Investment climate assessment : Improving enterprise performance and growth in Tanzania

33663 Investment Climate Assessment: Improving Enterprise Performance and Growth in Tanzania November 2004  Table of Contents AT-A-GLANCE TABLE.................................................................................................................4 ACKNOWLEDGMENTS ...............................................................................................................5 EXECUTIVE SUMMARY .............................................................................................................6 CHAPTER 1: MACROECONOMIC PERFORMANCE AND BACKGROUND.......................17 I. BACKGROUND 17 II. GROWTH AND INVESTMENT 18 III. ECONOMIC MANAGEMENT 19 IV. TRADE 21 CHAPTER 2: ENTERPRISE PERFORMANCE AND PRODUCTIVITY..................................24 I. DATA 24 II. PRODUCTIVITY OF MANUFACTURING ENTERPRISES 25 III. HUMAN CAPITAL 33 IV. EXPORTING BY MANUFACTURING ENTERPRISES. 37 CHAPTER 3: CONSTRAINTS ON ENTERPRISE OPERATIONS AND GROWTH...............42 I. CONSTRAINTS ON ENTERPRISE OPERATIONS AND GROWTH 47 II. CONFRONTING INFORMALITY 70 III. OTHER CONSTRAINTS ON ENTERPRISES OPERATIONS AND GROWTH 76 CHAPTER 4: THE INVESTMENT CLIMATE AT THE SUBNATIONAL LEVEL.................81 I. TAX RATES AND ADMINISTRATION 81 II. INFRASTRUCTURE 81 III. CORRUPTION 83 III. BUSINESS REGULATIONS AND BUREAUCRATIC BURDEN 83 CHAPTER 5: POLICY IMPLICATIONS.....................................................................................85  I. REDUCINGTHE BURDEN OF TAXATION ON FORMAL ENTERPRISES 85 II. IMPROVINGTHE PERFORMANCE OF THE POWER SECTOR 87 III. ENHANCING THE EFFECTIVENESS OF FINANCIAL SERVICES AND ACCESS TO CREDIT 88 IV. REDUCING CORRUPTION 89 V. MAINTAINING MACROECONOMIC STABILITY 90 VI. IMPROVING TIES TO THE INTERNATIONAL ECONOMY 91 VII. INCREASING LABOR AND TOTAL FACTOR PRODUCTIVITY 93 POLICY MATRIX FOR IMPROVING THE INVESTMENT CLIMATE IN TANZANIA...................................................................................................................................94 ANNEX 1: THE TANZANIAN INVESTMENT CLIMATE SURVEY DATA..........................99 ANNEX 2: TECHNICAL APPENDIX FOR PRODUCTIVITY CALCULATIONS................102 ANNEX 3: RANKING OF OBSTACLES BY FIRM TYPE......................................................107 I. RANKINGS BY REGION 107 II. RANKINGS BY SECTOR 109 III. RANKINGS BY FIRM SIZE 111 IV. RANKINGS BY EXPORT STATUS 112 ANNEX 4: REGIONAL DISTRIBUTION OF FOREIGN DIRECT INVESTMENT...............113 ANNEX 5: STANDARD TABLES.............................................................................................115 REFERENCES ............................................................................................................................125  AT-A-GLANCE TABLE Investment Climate at a glance China, Tanzania and Kenya Macro environment China Tanzania Kenya GNI per cap, PPP $ 1995 2000/1 1995 2000/1 1995 2000/1 3400 GNI per capita (US$, PPP) 2650 3920 440 500 1000 1010 Population, mid year (millions) 1205 1262 30 34 26.7 30.1 2400 GDP growth (1991-95 and 1996-2000, avg %) 12.1 8.2 1.8 4.1 1.6 1.78 Openness (Imports+Exports/GDP) 45.7 49.1 46.0 48.6 71.4 62.1 1400 FDI inflows (net, % GDP) 5.1 3.6 5.1 3.8 0.4 1.1 400 Governance 1995 1996 1997 1998 1999 2000 Control of corruption2 -0.3 -1.00 -1.05 China Tanzania Kenya Rule of law2 -0.19 -0.49 -1.04 Political Stability2 0.39 -0.25 -0.86 No. of visits by gvt officials, avg per year 36 33 .. % of senior manager time with gvnt officials 7 16 .. PC per 1,000 people 20 Infrastructure Share of firms with own generator, % 27 .. 55 .. 70 15 Days to clear imports, longest in last year 12 .. 33 .. .. 10 Telephone lines in largest city (per 1000 people) 294 22.7 20 78.4 78.4 5 Personal computers (per 1000 people) 16 .. 1 0.6 4.9 0 Paved roads, % of total 22 4.2 .. 13.8 12.1 1995 1996 1997 1998 1999 2000 China Tanzania Kenya Finance Credit to Priv. Sector (% gdp) 150 Cost of capital (lending interest rate, %) 5.85 .. .. 28.8 22.3 Share of credit from financial institutions, % .. 8 .. 5 100 Credit to private sector (stock, % of GDP) 125 13 29 34 30 50 0 1995 1996 1997 1998 1999 2000 China Tanzania Kenya Source: WDI, Governance Research Indicators, ICU firm surveys 1/ or most recent available year 2 Scale of -2.5 to 2.5. Higher values correspond to better outcomes  ACKNOWLEDGMENTS This Investment Climate Assessment (ICA) is based on an analysis of survey data collected by the Economic and Social Research Foundation (ESRF) in Dar es Salaam, Tanzania, and the Regional Program on Enterprise Development at the World Bank, in collaboration with the National Bureau of Statistics (NBS). The survey was conducted between April and July 2003. ESRF staff heavily involved in the project include Professor H.K. Amani, Josaphat Kweka, Oswald Mashindano, and John Kajiba. World Bank staff contributing to this report include Rita Almeida, George Clarke, Chad Leechor, Korotoumou Ouattara, Vijaya Ramachandran, and Tilahun Temesgen. John Paton played an important role in survey implementation. Ivan Rossignol, Andrew Stone, and Robert Utz acted as peer reviewers. Judy O'Connor, Linda Cotton, Odd-Helge Fjeldstad, Christiane Kraus, Melanie Marlett, Khalid Misra, Karen Rasmussen, Ben Tarimo, Simon Thomas, William Steel, and Michael Wong provided helpful comments.  