Adjustment and constrained response : Malawi at the threshold of sustained growth

INDUSTRY AND ENERGY DEPARTMENT WORKING PAPER INDUSTRY SERIES PAPER No. 41 Adjustment and Constrained Response: Malawi at the Threshold of Sustained Growth October 1990 ;EO The World Bank Industry and Energy Department, PRE FH F !OP'(  ADJUSTMENT AND CONSTRAINED RESPONSE: Malawi at the Threshold of Sustained Growth Claudio Frischtak October 1990 Industry Development Division Industry and Energy Department Policy, Planning and Extemal Affairs  TABLE OF CONTEANTS Page No. EXECUTIVE SUMIMARY .............................................. -v L INTRODUCTION .1 IL BARREERS TO INVESTMENT RESPONSE .5 Active Bloclages and Passive Resistance: Regulatoly and Attitudinal Constraints to Investment .5 Agents of Change and Investment Opportunities .10 From Blocking and Controlling to Facilitating and Promoting Investment 12 An Investment Promotion Board-with Political aout .14 nL CONSTRAINT FACING SMALLER FIRMS IN MALAWI: SURVEY RESULTS .16 Limited Markets .18 Credit Restrictions .20 Confined Horizons .24 Macro Environment .26 IV. CONCLUDING REMARKS .28 BIBLIOGRAPHY ANNEX lhe author is grateful to Mr. Kavinya and his staff of the Department of Economic Planning and Development, and to the invaluable assistance in the field work by Messrs. Mloza and Mwase. The data were entered and proocsed by Valerie Chisholm and Basanta Chaudhuri. Word processing was done by Wilson Peiris and Anna Maranon. The author acknowledges useful comments from William Steel.  EXECUTIVE SUMMARY i. In the last decade Malawi has undergone considerable efforts at adjusting its economy to adverse shocks in terms-of-trade and transportation costs. At the same time there was a relatively successful attempt ^.o cope with a large refugee influx despite rapid population growth and imited resource base. Due to a mixture of -nservative economic management, political and institutional stability, and commitment from international institutions and the donor community, Malawi is now poised for a period of sustained growth. Yet sustainabilty will be critically dependent on the size and nature of the investment response. ii. Tlhe Government should facilitate and actively promote productive investment by larger fms. These firms have an effective capacity for rapid capital accumulation and for bringing smaller producers of seasonal-dependent ac'ivitles into larger and more stable markets. Yet these agents encounter systematic blockages to their investment decisions. Some of these are active barriers in terms of firm registration and investment Ucensing and other elements of a regulatory character. More often, however, the blockages are of a passive nature, an unwillingness by officials to speed up the process, furnish information, cut the red tape. iii. If for larger producers and traders the barriers to investment are mostly related to administrative practies and bureaucratic habits and procedures, for smaller firms and micro producers what hurts most is their in. ility to access larger and fast-growing markets Limited in their ability to generate internal resources, smaUl producers tend to be credit starved, in an environment where commercial banks are unresponsive to their needs. hqey lack the skills to crack the system and use financial institutions and instruments for their bisic working capital and investment requirements. iv. In Malawi one finds a multitude of smaU players, often self-employed or commanding smal work formes, with great willingness to invest and improve their lives. Few "graduate" into larger entities, and few should be expected to. Even with access to broader markets, they would stil lack the resources to  - ij - accumulate capital and expand output at fast rates. On aggregate, their economy-wide Impact on investment and output growth is limited. They tend to pull few other activities In tandem. Nonetheless, small and micro enterprises can be the basis of employment growth, domestic market development, and Improved income distribution. v. Small and micro enterprises (and, to a lesser extent, medium-size flrms) continue, however, to be fundamentally dependent on the cycles of the Malawian agriculture economy. They tend to be constrained by their narrow demand base, both in an ireome and geographic sense. Their inability to accumulate capital at a fast pace and change the scale of operations precludes them from "jumping' over the demand barrier and entering new (including export) markets. Their size, the financial and demand- related constraints on any quantum expansion of their capital, as well as the limited and localized nature of their links with other producers, imply that these producers have a limited impact on making the Malawian economy less dependent on the cycles of nature and in accelerating GDP growth. vi. A suivey of 55 small firms in urban and rural areas shows that they face numerous operational constraints, including the cost of raw materials and transportation, working capital finance, and seasonality of demand. Limited access to credit (and its cost) is regarded as important barriers to entry facing small and micro enterprises in Malawi, in addition to cost of equipment and raw materials (the latter waS particularly pronounced in wood processing activities, in view of current restrictions on logging), and regulatory limits on location. viL Concerning aoess to credit, large proportion of firms complained that banks' procodures were non-transparent and tedious, with "too many demands,* large collateral requirements ('banks ate obsessed with collateral'), and attitudes discriminatory against rural-based and small entrepreneurs ('ban do not lend to uneducated people or people