Report No. 51815-BF Burkina Faso Promoting Growth, Competitiveness and Diversi�cation Country Economic Memorandum September 10, 2010 PREM 4 Africa Region Document of the World Bank GOVERNMENT FISCAL YEAR January 1 – December 1 CURRENCY EQUIVALENTS Currency Unit : CFA Franc (CFAF) 1 US$ : CFAF 441.89 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AFD French Development Agency AfDB African Development Bank AICB Association interprofesionnelle du coton du Burkina ANVAR Agence Nationale de Valorisation des Résultats de la Recherche ARTEL Telecommunication Regulatory Agency AZ Anglo Zimele BCEAO Central Bank of West African States BNLA La Direction de la Brigade Nationale de Lutte Anti-fraude de l’Or (National Brigade Against Fraud in the Gold Sector) BUMIGEB Bureau des Mines et de la Géologie du Burkina (Bureau of Mines and Geology of Burkina Faso) CAS Country Assistance Strategy CAS-PR Country Assistance Strategy Progress Report CEAS Centre Ecologique Albert Schweitzer CEM Country Economic Memorandum CFAA Country Financial Accountability Assessment CFAF Franc of the African Financial Community CID Computerized Expenditure Circuit CIE Government Integrated Accounting Software CNRST National Center for Scientific and Technological Research (Centre national de la Recherche Scientifique et Technologique) COGES Health Management Committee CONAGESE National Council for Environmental Management CPAR Country Procurement Assessment Report CSPs Community Health Centers CRA Regional Agriculture Chambers CSO Civil society organization CSPs Community Health Centers DAAF Directorate of Administrative and Financial Affairs DCMP Central Directorate for Public Procurement DEP Directorate for Planning and Studies DGB Directorate General for the Budget DGCCOP Directorate General for International Cooperation DGE Directorate General for the Environment DGMGC Direction Générale des Mines, de la Géologie et des Carrières (Directorate (DGM) General of Mines, Geology, and Quarries) DGTCP Directorate General of the Treasury and Public Accounts DHS Demography and Health Survey DSA Debt Sustainability Analysis ii DTIS Diagnostic Trade Integration Study ECOWAS Economic Community of West African States EIA Environmental Impact Assessement EITI Extractive Industries Transparency Initiative EMP Environmental Management Plan ENEP Teachers Training Colleges EU European Union FASOCOTON Private Cotton Company FRSIT Fire Service Improvement Team GAMA Environmental Management in Artisanal Mining (Peru) GDP Gross Domestic Product GNP Gross National Product GoB Government of Botswana GTZ German Technical Cooperation HIPC Heavily Indebted Poor Countries HIPC-AAP HIPC Accountability Assessment and Action Plan ICA Investment Climate Assessment ICRR Implementation Completion and Results Report ICT Information, Communication and Telecommunications IDA International Development Association IFC International Finance Corporation IGAME L’Inspection Générale des Activités Minières et Energétiques (Inspection General of Mining and Energy Activities) IGE General State Inspectorate IGF General Finance Inspectorate IMF International Monetary Fund INERA National Institute for the Environment and Agronomic Research INGO International non-governmental organization INSD National Institute of Statistics and Demography IRCT Cotton and Textile Research Institute IRD Institut de Recherche pour le Développement IRSAT Research Institute for Applied Science and Technology (Institut de Recherche en Sciences Appliqués et de Technologie) JSAN Joint Staff Advisory Note LDP Letter of Development Policy MAMS Maquette for MDG Simulations MDGs Millennium Development Goals MDRI Multilateral Debt Relief Initiative MEBA Ministry of Basic Education and Literacy MEDEV Ministry of Economy and Development MEF Ministry of Economy and Finance MMCE Ministère des Mines, des Carrières et de l’Energie MnO2 Manganese Dioxide MOH Ministry of Health MTEF Medium-Term Expenditure Framework NGO Non-governmental Organization OECD Organisation for Economic Cooperation and Development ONAPAD National Poverty and Development Observatory ONATEL National Telecommunication Company OPA Producer Organization ORCADE Organisation pour le Renforcement des Capacités de Développement P2O5 Phosporous Pentoxide iii PAMS Poverty Analysis Macroeconomic Simulator PAP Priority Action Plan PAFASP Projet d’Appui aux Filières Agro-sylvo-Pastorales PDDEB Ten-year Basic Education Development Plan PER Public Expenditure Review PNDS National Health Care Development Plan PNDSA National Program for the Development of Agricultural Services PNGT National Program for the Management of Territory PRECAGEME Le Projet de Renforcement des Capacités Nationales du Secteur Minier et de Gestion de l'Environnement PRGB Budget Management Reform Plan PRGF Poverty Reduction and Growth Facility PRSC Poverty Reduction Support Credit PRSP Poverty Reduction Strategy Paper PRSP-APR Poverty Reduction Strategy Paper Annual Progress Report ROSC Report on the Observance of Standards and Codes SBI Sustainable Budget Index (Botswana) SDR Special Drawing Rights SITARAIL Société Internationale de Transport Africain par Rail SME Small and Medium-sized Enterprises SMEELP Small and Medium Enterprise and Empowerment Program (Mozambique) SIGASPE Budget Payroll Management System SOCOMA Private Cotton Company SOFITEX Largest Cotton Company SONABEL National Electricity Company SONABHY National Petroleum Product Distribution Company SOPAFER Société de Gestion du Patrimoine Ferroviaire du Burkina SP-PPF Permanent Secretariat for the Supervision of Financial Policies and Programs STC-PDES Technical Secretariat for the Coordination of Social and Economic Development TOD Decentralization Laws TOFE Government Financial Operation Table UNDP United Nations Development Program UNIDO United Nations Industrial Development Organization UNPCB National Union of Cotton Producers of Burkina Faso VAT Value Added Tax WAMU West African Monetary Union WAEMU West African Economic and Monetary Union WHO World Health Organization Vice President: : Obiageli K. Ezekwesili Country Director: : Madani Tall Sector Director: : Marcelo Giugale Sector Manager: : Miria Pigato Task Team Leader: : Gilles Alfandari iv ACKNOWLEDGEMENTS This Country Economic Memorandum (CEM) was produced by a team of World Bank staff, international consultants and counterparts in Burkina Faso. Its structure and the topics selected were discussed with the Government of Burkina Faso and donors. The team consisted of Gilles Alfandari (TTL, AFTP4) with main responsibility for the report and final editing; Georgiana Pop (AFTP4) on growth, competitiveness, export and investment promotion, infrastructure and cross-cutting issues; Ali Zafar (AFTP4) on exchange rate dynamics, Vandana Chandra (PRMED) and Israel Osorio (PRMED) on income-enhancing diversification; Prof. Kimseyinga Savadogo (University of Ouagadougou), Philippe Mangenot (Consultant, Paris), Abdoulaye Touré (AFTAR), Kofi Nouvé (AFTAR) and Julien Vallet (AFTAR) on the cotton sector and agro-pastoral production; Gary MacMahon (COCPO) and Nongodo Joseph Ouédraogo (Consultant, Ouagadougou) on the mining sector; Jean-Christophe Ngo (AFTFP) on tourism; John May (AFTHD) and Jean-Pierre Guengant (IRD, Ouagadougou) on population growth; Jumana Poonawala (AFTP4) on risk management; Djibrilla Issa (AFTFP) on financial intermediation; Jan Gottschalk (IMF), Vu Lu (IMF), Hans Lofgren (DECPG) on MAMS and its application to fiscal space. Corinne Ilgun (AFTP4) and Virginie Briand (AFTP4) provided substantive contributions to the report. Siaka Coulibaly (AFTP4) also provided support and inputs during the scoping and dissemination missions. The report has benefited from background papers by Boulel Touré (AFTP4) on TFP growth, Quentin Wodon (HDNDE) and Kofi Nouvé (AFTAR) on shared growth, Adja Dahourou (AFTFP) on export promotion institutions, Siaka Coulibaly (AFTP4) on technological innovation, Virginie Briand (AFTP4) on cotton and vulnerability, Ji Eun Choi (Kennedy School of Government, Harvard University) on industry competitiveness, Aguiratou Savadogo-Tinto (AFTTR) on transport infrastructure; Joanna Syroka (ARD) and William Dick (ARD) on weather risk management; and Yemdaogo Tougma (SF-PPF, MEF, Ouagadougou) on taxation. In addition, the report benefitted from in-depth sectoral input from Giuseppe Iarossi (AFTFP), Alain Traoré (CAFJ2) and Inoussa Ouédraogo (CAFJ2); Stephen Mink (AFTSN); Brigitte Bocoum (COCPO); Fabio Galli (AFTTR), Pierre Pozzo di Borgo (AFTTR) and Lucien Aegerter (AFTTR); Fabrice Bertholet (AFTEG) and Leopold Sedogo (AFTEG); Mavis Ampah (CITPO); and François Onimus (AFTWR). Co-financing from the Diagnostic Facility for Shared Growth (DFSG), the Global Facility for Disaster Risk Reduction (GFDRR), the Extractive Industries Linkages Trust Fund, and PAFASP for sections of the report, is gracefully acknowledged. The report was prepared under the supervision of Antonella Bassani, Sector Manager (AFTP4), who offered conceptual guidance, provided critical analytical advice, and ensured quality assurance. Special thanks go to Ishac Diwan (Country Director, Burkina Faso) and Galina Sotirova (Country Manager Burkina Faso) who greatly supported the preparation of the report, and provided strategic guidance to the team. The Report benefited from useful comments from peer reviewers: Alain Gelb (DECVP Director), Vincent Palmade (Lead Economist, AFTFP), and Henri-François Henner (Professor Emeritus, Auvergne University) as well as from Sébastien Dessus (AFTP4), Philip English (AFTP4), Michelle Keane (AFCGH), Bronwyn Grieve (AFMBF), Patrick Labaste (AFTAR) and Gael Raballand (AFTPR). From the Country Management Unit, Sergiy Kulyk (Country Program Coordinator) and Sabine Hader (Senior Operations Officer) supported the overall process and provided valuable guidance on policy issues. Josette Percival and Judite Fernandes (AFTP4) provided logistical assistance. v  Promoting Growth, Competitiveness and Diversification (3 Volumes) Overall Table of Contents VOL I - EXECUTIVE SUMMARY ....................................................................................................................... x PROMOTING COMPETITIVENESS AND EXPORT DIVERSIFICATION.................................................. 1 Growth and Competitiveness ............................................................................................................................... 1 Exchange Rate Dynamics and Risk Management.............................................................................................. 33 Options for Income-Enhancing Diversification ................................................................................................. 44 Framework for Export and Investment Promotion ............................................................................................ 65 VOL II - SOURCES OF GROWTH KEY SECTORS FOR TOMORROW ..................................................... 8 The Cotton Sector: Performance, Crisis and the Way Forward ........................................................................... 8 Intensifying Agro-Pastoral Production .............................................................................................................. 51 The Mining Sector: Current Situation and Prospects ......................................................................................... 83 An Emerging Tourist Destination .................................................................................................................... 111 VOL III - ENHANCING GROWTH FACTORS ................................................................................................. 8 Coping with Population Growth .......................................................................................................................... 8 Public Policies and Market Instruments to Reduce Vulnerability...................................................................... 27 Closing the Infrastructure Gap to Sustain Growth ............................................................................................. 47 Improving Financial Intermediation .................................................................................................................. 92 Policy Options for Fiscal Space and Structural Changes —A Model-based Analysis....................................... 99 References........................................................................................................................................................ 141  vi TABLE OF CONTENTS FOR VOLUME I EXECUTIVE SUMMARY .................................................................................................................................... X VOLUME 1.- PROMOTING COMPETITIVENESS AND EXPORT DIVERSIFICATION ......................... 1 Growth and Competitiveness .............................................................................................................................. 1 The Last Two Decades ..................................................................................................................................... 1 Macroeconomic Performance and the Global Economic Downturn................................................................. 8 Burkina’s Performance vis-à-vis Comparator Countries ................................................................................ 12 The Diversification Challenge ........................................................................................................................ 16 Exchange Rate Dynamics and Risk Management ........................................................................................... 34 Currency Mismatch for Export Prices and Production Costs ......................................................................... 34 Has the Evolution of Non-tradable Prices Led to the REER Misalignment?.................................................. 35 A Holistic Approach to Managing Exchange Rate Risk in the Cotton Export Industry ................................. 40 Conclusions and Policy Recommendations .................................................................................................... 42 Options for Income-Enhancing Diversification .............................................................................................. 45 Export Performance in Burkina Faso .............................................................................................................. 45 Exports Sophistication .................................................................................................................................... 49 Options for Export Diversification ................................................................................................................. 54 Selection of Income-enhancing Exports ......................................................................................................... 59 Framework for Export and Investment Promotion ......................................................................................... 65 Market Forces and Institutions ....................................................................................................................... 65 Constraints Related to the Current Framework............................................................................................... 70 Practical Arrangements to Boost Competitiveness ......................................................................................... 80 Conclusions and Policy Recommendations .................................................................................................... 87 List of Appendices Appendix 1: Methodologies to Calculate the Exchange Rate Misalignment.............................................................. 90 Appendix 2: Performance of Other Landlocked or Commodity Producing Countries ............................................... 95 Appendix 3: Product Space Methodology .................................................................................................................. 96 Appendix 4: Burkina Faso’s Exports in the Product Matrix Framework ................................................................... 98 Appendix 5: Export Diversification-Technical Definitions Distance between a Pair of Products ........................... 100 Appendix 6: Burkina Faso’s Classic Exports and Neighboring Products................................................................. 104 List of Tables Table 1-1: Consumption and Investment, % of GDP ................................................................................................... 3 Table 1-2: Factor Contribution to Productivity Growth (in %) .................................................................................... 3 Table 1-3: Sectoral Contribution to GDP (%) ............................................................................................................. 4 Table 1-4: Evolution of Exports and Imports, 1980-2005 ............................................................................................ 5 Table 1-5: Inequality .................................................................................................................................................... 7 Table 1-6: Poverty Incidence ........................................................................................................................................ 7 Table 1-7: Key Macroeconomic Indicators, 2006 – 2009 ............................................................................................ 9 Table 1-8: Trends in Per Capita Gross National Income in Burkina Faso and Comparators (current PPP US$) ....... 14 Table 1-9: Trends in the Share of Exports in Gross Domestic Product (%) ............................................................... 15 Table 1-10: Economic Diversification in Sub-Saharan Low-income Primary Product Exporters.............................. 20 Table 1-11: 2009 Global Competitiveness Index for Burkina Faso ........................................................................... 21 Table 1-12: Loan Characteristics in Burkina Faso...................................................................................................... 27 Table 1-13: Telecommunication Costs in Burkina Faso ............................................................................................. 30 Table 1-14: Indirect and Invisible Costs (% of firms’ sales) ...................................................................................... 32 vii Table 1-15: Responsibilities of the Cotton Ginning Company’s Risk Management Unit .......................................... 44 Table 1-16: Structure of Burkina Faso’s Merchandise Exports .................................................................................. 53 Table 1-17: Sample of Burkina Faso Exports Organized by RCA in 1980-1984 and 2000-2006 .............................. 54 Table 1-18: Average Value and Densities for Burkina Faso’s Exports ...................................................................... 57 Table 1-19: Options for Export Diversification in Burkina Faso ............................................................................... 62 Table 1-20: Candidates to Economic Diversification outside the Cotton Sector ........................................................ 64 Table 1-21: Doing Business Reforms .......................................................................................................................... 66 Table 1-22: Export Promotion Institutions ................................................................................................................. 72 Table 1-23: SEZ Characteristics ................................................................................................................................. 82 Table 1-24: Clusters in Sub-Saharan Africa ............................................................................................................... 84 List of Figures Figure 1-1: Average Annual GDP Growth Rate (%) (1960 – 2008) ............................................................... 2 Figure 1-2: GDP Per Capita in Burkina Faso during 1985 – 2007 (constant 2000 US$) ..................................... 2 Figure 1-3: Average Real GDP Growth Rates by Sector (%), 1994-2008 ....................................................... 4 Figure 1-4: Foreign Direct Investment, Net Inflows as a % of GDP (1994-2006) ............................................. 6 Figure 1-5: Negative Correlation between Commodity Dependency and Per Capita Income in the Cotton-Exporting Countries (1980-2006) ........................................................................................................................ 17 Figure 1-6: Volatility in Burkina’s Per Capita Income and World Cotton Prices ............................................ 18 Figure 1-7: Ease of Doing Business in Burkina Faso, 2010 ........................................................................ 25 Figure 1-8: Constraints Indentified by the Enterprise Survey ..................................................................... 26 Figure 1-9: Cost of Electricity in Burkina Faso and .................................................................................. 28 Figure 1-10: Number of Tax Payments .................................................................................................. 28 Figure 1-11: Time Spent Paying Taxes .................................................................................................. 33 Figure 1-12: Time for Export and Import ............................................................................................... 33 Figure 1-13: Domestic and International Cotton Prices, 1999-2009 .......................................................................... 35 Figure 1-14: Disaggregated CPI in Burkina Faso, 1997-2006 ..................................................................... 36 Figure 1-15: Evolution of Burkina Faso’s REER, 1994-2006 ..................................................................... 37 Figure 1-16: Evolution of Current Account Balance in Burkina Faso, 1984-2007 (% of GDP).......................... 38 Figure 1-17: Evolution of the REER and FEER, 1980-2008 (%) ................................................................. 39 Figure 1-18: The Relationship between the Herfindahl Index of Export Concentration and Per Capita Income .... 46 Figure 1-19: Trends in the Herfindahl Index ........................................................................................... 46 Figure 1-20: Diversification across Regions ........................................................................................... 47 Figure 1-21 Diversification and Export Sophistication in Burkina Faso ........................................................ 48 Figure 1-22: PRODY of Selected Products ............................................................................................. 50 Figure 1-23: Burkina Faso’s EXPY Trend .............................................................................................. 52 Figure 1-24: GNI Per Capita in Burkina Faso Compared to Other Landlocked and Natural Resource-based Product Exporters ............................................................................................................ 52 Figure 1-25: Burkina Faso’s Position in the Product Space ........................................................................ 55 Figure 1-26: Density and PRODY in Burkina Faso .................................................................................. 57 Figure 1-27: Distance between High PRODY Trees ................................................................................. 60 Figure 1-28: Correlation of Exports to Export Promotion Budgets .............................................................. 74 viii List of Boxes Box 1-1: Policy Challenges for Developing Countries in Responding to the Global Economic Crisis...................... 11 Box 1-2: Diversification Patterns in Other Landlocked or Commodity Producing Countries.................................... 15 Box 1-3: The Global Competitiveness Index: A Tool to Benchmark Competitiveness ............................................. 22 Box 1-4: Holistic Approach to Exchange Rate Risk Management in Burkina Faso’s Cotton Sector .......................... 40 Box 1-5: PRODY and EXPY Measurement of Export Income Potential ................................................................... 50 Box 1-6: High PRODY of Bacon ............................................................................................................................... 51 Box 1-7: A Framework to Identify Products with Export Potential ........................................................................... 54 Box 1-8: A Comparison between the Product Matrix Framework and the DTIS Results .......................................... 61 Box 1-9: Successful Reform Implementation for Doing Business Better in Burkina Faso ........................................ 66 Box 1-10: What is required for Successful Export Promotion? .................................................................................. 75 Box 1-11: Instruments for Export Promotion in Tunisia ............................................................................................ 77 Box 1-12: Capacity-Building Programs to Support Quality Promotion ..................................................................... 79 Box 1-13: Characteristics of Special Economic Zones............................................................................................... 82 Box 1-14: Free Zone in Madagascar........................................................................................................................... 83 Box 1-15: Examples of Clusters in Sub-Saharan Africa............................................................................................. 84 Box 1-16: Potential of the Hauts Bassins and Cascades Regions ............................................................................... 86 Box 1-17: A Pilot Growth Pole Project in Bagré ........................................................................................................ 86 ix EXECUTIVE SUMMARY Motivation and Objectives 1. The Government of Burkina Faso is actively working on the preparation of a new Strategy for Faster Growth and Sustainable Development for 2011-2015, known as SCADD (Stratégie pour la Croissance Accélérée et le Développement Durable). The Government’s purpose is to define a new development framework to improve its policy effectiveness in economic and social areas, principally through the strategic promotion of productive sectors capable of improving people’s well-being and reducing poverty. In that context, the Government has sought support from the World Bank in identifying the country’s future sources of growth and socio-economic factors that constitute challenges and opportunities for enhanced growth and sustainable development. 2. This Country Economic Memorandum (CEM) entitled “Burkina Faso - Promoting Growth, Competitiveness and Diversification� was designed to inform policy choices in relation to this new strategy. This report builds on a compendium of earlier strategic work produced both by the Burkinabe Government, local think tanks and donors, including a broad prospective study on “Burkina 2025�, the 2009 National Scheme for Territorial Planning (SNAT - Schéma national d'aménagement du territoire), sectoral policies produced by the Ministerial Departments, and a 2005 research from the Centre d’Analyse des Politiques Sectorielles (CAPES) on competitiveness and diversification (2005). The CEM also builds on recent and ongoing analytical work produced by the World Bank, notably the 2007 Diagnostic Trade Integration Study, as well as on relevant operational work on agricultural intensification and on the development of growth poles. It borrows from and summarizes existing international studies and country cases to provide both relevant international comparisons and, wherever necessary, brings a regional dimension. Finally, it provides innovative analytical work on several topics, including on exchange rate competitiveness, product space and differentiation, the demographic transition, risk management instruments to reduce growth volatility and general equilibrium macro-modeling with the Maquette for MDG simulations (MAMS) to analyze fiscal priorities for growth. The CEM has three volumes: Volume I “Promoting Competitiveness and Export Diversification�, Volume II “Sources of Growth: Key Sectors of Tomorrow, and Volume III “Enhancing Growth Factors�. 3. The CEM’s core conclusion is that the past model of extensive growth has now exhausted its potential and that this development model needs being renewed. Given the existing demographic dynamics, the low environmental tolerance from its Sahelian environment and accrued competition from its open economy forces, Burkina Faso needs to invest massively in productivity-led growth, to overcome its low initial level of human capital, overall capacity and regulatory constraints. To help define Burkina Faso’s new development model, the CEM explores productivity-led growth at the macroeconomic, the meso or sectoral levels as well as at the micro and institutional levels. It also assesses growth sustainability on the human, demographic, physical infrastructure, financial, and fiscal dimensions. Wherever possible, it assesses performance of earlier development programs and offers diagnostics for problems encountered, analyzes the current situation in terms of challenges and opportunities, and presents x a few strategic axes and prioritized policy recommendations in time to enrich the Government’s consultations around the preparation of the SCADD. 4. Several binding constraints to growth are identified and the CEM proposes practical ways to alleviate or mitigate them. These constraints are: i. The frequency of exogenous shocks on Burkina Faso’s agriculture, particularly cotton, significantly slowing down the country’s socio-economic development; ii. The exchange rate’s real appreciation, which is not reflecting labor productivity gains, has deteriorated price competitiveness; iii. The country’s insufficient attractiveness to foreign direct investment, despite significant progress in the doing business environment, limits its growth potential; iv. High fertility rates hurt per-capita growth and social achievements, starting with human capital; v. Environmental constraints limit extensive growth in agriculture, while food security continues to challenge human development; vi. Excessive household vulnerability prevents the poor from truly engaging in productive economic activities; vii. Limits on institutions and human capacity reduce effectiveness in public policies. 5. Finally, key policy objectives toward enhanced growth and sustainable development come out clearly of this CEM: i. Promote productive sectors that can constitute robust sources of growth in the medium-run, whether oriented toward the export or the domestic market (the CEM identifies several of those and proposes ways to enhance the nation’s wealth through a progressive sophistication of its product-mix); ii. Promote trade both at the regional and global levels through a diversification and commercialization of national productions, including enhanced positioning of the country through active export promotion agencies; iii. Increase profitability and competitiveness through intensified, diversified and commercialized agriculture production, while expanding transformation activities to move-up the value chain; iv. Expand services such as tourism and activities in urban centers to create jobs and absorb rural migrants; v. Enhance private sector participation to the economy, including through public-private partnerships, and deepen financial intermediation; vi. Accelerate the demographic transition through a combination of family planning and socio-economic policies; vii. Reduce socio-economic vulnerabilities by expanding risk management at the macro, meso and micro levels, developing social protection and empowering the poor to engage in productive economic activities; viii. Maximize socio-economic returns from foreign aid as well as from significant windfall gains in the mining sector, through sound public infrastructure investments required for Burkina Faso’s new expansion phase; ix. Develop institutions and human capacity that have an impact on the effectiveness of public policies. xi Country Background and Envisioned Structural Transformation 6. Burkina Faso is a small, land-locked, predominantly rural, West African country. The rapidly expanding population of 13.6 million inhabitants relies upon a very narrow natural resource base, with cotton as the only major existing export commodity until recently, when gold emerged as a another significant product. The agrarian economy is particularly vulnerable to climatic and external shocks. Burkina’s fragile Sahelian environment is drought-prone and susceptible to flooding. External factors, such as exchange rates volatility, international prices of cotton, fluctuating fuel and food prices also impact the country. As a land-locked country, bordered by six neighbors, Burkina Faso is highly dependent on good relations with and the stability of its neighbors for transit, trade with external markets and political stability. 7. Since the early 1990s, the country has benefited from relative political stability, democratic rule and a progressive platform of economic and political reforms. Under the leadership of President Blaise Compaoré, Burkina Faso has moved from its Sankara-inspired pan-African socialist bent towards market-oriented reforms and re-engagement with the international community. Over the last two decades, the Government of Burkina Faso has embarked upon a dramatic economic and political reform agenda, involving reforms in trade, currency and price liberalization, as well as tentative moves towards decentralized governance. Burkina has experienced relatively strong economic growth and good macroeconomic performance since the beginning of the 1990s. Stable annual real GDP growth of about 6 percent was achieved after the devaluation of the CFA Franc until 2006. Despite one of the most rapid population growth in the world (3.1 percent per year), per-capita growth averaged 2 percent per year since then, reaching US$430 in 2007 and enabling a significant reduction in poverty incidence (still affecting 41 percent of the population in 2006). 8. Most of this achievement resulted from, among other things, the gains in competitiveness that followed the 1994 devaluation, the large public investment program (mainly externally financed), and the financial and structural policies (including price and trade liberalization) aimed at consolidating the market orientation of the economy and maintaining macroeconomic stability. The significant flow of external aid, estimated at between 8 percent and 9 percent of GDP since 1996, contributed strongly to this success as well. They resulted in the increase of public investment, which also benefited from a package of reforms in budget management and from an improvement of the business climate from a very low base. Rated among Sub-Saharan Africa’s better performers, Burkina Faso scores high marks for political stability and maintaining an economic environment marked by a reasonable degree of trade liberalization, stabilization, good governance and the rule of law. As such, Burkina Faso became in 1999 one of the first countries to be eligible for the Heavily-Indebted Poor Countries Initiative. 