Contents

Executive Summary

• Scope and key findings
• Recommendations
• Notes

Chapter 1: Overview

• Definition of fragile states
• Notes

Chapter 2: Private sector development in fragile states

• PSD in Africa
• PSD in fragile states
• Rationale for public sector support of the private sector
• Existing multilateral efforts—the World Bank Group
• Promoting business growth—policy goals in fragile states
• Private sector development policy design in fragile states
• Note

Chapter 3: Constraints to business growth in African fragile states

• World Bank Doing Business Reports
• World Bank Enterprise Surveys
• World Bank Group alignment with business constraints
• Conclusion
• Notes

Chapter 4: Government priorities in fragile states

• Methodology
• Country government priorities
• Economic sector priorities
• World Bank Group alignment with government priorities
• Conclusion
• Notes

Chapter 5: What works—proven PSD successes in fragile environments

• IDA alignment with what works
• IFC alignment with what works
• Notes

Chapter 6: Country case study—South Sudan

• Contextual overview
• Private sector overview
• Major business constraints
• Government priorities
• Existing donor programs
• Conclusion
• Notes

Chapter 7: Conclusion

• Moving forward
• Note

Appendixes

• Appendix 1: IFC investments in African fragile state sample, 2000–11
• Appendix 2: MIGA guarantees in African fragile state sample, 2011
• Appendix 3: Traditional aid modality limitations in fragile states
• Appendix 4: Private sector–related donor projects, South Sudan, as of end-2010
• Appendix 5: Country case study—Zimbabwe
• Appendix 6: Country case study—Somaliland
• Appendix 7: Fragile states and World Bank CPIA scores, 2005–09
• Appendix 8: Other private sector development initiatives in fragile states
• Appendix 9: Methodology for reclassifying IDA PSD-related projects
• Appendix 10: Top PSD-related constraints and economic sectors, African fragile states
• Appendix 11: IDA IEG project outcome ratings and distributions, 1980–2006
• Appendix 12: Correlation analysis of IDA IEG project rating components

Figures

• 1: Policy design framework for fragile states
• 1.1: Per capita World Bank Group disbursements by income category, 2010
• 2.1: Policy design framework for fragile states
• 3.1 Most frequently cited business constraints in African countries
• 3.2: IDA alignment, fragile state commitments
• 3.3 IFC alignment with business constraints, selected measures, 2000–11
• 4.1: World Bank Group alignment with countries’ PSD priorities
• 5.1: PSD-related project rating distribution in fragile states, 1980–2006
• 5.2: Historical IDA prioritization and outcome ratings, by PSD subsector
• 5.3: Current PSD subsector prioritization and outcome ratings, African fragile states
• 5.4: DOTS development outcome ratings by sector, weighted and unweighted
• 5.5: IFC investment return versus portfolio share, 2009–10
• 6.1: Donor alignment with major business constraints
• 6.2: Donor alignment with what works
• A5.1: GDP and sector growth, 2005–10
• A5.2: Change in Doing Business scores, 2006–11
• A5.3: “Protecting investors” score, Zimbabwe and comparator economies
• A5.4: Deposits and credit to private sector
• A5.5: Deposits (left axis) and loan-to-deposits ratio (right axis), 2008–10
• A11.1: Project outcome ratings by sector, fragile and nonfragile states, 1980–2006

Tables

• 1: Criteria to build roads in the Republic of Congo
• 1.1: African fragile states sample and selected indicators
• 3.1: Fragile states compared with other developing countries, Doing Business indicators
• 3.2: Most frequently cited business constraints in African fragile states (percent)
• 3.3: IDA alignment with “major constraints,” by country, selected measures
• 3.4: IFC alignment with constraints, 2000–11 (percent)
• 3.5: IFC investments in African fragile states by sector, 1980–2000
• 3.6: MIGA investments in African fragile states by sector, 1990–2011
• 4.1: Country PSD constraint priorities, by frequency
• 4.2: Country economic sector priorities, by frequency
• 4.3: IDA project alignment with government priority constraints
• 4.4: IFC investments and priority sector mapping
• 4.5: MIGA PSD project and priority sector mapping
• 5.1: IDA PSD-related project evaluation data, 1980–2006
• 5.2: IDA project outcome ratings by PSD-related sector, 1980–2006
• 5.3: IFC loan and equity portfolio income, 2009–10
• 6.1: Private enterprises in South Sudan, by number and distribution of employees
• 6.2: Commercial bank exposure, by sector (SDG millions)
• 6.3: Use of banking services among households, by state (percent)
• 6.4: Distribution of commercial banking services, by state (number of branches)
• 6.5: Price comparison of select intermediate inputs, Malakal and other cities
• 6.6: Time and cost to import a container, Juba and comparator cities
• 6.7: Donor funding for private sector–related projects, 2010
• 6.8: Donor alignment with government priorities

References

Supporting Private Business Growth in African Fragile States

A Guiding Framework for the World Bank Group in South Sudan and Other Nations

Benjamin Leo, Vijaya Ramachandran, and Ross Thuotte
April 2012

About the authors

Benjamin Leo is a former Research Fellow at the Center for Global Development and the Global Policy Director at the ONE Campaign. Vijaya Ramachandran is a Senior Fellow at the Center for Global Development. Ross Thuotte is a Research Assistant at the Center for Global Development. The authors would like thank the Government of Denmark for generous financial support. We are also grateful to James Emery for his detailed reading of several drafts and his comments on our interpretation of the IFC data. In addition, Alan Gelb, Alvaro Gonzalez, Charles Kenny, Todd Moss, and Gaiv Tata provided extensive comments on various drafts of this report, and we would like to thank them for their efforts. John Osterman was of great help in guiding this manuscript through to publication, and Julie Walz provided excellent research assistance. The authors are solely responsible for any errors in fact or judgment.

The Center for Global Development is grateful for contributions from the Royal Danish Embassy in support of this work.

Preface

Fragile and post-conflict states pose a daunting challenge to the World Bank Group. They suffer from a combination of harsh business environments, unstable and corrupt political regimes, and rent-seeking actors. These barriers prevent private businesses from generating much-needed services, economic growth, and jobs. Viewing the private sector as the key to economic and social progress in fragile states, the authors of this report assess the programs and projects supported by the three major arms of the World Bank active in those states (the International Development Association, the International Finance Corporation, and the Multilateral Investment Guarantee Agency) and propose a strategy to improve the overall effectiveness of the Bank’s work.

Though the World Bank Group and its shareholders have made fragile states a priority in recent years, their private sector–oriented programs in the past decade have not yielded many concrete development results. Bank Group staff has been asked to improve project outcomes and to help increase the absorptive capacity of fragile states while targeting priority sectors. But there has not been a clear World Bank Group-wide strategy for fragile states operations.

Using project documents and other sources of information, the authors have compiled a comprehensive dataset on the Bank Group’s work in 14 African states (Sudan, Central African Republic, Democratic Republic of Congo, Togo, Guinea Bissau, Guinea, Liberia, Angola, Côte d'Ivoire, Republic of Congo, Zimbabwe, Eritrea, Chad, and Burundi) which are classified as fragile by the World Bank Group. The dataset describes 5,000 IDA projects, 3,700 IFC projects and 700 MIGA projects over the period 1980–2011 that focus on building the private sector in these states. These data are available for the first time in an easily accessible format and will likely serve as a valuable resource for policymakers, donors and other interested actors. Analysis of the data shows that there often does not appear to be a clear strategy driving the interventions and that they are sometimes at odds with the stated needs of policymakers and the public.

Policymakers at the World Bank and those in its shareholder countries should heed the authors’ findings if they hope to help private sector businesses grow in Africa’s most challenging investment environments. The authors’ methodical and exhaustive assessment allows them to deliver a clear message. The World Bank should design and implement projects that a) alleviate the growth constraints most identified by businesses, b) target sectors that governments have explicitly made priorities, and c) align with proven, country-specific successes. Adherence to this framework could greatly increase the chances of successful future private sector–oriented interventions in fragile states.

Nancy Birdsall
President
Center for Global Development

Acronyms

Overview

In recent years, international financial institutions (IFIs) have dramatically increased their worldwide investments in the private sector—from $10 billion in 1998 to more than $35 billion in 2008.[1] In Sub-Saharan Africa, donor financing for private sector–related activities through loans, guarantees, and advisory services has also increased at a fast pace. By contrast, African fragile states overall have experienced little growth in donor projects targeting private sector activities and continue to receive infinitesimal (albeit slowly increasing) portions of World Bank Group disbursements in recent years (figure 1.1) on a per capita basis.[2] The time period for the data in figure 1.1 is 2010, which the World Bank Group considers to be a “postcrisis” period. Some disbursements in this year are countercyclical measures to mitigate the negative impact of the financial crisis. Therefore, we cannot assume that this is entirely indicative of World Bank Group disbursements in a typical year. However, countercyclical lending policies are mostly likely not the sole cause of the large discrepancy between disbursements to middle-income countries, low-income countries, and African fragile states.

There are a number of factors driving these low investment levels, such as small market size, high political risk, poor infrastructure, and weak legal and regulatory frameworks. Moreover, International Development Association (IDA) projects are roughly twice as likely to fail as those in nonfragile states.[3],[4] Institutional factors within IFIs themselves also have contributed to underinvestment over time. For example, the International Finance Corporation’s (IFC) risk-averse culture and mandate to earn a profit are just two factors that have led to very few investment deals in African fragile states outside of enclave sectors.[5] The current World Bank Group project portfolio reflects the realities of investing in fragile states. It also reveals some of the challenges that the World Bank Group and other IFIs might consider when scaling up their activities in fragile states over the near to medium term.