EXECUTIVE SUMMARY This Investment Climate Assessment is based on an analysis of data collected in the Investment Climate Survey of manufacturing firms in Tanzania. The survey was conducted between April and July 2003 by the World Bank and the Economic and Social Research Foundation (ESRF) in Dar es Salaam, in collaboration with the National Bureau of Statistics (NBS). In addition to data from this survey, the assessment draws on similar surveys of firms in the tourism and construction sectors, also conducted between April and July 2003; a survey of informal and micro enterprises conducted for World Development Report 2005; the Doing Business database; the World Bank's World Development Indicators; Investment Climate Surveys of firms in China, India, Kenya, and Uganda; and governance indicators from Kaufmann et al. (2003). The assessment compares measures of firm performance and the investment climate in Tanzania with similar measures in Kenya, Uganda, India, and China. The regional comparators, Kenya and Uganda, are chosen because of their geographic proximity to Tanzania, their joint membership of the East African Community, and the fact that similar Investment Climate Surveys were completed for these countries at the same time. India and China are chosen for different reasons. First, they have grown very rapidly for over two decades. These countries therefore provide a useful benchmark for the long-term progress that Tanzania might be able to achieve by improving its investment climate. Second, because of the large size of these countries and their growing importance in international markets, Tanzanian manufacturing firms will have to compete with enterprises from China and India as they expand into regional and international markets. Productivity Labor productivity. Value added per worker was about $2,028 for the median enterprise in Tanzania in 2003. This was higher than in Uganda ($960 per employee), but considerably lower than in India ($3,214 per employee in 1999), Kenya ($3,551 per employee), or China ($4,397 per employee in 2002). Workers were more productive in some sectors than in others. For example, in most sectors, value added per worker was lower in Tanzania than in Kenya, but the reverse was true in chemicals and paints, construction materials, and plastic products. Value added per worker was generally higher in larger firms. In very large firms (firms with 250 or more employees), the median enterprise produced $5,598 of value added per worker. In small firms (firms with between 10 and 19 workers), the median level was only $894 per worker. Value added per worker was particularly low for micro enterprises (firms with fewer than 10 workers)--only $474. Capital intensity. Labor productivity may vary across firms due to differences in capital intensity (i.e., the amount of capital per worker). The capital intensity of the median firm was lower in Tanzania ($6,853 per worker) than in Kenya ($9,731 per worker), but considerably higher than in Uganda ($1,421 per worker). Capacity  utilization was similarly low in the three countries--between 57 and 61 percent. Larger enterprises in Tanzania were more capital-intensive. The median very large enterprise had about $12,944 of capital per worker. In comparison, the median small enterprise had only $4,655 of capital per worker. Total factor productivity. Differences in labor productivity can sometimes be explained by differences in the use of other factors of production (e.g., capital). To control for such differences, we used regression analysis to calculate total factor productivity (TFP) for firms in Tanzania, Kenya, and Uganda. Differences in TFP are differences in productivity that cannot be explained by differences in the use of labor, capital, or intermediate goods. Firms with higher TFP produce more goods with fewer inputs. By this measure, Tanzanian firms are less efficient than firms in the comparator countries. Average TFP is about 5.6 percent higher in Kenya than in Tanzania. Average TFP is also higher in Uganda, even though value added and sales per employee are almost twice as high in Tanzania as in Uganda. This discrepancy can be explained by differences in capital intensity. Firms in Tanzania produce more value added per worker than firms in Uganda because they have more capital per worker, not