9. Nevertheless, due to swings in the agricultural production and to the economy’s vulnerability to a series of exogenous shocks, growth has been uneven since 2007 and poverty incidence is deteriorating again. The cumulative impact of the food and energy crisis, and of the global economic downturn, of low commodity prices combined with the real appreciation of the domestic currency, a better understanding of the impact of rainfall on economic cycles and of the limited land capacity to further expand agriculture, all have xii contributed to raise awareness that a different development model was needed for Burkina Faso. Overall, the country’s economic structure has changed relatively little in the last few decades with over 80 percent of the population deriving their living from animal husbandry and subsistence agriculture. One exception in that pattern, however, has taken place over the last two years, enhancing Burkina Faso’s resilience to shocks as a significant mining boom just started transforming this single export crop economy into a two-commodity exporter, with stronger linkages to the service and construction sectors and a beneficial counter-cyclical behavior of gold prices on world markets. Nevertheless, concerns on cotton’s medium-term profitability and very survival have continued to grow as cumulated subsidies to bring cotton companies and farmers afloat and transfer some risks away from the domestic banking system have proved costly and unsustainable for the Government. Despite a recent surge in foreign direct investment toward the telecommunication and construction sectors, in part due to mining activities, few formal jobs have been created in cities and agro-pastoral productions, for the main part, have continued to be exported in their unprocessed state rather than move-up along their products’ value chain. 10. The Government’s long-term vision for the country, as expressed in the Burkina 2025 study, calls for industrializing Burkina Faso with significantly enhanced human capital and full integration into global trade flows. This objective contrasts notably with the current conditions where the industrial sector contributes around 20 percent of economic output and employs approximately 10 percent of the workforce. Actually, “industrial� production in Burkina is mainly centered on the processing of agricultural commodities such as flour, milling, sugar refining and the small scale manufacturing of cotton yarn and textiles. This is the overall context in which this CEM proposes to encourage thinking on new export opportunities – using the product space methodology developed by a Harvard University team1 and a dynamic analysis of export sophistication. In particular, the CEM distinguishes clearly between export diversification and technical upgrading on the one hand and manufactured exports on the other, as is envisaged under the best-case scenario of the Burkina 2025 study. In the initial stage (which can safely be seen as no earlier than 2015), Burkina Faso, like other African countries, is expected to diversify mostly through widening the range of primary and processed exports, as well as tourism, hence the selection of traditional sectors studied in the second section of the report: cotton, agro pastoral productions, mining and tourism. 11. Mining in Burkina is a great example of how an industry specific reform (a new mining law) is contributing to increasing private investments. Investment in the sector was approximately US$700 million from 2006-2009, with an addition US$250 million expected in the next two years from ongoing projects. The CEM estimates that the mining sector would contribute approximately 12 percent of economic output by 2012. Mining in Burkina Faso is centered on the extraction of gold-bearing quartz, marble and antimony while viable deposits of zincs, silver and manganese along with limestone, bauxite, nickel, phosphates and lead provide further potential. Gold production, in particular, has risen significantly in recent years. It is expected to reach between 35-40 metric tons by 2015, which would place the country among the 15th-20th largest producers worldwide. The CEM estimates potential annual fiscal revenue generated by the mining sector (both direct and indirect) of nearly US$450 million by 2015. It also discusses the experience of similar countries, such as Botswana, which managed to use their mining sector as a springboard for growth. If sufficiently well managed, Burkina Faso’s ongoing 1 Hausmann, Hwang and Rodrik (2008) and Hausmann and Klinger (2007). xiii mining boom has the potential to relieve a significant part of the fiscal space constraint explored in the last chapter of the report. Scope of the Report 12. One of the objectives of this CEM was to identify the most promising products and conduct a competitiveness diagnostic. The products list is summarized in Table 1 below. Competitiveness, in this report, is seen as a combination of productivity and costs, and the second section of the CEM presents industry chapters that systematically benchmarks Burkina’s competitiveness performance against its main competitors. Sectoral chapters also explore reforms achieved and their impact on productivity, list remaining bottlenecks and opportunities and discuss possible emulation from other countries. For agro-pastoral productions, a chapter covers several industries, with the analysis focusing on a critical mass of interventions around the most promising value chains and locations. 13. Complementing the sectoral competitiveness analysis, the first volume of the report explores cross-cutting aspects of diversification and competitiveness to diagnose reform areas, building notably on the latest Africa Competitiveness Report. That volume explores limitations from land and financial markets, factor costs such as energy, communications and transports (air and road), excessive regulations and the weak institutional setting, policies to promote foreign direct investments and hedging instruments against excessive market volatility. High transportation costs are particularly relevant in a landlocked country still challenged by food security issues. 14. The third volume of the report further explores binding constraints to growth beyond competitiveness, such as weak infrastructure networks and human capital, insufficient financial intermediation for private sector growth and limited fiscal space for public investments, and raising population growth. The infrastructure chapter, in the third volume of the report, considers the impact of expensive and unreliable power on industrialization, and proposes possible solutions over time, looking at the overall regional context. Similarly, this chapter assesses Burkina Faso’s dearth of roads and the economic pertinence of existing networks when cotton crops, for instance, may stay weeks on the ground before they can be carried in small pickups to the factory, or when cereals and fruits can rot while they may be needed in other areas of the country. The construction and maintenance of roads or other infrastructure networks is a typical case that illustrates the need for sound public investment decision choice, as fiscal space is particularly constrained by relatively weak domestic revenue mobilization (around 13 percent of GDP) and an excessive dependency on foreign aid (as argued in the second chapter on exchange rate dynamics). 15. Promoting enhanced and sustained growth will require addressing vulnerabilities at all possible levels: macroeconomic, sectoral and households. The CEM expands on its competitiveness analysis to offer practical policy advice in risk management, on social policies and for MDG-friendly fiscal policy. As a Sahelian economy, the Burkinabe farmers know too well their excessive exposure to climatic elements. The CEM draws extensively on irrigation studies to show how investments can remedy some of this risk, while also addressing innovative risk transfer instruments for farmers, such as a weather index insurance. xiv Table 1: Candidates to Economic Diversification outside the Cotton Sector Product Space Methodology Sectoral Analysis (developed in Volume I) (developed in Volume II) Cereals, vegetables and other plants/seeds Maize (corn), unmilled Traditional cereals (sorghum, millet, maize) Buckwheat, millet, canary seed, grains Rice Fruit, fresh or dried Onions Other fresh or chilled vegetables Tomatoes Vegetable products, roots and tubers Green beans Plants, seeds, fruits used in perfumes Cowpeas Sesame Mangoes Shea nuts Animals/meat and other animal products Short-cycle species (poultry, sheep and goats) Cattle/Beef Milk Leather, hides, skins and bones/horns Leather of other hides and skins Hides and skins Sheep and lamb skin leather Bones, horns, ivory, hooves, claws Processed products Cotton seed oil Fixed vegetable oils Sugar, beet and cane, raw, solid Sugar confectionery and other sugar Sacks and bags of textile material Manufactures of wood Household appliances, decorative art Other musical instruments Cigarettes Soap, organic surface-active products Gold, non-monetary 16. The analysis of Burkina Faso’s demographic trends takes its full meaning when the country’s high fertility rate is shown to be incompatible with a major and sustained improvement in living standards. This is easily understood by looking at the budget of the education sector. While economic diversification and competitiveness would require new technical and managerial skills, with an education system promoting a stronger culture of imitation of tested technologies and of innovation set for the local context, demographic trends affect the fiscal ability of the Government to sustain existing schooling indicators, let alone reform the education system. It is in this context, that the last chapter of the report discusses the xv phasing of development spending and its impact on social objectives, using simulations from MAMS, a general equilibrium model built to assess how the MDGs can be reached. 17. From a methodological point of view, the report reviews both the past implementation experience of various programs and policies as well as international good practices. For example, when discussing diversification into higher-valued agriculture, the report takes into consideration lessons from past initiatives (Burkinabè textile, dried mangoes) as well as from abroad (Kenya cut-flowers and Rwanda coffee) to draw lessons for effective policy reforms. Similarly, the analysis of foreign direct investment promotion takes into full account lessons from the Government’s recent success in improving the country’s business climate. It also looks at interesting experiences across the continent, including cluster zones or growth poles that are being the focus of the new Government strategy. 18. The CEM is particularly careful at discussing institutional issues. For instance, Burkina’s impressive microeconomic reform track record along the Doing Business indicators (a gain of 8 ranks over the 2008-2010 period) provides positive institutional lessons and illustrates the importance of the human factor, a dedicated world class reform team, in successful implementation. But improving Burkina Faso’s competitiveness will require even more challenging institutional reforms than was needed to achieve better doing business indicators. The CEM points out the need to: (i) consolidate the export supporting agency; (ii) develop the investment promotion agency; and (iii) create a public-private partnership (PPP) unit. The report explores in detail the institutional requirements for successful PPPs, a topic also well reflected at the sectoral level in the discussion on tourism in the second section and in the chapter on infrastructure in the third section. 19. Finally, in selecting its recommendations, the CEM tried to put forward efficient policies, distinguishing new ones that should be adopted from those already in place, which could be improved, while drawing lessons from programs that did not work as expected. The CEM balances proposals for new policies with arrangements and measures needed to improve the quality of public policy implementation and service delivery in areas where there is already a framework. However, since some of the suggestions require long-run capacity building in difficult areas, including regulatory demands on the state, the policy matrix at the end of this section also highlights actions more easily implementable in the short run. And at times, the discussion targets areas where programs should be cut or regulations abolished because they do not work. Ultimately, promoting diversification and competitiveness can sometimes be a matter for the State of doing less rather than intervene heavily in every direction. Main Conclusions and Policy Recommendations 20. Volume one of the CEM highlights the need for Burkina to address macroeconomic and microeconomic constraints to growth and competitiveness, points to its low export sophistication and suggests policy tools to facilitate private-sector driven export and investment promotion. Despite good growth performance, the country has been exposed to a decline in cotton prices, which puts an additional strain on government finances and poverty reduction. Moreover, the appreciation of the country’s REER has hurt cotton companies’ profitability and emerging industries’ competitiveness. While Burkina could better use risk management techniques to deflect some of this exogenous shocks, export diversification remains xvi the country’s most effective way to raise its economic resilience and accelerate growth. Burkina must continue to enhance growth in its traditional sectors (cotton and metals) while fostering the development of more sophisticated agricultural products, eventually moving into low-scale manufacturing. Export and investment promotion programs are useful tools to complement market-driven processes, especially with regard to information asymmetries and other market failures. Implementing a coherent export and investment promotion strategy, building capacity of the export promotion agency while developing an investment promotion agency should also be complemented by a streamlining of the regulatory framework (investment legislation) and second-generation business-oriented reforms (taxation, VAT reimbursement, customs regime). 21. Volume two underlines (i) the need for sound choices in order for the cotton sector to continue operating; (ii) the development of selected supply-chains to achieve food security, growth and import substitution, (iii) the significant growth role of the mining sector if revenue are well managed; and (iv) potential in tourism as a service industry that will depend on improvements in the quality, capacity of lodging, and infrastructure. 22. Despite being the engine of economic growth in the past years, the production of seed cotton in Burkina has been extensive and uneven. Improving the cotton sector performance will depend on (i) enhanced productivity through improved research and extension services to help the Burkinabè farmers close the yield gap with more advanced cotton producers; (ii) the development of soil-fertilizer-water integrated management programs to prevent soil washout and erosion; (iii) better equipment for farms at more accessible equipment prices; (iv) human capital development, as the rate of illiteracy among the cotton producers remains high; (v) valorization of cotton seed by-products, such as oil and cake; and (iv) diversification within and outside agriculture, as a risk management/income enhancing mechanism. Additionally, putting in place functional risk management mechanisms is crucial, especially to mitigate: (i) weather-related risk; (ii) output price risk; and (iii) input price risk. 23. Burkina has a rich vegetable and ecological capital, but numerous weaknesses hamper the agriculture sector development. They range from high level of illiteracy, low productivity of the labor force, high factor costs, to weak infrastructure and storing facilities, weak management capacities along the value chain, precarious financial situation of the sector operators, and limited organization of the major value chains and of market promotion. Harnessing the potential of the sector will require a concerted campaign to intensify productivity and diversify into high value agriculture for export. Key crop and livestock products retain growth and can be positioned with respect to the strategic sector development objectives. Cereals (millet, sorghum and maize) and tubers are staple food security crops. Poultry, sheep and goats along with game animals and fish are major sources of animal proteins in Burkina. In addition, the most competitive products in the West African market seem to be onions, tomatoes, cowpeas, cattle/beef and maize. Apart from cotton, Burkina has a comparative advantage in exporting mangoes, sesame, and shea nut products, but it is trading these products at the lower levels of the value chain. Similarly, export performance of the hides and skins sector has been limited. There is also potential for rice and milk import substitution. 24. The mining sector is seen as an important pillar in Burkina Faso’s strategy to develop the private sector. The macroeconomic implications of the rapid growth in tax and foreign exchange revenues generated by the mining sector and its spinoffs may require new xvii policy and institutional initiatives by the Government. While the first steps towards the implementation of the Extractive Industries Transparency Initiative have been taken, it will soon be important for the Government to formulate a plan as to how it will use the increased fiscal revenues to further the development of the country as well as how it will manage the likely fluctuations in revenues generated by the mining sector. More systematic attempts to take advantage of infrastructure needs of the mining companies to extend such facilities to local areas, and training the Burkinabès to take higher skilled jobs in mining companies as encouraged by the Mining Code are necessary for growth in the sector to spill over to the rest of the economy. 25. Burkina Faso is still relatively unknown on the global tourism map, notwithstanding its rich natural and cultural endowments. The country has succeeded in attracting a growing number of international travelers, mostly from Europe and Sub-Saharan Africa, through its positioning as a regional leader for movie festivals and handicrafts fairs. Nevertheless, the sectors suffers from (i) an inadequate and fragmented institutional framework, with no leadership in destination promotion, (ii) inefficient public-private partnerships, particularly with regard to national parks and other wildlife domains, (iii) a low level of transparency in the sector’s financial flows, potentially resulting from current government regulations, (iv) an inadequate infrastructure network, particularly for road transport, which creates further costs to any traveler, (v) travel requirements, particularly cumbersome visa and other administrative procedures for overseas visitors, (vi) the poor quality lodging options on remote sites outside of the capital city, (vii) a lack of local norms and standards required for visitors to spend more and stay longer in the country, (viii) recurrent concerns on safety and security, particularly in rural areas or during night time, and (ix) limited financial and managerial capacity from a number of private operators. 26. Finally, Volume three identifies actions to (i) address demographic changes through better information, education, and communication campaigns aimed at behavior change; (ii) develop risk management instruments to address economic, social, health, natural risks, and food security; (iii) improve the country’s access to regional and world markets to better connections to regional transport, electricity, and telecom infrastructures, and to improved water services and irrigation systems; (iv) harness financial intermediation through new credit access mechanisms, reform of the financial sector’s institutional system, and building-up of financial and risk management capacity in the corporate sector; and (v) creating and using fiscal space by prioritizing expenditures, raising revenue, or scaling up aid inflows. 27. Demographic change in Burkina Faso has been too late as compared to Latin America and Asia and too slow in particular with respect to fertility. Despite impressive declines in mortality levels, fertility has remained very high at 6.2 children per woman on average. The decades lost for triggering a fertility decline bring some challenges. First, development strategies including poverty reduction programs need to factor in the importance of demographic change, using consistent data and more realistic assumptions. Given that the implementation of the revised National Population Policy has been disappointing, it is suggested to focus the effort on a few key interventions that can possibly and rapidly bring demographic change. These include effective information, education, and communication campaigns aimed at behavior change, universal education, especially for girls, and access to quality family planning services. Second, the consequences of rapid population growth for development and human capital investments need to be fully understood and acted upon by the Burkinabè leadership as xviii well as their development partners. This will require enhanced advocacy in the area of population and reproductive health as well as a strengthening of the current institutional framework to address population issues. In sum, it is urgent to re-legitimize interventions in the area of population and reproductive health. 28. Since the agriculture sector in Burkina is highly vulnerable to natural risks, the adoption of instruments for risk mitigation is essential to protect the farmers and households. At the same time, households, particularly the poor ones, are exposed to a variety of micro levels risks, and are able to manage only partially their nutrition and welfare. To reduce the impact of exchange rate volatility, the cotton ginning companies should institutionalize a trade finance regimen that offsets US Dollar import payments against US Dollar export proceeds prior to currency conversion into CFAF. Although the existing cotton smoothing fund provides price stabilization, it has not yet hedged its risks exposure to commodity price volatility. Burkina would benefit by accessing the futures markets to announce its producer price. Moreover, accessing insurance mechanisms against natural risks could be done through the establishment of mutual funds, saving and insurance systems. Despite the existence of a wide array of government social protection programs, their impacts seem to be limited because of inadequate financing, the lack of adequate institutional structures and the lack of coordination between ministries and among donors. Therefore, safety nets meant to reduce the most extreme forms of destitution and food security should be implemented and monitored with data on the beneficiary profiles, costs and effectiveness. 29. Burkina’s landlocked position requires improving the country’s infrastructure and regional integration. Lack of adequate infrastructure hampers private sector activity and firm productivity. The population growth in Burkina calls for better infrastructure and urban planning, while better regional integration would help improve access to cheaper electricity and ICT services. Nevertheless, when building new infrastructure, access to service, quality, affordability and financial sustainability of services are key criteria. In Burkina, some sub-sectors, such as railway transportation, telecom, and small-scale irrigation, have benefited from private sector participation. Nevertheless, Burkina does not have an adequate public-private partnership framework (legal framework and a PPP unit) to enable more systematic private sector participation in the infrastructure development. Overall, the quality of the road network remains poor. Electricity costs are higher than in Benin, Mali or Senegal because of the limited energy generation potential, but, under the West African Power Pool, the country is expected to benefit from access to additional capacity at a lower price. In the telecommunication sector, access to ICT services is most problematic. Furthermore, irrigation systems for agriculture production are covering only a small portion of the land. 30. The crucial role of financial intermediation for growth and private sector development calls for increased efficiency of the banking system. The supply of financial services is currently limited as indicated by the low share of population that has a bank account (6 percent) or an account with a microfinance institution (10 percent). The rural areas are not well served, most of the bank branches being located in the urban areas. Bank lending is channeled towards large enterprises and the public sector, while the cotton sector absorbs most of the bank financing, with virtually no credit available for other agricultural activities. Hence, in the context of the recent financial crisis, financing to the cotton sector is expected to shrink and borrowing in the international markets is likely to be less affordable. Moreover, the limited SME xix financing and the lack of expertise in this field are often cited as major impediments to SME development, but the informal status of many SMEs and their lack of guarantees partly contribute to their sparse access to formal finance. Overall, the regulatory framework is not yet fully developed to support diversification of financial products, such as financial leasing and equity investment. The supervisory capacity of MFIs is equally weak. Finally, some aspects of the regional BCEAO prudential rules seem to hinder the use of guarantees for loans to SMEs and in rural areas. 31. For the country to resume growth after the crisis, it is critical to sustain adequate levels of investment. However, Burkina Faso’s ability to do so is severely limited. To achieve investment rates required to sustain the pre-crisis growth momentum would require additional resources to bridge a significant financial gap. Fiscal space can be created by prioritizing expenditures, raising revenue, or scaling up aid inflows; its main uses in the context of Burkina Faso are boosting public infrastructure or human development (education and health) spending. The importance of adequate public infrastructure and health and education levels have been highlighted at a microeconomic level, including for enhancing competitiveness; promoting agro- pastoral production; unlocking the economy; or coping with population growth. The analysis uses MAMS, which is a large multi-sectoral model with MDG sectors. There is a tradeoff between growth and poverty-reduction objectives on the one hand—for these, public infrastructure investment is most effective—and health- and education-related MDG objectives on the other hand, where human development spending is most effective. Nevertheless, the simulations show that the growth effect of public infrastructure spending has a sizeable positive impact on health and education outcomes, which reduces the tradeoff. These findings seem to comfort the new orientation behind productive sectors that the Government is promoting through the preparation of the SCADD. xx Summary of Policy Recommendations Promoting Competitiveness and Export Diversification: Volume I Export Promotion x Redefine the role of the “taxe d’apprentissage� to support skills development for exporters, and strengthen the use of MEBF matching-grant funds. x Accelerate VAT reimbursement by: (i) simplifying procedures; and (ii) keeping VAT receipts in a special account for reimbursements or exempting only exporters. x Strengthen the ONAC mandate and functions to act as a single specialized agency for export promotion in closer consultation with the private sector; x Update the Trade Point database to improve domestic exporters - international buyers matches; x Transform FASONORM into a specialized standardization and certification institute to improve the national quality system; x Establish a strategy council, at the level of the PM, to coordinate investment and export promotion policies and lead reforms to improve the overall business environment (taxation, governance, infrastructure, sectoral constraints in agriculture, mining and other sectors). x Develop a technical committee for cooperation among various government ministries to ensure coordination with investment and sectoral policies, such as the programs dedicated to the promotion of various agriculture value chains and products (le Projet d’Appui au Développement de l’Agriculture du Burkina Faso, le Projet d’Appui aux Fillières Agro-Sylvo- Pastorale, le Projet d’Appui aux Fillières Agricoles). Investment Promotion x Revamp the investment legislation by: o Eliminating the ex ante investment authorization and replacing it with a simple self- declaration of investment; o Eliminating the “carte de commerçant étranger� and the minimum capital requirement for foreign investment; o Streamlining the Investment Code – in particular, the provisions on capital transfers, investment-state dispute settlement and guarantees against and compensations in case of expropriation. x Transpose and enforce all WAEMU directives, particularly with regard to competition policy and law, tax policy (VAT), mining codes (incentives) and telecommunications; x Streamline tax and customs regimes o Reduce the frequency of tax payments; o Limit fiscal incentives where a cost-benefit analysis predicts economic surplus; o Create transparency and predictability of the tax system. x Set up an investment promotion agency (marketing, start-up facilitation, aftercare services) reporting to the PM, with private sector participation, well coordinated to other agencies ONAC, CCIA, private sector organizations); xxi Sources of Growth: Key Sectors of Tomorrow: Volume II Cotton Sector x Replenish the cotton smoothing fund. x Facilitate equipment ownership among farmers. x Increase the use of organic fertilizer spurred by the extension of manure pit construction throughout the cotton zone. x Accompany loss-making farmers exiting from cotton (training, developing the commercialization and the value chains of alternative crops’ such as rice and maize, investing in land intensification). x Progressively reduce the involvement of the Government in the sector and put more emphasis on its regulatory function. x Bring in a strategic technical and financial partner for SOFITEX, possibly through equity participation, to improve its overall management and strengthen up its financial standing. x To reduce the impact of exchange rate and commodity price volatility, the Cotton ginning companies should: o Institutionalize a trade finance regimen that offsets US Dollar import payments against US Dollar export proceeds prior to currency conversion into CFAF. o Access more systematically the futures markets to announce its producer price. x Access to insurance mechanisms against natural agricultural risks could be done through the establishment of mutual funds, saving and insurance systems, including weather index-based insurance for farmers. Agro-pastoral Productions x Implement the rural land tenure legislation adopted by the Government. x Extend irrigation and improve the rural roads network, especially the ones connecting farms to markets. x Support the adoption of technology packages to increase productivity: improved seeds, fertilizers, and manure. x Computerize and network farmers with local and global markets to improve management and marketing. x For each crop, identify a private operator to play the role of Supply-Chain Leader and assist with inputs provision and technological guidance to farmers. x Implement standardization and promote quality by: o developing processing techniques (shelling, color sorting, etc.); o shifting to a more industrialized treatment process to enlarge production scale beyond raw seeds. x Transform FASONORM to create a specialized standardization and certification institute, driven by the private sector. x Pilot commodity and weather risk-management instruments. The Mining Sector x Revise the 2003 Mining Code and the 1996 Mining Policy Declaration to: o Streamline fiscal measures in the mining sector, particularly through a sliding scale royalty with different schedules for base metals versus precious metals, mine lifetime depreciation, and with a revamp of the process for VAT rebates. o Improve provisions on sustainable local community development, including mandatory tripartite discussions between industrial mining companies, central and local governments, local stakeholders and communities; o Target a share of mining sector revenues to local community development funds; x Consider the creation of a mineral revenue stabilization fund fully compatible with long-term fiscal sustainability goals. xxii x Strengthen capacities of the Direction Générale des Mines (DGM) in light of its ever increasing workload. x Set up an information service—possibly through the Chamber of Commerce—with respect to the goods and services required by the mining companies during construction and exploitation. Endow this service with a registry of Burkinabè companies that provide these types of goods and services. Complement this service by adapting existing training modules at the Maison de l’Entreprise to enhance SMEs’ capacity as sub-contractors to mining companies, with a particular focus on quality issues. x Establish a scholarship program for the development of professionals in the mining sector— with potential funding from the mining companies, donors, and the Government—and facilitate exchanges with other countries. Most effective programs usually are of a cooperative type, where students move back and forth between classroom and on-the-job instruction. x Enhance consultations between mining companies and the Government to better address cooperation opportunities (including through PPPs), particularly for infrastructure development, territorial planning and sustainable community development. The Tourism Sector x Develop a tourism master plan and prioritize the areas for development with clear attribution on the objectives (short and long term), the role for all the stakeholders, the priority poles of development (not more than two target segments), and a clear monitoring and evaluation tool to ensure the strategy is on track. In particular, this strategy will: o Identify new, high potential, specialization niches, taking into account regional initiatives (African fashion fair in Niger, desert festivals in Mali); o Devise appropriate incentives for quality entrants into specialized niches (for instance, building on FESPACO‘s global notoriety); o Undertake value chain analyses to identify and address bottlenecks (visa requirements, administrative processes before and at arrival, promotion and marketing); o Target a minimum number of sites with prime interest for the private sector and further develop the