Definition of fragile states

For the purposes of our analysis, we define African fragile states according to countries’ respective IDA Resource Allocation Index (IRAI) score between 2005 and 2009.[6] Specifically, countries are defined as fragile if they fall into one of two categories:[7],[8]

• All core. Country has remained below a score of 3.0 for all years.[9]
• All marginal. Country has remained below a score of 3.2 for all years.

Based on this approach, the countries of interest (in order of 2009 IRAI scores from lowest to highest) include: Zimbabwe, Eritrea, Sudan, Chad, Guinea-Bissau, the Central African Republic, the Democratic Republic of Congo, Togo, the Republic of Congo, Liberia, Angola, Côte d’Ivoire, Guinea, and Burundi. These 14 countries provide a variety of case studies spanning geographic regions, income groups, and natural resource endowments (table 1.1). Our diverse group of African fragile states also allows us to formulate a policy framework that may be relevant to a wider range of fragile environments.

In its latest World Development Report, the World Bank stresses the importance of integrating security and development activities in conflict-affected and fragile state environments.[10] In operational terms, the report suggests that the World Bank Group plan to make country strategies more fragility-focused; prioritize private sector development (PSD) and job creation; realign results and risk-based frameworks; and reduce volatility in financing levels. The World Bank’s concessional financing entity—the IDA—has already been pursuing a number of evolving strategies customized for fragile state environments. While modest progress has been achieved, significant work remains. In contrast with IDA, the World Bank Group’s other subsidiaries—IFC and the Multilateral Investment Guarantee Agency—currently do not have operational strategies for fragile states. So the World Bank Group faces a number of challenges in translating the new World Development Report directives into effective programs on the ground.

Against this backdrop, we consider a range of issues and options that may help the World Bank Group and other donor organizations streamline operations and improve their effectiveness in African fragile states. First, we examine whether the World Bank Group implemented its projects in African fragile states over the last decade in order to address the most significant obstacles to business growth; country government priorities; and areas where the World Bank Group has a proven track record. In this manner, we gauge how well the World Bank Group is focusing on what is needed, what is wanted, and what works. Second, we apply this approach to assess donors’ PSD support in the newly independent nation of South Sudan.[11] Taken together, our findings suggest a somewhat mixed picture about the World Bank Group’s alignment and effectiveness in promoting PSD in African fragile states. Finally, drawing upon this analysis, we propose a number of strategic and operational policy recommendations for the World Bank Group to consider as it seeks to prioritize and improve its PSD programs in African fragile states.

Notes

Private sector development in fragile states

PSD in Africa

In recent years, the majority of investment in the African private sector has flowed toward the rapidly expanding telecommunications and extractive industry sectors. Between 2005 and 2008, private investors contributed 62 percent of total funding to the telecommunications industry, which has resulted in the rapid expansion of networks and profitability, as well as prospects for continued growth.[1] By illustration, African telecommunications firms generated more than 316 million mobile phone subscribers between 2000 and 2010.[2] The rapid 43 percent annual growth rate leaves plenty of room for upward movement in the sector, as mobile penetration only reached 44 percent in 2009.[3] Unlike other sectors, telecommunications growth has spanned the gamut of Sub-Saharan countries, ranging from middle-income economies to fragile states.[4] The natural resources and extractive industries have also accounted for a significant portion of African growth, contributing roughly a quarter of Africa’s growth between 2002 and 2007.[5]

While progress in the telecommunications and extractive industry sectors is promising, current signals indicate that private investors’ appetite for other sectors continues to grow and that private sector expansion could provide a valuable boost to capital- and capacity-starved fragile states. Private sector investment projects in infrastructure could provide high investment returns (as in telecommunications) for both investors and customers in fragile states. For example, “bankable” investments in electricity generation capability and infrastructure (for which there is significant consumer demand) could greatly decrease costs for businesses while generating revenue for power providers.[6]

PSD in fragile states

Theoretically, the private sector has many opportunities to thrive in environments in which traditional aid cannot succeed. For instance, the private sector can exist (and even thrive) even when there is no central government that is stable enough to accept foreign aid (for example, Somaliland). This could make the private sector a particularly viable and valuable target for economic development interventions in fragile states. Therefore, promoting private sector growth in fragile states could be one tangible first step toward better governance and more diverse, robust economies. However, despite a sound rationale for public sector intervention in the private sector, private sector development (PSD)–focused activities in fragile state environments remain vulnerable to a range of binding or limiting constraints.

Fragile states generally are categorized by very weak business climates that often restrict individual firm activities through several channels. In particular, the indirect costs of poor infrastructure, regulatory challenges (such as excessive licensing fees, bribes, and so forth), and low labor productivity can reduce profit margins and reduce incentives for business owners and prospective entrepreneurs.[7] These effects can be exacerbated in fragile states, in which governments and institutions routinely fail to administer services, enforce contracts, and reduce corruption. Political risk also is a major concern for multilateral institutions that wish to invest in the African private sector. This illustrates African fragile states’ acute need for customized financing instruments, such as political risk guarantees.

Fragile states also lack the human capital needed to operate scalable business ventures. While skilled micro-entrepreneurs may exist en masse in countries like Chad and Burundi, many of the most skilled businesspeople (such as those with formal skills in accounting, personnel management, strategic planning, risk analysis, marketing, and the like) have often left these hostile business environments for more lucrative and/or secure opportunities abroad. Although these highly skilled workers often send home substantial remittances, they frequently do not maintain local businesses in the fragile-state environment from where they came.[8]

Many firms in fragile states are also heavily constrained by what Ramachandran, Gelb, and Shah (2009) refer to as “external costs.”[9] These external or indirect costs—such as those stemming from failures in electricity service provision, transport infrastructure, and supplier networks—often erode individual businesses’ profit-making capabilities. In other words, many African firms’ “ability to produce value beyond the cost of their direct and indirect inputs is heavily constrained by the magnitude of the cost of the latter.”[10] Finally, markets for goods in nearly all of our 14 fragile states are particularly disparate and weak. Even with strong support from multilateral development banks on the supply side, the private sector will not thrive without predictable and steadily increasing demand from local consumers.

Rationale for public sector support of the private sector

Before launching into a more in-depth discussion of PSD initiatives in fragile states, we shall examine several broad theoretical rationales for public sector support of the private sector. First, it is believed that PSD activities help to create jobs and foster economic growth (the private sector accounts for roughly 90 percent of jobs in the developing world).[11] Second, many argue that the public sector should support the private sector because individual businesses are constrained by numerous government-driven limitations, ranging from corruption to lack of physical infrastructure. Third, many of these constraints result from market deficiencies that theoretically can be rectified by public sector initiatives. For example, imperfect capital markets hinder businesses—notably small and medium enterprises—by not investing in profitable projects. This often occurs because of imperfect information regarding profitability, high transaction costs, and insufficient legal frameworks and enforcement mechanisms. Relatedly, informal and small firms are often unable to pledge collateral and lack formal title rights to physical property.[12] Another example relates to governance. PSD requires an appropriate institutional framework that the private sector cannot provide for itself. While there are several examples of private sector firms joining together to help stabilize the governance environment (such as in Somaliland), most firms in fragile states are unwilling or unable to create the institutional framework necessary to promote PSD by themselves.[13]

Existing multilateral efforts—the World Bank Group

The World Bank Group and others donor organizations’ PSD goals in African fragile states broadly mirror those in other low-income countries. The key differences relate to developing policies and projects that are tailored to the more difficult operating environments.

The World Bank’s soft loan facility (the International Development Association, or IDA) has a significant presence in fragile states. All of the African fragile states are IDA-eligible borrowers, though several countries (namely, Sudan and Zimbabwe) currently are inactive due to World Bank Group loan arrears. Oil-producing African fragile states (Angola and the Republic of Congo) are above the IDA lending income cutoff, but still have access to IDA loans on “hardened terms.”[14] Although one of IDA’s specific foci is PSD, its projects in many sectors such as infrastructure and regulatory reform result in positive spillover effects for private sector businesses. Indeed, much of IDA’s contribution to the private sector may result from indirect benefits from non-PSD–focused IDA projects. IDA’s current eligibility requirements have significant implications for the institution’s future. A recent study estimates that by 2025, most IDA-eligible countries will be African fragile states—a reality that may compel IDA to restructure its strategy around fragile lending environments in the coming years.[15] By extension, adapting to the specific constraints of fragile states will be essential to IDA’s continuing success.

The efforts of the World Bank Group’s private sector arm are of particular interest. The International Finance Corporation (IFC) is a leading global player in the PSD spectrum and makes nearly 40 percent of all investments that originate from development finance institutions.[16] However, IFC’s 2010 project disbursements to African fragile states, on a per capita basis, were four times smaller than commitments to middle-income countries.[17] The smaller levels of investment in African fragile states reflect investment conditions characterized by volatility and high levels of risk, limited private sector partners, and few choices for viable investment projects. And if IFC hopes to scale up its investments in African fragile states (a World Bank Group–wide measure has been proposed in the most recent World Development Report), it must innovate its investment model.

