Institutional reforms, private sector and economic growth in Africa

Mawusse K.N. Okey

Introduction

The relationship between institutional reforms and economic performance is now the subject of several studies that analyse empirically (Djankov et al. 2006) or theoretically (Antunes et al. 2008) the impact of reforms on the indicators of economic performance of countries, especially on their private sector. Often defined as all private enterprises, whose capital is majority-owned by private individuals or private companies, the private sector is a powerful driver of economic growth. It is also understood through indicators such as the share of private sector investment in gross domestic product (GDP), changes in foreign direct investment (FDI), manufacturing exports and the evolution of domestic credit to private sector (Ruhashyankiko and Yehoue 2006). Other studies incorporate into the private sector analysis, entrepreneurship, the creation of small- and medium-sized enterprises (SMEs) and the informal sector.

Therefore, institutional constraints to these indicators of dynamism of the private sector can seriously damage a country’s economic performance. Through the Doing Business programme, the World Bank provides a quantification assessment of regulations that apply to SMEs in various fields, notably regulations for starting a business, dealing with construction permits, employing workers, registering property, arranging credit, protecting investors, paying taxes, trading across borders, enforcing contracts and closing a business. These indicators, constructed to measure the reform of the institutions, have become fundamental to a successful development and have significant effects on the economic performance of the countries. Moreover, according to North (1990), institutions can be defined as the rules of society, the combination of constraints that shape human interaction between people.

Following North (1990), several studies, notably those of Acemoglu et al. (2001), Djankov et al. (2006) and Antunes et al. (2008), have explored the concepts of institutions and institutional reforms, and their relationship with economic performance. Most of these studies generally tested the hypothesis that differences in capital accumulation, productivity and the level of income per capita are basically due to differences in social infrastructure across countries. Social infrastructure means the political institutions and governments that determine the economic environment in which individuals accumulate knowledge, and where firms accumulate capital and produce output. Indeed, social infrastructure favourable to high levels of output provides a good economic environment, promotes capital accumulation, acquisition of knowledge, invention and technology transfer. But some reforms through regulations and laws are often the main driver of diversion in economics (Mylene and Kirsten 2001).

Carlin and Seabright (2008) have shown that the literature on the importance of business climate for economic development is too wide and often contradictory. Moreover, the relative importance of constraints in the business climate varies from one country or group of countries to another. For example in South and East Asia, access to finance is less of a problem than many other constraints are; in Latin and Central America, the tax administration is less problematic than many other constraints, and in the OECD countries, policy uncertainty is a less frequent problem than other constraints. The enterprises in South Asian countries do not classify the anti-dumping practices as problematic, but these practices are raised as a major problem in African countries. Analysis of Nabli et al. (2008) helps to understand the progress in reforms and private sector development in the Middle East and North Africa. It shows the critical role played by relations between the public and the private sector in determining progress in reforms and their impact on private sector development.

The 2007 and 2008 editions of Doing Business provide some results according to which the heaviness and slowness of the formalities creating an enterprise in some African countries, as well as expenses to which those that try to create an individual enterprise are exposed, constitute obstacles to the development of the private sector. According to the 2009 edition, African countries have adopted more positive reforms in 2007-2008 than in any previous year covered by Doing Business and three of the top ten reformers in the world are in Africa: Senegal, Burkina Faso and Botswana. Reforms are also increasing in countries emerging from conflict: Liberia, Rwanda, Sierra Leone and Mauritius. Note that these reforms take place in an institutional environment that is not at all favourable. According to the report by Transparency International (2009), among 180 countries, the sub-Saharan Africa countries and the Middle East are among the most corrupt. For example, the USA, perceived as not corrupt, is at 18th place, while Zimbabwe is 166th, Nigeria 121st, Kenya, 147th, Ethiopia 126th and Cameroon 141st. This report mentions notable advances in some African countries, such as Rwanda (102nd).

We note, however, that even if the business climate indicators are clearly defined and vary considerably from one African country to another, many questions remain about their relevance in explaining differences in economic performance between countries and differences in the size of the private sector. Thus we can ask whether differences between countries in indicators of business climate are a source of differences in economic performance of African countries. If yes, what are the indicators that explain the differences in the more dynamic private sector? This chapter aims to determine the impact of positive changes in business environment indicators of the Doing Business programme and the Index of Economic Freedom of the Heritage Foundation on the private sector development indicators and economic performance of African countries.

The rest of the chapter is organized as follows: in the next section, we evaluate the progress in economic reforms and the status of recent economic performance in African countries. Following that, we review the economic literature on the relationship between institutions and private sector growth. The section entitled Methodological approach is followed by the results of econometric estimates of the effects of some institutional indicators on the private sector and the growth rate. In the last section, we draw some conclusions and remark on future prospects for reform.