secondary sites once the first batch has produced some satisfactory demonstration effects; o Review the incentives and reporting system particularly in the areas prone to natural resource abuse. Devise a clear control mechanism that enables both public agencies and private operators to verify that their partners’ obligations are effectively and timely implemented. x Revisit the current PPP framework in light of the past experience and set up adequate arrangements that would need to consider alternatively: the role of the public agencies (ONTB, OFINAP, etc.), the private sector (both local and international), local communities (to ensure linkages with the tourism industry and equitable distribution of economic flows in exchange of the access to their land or for conservation initiatives), international donors (for the viable projects requiring greater levels of capital investments) and NGOs (in uneconomical or resource-sensitive areas). x Reform the tourism labor and training market, by reviewing the curriculum of local accredited schools in partnership with established, higher-end hospitality operators. Some of these partners would be willing to participate in industry training of new workers and are best placed to define the industry’s labor needs. xxiii Growth Enhancing Factors: Volume III Coping with Population Growth x Reposition population issues within development strategies, develop a positive public discourse on family planning, and prepare a well-documented component on “Population, Development and Reproductive Health� to be included in the new Strategy for Faster Growth and Sustainable Development for 2011-2015 (SCADD). In particular: o Update the population projections and simulate various objectives for contraceptive prevalence rates, within the overall framework of reproductive rights; o Articulate the objectives and deadlines spelled out in the new «Declaration of the Government on Population and Reproductive Rights» in the National Health Policy, the Reproductive Health Policy, the Strategy of Reproductive Health Products Security, and the Gender Policy – and formulate those with quantitative objectives, using updated population projections; o Fully budget population policies in the new SCADD; o Disseminate a short brochure and a poster to raise awareness among high-level leaders and decision-makers of the criticality of population and reproductive health dynamics; x Enhance the supply-side approach to family planning services to meet pent-up demand for modern contraception. In particular: o Provide a specific item line in the Budget for the purchase and distribution of contraceptive and reproductive health products; o Organize nation-wide information, education, communication and behavior change communication campaigns to help increase the contraceptive prevalence rate by at least 1.5 percentage point per year; o Mobilize development partners to raise funding for contraceptive and reproductive health products in order to reach the objectives of the «Declaration». Public Policies and Market Instruments to Reduce Vulnerability x Incorporate both alleviation and prevention actions as well as ex-ante risk management mechanisms in the new Strategy for Faster Growth and Sustainable Development for 2011- 2015 (SCADD). x Address sustainability, inadequate financing, lack of appropriate institutional infrastructures and lack of coordination between Ministries and among donors to improve the effectiveness of the social safety nets. In particular: o Collect systematically detailed data on beneficiary profiles, costs to improve effectiveness and targeting of existing social safety net programs; o Ensure that safety nets target the poorest households, reduce extreme forms of destitution and food insecurity and provide minimum resources to support human or physical capital. x Cotton ginning companies should: o Develop trade finance capabilities to negotiate and manage the timing of incoming and outgoing payments via letters of credit related to the import and export needs of the cotton sector; o Request an authorization to open USD accounts and net import payments against export proceeds prior to any local currency conversion of proceeds; xxiv o Request an authorization to execute forward currency contracts to hedge their net USD export proceeds in March/April after import orders have been placed for fertilizers against projected export proceeds based on annual cotton production estimates. x The trading companies that are also the shareholders of Burkina’s cotton ginning companies should use the futures market more systematically to facilitate annual hedging of the producer price. In the longer term, this capability can be developed at the local ginning company level. x Local and international banks participating in the cotton financing pool should open a USD credit line against the Euro denominated Smoothing Fund. x Pilot a commercial index-based excess and deficit rainfall insurance product in the cotton sector. x Encourage the use of formal micro insurance, building on the recent expansion of microfinance institutions in Burkina. Closing the Infrastructure Gap to Sustain Growth x Improve spatial planning of infrastructure investments by connecting productions zones to consumption centers. x Adopt a coherent legal framework and set up a PPP unit to enable public-private partnerships for infrastructure investment. Transport Infrastructure x Ensure systematic implementation of domestic and international transport regulations: for instance, enforce existing legislation on axle load restriction by more systematically weighing and sanctioning when necessary to protect roads from early degradations. x Deregulate the trucking industry and address potential cartel practices. x Improve financial sustainability of the road fund for maintenance and rehabilitation. x Use ASYCUDA++ for online customs declarations to facilitate transit and reduce delays. x Upgrade commercial vehicle fleets through PPPs and train transport professionals to improve the quality of road transport services. x Rehabilitate railway transportation by revising the existing concession agreement between the government (financier of the railway tracks) and the concessionaire (to invest in the rolling stock). Energy Infrastructure x Accelerate connections to electricity grids under the West African Power Pool, in particular those between Burkina – Ghana, Burkina-Ghana-Mali and Burkina-Nigeria-Niger-Benin. x Strengthen capacity of the Fonds du Développement de l’Electrification (FDE) to expand electricity access in the rural and peri-urban areas. x The electricity regulator (Autorité de Régulation du Secteur de l’Electricité or ARSE) should be fully operational (staffing, budget) to meet its purpose. x Design a tariff indexing mechanisms for SONABEL that is financially sustainable once fuel subsidies have been phased out. x For other electricity operators in areas not covered by SONABEL, output-based subsidies should be provided to reduce tariffs gap in rural areas. Telecommunication Infrastructure xxv x Improve access to the submarine SAT-3 cable to facilitate access to ICT services at reasonable prices. Irrigation Infrastructure x Support the development of agriculture value chains through irrigation investments: o Focus first on a few selective growth poles to facilitate market access and maximize productive externalities and cross-sectoral linkages. Improve the coordination among irrigation projects and instruments at the national and local levels. o Extend private sector participation in the development of irrigation systems through demand-driven initiatives, adequate financial instruments (land lease agreements) and support for technological development (asset management, system design). x Focus on maintenance cost recovery and private delivery/operation services to improve long- term sustainability of irrigation infrastructure. Improving Financial Intermediation x Extend the range of financial products offered. Banks and microfinance institutions (MFIs) should develop new lending techniques and cover new market segments (move, respectively, downscale and upscale). x Increase access to a diversified system of guarantees such as endorsements, pledges, stock collateral, and leasing and allow the acceptance of such guarantees by the supervisor as collateral. x Increase access to information by lowering the thresholds for reporting information on borrowers to the credit registry to allow information on SMEs to be collected and shared with lenders. x Diversify risks, products, and partnerships to increase access to finance in rural and agricultural areas. There are various strategies in this respect, including actions to: o Develop a reliable system of warehouse receipts, which will be based primarily on warehouse infrastructure, a system of product inspection, insurance, verification, and classification, or a disaster-relief fund; o Develop new products and partnerships by: (i) facilitating partnerships between banks and MFIs, ranging from the simple line of credit to the syndication of larger loans to serving as an agent for the distribution of various services, including insurance and the transfer of funds; (ii) providing greater access to financing for agricultural equipment, especially through increased access to leasing; and (iii) expanding the pilot program on mobile banking, based on the success achieved in Kenya and in South Africa, in partnership with the institutions present in the rural areas, such as SONAPOST, RCPB, and the mobile telephone companies. x Review and remove regulatory aspects that constrain financial deepening including (i) the revision of interest rate ceiling; and (ii) the review of fiscal, legal, and prudential constraints on the development of leasing. Establish regulations that facilitate access to financing, in particular by raising or eliminating the ceiling on lending rates to encourage improved credit risk pricing. x SMEs should improve their financial management, and their access to markets and technology. The banks should set up departments dedicated to SMEs. x Cotton companies should build-up their risk management functions and, in particular, transfer some of their risk offshore or share it in a wider pool. xxvi Policy Options for Fiscal Space x Consider a long term approach to increasing fiscal space. There are different ways to increase fiscal space among which generating additional revenue through changes in tax policy, reallocating from lower to higher priorities, and setting up public-private partnerships. It is necessary to consider the long term impact of additional expenditure, not only whether space is available in the annual budget. x Expand fiscal space through good governance. Reducing corruption can help reduce unproductive spending, as well as moving toward a results-oriented budget to help strengthen accountability and the effectiveness of programs and/ or strengthening public financial management systems to ensure that resources reach intended users. x Encourage government policies that foster significant improvements in the efficiency through which the private sector enhance its resources. Such policies may have the impact of facilitating higher and more effective spending. xxvii VOLUME 1. PROMOTING COMPETITIVENESS AND EXPORT DIVERSIFICATION GROWTH AND COMPETITIVENESS The Last Two Decades 1.1 Burkina Faso’s growth performance has been robust but uneven in the aftermath of the 1994 devaluation. During 1960-1993, the real GDP growth rate averaged 3 percent per year. By contrast, during 1994-2008 the real GDP growth rate reached an average of 6 percent per year (Figure 1-1). However, due to swings in the agricultural production and to the economy’s vulnerability to external shocks, recent growth has been uneven. The GDP growth rate was 5.5 percent in 2006, exceeding the average rate of 3.9 percent in the WAEMU. It dropped to 3.6 percent in 2007, primarily due to rising food and oil prices. Then it rose to 5.2 percent in 2008, mainly due to a good agricultural season and the impact of a series of government stimulus measures implemented during 2007-2008 (Figure 1-1). GDP per capita (constant US$2,000) has also increased steadily, from around US$214 in 1995 to US$260 in 2007(or US$430 in real terms in 2007) (ADI, 2007 and WDI, 2008). Nevertheless, it remains relatively low – representing only half of the average GDP per capita in Sub-Saharan Africa (Figure 1-2). 1.2 Structural reforms, domestic consumption and steady investment growth fueled the aforementioned growth performance. Reforms supporting private sector development, price and trade liberalization, the privatization of public enterprises and the improvement of the investment regime have helped sustain growth since the mid-1990s. In addition, a significant inflow of foreign aid enabled financing in several key sectors, such as construction. In 2009, growth was mainly driven by exports of goods and services and consumption. Consumption absorbed most of the GDP from 1990-2008, but it declined slightly from 94.6 percent in 1990 to 90 percent in 2008. This was the result of a drop in private consumption, which was generated by the upward spiral in food prices in 2007-2008. By contrast, public consumption has regularly absorbed around one-fifth of the GDP from 1990-2008 and shrank only slightly compared to private consumption in 2008 (1.8 percent decrease compared to a 10.2 percent drop in private consumption) (Ministry of Economy and Finance, 2009). In 2009, consumption is expected to grow by 2.7 percent, mainly driven by public consumption (2.1 percent compared to 0.6 percent for private consumption). The investment rate has fluctuated since 1990, but overall it has risen – from 17.7 percent of the GDP in 1990 to 19.9 percent in 2008. Private investment has also risen – it was 9.7 percent of the GDP in 1990, and 14.7 percent in 2008 (Ministry of Economy and Finance, 2009). However, the inclusion of quasi-public companies such as SONABEL, SONABHY and SONAPOST in this category may have distorted the real private sector dynamic (Table 1-1). The relatively high level of investment is not mirrored by similar growth rates – indicating low investment efficiency. The low capital productivity reflects structural bottlenecks related to a still unattractive business environment and high factor costs. 1 Figure 1-1: Average Annual GDP Growth Rate (%) (1960 – 2008) 10 Average annual growth rate 1960-1993 Average annual growth rate 1994 - 2008 8 6 4 2 0 -2 GDP (constant LCU) Source: World Bank, WDI 2008 Figure 1-2: GDP Per Capita in Burkina Faso during 1985 – 2007 (constant 2000 US$) 600 47 500 45 400 43 300 41 200 39 100 37 0 35 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Burkina (left, in 2000 US$) SSA (left, in 2000 US $) Burkina as share of SSA ( right, in %) Source: ADI, 2007 and World Bank, WDI 2008. 1.3 Domestic savings have remained too low to finance new investment. The domestic savings rate is low compared to the investment rate – from 1990-2000, it only grew from 5 percent to 6.5 percent, and was estimated at around 5.1 percent during 2007-2009. Consequently, Burkina depends upon external sources to be able to undertake public investment, with around 60 percent of public sector investment being financed by foreign aid. 2 Table 1-1: Consumption and Investment, % of GDP 1990 1995 2000 2005 2006 2007 2008 Total consumption 94.6 88.5 97.7 99.4 99.8 99.0 90.1 Private consumption 73.5 63.3 76.9 77.3 76.9 76.2 69.7 Public consumption 21.1 25.2 20.8 22.1 22.9 22.9 20.4 Total investment 17.7 22.5 19.2 14.3 16.9 20.9 19.9 Private investment 9.7 10.4 7.7 8.0 10.1 15.2 14.7 Public investment 7.8 11.9 10.9 6.3 6.8 5.7 5.3 Source: IAP, Ministry of Economy and Finance, 2009. 1.4 Efficiency gains in the use of resources have been made, but they are insufficient. Among the factors that determine growth and competitiveness – human capital, physical capital, total factor productivity, etc. – capital deepening2 has been the main contributor toward increasing productivity. This is shown clearly in Table 1-2.3 More important than the quantity is the quality of factors that pushes the production frontier and potential growth. The contribution of human capital accumulation has been positive but less substantial than capital deepening. In the 2000s, the productivity growth has decelerated because the growth of capital per worker and total factor productivity (TFP) has decelerated. This may have been associated with a deceleration of investment, including a decrease of marginal return to investment. Table 1-2: Factor Contribution to Productivity Growth (in %) Output per unit of Capital per unit of Human capital per labor force labor force unit of labor force TFP 1960-1979 1.7 7.4 0 -1.2 1980-1993 1.5 4.7 0.1 -0.4 1994-1999 4.7 3.3 0.2 2.7 2000-2006 3.3 2.1 1.7 1.7 1994-2006 3.8 2.5 0.9 2.1 Source: Authors’ calculations. 1.5 Primary and tertiary sectors fueled most of the growth in the 2000s. The primary and tertiary sectors’ contribution to GDP have been relatively stable since the 1990s, attaining an average of 32 percent and 46 percent of GDP, respectively, from 1990-2008 (Table 1-3). The secondary sector’s contribution has progressively increased since the 2000s, reaching 24 percent in 2008 (Ministry of Economy and Finance, 2009). The secondary sector growth has been driven by mining (gold, marble, and antimony), electricity, constructions and trade, which has a significant informal component (Figure 1-3). According to the IMF data, in 1994-2008 the average real GDP growth rate was 8.7 percent in the secondary sector, 7.4 percent in the tertiary 2 Capital deepening is defined as the growth of capital per worker. 3 The relationship between labor, physical capital, human capital and technology improvements (proxied by the Į 1 Į TFP) is estimated based on a Cobb-Douglas production function with constant returns to scale: Y AK (Lh) , where Y is the output, K is the stock of capital, L is labor force, h is the stock of human capital per unit of labor force (Lh is usually labeled as “effective labor�), and A is the TFP. The output elasticity of physical capital ( D ) and effective labor ( 1  D ) are assumed to be equal to 0.4 and 0.6, respectively. 3 sector, and 5.9 percent in the primary sector. Since 1994, growth of the primary sector4 has been volatile due to overdependence on cotton. The expansion of the tertiary sector has been propelled by transport, telecommunications and financial services. The decrease in the contribution of the primary sector and the predominance of the tertiary sector are not necessarily indicators of the expected economic transformation outside agriculture, but rather signs of low productivity in both primary and secondary sectors. Table 1-3: Sectoral Contribution to GDP (%) 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007 2008 Primary sector 27.6 34.6 33.4 34.5 33.6 33.7 31.6 32.8 31.5 29.3 30.8 Secondary sector 22.1 20.0 21.4 19.8 22.2 22.5 22.9 22.6 22.7 23.8 24.2 Tertiary sector 50.3 45.4 45.2 45.8 44.2 43.8 45.5 44.6 45.8 46.9 45.1 Source: Ministry of Economy and Finance, 2009. Figure 1-3: Average Real GDP Growth Rates by Sector (%), 1994-2008 16 14 12 10 8 1994-2008 6 4 2 0 Agriculture gas, and water Manufacturing Mining Financial Trade Other Livestock Construction Transport services Electricity, and telecom services Source: IMF, 2009. 1.6 Exports and imports. Burkina’s exports increased five-fold from 1990-2008. The main export destinations in 2005, as illustrated by UNCOMTRADE data, were: China (52 percent), Thailand (8 percent), Taiwan, China (6 percent), Niger and France (3 percent each).5 Overall, exports have had a limited contribution to Burkina’s growth, accounting for approximately 8-10 percent of GDP during 1980 - 2008. Cotton has progressively become the dominant export merchandise. Cotton accounted for 31 percent of exports in 1990, rose to 59 percent in 2001, and 4 Agriculture absorbs most employment - around 85 percent of the working age population. Outside of agriculture, 11 percent of the working age population is employed in the informal sector and 4 percent in the formal one. The government is the largest formal employer, despite emerging private sector firms in the service sector. 5 2005 is the most recent year for which data is available in the UNCOMTRADE database. The export shares are compiled based on mirror data. Mirror data represent the values reported by the partner countries that import goods from Burkina Faso. 4 then dropped to 36 percent in 2008. The second largest exports are livestock and leather hides, contributing an estimated 12 percent of foreign earnings. The share of imports in GDP was substantially higher, but decreased from more than 30 percent in 1980 to 22 percent in 2005. During the past ten years, it was approximately 21 to 25 percent of GDP. According to the UNCOMTRADE data, the main imports (foodstuffs, fuel, energy, capital goods) came from France (26 percent), Côte d’Ivoire (25 percent) and Togo (7 percent) in 2005.6 The country’s trade openness – defined as the sum of exports and imports to GDP – has progressively decreased, from 40 percent in 1980 to 30 percent in 2003. This indicates a persistent lack of exposure to and competitiveness in international markets, with potential negative effects on long- term growth. The terms of trade7 also deteriorated from 1990-2000, but progressively recovered from 2000-2003 (Table 1-4; ADI, 2007). Nevertheless, the existing trade deficits are not necessarily the result of international price volatility, but rather suggest structural deficiencies (Savadogo, 2009a). Table 1-4: Evolution of Exports and Imports, 1980-2005 Terms of trade Years Export, % of GDP Import, % of GDP (2000=100) Burkina Faso 1980 9.0 31.3 65.5 1990 11.3 24.3 119.2 2000 9.1 25.3 100.0 2005* 8.5 21.9 132.1 Source: ADI, 2007; 2003 data for exports as a % of GDP. 1.7 Burkina Faso’s external balance highlights dependence on external public and private financial flows. Private flows in form of workers’ remittances decreased from 3 percent of GDP in 1990 to 1.3 percent in 2006. Similarly, concessional public flows meant to support the country’s budget decreased from 3 percent of GDP in 1998 to around 2 percent in the 2000s. The recent mining activities have attracted increasing foreign direct investment flows, which rose from around CFAF 0.3 billion in 1990 to CFAF 17 billion in 2006 (Ministry of Economy and Finance, 2009). However, the average foreign investment ratio to GDP in 1994-2006 was 0.5 percent, which is lower than the average in Sub-Saharan Africa – which was 2.5 percent (Figure 1-4; DDP, 2008). As a precautionary measure, Burkina has used concessional loans rather than other short-term lending instruments. This has shielded the country against major debt crises, but, in turn, compressed the resources available for investment and growth. 1.8 Credit to the private sector remains low. It represented an average of 14 percent of GDP from 2004-2007, despite an annual average increase of 15 percent per year during the same period. This increase in credit to the private sector parallels an increase in private investment. However, the low levels of credit to the private sector indicate a lack of financial sector depth. In particular, the M2 to GDP ratio has risen slowly – from 18 percent in 1990, to 25 percent in 2008 (IMF, 2008; and Ministry of Economy and Finance, 2009). 6 2005 is the most recent year for which data is available in the UNCOMTRADE database. The export shares are compiled based on mirror data. Mirror data represent the values reported by the partner countries that export goods to Burkina Faso. 7 Defined as the relative price of exports to the relative price of imports. 5 1.9 The reduction in the external debt has not been the result of better export performance. The external debt to GDP skyrocketed from 24.7 percent in 1990 to 56 percent in 1995 and 57 percent in 2000. The Heavily Indebted Poor Countries (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI), which was initiated at the beginning of the 2000s, has progressively helped reduce the external debt stock. The latter has been around 20 percent of GDP since 2006. The debt service has concomitantly decreased from 13 percent of exports in 1990 to 4 percent in 2008 (Ministry of Economy and Finance, IAP 2009), mostly as a result of the HIPC Initiative and the MDRI and not because of better export performance. Figure 1-4: Foreign Direct Investment, Net Inflows as a % of GDP (1994-2006) 5.00 4.50 4.00 3.50 3.00 Burkina Faso 2.50 SSA Average 2.00 1.50 1.00 0.50 0.00 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: World Bank DDP, 2008. 1.10 The Burkinabè economy faces several challenges and risks, notably growth volatility, and vulnerability to exogenous shocks. Growth vulnerability stems mainly from the economy’s dependence on a few commodities (cotton, gold) and external concessional flows. The dominance of cotton production creates the following vulnerabilities, underlined recently by: (i) a fall in international cotton prices due to competition of synthetic fibers or falling demand as a result of the financial crisis; (ii) the decrease in domestic production from its 2006/2007 peak due to a recent decrease in cultivated areas; (iii) poor factor productivity – Burkina’s is two times lower than that of Egypt (Savadogo and Mangenot, 2009); (iv) the failure of cotton companies to adapt to the changing conditions in the international markets. The country’s vulnerability is further reinforced by significant foreign aid flows, which support 80 percent of public investment in agriculture. 1.11 Another challenge stems from the limited impact that growth has had on poverty reduction in rural areas. Even though the growth rate per capita has been consistently 2-3 percent of GDP since 2000, poverty has not diminished accordingly and mostly affects rural areas. Official poverty estimates8 suggest that from 1994–2003, the poverty headcount index stagnated at a high level of roughly 45 percent. This indicates that the growth-elasticity of 8 Based on household survey data from 1994, 1998 and 2003. 6 poverty was almost zero. Inequality did not diminish over the period – the Gini coefficient was as high as 0.46 in 2003 (Table 1-5). Overall, the share of population in poverty fell from 46.4 percent in 2003 to 38.5 percent in 2007, which represents a decrease of 7.9 percent at the national level (Table 1-6).9 The share of population living in poverty is still significantly higher in rural areas than in urban areas (43.9 percent in rural areas, compared to 13 percent in urban areas in 2007). The deceleration in economic growth in 2007/2008 – along with rising fuel and food prices – resulted in an increase in poverty of 0.5 percent in 2007 and 4 percent in 2008 (World Bank, 2009a). Additionally, in 2007 the depth of poverty increased by 0.2 percent and the severity of poverty increased by 0.3 percent. This suggests that the minimum amount necessary for the poor to make up the resource gap compared to the poverty line has increased. This is explained by: (i) a drop in incomes in the cotton sector; (ii) damage due to flooding; (iii) cereal deficits in some provinces; and (iv) a rise in energy and food prices. Table 1-5: Inequality Urban Rural National 1994 1998 2003 1994 1998 2003 1994 1998 2003 Gini 0.45 0.51 0.49 0.38 0.37 0.39 0.46 0.46 0.46 Index Source: INDS. Table 1-6: Poverty Incidence Population in poverty (percent) National 2003 46.4 2005 40.4 2007 38.5 Change in% (2003-2007) -7.9 Urban 2003 19.9 2005 16.3 2007 13.0 Change in % (2003-2007) -6.9 Rural 2003 52.3 2005 45.6 2007 43.9 Change in% (2003-2007) -8.4 Source: Wodon and Nouvé, based on EPCV 2003, 2005, and 2007. 9 The 2005 and 2007 household surveys do not include a monetary measure of the households’ standard of living. Poverty evolution was measured taking into account both the assets or households’ wealth and the perception households have of their own well-being. 7 1.12 Unemployment10 in Burkina is essentially an urban phenomenon, mostly affecting women, youth and educated individuals. The unemployment rate is 8.6 percent in the urban areas compared to only 2.2 percent in the rural area in 2007, representing, nevertheless, a decrease from 11.5 percent in 2003. For example, the unemployment rate for women was 11.6 percent compared to 6.2 percent for male. Urban unemployment among youth (15-24 years old) has fallen since 2000s, but that trend reversed between 2005-2007.14.4 percent of youth between 15-24 years old and 9.6 percent of youth between 25-35 years old were unemployed in 2007. Unemployment is even more problematic for young women (16.7 percent for 15-24 years old and 15.1 percent for 25-35 years in 2007). Additionally, unemployment rates were non- negligible for the active population that finished secondary education (12.2 percent), and vocational training (12-17 percent). 1.13 In the context of a significant informal sector, the quality of jobs does not seem to have improved over time. The informal sector absorbs 47 percent of the active population in the urban areas, mostly including women (61 percent for the women between 15-24 years old and 56.3 percent for the women between 25-35 years old). Although the informal sector is an important source of job creation, the quality of such jobs is typically lower, because of the lower wages and the lack of social protection. An analysis based on four indicators (the rate of poor workers, the rate of uncovered wage earners, the rate of vulnerable employment and the rate of precarious jobs) indicates that most of the jobs are precarious in Burkina. The rate of precarious jobs dropped from 42.4 percent in 1998 to 32 percent in 2003, but the country-level rate of vulnerable employment was as high as 93.4 percent. Moreover, the rate of wage earners which were not covered by social security was estimated at 43.4 percent in 2007. Despite a decrease from 38 percent in 1998, underemployment11 attained around 25 percent of the active population in 2007. These indicators suggest that the job quality has not significantly improved in the past ten years, which might have also reinforced existing poverty levels. Macroeconomic Performance and the Global Economic Downturn 1.14 The current downturn of the global economy raises new developmental challenges for Burkina Faso. Addressing the current global economic downturn requires well-tailored policy responses. Global industrial production declined by 20 percent in the fourth quarter of 2008. This decline was caused by a contraction in activity of 23 percent in high-income countries and 15 percent in developing countries. Global GDP is also expected to decline by at least 5 percent in 2009. The developing countries face deteriorating financial conditions, which translate into an estimated financing gap of US$270-700 billion (World Bank, 2009c). The challenge for a low-income country like Burkina is to manage, with fewer resources, policies that cushion the effects of economic volatility and protect or expand critical expenditure – in particular, expenditure on social safety nets, human development and infrastructure. 10 Unemployment rate is defined as the share of unemployed individuals in the total active population. According to the ILO definition, unemployment includes individuals between 15-65 years old, who do not have a job, are actively seeking one and are available to be hired with 15 days. 11 Underemployment is defined as the underutilized active population. It includes visible and invisible underemployment. Visible underemployment corresponds to an employment time which is below the standard time (i.e., 9 months/year in Burkina). Invisible underemployment corresponds to an activity which pays a lower wage compared to the employee’s expectations, productivity or education. 8 1.15 Burkina shares similar concerns with other African countries with regard to: (i) the impact of financing constraints; (ii) lower commodity prices; (iii) weak external demand; and (iv) associated spillovers to domestic demand on economic growth. The IMF’s World Economic Outlook forecasts a GDP growth rate for Africa of 3.5 percent. This is 1.6 percentage points lower than the previous forecast, and 1.9 percentage points below the 2008 growth rate. The direct effects of the global financial and economic crisis are likely to be much more limited in Africa than in other regions, because African economies are less integrated into the international financial system and rely less on international capital and bond markets to finance investment. For Africa, the weaker external demand and lower commodity prices will be the main transmission mechanism. With the tightening of credit conditions, foreign direct investment is expected to decline – especially in mining and oil (see Section 2 on mining). Moreover, the official aid may be squeezed by reduced fiscal space in donor countries as they tackle financial crises at home. 1.16 Economic activity in Burkina slowed down in 2009, as a result of the global food, economic and financial crisis as well as the severe flooding in September 2009. Burkina has been strongly impacted by the decline in cotton prices, which puts additional pressure on its external account and government finances. IMF estimates indicate that the real GDP growth in 2009 would be 3.1 percent. That is over 2 percentage points less than pre-crisis projections. Growth projections for 2010 have been revised from 6.0 percent to 4.2 percent. Furthermore, the flooding made the living conditions of many households precarious, with direct consequences on poverty. It was estimated that the food and energy crisis of 2008 aggravated the incidence of poverty, which rose from 38.5 percent in 2007 to around 42.8 percent in 2008.12 1.17 The food and fuel crises and the euro appreciation created inflationary pressures on the economy, but recent developments may have eased those pressures. Inflation has been kept under control – it was 2.4 percent in 2006, and -0.2 percent in 2007. Nevertheless, in the context of the rising food and international oil prices in 2007, annual inflation attained 10.7 percent in 2008, but stood at 5.3 percent (average 12-month inflation rate) in September 2009. It is expected to have further declined by the end-2009 at around 2.6 percent (IMF, 2009e), as a result of a good harvest and lower international food and oil prices in 2008. Although the real effective exchange rate appreciated in 2008, the recent euro depreciation may temporarily reduce pressures on competitiveness (World Bank, 2009a). However, non-price factors, such as the business climate, may continue to weigh on the country’s competitiveness, underlining the need for structural reforms. Table 1-7: Key Macroeconomic Indicators, 2006 – 2009 2006 2007 2008 2009* Real GDP growth ( percent annual change) 5.5 3.6 5.2 3.1 Consumer price inflation ( percent change, annual average) 2.4 -0.3 10.7 2.6 Overall fiscal balance (cash basis, incl. grants, percent of GDP) 16.7 -5.2 -4.4 -6.6 Terms of trade ( annual percent change) -3.3 -1.2 -3.2 17.8 Direct investment (CFAF bn) 17.0 164.5 36.5 16 Workers’ remittances (CFAF bn) 31.7 -0.5 0.2 2.9 Net official transfers (CFAF bn) 91.3 138.3 126.3 180.6 Current account balance including official transfers (percent of -9.6 -8.3 -11.8 -8.7 12 2008 data is based on simulations with PAMS. 9 GDP) Net foreign reserves (months of imports covered) 3.8 6.8 5.4 5.8 GDP at current prices (CFAF bn) 3,017.7 3,239.4 3,647.9 3,809 Source: Burkinabè Authorities and IMF staff estimates, 2010; *projection. 