Taken together, the World Bank Group has shown an increased level of commitment toward fragile states in recent years. During the World Bank’s spring 2011 Development Committee meeting, shareholders agreed on the following commitments:[18]

• Make fragile and conflict situation (FCS) strategies more fragility-focused by preparing new strategies for FCS countries.
• Increase attention to jobs and PSD by promoting a common World Bank Group approach to employment and introducing new IFC/Multilateral Investment Guarantee Agency (MIGA) instruments.
• Realign results and risk frameworks for FCS countries through the development of results metrics that are sensitive to conflict and fragility.
• Strive for “global excellence in FCS” by establishing a new FCS hub in Nairobi by the end of fiscal year (FY) 2011 and further revising human resource policies that reflect FCS priorities and needs.

Since this World Bank Group strategy was approved only recently, it has yet to be operationalized by the individual World Bank subsidiary organizations such as IFC and IDA. However, the IFC launched its five-year Conflict Affected States in Africa Initiative in 2008 to help design and implement integrated strategies that support economic recovery in conflict-affected countries. Roughly 18 percent of total IFC advisory service expenditures worldwide are committed to World Bank–classified fragile states, which include non-African countries. Specifically, the Conflict Affected States in Africa program has four main elements: improving the business environment through regulatory reform; strengthening small and medium enterprises and support institutions (such as chambers of commerce); rebuilding financial markets and other financial institutions; and increasing private sector involvement in rebuilding infrastructure.[19] The IFC has implemented Conflict Affected States in Africa projects in several postconflict countries with severe business climate constraints, such as Burundi, the Central African Republic, the Democratic Republic of Congo, Liberia, and Sierra Leone. It continues its extensive advisory service operations in many African fragile states. IFC emphasizes the importance of these services in lieu of larger investment project operations, which it says are especially difficult in fragile environments.[20]

Although there are numerous efforts aimed at promoting African infrastructure growth (one result of which would be private sector growth), few of these initiatives have the capability and/or audacity to commit resources to fragile states. Although examined for this report, many private sector and infrastructure initiatives were not included because they do not focus on fragile states. These initiatives/institutions include NEPAD’s Infrastructure Investment Fund, DevCo (a fund overseen by the Private Infrastructure Development Group), and InfraCo (also funded by the Group). A list of selected PSD initiatives in fragile states is located in appendix 8. Of particular interest is the Public-Private Infrastructure Advisory Facility (PPIAF), which was established in 1999 to increase private sector participation in emerging markets. PPIAF provides grants to help governments create a sound enabling environment for private participation in infrastructure through activities such as framing infrastructure development strategies, organizing stakeholder consultation workshops, and designing pioneering projects.[21] PPIAF, committing about $20 million a year globally, has sponsored projects in fragile states such as the Democratic Republic of Congo, Guinea, Guinea-Bissau, Liberia, and Sierra Leone.[22] The projects often have a regional focus, and PPIAF’s 2011–13 work plan cites fragile states as one of four major cross-cutting themes for future projects.

The World Bank Group’s Financial Investment Advisory Service (FIAS) is a multidonor investment climate program that assists developing and transition economies to improve their business environments with an emphasis on regulatory simplification and investment generation.[23] FIAS also coordinates with IFC Advisory Services and other World Bank Group departments. Forty-five percent of FIAS activities in FY10 occurred in Sub-Saharan Africa, including 31 percent of its implementation expenditures in fragile and postconflict states.[24] FIAS completed five business reforms in three fragile states, including business taxation reform in Sierra Leone, construction permits in the Democratic Republic of Congo, and investment policy reforms in Guinea-Bissau. In 2011, FIAS began designing a methodology to estimate the savings accrued to firms resulting from its business climate reform support. FIAS’s client satisfaction rating has hovered around 90 percent in recent years.[25] Moreover, FIAS released a Rough Field Guide to Investment Climate Reform in Conflict-Affected Countries in 2010, which explicitly links investment climate improvement with peace-building efforts in postconflict countries. The report also provides highly detailed instructions on the design, implementation, and evaluation of investment climate reforms, including laws, regulations, and procedures that govern industry competiveness, bureaucratic efficiency, and institutional governance.[26]

The World Bank’s Doing Business project provides absolute and relative measurements of business regulations and obstacles across 183 economies. These annual reviews contain extensive data on constraints to business growth, including time and costs required to start a business, licensing fees, construction permits, and trading across borders. Unlike most private sector–oriented diagnostics, Doing Business collects data annually for nearly all of the world’s economies.[27] While the Doing Business program does not support specific business reform activities, its field analysis and findings feed into IFC, FIAS, and non–World Bank Group programs assisting fragile states (and other countries) with business climate reforms.

Promoting business growth—policy goals in fragile states

The next chapters describe the World Bank Group’s projects in some detail. But first, with a view to evaluating the efforts of the World Bank Group, we describe four key business growth–related objectives in fragile states: supporting broad-based economic growth, job creation, tax mobilization, and positive spillovers. We also introduce a conceptual framework to guide support operations that could be adapted and applied to a variety of African fragile state environments.

Broad-based economic growth

Sustained, broad-based economic growth is the critical driver for significant poverty reduction in low-income countries, particularly in view of the limited scope for income redistribution. But as the World Bank’s Commission on Growth and Development states, economic growth is not an end in itself. Rather, it is the spark to create resources and social services to support health, education, job creation, and other development goals. By illustration, one study estimated that a 2 percent rise in average household income resulted in a 1.2–7.0 percent decline in poverty rates.[28] Therefore, economic growth has major implications for poverty reduction in African fragile states.[29] Over the last 30 years, poverty levels have fallen significantly, with much of the progress being attributable to economic growth. Globalization has provided the platform to expand markets, import ideas and technology, and facilitate the movement of human capital and investment to regions that were previously largely closed off from the global economy. Although there is not one common success story, countries that have achieved sustained economic growth have maintained macroeconomic and political stability, raised investment and savings, and opened their markets. The overriding policy challenge is to determine how to apply these success stories to the poorest and most fragile countries.

The World Bank’s Commission on Growth and Development outlines several types of countries that face dramatic challenges in achieving sustained economic growth. These include Sub-Saharan countries still contending with postcolonial resource extraction models and negative spillovers from unstable and violent neighbors; small states with significant concentration in a few economic sectors highly vulnerable to exogenous shocks; governments facing comparatively high per capita costs of social services; and countries rich in natural resources facing Dutch disease and rent-seeking risks. Most African fragile states examined in this report fall into one of these categories.

Job creation

The labor market is deeply entwined with both economic growth and poverty reduction. Many African fragile states face high, persistent unemployment levels, particularly among youth and demobilized combatants, which can contribute to increased rates of violence, political instability, and higher levels of poverty.[30] Therefore, supporting job creation opportunities should be a central objective of any World Bank Group operation that aims to promote business growth. The relationship between jobs and growth is largely a two-way street: sustainable economic growth depends at least partly on the underlying labor market structure and a flexible labor force, while employment growth often depends on growth of output in the formal sector. But a key characteristic of African labor markets is the very high ratio of informal to formal sector employment.[31] Thus, although formal sector growth is essential in the long term, the informal sector often has greater capacity to absorb the ever-expanding labor force—especially in economies constrained by low formal output growth.[32] Therefore, African fragile state governments and donor organizations often need to pursue two-track approaches for supporting increased productivity within the informal sector while simultaneously improving the operating environment for formal enterprises.

Tax mobilization

A third PSD-related objective is fostering a broad, stable tax base, which contributes to improved governance, accountability, and economic growth. Domestic tax policies have the potential to strengthen government legitimacy in the eyes of constituents through increased accountability and transparency, perceived fairness, and a clear political commitment to shared prosperity.[33] Government revenues are also necessary for providing social services and can be used to support economic growth and diversification. There is considerable variation in African countries’ tax bases, with the lowest tax bases often corresponding to almost exclusive dependence on natural resource rents. Tax revenues average roughly 14 percent of GDP in African fragile states, with oil exporters Chad and the Republic of Congo on the low end with slightly higher than 5 percent of GDP and Liberia and Zimbabwe on the high end with approximately 30 percent of GDP.[34] Due to large informal sectors, most fragile states have relatively narrow tax bases. Thus, the government’s “fiscal-social contract” with the private sector is an important step toward reform. Formalizing the informal sector of the economy creates not only a broader tax base and larger stream of revenue to provide necessary services, it provides an incentive for expanded political participation.[35]

Positive spillovers and multipliers

Another driver of success is growth spillovers—when growth in one part of the country or some subset of firms impacts the growth of other firms or regions. At the country level, open borders for the flow of goods and services, along with increasing migration and flow of human capital, lead to increasingly positive spillovers. Within countries, knowledge and technology are key ingredients in the development of industry, and can be shared across firms. Also, firms in fragile states may be able to “borrow” knowledge cheaply, helping to “leapfrog” the historic development process. Mobile phone technology is a prime example.[36] Finally, some types of investments can also spur the growth of related industries, either upstream or downstream in the production process.[37]

Private sector development policy design in fragile states

In light of these policy goals, how should the World Bank Group best prioritize its PSD-related support programs in African fragile states? Upon careful review of the diagnostics of each economy and the tools available to donors, we propose that good policies are drawn from the intersection of three elements—the private sector’s most severe constraints, the stated priorities of governments, and policy interventions with an acceptably effective track record (figure 2.1). The policies emerging from the intersection of these areas must also support the above-mentioned goals of economic growth, job creation, tax mobilization, and positive spillovers.

