The Policy and Regulatory Environment in East Africa: Nuts and Bolts

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1 The Policy and Regulatory Environment in East Africa: Nuts and Bolts The USAID-funded East Africa Trade and Investment Hub (the Hub) focuses on selected policy, legal and regulatory issues that affect key sub-sectors and commodities in East Africa. This is done through an investment lens. The policy and regulatory environment component of the Hub is designed to be a service provider to the other main components: Investment; Agribusiness; and Africa Growth and Opportunities Act (AGOA)/Trade Promotion. The Hub works in partnership with the private sector to help define a pro-investment regulatory reform agenda. This agenda is based on evidence that makes business sense for driving trade competitiveness of East African countries. The East African Community began implementation of the Customs Union in 2005 and the Common Market in To date, neither has been fully implemented. In fact, the first component or foundation of the EAC Common Market Protocol is the operationalization of the Customs Union. Why is important to focus on the policy, legal and regulatory environment? Perhaps it can best be summarized in the quote below from the recent World Bank s Doing Business 2015 Going Beyond Efficiency report. The laws that determine how easily a business can be started and closed, the efficiency with which contracts are enforced, the rules of administration pertaining to a variety of activities such as getting permits for electricity and doing the paperwork for exports and imports are all examples of the nuts and bolts that are rarely visible and in the limelight but play a critical role. Their malfunctioning can thwart an economy s progress and render the more visible policy instruments, such as good fiscal and monetary policies, less effective. Just as the Space Shuttle Challenger broke apart on takeoff from Cape Canaveral, Florida, on January 28, 1986, not because (as was later realized) something major had gone wrong but because a joint held together by a circular nut called the O-ring had failed, an economy can be brought down or held back by the failure of its nuts and bolts. Although there has been significant progress in implementation of the EAC Customs Union and Common Market Protocol, much remains to be done. Although agreements have been discussed and signed, implementation at the national level remains a major problem. It is important to understand why delivery or implementation has not taken place. Is it due to market failures, government policy failures underlying market failures, lack of transparency and accountability (opportunities for rent-seeking), lack of capacity or a combination of some or all of these factors? In other words, which nuts and bolts are impeding broad-based sustainable economic growth and investment in East Africa in key sub-sectors and commodities?

2 Below are the latest rankings of the EAC Partner States in the World Bank s Cost of Doing Business 2015 report. Apart from Rwanda, whose government has taken the measurements very seriously, the other countries generally lie towards the bottom of the rankings, especially Burundi and Uganda. The trading across borders ranking is particularly worrisome for all countries, including Rwanda, because of the importance of trade to their relatively small economies. 1 The trading across borders component essentially measures the time and cost (excluding tariffs) associated with exporting and importing by sea transport to the point of destination, and the number of documents necessary to complete the transaction. The low rankings in the EAC are principally due to outdated, non-transparent and inefficient border and port procedures, inadequate infrastructure and lack of reliable logistics services, which in turn lead to extremely high transaction costs and long delays, particularly for the landlocked economies (Uganda, Rwanda and Burundi). Cost of Doing Business in East Africa 2015 Component/Country Kenya Uganda Tanzania Rwanda Burundi Ranking (out of 189 countries) Starting a business Dealing with construction permits Getting electricity Registering property Getting credit Protecting minority investors Paying taxes Trading across borders Enforcing contracts Resolving insolvency Overall Ranking Source: World Bank, Doing Business Report Kenya, the largest economy in the region, has a GDP roughly equivalent to that of Slovenia.