1.18 The food and oil price shock underlines the urgency to raise agricultural productivity and identify income-enhancing products outside traditional cotton production. If there is a continuing decline in the global growth and the price of cotton, it will affect the profitability of ginning companies and dampen economic performance. As international oil prices dropped, the Burkinabè authorities lowered pump prices at the end of 2008. Nevertheless, they are still 8 percent above the level mandated by the automatic price mechanism. Moreover, domestic food prices remain high despite the fact that international food prices have fallen – they have dropped by only 5 percent since the beginning of 2009 (IMF, 2009d). This suggests that increasing agriculture productivity and diversifying agricultural production outside of cotton would help reduce Burkina’s vulnerability to exogenous shocks (see Section 1 on opportunities for income-enhancing diversification and Section 2 on agriculture). 1.19 Burkina has been pursuing a prudent fiscal policy, despite: (i) low levels of revenue mobilization (around 13 percent of GDP); (ii) dependence on trade taxation; (iii) fiscal liabilities from the cotton sector. In the past two years, the overall fiscal deficit averaged 4.6 percent of GDP, which was mainly financed by external loans and grants. In late 2007, the Government introduced temporary suspensions of customs duties and VAT for certain basic products, in order to ease the pressure from high international food prices. Improvements in tax administration through the creation of a tax policy unit and the adoption of a tax policy strategy have lessened the need for these temporary measures, which are currently being phased out and were estimated to have reached 0.1 percent of GDP. However, annual subsidies to the cotton sector and the recapitalization of cotton companies in 2007 have created a significant burden on public finances (World Bank, 2009a). 1.20 However, fiscal performance was mixed in the first half of 2009. The overall budget deficit (excluding grants) stood at 3.8 percent of GDP through June 2009, compared to a programmed full-year deficit of 5.1 percent,13 as a result of higher current expenditure (27 percent of GDP in the 2009 supplementary budget compared to 21 percent in 2008) and lower tax revenues as a result of the economic slowdown. The need to address the impact of exogenous shocks shaped the fiscal policy in 2009, which includes, among others, emergency and humanitarian spending linked to the flooding, higher subsidies to cotton farmers to lessen the impact of costly import fertilizers and recapitalization of SOFITEX, support to vulnerable groups through cash transfers and a salary increase as a result of the global crises in 2008 (IMF, 2009e). Creating fiscal space and considering a countercyclical fiscal policy would help address poverty needs and maintain growth sustainability (see Section 3 on fiscal space). However, in the context of existing financing and capacity constraints, the initial ambitious fiscal stimulus measures required a review and prioritization of expenditure, which help reduce the budget deficit. Going forward, although the fiscal policy would be geared to support economic recovery, the 13 According to the latest IMF estimates, the overall fiscal deficit (cash basis, including grants) is expected to reach 7.3 percent of GDP in 2009. 10 implementation of public financial management reforms, tax policy reforms and tax administration measures are also expected to contribute to reducing the overall fiscal deficit. 1.21 Burkina continues to face a high risk of debt distress. The 2009 joint IMF/World Bank Debt Sustainability Analysis (DSA) classified Burkina as being at high risk of debt distress, because the threshold for the NPV of debt-to-exports ratio is breached in the medium- term. Burkina’s NPV of debt-to-exports ratio – which was estimated at 116.7 in 2008 and projected to be 117.6 in 2009. Other debt indicators were below their policy-dependent thresholds, and the rate of external debt accumulation was projected to remain manageable. Nevertheless, the debt outlook seems to be vulnerable to persistent large fiscal deficits. Implementing a prudent fiscal policy, limiting external borrowing to concessional loans and grants to finance infrastructure projects and pursuing a prudent expenditure policy would lower the risk of debt distress. Although the increase in domestic and external financing to cope with the impact of exogenous shocks in 2009 does not deteriorate significantly the debt indicators, the main risk factor for the debt sustainability outlook is the low export base and the dependence on unprocessed cotton exports. Box 1-1: Policy Challenges for Developing Countries in Responding to the Global Economic Crisis In responding to the global economic crisis, developing and emerging market countries will face several different challenges. In a context of rising needs and scarce resources, policymakers face challenges regarding the setting of spending priorities and maximizing the development impact of their spending. The risk-distressed countries are particularly exposed, because their resource constraints are greatest. The main challenges stemming from the global economic crisis are: x Stabilization: Because the crisis threatens growth, employment and balance of payments stability – even in the countries with solid macroeconomic management – the pressures on the fiscal and external positions are even higher. The challenge for policymakers is to assess their ability to undertake countercyclical policies, given the resources available to them as well as their institutional and administrative capacity to expand and adapt existing programs. x Protection of longer-term growth and development: Neglecting core development spending can have large costs in the long run, as was shown during the Asian crisis. Responding to immediate fiscal pressures by putting off existing infrastructure needs can lead to costly rehabilitation over the longer term and hold back economic recovery. Similarly, reducing public spending on human capital development – such as basic education – can have negative effects on skill accumulation and private sector development. x Protection of vulnerable population: Declining growth rates and high levels of initial poverty mean that many households in developing countries are more vulnerable to the crisis. The World Bank estimates that 94 out of 116 developing countries have experienced decelerating growth – 43 of those countries experience high levels of poverty. This implies new spending needs, and may warrant a re-prioritization of existing public spending. Countries that have established or improved the efficiency of the social safety net during the food and fuel crisis can utilize these channels to protect the poorest and most vulnerable. The ability of Government to cope with the fallout, to finance programs that create jobs, to ensure delivery of core services, and to provide safety nets is critical to protecting households in exposed countries. However, given the scarcity of resources, the challenge remains to continue to improve the targeting and effectiveness of social support. Source: World Bank, 2009c, “Swimming against the tide: How developing countries are coping with the global crisis�. 11 1.22 The overt reliance on cotton widened Burkina’s exposure to the effects of the global crisis. Falling cotton exports in 2007 – which were only partly offset by gold exports – coupled with imports of expensive food and energy products, led to the widening of the current account deficit (including grants) from 8.3 percent of GDP in 2007 to almost 12 percent in 2008 (IMF, 2009a and e). Estimates for 2009 indicate an improvement supported by the decline in oil prices and a significant rise in gold exports, which would lead to a decline in the current account deficit to around 9 percent of GDP. The high cotton price volatility coupled with lower productivity underlines the need to reform the cotton sector and to promote private sector development in other areas. The increase in the percentage of nonperforming loans suggests the need to strengthen the financial sector, in order to make it more resistant to shocks (see Section 3 on financial intermediation). Moreover, the existing price risk management mechanism – the cotton smoothing fund – has proven to be insufficient to mitigate the drop in the international cotton price. Restructuring SOFITEX and the recapitalization of two ginning companies by end-2009 are other significant challenges in the context of declining global prices and demand for cotton (see Section 2 on cotton). 1.23 Burkina Faso’s economic outlook in the short- and medium-term is promising. Domestic factors have historically been the main growth drivers in Burkina Faso. Therefore, a rebound in cotton production supported by a good harvest is expected to boost GDP growth. The operations of several gold mines may also support growth, including credit growth. In addition, agricultural production is expected to remain robust, and activity in the service sector should benefit from the anticipated rebound in the cotton sector. Lower international oil and food prices may also ease inflationary pressures. In the medium-term, growth would return to historical trends of around 6 percent, as higher investment in infrastructure, a recovery in credit to private sector, an expansion in the mining sector, and the rebound in the cotton sector would support recovery and contribute to the stabilization of terms of trade. Burkina’s Performance vis-à-vis Comparator Countries 1.24 Burkina Faso’s gains in per capita income have been significant relative to its low income comparators from Sub-Saharan Africa. With the exception of copper-dependent Zambia, Burkina has outperformed other landlocked countries – including coffee and cotton- dependent Uganda, coffee-dependent Rwanda and Burundi, and tobacco-dependent Malawi. Among Sub-Saharan African cotton exporters per se, only Benin and Mali grew richer faster than Burkina Faso (Table 1-8). In the near future, large revenues from metals exports will decrease the relative weight of cotton exports and lead to significant diversification. However, the discovery of metals poses the risk that Burkina Faso could go down the Rwandan or Ghanaian paths of development. The combination of metals and primary commodity dependence – coffee in Rwanda and cocoa in Ghana – became confounded with problems typical of a natural resource abundance economy and stymied the prospects for faster growth in the longer-term. 1.25 Compared to countries outside Sub-Saharan Africa, Burkina Faso’s economic performance is less impressive. Examples include landlocked countries such as Paraguay, Bolivia and Mongolia, which have been successful in accelerating growth and graduating to middle income economies (Table 1-8). The performance of some other landlocked countries – 12 such as Lao PDR, the Kyrgyz Republic, Nepal and Uzbekistan – suggests that in general, landlocked countries are disadvantaged relative to their coastal counterparts. It appears that being a primary product exporter is less of a disadvantage in countries outside Sub-Saharan Africa, as evidenced from the increase in per capita income levels in Nicaragua, Sri Lanka, Cambodia and Guatemala (Table 1-9). 1.26 In Burkina Faso, the share of exports in GDP was about 11 percent, and remained virtually unchanged from 1980-2007. This is lower than Lao PDR (32 percent in 2005-2007) or the Kyrgyz Republic (39 percent in 2005-2007). In Lao PDR and the Kyrgyz Republic, exports were the only channel of growth, because the small size and low purchasing power of their domestic markets constrained demand (Box 1-2). Even in several of Burkina’s Sub-Saharan African comparators – such as Mali or Senegal – the share of exports in GDP was at least twice as high. The increase in the trend for lower middle-income countries from 11 percent in the 1970s to 36 percent in 2007 indicates that becoming richer will be difficult for Burkina unless it increases the role of exports. This is confirmed by the cross-country econometric analysis in which Wood and Mayer (2001) recommend that the highest priority for unprocessed primary product exporters in Africa is to increase the absolute level of exports in all sectors. 1.27 Like many other African countries, Burkina Faso has diversified little from low- value uncarded cotton exports (Appendix 2). Over a period of twenty years, the share of cotton exports has more than doubled in Burkina Faso, Benin, Mali and Uganda – and the dominance of other unprocessed agricultural products has persisted. However, in Uganda, diversification toward emerging sophisticated export industries – such as fish (frozen and fillet), cut flowers, fresh vegetables and fruits – is occurring rapidly. Since these low weight/ high value industries are less constrained by the fact that Uganda is landlocked, they are more conducive to faster and inclusive growth-enhancing diversification. 13 Table 1-8: Trends in Per Capita Gross National Income in Burkina Faso and Comparators (current PPP US$) -69 -79 -89 -99 -03 62 70 80 91 00 04 05 06 07 19 19 19 19 20 20 20 20 20 Burkina Faso 86 148 270 269 250 340 400 420 430 Landlocked (LL), cotton Nepal 65 99 165 205 232.5 270 300 320 340 LL, leather, beans Lao PDR 378 302 320 420 450 500 580 LL, coffee, wood Kyrgyz Republic 388 298 400 450 500 590 LL, cotton, gold, tobacco Uzbekistan 605 515 460 530 610 730 Landlocked Turkmenistan 850 686 650 LL, nuts, tobacco, cotton Mongolia 1474 579 475 690 810 1000 1290 LL, wool, wood,minerals Bolivia 490 851 867 953 960 1020 1110 1260 LL, petroleum, tin Paraguay 1569 1185 1080 1230 1410 1670 LL,cotton, soya beans, wood Cambodia 286 305 380 440 490 540 Sya beans, wood, rubber Senegal 250 366 548 591 485 640 740 760 820 Groundnuts, seafood,min. Nicaragua 224 484 670 467 738 820 890 930 980 Coffee, cotton, bananas Sri Lanka 154 234 371 664 875 1070 1200 1350 1540 Tea, rubber Guatemala 294 611 1101 1328 1700 1930 2080 2250 2440 Cotton, coffee, sugar Burkina Faso 86 148 270 269 250 340 400 420 430 Landlocked, cotton Burundi 63 109 231 165 100 90 90 100 110 Landlocked, coffee Malawi 58 116 168 186 155 220 220 230 250 Landlocked, tobacco Rwanda 44 112 284 274 218 210 250 280 320 Landlocked, coffee Uganda 283 243 240 250 270 300 340 Landlocked, cotton, coffee Mali 70 144 241 293 270 390 450 460 500 Cotton Benin 114 193 319 328 340 450 510 530 570 Cotton Zambia 270 483 443 356 323 410 500 640 800 Landlocked copper Source: WDI, 2008. 14 Table 1-9: Trends in the Share of Exports in Gross Domestic Product (%) 1962-69 1970-79 1980-89 1991-99 2000-04 2005-07 Burkina Faso 5 7 10 11 9 11 Nepal 7 8 11 20 19 14 Lao PDR 7 23 28 32 Kyrgyz Republic 34 40 39 Uzbekistan 26 32 36 Turkmenistan 66 74 67 Mongolia 27 50 58 65 Bolivia 26 23 21 23 37 Paraguay 14 15 21 42 42 51 Cambodia 12 6 4 24 56 67 Nicaragua 27 32 19 21 24 35 Sri Lanka 24 28 27 34 36 31 Guatemala 15 21 16 18 25 25 Vietnam 10 38 58 73 Sub-Saharan Africa 24 26 27 27 32 33 Low income 14 15 15 23 28 31 Lower middle income 11 15 22 29 36 Burundi 11 12 10 9 8 11 Benin 7 16 17 16 14 13 Malawi 22 26 24 25 28 18 Mali 11 12 16 21 29 28 Rwanda 10 13 10 6 9 10 Senegal 19 29 27 26 28 26 Uganda 26 16 12 10 12 14 Zambia 54 44 34 33 30 38 Source: WDI, 2008. Box 1-2: Diversification Patterns in Other Landlocked or Commodity Producing Countries Over a period of one or two decades the fast growing countries diversified or structurally transformed their economies from mostly low-value primary products toward more sophisticated products. Evidently, the patterns of diversification varied across these countries – with no particular trend toward manufactured products. In fact, high- value agricultural products remain important. The distinct marker of diversification in all cases is a substantial reduction in the share of the primary product. In East Asia, Lao PDR diversified its economy from coffee and wood to garments. Vietnam diversified its economy from crustaceans, anthracite and natural rubber to footwear, garments, furniture and petroleum. In Central Asia, the Kyrgyz Republic diversified its economy from cotton and non-ferrous metals to metal and glass manufacture and high-value agricultural products (Appendix 2). In South Asia, Sri Lanka diversified its exports from tea and rubber to a variety of high-value garments for the U.S. market. In Latin America, Paraguay’s agricultural economy was based on soya beans, cotton, other agricultural products, and wood exports. While its traditional exports are still important and soy beans account for a third of all exports, the emergence of a high-value fresh meat export industry has led to diversification. Guatemala diversified its economy from agricultural products such as cotton and coffee to garments and bananas. 15 The Diversification Challenge 1.28 Empirical evidence indicates that there is a U-shaped relationship between economic concentration and per capita income. The negative association on the downward part of the U applies to poor countries with concentrated economies or exports below the income level of US$10,000 (constant 2000 dollars). Above this income level, the relationship turns positive (Imbs and Wacziarg, 2003).14 Figure 1-5 points out the negative relation between cotton exports and income levels in Burkina Faso. This relationship holds even when cotton producers like Brazil are included in the sample. In fact, the share of cotton in Brazilian exports is too low (0.2 percent) to influence any major movement in its export growth rate. 1.29 Dependence on exports of a few low value-added products, such as cotton and gold, coupled with commodity price volatility increases the country’s vulnerability to external shocks. Burkina’s Export Concentration Index was fairly high (58.0). Cotton comprises 80 percent of its total merchandise exports. Its other main export products are livestock, sesame, fruit, raw sugar, and cotton seeds.15 Gold exports have potential for growth – despite the fact that they officially account for only 15 percent of exports at present (WTI, 2008).16 For a long time, development economists have worried that an abundance of natural resources can be a curse on developing countries.17 Sachs and Warner (2001) found support for this hypothesis. When this argument is applied to cotton it becomes quite apparent why it is not a promising commodity in Burkina Faso. World cotton consumption per capita has barely recovered from stagnation in the 1990s. The recovery is mainly due to the increase in cotton consumption in some developing countries, especially in Asia. During 1998-2004, 3.8 metric tons of additional cotton products were consumed in the world and consumption in developing countries accounted for 72 percent of that increase. 1.30 Furthermore, cotton substitutes have been growing faster than cotton. For example, chemical fiber consumption increases by 7.8 percent per annum compared to 3.5 percent for cotton. In fact, cotton’s share of the world textile market has declined every year since 1990 (Valderrama Becerra, 2004). 1.31 In addition, sizable subsidies to unprocessed cotton in developed nations have depressed international prices, which have adversely affected exports and, thus, the incomes of poor farmers.18 Anderson and Valenzuela (2006) use the Global Trade Analysis Project (GTAP)19 to estimate the potential gains to cotton-producing developing countries if cotton productivity was increased through the adoption of genetically modified cotton seeds, and the global cotton market was not distorted by subsidies and tariffs. Under the most optimistic 14 High-income countries are on the upward rising part of the U. They are distinct from low-income countries in two ways: they tend to specialize in manufactured exports (OECD countries, Hong Kong SAR, China, Korea) and their share of goods exports is smaller than services exports. 15 The crisis in Côte d’Ivoire, Burkina’s main trading partner, affected exports of animal products. 16 Given the informal nature of the sector, gold exports are probably understated (WTI, 2008). 17 In their natural resource hypothesis in the 1960s, Prebisch and Singer predicted that declining terms of trade for natural resource-based products would be the bane of future economic development. The main reason for this was that natural resource-based products are not very amenable to technological progress and they are particularly vulnerable to trade shocks which dampen income growth. 18 For a detailed discussion about cotton subsidies and its impact on West Africa see Heinish (2006). 19 For more information about the GTAP visit https://www.gtap.agecon.purdue.edu/ 16 scenario20 they predict three important results: (i) an additional annual gain of US$58.8 million in economic welfare for Burkina Faso, Mali, Benin, and Chad; (ii) a 30 percent increase in the net incomes of farmers; and (iii) a 55 percent increase in the proportion of cotton in total exports for the whole of Sub-Saharan Africa. Given the status of the Doha round of talks, the probability that the developed nations will eliminate cotton subsidies seems to be slim. Furthermore, the lack of demand for cotton suggests that reliance on cotton exports as the driver of growth would not be an effective strategy even if there were no subsidies. Figure 1-5: Negative Correlation between Commodity Dependency and Per Capita Income in the Cotton-Exporting Countries (1980-2006) 0.80 TCD 0.70 MLI 0.60 Cotton (% Total Exports) BFA BEN 0.50 0.40 0.30 TKM TGO SDN PRY 0.20 TZA 0.10 CAF KGZ NIC EGY PAK AZE 0.00 5 5.5 6 6.5 7 7.5 Log of GDP pc (constant US$) Source: Authors’ calculations using UN-COMTRADE database and WDI 1.32 The volatility of cotton production stems from natural shocks. Cotton production is dependent upon unpredictable weather conditions that are unconnected to previous production or consumption decisions (Gilbert 2000). This is another reason why it is prudent to diversify. 1.33 Global cotton price trends indicate a high degree of price volatility21 that makes cotton a source of unstable incomes. The correlation between the growth rates of international cotton prices and Burkina’s GDP per capita is 0.47 (see Figure 1-6). Moreover, volatility associated with negative terms of trade shocks depresses farmers’ incomes and fiscal resources, and frequently leads to balance of payments and external indebtedness crises (UNCTAD, 2003). 20 Moderate assumptions contemplating only a Doha partial reform highlights that a partial decrease in subsidies and tariffs will yield only US$14 million in economic welfare gains for the cotton-four countries, and only a 8.2 percent increase in farmers’ net incomes in all of Sub-Saharan Africa. 21 For a comprehensive research paper about dependency on commodity exports see Page and Hewitt (2001). Also see Dehn (2000), who presents empirical and theoretical research on the effects of primary commodity shocks on developing countries. Collier (2002) focuses on the challenge for African Countries. 17 Figure 1-6: Volatility in Burkina’s Per Capita Income and World Cotton Prices 0.08 0.4 0.06 0.3 CottonPriceIndexGrowth 0.2 GDPPerCapitaGrowth 0.04 0.1 0.02 0 0 Ͳ0.1 Ͳ0.02 Ͳ0.2 Ͳ0.04 Ͳ0.3 Ͳ0.06 Ͳ0.4 1981 1986 1991 1996 2001 2006 GDPpc Growth CottonPriceIndex Growth(CropYear) Source: Authors’ calculations using WDI Data and Cotton Price Indexes obtained from the National Cotton Council of America http://www.cotton.org 1.34 Nevertheless, none of the reasons that make cotton a less desirable export product implies that the sector does not need growth-enhancing policies. It is the key source of livelihoods for the Burkinabè population and will always remain important for the economy. Recent growth in the cotton sector was related to an expansion in acreage – thus, future growth through an increase in acreage will be limited. Cotton’s competitive position should be promoted domestically by increasing efficiency and productivity through the use of better technologies, and internationally, through multilateral trade negotiations. The Diagnostic Trade Integration Study (DTIS) on Burkina Faso provides detailed information about strategies that can boost productivity in this sector.22 A more detailed discussion on this sector is presented in Section 2. 1.35 The recent discovery of metals may reduce dependence on cotton and also constitute a key source of government revenues. Deposits of gold, manganese and zinc have been confirmed and several gold mines are operational. Gold accounts for about 61 percent of the new discoveries. Estimates suggest that from the proven reserves of all metals, Burkina Faso may earn as much as US$6.6 billion in revenues from 2008-2015. For 2011 alone, the forecasted revenues range from US$1.1 billion (McMahon and Ouédraogo, 2009) to US$800 million (IMF, 2008). Given that Burkina Faso’s exports in 2006 – which were mostly from cotton – averaged only US$665 million, the discovery of metals will substantially reduce dependence on cotton. However, metal prices – like cotton prices – are vulnerable to terms of trade shocks and lead to revenue volatility. This may undermine income growth over the longer term. For example, a 70 22 Seven actions are listed: changing behavior in the management of ginneries, strengthening the capacity of producers, improving feeder roads and storage facilities, improving farm equipment, improving the input package, intensifying agricultural research and preserving soil fertility and the environment, combining cotton cultivation with other ventures (World Bank, DTIS 2007a). 18 percent fall in the price of zinc since 2007 has made its profitability uncertain and slowed down significantly the pace of zinc-related construction.23 1.36 Income-enhancing possibilities in agriculture other than cotton may be achievable in the short-to-medium term, provided that appropriate, dedicated and enabling policies are pursued. Many development experts have argued that the alternative to over-dependence on cotton exports in Burkina Faso is diversification to manufactures as a means of raising per capita income – just as in the developed countries (Collier, 1998; Collier and Gunning, 1997; Wood and Mayer, 2001). The distinction between manufactures and non-manufactures or primary and non-primary products deflects attention from the income-enhancing opportunities in agriculture. The following are cases in which new high-value industries drove diversification and growth in relatively short periods of time: (i) India’s success in penetrating the global market with table grapes, nuts, and flowers; (ii) Vietnam’s success with pulpwood and vegetable products; and (iii) Uganda, Tanzania and Kenya’s success with fruits, flowers and fish (Table 1-10). 1.37 Diversification in manufactures is hampered by several constraints on the development of manufacturing industries. Burkinabè manufactures account for only 12 percent of GDP and 10 percent of exports. These small shares may be explained by: (i) an abundance of natural resources –a especially land per worker; (ii) a relative scarcity of skills, infrastructure and policy reform (Collier, 1998, 2002; Habiyaremye and Ziesemer, 2006); and (iii) higher transaction costs and higher risks (Collier, 2006). 1.38 Investment climate indicators are cited among the most common constraints to manufacturing, but the statistics for Burkina Faso suggest that the link may be tenuous. Several years ago, a weak investment climate was identified as the cause of low TFP, which is a broad productivity measure that calculates the rise in the costs of doing business due to delays in waiting times required to obtain licenses and permits, spoilage, etc. (Eifert, Gelb and Ramachandran, 2006). The Doing Business report for 2005 ranked Burkina Faso 154th out of 155 countries – in other words, the one with the second most difficult business environment. By 2009, Burkina Faso was ranked 147th out of 183 countries (Doing Business, 2010) – and it was among the top ten countries in the world with regard to carrying out reforms. The highlights are surprising. In the areas of setting up business, issuing building permits and labor policies, Burkina Faso is comparable to China – and in the number of procedures, it is comparable to Botswana. However, these operations are more costly in Burkina Faso – the cost of setting up business is 50.3 percent of income per capita in Burkina Faso, but only 2.1 percent in Botswana and 4.9 percent in China. The rigidity index for employment has dropped from 61 to 21, making it as competitive as Botswana (13) and China (31). Moreover, restrictions on the employment of temporary workers in firms active in seasonal activities have softened (Dahourou, 2008). 1.39 The World Bank’s Trade Tariff Restrictiveness Index (WTI, 2008) ranks Burkina Faso as having one of the most restrictive trade environments. This is mainly due to tariffs that are higher than the average for Sub-Saharan Africa (it ranks 100th out of 125 countries). 23 As in most metal exporting countries, the metal discovery runs the risk of unleashing a host of relative prices and political economy problems related to governance and political instability. In the event of positive shocks, governments in developing countries usually do not have the institutional capacity to take full advantage of this overflow of resources. Problems of waste, misuse and corruption are frequent, especially in industries which are more easily taxed (Collier, 2002). Developing countries implement programs to overcome commodity dependency in collaboration with the international community. For example, UNCTAD is making efforts to reduce commodity dependence through programs on capacity-building, access to information, and institution building. 19 Nevertheless, its cotton exports remain eligible for: (i) “Everything but Arms� or duty free access to Europe; and (ii) the Africa Growth and Opportunity Act (AGOA) for similar access to the United States. Evidently, market access does not seem to be a key constraint to diversification. 1.40 The fact that many countries that have grown relatively prosperous have an even worse-rated investment climate than Burkina, suggests that factors other than pure market forces may have been at work. Undoubtedly, further improvement in the economic environment would be beneficial for growth, but it seems unlikely that it would automatically scale-up nascent non-traditional export industries that are a prerequisite for a structural transformation of the Burkinabè economy. Table 1-10: Economic Diversification in Sub-Saharan Low-income Primary Product Exporters24 1980-84 2000-06 Benin SITC SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 721 Cocoa beans,whole or broken,raw 0.23 PP 1,542 2631 Cotton (other than linters),uncarded 0.55 PP 1,500 2631 Cotton (other than linters),uncarded 0.20 PP 1,500 577 Edible nuts 0.10 HV 1,727 4244 Palm kernel oil 0.14 RB1 4,661 2882 Other non-ferrous base metal waste 0.04 RB2 6,030 711 Coffee,whether or not roasted 0.12 PP 1,936 2472 Sawlogs and veneer logs 0.03 RB1 2,287 4249 Fixed vegetable oils,n.e.s 0.05 RB1 5,377 1222 Cigarettes 0.03 RB1 12,204 Burkina Faso SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 2238 Oil seeds and oleaginous fruit. n.e 0.34 PP 1,902 2631 Cotton (other than linters),uncarded 0.65 PP 1,500 2631 Cotton (other than linters),uncarded 0.32 PP 1,500 2225 Sesame (sesamum)seeds 0.04 PP 1,179 2225 Sesame (sesamum)seeds 0.04 PP 1,179 611 Sugars,beet and cane,raw,solid 0.04 LT1 4,516 2114 Goat & kid skins,raw (fresh,salted) 0.04 PP 1,217 1222 Cigarettes 0.03 RB1 12,204 545 Other fresh or chilled vegetables 0.04 HV 5,477 6115 Sheep and lamb skin leather 0.02 LT1 2,526 Mali SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 2631 Cotton (other than linters),uncarded 0.53 PP 1,500 2631 Cotton (other than linters),not car 0.76 PP 1,500 9710 Gold,non-monetary 0.20 RB2 5,716 579 Fruit,fresh or dried, n.e.s. 0.01 HV 5,187 2238 Oil seeds and oleaginous fruit. n.e 0.05 PP 1,902 8960 Works of art,collectors pieces & an 0.01 LT2 8,542 4234 Groundnut (peanut) oil 0.03 RB1 1,767 6115 Sheep and lamb skin leather 0.01 LT1 2,526 11 Animals of the bovine species 0.02 PP 4,391 6672 Diamonds,unwork.cut/otherwise work. 0.01 RB2 5,607 Uganda SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 711 Coffee,whether or not roasted 0.94 PP 1,936 711 Coffee,whether or not roasted 0.35 PP 1,936 2631 Cotton (other than linters),uncarded 0.02 PP 1,500 343 Fish fillets,fresh or chilled 0.16 HV 5,859 2111 Bovine & equine hides 0.01 PP 5,653 1212 Tobacco,wholly or partly stripped 0.08 PP 1,531 2911 Bones,horns,ivory,hooves,claws 0.01 PP 4,419 344 Fish fillets,frozen 0.06 HV 8,939 7144 Goat & kid skins,raw (fresh,salted), 0.00 PP 1,216 2631 Cotton (other than linters),uncarded 0.06 PP 1,500 Source: Authors’ calculations based on data from WDI and COMTRADE. 1.41 Burkina Faso is a factor-driven economy, whose competitiveness is low. Despite the fact that Burkina has been one of the best performers in West Africa over the past 10 years, it 24 Gold is not included as production started after the reference period (2000-2006). 20 ranks 129th out of 134 countries in the Global Competitiveness Index (GCI), and 126th in the Basic Requirements Sub-index (WEF and World Bank, 2009; Table 1-11). It lags behind other African cotton producers, such as Benin (106th), Tanzania (113rd) and Ghana (102nd), and fares much worse than Botswana (56th) and South Africa (45th; WEF and World Bank, 2009). Table 1-11: 2009 Global Competitiveness Index for Burkina Faso Overall Ranking (out of 134 economies) 129 Basic requirements sub-index 126 Efficiency enhancers sub-index 118 Innovation factors sub-index 95 Ranking by components Health and primary education 131 Higher education and training 124 Macroeconomy 120 Technological readiness 120 Market size 117 Financial market sophistication 108 Infrastructure 104 Business sophistication 96 Innovation 89 Goods market 83 Labor market efficiency 80 Institutions 75 Source: WEF and World Bank, 2009, The Africa Competitiveness Report 2009. 1.42 At this stage of its development, Burkina’s competitiveness primarily hinges on its ability to produce: (i) a stable macroeconomic framework; (ii) well-functioning public and private institutions; (iii) adequate infrastructure; and (iv) a healthy, literate workforce. Burkina Faso fares poor in health and primary education (131st) compared to Benin (110th), Tanzania (117th), Botswana (112th) and South Africa (122nd). In macroeconomic performance (120th), it lags behind Benin (95th), Tanzania (108th), Uganda (92nd), Botswana (22nd) and South Africa (63rd). In infrastructure (104th), it lags behind Botswana (52nd) and South Africa (48th). In institutional performance, Burkina Faso performs better (75th) than Benin (85th) and Uganda (113th), but worse than Botswana (36th) and South Africa (46th). Burkina’s relatively strong performance in this particular area is primarily due to inter alia the implementation of reforms meant to improve the overall investment environment (WEF and World Bank, 2009). Reflecting the impact of some of these reforms, Burkina scores best in: (i) soundness of banking; (ii) business costs of terrorism; (iii) business impact on rules on FDI; (iv) quality of local suppliers; and (v) business impact of tuberculosis. By contrast, it scores worst in: (i) public trust of politicians; (ii) quality of the railroad infrastructure; (iii) Internet access in schools; (iv) ease of access to loans; and (v) availability of venture capital (WEF and World Bank, 2009). 