living in remote areas'). Banks were seen as basically interested in operating with large customers and near-riskless project This perception was present even among the more successful business people, managing profitable export-oriented enterprises. Although the vast majority  - iii - of entrepreneurs inteniewed had bank accounts (84%), paid taxes regularly (near 100%), and were in this sense part of the formal economy, thdir credit needs were unmet viii. Limited &ccess contrasts with signiflcant demand for credit. Over 60% of firms were willing to pay nominal annual interest rates of 50% (approximately 35% in real terms) to receive credit for working capital. Similarly, more than a third of producers interviewed would be interested in credit on such terms for new investment The willingness of firms to pay such high real rates reflects the cost associated with alternative credit sources and their inability to generate enough cash internally. For most producers (two- thirds), obtaining funds from family members wouvd be a 'major problem.' A majority (73%) either has been too discouraged to attempt borrowing from a commercial bank or, having attempted to borrow, has not succeeded. Money lenders ('katapillas') would be a last (although frequently used) resort: nominal interest charged in this case often approaches 100% for a three-month period. ix. Yet the importance of credit should not be overstated. More often than not, the underlying factor that restricts the growth of smaller enterprises is the difficulty of establishing links to larger producers and more dynamic markets. Such isolation from effective marketing channels appears to be causally prior to ceit restrictions, hign raw material costs, or seasonality of demand when it comes to exphining their weak financial position and inability to expand their operations in a substantial way. Thus, even though market and institutional weaknesses in the financial system do impose limitations on small firms, they tend only to become binding once these firms start growing out of a demand-cnstrained market environment. x. Among other relevant problems constraining smaller fms are their lack of managerial skills, including marketing, accounting and knowledge for accessing credit institutions. There was marked interest for trining in those areas. Marketing was perceived to be quite important as a means of overcoming seasonality of demand. Although affecting most producers in Malawi, demand instability is panicularly adverse for smaller enterprises. As stressed aboe, opening up marketing channels would be critical to  promote the development of small and micro firms. Yet opening up such cannels would require the involvement of agents such as traders and upstream producers xl In fact, a small enterprie development strateg, under demand-constrained conditions, cannot be successfuly pursued In the absence of an vestment-promotion strategy focused on activties to overcome the smalness and unstable nature of domestic markets. Smaler enteiprises thrive when connected with lar3er markeis. The agents that help establish those connections would need to be larger or at least more aophkircatc traders and producers. The entry and expansion of those *catalytic agents in the market need to be favored through a strategy of facilitating and promoting investmenL Xli Thus, investment by la&ger firms should not only be promoted to ensure that current output response becomes part of a sustainable growth path. Equally important, investment response and entry of new actors into the market will allow an increasing number of smaller firms to ovetcome demand constraints as they tie up with larger producers and external buyers Combined with credit, managerial training regulatory improvements, and better access to inputs, it would signficantly improve the prospects for successful small and micro enterprse development in MalawL  I. INTRODUCfION 1.01 The Malawlan economy has a fragile and narrow endowment base. The country is landlocked, smaU and with high population density (67 people per square mile, compared to 20 per square mile for all of Subsaharan Africa). Population growth iates stand at 3.1%, a sharp acceleration from 25-30 years ago (when it stood at 2.3%). Poverty is widespread, mortality rates are high (the most recent estimate for infant mortality is 150 per thouand live births) and investment in human capital (health and education) is limited (2.1% of GDP--immunization rates, for example, hover around 50% of targeted age group, and secondary school enrolhment Is a mere 4% of scLool age group)Y 1.02 Following independence in 1964, the Government's development strategy focused on expansion of agriculture output (particularly export commodities such as tobacco and tea) through extensive growth of the estate sector. Public investment was aliocated primarily to infrastructure (transport and communications). Led by the agricuitural estate sector, real GDP per capita increased on average by 3% in 194-79. Lving conditions, however, improved slowly, and real wages remained low. Still, the period preceding the 1980s may be regarded in retrospect as a time when development perspectives were quite bright. 1.03 Beginning in the early 1980s, the economy suffered a number of exogenous shocks, induding adverse shifts in the terms-of-trade, droughts, and war and civil strife in neighboring Mozambique. This led not only to a severely debilitating increase in international transportation costs, but also to the growth of vecurity-related expenditures and a large influx of refugees. Per-capita GDP growth turned negative, and in t1 agiculture and industry, average annual growth rates between 1965-80 and 1980-88 suffered an ir2exion 1. o