because they are more efficient. Total factor productivity, like labor productivity, is higher for large firms. Thus, the differences in labor productivity between large and small firms are not simply due to the fact that large firms employ more capital per worker. Firms that export also tend to have higher TFP than non-exporting firms--something that is true in many countries. Human Capital Education of the workforce. The quality of the workforce is a serious constraint on productivity in many developing countries. It appears to be an especially serious problem in Tanzania, even by regional standards. Workers in Tanzania tend to have considerably less formal education than workers in either Kenya or Uganda. Some 43 percent of workers in Tanzania have only a primary education, compared to 20 percent in Kenya and Uganda. The main cause of this gap appears to be Tanzania's low levels of secondary and vocational education. There is little difference between Tanzania and the comparator countries with respect to tertiary education. The education of the top manager also has an important influence on firm performance. On average, total factor productivity is 24 percent higher in enterprises where the manager has a university degree. In this respect, Tanzanian enterprises do well by regional standards. More managers have a university degree in Tanzania (68 percent) than in Uganda (40 percent) or Kenya (60 percent). However, top managers in China were far more likely to have a university degree (84 percent). Training. Enterprises in Tanzania were less likely to have formal training programs than enterprises in either Kenya or China (but not Uganda). Tanzanian firms with formal training programs also provided less training than their counterparts in the comparator countries. Enterprises without formal training programs generally reported  that they were unable to afford a formal program or that informal training was sufficient. But contrary to the latter belief, formal training appears to pay off. Total factor productivity was 11 percent higher in Tanzanian enterprises with formal training programs. Technology. Tanzanian enterprises tend to use technology less intensively than enterprises in Kenya and China, but more intensively than enterprises in Uganda. About 68 percent of enterprises in Tanzania reported that at least some of their employees used a computer on the job, compared to 85 percent in Kenya and 96 percent in China. Similarly, about 58 percent of enterprises in Tanzania used email to communicate with clients and suppliers, compared to 71 percent in China and 79 percent in Kenya. Tanzanian enterprises that used technology more intensively were more productive and had faster sales and employment growth. The impact of HIV/AIDS. In addition to being a human catastrophe in terms of lost lives, HIV/AIDS undermines economic development. Firms in Tanzania generally appear to be responding less aggressively to HIV/AIDS than enterprises in Kenya. About 31 percent of Tanzanian enterprises had some type of prevention program by mid-2003, compared to 32 percent of Ugandan enterprises and 44 percent of Kenyan enterprises. The most common program involved displaying HIV prevention messages--most enterprises with a program provided this service. Close to half of enterprises with a program also reported that they provided counseling. Programs involving condom distribution, anonymous HIV testing, and financial support for dependents were far less common Exports Manufacturing enterprises in Tanzania are less likely to export and export less of their output than manufacturing enterprises in Kenya and China. The difference between Tanzania and Kenya is not entirely explained by differences in firm characteristics, such as enterprise size and sector of operations. When we controlled for these differences, enterprises in Tanzania were 18 percent less likely to export and exported 4.7 percent less of their output than similar Kenyan firms. This difference reflects the fact that trade and customs regulations are more burdensome in Tanzania than in Kenya. For example, it takes about seven days on average for exports to clear customs in Tanzania, compared to four days in Kenya. Barriers to Enterprise Operations and Growth Enterprises in Tanzania were most likely to rate tax rates, electricity, cost of financing, tax administration, corruption, access to finance, and macroeconomic instability as major or very severe obstacles. In addition, large enterprises and exporters rated customs and trade regulations as a serious problem. Tax rates. Tax rates were more likely to be considered a serious problem than any other constraint, with 73 percent of enterprises rating them as a major or very severe obstacle. In fact, more enterprises rated tax rates as a serious problem in Tanzania than in  any of the other