1.43 At the macroeconomic level, the real effective exchange rate (REER) appreciation in years past put a strain on the country’s competitiveness. Econometric analysis of Burkina Faso’s REER shows no clear-cut evidence of an overvaluation – it does suggest some loss of competitiveness (IMF, 2007a). During 2001-2008, based on a model that estimates the fundamental equilibrium exchange rate, it was estimated that the REER was overvalued by more than 20 percent (see the next Section for a detailed discussion on REER evolution). Despite diverging opinions on whether the REER is overvalued or undervalued, there is broad agreement 21 that deterioration in the terms of trade would tend to depreciate Burkina’s equilibrium real exchange rate, whereas fast productivity growth would tend to appreciate it.25 Consequently, the recent decline in the terms of trade should have led to depreciation. However, the actual real exchange rate appreciated during that period, leading to a loss in competitiveness (IMF, 2007a).26 Because of the recent euro depreciation, the REER has depreciated since July 2008, which may have temporarily reduced pressure on competitiveness (IMF, 2009a). Box 1-3: The Global Competitiveness Index: A Tool to Benchmark Competitiveness The World Economic Forum has developed the Global Competitiveness Index (GCI) to measure competitiveness. Competitiveness is defined as a set of institutions, policies, and factors that drive productivity and set the sustainable current and medium-term levels of economic prosperity. The GCI provides an overview of factors that are critical to driving productivity and competitiveness, and groups them into twelve pillars: (i) institutions (public and private); (ii) infrastructure; (iii) the macroeconomy; (iv) health and primary education; (v) higher education and training; (vi) goods market efficiency; (vii) labor market efficiency; (viii) financial market sophistication; (ix) technological readiness; (x) market size; (xi) business sophistication, and (xii) innovation. The GCI is the most comprehensive competitiveness index to date – it measures the macro and microeconomic drivers of competitiveness across a large number of countries. The twelve pillars are measured using: (i) hard data – such as inflation, internet penetration, life expectancy, and school enrollment rates – from public sources; and (ii) data from the World Economic Forum’s Executive Opinion Survey, which is conducted annually among top executives in all of the countries assessed. The Survey provides crucial information for which no hard data exists on a number of qualitative issues, such as corruption, confidence in the public sector, and quality of schools. The sample covers 134 economies at different stages of economic development. Policy priorities evolve as countries advance on the development path, because the policies necessary to achieve productivity improvements – such as, improving health, fighting illiteracy, fighting corruption, and providing basic infrastructure – in a less-advanced economy will no longer suffice to increase productivity in a more sophisticated economic framework, where productivity gains from those policies have already been exploited. This concept is integrated into the GCI. Countries are separated into three stages of development: (i) factor-driven; (ii) efficiency-driven; and (iii) innovation-driven. The twelve pillars are organized into three sub-indexes, each of which corresponds to one of the three stages of development. The basic requirements sub-index includes pillars 1-4. It corresponds with factor-driven economies. The efficiency enhancer’s sub-index includes pillars 5-10. It corresponds to efficiency-driven economies. The innovation and sophistication factors sub-index includes pillars 11 and 12. It corresponds to innovation- driven economies. Factor-driven economies compete based on their factor endowments, primarily unskilled labor and natural resources. These companies compete on the basis of price, and sell basic products or commodities – with their lower productivity reflected in low wages. As wages rise with advancing development, countries must develop more efficient production processes and increase product quality. Finally, countries in the innovation-driven stage compete with new and unique products, and they are able to sustain higher wages and the associated standard of living. The GCI implements the concept of developmental stages by weighting each of the sub-indexes differently, depending on the development stage of a given country. The GCI places more weight on those pillars that are most important at a given stage of a country’s development. In order to formulate policy recommendations to improve the investment climate and to measure impact in the African countries, a detailed analysis of firms’ performances based on the World Bank’s Enterprise Surveys complements the benchmarking of competitiveness based on GCI. This provides useful information on the impact of investment climate conditions on firms’ performances, underlining the direct and indirect costs that may affect firms’ competitiveness in the long-run. Source: WEF and World Bank, 2009, The Africa Competitiveness Report 2009. 25 This is in line with the Balassa-Samuelson effect. 26 Given the difficulties in determining the equilibrium real effective exchange rate, there is uncertainty whether this has led to an overvaluation of the real effective exchange rate. Determining whether there was an overvaluation depends on the level of the equilibrium real exchange rate prior to the terms of the trade shock. The level of the equilibrium real effective exchange rate depends, inter alia, on choices regarding the sample period, explanatory variables, and modeling of the 1994 devaluation (IMF, 2007a). Section 2 of this chapter will present an analysis of the REER movements and its implications on Burkina Faso’s competitiveness. 22 1.44 At the microeconomic level, income-enhancing diversification and higher productivity are key to enhancing Burkina’s competiveness and reducing its vulnerability to external shocks. Burkina’s agriculture-based economy has the potential to mitigate vulnerability to weather damage and external shocks provided that it fully exploits its export potential. Several studies and strategic documents27 point out the need for Burkina to take the following steps: (i) select income-enhancing products by exploring comparative advantages, and identify potential new markets; (ii) improve productivity through intensification and innovation; (iii) encourage private sector development by promoting a conducive business environment with improved financial services and reduced factors (labor, energy) costs; and (iv) create an enabling environment for trade with physical and support infrastructure, a national export promotion strategy, national quality standards and improved linkages with global and regional markets. Firms’ competitiveness 1.45 The relatively low labor productivity, coupled with a high unit labor cost (ULC),28 limits the Burkinabè firms’ competitiveness compared to their main international competitors. In 2005, labor productivity in the manufacturing sector29 was estimated at US$3,105 per worker – lower than in Kenya (US$3,146) and Senegal (US$5,575). It was 4.5 times lower than the labor productivity in South Africa (US$14,030) and 5.1 lower than China (US$15,931 in the export region of Hangzhou). Nevertheless, it was still higher than other cotton-producing countries, such as Benin (US$2,481) and Uganda (US$1,075), highlighting the country’s growth potential. In addition, the ULC attains 33 percent of the value added,30 which is higher than the ULC in Senegal (29 percent), Tanzania (27 percent) and China (13 percent).31 This indicates a loss in the Burkinabè firms’ competitiveness compared to their main international competitors. Moreover, there is a disconnect between labor productivity and wage level. For example, the average monthly salary for a low-skilled worker in the manufacturing sector is around US$80.8, which is higher than Tanzania (US$51.7), Uganda (US$57.5) and Benin (US$76.9; World Bank, 2006a). 1.46 Potential for competing internationally exists, but typically large firms in Burkina Faso are better positioned due to their higher productivity and lower ULC. For example, labor productivity of large firms (more than 50 employees) is around US$8,500 per year, 27 2006 Investment Climate Assessment; 2008 Sectoral strategy to promote commerce, industry and handicraft; 2009 Country Assistance Strategy. 28 Labor productivity offers only a partial view of the country’s competitiveness, because it is highly sensitive to exchange rate fluctuations. Therefore, the unit labor cost (ULC) is calculated to enable a more direct comparison of competitiveness among countries. The ULC is calculated based on the following formula: ULC = (w*L/Q)*(1/e), in which w is the wage in the manufacturing sector, L is the number of workers, Q is the production, and e is the nominal exchange rate vis-à-vis US$. Maintaining a low level of ULC implies one of the following three elements: (i) low wages; (ii) a competitive exchange rate; and (iii) high productivity – or a combination of these three elements. The estimation is based on data from the 2006 Enterprise Survey. The sample includes 146 formal firms, which represents 33 percent of firms operating in the manufacturing sector, 23 percent of firms in the tourism/hotel sector, and 25 percent of firms in the service and other sectors – 99 informal firms operating in the urban areas were also surveyed. 29 Based on data from the 2006 Enterprise Survey. 30 Value added is the value of sales minus the cost of intermediary products and of energy. 31 According to the 2009 Africa Competitiveness Report, the share of labor costs in firms’ sales was estimated at 26 percent. Labor costs in this case include the total compensation of workers adjusted for temporary workers. 23 compared to only US$1,400-2,300 per year for micro and small firms. Similarly, the labor cost32 per employee tends to increase with the firm’s size, but not in the same proportion. This enables firms with more than 50 employees to incur a ULC of 18 percent of value added which may make them more competitive even than firms from India (21 percent) and China (20 percent in Shenzen; World Bank, 2006a). 1.47 Domestic firms and firms that do not export have lower labor productivity and, hence, are less likely to be competitive. Labor costs per employee for non-exporters are much lower than those for exporters (US$709 vs. US$1,511). However, non-exporters’ labor productivity is lower (US$1,612 vs. US$7,952) and their ULC is higher (42 percent of value added vs. 16 percent) – making them less competitive. Domestic firms also have lower labor productivity and higher ULC than foreign firms that operate in Burkina Faso (US$1,759 vs. US$13,501, and 42 percent of value added vs. 16 percent, respectively; World Bank, 2006a). 1.48 Notwithstanding their higher labor costs, firms that are technologically more advanced and that train their employees are more competitive. Their labor productivity (US$6,452 vs. US$1,085) and labor costs (US$1,511 vs. US$638) are higher than those of firms that are less technologically advanced and do not offer training programs to their employees. Their ULCs are also lower (21 percent of value added vs. 63 percent for firms that do not use internet, and 23 percent vs. 37 percent for the firms that do not offer training, World Bank, 2006a). 1.49 Capital intensity33 is lower in Burkina Faso than in the other African countries, but higher returns to capital highlight the potential for increased investment. Differences in firms’ productivity are not only the result of differences in labor productivity, but also of differences in the use of capital during production processes. Typically, firms that are capital intensive (their capital per worker is high) tend to be more productive than those that use less capital. The capital intensity of Burkinabè firms (US$1,288) is lower than in Uganda (US$1,704), Tanzania (US$6,301), Benin (US$7,376) and China (US$1,981 in Hangzhou). Nevertheless, the return on invested capital is high, showing potential for increased investment and innovation. One dollar of capital investment is likely to generate US$1.75 of value added in Burkina Faso, compared to only 58 cents in Senegal and 77 cents in Mali (World Bank, 2006a). 1.50 Overall, Burkinabè firms rank lower in total factor productivity (TFP)34 than the most efficient countries in Sub-Saharan Africa, but about the same as their competitors in West and East Africa. According to the 2006 Investment Climate Assessment (ICA), the Burkinabè TFP is 27 percent lower than Senegal, 22 percent lower than Cameroon, 16 percent lower than Kenya and 91 percent lower than South Africa. Nevertheless, the Burkinabè TFP is similar to Tanzania, Uganda, Niger and Ethiopia. Furthermore, the Burkinabè TFP is 18 percent higher than Zambia. In most of the sectors, except textiles and agro-industry, the large firms are more or less as productive as the small ones, suggesting that the higher labor productivity of 32 The labor costs include wages, compensations, premiums, and other allowances to which administrative personnel and workers are entitled. 33 Calculated based on data from the 2006 Enterprise Survey. 34 TFP was estimated based on the 2006 Enterprise Survey for Burkina Faso, taking into account a Cobb-Douglas production function in nine industrial sub-sectors. To enable cross-country comparisons, the following countries were pooled into a simple regression: Cameroon, Ethiopia, Kenya, Mali, Mozambique, Niger, Senegal, South Africa, Tanzania, Uganda and Zambia. Data for the other countries was based on the most recent Enterprise Surveys. 24 large firms is the result of higher capital intensity and not necessarily of higher productivity and efficiency. Exporters are slightly more productive than non-exporters (by 2 percent), while importers’ productivity is only 0.5 percent higher than that of firms using domestic intermediary goods. Similarly, firms that are more technologically advanced are more productive than firms that are less technologically advanced (by 5 percent). Business environment constraints that impact firms’ competitiveness 1.51 The business environment in Burkina Faso is generally not favorable to the private sector, hampering firms’ competitiveness and increasing their operational costs. Burkina Faso ranks 147th in the ease of doing business (Figure 1-7), lagging behind Tanzania (131st) and Uganda (112th; Doing Business 2010). According to the 2006 ICA, the most serious constraints hurting private sector development are: (i) lack of access to finance; (i) lack of access to electricity; (iii) prohibitive tax rates; (iv) detrimental practices of the informal sector; (v) corruption; (vi) inadequate transportation; and (vii) lack of access to land (see Figure 1-8). Other competitiveness and investor surveys point to several additional constraints, including (viii) inefficient government bureaucracy; (xix) lack of technological readiness; and (x) inadequate health services and poorly educated workforce (WEF and World Bank, 2009). Figure 1-7: Ease of Doing Business in Burkina Faso, 2010 200 179 178 174 180 157 156 160 147 133 131 140 112 106 120 100 89 80 60 45 34 40 17 20 1 0 Egypt Uganda Mali Niger India Tanzania Botswana Singapore China South Africa Mauritius Chad Senegal Congo, Dem. Rep. Burkina Faso Source: Doing Business, 2010. 25 Figure 1-8: Constraints Indentified by the Enterprise Survey Source: The World Bank Group, IFC, www.enterprisesurveys.org 1.52 Lack of access to finance affects most Burkinabè firms’ operations, in particular, small and medium-sized enterprises (SMEs). The 2006 ICA highlights that almost 80 percent of the formal firms in the manufacturing and service sectors – including tourism and hotels – consider access to finance35 an important obstacle to doing business. 70.5 percent of those firms consider the cost of finance a major obstacle to doing business (World Bank, 2006). This is mainly the result of: (i) an inadequate supply of financial services; (ii) a poor regulatory environment; and (iii) weaknesses in the financial information infrastructure. Access to finance is particularly difficult for SMEs because: (i) lenders require more collateral36 from SMEs than large firms (Table 1-12); and (ii) there is a lack of expertise among financial institutions – in particular microfinance institutions – at targeting financial products toward SMEs (World Bank, 2006a and 2009a). The limited access to finance is also reflected in the low level of domestic credit to the private sector, which represented only 16.8 percent of GDP in Burkina in 2007.37 The real interest rate (12.8 percent) is slightly higher than other African countries such as Cameroon (11.5 percent), Benin and Senegal (10.9 percent). It varies between 11.7 percent for large enterprises and 13.1 percent for small enterprises (World Bank, 2006a). At the same time, there is a certain amount of credit rationing by firms, partly explained by significant collateral 35 The banking sector is the most important segment of the financial system. The gross domestic savings were estimated at around 4.5 percent of GDP in 2007 and 3 percent in 2008. The domestic credit provided by the banking sector represented 12.4 percent of GDP in 2007, similar to Tanzania (12.6 percent of GDP) and lower than South Africa (88.7 percent of GDP). 36 The collateral may be as high as 123 percent of the loan amount (World Bank, 2006a). 37 That compared to 19.9 percent for Benin, 84.5 percent for South Africa, and an average of 47.1 percent for Sub- Saharan Africa (DDP, 2008). 26 requirements and the complexity of the loan application process. The firms’ main source of finance for their current operations and investments are internal funds and reinvested profits – that is how 66-92 percent of operations and 46-82 percent of investments (depending on the sector) are funded (World Bank, 2006a).38 Table 1-12: Loan Characteristics in Burkina Faso Large firm Medium firm Small firm Average maturity (months) 41.1 23.2 27.3 percentage of loans for which collateral is required 74.5 81.8 94.5 Collateral (% of Total) Land and buildings 63.4 86.5 81.9 Equipment 36.6 13.5 5.1 Owner’s assets 0.0 4.9 6.1 Source: World Bank, 2006 Enterprise Survey, Burkina Faso. 1.53 Furthermore, poor access to reliable power supplies makes it difficult for Burkinabè firms to compete in international markets. According to the 2006 ICA, 61.8 percent of firms in the manufacturing sector perceive poor access to energy supplies as a severe constraint to their operations. The country’s hydroelectric potential is limited because of its small potential capacity (less than 100MW). SONABEL has a monopoly on electricity, which drives the price of electricity up. The electricity supply is not sufficient to meet the demand – the growth rate was estimated at 7 percent in Ouagadougou and Bobo-Dioulasso. According to the 2009 Africa Competitiveness Report, the cost of electricity would represent 2.7 percent of sales, more than in Zambia (0.9 percent), Ghana (1.2 percent), Benin (1.4 percent), Uganda (1.5 percent), and Mali (1.8 percent). Also, the cost of electricity for industrial use is estimated to be four times higher in Burkina Faso than in Côte d’Ivoire (World Bank, 2006a; Figure 1-9). 1.54 Despite the fact that the total tax rate in Burkina Faso is not among the highest in Africa, the overall tax system is perceived as burdensome. The 2006 ICA indicated that 76.5 percent of formal firms and 62.6 percent of informal firms perceive tax rates as severe constraints to doing business. These perceptions are lower in China and India (less than 40 percent), Tanzania (around 35 percent) and South Africa (less than 20 percent). According to the 2010 Doing Business Indicators, the total tax rate is 44.9 percent of the profit, which is below the average of 67.5 percent for Sub-Saharan Africa. It is higher than the total tax rate in Uganda (35.7 percent), South Africa (30.2 percent), and Botswana (17.1 percent). It is lower than the rate in Tanzania (45.2 percent) and Benin (73.3 percent; Doing Business 2010). Nevertheless, tax collection and administration in Burkina are perceived as burdensome (Figure 1-10). Tax collection relies on a narrow taxpayer population, which indicates that many firms operate informally and are likely to evade taxes. 38 The government plans to develop a financial sector strategy by March 2009. The objectives are to strengthen monetary policy and increase the efficiency of the banking system by improving financial intermediation and access to finance. It aims to improve SME finance, rural finance, housing finance and long-term finance. The planned strengthening of the microfinance industry will focus on: (i) reinforcing supervisory capacity; (ii) strengthening microfinance institutions; (iii) diversifying the financial sector; (iv) fostering access to credit through decentralized access to microcredit; and (v) modernizing financial markets (World Bank, 2009a). 27 Figure 1-9: Cost of Electricity in Burkina Faso and Neighboring Countries (in CFAF/KWh) 140 120 100 80 60 40 20 0 Nigeria Niger Ghana Bénin Burkina Côte d'Ivoire Mali Sénégal Basse tension Moyenne tension Source: World Bank, DTIS 2007a. Figure 1-10: Number of Tax Payments Tanzania Burkina Faso Uganda Botswana South Africa 0 10 20 30 40 50 60 Number of payments Source: Doing Business 2010. 1.55 The perception of burdensome taxation tends to drive firms into informality, creating unfair competition for formal firms through lower input costs. Although only firms in the service sector cite unfair competition from the informal sector as a major or severe constraint (57.5 percent), firms in other sectors, such as manufacturing and hotels, are also affected by the informal sector practices (World Bank, 2006a). The sheer size and scope of the informal sector makes this inevitable. The informal sector represents around 30 percent of GDP. It employs 80 percent of the active urban population and more than 50 percent of the active rural population – mostly in the secondary and tertiary sectors. Informality is predominant in trade, transport, food industry (restaurants), and small business. Because informal firms do not comply 28 with regulations (including import regulations), they incur lower costs of inputs, and are therefore able to sell at lower prices. This creates unfair competition for the formal firms. 1.56 The perception of corruption and the lack of confidence in the regulatory framework fuel the instability of the business environment. In the 2008 Transparency International ranking, Burkina Faso ranked 80th out of 180 countries on corruption, which was an improvement over 2007, when it was ranked 105th. Despite this improvement, according to the 2006 ICA, 55.4 percent of formal firms perceive corruption as one of the major constraints to business in all sectors. In addition, firms have little confidence in the consistency of the regulatory framework and the impartiality of the judicial system. There is an insufficient number of courts and judges, which results in low coverage of the judiciary, with most of the courts concentrated in the two largest cities. Court decisions suffer long delays, and they are not always executed. Consequently, 63 percent of firms believe that the interpretation and application of regulations is unpredictable and 60 percent of manufacturing firms consider tribunals to be unfair and corrupt. To address these issues, the Government has embarked on reforms to improve governance and public finance management, to increase accountability, transparency, an efficient allocation of resources and a better functioning of the public procurement system.39 1.57 Trade competitiveness suffers from inadequate transport infrastructure and high transportation prices. Burkina Faso is a landlocked country that is dependent on its neighbors (Côte d’Ivoire, Togo, Ghana and Benin) for its export and import activities. 53.3 percent of formal firms perceive transportation as a major constraint that increases their operational costs (World Bank, 2006a). On the Logistics Performance Index, Burkina was ranked 122nd out of 178 countries. One of the weakest logistics indicators for Burkina is the quality of infrastructure (WTI, 2008)40. When expressed in US dollar per kilometer, transport prices on the corridor Tema/Accra – Ouagadougou (on average US$3.53 per km) are higher than those on the corridors from Eastern (on average US$2.2 per km) and Southern Africa (on average US$2.3 per km). (Teravaninthorn and Raballand, 2008). Despite the relatively good condition of the road network, road scope is limited. For example, in 1999, only around 16 percent of the classified roads in Burkina Faso were paved. It is true that this exceeds the average of 12.7 percent in Sub-Saharan Africa. However, it is far lower than the average of 66.4 percent in North Africa and the Middle East. The roads are also overloaded – 10 percent of the road network facilitates 50 percent of the traffic. Road maintenance seems to be under-funded.41 The highly regulated trucking industry – which operates on a rotational basis – contributes to higher transportation costs. The airports in Ouagadougou and Bobo-Dioulasso face significant challenges regarding the logistical capacity for air freight. Inadequate infrastructure also affects trading across the borders. According to the 2010 Doing Business indicators, Burkina ranks poorly in trading across borders – 176th out of 183 countries – notwithstanding the revival of corridors with Togo, Ghana and Benin. Ultimately, this may also increase the costs to export (US$2,262 per container) and to import (US$3,830 per container; Doing Business, 2010).42 39 A new Control Authority was created to fight corruption. 40 It lags behind Benin (ranked 89th), Uganda (ranked 83rd) and South Africa (ranked 24th). 41 The Government is currently preparing a transport sector strategy for 2011-2015. A key challenge for the government will be to ensure adequate financing of future road maintenance. 42 These costs are higher than the average for Sub-Saharan Africa – cost to export is US$1,941.8 per container and cost to import is US$2,365.4. 29 1.58 Access to ICT services is low and costly. Several government initiatives undertaken from 2005-2008, helped improve access to mobile communication networks from 5.5 percent to 14.5 percent. Nevertheless, the overall penetration rates for voice and data in Burkina are low, and prices are high (Table 1-13). Burkina’s Internet subscribers (per 100 people) were a mere 0.1 in 2007, below the Sub-Saharan average (1.2) (WDI, 2009). A major constraint to the development of the ICT sector stems from poor access to international capacity, overdependence on satellite technologies, and absence of competitive access to SAT-3. The lack of ICT skills also acts as a drag on firms’ competitiveness. More effective competition through regulatory reforms in the telecom sector and better use of ICT applications is likely to consolidate the ground for more innovation and to improve capacity to compete internationally (World Bank, 2009a). Table 1-13: Telecommunication Costs in Burkina Faso Burkina Faso Mali Benin Niger Senegal Ghana Nigeria Average cost per minute (conventional) (CFAF) 29.5 15 23 25 21 n.a. 16 Hourly cost of connection to 1,180 500 1,320 3,000 1,770 500 n.a. Internet (CFAF) Average cost of international 236 450 564 945 140 n.a. n.a. call to France (CFAF) Source: World Bank, DTIS 2007a. 1.59 Land titles generate uncertainty about ownership in Burkina, with potential negative consequences for private investment. Traditional and communal land (customary) ownership is the rule, although in theory all land belongs to the state.43 The difference between formal and customary ownership may generate uncertainty and insecurity, potentially standing in the way of any form of medium or large-scale commercial agriculture or intensive livestock production. Moreover, a well functioning rural land register does not exist. The lack of secure access to land may be an impediment to private investment in irrigation and other land improvements. It also limits access to bank financing, because land cannot be used as collateral. In 2006, recognizing the need for land reforms, the Agriculture Minister highlighted the growing consensus within the Government on securing land access (World Bank, DTIS 2007a).44 The recently adopted national policy on securing access to land in rural areas is a step forward. It aims at: (i) addressing inter alia issues related to increasing agriculture productivity and livestock-raising; (ii) expanding irrigated areas; and (iii) resolving land-related conflicts (Ministry of Economy and Finance of Burkina Faso, 2008). It should also be noted that, recently, a new land law has been passed to allow long-term land tenure, in particular through long-term lease, but the administrative system that would grant such lease contracts needs to be established. This would provide private investors with long-term land tenure security, facilitating enhanced private investment. 43 The land reform law and its 1996 revisons stipulate that in principle all land belongs to the state, but it allows for the issuance of development permits and the possibility of transferring full ownership to private operators as well as the management of some lands by village communities (World Bank, DTIS 2007a). 44 The World Bank DTIS 2007 recommended a program whereby the government would: (i) identify appropriate parcels of land that are relatively free of customary claims; (ii) clear these parcels of any remaining claims; and (iii) define the legal and operational modalities under which these parcels could be set aside as reserves to be leased to strategic investors for a period of 30 years or more. This would support private sector investment in agriculture, irrigation and intensive livestock-raising activities. 30 1.60 Inadequate education and health services may impair the quality of the workforce and, hence, firms’ productivity. Despite improvements in accessing education, health and other basic services (potable water), Burkina Faso ranked 176th out of 177 countries in the 2006 Human Development Index (HDI). Gross enrollment rates in schools increased from 41.7 percent in 1999-2000 to 72 percent in 2008. Access to health services was improved through increased public expenditures – it went from 7.4 percent in 2004 to 9.4 percent in 2006. Nonetheless, the literacy rate remains below 30 percent (28.7 percent in 2007), affecting the education and skills of the labor force. Gender gaps are decreasing. Nevertheless, significant gender gaps remain in school enrollment rates, literacy rates, primary school completion rates and access to health service. There is also a perceived mismatch between labor market needs and education policies. Moreover, highly trained individuals seem to have difficulties integrating into the labor market. Workers’ health also affects productivity and generates indirect costs due to non-negligible absenteeism. Implications for competitiveness 1.61 The perceived constraints on the business environment have indirect costs45 for firms. In particular, constraints related to transportation, telecommunications, access to electricity, corruption, informality and the regulatory framework increase firms’ operational costs and hurt their competitiveness. Based on the 2006 Enterprise Survey for Burkina, the indirect and invisible costs46 associated with the constraints on the business environment would amount to 8.2 percent of the firms’ sales, compared to 6.5 percent in Benin and 4.6 percent in Mali (Table 1-14). 1.62 The inefficiency of the transport system and the unreliability of the power supply lead to non-negligible losses in production. The transport costs would represent 2.2 percent of firms’ annual sales. Power outages generated a loss of around 1.2 percent of firms’ annual sales in 2005 (Table 1-14). Manufacturing firms in Burkina Faso faced power outages almost on a daily basis – on average, 12.9 times per month – which lasted on average 1.5 hours (World Bank, 2006a).47 Telecommunications impose an additional indirect cost of 0.7 percent of firms’ sales. 45 Indirect costs include transport costs, electricity costs (cost of fuel used to run generators), telecommunications cost, costs associated with the regulatory environment (sum of (1) interest paid on bureaucratic procedures to start a business and minimum capital requirement, plus (2) cost of custom clearance times the estimated number of trips) (WEF and World Bank, 2009). 46 Invisible costs are losses as a percentage of firms’ sales related to power outages, burdensome regulations, corruption, and security threats. 47 The time to connect to electricity grids (days between the connection request and the service provision) was on average 20 days, longer than in Senegal (around 12 days) or China (around 18 days). 31 Table 1-14: Indirect and Invisible Costs (% of firms’ sales) Indirect costs Invisible costs Total Cost of indirect and Cost of corruption: invisible Losses manager’s informal costs due to time to payments Cost of power deal with to get security Transport Telecom Customs outages regulations things done measures BurkinaFaso200648 2.23 0.70 1.63 1.20 0.05 1.48 0.86 8.20 Benin2004 - - 0.48 1.16 0.06 4.27 0.57 6.55 Mali2007 1.96 0.86 0.26 1.39 0.05 0.24 0.12 4.60 Uganda2006 1.08 0.50 0.52 28.16 0.06 2.18 0.43 32.93 Zambia2007 0.61 0.71 0.68 1.79 0.04 0.05 0.93 4.81 Source: World Bank, Enterprise Surveys 2004-2007. Estimates are based on at least 15 observations. 1.63 In addition to generating an uncertain business environment, corruption also creates additional costs for firms, especially for SMEs. Overall, losses associated with corruption would represent 1.5 percent of Burkinabè firms’ sales. That compares to 0.2 percent in Mali (0.2 percent), and 0.1 percent in Zambia (Table 1-14). The informal payments made by the SMEs are even higher than the average for the manufacturing sector. Furthermore, access to basic services seems to open up avenues for corruption. According to the 2006 ICA, 16.7 percent of firms were requested to make an informal payment for a phone connection, 12.5 percent for a connection to electricity, and 16.7 percent for a connection to a water system (World Bank, 2006a). 1.64 The burdensome and unpredictable regulatory framework also increases firms’ operational costs. Overall, the cost of manager’s time spent on dealing with regulations was estimated at around 0.1 percent of firms’ sales. In Burkina, the cost associated with customs clearance was estimate at around 1.6 percent of firms’ sales, as compared to 0.5 percent in Benin, 0.3 percent in Mali, and 0.5 percent in Uganda (Table 1-14). The relatively complicated Burkinabè tax system creates an additional burden for firms in terms of time spent paying taxes. This takes up much more time in Burkina Faso than in Uganda or Tanzania (Figure 1-11). The time for export in Burkina is 41 days, compared to 24 days in Tanzania, 37 days in Uganda, 30 days in Botswana, and 30 days in South Africa. The time for import in Burkina is 49 days, compared to 31 days in Tanzania, 34 days in Uganda, 41 days in Botswana, and 35 days in South Africa (Figure 1-12; Doing Business, 2010). 