Summary of Madagascar's investment climate assessment

WORLD BANK GROUP AFRICA REGION, PRIVATE SECTOR UNIT 33673 Summary of 2005 Madagascar's Investment Climate Assessment EPTEMBER S Malagasy's private sector suffers from low productivity, particularly for non-EPZ firms, and a poor business environment which affects the sector as a whole. EPZ firms, however, perform better than firms in most other Sub-Saharan African countries. Cost of and access to finance and macroeconomic instability are major concerns which Malagasy firms share with 3 other African countries. One notable difference, however, is that firms in Madagascar rank corruption and tax rates lower than other African countries. Price controls and inflation are the leading constraints in Madagascar. UMBER N is assessment is based on a detailed survey of 293 enterprises in the manufacturing sector. Within each firm, up E to ten employees were also surveyed for a total of 639 workers. rough benchmarking perceptions between comparator OT N countries, it links business environment to firm level costs and investment disincentives. Firm and Worker Competitiveness ees, who add almost twice as much value as those in the in International Perspective median-sized enterprises (less than 100 employees). EPZ firms have also slightly higher labor productivity. Two different conclusions can be drawn from this analysis: First, Malagasy firms lag behind in most aspects of com- Figure 1: Country Comparison of Median Value-added petitiveness when compared with firms in other countries; per Worker and second, export processing zone (EPZ) firms are not Value-added per worker Large Firms only significantly more efficient than non-EPZ firms but also more competitive regionally. $ 6.000 Non-EPZ enterprises perform on par with firms $ 5.000 in Uganda and Tanzania, but EPZ firms perform better $ 4.000 than firms in most other Sub-Saharan African countries. As Table 1suggests, EPZ and non-EPZ firms differ in $ 3.000 many aspects, which partly explains these opposing con- $ 2.000 clusions. $ 1.000 Taking into account these differences, the results for $ 0 Malagasy firms show the following characteristics. A Overall, Malagasy firms show a low median labor produc- KENY INDIA CHINA UGANDA ZAMBIA tivity. Labor productivity is higher for large firms' employ- ANZANIAT MADAGASCAR Table 1: Median Productivity for Madagascar by Export Status Capacity Capital per Capital Value Added Labor Cost Utilization Worker Productivity per Worker per Worker Median 80.0 $2029 0.86 $1,453 $495 EPZ firms 80.0 $947 1.33 $1850 $591 Non-EPZ firms 75.0 $2298 0.64 $1407 $475  Madagascar has the highest value added as a percentage Figure 3: Country Comparison of Median Capital per Worker of capital stock compared with all other comparator coun- tries except India. High returns to capital are mainly due to Capital per worker (US$) Large Firms limited investment in capital stock: During the last three years combined, gross investment accounted for only 7 per- $ 15.000 cent of sales or 3.8 percent of capital stock. $ 10.000 An estimate of total factor productivity (TFP) shows that there are increasing returns to scale in manufacturing.1 $ 5.000 Fully foreign EPZs are most productive (with 46 percent $ 0 higher productivity). Human capital affects productivity, so A firms that provide internal formal training to workers also KENY INDIA CHINA ANZANIAT UGANDA ZAMBIA tend to have higher productivity. However, the use of exter- MADAGASCAR nal training institutions has not been shown to yield better performance.2 note sharing most of the same problems, with cost of and Survey results show that Malagasy firms have low unit access to finance and macroeconomic instability as major labor costs (see figure 2). With a median value of 0.33, unit constraints. One notable difference, however, is that firms in labor cost falls with firm size, as labor costs rise less than Madgascar rank corruption and tax rates lower than other labor productivity. Unit labor costs are also lower for EPZ African countries (Table 2). Price controls and inflation are firms compared with non-EPZ firms because their higher la- the leading constraints in Madagascar. bor costs are largely offset by their higher labor productivity. Trade policies in Madagascar are fairly efficient com- pared with other countries. Madagascar has one of the lowest clearing times and is bettered only by Malaysia and Figure 2: Country Comparison of Median Labor Costs Mauritius (among countries where surveys were conduct- ed) in import clearing time and only by Malaysia in export Labor cost (as% of Value-added) Large Firms clearing time. However, for a significant proportion of the 50% largest firms (40 percent), which are the main exporters, the 40% quality of customs administration is considered to be poor or very poor. 30% Malagasy firms experience a high bureaucratic burden 20% measured as the proportion of senior management time 10% spent with regulators. Infrastructure represents a major constraint as well: 0% A Electricity and waste disposal were viewed as operating KENY INDIA CHINA poorly/very poorly by over 40 percent of the firms surveyed ANZANIAT UGANDA ZAMBIA and account for most of indirect costs.Compared with most MADAGASCAR other countries surveyed, Malagasy firms face the most un- Enterprises in Madagascar have less capital per worker reliable electricity service regime considering the high fre- than all other comparator countries except Uganda (figure quency of power outages per year and the low degree of 3).Capital intensity falls with firm size however.Large firms generator ownership (table 3). operate in the low-capital garments sector, while small firms operate in the more capital-intensive paper and publishing sector. 