countries where Investment Climate Assessments had been completed by the end of 2003 (except Ethiopia and Brazil). Tax rates are not a new concern for Tanzanian enterprises. They also ranked as the leading problem facing enterprises in a survey conducted in 1999. Complaints about tax rates were common among most enterprises, with the exception of informal micro enterprises. This probably reflects the extremely low level of tax compliance within this group. Unregistered micro enterprises estimated that they reported about 19 percent of sales to tax authorities, whereas formal micro enterprises estimated that they reported about 28 percent of sales. In comparison, very large enterprises estimated that they reported about 83 percent of sales to the authorities. Despite complaints about tax rates, corporate income tax rates are similar to rates in other developing countries. But value-added tax (VAT) rates are somewhat higher than in the comparator countries. In addition, enterprises face many other national and local taxes. Nonetheless, tax revenues in Tanzania are relatively low. Total tax revenues were about 10 percent of GDP in 2000, compared to 23 percent in Kenya and 11 percent in Uganda. This gap appears to reflect problems associated with informality and evasion, as well as differences in economic structure. Formal enterprises in Uganda and Kenya estimated that they reported more of their sales to tax authorities (77 and 86 percent respectively) than enterprises in Tanzania (69 percent). The complaints about tax rates suggest that the government might want to consider reducing the tax burden on formal enterprises by cutting rates. But such moves must be combined with efforts to improve administration, reduce exemptions, and broaden the tax base. Unless the government improves revenue mobilization, rate reductions could harm Tanzania's public finances, undermine macroeconomic stability, and increase inflation. Tax administration. Some 58 percent of enterprises rated tax administration as a serious problem, making it the fourth-greatest problem facing Tanzanian firms. Reforms in this area should reduce the burden that tax administration imposes on enterprises, as well as improve compliance. Enterprises in Tanzania reported spending an average of seven days per year dealing with tax officials, compared to two to three days in Kenya, Uganda, and China. Despite recent reforms, managers did not report any improvement in this regard between 2001 and 2002. In addition, 21 percent of enterprises reported that tax inspectors requested gifts or informal payments during required meetings. Power. Despite recent reforms, about 59 percent of enterprises rated the power sector as a serious problem, more than in Kenya, Uganda, or China. Concern about power was particularly widespread among larger enterprises. Whereas over 60 percent of medium, large, and very large enterprises said that power was a serious problem, only 39 percent of informal micro enterprises, 52 percent of formal micro enterprises, and 44 percent of small enterprises said the same.  The cost of power does not seem to be excessively high in Tanzania. The average price per kilowatt hour was no higher in Tanzania ($0.08) than in most of the comparator countries. However, reliability does appear to be a serious problem. The median enterprise in Tanzania reported losing 5 percent of production due to outages and surges. This was considerably higher than the median estimates for China (0 percent), Uganda (0 percent), and Kenya (3 percent). Problems with maintenance and the poor commercial performance of the Tanzania Electricity Supply Company (TANESCO) partially explain the sector's problems, but they are not the whole story. Per capita generating capacity is also lower in Tanzania than in the comparator countries. A severe drought, which has limited hydroelectric power generation, might exacerbate these problems in the near term. Finance. Tanzania has made considerable strides in developing its banking sector in recent years--privatizing several state-owned banks and allowing foreign banks to enter the Tanzanian market. But enterprises continue to report that access to finance and high interest rates are serious problems. About 58 percent of enterprises reported that cost of financing was a major or very severe constraint on operations and growth, and 48 percent reported the same for access to finance. Interest rates in Tanzania are in line with rates in the regional comparators, Kenya and Uganda. The median nominal interest rate was 13 percent in Tanzania, slightly lower than in Kenya (15 percent) and significantly lower than in Uganda (18 percent). Inflation was also slightly lower in Tanzania than in Kenya and Uganda, suggesting that real interest rates in the three countries were fairly close. But the median interest rate