48 Companies operating in the mining sector arenot included, since mining exploitation started after the reference period. The Malian survey from 2007 incorporates the opinion of mining companies. Mining sector has been one of the Malian growth engines since the 1990s. 32 Figure 1-11: Time Spent Paying Taxes Burkina Faso South Africa Tanzania Uganda Botswana 0 50 100 150 200 250 300 Hours per year Source: Doing Business 2010. Figure 1-12: Time for Export and Import Burkina Faso Botswana Time for Import South Africa Time for Export Uganda Tanzania 0 10 20 30 40 50 60 Number of days Source: Doing Business 2010. 1.65 In addition, security costs add to the total indirect costs. These were estimated at 0.9 percent of the firms’ annual sales compared to 0.2 percent in Mali and 0.4 percent in Uganda (Table 1-14). 1.66 In order to address the key macro and microeconomic constraints on competitiveness, the following sections will provide a detailed analysis of their implications and formulate recommendations to boost income-enhancing diversification in Burkina Faso. Section 2 of this chapter will analyze in detail the implications of the REER fluctuations on competitiveness, and presents options for market-based risk management of such fluctuations. Section 3 will identify sectors with growth potential that may provide opportunities for reducing dependence on cotton production. Section 4 will look in detail at the current policy framework for export and investment promotion, and suggest a strategic approach to promote diversification, exports and investments. 33 EXCHANGE RATE DYNAMICS AND RISK MANAGEMENT 1.67 The recent appreciation of the CFA franc against the U.S. dollar and the evolution of international cotton prices have raised some concerns about the competitiveness of the cotton sector and the sustainability of growth. The Burkinabè cotton industry is a very important source of cash revenue for rural farmers and foreign exchange for the domestic economy. Burkina is a member of the West African regional economic and monetary union, which has its currency pegged to the euro. Cotton is traded in world markets in dollars, but West African farmers are paid in CFA francs. Therefore, a bilateral swing in the dollar-euro exchange rate has significant implications on the profitability of cotton in the zone. An appreciation of the euro vis-à-vis the dollar increases the costs for individual farmers in Burkina Faso, and hence, worsens the competitiveness of cotton producers by eroding their profit margins. Burkina’s competitiveness has been made more vulnerable to external shocks due to: (i) the currency mismatch between export prices and production costs; (ii) the poor performance of the cotton sector; and (iii) an increase in the CPI, including the price of non-tradables. Currency Mismatch for Export Prices and Production Costs 1.68 Heightened real exchange rate volatility could hurt the competitiveness of low- income countries whose currencies are pegged to the euro. While predicting the euro/dollar exchange rate is a very risky proposition, the recent global financial crisis suggests higher volatility as investors hesitate between the dollar’s safe haven status and economic fundamentals as expressed by rising twin deficits in the US. Since 2003, the dollar has slid by more than 30 percent vis-à-vis the euro. A strong depreciation of the US dollar vis-à-vis the euro since 2001, has been accompanied by a long-term downturn trend in the world market price of cotton. Although world cotton prices have generally been quite volatile over the past two decades, there were sustained downward episodes in 2002 and 2006 (Figure 1-13). Cotton prices recovered in 2007, reaching a peak of EUR0.9 per kilogram in mid-2008 (IMF, 2009). However, they have since fallen again in the wake of the global economic downturn and could continue to decline if the consequences of the crisis amplify. 1.69 The 30 percent depreciation of the dollar against the euro since 2003 is estimated to have reduced the profit of cotton companies by some CFAF 45 billion – about 1.5 percent of GDP (IMF, 2007b). Cotton farmers are earning less, as a result of relative price fluctuations in international markets. Input costs such as labor and fertilizers, which are typically priced in CFAF, have increased in dollar terms, further hurting profitability. 1.70 Burkina may lose its competitive position vis-à-vis its main cotton producing competitors, because the latter can use exchange rate adjustments. For many exporters whose currency is not pegged to the euro – such as Egypt and Tanzania – the exchange rate adjustment has helped lead to rising prices in domestic currencies. Depreciating currencies have provided the adjustment mechanism to maintain competitiveness in the sector. The cotton price converted to Egyptian pounds has increased from 1 pound (around US$0.18) per kg in the early- 1980s, to 6 pounds (around US$1.07) per kg in the mid-1990s, to about 7 pounds (around US$1.25) per kg in the current season. In Tanzanian shillings, international cotton prices have 34 risen continuously since the early 1980s (ICAC, 2007). For example, cotton prices increased from an average price of Tanzanian shilling 220 (around US$0.16) per kg of seed cotton in 2005- 2006, to Tanzanian shilling 450 (around US$0.33) per kg in 2006-2007. Moreover, since Burkina cotton sells predominantly to countries in Asia – including China – it competes with exporters such as the United States (which subsidizes cotton) and Uzbekistan whose currencies are not pegged to the euro. Figure 1-13: Domestic and International Cotton Prices, 1999-2009 240 Cotton Prices, 1999ņ09 (CFAF per kilogram) 230 220 210 200 World Price 190 Producer Price Latest price 180 January 2009 170 160 150 140 1999/00 2001/02 2003/04 2005/06 2007/08 Source: IMF, 2009. Has the Evolution of Non-tradable Prices Led to the REER Misalignment? 1.71 In Burkina, the large increase in the price of non-tradables compared to tradables highlights the effects of the changing exchange rates. A disaggregated look at the CPI shows that from 1997-2006, transport and communications increased much more than the average CPI increase, exhibiting a significant differential between tradables and non-tradables (Figure 1-14). This happened in the context of stagnant tradable output. Given Burkina’s narrow export base, the rising price of non-tradables illustrates the exchange rate shock. 49 49 One common trend in the analysis of misalignment is overreliance on the aggregate CPI as the best index. Since the CPI is broadly representative of both traded and nontraded goods and easily available on a monthly basis, it is commonly used for developing countries. The WPI is heavily weighted with traded goods. In the case of Burkina, using a price index that is more heavily weighted with non-tradable prices would show more manifestly the extent of the misalignment. 35 Figure 1-14: Disaggregated CPI in Burkina Faso, 1997-2006 CHART 3: BURKINA CPI DISAGGREGATED 1997-2006 (INDEX) 170.0 160.0 150.0 140.0 130.0 120.0 110.0 100.0 90.0 80.0 97 98 99 00 01 02 03 04 05 06 97 98 99 00 01 02 03 04 05 06 l- l- l- l- l- l- l- l- l- l- n- n- n- n- n- n- n- n- n- n- Ju Ju Ju Ju Ju Ju Ju Ju Ju Ju Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Overall CPI Food and beverages CPI excluding f ood and beverages Transport and communication Core CPI (CPI excluding f ood and transport) Source: The Burkinabè Authorities and IMF, 2007. 1.72 Evidence regarding the Real Effective Exchange Rate (REER) misalignment in Burkina Faso is mixed.50 The purchasing power parity (PPP) methodology and the trade equations model suggest a significant overvaluation. The single equation estimation econometric evidence is inconclusive, with contrary findings in the literature (Appendix 1). While the PPP suggests a misalignment of 16 percent from 1999-2008, the elasticity-based trade equations model and an Engle Granger two-step methodology estimates that the CFA is overvalued by close to 20 percent during the same period. The deterioration of the terms of trade typically tends to depreciate the equilibrium exchange rate, while the actual real exchange rate appreciates during the same period leading to losses in competitiveness. Similarly, rising current account deficits are correlated with declining equilibrium exchange rate values, and a divergence from the actual real effective exchange rate. 1.73 Based on the PPP methodology, it is estimated that the REER registered a cumulative appreciation of more than 16 percent from 1999-2008, mainly driven by a strong euro. In particular, the PPP methodology shows a growing and systematic appreciation of the REER since the introduction of the euro. Over this period, there have been occasional fluctuations, partly driven by higher inflation in Burkina Faso than that in some of its trading partners. In spite of prudent monetary policies at the BCEAO, inflation in Burkina was above the regional WAEMU average in both 2005 and 2008 – although it was lower than in countries with more flexible exchange rates, such as Nigeria and Angola. For example, in 2008, CPI inflation in Burkina was 9.5 percent compared to 5.4 percent in Senegal, 8.8 percent in Benin, 2.5 percent in 50 Three different methodologies are used to analyze REER misalignment: (i) a PPP methodology; (ii) a trade equations elasticity-based model; and (iii) a single equation econometric estimation using cointegration. 36 Mali, and the average of 4.3 percent for WAEMU. From mid-July 2008 to early 2009, there was a slight depreciation of the REER due to gains in the dollar.51 1.74 Time series econometrics provides mixed results. One IMF report finds that movements in the terms of trade, trade openness, productivity and government consumption can explain most of the long-run behavior of the REER (IMF, 2008). Based on these fundamentals, the study finds that the REER at the end of 2006 was very close to its estimated equilibrium level. Another study, using panel data methods, concludes that Burkina Faso's real exchange rate is either close to its equilibrium level or is undervalued. Using a panel of eight WAEMU countries, the authors find some degree of undervaluation of the REER. Nevertheless, they also find that – based on single-country estimators and the panel estimators – the REER for Burkina Faso may have been overvalued by about 9 percent in 2006 (Roudet et al, 2007). This is in sharp contrast to the results obtained using the panel estimators, which suggested an undervaluation ranging from 1-24 percent.52 Figure 1-15: Evolution of Burkina Faso’s REER, 1994-2006 CHART 4: EVOLUTION OF BURKINA REER POST-DEVALUATION: 1994-2006 120.00 115.00 110.00 105.00 100.00 95.00 90.00 85.00 80.00 94 95 96 97 98 99 00 01 02 03 04 05 06 n- n- n- n- n- n- n- n- n- n- n- n- n- Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Source: IMF, 2007. 1.75 An indicator that Burkina’s real exchange rate is overvalued is the persistent and widening current account deficit. The latter – including grants – increased from around 4 percent of GDP in 1990 to 8.3 percent in 2007 and 11 percent in 2008. This exceeded the WAEMU average, which was 5.6 percent in 2007 and 5.4 percent in 2008 (IMF, 2009a; Figure 1-16). Burkina’s current account position has worsened due to weak export performance and growing dependence on foreign aid. A sharp deterioration of the terms of trade in 2003-2005, followed by a modest improvement in 2006-2009, also contributed to the progressive widening of the current account. 51 This is mainly due to the safe haven status of US bonds during the financial crisis. 52 The empirical results from single equation econometrics are quite mixed, and are subject to a range of methodological and data issues (Appendix 1). 37 1.76 Burkina has made some revenue improvements and fiscal adjustments, but not enough to reduce the current account deficit. Although half of fiscal deficit financing is through grants, the public savings-investment gap remains large. If the deficit were maintained over the long-term and financed entirely through borrowing, the net present value (NPV) of debt- to-exports ratio would exceed 60 percent by 2025, which would clearly be unsustainable (IMF, 2007a).53 One could consider widening the current account and scaling up aid if: (i) aid is used to finance capital goods from abroad to help move productivity in the non-tradable sector (create a supply response, which would improve the current account over the medium-term); (ii) aid is used productively for investment purposes, such as infrastructure; and (iii) aid is in grants and does not lead to further debt distress. The account deficit of the past five years was only partially financed through borrowing – representing about 3.5 percent of GDP. However, the structural imbalance between exports and imports has adverse sustainability implications. Rising oil and energy prices and the accumulation of large net liabilities are further manifestations as well as a cause of the current account deficit. Whether in comparison with WAEMU averages or past trends, the current account deficit is not sustainable due to long-term solvency issues and poor export performance.54 Figure 1-16: Evolution of Current Account Balance in Burkina Faso, 1984-2007 (% of GDP) CHART 5: CURRENT ACCOUNT BALANCE IN BURKINA:1984- 2007 (% OF GDP) 2 0 -2 -4 -6 -8 -10 -12 -14 -16 84 86 88 90 92 94 96 98 00 02 04 06 19 19 19 19 19 19 19 19 20 20 20 20 Current account balance (including grants) Current account balance (excluding grants) Source: IMF, 2008. 53 At current levels, the NPV of debt-to-exports exceeds the threshold in the medium-term, and across-the board- debt thresholds are higher than base thresholds. 54 Based on the trade equations methodology, 1 percent depreciation in the real exchange rate should be expected to increase exports by 0.3 percent and decrease imports by 1.1 percent. The import elasticity with respect to foreign income was -1.7, and the export elasticity with respect to domestic income was 0.7. Surprisingly, the income elasticity of demand was found to be negative, but the t-statistics are insignificant. In 2007, exports of goods and services were 12.1 percent of GDP, while imports of goods and services were 25.6 percent of GDP. Hence, a 10 percent fall in the REER would increase exports by 3 percent or 0.4 percent of GDP and decrease imports by -11 percent or 2.8 percent of GDP, resulting in a change in the current account of 2.4 percent (Appendix 1 for a description of the methodology). 38 1.77 Based on an econometric model that estimates the fundamental equilibrium exchange rate (FEER), the REER both parallels and diverges from the FEER during the period of 1980-2008. At the beginning of the sample, the REER is overvalued, then converges to equilibrium, and then diverges again (Figure 1-17). Prior to 1994, the CFAF is significantly overvalued. The largest degree of overvaluation – more than 20 percent – is seen in the run-up to the 1994 devaluation, which is then followed by a significant undervaluation up through 1998. After 2001, the REER started to be overvalued and, by 2008, the misalignment was close to 20 percent – reflecting the widening current account deficit. The movement in the REER closely parallels the terms of trade movements.55 Figure 1-17: Evolution of the REER and FEER, 1980-2008 (%) CHART: REER AND FEER 1980-2008 5.6 5.4 5.2 5 4.8 4.6 4.4 4.2 4 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 REER FEER Source: Author’s calculations. 1.78 As expected, the current misalignment of the CFAF due to the dollar decline has adverse effects on Burkinabè export performance, particularly on that of the cotton sector. The following factors are all testimony to the loss in competitiveness: (i) the large, persistent, and widening current account deficits; (ii) the increase in the price of non-tradables relative to tradables; (iii) the increase in the real effective exchange rate in PPP terms of more than 15 percent since 1999; (iv) the financial losses incurred by ginneries and the significant increase in farmers’ operating costs (with costs priced in CFAF); and (v) the strong decline in production and weak export performance, particularly in the cotton sector. Additionally, econometric evidence indicates that a significant depreciation is needed to restore sustainability of the current account. All of these factors suggest that risk management mechanisms are necessary to reduce Burkina’s vulnerability to external shocks. 1.79 Alternative strategies need to be examined in light of the fixed parity against the euro and the short-term unavailability of exchange rate adjustments to deal with terms of 55 Theoretical and empirical evidence suggest that rising current account deficits are correlated to decreases in the equilibrium exchange rate. 39 trade shocks. Countries with fixed exchange rates like Burkina may face pressures on these arrangements owing to lower net exports. The negative impact of the euro hike on Burkina’s economy and other cotton-producing economies, such as Niger and Benin, may lead to demands for adjustments or new institutional arrangements. The presence of asymmetric shocks within the zone will also have to be addressed at a regional level. In the aftermath of the twin food and financial crises, it is important that, in addition to financial markets, agricultural commodity markets be part of reformed regulatory systems in order to move out of the crisis and prevent future turmoil. These reforms may help agricultural parastatals and farmers avoid price volatility and strengthen their fiscal position in the wake of such volatility. A Holistic Approach to Managing Exchange Rate Risk in the Cotton Export Industry 1.80 Burkina Faso’s cotton industry consists of three cotton corporations that procure inputs for cotton production through imports, operate ginning plants, and finally export the cotton fiber. Through the provision of these services, the cotton corporations also access credit for the cotton industry. Their working capital needs are met by loans from input suppliers, credit lines from a local pool of banks (some of which are unsecured), as well as financing from an international pool of banks against endorsement of export contracts and collateral management agreements. The foreign suppliers of agricultural inputs such as fertilizers (purchased in bulk) provide a 270 day credit, which starts from shipments received in March. The export proceeds are received from December through May. (FSAP, 2008). Box 1-4: Holistic Approach to Exchange Rate Risk Management in Burkina Faso’s Cotton Sector EXCHANGE RATE RISK MANAGEMENT FOR BURKINA FASO COTTON EXPORT INDUSTRY Fertilizer Import Orders USD Export Proceeds Placed exchanged for EUR Funds at maturity of Producer Price forward contract Announced EUR-USD FORWARD EXCHANGE RATE CONTRACT EXECUTED IN APRIL: Hedged USD Amount = 85% Annual Production Estimate – Imports Ordered Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May 270 Day Supplier Credit on Imported Fertilizers Export Proceeds Materialize 40 1.81 The cotton sector’s competitiveness has been made more vulnerable to external shocks due to CFAF-USD exchange rate volatility and multiple fund transfers related to export proceeds and import payments. The exchange rate is one of the key macroeconomic variables that impact the overall competitiveness of the economy as well as the cotton dynamic and sector performance. Cotton is traded in world markets in dollars, but West African farmers are paid in CFA francs. An appreciation of the euro vis-à-vis the dollar worsens the competitiveness of cotton producers by eroding their profit margins. The appreciation of the euro coupled with a rising CPI has led to fiscal difficulties for the cotton farmers. An unfavorable exchange rate worsens the financial viability of the sector, and has adverse effects on poverty. Currently, no mechanism exists to offset US Dollar import payments against US Dollar export proceeds prior to currency conversion into CFAF by the Burkinabe cotton ginning companies. 1.82 The cotton sector in Burkina Faso faces exchange rate volatility and market transactions costs at both ends of the cotton value chain. Both exports and imports for Burkina i.e. cotton and fertilizers, are traded in the world markets in dollars. Currently, no mechanism exists to offset import payments against export proceeds in US Dollars prior to currency conversion into CFAF by the Burkinabe cotton ginning companies. The ginning companies face currency conversion transaction costs when they buy CFAF against their USD export proceeds and when they re-enter the foreign exchange markets to purchase dollars for their fertilizer inputs. Therefore, Burkina’s exposure to exchange rate volatility is exacerbated by repeated transactions to and from the US Dollar. This impact of transaction costs on profit margins for cotton producers in Burkina Faso is not insignificant. 1.83 Burkina Faso’s ginning companies should adopt a risk mitigation strategy based on three criteria to address exchange rate volatility. Using a multi-pronged strategy, the Burkinabe ginning companies should (i) minimize the number of CFAF/USD transaction costs due to repeated exchange rate transactions to convert CFAF to USD for import payments at the beginning of the season and to again convert USD export proceeds to CFAF at the end of the season. This should be done by establishing a USD account where export proceeds and input import payments can be netted prior to conversion to the local currency; (ii) leverage USD denominated trade finance instruments to minimize the currency mismatch from incoming dollar receipts (export proceeds) and outgoing payments (input imports). Utilizing USD-denominated import letters of credit against USD-denominated export letters of credit will facilitate cash-flow management without the need for repeated currency conversion transactions in the USD-CFAF exchange rate markets and finally; (iii) hedge net USD export proceeds after import orders have been placed for fertilizers against projected export proceeds based on annual cotton production estimates. Burkina Faso can leverage its pegged exchange rate to the Euro and access the deep and liquid EUR-USD forward exchange rate market. Hedging expected USD export proceeds against the Euro exchange rate early in the season will effectively hedge the USD-CFAF exposure for the cotton ginning companies. 41 Conclusions and Policy Recommendations Step 1 - Ginning companies to reduce CFAF/USD currency conversion transaction costs by opening USD accounts to net import payments against export proceeds 1.84 Burkinabe farmers are ultimately bearing the currency risk exposure through increased cost of inputs. Farmer’s margins after payment of inputs have seen a steady decline over the past several years. (FSAP, 2008) Currently, the ginning companies are effectively passing on the import prices that are linked to the dollar conversion rate without any measures for the mitigation of exchange rate volatility. Therefore, farmers face higher payments for imports in the domestic currency not just because of global rising fuel and oil prices which have led to higher fertilizer prices, but also because of the EUR-USD exchange rate volatility. The lack of exchange rate risk mitigation by the Burkinabe ginning companies also fails to protect the local banks that face less currency risk but a higher default risk. 1.85 The cotton ginning companies should request authorization from the Ministry of Finance to open a US dollar denominated foreign exchange account. The opening of a US Dollar account by the cotton ginning companies to collect export proceeds and make import payments will sharply reduce the transaction costs associated with repeated currency conversion. At the government level, the Burkina authorities can facilitate the establishment of a US Dollar based account for its three main ginning companies in order for cotton export proceeds to be utilized for making import payments. Export proceeds should be converted to CFAF only after payments on US Dollar based imports have been made at the end of the season. Step 2 - Minimize currency mismatch in the case of incoming receipts and outgoing payments through US Dollar denominated letters of credit for imports and exports by Burkina ginning companies 1.86 Transactional efficiency using trade finance instruments to reduce the impact of exchange rate volatility on the trading costs of cotton ginning companies can result in materializing immediate benefits to the Burkina cotton sector. Both the international cotton markets as well as the fertilizer markets are denominated in US Dollars. The cotton ginning companies should institutionalize a trade finance regimen that offsets US Dollar import payments against US Dollar export proceeds prior to currency conversion into CFAF, thereby avoiding sizeable transactions costs in currency conversion to the detriment of the cotton sector’s profitability. 1.87 Trade finance instruments such as letters of credit for import and export transactions should be denominated in US Dollars. Under this arrangement, the international banks and input suppliers that provide the financing for imports should use the US Dollar as the base currency for the letters of credit. The cotton ginning companies should use their end-of season dollar proceeds to offset these payments. Converting CFAF to USD when import payments are due leads to exposure to the USD-CFAF exchange rate and uncertainty (between the time when import orders are placed and the point of currency conversion at payment) of the actual local currency cost of imports. Finally, the ginning companies can manage the timing of incoming versus outgoing cash-flow, by instituting a trade finance regimen, where the export 42 letters of credit are shorter dated instruments than longer dated import letters of credit (which currently allowing of 270 days of credit). Step 3 - Hedge against exchange rate volatility on net export proceeds using forward exchange rate contracts in the USD/EUR foreign exchange markets 1.88 The net export proceeds can be hedged against foreign exchange risk earlier in the year using derivative instruments such as a forward contract. Given the large number of transactions in the cotton industry that use credit financing, accurate accounting of the expected export proceeds and committed import payments can result in heightened visibility of net proceeds due at the end of the cotton season. Once the net proceeds have been calculated, this amount can be hedged against exchange rate fluctuation using a derivative instrument such as a forward contract. Forward exchange contracts are used by market participants to lock in the exchange rate in the future. A forward contract is a binding obligation for an exchange of funds at a future date and there is no payment upfront. At the end of the season, Burkina cotton ginning companies can convert the net USD export proceeds to Euros based on the agreed forward exchange rate. Transactions involving derivative instruments such as the forward contract will need to be made in the EUR-USD markets as the derivative markets for emerging currencies such as the USD-CFAF are not very liquid or very deep. 1.89 Burkina Faso has the opportunity to leverage its pegged currency exchange rate of the CFAF to the Euro to access the EUR-USD foreign exchange market, which is one of the most liquid foreign currency markets. Prior to the financial crisis of 2008, on average the forwards market priced EUR-USD contracts as competitively as 5pips (1 pip = 1% of 1% of the amount being hedged) from rates on the screen. The forward contract will address the economic risks associated with exchange rate volatility and any unexpected impact on ginning company balance sheets in the future. Finally, in order to address concerns arising due to risks related to cotton price (market, quality); losses in storage and local transportation; and shipping and final delivery (FSAP, 2008), GPCs should hedge 80%-85% of forecasted net proceeds leaving remaining proceeds unhedged. This will avoid the situation of the ginning companies being overhedged at maturity of forward contract. 1.90 Given the existing balance sheet history of Burkina Faso’s ginning companies; the government will need to play the role of guarantor initially in order for the ginning companies to receive efficient pricing on forward contracts. Credit-worthiness is a key requirement by banks entering into forward transactions due to counterparty risk i.e. failure to deliver funds at the future delivery date. The government will need to provide guarantees for banks to agree to face the cotton corporation in forward exchange rate transactions which are highly credit intensive. In the medium to long term, as the cotton ginning companies’ risk management capacity is increased through training and experience, the use of export L/C’s as collateral can serve to meet the credit concerns of banks entering into forward contracts with the Burkina ginning companies. Over time, the ginning companies can build their credit history and use the same banking institutions for executing the USD-EUR forward contract that are holding their export letters of credit (which can serve as collateral). 43 Step 4 - Instituting a risk management unit within cotton ginning companies is necessary to ensure a transparent and effective risk management strategy while also addressing local capacity constraints. 1.91 Ginning companies will need to establish an internal risk management unit with one risk management specialist heading a two person department to manage trade finance negotiation and cash management roles. While the risk manager will need to be familiar with executing transactions in the foreign exchange market; the cash management role will need to optimize the use of the USD dollar account for incoming and outgoing payments at year end. In addition, the negotiation of trade finance instruments to manage the timing of incoming and outgoing payments via letters of credit will require a seasoned banking professional. A three person unit housed within a ginning company will be able to execute the proposed risk management strategy outlined in this section. 1.92 In conclusion, Burkina Faso’s cotton sector depends on the cooperation between the cotton ginning companies and the government to institute the necessary mechanisms required for effective risk management. In the short term, the cotton ginning companies of Burkina Faso should request authorization from the Finance Ministry to open USD accounts and net import payments against export proceeds prior to any local currency conversion of proceeds. In the medium term, there is a need develop trade finance capabilities at the cotton ginning company level to negotiate and manage the timing of incoming and outgoing payments via letters of credit related to the import and export needs of the cotton sector. In the long term, the cotton industry will need authorization from the authorities to execute forward currency contracts to hedge their net USD export proceeds in April, after import orders have been placed for fertilizers against projected export proceeds based on annual cotton production estimates. Table 1-15: Responsibilities of the Cotton Ginning Company’s Risk Management Unit ROLE RESPONSIBILITIES Risk Manager x Once a year, purchase a USD-EUR forward contract to exchange US Dollar net proceeds to Euros in March of next year after production estimates are finalized and import orders placed x Publish quarterly statements with USD account balance and cash flow details Trade Finance Specialist x Develop and manage the schedule for import orders and expected export receipts x Negotiate letters of credit and guarantees with international banks on export and import transactions Cash Management Specialist x Perform cash management function for the US Dollar account with incoming export proceeds and outgoing import payments x Convert net EUR export proceeds to CFAF using the pegged exchange rate 44 OPTIONS FOR INCOME-ENHANCING DIVERSIFICATION Export Performance in Burkina Faso 1.93 Landlockedness and overt dependence on cotton exports are identified as constraints on trade competitiveness and growth in Burkina Faso. Despite reforms that occurred in the 1990s, the diversification has yet to unfold in Burkina Faso. The experiences of similar countries suggest that the crux of development lies in achieving a critical balance between efficiency-improving reforms and economic diversification (Commission on Growth and Development, 2009). Imminent windfalls from newly discovered metal deposits seem to promise a structural transformation away from cotton. However, the discovery of metal deposits can be a double-edged sword that can undermine sustainable and inclusive growth in natural resource rich economies. The challenge of income-enhancing diversification will lie on the one hand in maximizing growth in the uncarded cotton and metals-based economy, and on the other hand, in offsetting overt dependence on these primary commodities by fostering diversification into more sophisticated agricultural exports. Undoubtedly, this is a daunting challenge, but it appears to be the only approach that could thrust the Burkinabè economy onto a faster and sustainable growth trajectory in the direction of a middle-income country.56 1.94 In Burkina, there is a negative correlation between export concentration and income levels (Figure 1-18). However, none of the measures of economic and export concentration is able to provide any country-specific policy pointers beyond the general case that diversification is good for growth. The Herfindahl Index (HI)57,58 has been higher than 0.5 in the past five years. This indicates that Burkina Faso has highly concentrated exports in a relatively narrower income range compared to richer economies. By contrast, Singapore, Brazil, Chile, and Mexico typically 56 This section will provide an analytical approach to the design of an economic diversification strategy, with emphasis on export diversification. The recommended approach can be leveraged by the government of Burkina Faso to inform polices for economic diversification. It takes a forward looking view that assumes that the status quo offers necessary but not sufficient conditions for economic diversification. It also looks at the evidence from Burkina Faso and comparable economies which suggest that diversification will likely require some level of government facilitation in the area of public goods. This section uses a combination of conventional and unconventional evidence-backed concepts to design options. Data used is trade-related. 57 Figure 1-19 represents the U-shaped relationship between economic/export concentration and per capita income hypothesized by Imbs and Wacziarg (2003). 