Our conceptual model brings together these three fundamental areas for policy design. First, to generate growth, policymakers must create a conducive environment for business owners and managers of small, medium, and large firms. Extensive survey data on the problems reported by businesses are available on the World Bank’s website and from other sources.[38] We analyze these data to identify the most critical problems facing businesses that are trying to survive in fragile environments. Understanding their constraints is the crucial first step toward good policy design. Whether it is the basics (infrastructure and public services), regulations (taxes, licensing rules), or labor shortages, we need to know what the private sector believes is holding back growth.

The second area is understanding government priorities. Policymakers in fragile states operate in very difficult environments, often trying to address various constraints simultaneously with very few resources. Understanding their perspective and primary objectives is important, especially for policymakers in multilateral institutions. By searching through public documents, speeches, and other data, we try to identify what African fragile state governments perceive to be their most binding PSD-related obstacles. There may well be some overlap between their perspective and that of the private sector, as we will see in next chapters.

Third, we must use the lessons learned from past policy interventions. Understanding what has worked in fragile environments will be useful to the design of new policies, programs, and projects, particularly when these findings are referenced against public and private sector constraints and priorities. To accomplish this task, we analyze past policy interventions using a database of IDA projects and other sources to identify successful projects by sector, type, and location.

When considered together, these three analytical components can help multilateral organizations prioritize PSD-related programs in fragile states. As noted previously, donor institutions ideally would pursue projects in sectors or areas where all three components intersect (what the private sector needs, what the government wants, and what donors do effectively). This is the “priority action” zone of the conceptual framework. But there will be situations or environments in which multilateral organizations may wish or need to pursue projects or investments that do not meet this condition. In this instance, we recommend that multilateral organizations then prioritize projects in sectors or areas where two of the three components intersect. Careful attention should be given to why one of the components does not meet this condition and what types of remedial actions would be required. For each of the omitted policy prioritization components, potential remedial steps could include the following in different situations:

• Major PSD constraints (need to tread carefully). Multilateral organizations should proceed very cautiously in the absence of private sector buy-in. However, there could be instances when proceeding could be justified—such as a prioritization overlap with informal and/or small and medium enterprises, though not with the business elite.
• Government priorities (need to get buy-in). Multilateral organizations should determine why the private sector and national government priorities are not consistent. After this, steps should be taken to encourage government buy-in as appropriate—particularly in areas where direct or indirect government involvement is likely. But multilateral organizations may want to deprioritize the need for buy-in in failed or highly repressive states.
• Proven results (need to innovate) : Multilateral organizations will need to consider innovative or alternative implementation models to ensure that project or investment results exceed historical performance patterns. Moreover, careful attention should be given to programmatic factors that are significantly predictive of project outcome performance ratings, such as quality-at-entry and supervision (these issues are examined in greater detail in chapter 4).

The next chapters explore each of these areas—constraints reported by businesses, priorities of governments, and understanding what works—in significant detail. Each chapter examines the available data, and then compares them with the project portfolio of the three relevant World Bank Group entities—IDA, IFC, and MIGA (when possible). The aim of this analysis is to understand whether these institutions have operated with a consistent, well-defined strategy and whether their projects have met needs identified by either the government or the private sector (or ideally both). Finally, our conceptual model is used to identify priorities for Africa’s newest country, South Sudan (chapter 6). Case studies for Somaliland and Zimbabwe are included as well.

Notes

Constraints to business growth in African fragile states

One of the public sector’s primary objectives in assisting the private sector is to relieve constraints that may stifle businesses’ ability to grow, expand employment opportunities, and generate profits. Recognizing this, donor organizations have increased funding over the last decade for private sector development (PSD) diagnostics that help to identify these binding constraints. While there are a number of instruments available, we focus primarily on two World Bank surveys: the Doing Business reports, which provide comprehensive assessments on regulatory, financial, and political constraints through a top-down methodology; and the Enterprise Surveys, which gauge firms’ views about business environment constraints.

World Bank Doing Business Reports

Doing Business country (and subnational) reports provide relative and absolute measures of business environment constraints across eight distinct categories, such as the ease and cost of starting a new business, enforcing contracts, and trading across borders. The Doing Business methodology scores countries according to both the attractiveness of their current business environment (the number of days it takes to secure an import license) and their progress toward delivering more private sector–friendly policies (the number of regulatory reforms that have been completed in a given year). Overall, the Doing Business reports, providing the most comprehensive country coverage, are completed on an annual basis—which allows for more dynamic monitoring of business environment changes and trends.

With few exceptions, African fragile states lag far behind their higher income and non-African fragile counterparts on nearly every Doing Business measure. On average, African fragile states have an ease of doing business ranking of 171 (of 182 countries) compared with an average ranking of 125 for other low-income countries (table 3.1). Importing a standardized container of goods costs nearly three times more in African fragile states than in middle-income countries.[1] And starting a new business costs more than three times as much in African fragile states than in other low-income countries. These exorbitant operating costs have a profound impact on businesses’ ability to generate profits, expand, and compete in a globalized marketplace.[2] Moreover, they contribute to broader economic effects, such as inflation, large informal sectors, and rent-seeking behavior.

While Doing Business reports provide a useful assessment of business environment issues, they also omit several factors that impact PSD, such as macroeconomic stability, security, quality of infrastructure, and corruption. As such, they should be used with other diagnostic instruments to identify the most binding constraints on business growth in African fragile states.

World Bank Enterprise Surveys

The World Bank Enterprise Surveys compile individual firms’ opinions and concerns to assess national and regional business environments. The surveys fill in many of the gaps in the Doing Business reports, such as corruption, physical infrastructure (including transport), crime, informality, competition, and access to finance. Private contractors administer the surveys to firms largely in the manufacturing and service sectors, including construction, transport, and information and communication technology. As of mid-2011, World Bank Enterprise Surveys were available for 12 of our sample of 14 African fragile states.[3]

Despite their significant strengths, World Bank Enterprise Surveys have two key weaknesses. First, they are fairly expensive, time-consuming, and infrequently completed (not annually or according to a clearly defined timetable). So they are not an ideal instrument for identifying country trends over time. Second, the surveys focus almost exclusively on firms in the formal sector.[4] Since the informal sector accounts for the overwhelming majority of businesses and employment in low-income countries, enterprise surveys may not adequately reflect constraints impacting the broader business sector. Even so, while World Bank Enterprise Surveys may have limitations, they remain a very useful tool in gauging firms’ views about major constraints.[5]

Ramachandran (2010) summarizes in detail the available survey data for African countries, along with analyzing trends between countries and income groups.[6] Businesses in the poorest African countries—in which most fragile states are included—tend to cite basic infrastructure deficiencies, access to financing, and lack of macroeconomic stability as the primary constraints to profitability and expansion.[7] Other constraints, such as weak governance, low administrative and bureaucratic capacity, and official corruption are cited more frequently in the next highest income tier of Sub-Saharan countries (such as Kenya and Senegal). Businesses in the highest income group (such as Gabon and South Africa), on average, cite the lack of job skills and labor regulation as more binding constraints.

Since country fragility is defined according to policy and institutional quality measures, we also examine business constraints in relation to IDA Resource Allocation Index (IRAI) scores (as opposed to income per capita levels). Figure 3.1 illustrates several of the most frequently cited business constraints in African countries—political instability, transport infrastructure, electricity, and access to finance.[8] Across the board, the percentage of firms reporting these issues as “major constraints” declines as countries’ IRAI scores increase. Not surprisingly, concerns about political instability decline the most dramatically across our country sample. Nearly twice as many African firms cite concerns about electricity as a “major constraint” compared with concerns about transport infrastructure. And access to finance is also cited more frequently as a “major constraint” than transport infrastructure is.

For African fragile states, the most frequently cited business constraints include: electricity (68 percent), access to finance (56 percent), political instability (56 percent), corruption (48 percent), taxation rates (40 percent), competition from informal firms (40 percent), transport (38 percent), crime (35 percent), customs regulations (28 percent), and worker skills (27 percent; table 3.2).

World Bank Group alignment with business constraints

The aforementioned surveys and analysis provide programmatic prioritization insights for respective donor organizations.

Since the World Bank Group expends significant resources on business diagnostics, we would expect International Development Association (IDA), International Finance Corporation (IFC), and Multilateral Investment Guarantee Agency (MIGA) activities to direct their projects toward those factors that pose a “major constraint” to PSD in fragile states.[9] Put differently, the World Bank Group should be drawing upon individual firms’ opinions before developing and implementing sizable support programs and investments for PSD-related activities.[10]

Methodology

To gauge the World Bank Group’s alignment, we focus on a subset of major business constraints that can be mapped clearly to World Bank Group projects and investments, including electricity, access to finance, and transport infrastructure. The multifaceted dimension of other constraints—such as political instability and crime—makes it difficult to identify overlap with donor programs in a concise manner.[11] For projects and investments, we examine all IDA, IFC, and MIGA activities between 2000 and 2010 in 11 African fragile states with business enterprise survey data.[12] Moreover, we use each institution’s classifications to determine the priority sector or area for each project, investment, or guarantee.[13]

IDA

As seen in a number of different measures, IDA projects over the last decade exhibit a significant level of alignment with firm views concerning electricity and transport constraints. The correlation between the number of IDA projects targeting these sectors (measured as the percentage ofall IDA PSD-related projects) and the percentage of firms citing them as “major constraints” is 0.54 and 0.52, respectively.[14] As expected, there is almost no correlation between the total value of IDA projects targeting these sectors (measured as the percentage of all IDA projects). Put differently, IDA has prioritized electricity and transport projects within its PSD-related portfolio while not necessarily prioritizing them with respect to its overall project portfolio value in African fragile states. Given broader development priorities that commonly exist in African fragile states—such as social service delivery and security sector reform—this is not particularly surprising. By contrast, IDA’s alignment with firms’ concerns about access to finance is strikingly low. The correlation between IDA projects targeting this constraint (measured as a percentage of all PSD projects) is only 0.04, suggesting that IDA has deprioritized financial sector projects in African fragile states—in the form of either regulatory reform or support for local financial institutions (table 3.3).[15] ,[16] IDA’s low level of access to finance projects could also be attributed to the comparative advantage of other World Bank Group subsidiaries (IFC) in this sector, which may be better-equipped to promote access to finance.