1 Estimated by using an OLS production function where log of total sales was the dependent variable. Chief Barriers to Growth, Productivity, 2Several econometric issues can be raised in the context of these and Investment in Madagascar regressions. Endogeneity is always an issue in cross-section data. Sector specific production functions are also more appropriate. ese issues will be addressed in future research papers. Produc- Overall,Malagasy firms perceive a less favorable business en- tivity regressions, using a single-step OLS procedure, have been vironment than do Mauritian and Chinese firms. However, shown to yield consistent estimates and is the approach used when compared with firms in other African countries, they here.  Table 2: International Comparisons of Constraints to Business Respondents' Evaluation of General Constraints to operation (% of firms evaluating constraint as "major" or "very severe") Kenya Tanzania Uganda Zambia Mauritius* China Madagascar Cost of financing 73.3 57.8 60.3 82.1 35.19 21.8 66.9 Macroeconomic instability 51.3 43.0 45.4 73.9 31.48 30.2 64.38 Access to financing 44.1 48.3 45.0 54.1 25.93 22.8 59.14 Anti-competitive or informal practices 65.3 24.3 31.1 38.7 35.19 23.7 48.45 Corruption 73.8 51.1 38.2 46.4 37.04 27.3 46.55 Tax rates 68.3 73.4 48.3 57.5 16.67 36.8 44.86 Tax administration 50.9 55.7 36.1 27.5 14.81 26.7 42.41 Economic and regulatory policy uncertainty 51.5 31.5 27.6 57.0 13.46 32.9 41.52 Electricity 48.2 58.9 44.5 39.6 14.81 29.7 41.3 Crime, theft and disorder .. 20.0 .. 48.8 27.78 .. 37.72 Customs and trade regulations 39.9 31.5 27.4 32.4 12.96 19.3 32.79 Skills and education of available workers 27.6 25.0 30.8 35.8 29.63 30.7 30.48 Access to land 24.6 24.6 17.4 17.4 20.37 14.7 20.7 Telecommunications 44.1 11.8 5.2 32.9 11.11 23.5 16.38 Transportation 37.4 22.9 22.9 30.4 15.09 19.1 16.1 Labor regulations 22.6 12.1 10.8 16.9 27.78 20.7 14.83 Business licensing and operating permits 15.2 27.4 10.1 10.1 44.44 21.3 14.58 * data for Mauritius is preliminary Access to credit in Madagascar is not different from ever, it is important to note that Madagascar has the fewest countries like Tanzania and Uganda, although it does have university-educated workers in manufacturing (figure 5). a higher share of firms with lines of credit (Figure 4). e Wages are low in Madagascar compared with those in main problems are that small firms have less access than other countries: Unskilled production workers earn about large firms and, on average, firms use retained earnings to $36 per month compared with $45 in India, $57 in Uganda, finance 80 percent of new investments. $85 in China, and $145 in Mauritius. Wages increase with e value of collateral requirement is high in Madagas- firm size, education, tenure, and formal training and are car. Relative to the value of the loan, the collateral require- higher in EPZ firms than in non-EPZ firms. ment is 137 percent on average, higher than every other And, finally, there are limited opportunities for in-firm country except Kenya. ere is also a strong correlation and off-site training. However, it is only firm-supplied train- between the quality of records generated by firms (that is, ing that has a direct positive impact on productivity. annual budgets) and access to bank finance. Regarding educational distribution,the model worker in EPZ and Non-EPZ Firm: Main Differences Madagascar has between 6 and 9 years of schooling making education levels in the country comparable to those of work- A comparison between EPZ and non-EPZ firms shows ers in other countries at similar stages of development. How- marked differences in the two types of firms for a number of  Table 3: Cross-Country Comparisons of Infrastructure Quality Uganda Zambia Madagascar Mauritius China Freq of power outages(times last yr) 38.6 37.2 77.99 5.3 na % of production lost due to power outages 6.3 4.5 10.66 2.5 1.8 Have own generator (%) 35.3 38.2 21.5 42.6 17 Have own well (%) 13 59.9 17.41 33.3 21.1 % of production lost in shipment na 3.8 1.81 0.8 1.2 No. of days to obtain a telephone connection 33.2 132.5 30 9 12.5 No. of days to obtain an electricity connection 38.3 120.7 49 2 18.2 difference factors. Clearly, EPZ firms are much more com- Policy Implications petitive than non-EPZ firms. A comprehensive strategy in Madagascar that would lead