58 The Herfindahl index simply computes the sum of squared shares of the variable in question, in this case export shares, or N HERFINDAHL ¦s 2 i i 1 where s i is the share of total exports attributed to the ith industry. It lies between 0 and 1 where being close to 0 indicates well diversified exports. The HI indicates that there are two factors that can lead to a lower HI: an increase in the number of products or a more even distribution of the shares of the products. For the remainder of this study, it will be useful to think about diversification in terms of thresholds. Economies with highly diversified export baskets are likely to have Herfindahl indices below 0.10, while those with concentrated ones above this threshold. 45 have highly diversified export baskets – therefore, they have HI scores that are less than 0.10 across a wide income range (Figure 1-19). Figure 1-18: The Relationship between the Herfindahl Index of Export Concentration and Per Capita Income GDP per capita and Export Diversification, 2000-2004 AGO NGA .8 GNQ rts COG TCD xpo BWA .6 GAB fE MLI VEN xo BDI ZAR de SYC LBR l In .4 MOZ BFA ah RWA rfind ETH MLT ZMB BHR .2 e UGA GHA H TGO ZWE CHL KEN BRB MAC SGP TZA IDN ZAF MEX ARG KOR CHN THA BRA 0 0 5000 10000 15000 20000 2 GDP per capita constant US$(2000) Author's calculations Data Source: UN Comtrade (SITC Rev. 2 - 4 digit) and the World Bank (World Developmen Source: Authors’ calculations, COMTRADE, SITC 2- 4 digit. RWA - Rwanda., BFA – Burkina Faso, MLI – Mali, CHN- China, BRA – Brazil. Figure 1-19: Trends in the Herfindahl Index Herf indahl Index of Export Concentration 0.8 0.7 0.6 Herfindahl Index 0.5 0.4 0.3 0.2 0.1 0 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 Benin Burkina Faso Guatemala Mali Rw anda Sri Lanka Tunisia Malaysia Nicaragua Source: Authors’ calculations, COMTRADE, SITC2-4 digit. 46 1.95 Burkina’s natural comparative advantage in cotton has reinforced its export concentration in unprocessed cotton.59 Between 1976 and 2006, Burkina’s HI increased from 0.2 to 0.6, due to an increase in the share of cotton from 32-82 percent. During the same time period, Rwanda’s HI declined from levels above 0.7 when coffee was the predominant export, to around 0.4 when metal exports became equally important. Relative to other coffee and metal exporters outside Africa that are more diversified and richer, the level of the Index in Burkina Faso is still very high. Richer countries such as Guatemala, Nicaragua, Malaysia, China, and Sri Lanka have Herfindahl indices below 0.10.60 1.96 Burkina’s export diversification toward manufactured products has been negligible – most of its exports have been concentrated in the primary products for more than two decades. Exports from the OECD countries consist mostly of manufactured products, such as low, medium and high-tech (LT, MT, and HT) products. Lall (2000) suggested that these types of exports are technologically superior and amenable to sustainable growth, because of their relatively stable prices and because of growing world demand. From 1980-2006, the share of resource-based (RB) and LT products increased marginally in Burkina Faso, because exports of products like sugar (LT) and metals (RB) grew larger. By contrast, in Bangladesh and Vietnam there was a distinct increase in the share of LT, MT and HT products. This was also true of OECD exports, which mainly shifted from LT to HT products. However, primary products (PP) and RB products still prevail in Sub-Saharan Africa as a whole. Nevertheless, most regions diversified away from primary or natural RB exports (Figures 1-20 and 1-21). Figure 1-20: Diversification across Regions61 Regional export Composition Tech categories, 1990-95 Tech categories 2000-04 1 1 .8 .8 .6 .6 .4 .4 .2 .2 0 0 First_EA OECD SA LAC SSAnoZAF First_EA OECD SA LAC SSAnoZAF HT MT LT RB PP HT MT LT RB PP First EA: HKG, TW N, KOR and SGP First EA: HKG, TW N, KOR and SGP 59 Non-cotton agriculture is oriented mostly toward domestic consumption. The manufacturing sector contributes only about 12 percent to GDP. 60 Although the The Herfindahl Index provides a measure of export concentration, it does not provide guidance on the mix of products to be exported. 61 SSA, excluding South Africa. 47 Figure 1-21 Diversification and Export Sophistication in Burkina Faso 1980-84 2000-06 GD BGD IC NIC EN BEN MLI MLI TM GTM M VNM RY PRY FA BFA 0% 20% 40% 60% 80% 100% 0% 20% 40% 60% 80% 100% PP RB LT MT HT PP RB LT MT HT Source: Authors' calculations, COMPTRADE, SITC2 – 4 digit. Paraguay (PRY), El Salvador (SLV), Burkina Faso (BFA), Togo (TGO), Chad (TCD) 1.97 The technology classification is useful in linking an exported product to the income level of its exporters, but its implications need to be interpreted cautiously because it suggests that for a country like Burkina Faso, manufactured exports may be the only path to economic development.62 Products such as cotton, fish and fruits are all classified as ‘primary’. However, the income levels of households that produce these products are significantly higher than that classification would imply. The worldwide demand for these products – unlike unprocessed cotton – rises as countries get richer and consume more fresh produce. They do not have good substitutes. Their exports reflect a certain level of technological sophistication that an exporter needs to acquire in order to comply with the strict phytosanitary standards of higher income countries. Furthermore, exports of these products indicate domestic capabilities that can also be utilized to produce similar high-income products. They may also generate forward linkages, as in the case of fish filleting and fresh produce canning and packaging industries that further lay the foundations of light manufacturing.63 62 This message is also echoed by researchers that point to the “Africa� factor as the main cause for a primary exporter like Burkina Faso’s underdevelopment. 63 Another link between what a country exports and how rich it is underlies the Leamer classification of products into 10 sectors based on their relative factor intensities (Leamer, 1984). Leamer categories are: petroleum, raw materials, forest products, tropical agriculture, animal products, cereals, labor intensive, capital intensive, machinery, chemical. This classification suggests that richer countries export more capital intensive products. Unfortunately, this classification is also not too useful for Burkina Faso as unprocessed cotton does not fall explicitly into any of the 10 categories. Within-sector diversification is difficult to analyze when in fact, it may offer the greatest opportunities for income-enhancing export diversification for Burkina Faso. 48 Exports Sophistication 1.98 Burkina Faso’s export sophistication is low. To identify income-enhancing export opportunities, Hausmann, Hwang and Rodrik (HHR) (2007) designed an innovative measure of export sophistication called PRODY. It provides a measurable link between a given product that a country exports and its income level (Box 1-5).64 1.99 Unprocessed cotton has a low PRODY, which indicates the need for Burkina to diversify its exports into higher PRODY products. Between the 1970s and 2007, the structure of Burkina Faso’s merchandise exports moved toward low PRODY products. Unprocessed cotton, Burkina’s leading and traditional export, has a PRODY of only 1,500 (Box 1-5). From 2000-2003, unprocessed cotton exports had a share of about 65 percent, which further increased to 80-87 percent by 2004-2006. The low PRODY of unprocessed cotton is mainly due to the fact that, like Burkina, many other low-income countries such as Uganda and Benin export a large amount of unprocessed cotton. By contrast, the PRODYs of fruits, fish and wood products are higher compared to low-tech products (Box 1-5). Although Burkina Faso exports vegetables, fruits and sugars, which have a relatively high PRODY, their export shares are not high.65 Because the PRODY of a product is identical for all countries, Burkina Faso would benefit from exporting some higher PRODY products which other middle-income countries export.66 1.100 PRODY reveals that manufactured products are not necessarily a prerequisite for growth in Burkina Faso in the short-to-medium term. By attaching an income level to each product, it makes it possible to differentiate between exporting sesame and cotton and whether diversification into sesame would enhance Burkina Faso’s per capita income in the long-term. The higher PRODYs of fruit compared to raw cotton suggests that the former may be a good candidate for a diversification strategy for Burkinabè farmers. The leap from agriculture to manufactures would be unrealistic in the medium-term. Structural transformation within the agricultural sector may be compatible with Burkina Faso’s current stage of development. However, in the long-run, income-enhancing diversification into higher PRODY67 products would need to be considered. 1.101 The overall income potential of Burkina Faso’s export basket remained low relative to landlocked cotton exporters outside of Sub-Saharan Africa. This is reflected in the low per capita income despite high growth rates in the past two years (Figure 1-23). Burkina Faso’s EXPY (in PPP) was 1,700 in 1976 – it rose to 2,900 in 1995, but declined to 870 in 2006. It was lower than EXPY trends in the landlocked and low-income Lao PDR, Paraguay (landlocked and cotton exporter), Nicaragua (cotton exporter), Guatemala (cotton exporter) and Bangladesh68 (Figure 1-24). Burkina’s long-term EXPY trend is nearly flat, which highlights the export 64 A finer level of disaggregation (SITC2 4 digit – about 800 products). In the absence of good production data, these measures rely on export data. 65 A high PRODY product can enhance incomes only if it has a sufficiently large export share. 66 In this sense, the concept of PRODY is close to that of Lall’s technology classification, which also shows that high and middle-income countries export a larger proportion of low, medium and high-tech products. It is also close to the diversification literature for Sub-Saharan Africa, which argues that manufactured products are the pathway out of low-growth equilibrium in Burkina Faso (Wood and Mayer, 2001; and Habiyaremye and Ziesemer, 2006). 67 Diversification that is indifferent to the income potential of products can also occur, but it is unlikely to lead to faster and sustainable growth. 68 Garment exports in Bangladesh lifted its EXPY from 2,500 in 1976 to 3,500 in the early 1990s. Their flat trend since the early 1990s is explained by an over-concentration of mostly low PRODY garment exports. 49 dominance of uncarded cotton with a PRODY of only 1,500. The gap between an almost flat EXPY and a rising per capita income also reflects the fact that exports were not the main engine of growth of income in Burkina Faso.69 When exports of the newly discovered deposits of higher PRODY gold and other metals come on line in a few years, it may cause a significant rise in Burkina Faso’s EXPY. Nevertheless, a rise in the EXPY should not diminish the urgency of diversification into more stable and higher PRODY products.70 Box 1-5: PRODY and EXPY Measurement of Export Income Potential HHR’s concept of PRODY ranks products according to their income potential. The PRODY of a product is the sum of the revealed comparative advantage (RCA)71 of each country which exports the product weighted by its per capita GDP (Appendix 3). For example, the PRODY of quality cotton textiles is high because high-income countries such as the U.S., Japan, Italy and Germany export it. It comprises a significant share of the exports of those countries compared to low-income countries. Not all primary and resource-based commodities are low PRODY products (see Figure 1-22 below). The income potential of a country’s full merchandise export basket can be gauged from its EXPY. The latter is the weighted sum of the PRODYs of all products (the average PRODY) that it exports. The weights are the export value shares of the products.72 Figure 1-22: PRODY of Selected Products 30 25 PRODY ('000) 20 15 10 5 - Maize, unmilled Other Fruit, Knitted/crocheted Paper for printing & writing or chilled Olive oil Palm oil Milk and cream Electronic piston engines receivers, colour & other Int.combustion Television fresh or dried Bacon,ham Articles of fabrics elastic Cocoa beans leather Coffee,whether Cotton (other Potatoes,fresh microcircuits than linters) or not roasted High-Medium-Low Tech Manufactures Primary Products and Resource Based Source: Authors’ calculations using UN-Comtrade Database, based on Hausmann, Hwang and Rodrik, 2007. 69 In countries where exports have played a dominant role in the economy, diversification and a rise in the proportion of products with higher PRODYs have lifted the EXPY and per capita incomes over time. 70 The metal deposits are estimated to last for about a decade (McMahon and Ouédraogo, 2009). 71 Burkina Faso would have an RCA in cotton if the share of cotton in Burkina Faso’s total exports were larger than the share of cotton in total world exports. 72 Hausmann, Hwang, and Rodrik (2007) demonstrate that there is generally a strong and positive correlation between EXPY (denominated in dollar values – US$2,000 constant or PPP) and the exporter’s per capita GDP. 50 Box 1-6: High PRODY of Bacon The average world exports of bacon in 2000-04 were US$1.9 billion. 99 percent of total exports depart from developed countries. Outside developed countries, only China, Poland, Mexico and Brazil have export values of bacon greater than US$1 million. In the world, just 5 countries have a revealed comparative advantage in it. Country Exports (‘000 US$) Market share (%) Netherlands 415,185 22 Italy 383,327 20 Denmark 378,110 20 Spain 127,913 7 Canada 112,455 6 Belgium 106,345 6 Total 79 Source: Authors’ calculations based on Hausmann, Hwang and Rodrik, 2007. 1.102 Competitiveness in a few high PRODY natural resource-based products may trigger higher income levels of growth in Burkina Faso. For rapid growth, not every product Burkina exports needs to be high PRODY, nor must it be a manufactured good. Burkina Faso can maximize the gains from cotton cultivation by reinforcing its comparative advantage in cotton through diversification into genetically modified (GM) seeds and adoption of more efficient production technologies (World Bank, DTIS 2007a). For example, although Chile’s export basket continues to be dominated by copper, Chile has also successfully diversified into high PRODY wood pulp and paper, sawn wood, wine, fish, grapes and other fruits. Malaysia continues to export wood, rubber and palm oil products, but in order to leapfrog to a middle- income status, it developed the capability to export some medium-tech electronics. The dominance of tea exports has not diminished in Sri Lanka, but its dampening effects on EXPY have been mitigated by diversification into garments and electronics.73 73 Brazil’s leading exports remain soy beans, oil cake and iron ore, but it has also developed the capability to export high PRODY passenger cars. The leap in China’s EXPY is an example of a country whose leading exports virtually transformed the economy in a period of less than 25 years. 51 Figure 1-23: Burkina Faso’s EXPY Trend EXPY (cosntant 2000 $) 5000 4500 4000 3500 3000 EXPY 2500 2000 1500 1000 500 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 Benin Burkina Faso Bangladesh Guatemala Lao PDR Paraguay Nicaragua Mali Source: EXPY - Authors’ calculations using UN-Comtrade Database and WDI, based on Hausmann, Hwang and Rodrik, 2007. Figure 1-24: GNI Per Capita in Burkina Faso Compared to Other Landlocked and Natural Resource- based Product Exporters 2580 2080 Income per capita (Current US $) 1580 1080 580 80 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Guatemala Kyrgyz Republic Lao PDR Mongolia Nepal Nicaragua Burkina Faso Paraguay Sri Lanka Source: EXPY - Authors’ calculations using UN-Comtrade Database and WDI, based on Hausmann, Hwang and Rodrik, 2007. 52 Table 1-16: Structure of Burkina Faso’s Merchandise Exports 1976-1980 1981-85 1986-1990 1991-95 1996-2000 2001-02 2003-04 2005 2006 2007 GDP per capita (2000 constant US$) 161 170 180 182 212 229 242 252 258 260 1985 1986 1987 Prody_PPP 2631 Cotton (other than linters),uncarded 31.5% 25.4% 32.7% 1500 9710 Gold,non-monetary 21.6% 38.5% 42.6% 5716 545 Other fresh or chilled vegetables 7.7% 9.6% 6.0% 5477 2114 Goat & kid skins,raw (fresh,salted) 7.4% 4.9% 2.6% 1217 2225 Sesame (sesamum)seeds 5.3% 0.8% 0.3% 1179 2116 Sheep & lamb skins with wool 4.5% 3.3% 2.5% 4956 2238 Oil seeds and oleaginous fruit. 4.5% 4.1% 1.8% 1902 Share of Total Exports 82.6% 86.5% 88.6% 1994 1995 1996 Prody_PPP 2631 Cotton (other than linters),uncarded 57.7% 59.9% 67.6% 1500 9710 Gold,non-monetary 16.4% 14.4% 9.7% 5716 545 Other fresh or chilled vegetables 6.6% 7.6% 4.2% 5477 6116 Leather of other hides or skins 4.2% 4.6% 4.6% 2156 2223 Cotton seeds 2.0% 0.9% 0.0% 2473 2116 Sheep & lamb skins with wool 1.8% 2.0% 0.0% 4956 2877 Manganese ores and concentrates 1.7% 0.0% 0.0% 4238 Share of Total Exports 90.3% 89.4% 86.2% 2004 2005 2006 Prody_PPP 2631 Cotton (other than linters),uncarded 65.2% 80.7% 82.1% 1500 2225 Sesame (sesamum)seeds 4.1% 3.3% 3.7% 1179 579 Fruit,fresh or dried, n.e.s. 1.1% 1.7% 2.2% 5187 611 Sugars,beet and cane,raw,solid 7.2% 1.7% 1.0% 4516 2223 Cotton seeds 1.6% 1.5% 0.6% 2473 1222 Cigarettes 2.8% 1.0% 0.0% 12204 6116 Leather of other hides or skins 0.8% 0.9% 0.9% 2156 Share of Total Exports 82.6% 90.9% 90.5% 53 Options for Export Diversification 1.103 The scope for across sector and within sector income-enhancing export diversification in Burkina Faso may be analyzed based on a framework that combines the concept of PRODY with product space methodology.74 Burkina Faso presently occupies low PRODY trees. It is clearly at the periphery, and its challenge is to jump from cotton and other traditional export trees toward the core. Figure 1-25 presents a map of the product space of Burkina Faso’s current exports. Box 1-7: A Framework to Identify Products with Export Potential To identify products with export potential, it is important to build an analytical framework. Within this framework, each product in Burkina Faso’s export basket is assigned to a category that is determined by its current and former revealed comparative advantage (RCA). An RCA that is less than or equal to 1 is assigned a value of 0. An RCA that is greater than 1 is assigned a value of 1. The time span considered should be about 25-28 years. This period of time is sufficient to study the direction of structural transformation in any given economy. Starting in 1980-1984, Burkina’s exports were classified into four different categories based on their past and present RCA. Those categories are: (i) classics; (ii) disappearances; (iii) emerging champions; and (iv) marginals (Table 1-16). Each quadrant displays: (i) the products in a particular category; (ii) the export shares of those products in two periods 26 years apart; and (iii) their PRODY. The latter suggests that the export share of low PRODY uncarded cotton (1,500) increased from 32 percent to 62 percent. This is detrimental compared to the income growth that would have been possible through an increase in the share of higher PRODY products such as leather, vegetables, sugar, and cotton seed oil. Table 1-17: Sample of Burkina Faso Exports Organized by RCA in 1980-1984 and 2000-2006 (a) The Classics (b) Disappearances RCA 80-84 = 1 SHARE SHARE RCA 80-84 = 1 SHARE SHARE PRODY PRODY RCA 00-04 = 1 80-84 00-06 RCA 00-04 = 0 80-84 00-06 1. Cotton uncarded 32.1 62.3 1,500 1 Oil cake & residues 2.6 0.3 5,718 2 2 3 3 4 4 (c) Emerging Champions (d) Marginals RCA 80-84 = 0 SHARE SHARE PRODY RCA 80-84 = 0 SHARE SHARE PRODY RCA 00-04 = 1 80-84 00-06 RCA 00-04 = 0 80-84 00-06 1 Sugar - 3.4 4,516 1 Cotton seeds - 0.9 2,473 2 2 3 3 4 4 Source: Authors’ representation. 74 Hausmann and Klinger developed the product space methodology in 2006. This methodology is different from a traditional diversification strategy that adopts a value chain approach. For example, if you are a cotton exporter you can diversify by producing ginned cotton or yarn. Instead, the product space methodology allows firms to diversify in a discontinuous manner to products that may not be a part of the value chain. 54 Figure 1-25: Burkina Faso’s Position in the Product Space75 Sheep and lamb Sesame (sesamum)seeds skin leather Leather of other hides or skins Cotton (other than linters),not car Fruit,fresh or dried, n.e.s. Fixed vegetable oils,n.e.s Other fresh or Maize (corn),unmilled chilled vegetables Sacks and bags,of textile materials Buckwheat,millet,can ary seed,grain Manufactures of wood for Cotton seed domestic/d oil Cigarettes Sugars,beet and cane,raw,solid Vegetable products,roo Sugar ts & tubers, confectionery and other sugar Natural rubber latex; nat.rubber & Bones,horns,ivor y,hooves,claws,c ora Plants,seeds,fruit Other musical used in perfumer instruments; not 898. Household appliances,decorative art Soap;organic surface-active product Classics Emerging Champions Disappearances Marginals Source: Authors’ estimates / Map generated using software by Hidalgo, et. al. (2007) available in http://www.nd.edu/~networks/productspace/index.htm. The colored dots are markers of Burkina Faso’s current exports. 75 Non-monetary gold is also an emerging champion, and is located near the natural rubber product exports. 55 1.104 Burkina’s inability thus far to diversify out of cotton indicates that catching-up with richer countries requires different and more efficient ways to reach higher PRODY trees. To determine which high PRODY trees Burkina Faso can move to from its present location depends on its capability and the inputs required for higher PRODY products. Burkina Faso needs to jump to trees in which it has a relatively high density.76 77 If densities of the Burkinabè products are low, then the development of higher density products will require longer-term investments in the factors necessary to produce those products. Moreover, because Burkina Faso and a number of its competitors such as Benin export similar products, the densities of related products are likely to be similar.78 1.105 The four categories of exports identified in Burkina Faso based on their comparative advantage have different income potentials. However, the correlation between density and PRODY of these products is negative.79 This suggests that a scaling-up to higher PRODY products would be a challenge for the Burkinabè exporters (Figure 1-26). However, reversing this negative trend would trigger a process of sustainable diversification. The four categories are: x The classics, which have maintained an RCA greater than 1 in the past (1980-84) and the present (2000-06). These are traditional exports dominated by cotton. They tend to have low PRODYs that reflect Burkina Faso’s low per capita income. A rapidly increasing value (in ‘000s of US dollars) of the classics indicates their growing concentration in Burkina Faso’s export basket. This is mostly due to the high demand for exports of uncarded cotton in China. At 3,100, the average PRODY of the classics is significantly below that of the emerging champions and suggests the diversification into the latter. x Disappearances, which have an average PRODY that is higher than that of the classics. These are products that maintained an RCA greater than 1 in the past, but their present RCA tends to 0. Their density is also very low (0.002 in 2000-2006). Therefore, in the absence of an RCA, it would be risky and inefficient to scale-up these products. Their declining densities also reflect weaker capabilities to export these products. x Emerging champions, which are products in which Burkina Faso has developed an RCA in recent times. They have evolved in a fiercely competitive global market and, on average, have significantly higher PRODYs than the classics. Therefore, they are attractive for income-enhancing diversification. Their lower densities reflect the fact that exporters have had less experience with them. This also suggests that scaling them up would require more effort. 76 This is the capability – or ease of diversification – density (Hausmann and Klinger, 2006). For each product, density measures how close one specific product is to the country’s current production capabilities. Density varies from 0 to 1. The higher the country’s density in a product, the easier it is to develop or maintain an RCA in that product. Density basically measures the ease with which the current capabilities in the economy can be adapted to a new product. Unlike other product space concepts, density is a country-specific concept. 77 Typically, higher densities imply that the country can diversify into the product relatively easily and in the short- term, while lower densities imply longer learning and planning horizons. 78 Two countries are likely to have similar densities for a product if their capabilities are approximately similar, which implies that there is similarity between their exports. 79 By contrast, a positive relationship between the PRODY and density of exports would suggest a dynamic economy in which exporters are rapidly sharpening their capabilities to produce higher value products. 56 x Marginals, which are products in which Burkina Faso has not yet developed an RCA. Some of them are exported sporadically and in very small quantities. Their densities are low (0.003 in 2000-2006). Nevertheless, their PRODY is higher than the classics. They should not be fostered until the country develops an RCA in them and they command a sizable share of exports. Table 1-18: Average Value and Densities for Burkina Faso’s Exports 1980-84 1990-94 2000-04 2005-06 Exports (‘000 US) - Classics 24,942 98,789 155,496 272,043 - Emerging Champions 1,030 1,256 37,943 12,454 - Disappearances 27,075 28,979 5,816 4,428 - Marginal Products 3,027 2,509 6,007 7,211 Prody / Density PRODY Density Density RCA RCA (PPP) 1980-84 2000-06 1980-84 2005-06 - Classics 3,100 0.044 0.156 1 1 - Emerging Champions 5,360 0.001 0.006 0 1 - Disappearances 4,412 0.043 0.002 1 0 - Marginal Products 3,581 0.004 0.003 0 0 Source: Authors’ calculations using UN-Comtrade Database, concepts from Hausmann and Klinger 2007. Figure 1-26: Density and PRODY in Burkina Faso 0.18 0.16 0.14 0.12 ity 0.10 ens 0.08 D 0.06 0.04 0.02 - - 2 4 6 8 10 12 14 16 Prody ('000) Classics Emerging Champions Marginals Dissappearances Source: Authors’ calculations using UN-Comtrade Database and WDI. 1.106 Classics such as uncarded cotton and sesame have the lowest income potential, whereas the strong RCA Burkina Faso has in exporting fruits, vegetables and manufactured leather indicates the potential for diversification. Of all its exports, Burkina Faso has the highest density in uncarded cotton (0.19) and sesame (0.18) – which is consistent with its long experience in cultivation and export of these products. Nevertheless, uncarded cotton and sesame have low PRODY (1,500 and 1,179, respectively) reflecting their primary product status80 (Appendix 4).81 Sesame is often touted as a superior substitute for cotton. 80 Consistent with their technology code PP. 57 However, because sesame’s income potential is even lower than cotton’s, scaling it up would not have an income-enhancing effect.82 By contrast, classics such as fresh fruits and vegetables, and leather have a higher technology content and a significantly higher PRODY (5,187 and 2,156, respectively). This makes them superior alternatives to cotton and sesame. Despite the fact that fruits and vegetables, and manufactured leather have high PRODYs and have given Burkina Faso strong RCAs in the past two decades, they have only managed to capture a low share of exports. This highlights how difficult it has been for Burkina to diversify outside the cotton sector. However, the aforementioned products may be good candidates for scaling-up as a part of an income-enhancing diversification strategy. 1.107 The total export share of the emerging champions inched up from 4 percent in 1980- 1984 to over 15 percent in 2000-2004. The 16 emerging champions – with the exception of natural rubber – constitute a combination of high PRODY primary resource-based products and low-tech manufactures in which Burkina Faso has recently acquired an RCA (Appendix 4). The current export value of each emerging champion is small but growing. For example, Burkina Faso has a relatively high density of 0.182 in sugar, beet and cane (raw, solid), which rivals cotton and sesame. These are perfect candidates for scaling-up in the short-to-medium term. The densities of most of the agricultural and animal product emerging champions are around 0.14- 0.16 higher than the classics, which suggest that a concerted long-term strategy of diversification may be needed to foster the scaling-up of these nascent products. Cultivators could also consider diversifying toward cotton seed oil, vegetable oils, wood products, and even some low-tech products such as sheep and lamb skin leather, sacks and bags of textile material. Non-monetary gold had volatile values in the early 1990s, when its exports boomed and later collapsed. As exports from the newly discovered gold mines come on-line in 2009, the export share of the emerging champions will rise rapidly and record a significant and speedy diversification toward higher PRODY metals. Nevertheless, the limited gold reserves suggest a diversification into more sustainable products.83 1.108 The total export share of disappearances collapsed from 44 percent in 1980-1984 to less than 3 percent in 2005-2006. In the early 1980s, their aggregate export share exceeded the classics. At that time, uncarded cotton (share of 32 percent) and oil seeds (share of 34 percent) comprised over two-thirds of Burkina Faso’s exports. Ten years later, the decline in the share of oil seeds was absorbed by a corresponding increase in the share of cotton. It is not clear why Burkina Faso lost its RCA in a variety of high PRODY animal products, such as hides and skins. 1.109 The marginals have a low importance in the Burkinabè export basket, with shares ranging from 2-5 percent since the 1980s. Most of the marginals, including animal products, live animals, skins and tobacco, also have relatively low densities (range of 0.10-0.17). The classifications of some of these products are anomalies, apparently because they seem to be from the same family, and have a similar PRODY and density. One would expect to find marginals such as cotton seeds, cotton waste, beans, peas and lentils, spices and groundnuts in the emerging 81 Appendix 4 presents a complete product matrix framework. Several export statistics in levels are unreliable (World Bank, DTIS 2007a) and may explain the jumps in levels, especially in recent years. They may also explain some anomalies, such as why beans and peas fall in the marginals group as opposed to the emerging champions. 82 The low PRODY of sesame is explained by the stagnant world demand. This is unlikely to grow as fast as world income as the world supply of sesame comes mainly from low income countries. As more of the latter compete to export it, its price will fall. 83 Current estimates suggest that once the metals are exhausted, the export basket will become concentrated again. 58 champion category. Their misclassification as marginals could be due to data reporting deficiencies.84 Selection of Income-enhancing Exports 1.110 Scaling-up the non-cotton and non-sesame exports is the crux of the export diversification strategy in Burkina Faso. The development of this strategy depends on how far other products’ trees are from the cotton and sesame trees on which Burkina Faso is presently located.85 However, since the distances between the trees are long (distances between products are the same for all countries), income enhancing diversification is unlikely to occur on its own (Figures 1-27). The distance argument based on product location highlights the need for an income-enhancing diversification strategy. 1.111 Thus far, diversification has been negligible because most classics and emerging champions are far from the uncarded cotton tree. It is striking that there are no trees in the vicinity of the cotton tree that would qualify as potential candidates for scaling-up. For example, the closest tree – goat or kid skins – is a disappearance. There are also several marginals and missing exports, but they are not desirable because they have no RCAs, and selecting them would imply picking winners. The classics – sesame and leather trees – as well as the emerging champion sugar and beet trees are the farthest and do not make the jump easily (Figure 1-27). Therefore, an automatic diversification from cotton to other products is unlikely, and explains why – in spite of structural adjustment – diversification in Burkina Faso has not occurred. 1.112 Burkina Faso has an RCA in several emerging champions, such as plants, seeds, vegetables and soaps, which suggests export potential. Figure 1-27 shows that these emerging champions are in the proximity of the classic export – fresh or dried fruits. Since Burkina Faso has an RCA in these products and they are also trees with PRODYs higher than cotton, they may be considered as potentially income-enhancing export products. The other products in the vicinity of the classic fresh or dried fruits are either marginals or simply not a part of the set of products exported by Burkina Faso, which suggests that they would not be good candidates for diversification. 84 Like the emerging champions and some disappearances, the World Bank DTIS 2007 flags them as new exports – although it does not comment on their competitiveness as measured by their RCA. Because the DTIS notes that live animals are an important export product, it is possible that the official statistics are flawed and report smaller figures. To compensate for missing data, import data reported by Burkina Faso’s trading partners (mirror data) were used. This is usually deemed more reliable. 