in China was significantly lower than in the three African countries (5.9 percent with inflation of about 1.2 percent). Despite the similarity in interest rates, access to credit appears to be worse in Tanzania than in Kenya. Only 20 percent of enterprises in Tanzania reported having loans from a financial institution, compared to 40 percent in Kenya (and 57 percent in China). Similarly, only 16 percent of investment is financed through bank lending in Tanzania, compared to 32 percent in Kenya. Smaller enterprises were far more likely to rate access to finance as a serious problem. They also financed far less investment through the formal financial sector--0 percent for informal micro enterprises on average, 2 percent for formal micro enterprises, and 5 percent for small enterprises. In comparison, very large enterprises financed 31 percent of investment through the banking sector. Corruption. Compared to other low-income countries, Tanzania performs well on most measures of governance (e.g., political stability, rule of law, and regulatory quality). But despite some recent progress, it trails many countries when it comes to controlling corruption. On one common corruption measure, only Kenya, among the comparator countries, performed worse.  Corruption ranked as the fifth-greatest problem facing enterprises in Tanzania. About 33 percent of enterprises that did business with the government said that unofficial payments were typically needed to secure a government contract. The median reported payment was about 10 percent of the value of the contract. Furthermore, 35 percent of managers said that informal payments were typically needed to "get things done" in such areas as customs, taxes, licenses, and other government services. The median reported payment in this case was about 0.3 percent of sales. Bribes were also common when obtaining utility connections, applying for import licenses, undergoing inspections (particularly tax inspections), and participating in mandatory meetings with government officials. Micro enterprises appeared to avoid some of the burden of corruption by avoiding contact with bribe-taking institutions. Macroeconomic instability. Despite Tanzania's improved macroeconomic performance, enterprise managers continue to see macroeconomic instability as a major problem. About 43 percent rated macroeconomic instability as a major or very severe obstacle to enterprise operations and growth. Consequently, continued efforts to control inflation and maintain economic growth are important from an investment climate perspective. As part of these efforts, the government must continue to pursue fiscal stability. Cutting taxes on enterprises without steps that improve compliance, boost tax collection in other ways, or reduce spending would be risky. Customs and trade regulations. Although most enterprises did not rate customs and trade regulations as a serious obstacle, they were rated a serious constraint by more than 52 percent of very large enterprises (i.e., the enterprises most likely to engage in foreign trade). Customs delays illustrate the scale of the problem. The median delay for imports was 14 days in Tanzania, while the median delay for exports was 7 days--longer in both cases than in any of the comparator countries. In China, for example, the median delay for imports was 5 days, and the median delay for exports was 3 days. Confronting Informality Recent estimates suggest that the informal sector in Tanzania is equivalent to about 58 percent of gross national income (GNI)--more than in any of the comparator countries. By reducing the level of informality, the government could reduce the tax burden on formal enterprises without compromising macroeconomic stability. Reforms should focus on reducing the costs and increasing the benefits associated with operating in the formal sector. Reducing the regulatory burden on formal enterprises is one way to achieve this goal. Barriers to entry. Recent work has shown that informality is higher in countries where it is costly to register a business. Although most enterprises in Tanzania did not see business licensing as a serious obstacle to enterprise operations and growth, this result is likely to underestimate the impact of entry-deterring regulations. Businesses that are already operating--especially those that have been operating for a long time--may not see entry restrictions as an important barrier to their future operations and growth. For this reason, evidence from the Investment Climate Survey is supplemented with evidence from the World Bank's Doing Business database.  