3 According to the World Bank s Logistics Performance Index, transport costs in East Africa are among the highest in the world. Freight costs per kilometer in East Africa are over 50% higher than those of developed countries in Europe and the USA, while in some cases transport costs for landlocked countries constitute as much as 75 percent of the value of export commodities. While some of this is due to poor infrastructure, the majority of costs are due to the nuts and bolts involved in the policy and regulatory environment. For example, the regional transport system is fairly regulated and extra inventory costs due to delays and inefficiencies in the corridors have a significant impact on the total costs of the goods, accounting for percent of the total logistics cost. 2 The EAC has a population of million, GDP of $110.3 billion 3 and a GDP per capita of $ Economic growth has been relatively high at 6.2% for the region over the past decade ( ). However, this may not be sustainable. Agriculture s share of GDP has declined from about half in 1970 to a third in This could imply from a structural transformation perspective that the decline in the share of agriculture could be related to gains in productivity, given that agriculture tends to have lower valueadded than the secondary and tertiary sectors. The biggest gains were in transportation and construction 5. Increases in manufacturing and mining were much smaller. According to a recent IMF report, the changes should be viewed with the following perspective: When attempting a possible interpretation of these facts, the picture that seems to emerge is that recent diversification and structural transformation bode well for continued economic growth. Yet, the kind of growth observed seems to be one in which consumer and investment demands for more sophisticated goods and services are beginning to be met, as one would expect as per capita incomes rise in the region. There do not yet seem to be any clear winners on the production side that are likely to embed a clear and durable comparative advantage in international markets, particularly beyond the region. Nor are there major quality improvements vis-à-vis competitor countries, where progress is also being made. These observations may instill a further note of caution against projecting continued rapid growth into the distant future. 6 This suggests that although there has been progress, unless deeper policy, legal and regulatory reforms are undertaken as well as the private sector becoming more competitive, sustainable broad-based economic growth may not be achieved in the short to medium-term. As the Chairman of the East Africa Business Council recently noted, economic growth in the EAC has not been pro-jobs. 7 Furthermore, the median age in East 2 Corridor Diagnostic Study of the Northern and Central Corridors, Nathan Associates, April 15, Kenya accounts for 40% of EAC GDP. 4 EAC Facts and Figures Report 2014, East African Community, November Some analysts would suggest that this could indicate money laundering, as real estate is a relatively easy and common mechanism through which dirty money can be laundered. 6 How Solid Is Economic Growth in the East African Community? Nikoloz Gigineishvili, Paolo Mauro, Ke Wang, IMF, August TMEA Stakeholder Forum Keynote Address, Nairobi, Kenya, November 3, 2014.

4 Africa ranges from a low of 15 in Uganda to a high of 19 in Kenya and Rwanda. 8 9 Equally worrying is the fact that 42% of official GDP in Africa overall is represented by the informal sector. 10 EAC Trade The principle exports from the EAC are cash crops and minerals, specifically: Coffee, tea and cocoa Gold Horticultural products Tobacco, sugar and cotton Mineral ores Crude and petroleum products The principle imports are petroleum products and capital goods, specifically: Crude and petroleum products Machinery and vehicles Electronics Iron and steel Cereals Palm oil According to the EAC, intra-eac trade has increased from $2.7 billion in 2005 to $5.5 billion in 2013 but the percentage of total trade remains relatively small, compared to other regions, at 10.5%. The following are the major categories, in rank of importance, of intraregional trade in the EAC. 11 Manufactured goods (75%) Crude and petroleum products (fuels) Iron and steel Ores, metals, precious stones and non-monetary gold Agricultural raw materials As noted above, manufactured goods capture the lion s share of intra-eac trade. However, this does not take into consideration the considerable amount of informal trade that takes place in the region, particularly agricultural goods. It is important to note that there are roughly two broad categorizations of informal trade. First, there are small-scale survivalist traders. Second, there is large-scale contraband and smuggling trade that is dominated by business people with powerful political patronage. The 8 State of East Africa 2013, Society for International Development. 9 More than 62% of East Africans are under 25 years of age, ibid. 10 Is Informal Normal? Towards More and Better Jobs in Developing Countries, C. Lesser and E. Moise- Leeman, OECD, Just Do It: Regional integration and foreign direct investment in Africa, African Development Bank, August 30, 2013.

5 latter is by far the largest part of informal trade. 12 They take advantage of this because of the weak and non-transparent business and regulatory environment. Staple foods are a key aspect of informal trade in East African and can have a profound effect on food security. In East Africa, maize, rice, beans, and sorghum accounted for 64 percent of informal staple food trade flows in The Policy, Legal and Regulatory Environment in East Africa: The Common Market Scorecard The EAC Common Market Scorecard (CMS) addresses three aspects of the EAC Common Market Protocol (CMP): 1) free movement of capital; 2) free movement of services; and 3) free movement of goods (the first component of the CMP, which essentially is the operationalization of the EAC Customs Union). Below are the major areas of each aspect of the CMP. I. Freedom of Movement of Capital Eliminate Restrictions Based on: Nationality Place of residence Current payments Where capital is invested Eliminate Legal and Regulatory Encumbrances: Securities Credit Direct investment Personal capital transaction II. Freedom of Movement of Services Supply of services from the territory of a Partner State to consumers in another Partner State Supply of services to consumers who have travelled abroad Direct foreign investment from one Partner State to another one Temporary movement of professionals to supply services in another Partner State Covers: Professional Services o Legal 12 The segmented nature of cross-border trade in East Africa and implications for Aid for Trade interventions, Julia Lipowiecka, Tom Pengelley, Henrik Jonstromer, Saana Consulting Ltd., November East Africa Cross border Trade Bulletin, Food Security & Nutrition Group, FEWSNET, January 2014.