Table 3.3: IDA alignment with “major constraints,” by country, selected measures [CLICK TO VIEW]

Figure 3.2 provides another illustration of IDA’s prioritization across the examined sectors according to the percentage of individual firms citing them as “major constraints.” As the aforementioned correlation analysis suggests, IDA appears to prioritize PSD projects in electricity and transport in African fragile states where they present the greatest constraints. Alternatively, IDA appears to pursue fewer financial sector projects when firms cite access to finance more frequently as a “major constraint.”

IFC

Unlike IDA, IFC investment services focus on economic sectors (such as manufacturing and services companies) rather than broader constraints to PSD growth. Conversely, IFC advisory services often work with governments to improve the overall investment climate in fragile states such as the Democratic Republic of Congo and South Sudan. Neither investment nor advisory services focus explicitly on electricity and transport constraints, and thus we expect that very few investments have targeted those obstacles to private business growth. However, we could expect IFC investments in the financial services sector (to counteract the “access to finance” constraint).

IFC investments in recent years. Based on a number of different measures, IFC investments in African fragile states over the last decade exhibit almost no alignment with firm concerns about binding electricity and transport constraints (figure 3.3 and table 3.4).[17] Indeed, the correlation between the number of IFC investments targeting these sectors (measured as the percentage of total number of IFC investments) and the percentage of firms citing them as “major constraints” is –0.25 and 0, respectively.[18] For electricity, possible reasons for the misalignment are the highly regulated nature of electricity sectors in African countries and the limited openings for private investment in public power projects. IFC has been successful in investing in Togo’s power sector, and it has been able to contribute to the electricity-related regulatory dialogue in Liberia.

Ultimately, however, the IFC is less likely, on average, to support investment deals in environments with more binding constraints, apart from access to finance. The data illustrate IFC’s recent concerted efforts to target access to finance constraints in several African fragile states, including Côte d’Ivoire and Guinea-Bissau. Recent IFC investments in these two countries are wholly concentrated in finance-related sectors.[19] While firm concerns could signify strong market demand opportunities for IFC, the high respondent rates likely also signify regulatory distortions and other market risks that could jeopardize IFC’s financial returns. While these findings are striking, they should not be overemphasized given IFC’s historical focus on market sectors (as noted above). IFC alignment with these sectors is explored in chapter 4.

IFC investments before 2000. When we extend our country sample prior to recent years and beyond the 14 current African fragile states, historical IFC investment trends show little focus on constraints such as electricity, roads, and access to finance. Between 1980 and 2000, IFC invested $2.6 billion in all African fragile states that fit our definition of “chronically fragile” states (table 3.5).[20] Of this $2.6 billion, 63 percent went to mining projects alone, while just 0.7 percent went to electricity and 0.5 percent to roads. Nineteen banking and finance projects accounted for just 3.2 percent of the total. Assuming that business constraints in African fragile states have remained relatively unchanged over the past few decades, IFC’s investment record does not show a commitment toward addressing some of these limitations.[21]

MIGA

Between 2000 and 2010, MIGA provided only one banking sector guarantee in our sample of 14 African fragile states. It did not provide any guarantees to support foreign investments to improve electricity or transport infrastructure networks. As a result, there is no alignment between MIGA activities and firms’ concerns about “major constraints” to growth and profitability. Historical MIGA guarantees mirror this trend when we extend our country sample beyond the 14 current African fragile states. Between 1990 and 2011, MIGA provided guarantees totaling $797 million in African fragile states—of which 27 percent went to telecommunications projects (a low priority for businesses; table 3.6). Also during this time, MIGA guarantees for electricity and roads projects were just 2 percent and 0 percent of total guarantees in African fragile states. However, as with IFC, MIGA has traditionally been focused on market sectors instead of broader PSD-related constraints. MIGA alignment with these sectors is explored in the chapter 4.

Conclusion

While the World Bank Group has made significant strides in assessing the constraints to business growth in fragile states over the past 10 years, two of its subsidiaries (IFC and MIGA) have not committed significant financial resources to address the most binding business constraints. As noted above, both organizations’ business models prioritize financial returns as opposed to development returns. Given this, IFC and MIGA, for various reasons, have been reluctant, unable, or unwilling to execute investments and guarantees in African fragile states that target the most binding business constraints. By contrast, IDA displays a significant level of alignment with business constraints in African fragile states—with the possible exception of access to finance.

Notes

Government priorities in fragile states

This chapter examines the alignment between fragile state governments’ private sector development (PSD) priorities and World Bank Group activities over the past decade. As illustrated by the Paris Declaration, Accra Declaration, and various other international initiatives, donor institutions have strived to empower country ownership and improve alignment with recipient government strategies and development objectives. Against this backdrop, how has the World Bank Group performed with respect to PSD in African fragile states?

Methodology

Overall, we categorize governments’ PSD priorities into two general areas: broader business environment constraints and cost drivers (such as regulatory framework and infrastructure); and key business growth sectors (such as agriculture and extractive industries). To determine individual country priorities, we draw on several types of government documents, including national development plans (Angola’s Vision 2025 plan); poverty reduction strategy papers; economic growth strategies (the South Sudan Growth Strategy); and government budget reports.[1], [2] Given the widespread prevalence of conflict and relative lack of national development strategies during the 1990s, we focus on the period between 2000 and 2010. Our analysis excludes Eritrea and Zimbabwe due to the lack of either a publicly available national development strategy (Eritrea) or significant World Bank Group activities during the examined period (Zimbabwe).[3]

In some cases, government documents delineate an explicit PSD strategy, including the top business constraints and priority growth sectors.[4] In others, it is more difficult to ascertain the government’s strategic focus or priorities. For example, a given poverty reduction strategy paper may include an exhaustive list of proposed PSD-related interventions covering the range of economic sectors as well as regulatory, trade, infrastructure, finance, and supply chain issues. In these instances, we have attempted to identify priority constraints and growth sectors that appear more central to the government’s broader strategy.[5] Despite our best efforts, this approach is prone to measurement error given the subjective nature of our assessments. So while our analysis provides a constructive overview of the World Bank Group’s alignment with specific government priorities, it should be considered indicative and subject to further consideration and adjustment.[6]

Country government priorities

Not surprisingly, there is a significant amount of consistency across African fragile state governments’ priorities for addressing PSD-related constraints (table 4.1). The most frequently cited priorities include regulatory framework (100 percent); transport infrastructure (100 percent); electricity infrastructure (92 percent); access to finance (83 percent); and macroeconomic stability (75 percent). In addition, half the African fragile state governments cite the improvement of security and telecommunications infrastructure as priority areas.

Government constraint priorities illustrate a somewhat mixed picture when compared with firm-level views about the most binding constraints to business growth.[7] First, government priorities appear well aligned with the two constraints cited most frequently by individual firms—electricity and access to finance. By contrast, two top government objectives—improving the regulatory framework and transport infrastructure—are cited much less frequently by surveyed firms.[8] For example, every African fragile state includes expansion or rehabilitation of transport infrastructure as a primary component of its PSD strategy.[9] But less than 40 percent of surveyed firms cited transportation as a “major” obstacle.

Economic sector priorities

As with PSD-related constraints, African fragile state governments overwhelmingly prioritize a few economic sectors—namely, agriculture and extractive industries (table 4.2).[10] Only Togo has not targeted the extractive sector as a priority growth driver. Roughly one-third of fragile state governments have specifically prioritized the industry, manufacturing, and tourism sectors. Surprisingly, only Togo has explicitly prioritized the financial sector as a strategic driver of private sector activity and economic growth.

World Bank Group alignment with government priorities

IDA PSD constraint alignment. Since 2000, the International Development Association (IDA) has supported 70 PSD-related projects in our sample countries, of which 65 have been focused on the governments’ priority constraints. In monetary terms, these priority projects account for nearly 100 percent of total PSD-related activities. Indeed, IDA programs are entirely focused on government priorities in 10 of 12 African fragile states—that is, there is 100 percent alignment in those 10 countries (table 4.3). The one notable outlier is the Central African Republic, which is driven by several finance and banking projects that fall outside the scope of the government’s core priorities. Taken together, this suggests that IDA activities are very aligned with fragile state government objectives.

IFC PSD alignment. The International Finance Corporation (IFC) also exhibits a decent alignment track record between its investment operations and governments’ sectoral priorities—though much lower than IDA’s performance.[11] More than half of IFC investments in African fragile states (by monetary value or number of transactions) since 2000 have focused on priority economic sectors or priority constraints (table 4.4). Four telecommunications projects located in Burundi, Chad, and the Democratic Republic of Congo account for nearly all the nonaligned IFC investments during the specified period ($265 million of $266 million). So while aggregate alignment figures illustrate a largely positive picture, the IFC has room for improvement.