According to this data, it takes about 35 days to fulfill all legal requirements for starting a business in Tanzania. Registering a business takes even longer in most of the comparator countries: 41 days in China, 89 days in India, 47 days in Kenya, and 36 days in Uganda. But the monetary cost of this process is considerably higher in Tanzania-- 204 percent of per capita GNI--than in any of the comparator countries. The most expensive procedures are getting the certificate of incorporation, getting a business license, and getting a company seal. Registration requirements are not the only barriers to entry. The process of obtaining infrastructure services--particularly power--also acts as a barrier. The median wait for an electricity connection in Tanzania was 30 days--twice as long as in any of the comparator countries. Micro and small enterprises faced far greater delays than larger firms. The median wait for very large enterprises was only 3 days. Labor regulations. Labor laws can also act as an entry barrier. According to the Doing Business database, labor laws are considerably more restrictive in Tanzania than in most of the comparator countries. But very few enterprises rated labor regulation as a significant obstacle--possibly because labor laws are poorly and unevenly enforced. Other evidence supports this explanation. Very large enterprises, which are more likely to face close scrutiny, were far more likely than smaller firms to rate labor regulations as a serious problem. Business regulations and inspections. The high cost of complying with regulations may also encourage enterprises to remain in the informal sector. The median enterprise in Tanzania reported having 15 inspections or meetings with government agencies per year--significantly more than in Uganda (5) and India (6). Micro enterprises appear to avoid a significant part of this burden by remaining informal. Other Constraints on Enterprise Operations and Growth One concern about perceptions data, such as data collected by the Investment Climate Surveys, is that enterprises that have adapted to certain constraints might not see them as problematic. For example, microenterprises without power did not consider electricity to be a serious problem even though access would probably improve their performance. For this reason, we also examine several potential problems that enterprises by and large did not identify as major constraints. Legal System. Only 20 percent of enterprises reported that the legal system was a major obstacle to their operations and growth. This is consistent with other evidence that suggests that the "rule of law" is relatively well established in Tanzania. Consistent with this, the court system appears to be relatively efficient. For example, according to the Doing Business database, it takes less time to get a court to enforce a standardized debt contract in Tanzania (127 days) than in Kenya (255 days) or China (180 days). However, there is still room for improvement. Enterprises in Tanzania were less likely to report that they could rely on the courts to enforce contracts and uphold property rights (45 percent of enterprises) than in Kenya (49 percent) or China (92 percent).  Access to Land. Although larger enterprises were not very concerned about access to land, both formal and informal micro enterprises reported that it was a serious concern. Only access to financing and the cost of financing were greater problems for these groups. It appears to be an especially significant problem in rural areas. Telecommunications. Enterprises in Tanzania rated telecommunications as a less serious constraint than other infrastructure. Although the number of fixed-line phones in Tanzania is low even by regional standards (4 lines per 1000 people), the sector appears to perform well on other dimensions. Only 51 of 214 firms that used fixed line phones to communicate with clients reported losing service at some point in 2002. In comparison, 211 of 257 firms in Kenya reported losing service for at least one day over the same period. Transportation. About 23 percent of manufacturing enterprises regarded transportation as a major obstacle to enterprise operations and growth. However, transportation appears to be a greater concern for enterprises in other sectors--38 percent of enterprises in tourism reported the same. Access to sealed roads and railways appear to the greatest problems within this sector. Regional Differences Perceptions of different constraints varied by region. For example, establishments in Iringa/Mbeya, Kilimanjaro, and Dar es Salaam were most likely to report that tax rates were a major or very severe problem, while tax administration was a particularly serious concern in Iringa/Mbeya, Arusha, and Dar es Salaam. Firms in Arusha, Dar es Salaam, and Iringa/Mbeya were most likely to rate power as a major or very severe obstacle. The reliability of the power supply was a leading concern in Arusha and Dar es Salaam, while the wait to get a power connection was particularly long in Iringa/Mbeya. Enterprises in Morogoro, Dar es Salaam, and