventions. A asymmetric regulation of interconnection reform momentum has already started, rates). Access to critical infrastructure particularly in the education sector, could also facilitate competition, but efforts need to be accelerated for example by allowing access to if Madagascar is to improve learning bottleneck facilities by third parties and outcomes and reduce unacceptably high by ending the prohibition of investing in levels of stunting. A holistic approach to backbone infrastructure in areas that teacher training and career management is could compete with the incumbent. required, as well as ensuring that teachers are competitively recruited according to • Enhance access to electricity from their skills. Addressing stunting requires re n ewa b l e e n e rg y s o u rc e s by strengthening the health system (such as implementing the least-cost development investing in health workers, and enhancing plan and reforming JIRAMA. Substantial monitoring and management), improving reforms have commenced to address access to water and sanitation services, low electrification rates and the poor as well as promoting positive parenting financial health of the state-owned utilities practices such as nutrition. company, which requires continued momentum. Key reforms include ensuring • Increase resources for human capital that pipeline renewable energy projects related expenditures to be supported are implemented according to plan, by improved financial management and that these new investments are systems and procedures. Expenditures on selected on a least-cost basis in line with education and health in Madagascar are demand and capacity to pay, supported amongst the lowest in the world. However, by financial, social and environmental to make the case for increasing public feasibility studies. Critical to the endeavor spending, reforms would need to continue A holistic approach to teacher training and career management is required, 102 6 | Summary of Reforms to improve financial management practices enhanced by tackling the non-regulatory to reduce the possibility of leakages. barriers to entry which give certain firms advantages such as discretionary • Encourage female leadership to help procurement and fiscal practices. enhance productivity and the possibility of Madagascar realizing a demographic • Encourage new investors to Madagascar dividend. Female labor force participation could involve the enforcement of the in Madagascar is high, but the quality Trade Facilitation Agreement. Such of employment is low, given the large measures would involve identifying and prevalence of informality and subsistence eliminating discretionary procedures agriculture. Firms that employ females and supporting Investor Aftercare in positions of leaderships have been Programs. Going further, improvements to shown to have higher levels of labor and commercial justice and arbitration could productivity growth. Madagascar’s fertility also help to encourage investment by rates are declining, and the country is promoting fairer access to markets. characterized by its youthful population (41.6 percent of the population are below • The business environment could further 15 years old). Encouraging females in be enhanced through the lowering leadership positions can have a role- of interest rates, which would require modelling effect for the next generation, reducing risks. Recommendations to which may provide further incentives for reduce risks include making the credit reducing fertility rates, particularly as the registry available, adopting a law on formal sector expands. movable collateral to allow assets- based lending, and improving the legal 5. Levelling the playing field infrastructure and efficiency of the • Strengthen the institutional framework judiciary system, such as credit and for competitive behavior to promote bankruptcy proceedings. productivity and the sustainability of growth. Weaknesses in the investment 6. Incentivizing the uptake of improved climate have resulted in firms finding technologies, particularly in the agriculture alternative ways of doing business, sector including through the manipulation of • Bring farmers closer to markets by rules and regulations. Addressing these improving connectivity. Improvements to challenges requires a multi-faceted rural roads can bring farmers physically approach. In certain agribusinesses closer to markets. These efforts can be such as cocoa, private associations with complemented by bringing farmers public interest have been important for figuratively closer to markets, for example ensuring the benefits of exports are felt through a warehouse receipt system, more inclusively, which could be further which would allow farmers to produce promoted under an overarching regulatory and sell when prices are higher, and for framework. The Competition Law could traders to position their stock around the be further strengthened to specifically country until physically needed. However, prohibit the use of cartels, which could for the warehouse receipt system to be be supported by an effective Competition effective, farmer organization would Council. These measures could be further have to improve, for example through 103 Summary of Reforms | 6 cooperatives. Establishing regional rice could be complemented