MIGA PSD alignment . Since 2000, the Multilateral Investment Guarantee Agency (MIGA) has supported only 19 guarantees in African fragile states, of which slightly more than half are aligned with the governments’ priority economic sectors (table 4.5). Put differently, MIGA has supported one aligned guarantee per country, on average, over the last decade. In monetary terms, slightly more than 80 percent of MIGA guarantees have been aligned with government priorities. But a small number of transactions account for the overwhelming majority of guarantees (as with IFC).[12] If compared with the total number of guarantees in African fragile states, MIGA’s alignment with government priorities falls to less than 60 percent. Taken together, these data suggest that the limited MIGA activities are only modestly aligned with fragile state governments’ priorities—with significant room for improvement.

Conclusion

Overall, World Bank Group activities illustrate strong alignment with fragile state government priorities for addressing private sector constraints and supporting key economic growth sectors. In monetary aggregates, more than 90 percent of World Bank projects and investments have targeted priority areas (figure 4.1). However, as noted above, this is largely driven by IDA’s sizable project commitments (nearly 80 percent of total World Bank Group support) and strong alignment. By contrast, IFC and MIGA have additional room for improvement. (This is discussed in greater detail in chapter 6.)

There is considerable cross-country disparity in World Bank Group alignment. For example, IDA, IFC, and MIGA support is almost universally aligned with government priorities in Angola and Liberia. By contrast, World Bank support exhibits only low overlap in several other African fragile states, such as the Democratic Republic of Congo. And IFC and MIGA have not completed any transactions in a few country markets, including the Central African Republic, the Republic of Congo, and Sudan.[13] These trends emphasize the need for the World Bank Group—including its individual subsidiary organizations—to improve alignment performance not only at the aggregate fragile states level, but also at the individual country level.

Notes

What works—proven PSD successes in fragile environments

This chapter examines the effectiveness of World Bank Group projects in fragile states over time. In other words, have the International Development Association (IDA) and the International Finance Corporation (IFC) prioritized their financing and programmatic support in high-performing sectors? As noted previously, project performance in fragile state environments has lagged significantly compared with outcomes in other low- and middle-income countries. So it is even more important for IDA and IFC to identify the private sector development (PSD)–related sectors and subsectors with adequate project performance, prioritize development and investment operations accordingly, and consider innovative ways to improve project outcomes in historically low-performing areas.

IDA alignment with what works

To identify sectors with high-performing IDA projects, we use World Bank Independent Evaluation Group (IEG) project outcome ratings during the period between 1980 and 2006. The IEG rates individual World Bank Group project outcome performance on a range between 0 and 5 (the latter being defined as a “highly satisfactory” outcome).[1] IEG ratings are available for more than 4,800 IDA projects completed during the examined time period.[2] We define IDA recipient countries as “fragile” if their average Country Policy and Institutional Assessment (CPIA) score was below 3.2 during the project implementation period. This provides for a broader country sample, important for determining what types of IDA projects have worked in fragile environments globally and over time. As with previous analysis, we use IDA’s sectoral classifications to the extent possible to determine the priority sector or topic for each project.[3] Under this methodology, there are 1,924 PSD-related projects, of which 321 are in African and non-African countries defined as fragile states (table 5.1). In addition, our dataset includes nearly 2,900 non-PSD projects (health, education), of which 533 are in African and non-African fragile states.

IDA PSD-related project performance

Overall, IDA projects in fragile states have performed at a consistently low level over time. On average, they have received an IEG project outcome rating of 2.5, falling between “moderately unsatisfactory” and “moderately satisfactory.” But PSD-related projects in fragile states have performed at a slightly higher level when compared with non-PSD–related projects, with an average IEG rating of 2.60 versus 2.43. The same is true for nonfragile states as well (3.23 versus 3.16). Within PSD-related areas, extractive industry and regulatory reform projects have produced the best outcomes, followed by infrastructure (table 5.2). Financial sector and general PSD (that is, multisector) projects have produced the lowest outcome scores on average. Compared with nonfragile states, the largest lagging sectors are finance and infrastructure, with average IEG project outcome ratings roughly one-third lower than in nonfragile state environments.

There is a wide distribution of IEG project outcome ratings within sectors and subsectors. In simple terms, IDA projects in fragile states are not universally poor-performing (“unsatisfactory”). Instead, roughly the same share of projects have either “unsatisfactory” or “satisfactory” outcome ratings (36 percent and 45 percent, respectively; figure 5.1).[4] Despite relatively low average outcome ratings overall, at least half of IDA projects had “satisfactory” outcomes in the following subsectors: telecommunications, roads, general industry regulatory reform, trade policy reform, agricultural financing, and oil and gas (see appendix 11 for details).

Over time, IDA’s prioritization of higher performing PSD sectors has been mixed. Figure 5.2 maps the percentage of IDA projects targeting PSD-related subsectors against the average IEG outcome rating for that sector. On the positive side, IDA appears to have deprioritized those subsectors with very low project outcome ratings (ports, banking, railways). At the same time, IDA has pursued a relatively modest number of projects in higher performing areas, such as industry regulation reform, telecommunications, and trade policy reform. Importantly, this analysis does not control for several potentially influential issues, such as client government demand, intertemporal differences in project performance regional factors, and determinants of project outcomes. We explore the latter issue in some detail below, though not exhaustively. Even so, it does provide some indication of IDA’s portfolio performance management over time.

IDA’s current alignment with what works

On the basis of historical IEG project outcome ratings, how much is IDA currently focusing on fairly strong performing PSD-related areas in African fragile states? As with other areas, the answer is mixed and somewhat complex. As figure 5.3 illustrates, there is almost no correlation between IDA sector prioritization (measured relative to the total PSD commitments or number of projects) and project outcome ratings.[5] Overall, roughly 84 percent of IDA’s PSD portfolio in African fragile states lies in subsectors with “moderately unsatisfactory” project outcomes between 1980 and 2006. By contrast, only 1 percent of IDA’s existing PSD-related portfolio is targeting subsectors with “moderately satisfactory” project outcomes. This tentative result appears to be driven by two factors: IDA’s heavy relative focus on the slightly lower performing road and electricity subsectors; [6] and IDA’s modest (or nonexistent) focus on relatively well-performing subsectors, such as general industry reform.

But this does not necessarily mean that IDA’s projects have a poor alignment with PSD subsectors with strong, proven results. As noted above, more than half of road projects in fragile state environments have provided “satisfactory” outcomes—despite the subsector’s overall average rating of “moderately unsatisfactory.” This illustrates the imperative to focus also on the micro, macro, and operational factors that influence project outcomes, explored extensively in the literature. Several studies find that operational factors—such as project preparation, quality-at-entry, and project supervision—have significant explanatory power in determining project outcome ratings.[7] By illustration, electricity projects in fragile states with strong quality-at-entry ratings had “satisfactory” outcome ratings nearly 80 percent of the time.[8] So it is theoretically possible that IDA’s existing PSD-related portfolio may be well aligned with what works in a broader context. This assumes that IDA has only pursued projects after strong preparatory work and favorable initial conditions, and subsequently has taken steps to ensure strong supervision over time. Additional regression analysis by the World Bank Group and other researchers examining the empirical impact of these factors in fragile states would be a constructive contribution.

IFC alignment with what works

The IFC evaluates its investment projects using two core metrics: development outcome performance and financial performance. This section outlines the criteria for each metric and determines whether IFC is committing its resources and projects toward relatively well-performing sectors.

Development outcome performance

The IFC uses its Development Outcome Tracking System (DOTS) to determine the development effectiveness and reach of its projects. According to IFC, the DOTS tracks four performance benchmarks:

• Financial performance. Financial returns in excess of a project’s weighted average cost of capital.
• Economic performance. “Economic rate of return” in excess of 10 percent (for example, benefits beyond those generated to project financiers).
• Environmental and social performance. Conformity to IFC’s environmental and social performance standards, which include measures of pollution prevention and abatement, community health and safety, and land acquisition and involuntary resettlement procedures.[9]
• Private sector development impact. Improvement of the general private sector environment, which often is measured by the number of follow-up investments by other in-sector private companies.

The IFC also uses additional, specific development effectiveness subcriteria, such as the number of jobs created, increase in sales volume, reduction in emissions, and return on equity.

Currently, the IFC does not make its project-by-project evaluation data available publicly, which prevents us from analyzing IFC alignment in fragile states in a targeted manner. In light of the World Bank Group’s Open Data Initiative, steps should be taken immediately to post this IFC information on its website in a user-friendly format.[10] Even so, the IFC’s Annual Portfolio Performance Review provides regional and sector breakdowns of development effectiveness outcomes. According to sectorwide DOTS evaluations, health and education projects have the highest development outcome ratings. Oil, gas, and mining projects also receive consistently high DOTS ratings. Global manufacturing projects have the lowest percentage of highly rated projects. However, when weighted according to project commitment values (as opposed to the number of projects), most projects in each sector receive high DOTS ratings with little discrepancy between sectors (figure 5.4). Since these results reflect projects aggregated across all regions, income levels, and CPIA ratings, they provide limited value and insights for African and non-African fragile states.

Financial performance

The IFC also uses project profitability to gauge operational performance. The IFC’s principal measures of financial performance include loan income, loan returns, and equity returns.[11] Table 5.3 illustrates how financial performance fluctuates widely across sectors and fiscal years. For example, financial services accounted for 70 percent of total IFC equity income in fiscal year (FY) 2009 compared with only 17 percent in FY10. Conversely, oil, gas, and mining projects had an equity return of 13 percent in FY09 and a 291 percent return in FY10—which illustrates how a few large IFC investments can drive respective sectors’ financial performance. Since these results reflect projects aggregated across all regions, income levels, and CPIA ratings, they provide limited value and insights for African and non-African fragile states.