Arusha were most likely to report that import competition was a major or very severe obstacle, while enterprises in Tanga and Iringa/Mbeya were most concerned about corruption. Firms in Morogoro and Tanga reported that senior managers spent the most time dealing with government regulations, while the number of annual visits and inspections was highest in Tanga, Mwanza/Mara, and Iringa/Mbeya. Policy Recommendations Reducing the burden of taxation. Any proposal to reduce the burden of taxation must consider the likely impact on tax revenues--and subsequently, on macroeconomic stability and the country's ability to achieve broader social goals. The fact that many enterprises expressed concern about macroeconomic stability underlines the importance of safeguarding macroeconomic performance while reducing taxes. Anecdotal evidence suggests that complaints about tax rates largely reflect concerns about the multiplicity of national and local taxes and fees. A follow-up study  on the marginal effective tax rates facing firms of different types (e.g., along the lines of a FIAS incentives review) could help provide specific recommendations on streamlining the tax system. This review should pay particular attention to opportunities for abolishing burdensome local fees and levies. The government should also improve revenue mobilization. Exemptions and evasion have eroded the tax base and created a highly distortionary system. The government should continue to reduce exemptions and expand the tax base by encouraging firms to enter the formal sector (by, for example, reducing the cost of business registration and the burden of regulation). Finally, the government should improve tax administration, both to increase compliance and to reduce the burden imposed on formal enterprises. Reforms should include steps to reduce corruption at the Tanzania Revenue Authority (TRA). Because corruption in individual agencies is affected by the general level of corruption in the country, progress will depend upon making progress in the general fight (see below). Allowing independent internal and external audits, protecting whistleblowers, and giving citizens a way of complaining about harassment can all help in this regard. In addition, two principles have proven effective in reducing corruption specifically in revenue agencies. (See Bird (2003) or Das-Gupta et al. (1999) for more detailed discussion.) The first is minimizing direct contact between tax officials and taxpayers--by automating and computerizing procedures, increasing the use of third-party data for assessments, and relying on tax withholding. A second useful principle is to organize tax agencies along functional lines (such as auditing, taxpayer assistance, and processing tax returns) rather than by tax type. This makes it harder for officials to develop relationships with taxpayers. Improving the performance of the power sector. Although TANESCO's commercial performance has improved since the government signed a two-year management contract with a private firm in May 2002, serious problems remain. Due to deferred maintenance and earlier underinvestment, the company needs significant resources to improve access and reliability. Current market conditions will make privatization difficult in the near term. Consequently, the government's first goal should be to extend the current management contract for three to five years. A new contract should be based on revised performance indictors aimed at reducing losses, increasing connections, and investing in system rehabilitation. In the medium term, the government should promote private participation in the power sector. In preparation for this step, the government should: (i) ensure that TANESCO can finance its own operations; (ii) restructure sector debt; (iii) unbundle generation, transmission, and distribution; and (vi) establish an independent regulator. Enhancing the effectiveness of financial services and access to credit. Access to finance remains problematic, especially for small and medium enterprises. The government should improve access by privatizing the National Microfinance Bank and other remaining state-owned banks, clarifying regulations for smaller microfinance institutions (MFIs), developing and strengthening umbrella organizations for MFIs, and  reducing their reliance on external donors. At the same time, the government should avoid disrupting the development of self-sustaining savings and credit cooperatives (SACCOs) or NGO-based MFIs. Plans to open special SME windows at financial institutions or promote development banks should, therefore, be abandoned. Reforms should also focus on improving contract enforcement and increasing the efficiency of the judicial system. Useful steps would include: (i) upgrading the payments and securities settlement infrastructure; (ii) finalizing