by investments mills would also reduce the cost of in remote sensing systems that help to transporting rice across long-distances gauge crop yields to determine where and improve the competitiveness of surpluses exist across the country. domestic farmers. • The reversal of arbitrary bans on • Promote access to information to the exportation of rice and other help address market inefficiencies. commodities could also help to Investments in even very simple incentivize the exports of agricultural information systems for rice and other goods. Specialty rice that serve niche crops would be a good way to improve markets have been subject to exports market efficiencies, for example through bans which are unevenly applied. radio bulletins, which was previously Reversing these ad hoc bans could implemented, but came to an end once help to improve the predictability of the donor financing stopped. These efforts business environment. 104 6 105 Table 9: Summary of Key Reforms and Expected Impacts | Key Issue Proposed reforms Link between the CEM and the Government’s General Policy Strengthening There is a pipeline of national roads (largely • Strengthen systems to support the • Inclusion (Chapter 2): improvement of road connectivity externally financed) but implementation has not execution of externally financed investment networks will unlock connectivity constraints followed the expected pace projects (ongoing) to major agricultural production zones. • Consider new financing sources for O&M • Pillar 11 of government’s program on Summary of Reforms (such as parking, vehicle registration and infrastructure inspection fees) (new) • Improve the public transportation system to facilitate access to jobs (ongoing) • Air transportation is important for the • Review the partial Open Skies policy (post- • Inclusion and productivity (Chapters 2 and transportation of cargo and passengers, but fares 2020) to increase routes to Madagascar 3): availability of air transport at reasonable are high, and routes are restricted (partially ongoing) cost will reduce connectivity constraints and • Open the jet fuel market to competition production cost to reduce costs of air passenger fares and • Pillar 8 of the government’s program on cargo (new) tourism. Broadband speed is fast, but costs are high and Reduce regulatory and non-regulatory barriers • Inclusion and productivity (Chapters 3 and rural connectivity is limited (there is momentum to reform the sector, but 5): equal treatment of operators contributes reforms are new) to sustainability while opening the market • The regulatory agency to identify actors with to competition will reduce operating cost, significant market power; increased access will unleash the potential • Ensure access to bottleneck facilities by for formal job creation third parties; • While there is not a specific digital pillar in • End the prohibition of investing in backbone the government’s program, it is a reform infrastructure in areas that could compete priority with some reform momentum. with the incumbent; • Review the costs of licenses; • Promote the competitive assignment of spectrum; • Ensure the Universal Services Fund is fairly and objectively considered for all operators; Key Issue Proposed reforms Link between the CEM and the Government’s General Policy • Consider possible asymmetric regulation of interconnection rates to give smaller operators a better chance; and • Improve the functionality and independence of the regulatory agency, including through greater collaboration with the Competition Council Electrification rates are low and energy supply • Select hydropower projects on a least cost • Productivity and sustainability (Chapters is unreliable basis supported by financial, social and 2 and 3): reforms to the energy sector will environmental feasibility studies (ongoing) remove one of the most binding constraints Continue improvements to JIRAMA, to move to business, which is the quality and cost of towards financial recovery (ongoing) energy, and relieve the burden of subsidies • Improve revenue collection on public finances • Reduce non-technical losses • Government’s program - pillar 2 on energy. • Promote greater transparency in the renegotiation of arrears • Apply a well-defined tariff policy (under Investing in human preparation) capital The vocational training curricula does not meet • Public sector to promote coordinated inputs • Inclusion and productivity (Chapters 2 and the needs of the private sector to the vocational training curricula to avoid 3): a better organized vocational training ad-hoc and fragmented inputs (new) will supply growing sectors the labor input • needed for efficiency and their development while opening opportunities for the labor force to access jobs Placing women in leadership positions is • Promote women in roles of increasing • Inclusion and productivity (Chapters 2 and correlated with firms having greater labor responsibility and encourage female role 3): access of women to managerial position productivity and employment growth models (new) will increase firm’s productivity Teachers lack the skills and qualifications to improve • Develop a holistic approach to teacher • Inclusion and productivity (Chapters 2 and Summary of Reforms the learning outcomes of the next generation