Financial performance versus annual disbursements

To determine whether IFC is committing its entire investment portfolio toward relatively high-performing sectors, we compare IFC annual disbursements with the financial performance metrics presented above. Figure 5.5 shows the strong relationship between these two indicators in IFC’s equity and loan portfolios. This indicates that IFC effectively aligns its investment in each sector according to that sector’s expected annual financial returns. Again, since these results reflect projects aggregated across all regions, income levels, and CPIA ratings, they provide limited value for our exercise. With the availability of project-level performance data, additional targeted analysis should be pursued for IFC activities in African fragile states.

Notes

Country case study—South Sudan

This chapter applies the proposed private sector development (PSD) guiding framework to the specific case study of South Sudan. First, it examines the private sector profile and major business constraints. Next, it outlines the guiding priorities of the government of South Sudan. Then it gauges how well donor institutions’ PSD-related projects are aligned to what matters in South Sudan and what has worked well over time.

Contextual overview

In July 2011, the Republic of South Sudan became the world’s newest nation. When Sudan’s destructive two-decades-long civil war ended in 2005, South Sudan was left with almost no physical or institutional infrastructure. Since then, substantial rebuilding and rehabilitation of destroyed or damaged structures has taken place. National, state, and local governments have been established along with the passage of a broad range of new legislation. Modern banking services have been introduced, and courts, schools, and health clinics across the region have been established.

Despite this significant progress, the new nation still faces monumental challenges in fostering broad-based private sector growth and economic opportunities for its people. Among the major economic challenges facing South Sudan: weak or nonexistent physical infrastructure (especially power and transport); inadequate access to and cost of finance; dependence on subsistence agriculture; a poor business regulatory climate; and the overwhelming dominance of the oil sector for national output, exports, and government revenues. At the same time, the nation is endowed with significant natural resources beyond oil, such as timber, gold, and plentiful water for agriculture. Moreover, South Sudan will undoubtedly receive strong support from bilateral donors and international financial institutions, which have already initiated comprehensive economic and social support programs.

Private sector overview

Despite significant challenges, the private sector in South Sudan has expanded rapidly over recent years, shown by the registration of more than 6,000 new firms since 2005.[1] Despite the strong new business growth, the private sector in South Sudan remains constrained and is dominated by micro and small firms in the retail sector. As of 2010, roughly 93 percent of registered firms had fewer than six employees (table 6.1). By extension, there is a nearly complete lack of medium or large firms, with only 20 firms having 50 or more employees.

As noted previously, private enterprises are heavily concentrated in the wholesale and retail trade sector, accounting for 70 percent of registered firms (see table 6.1). Another 14 percent of firms operate in hospitality-related sectors, such as lodging and food service. Less than 5 percent of registered South Sudanese firms are in industry-related sectors, such as manufacturing, construction, or mining. In geographical terms, nearly two-thirds of private enterprises are located in South Sudan’s three largest cities (Juba, Malakal, and Wau). Even in these urban areas, business density remains very low, whether measured in per capita or per household terms. For example, there are only 0.014 businesses per household in Juba and 0.006 in Malakal.

Given the business profile in South Sudan, the government and its donor supporters face a dual challenge of both creating enabling conditions for micro-entrepreneurs to grow and simultaneously preparing the environment for the establishment of larger, formal sectors such as food processing, mining, or light manufacturing.[2] In this context, the government must take concerted steps to reduce operating costs and associated investment risks through an improved policy framework, infrastructure network (such as reliable electricity and transport), supply chains, access to finance, and technical and managerial skills. The next section examines these constraints in greater detail.

Major business constraints

Our business constraint analysis draws upon several recent private sector diagnostics and surveys, including the Sudan Investment Climate Assessment, the Juba Doing Business report, and the 2009 Population and Household Survey. The World Bank’s Investment Climate Assessment is based upon firm-level surveys in the manufacturing, services, and informal sectors. While the survey was conducted nationally, information was collected in Juba and Malakal. The Doing Business report, produced in partnership by the World Bank and the U.S. Agency for International Development (USAID), examines the business environment for a typical manufacturing firm in Juba. Based upon these sources, the largest obstacles to private sector activity in South Sudan concern access to electricity, access to and cost of finance, transportation, corruption, and customs.

Reliable electricity

Reliable access to electricity is the most commonly cited business obstacle in South Sudan. In Juba, 87 percent of the business survey respondents cited electricity as the most significant constraint on their operations. This proportion reaches 100 percent for manufacturing firms located in Malakal. Electricity delivery has improved recently in Juba following the installation of oil-fueled generators. But two power stations (of three) are out of service, contributing to frequent power cuts.[3]

Most businesses in South Sudan own or share generators due to the lack of reliable power generation. These generators account for a significant share of their businesses energy consumption—83 percent of firms based in Juba rely upon generator power, which accounts for 93 percent of their energy consumption. Not surprisingly, generator-based electricity significantly increases businesses’ operating costs—both through fairly expensive fuel imports and inconsistent supply. Spending capital on purchasing and operating generators often directly reduces firms’ resources for investing in fixed assets and other productivity-enhancing factors. This undermines the ability of South Sudanese firms to compete in both regional and global markets. However, according to the World Bank’s Investment Climate Assessment survey, companies with generators do experience fewer production interruptions and lower associated output losses.

Access to finance

The second most frequently cited business obstacle in South Sudan is access to and cost of finance. Roughly 75 percent of firms located in Juba cited these issues as “major” to “severe” constraints on their ability to operate and expand. Most available financial products relate to foreign exchange transactions, bank transfers, and remittance services—with only a handful of commercial banks providing more traditional services such as loans, trade finance, and savings accounts. Almost all bank lending is short-term, with relatively high interest rates (15–20 percent).[4] According to the Bank of South Sudan, commercial bank exposure totaled only SDG 139 million (roughly $60 million) as of 2009 (table 6.2). This exposure is highly concentrated in retail trade and service companies (60 percent) because of their ability to generate short-term cash flow and capture government procurement and guarantees. Only a quarter of existing commercial bank exposure is targeted toward industry-related sectors such as manufacturing, construction, and transport. Not surprisingly, constrained access to operating capital has contributed to the underuse of capacity in the manufacturing sector.

This trend extends to the household level as well. Due to various factors, South Sudan remains heavily underbanked.[5] Only 1 percent of South Sudanese households had a bank account as of 2010. And only 18 percent of households borrowed or obtained money that must be repaid (table 6.3).

The exit of several Islamic banks in February 2008—following the Bank of South Sudan ruling that all financial intermediation must be implemented on conventional terms—sharpened households’ lack of access to finance. Border states such as Northern Bahr El Ghazal and Warrap were impacted the most by this exit (table 6.4). However, several banks from neighboring countries (Ethiopia and Kenya) have been issued operating licenses in recent years, expanding rapidly. Despite this, competition in the banking sector remains limited, with correspondingly high margins and service concentration in the larger urban areas.

Table 6.4: Distribution of commercial banking services, by state (number of branches) [CLICK TO VIEW]

In addition to commercial banks, many microfinance institutions operate in South Sudan. But they currently service less than 1 percent of the potential market in South Sudan and only 5 percent of available clients in the greater Juba region, offering a limited range of products.[6] As of 2010, microfinance institutions had not started addressing the rural and agricultural sectors effectively—where most households derive their primary source of income.[7] Lending rates are comparable with those of other developing countries, ranging between 15 percent and 35 percent.[8]

Banking sector growth and coverage going forward, for both commercial and microfinance institutions, will depend on strengthening land registry systems,[9] improving legal and enforcement mechanisms, enhancing bank management capacity (risk management, corporate governance), and reducing high transaction costs driven in part by poor infrastructure (electricity, telecommunications, transport).

Transport infrastructure

As with electricity and financing, the lack of transport infrastructure acts as a binding constraint to almost all productive sectors in South Sudan. There are approximately 4,100 kilometers of year-round gravel trunk roads and almost no rehabilitated feeder road network (see additional details below).[10] The government budget allocated little funding to upgrade and maintain these trunk roads, raising serious concerns about their sustainability over the medium to long term.[11] The only rail line in South Sudan connects Wau (Western Bahr el Ghazal state) to Muglad (West Kordofan state) in northern Sudan. Plans to extend the rail network to Juba have not been realized to date—nor are there any rail linkages to neighboring countries.[12]

Since South Sudan imports the most product inputs from neighboring countries or from northern states, the lack of adequate road and rail networks has the greatest relative impact in regions located far from international borders. This is particularly problematic in such states as Upper Nile, Lakes, Warrap, and Western Equatoria. As a result, input and product costs are substantially higher than in southern cities—such as Juba—which are closer to the borders with Kenya and Uganda (table 6.5). While transport requirements and costs may be lower in southern areas, they still remain extremely high relative to those in neighboring countries.

Corruption

Corruption is yet another leading constraint to PSD in South Sudan. The weak legal framework and relatively poor administrative capacity of the government has contributed to this problem. Overall, research suggests that corruption can severely distort competition and impose high direct costs on firms in developing countries, particularly among small and medium enterprises.[13] Given that South Sudan is dominated by micro and small enterprises, the potential negative impact may be substantial. But corruption appears to be a larger concern in certain regions (Juba) and among informal firms—for example, 74 percent of surveyed firms in Juba cited it as a major constraint, while only 60 percent did in Malakal.