the credit registry/bureau project; and (iii) revising some banking regulations to relax unduly constraining barriers and tighten loopholes. Reducing corruption. The government is currently working to repeal the Anti- Corruption Act of 1971 and replace it with a new anti-corruption law. The revision will widen the definition of corruption, improve protection for whistleblowers, and place the onus on those being investigated to prove that assets were not amassed through corrupt or unethical behavior. These efforts should target the areas where corruption has been identified as a particularly serious problem. These include the Tanzania Revenue Authority, officials associated with labor regulations and social security, and the municipal police. Maintaining macroeconomic stability. Despite Tanzania's improved macroeconomic performance, enterprise managers remain concerned about macroeconomic instability. Therefore, the government must maintain fiscal discipline. This effort must include steps to improve revenue mobilization and tax administration, as discussed above. In addition, the government must ensure that Tanzania's public and publicly guaranteed debt remains sustainable. Provisional results of the annual debt sustainability analysis for the period ending in June 2003 indicate that this is currently the case, following the granting of irrevocable debt relief under the enhanced HIPC Initiative. However, the continued sustainability of Tanzania's external debt depends on the implementation of macroeconomic and structural reforms, as well as prudent management of external debt. Furthermore, if GDP or export growth is less than projected, or agreement on debt relief from non-Paris Club creditors is not reached, Tanzania's debt might not be sustainable. Improving ties to the international economy. Although exports have been growing--due primarily to increased sales of gold--few manufacturing enterprises export, and very few export much of their production. To address this problem, the government should improve the performance of the customs administration and eliminate overly burdensome trade regulations. Work on a customs reform strategy is currently proceeding with technical assistance from DFID. It is important that these efforts do not only focus on increasing revenue--it is just as important that they reduce the burden that excessive regulation puts on exporters and decreasing processing times. Increasing productivity. Labor productivity and total factor productivity remain low, especially when Tanzania is compared to the fast-growing Asian economies. The  government could increase productivity by encouraging enterprises to invest in worker training, which is less common in Tanzania than in Kenya or China. Rather than become directly involved in worker training, the government should facilitate training and apprenticeship programs that are designed and implemented by the private sector-- perhaps by offering tax credits to firms that provide training. The government could also stimulate productivity growth by improving access to business education. This recommendation is based on the finding that enterprises with university-educated managers are more productive than other enterprises. Improving access to business education may also reduce inequality, offsetting the advantages of inherited ownership and family based business knowledge. It may be worthwhile for both governments and donors to revisit their priorities in this area at least with respect to business studies.  CHAPTER 1: MACROECONOMIC PERFORMANCE AND BACKGROUND Tanzania is a country of 35 million people. In 2003, its GDP was $10 billion, and per capita income was about $285. (See Box 1.1.) The country's economic performance has improved significantly in recent years. Effective expenditure control and increased flexibility have strengthened fiscal policy and enhanced the efficacy of public services. The government has reduced inflation sharply, allowing foreign exchange markets to stabilize. The international reserves position has remained strong, despite modest export expansion and a major decline in export prices. And since 1995, the Tanzanian economy's growth rate has exceeded the average for sub-Saharan Africa, as well as for developing countries overall. But achieving the major policy goals set out in the Poverty Reduction Strategy Paper (PRSP) remains a substantial challenge.1 Box 1.1 Human development and poverty in Tanzania Tanzania's per capita income was about $285 in 2003. Life expectancy at birth fell from 50 years in 1990 to only 44 years in 2001--due primarily to HIV/AIDS. Infant mortality remains relatively high, with 104 deaths per 1,000 births in 2001 (up from 102 deaths per 1,000 births in 1990). Nevertheless, Tanzania has made significant progress in terms of human development in recent years.