6 o Accounting o Architectural o Engineering Road Transport Distribution (retail and wholesale) Telecommunications III. Freedom of Movement of Goods Ensure complete elimination of tariffs and equivalent measures Elimination of NTBs Effective implementation of Common External Tariff (CET) Continue process of harmonization and mutual recognition of Sanitary and Phytosanitary standards (SPS) and standards preventing Technical Barriers to Trade (TBTs) Key Issues: Certificates of Origin (COOs) not recognized at borders o No Partner State has complied with EAC Council s recommendations to enact domestic legislation imposing penalties on people who furnish false documentation to obtain COOs. Application of Non-Tariff Barriers (NTBs) o SPS standards and measures [NB: the most significant one] o Rules of Origin o Additional taxes and charges o TBTs Application of different tariffs to extra-regional trade partners (CET in place but Partner States belong to different RECs) Getting at the Nuts and Bolts of Major Issues To use an example from the East African Common Market Scorecard 2014, EAC Partner States apply harmonized rules of origin. However, EAC certificates of origin are frequently not recognized at borders and issues related to certificates of origin accounted for almost 25 percent of all NTBs 14 reported between 2008 and Below is the percentage of issues reported: Tanzania 50% Uganda 30% Kenya 20% Burundi 10% Rwanda 0% Source: East African Common Market Scorecard SPS measures account for nearly a third of all NTBs reported between , principally cumbersome testing and certification procedures, non-recognition of quality marks and SPS certificates and stringent requirements for the export of certain products (e.g. tea and milk).

7 Similarly, all EAC Partner States have formally eliminated tariffs on intra-regional trade, excluding goods identified as sensitive ones. However, since 2008 all Partner States except Rwanda have imposed measures with equivalent effect to tariffs on intra-regional trade, including additional taxes and charges that affect import costs. Commodities particularly affected were dairy, agricultural, pharmaceutical, aluminum and alcoholic products. Similar to the lack of recognition of certificates of origin, the following countries initiated such measures [data in parentheses indicate the percentage of the regional total): Tanzania (40%); Uganda (30%); Kenya (20%); and Burundi (10%). Rwanda had not introduced any tariff equivalent measures. Clearly, something is amiss in the nuts and bolts of policy implementation and regulatory oversight. Regulatory Impact Assessments Lite EATIH will utilize various methodologies and mechanisms to analyze specific policy and regulatory issues. EATIH will principally use lite versions of Regulatory Impact Assessments (RIAs) to analyze the policy and regulatory effects on key sub-sectors and commodities. Essentially RIA is a tool used for analysis of options to address government and/or market issues and programs. The value of RIAs are: 1) enhance the quality and efficiency of government polices and programs through the establishment of a robust monitoring and evaluation mechanism; 2) improve the decision-making process, particularly increased transparency and accountability; 3) improving economic competitiveness; and 4) ensuring the quality of proposed regulations. 15 Generally, an RIA includes the following: Problem definition, including the rationale for intervention Identification of options (including benefit-cost analysis of each option) Analysis of impacts of each option Selection of the best option Consultation, including the private sector and civil society Implementation Monitoring and review Communication of results to governments, businesses and the public. As the World Bank notes, this can be particularly useful in identifying and eliminating key chokepoints. Most administrations, especially in developing and least developed countries, face a number of constraints in adopting this agenda of modernization. First, reviewing a regulatory framework is a time- and resource-consuming task that requires highly technical knowledge. Second, most developing countries have limited skills and human resources to put in place new, independent, regulatory agencies, and at the same time maintain capacity to define broad policies in ministries that are often sector based. Finally, assessing the impact of existing regulations and designing 15 Regulatory Impact Assessment (RIA) Brief, Egyptian Regulatory Reform and Development Activity (ERRADA).

8 suitable alternatives requires a careful balance between technical feasibility, trade impact, and policy goals. Achieving this balance is challenging for countries at all levels of development. The question is not whether to regulate, but how to do so in a way that maximizes policy objectives and economic benefits. Not only can a well-designed regulatory framework help prevent market failures and achieve legitimate policy goals, it can also promote access to low-cost and high-quality services to benefit the poor, increase competitiveness, and foster growth. Moreover, with rapidly changing technology in particular, information and communication technology innovations there is an ongoing need to reassess the existing regulatory environment to take full advantage of the new opportunities opened by trade, to diversify the economy, and to participate in global value chains Regulatory Assessment Toolkit, Martin Molonuevo and Sebastian Saez, World Bank, 2014.