training and career management (ongoing) 4): having the basic skills will boost the | 106 6 6 107 Key Issue Proposed reforms Link between the CEM and the Government’s General Policy | ability to learn at higher education level and to access jobs • Government’s program – pillar 4 education for all. Strengthen the quality of health service delivery • Improve the training of community and nutrition • Inclusion and productivity (Chapters 2 and Summary of Reforms health workers (ongoing in selected areas) 4): improved health service delivery in rural • Increase uptake of antenatal care in the area will reduce the gap between urban first three months of pregnancy (ongoing in and rural area and boost productivity of the selected areas) labor force • Enhance the monitoring and management of the health system (certain interventions ongoing in selected areas such as monitoring if primary care facilities have tracer medications in stock) Reduce stunting so that citizens are healthy • Increase access to water and sanitation • Inclusion and productivity (Chapter 2): and productive services (ongoing) reducing stunting will enhance learning • Promote positive parenting practices outcomes and productivity (such as breastfeeding) including nutrition (ongoing) Levelling the Rules and regulations are manipulated to • Strengthen commercial justice, including • Inclusion and sustainability (Chapter 5): playing field access and maintain access to markets use of the Center of Arbitrage and Mediation leveling the playing field eases the entry of resulting in unfair business practices (ongoing but stalled momentum) new players on the market, reduces undue • Continue to strengthen customs controls costs for businesses and consumers, and (ongoing) attenuates one of the factors of political • Avoid ad hoc and discretionary fiscal instability. practices through restrained used of tax expenditures including publishing the • Government’s program – pillar 3 on the fight criteria for award (reforms started but tax against corruption. expenditures increasing) • Support e-procurement processes and open Key Issue Proposed reforms Link between the CEM and the Government’s General Policy contracting standards (reform momentum • Inclusion and productivity (Chapter 2): but relatively new) reforms to ease access to finance will • Greater transparency in the recruitment of enhance firm’s productivity Board members for regulatory agencies and state-owned enterprises (uneven implementation) • Strengthen the Competition Law to prohibit cartelistic behaviors and to eliminate price controls (new) • Support a framework for Private Associations of Public Interest (drawing upon the cocoa example) (new) Enhancing agricultural Accessing finance is important for firm’s labor • Improve the credit infrastructure, including productivity productivity but interest rates are high the availability of a credit registry (ongoing) • Allow asset-based lending by adopting the law on movable collateral (ongoing) • Improve the legal infrastructure and efficiency of the judiciary system to reduce risks which are passed through to consumers in the form of higher interest rates (ongoing but uneven implementation) Investors face complicated procedures and • Enforce the Trade Facilitation Agreement • Inclusion and sustainability (Chapters 3 and onerous non-tariff barriers with supporting measures including 5): clear and transparent procedures will greater transparency of non-tariff barriers, support the entry of new investors and allow streamlined procedures for investors, and for equal treatment of all operators a comprehensive review of existing tax and regulatory incentives (ongoing but uneven implementation) • Identify and eliminate discriminatory requirements and streamline procedures Summary of Reforms for investors, including visas and expatriate | work permits, as well as develop investor 108 6 6 109 Key Issue Proposed reforms Link between the CEM and the Government’s General Policy | • after-care programs (ongoing but uneven implementation) Enhancing Smallholder farmers are disconnected from • Develop feeder roles (including through • Inclusion and productivity (Chapters 2 critical infrastructures such as feeder roads decentralized financing mechanisms) (new) and 4): addressing rural infrastructures agricultural and transport mechanisms • Develop regional rice mills which will reduce constraint will improve rural farmers income productivity Summary of Reforms transportation costs and bring farmers and therefore incentivize production above closer to markets (stalled momentum) subsistence level • Reform the warehouse receipt system to provide more flexibility in withdrawal periods and trade between crops (new) Farmers and policy-makers do not have access • To enable farmers to have a greater say in • Inclusion and productivity (Chapter 4): to information that could support better negotiating prices, support greater access availability of market information, combined decision making to information on prices for rice and other with the ability to decide on the timing of crops (new) sale, will improve rural farmers income and • Invest in remote sensing systems to help therefore incentivize production above gauge crop yields across the country (new) 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