Trading across borders

As South Sudan is a landlocked country, the time and cost of trading across borders has been a major negative driver of its firms’ operating costs and international competitiveness. Indeed, there are only Afghanistan and the Central African Republic score worse on the Doing Business rankings.[14] While poor transport infrastructure is the largest cost driver (as discussed earlier), firms also face an extremely burdensome customs process and multiple checkpoints that add significant time delays.[15] On average, firms located in Juba spend 34 days to obtain 11 documents required for importing, and 28 days for the 9 documents required for exporting (table 6.6).[16] According to the World Bank, the main cause of document delays is the letter of credit requirement, which must be approved by the Bank of South Sudan.[17] And it costs firms in Khartoum or Kampala roughly $2,900 to import products, or roughly 30 percent of the costs faced by South Sudanese firms.

Government priorities

According to the South Sudan Growth Strategy, the government is pursuing a broad-based approach for reducing the country’s “absolute dependence” on oil and establishing a diversified, inclusive, and sustainable economy.[18] A central component of the Growth Strategy is adopting policies designed to stimulate growth in low-skill, labor-intensive sectors.

• Business constraints . For business environment constraints, the government has prioritized improvements in five key areas: transport infrastructure, rule of law, taxation policies, access to finance, and macroeconomic stability.[19]
• Economic sector priorities. For economic sectors, the government has heavily prioritized agriculture given the country’s plentiful arable land and rainfall endowments as well as the overwhelming percentage of the national labor force engaged in agriculture. To increase agricultural productivity and market opportunities, the government has pursued a three-track approach: increasing information dissemination (capacity-building), distributing inputs (seeds, fertilizer, irrigation), and supporting market integration and access through physical infrastructure improvements (feeder roads). The government also recognizes the growth potential within the services and light manufacturing sectors, but it plans to support them as secondary priorities.

Existing donor programs

As of 2010, donors’ private sector–related project portfolio totaled almost $730 million (table 6.7).[20] Actual donor expenditures totaled roughly $212 million for PSD in 2009, or roughly a quarter of total outlays for all donor projects. Slightly more than half of this total was allocated to the construction of roads throughout South Sudan. Agriculture programs—dominated by capacity-building and distribution of inputs (for example, seeds)—are the second-largest sector by project portfolio (roughly $196 million).

Donor alignment with business constraints

Overall, donor programs are not aligned with many of South Sudan’s greatest business environment obstacles—particularly electricity and access to finance (figure 6.1). Despite these being the two largest business constraints, donors supported only one electricity project and one microfinance-related program as of 2010.[21] Taken together, these two projects total less than 4 percent of all private sector–related projects ($26 million of roughly $730 million; see table 6.7).[22] Going forward, donor funding for power generation and banking programs could have a significant positive impact on business activity in South Sudan. However, donor programs are focusing on several important private sector obstacles, such as transport infrastructure and economic and regulatory institutions. As noted previously, the expansion of South Sudan’s nearly nonexistent road network is one positive area of donor engagement.

Ideally, donor institutions would take a division-of-labor approach both among themselves and with the recipient country government. But that does not appear to be the case in South Sudan for the aforementioned neglected constraints to private sector growth. Between 2006 and 2010, the government directed only 1 percent of its total budget expenditures toward expanding access to reliable electricity.[23] By contrast, it provided roughly 8.4 percent of budget expenditures for transport construction and rehabilitation (SDG 1.8 billion). Put differently, both the government and donor institutions are crowding into several important sectors while almost completely ignoring several major constraints to more urban-based business activity.

Donor alignment with government priorities

In contrast to business constraints, donors are very well aligned with the South Sudanese government’s priorities. Overall, roughly 90 percent of PSD-related projects are focused on the government’s priority business constraints and economic sector (agriculture). The alignment ratio rises to 95 percent if measured as a percentage of total PSD-related project commitments (table 6.8). The one outlier is the nearly complete lack of donor assistance to improve access to financing. As noted previously, donors have supported only one microfinance project in South Sudan. This suggests that donors should explore ways of helping South Sudanese farmers and business owners to better access affordable expansion and operating capital.

Donor alignment with what works

Next, we examine donor alignment with PSD-related sectors and subsectors that exhibited higher project outcome ratings in African and non-African fragile states over time.[24] Given the impracticality of gauging historical project performance across the 15 different donor organizations with active PSD-related programs in South Sudan, we use the World Bank’s Independent Evaluation Group project outcome rating figures as a proxy (see chapter 5). As figure 6.2 illustrates, existing donor projects exhibit mixed alignment results with higher performing PSD-related sectors. Except for two regulatory subsectors (legal system reform and labor policy), the percentage of donor projects targeting specific PSD-related areas is higher in subsectors with better average project outcome ratings. But donors’ heavy focus on road transport and agriculture sectors—accounting for 80 percent of all PSD-related projects—may be considered excessive based solely on their historical outcome performance in fragile state environments.

Conclusion

Overall, donors exhibit strong alignment with one of the proposed guiding PSD framework pillars (government priorities) and modest alignment with what has worked in other fragile state environments over time. Alignment with firm views about major constraints is mixed at best—stemming largely from the disconnect between what South Sudanese firms and the government believe are the most pressing PSD constraints. This apparent conflict illustrates the operational and strategic complexities of balancing rural development–based growth strategies with the needs and priorities of largely urban firms that are represented in World Bank Enterprise Surveys. The World Bank Group can respond to this phenomenon by better reflecting the views of rural businesses (including smallholder farmers) in their survey diagnostics, particularly for African countries with sizable employment shares in the agriculture sector.

Regardless of this issue, there is a clear need for donors to give greater priority to PSD-related programs to improve access to and cost of finance, for both South Sudanese farmers and other economic sectors. But with finance projects’ poor performance in fragile states over time, careful consideration should be given to ensuring an improved track record in South Sudan. Moreover, donors should give additional consideration to whether a heavier emphasis on electricity infrastructure would be justified, both in the context of addressing firms’ views and of broader economic and social development imperatives.

Notes

Conclusion

The World Bank Group and other development institutions have committed to further prioritize programmatic operations in fragile states. The strategic imperative for this focus is particularly warranted given the projected IDA graduation by more than half of its existing client countries by 2025. And the World Bank Group’s existing efforts to devise a new Group-wide strategy for fragile states present an opportune time to reexamine one key aspect of its operations—promoting private sector development. This report examines three key private sector–related factors in African fragile states: what businesses cite as the most binding constraints to private sector growth; what government priorities are for business climate improvements or strategic economic sectors; and what types of projects have been more effective over time. Subsequently, we assess the alignment of World Bank Group operations within these three areas over the past decade. Overall, we find that project alignment varies widely across the World Bank Group’s three largest subsidiaries—the International Development Association (IDA), International Finance Corporation (IFC), and Multilateral Investment Guarantee Agency (MIGA).

• IDA exhibits very strong alignment with government priorities and reasonably good prioritization in sectors with higher project outcome ratings. But it has a more mixed performance with respect to focusing on what businesses cite as the most binding private sector–related constraints. IDA has pursued comparatively few projects focusing on the most binding constraints, such as electricity and access to finance.
• By contrast, IFC and MIGA projects are only modestly aligned with the private sector’s most binding constraints or fragile state government priorities. Instead, projects have been heavily concentrated in low-risk sectors, such as the extractive sector. Taken together, IFC activities over time suggest that the organization lacks a comprehensive, systematic strategy in African fragile states[1]

Moving forward

Despite several bright spots, our analysis suggests that strategic changes in the World Bank Group’s operations are needed—particularly for IFC and MIGA. Given this, we propose a new methodology by which they could prioritize and structure assistance and investment programs in fragile states. Our conceptual model brings together three simple, yet fundamental, components for policy design—what is needed, what is wanted, and what works.

• What is needed . To generate growth, policymakers must create a conducive environment for business owners and managers of small, medium, and large firms. Understanding the business community’s concrete and most binding constraints is the crucial first step toward good policy design.
• What is wanted. Policymakers in fragile states operate in very difficult environments. Understanding their perspective and private sector objectives is important, especially for policymakers in multilateral institutions.
• What works . We must use the lessons learned from past projects and policy interventions. Understanding what has worked in very difficult environments will be useful to the design of new policies, programs, and projects—particularly when these findings are referenced against public and private sector constraints and priorities.

When viewed together, these three analytical components can help the World Bank Group and other development organizations prioritize private sector–related programs in fragile states. Ideally, donor institutions would pursue projects in sectors or areas where all three components intersect (what the private sector needs, what the government wants, and what donors do effectively). But there will be situations or environments in which multilateral organizations may wish to pursue projects or investments that do not meet this condition.

The challenge will be ensuring flexible operational and institutional structures to implement these objectives. Broadly speaking, three main areas need to be addressed: improving managerial capacity to enable a bolder approach to fragile states; significantly changing human resources strategies to attract and retain staff who are willing to take risks and understand the conditions of operating in fragile states; and improving the incentives of existing staff so that they are more willing to take on riskier projects. Each of these areas is enormously challenging, but must receive concerted efforts in order for a fragile states–specific agenda to be implemented.

Note

Appendixes

Please see the pdf for full appendixes

Copyright © 2012 by the Center for Global Development. Cover photo: United Nations Environment Programme. Editing and print design and production by Communications Development Incorporated, Washington, D.C., and Peter Grundy Art & Design, London. Online design and production by John Osterman. The Center for Global Development is grateful for contributions from the Royal Danish Embassy in support of this work.

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