85 Three factors were used to identify which trees Burkinabè firms can jump to: (i) whether they are in the neighborhood, (ii) whether they have RCAs in Burkina, and (iii) whether they comprise a high PRODY, non-cotton export that should be scaled-up. The distance between two trees is useful in determining whether the jump is feasible – the farther the distance, the more difficult will be the jump. 59 Distance Distance Distance 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.36 0.38 0.4 0.42 0.44 0.46 0.48 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 Sheep and lamb skin Goat & kid skins,raw Other fresh or chilled leather (fresh,salted, vegetables Leather of other bovine Edible nuts(excl.nuts Crustaceans and Classics Classics cattle and used for the Classics molluscs,fresh,chil Goat & kid skins,raw Cotton waste (including Plants,seeds,fruit (fresh,salted, pulled or g used in perfumer Source: Authors’ calculations. Bones,horns,ivory,hoove Vegetable Tobacco,not stripped s,claws,cora products,roots & 60 tubers,f Emerging Champion Plants,seeds,fruit used in Emerging Champion Vegetables,prepared Cotton seeds Emerging Champion perfumer or preserved,n. Groundnuts Cotton (other than Spices (except champions (peanuts),green,whether linters),not car pepper and pimento) champions/classics Soap;organic Sesame Hides and skins,n.e.s surface-active (sesamum)seeds Dissappearance waste and use Dissappearance Dissappearance product Beans,peas,lentils & Other fresh or chilled Under other legumino vegetables garments,knitted of cotton Figure 1-27: Distance between High PRODY Trees Leather of other hides or Marginals Beans,peas,lentils & other Marginals Closest Products to Classic: Fruit,fresh or dried, n.e.s. Edible products and skins Marginals Closest Products to Classic: Cotton (other than linters),not car Closest Products to Classic: Leather of other hides or skins legumino preparations n. Sugars,beet and Calf skins,raw Edible nuts(excl.nuts cane,raw,solid Empty (fresh,salted,dried, Empty used for the Empty a. The distance between uncarded cotton tree and the emerging b. The distance between fresh or dried fruits and several emerging c. The distance between leather of other hides and skins and the classics Box 1-8: A Comparison between the Product Matrix Framework and the DTIS Results The product matrix framework helps identify similar products to the World Bank DTIS 2007 recommendations. Appendix 4 shows several overlaps. The list of common products covers all five classics, and nearly all agro-pastoral emerging champions. It does not cover those products that are more processed. Nor does it cover light manufactures, such as musical instruments, wood manufactures for domestic use, simple household appliances, cigarettes, and surface active organic soap and related products that are prolific in all metal/mineral exporting countries. The disappearances list contains several products that DTIS recommended, such as oil seeds and various types of animal products. The marginals list also contains several products DTIS recommended, such as cotton seeds, cotton waste, groundnuts and other animal products. The product matrix framework – like the DTIS – suggests that Burkina Faso does not have a comparative advantage in exporting cotton textiles. The differences with the DTIS recommendations may stem from several factors. First, as the DTIS notes, government data is inconsistent with official trade data. The sole source of data used by the product matrix framework is official COMTRADE statistics. The latter were used to verify that export data reported by the Burkinabè Government matches with data reported by the countries importing Burkinabè products. Therefore, the classification of products in the marginals and disappearances list may include some products that could be classified in a different category. This is highly dependent on the accuracy of the COMTRADE statistics. A significant difference between the product matrix framework and the DTIS is that the former uses a set of objective and robust criteria to screen products in ways that attach to each product a notional income value (PRODY), or a notional capability statistic (Density). Both measures are neutral with respect to data flaws, and independent of whether Burkina Faso has an RCA in the product or whether it is a classic or emerging champion. Density and PRODY are also useful in distinguishing products that can be scaled-up in the medium-term as opposed to the long-term. The framework is useful in informing planning and policy. The DTIS presents a wealth of information regarding each sector, and also the main sub-sectors of Burkina Faso’s exports. It recommends specific actions in the following sub-sectors: x Cotton: increase farmers’ productivity, improve marketing, and manage price fluctuations; x Livestock: clarify the export data, develop semi-intensive animal production systems to increase live animal exports, and reorganize and strengthen associations of actors and professionals; x Sesame: encourage private sector development and better organization within the sector, and increase the share of sesame that is processed in Burkina Faso; x Groundnuts, cashew nuts and shea: improve the groundnut action plan, increase profitable exports of shea nuts, and decide on the level of support to provide to the cashew nut sector; x Cereals: evaluate potential to expand maize exports, collect better information on increased regional cereals trade, increase the volume of processed cereals sold with greater value added, implement Burkinabè standards for cereals, and relaunch the cowpeas sector action plan; x Horticulture: assess and improve Burkina’s competitiveness in horticultural exports, increase the exports of fruits and vegetables to sub-regional markets, and increase the share in European horticultural product markets; x Mines: increase the efficiency of artisanal mines, improve the living conditions of artisanal miners, and improve overall sector management; x Industrial products: increase the value added of by-products, encourage transformation of agricultural products, and develop the hides and skin sector (World Bank, DTIS 2007a). 1.113 Other options, such as ship and lamb skin leather, bones and horns may provide income-enhancing opportunities. The emerging champions – sheep and lamb skin leather, bones and horns and plants and seeds – are high PRODY, and, hence, may be good candidates for diversification (Figure 1-27). They are in the proximity of the classic leather of other hides and skins, which is in a relatively dense part of the forest because there are several attractive trees in the vicinity. This highlights the importance of searching for diversification options not 61 just around cotton, but also around relatively small exports – especially the classic leather of other hides and skins.86 1.114 In the past, gold has not been an outlier in Burkina Faso’s export basket – nor will it be in the future. Interestingly, some of the other products that the country exports – groundnuts, beans, peas, legumes, nuts, hides and skins, leather, and sugar – are in the distant neighborhood of gold. The probability that a given country would have an RCA: (i) in gold and in groundnuts is 0.37; (ii) in gold and in beans and legumes is 0.36; and (iii) in gold and in ores and other metallic concentrates such as manganese and zinc, is 0.51. 1.115 Burkina Faso may consider a mix of agriculture and manufactured products to lead its economic diversification. The automatic diversification into manufactured exports is not necessarily a viable option for Burkina since those areas may require a certain level of capacity development, including capital, skilled labor and technology. Table 1-19 identifies a set of approximately 20 products and industries from the classic (all except cotton and sesame) and emerging champion categories that could be scaled-up to achieve an export basket that has a significantly higher income potential. The PRODYs of all these products are higher than cotton’s and – with the exception of sugar – their densities are lower than cotton’s and sesame’s. Table 1-19: Options for Export Diversification in Burkina Faso PRODUCT DESCRIPTION TECH DENSITY SHARE SHARE SHARE SHARE Type CODE PRODY (00-04) 00-06 80-84 90-94 00-04 05-06 Fruit,fresh or dried, n.e.s. PP 5,187 0.154 2.0 1.5 0.9 2.0 Classic Other fresh or chilled vegetables PP 5,477 0.153 4.0 5.8 1.5 0.7 Classic Leather of other hides or skins LT1 2,156 0.156 0.9 2.2 1.8 0.9 Classic Cotton seed oil RB1 3,173 0.145 - - 1.1 0.1 Emerging Champion Fixed vegetable oils,n.e.s RB1 5,377 0.140 0.9 0.4 0.2 0.2 Emerging Champion Sugars,beet and cane,raw,solid LT1 4,516 0.182 - - 4.2 1.4 Emerging Champion Sugar confectionery and other sugar RB1 8,772 0.127 0.0 0.0 0.2 0.0 Emerging Champion Vegetable products,roots & tubers,f PP 4,789 0.158 0.2 0.0 0.3 0.3 Emerging Champion Plants,seeds,fruit used in perfumer PP 3,622 0.156 0.1 0.0 0.1 0.1 Emerging Champion Buckwheat,millet,canary seed,grain PP 5,009 0.131 0.0 0.1 0.3 0.1 Emerging Champion Maize (corn),unmilled PP 6,430 0.129 0.3 - 1.5 0.1 Emerging Champion Sheep and lamb skin leather LT1 2,526 0.162 0.1 0.2 2.2 0.6 Emerging Champion Bones,horns,ivory,hooves,claws,cora PP 4,419 0.145 0.0 0.0 0.1 0.0 Emerging Champion Sacks and bags,of textile materials LT1 5,209 0.146 0.0 0.0 0.1 0.0 Emerging Champion Manufactures of wood for domestic/d RB1 5,919 0.141 0.0 0.1 0.2 0.1 Emerging Champion Household appliances,decorative art LT2 8,725 0.113 0.0 0.0 0.0 0.0 Emerging Champion Other musical instruments; not 898. LT3 3,843 0.106 0.0 0.0 0.1 0.0 Emerging Champion Cigarettes RB1 12,204 0.118 - - 4.0 1.0 Emerging Champion Soap;organic surface-active product MT2 5,409 0.150 0.0 0.1 0.2 0.0 Emerging Champion Gold,non-monetary RB2 5,716 0.144 2.3 16.9 1.2 1.2 Emerging Champion 1.116 Unsurprisingly, some of the classics and emerging champions in Burkina Faso’s export options can be scaled-up more easily than others. This suggests that the density or capability to export should guide the diversification process and the scaling-up. In the short-to- medium term, the goal should be to reach out for low hanging fruit or to jump to the nearest 86 One can also jump to several other trees whose products Burkina Faso does not export (empty), or which are disappearances or marginals. Because the country does not have an RCA in these products, they would be risky choices. 62 trees, preferably those with fruiter fruits (higher PRODY). Because the three classics with densities of about 0.15 have been exported since 1980, policies that identify and remove constraints that are specific to their scaling-up may be feasible in the short-to-medium term. There is a stronger capability to produce and export champions with densities in the range of 0.14 and upward than the other champions, and the former should be useful in scaling-up in the medium-term. Scaling-up products in industries with low densities would require longer horizons, because the development of industry-specific infrastructure, technologies and skills is a longer-term process. Unless investments in these factors are made quickly, the scaling-up of the remaining emerging champions will not be possible. Although many of the marginals seem like attractive choices for diversification, they are not feasible options because Burkina Faso has never had an RCA in them. 1.117 The list of classics and emerging champions above offers viable diversification options, warranting specific in-depth value chain analyses. Growing domestic demand (estimated at 4 percent per annum) and demand in the regional market represent real windows of opportunity. For example, urbanization and increased income are boosting demand for rice, while demand in the regional market for Burkina’s products (maize, beans, vegetables and livestock) provides export opportunities. Moreover, outside cotton and sesame, Burkina has a real comparative advantage in supplying products, such as fruits and vegetables, hides and skins, to the international markets. Nevertheless, international and regional markets also require quality and timely delivery. To complement product matrix framework, Chapter 6 zooms in on several agricultural products, such as cereals, vegetables and animal products, and provides a detailed Strengths, Weaknesses, Opportunities and Threats (SWOT) analysis of the respective value chains. While the product matrix framework helps identify the income-enhancing products, the SWOT analysis highlights advantages and bottlenecks at micro and meso levels, along the respective value chains. Table 1-20 highlights a menu of promising value chains that may be candidates to diversification. 63 Table 1-20: Candidates to Economic Diversification outside the Cotton Sector Product Space Methodology Sectoral Analysis Cereals, vegetables and other plants/seeds Maize (corn), unmilled*** Traditional cereals (sorghum, millet, maize) Buckwheat, millet, canary seed, grains*** Rice Fruit, fresh or dried* Onions Other fresh or chilled vegetables* Tomatoes Vegetable products, roots and tubers** Green beans Plants, seeds, fruits used in perfumes** Cowpeas Sesame**** Mangoes Shea nuts Animals/meat and other animal products Short-cycle species (poultry, sheep and goats) Cattle/Beef Milk Leather, hides, skins and bones/horns Leather of other hides and skins* Hides and skins Sheep and lamb skin leather** Bones, horns, ivory, hooves, claws** Processed products Cotton seed oil** Fixed vegetable oils** Sugar, beet and cane, raw, solid ** Sugar confectionery and other sugar*** Sacks and bags of textile material** Manufactures of wood*** Household appliances, decorative art*** Other musical instruments*** Cigarettes*** Soap, organic surface-active products** Gold, non-monetary** Note: * Classic – density > 0.15 ĺ stronger capabilities to produce and export. ** Emerging champion – density > 0.14 ĺ stronger capabilities to produce and export. *** Emerging champion – density < 0.14 ĺ weaker capabilities to produce and export. **** According to the product space methodology, sesame is considered to have an income potential lower than that of cotton. 64 FRAMEWORK FOR EXPORT AND INVESTMENT PROMOTION Market Forces and Institutions 1.118 Exports will not diversify unless the overall economic environment is favorable to trade and investment. Diversification typically requires shifting resources across sectors or investing in new areas, which can happen in an economic environment that allows for the competitive production of goods and services. Therefore, the main objective of an export promotion policy would be to reduce anti-export bias, macroeconomic imbalances, and behind- the-border constraints and to improve trade facilitation and access to services (Newfarmer et al., 2009). When promoting diversification through new export activities, there is a need to address constraints that firms may face at the very early stage of discovery process. Policy tools may vary from matching grants for marketing activities, business development assistance or start-up schemes. 1.119 Export and investment promotion are market-driven processes. When information asymmetries and other market failures exist, export and investment promotion programs may be tools to address them. The divesture of the state from most of the sectors with export potential in Burkina has created room for a stronger private sector involvement. Nevertheless, the emergence of a new class of exporters outside of the cotton industry87 has been limited, despite numerous capacity-building programs that provide technical assistance and financial support to smallholder farmers and their associations. Investment and export promotion are always firm-driven processes as they represent a supply response to demand in the domestic and foreign markets. Therefore, the government involvement in export promotion would be only that of a facilitator aiming at addressing asymmetric information and other market failures. In particular, the government involvement could enhance externalities that are associated with gathering foreign market information on consumers’ preferences, business opportunities, quality and technical requirements. This is especially relevant in a market context where private firms are reluctant to share such information with their competitors and to incur research and development costs that can also benefit their competitors (Newfarmer et al., 2009). 1.120 An enabling business environment88 is both a process and an outcome that can enhance domestic and foreign private investment. In the past three years, Burkina has been one of the best performers of Sub-Saharan Africa in the Doing Business ranking due to strong political leadership and a strategic approach to the implementation of business environment- related reforms (Box 1-9). Obviously, a better investment policy framework would enhance conditions for improved domestic private sector performance and attract foreign investors. Moreover, export-oriented foreign investment would support diversification within and outside agriculture through financial transfers and spillovers of technical and managerial know-how. 87 In the cotton sector, a strong and well-structured operator with solid management and technical skills and with access to financing has played a key role in organizing the supply chain and facilitating its access to the export market (World Bank, DTIS 2007a). 88 The first section provides an inventory of the main business climate constraints on firms’ competitiveness. 65 Box 1-9: Successful Reform Implementation for Doing Business Better in Burkina Faso Acknowledging that a good investment climate stimulates the private sector development and increased investment, in the past years the Burkinabè government has undertaken a series of reforms aiming at improving the business environment. It set up a strategic approach and an institutional framework under the Prime Minister’s supervision that enabled the country to make progress in the 2010 Doing Business ranking, from the penultimate place in 2005/2006 to the 147th out of 183 countries in 2009. The successful implementation of such reforms was mainly due to a well-tailored Government strategy which included: x Preliminary diagnostic studies by the World Bank group within the IFC Program Doing Business Better in Burkina Faso. The diagnostic covers the Doing Business themes and the main investment climate issues, involve several studies and consultations with both the government and private sector. x An action plan that a Government official and a private sector representative prepared jointly with the IFC Program Doing Business Better in Burkina Faso. This action plan includes the milestones and the responsible persons for the reform implementation. x Transmission of the reform proposals by the Cabinet of the Prime Minister to the relevant Ministries in charge of reform implementation. x In the implementation phase, on-demand technical and/or financial assistance to the respective ministries by the Doing Business Program. Focal points were set up within each ministry and reform implementation unit. Moreover, several technical committees were set up to ensure reform design and monitoring of implementation in key areas. x A review process. As the deadline for reform evaluation of the Doing Business process is May 31 every year, the Prime Minister convenes a ministers’ council every April to assess progress with reform implementation and ensure implementation of the remaining reforms. x Communication and dissemination process. Every May 15, each concerned minister or unit is supposed to inform the Prime Minister on the implemented reform measures (laws, statistics, activity reports), followed by reform dissemination (meetings, letters, releases). This strategy facilitated significant reform achievements: 3 reforms in 2007, 4 in 2008 and 5 in 2009, as indicated in the table below. Table 1-21: Doing Business Reforms 2007 2008 2009 Business registration On May 6, 2007 the A tax agent has been sent Government issued a to CEFORE to issue decree (amendment to the directly a tax finance law) abolishing identification number to the requirement to register new businesses. This articles and minutes of reform reduced the time founding meeting with the for business creation tax administration. These formalities from 7 to 5 amendments reduce and working days at the accelerate the procedure CEFORE. in the business registration process and Business start-up was reduce the costs involved. eased by allowing publication to be done directly on the Web site of the one-stop shop. This reduces the registration cost. Registering property Burkina Faso cut Amendment of the The establishment of the registration taxes from 15 finance law on May 6, one stop shop for land 66 percent to 10 percent of 2008, this includes a registration, Guichet the property value reduction in transfer tax unique du foncier (GUF), for real property from 10 which was set up on May percent to 8 percent. 2, 2008. The GUF became operational on The number of March 20, 2009. procedures required to Property registration was register of property was streamlined by allowing reduced from 8 to 6. transfer taxes to be paid at Processing time has been the land registry. In cut by 46 days, from 182 addition, new regulations to 136 days. The cost of reorganized the land registering a property was registry and set time also decreased by 2 limits for procedures. percent (from 12.2 to 10.2 Property valuation by percent). government officials after inspections was simplified by using tables of values for properties based on the materials used. Enforcing contract Since October 2006, 4 Contract enforcement was judges have been dealing improved by lowering exclusively with fees and introducing commercial cases in alternative dispute Ouagadougou and Bobo – resolution (ADR) Dioulasso. mechanisms. On January 28, 2009. A circular letter has been issued by the Minister of Justice in order to encourage judges to use ADR mechanism to solve disputes. Dealing with The one stop shop for The one stop shop for construction licenses construction permits building permits (CEFAC) was set up in (CEFAC) is fully December 2007. The operational in CEFAC started its Ouagadougou and Bobo- activities on April 2008 Dioulasso. Technical and by mid- May it had files, which were used to issued its first 20 licenses. be deposited at the The method of fee “municipality� are now payment for building handled through the one permits was changed as stop shop within a period well as the costs involved. of 30 days. The time to For example, costs of the issue permits is on National Laboratory of average 20 days. Public Works were cut from CFAF 700,000 to CFAF 300, 000; municipal charges were cut from CFAF 400,000 to CFAF50,000. The reform cut 17 procedures, 12 days and US$933 from the process of obtaining a 67 construction permit. A decree was issued on May 22, 2008 setting to 10 the maximum number of days to connect a company to the electrical network. Labor The Parliament adopted Burkina Faso’s new Labor Code on May 13, 2008. This new labor code makes it easier for firms to hire workers through fixed term contracts. Requirements for firing employees were reduced. Third party notification consent and approval are also no longer necessary for workers. Priority rules were also abolished. Trading across borders Decisions has been taken to reduce the time to obtain some documents: The Central Bank and the commercial banks association issued letters announcing the reduction of the time to issue the foreign exchange authorization and the letter of credit. The government amended the regulation instituting the escort for goods in transit. The amendment suppressed the escort for specific goods in transit: containerized goods, vehicles, heavy trucks and refrigerating trucks. Paying taxes Burkina Faso reduced its profit tax rate from 35 percent to 30 percent and its dividends tax rate from 15 percent to 12.5 percent, as provided in the amendments to the Tax Code. Source: Doing Business 2010. 68 1.121 With some exceptions, the regime for foreign direct investment (FDI) is generally favorable to foreign investors. Burkina Faso has adopted an open policy in order to attract foreign direct investment ever since it laid the foundations for the market economy in the 1990s.89 The Investment Code of 1995 and its subsequent amendments,90 ensure adequate protection of foreign and domestic investment, including national treatment of foreign investment, capital transfer guarantees and arbitrage rules for investor-state dispute settlement (foreign investors need an authorization). Burkina is a member of the MIGA convention. Therefore, foreign investors are protected against: (i) restrictions on capital transfer; (ii) expropriation; (iii) war and political unrest; and (iv) termination of contracts (UNCTAD, 2008). Nevertheless, the capital transfer guarantee is linked to the minimum capital subscribed by investors and is not explicitly applicable to investment in form of technology transfer or other forms of intellectual property. There are further limitations stemming from a mandatory ex ante investment authorization, and from the obligation for investors to obtain a “carte de commerçant�91 and/or register themselves with the trade register. There is uncertainty with regard to the conditions for granting this authorization, and there is no appeal mechanism in case of disputes (UNCTAD, 2008). 1.122 The Investment Code provides fiscal incentives for exports and new investment under five categories. The Mining Code also includes certain fiscal incentives. The eligibility for fiscal incentives92 under the five investment regimes depends on: (i) the sector (manufacturing or services); (ii) the amount of the investment; and (iii) the number of jobs created. The National Investment Commission is in charge of formulating recommendations for the granting of such incentives based on certain specific criteria93, but no appeal mechanism is in place to challenge its recommendations, which leaves some room for discretionary interpretation. In addition, the 2003 Mining Code94 provides fiscal incentives in the mining field, such as customs duty exemptions in the exploration phase, and VAT exemption on goods and equipment during the exploration phase and during other preparatory activities (UNCTAD, 2008). 89 Burkina is a WTO member. It ratified 10 investment protection and promotion agreements in 2003 and 2004 with several European, African and Asian countries. 90 The Investment Code was amended in 1997, and then again in 2000. An attempt to further amend it in 2007 and introduce more generous tax incentives has not been successful, because the previous set of incentives failed to attract enough FDI. 91 The obligation for companies to obtain a “carte de commerçant� has been recently eliminated. It is still mandatory for individual investors. Companies are still obliged to register with the trade register (UNCTAD, 2008). 92 The fiscal incentives under each of the five categories provide a reduction or exemption from customs, duties, or other indirect taxes on imported or domestic equipment. They also involve a 5-year exemption from the profit tax and other taxes, such as the minimum tax (0.5 percent on the turnover of firms that pay profit tax), “tax patronale d’apprentissage� (4 percent paid by employers for salary incomes and other compensations, and 8 percent for foreigners’ incomes) and “taxes des biens de mainmorte� (10 percent on half of the value of the real estate, UNCTAD, 2008). 93 These criteria include: (i) project value added, number of jobs created; (ii) use of domestic raw materials; (iii) environmental impact; and (iv) overall contribution of the investment to the economy. 94 The 2003 Mining Code includes guarantees for private investors concerning: (i) the exclusivity and renewal of exploration rights; (ii) the granting of exploitation right to the holders of exploration rights who discover deposits; (iii) the possibility of totally or partially transfering these rights; (iv) the liberty of management, marketing, selection of various providers. State protection is ensured through the investors’ obligation to follow an exploration program according to technical specifications during the exploration phase and to have access to the geological information collected during the exploration phase upon expiration of the exploitation right (UNCTAD, 2008). 69 1.123 Nonetheless, the existing export regime has not been very successful at facilitating the expansion of export-oriented activities. The regime grants a 7-year tax exemption for the imported inputs and an unlimited revenue tax exemption of 50 percent. In practice, agro-business exporters have benefited from these advantages to only a limited extent, mainly because of the lengthy and complex procedures for their administration. Consequently, these firms have not always been able to import the necessary inputs that are tax-exempted, which limits their operational efficiency (Dahourou, 2008). 1.124 The Burkinabè tax regime imposes additional administrative costs on investors. The system imposes various levels of taxes on revenues based on the revenue origin and not on the taxpayer type.95 Exporters also cite the following as constraints on their operations: (i) a 0.5 percent minimum tax on turnover (not on profits), which has to be paid even in the case of losses; and (ii) the high frequency of tax payments – one or more taxes are due each month (World Bank, DTIS 2007a). A VAT of 18 percent is applied to all activities, except the exports of goods and the sales of raw foodstuff. However, contrary to international practice, a zero VAT does not exist. This would allow producers to obtain a VAT reimbursement for goods falling under this category. 1.125 Better governance and coordination with WAEMU regional policies is also important to enable foreign and domestic investment. The Burkinabè market is relatively small, which makes it difficult to attract significant and diversified FDI outside the cotton and mining sectors. Therefore, integration with regional policies in the fields of competition, taxation (VAT), the mining code (fiscal incentives) and telecommunications is important for investment. Competition policy is dealt with at the WAEMU level. Decentralization at the national level might help strengthen local capacity to enforce competition rules to reduce prices for consumers and production costs for investors – in particular in the fields of transportation, trade logistics, and telecommunications. In the latter, the transposition of the several recent community directives would ensure the independence of the regulatory telecommunication agency and reinforce the supervision of telecom prices. Strengthening the anti-corruption agenda by introducing e-governance systems combined with streamlining licensing and administrative procedures would help curb corruption at the administration level, and thereby contribute to reducing indirect costs for investors (UNCTAD, 2008). Constraints Related to the Current Framework Export and Investment Promotion Strategies 1.126 In Burkina, diversification is one of the national priorities in the context of rural development, as underlined in various Government strategic documents. The Poverty Reduction Strategy Paper (PRSP) recognizes the need to increase the country’s competitiveness in export markets. Furthermore, the Government has initiated a policy of diversifying export revenue sources through agriculture, agro-processing and the promotion of tourism and mining, which were complemented by investment climate reforms. The new Country Assistance Strategy stresses that Burkina’s development hinges inter alia upon transformation toward a diversified economy. Building on the PRSP, the Schéma National d’Aménagement du Territoire (SNAT) provides a diagnostic and recommendations for economic growth and diversification which 95 A reform of the tax system has been suggested. 70 evolve around: (i) improvement of economic infrastructure; (ii) establishment of support mechanisms for trade; (iii) facilitation of access to resources (finance, production inputs, technology) for economic agents; (iv) increased revenue generation for the population through better access to markets; and (v) support to small and medium-size processing enterprises. 1.127 Thus far, the pro-agricultural approach to diversification has not been able to usher in a new wave of exporters capable of competing internationally. Only the cotton sector has been able to yield results, having produced structured supply chains, and firms with technical and management skills and access to funding. The Ministry of Commerce is responsible for export promotion. However, the Ministry of Commerce is not responsible for either cotton, sesame, livestock and gold, or customs, taxation, labor and infrastructure. This makes it harder for the Ministry to formulate a strategic vision for trade and export promotion. The diversification of non-cotton agricultural products has thus far been the responsibility of the Ministry of Agriculture. The focus has been on the development of production capacity in the rural areas, often with the support of donor programs. Burkina has several producer and exporter associations in the fruits and vegetable, livestock and meat, and cereals sub-sectors. However, a lack of strategic support at the policy level has meant that small farmers have not had the means to solve problems related to poor sales or poor product quality (Dahourou, 2008). 1.128 Acknowledging the lack of a strategic vision for promoting exports and attracting export-oriented FDI, the Burkinabè government is in the process of preparing a private sector development policy as well as specific strategies for export promotion, quality, standards and norms. For agriculture, it already approved an irrigation strategy and an action plan. Diversification outside of cotton is not an automatic process mainly because the way to encourage entrepreneurs to move into unknown activities relies upon reducing the cost of experimentation. Export promotion programs can provide useful support by identifying firms that wish to move into new activities, and help them explore unknown markets through study tours abroad or bringing in consultants that would restructure an existing business. Therefore, an export strategy would: (i) facilitate private sector development in sectors with growth potential; (ii) help identify the factors that limit the development of higher quality and differentiated products; and (iii) address information asymmetries in the search for foreign markets.96 Moreover, the adoption of a strategy to attract foreign direct investment would: (i) improve the business environment; (ii) promote the country’s image abroad; and (iii) attract funds that could generate new growth and export opportunities. Export and Investment Promotion Institutions 1.129 The role of a well-functioning export promotion agency is to support exporters’ efforts to find markets for their products and to understand better the products demanded in export markets. Typically, an export promotion agency may offer a variety of services, such as: (i) country image building (advertising, promotional events, policy advocacy); (ii) export 96 Key elements of an effective trade policy include: (i) a clear trade and export strategy developed with and supported by stakeholders, which is based upon careful identification of the key constraints to trade; (ii) effective consultation with the government, the private sector, and civil society; (iii) successful inter-ministerial coordination; (iv) collection and timely dissemination of accurate, easily accessible trade information; (v) capacity for analysis of trade-related information, and provision of advice on all major trade issues; (vi) effective trade support institutions – standards, export promotion, customs (OECD, 2001). 71 support services (exporter training, technical assistance, capacity building on regulatory compliance, information on trade finance, logistics, customs, packaging, and pricing); (iii) marketing (trade fairs, exporter and importer missions, and follow-up services); and (iv) market research and publications (general, sector- and firm-level information such as market surveys, on-line information on export markets, publications encouraging firms to export, and importer and exporter databases) (Newfarmer et al., 2009). 1.130 Similarly, an investment promotion agency aims at ensuring the coherent implementation of an investment promotion strategy. An investment promotion agency would act as a demand generator through image building, marketing and sales as well as an investment facilitator (aftercare services with regard to licenses, procedures, certification, specific taxes, work, building and residence permits, company registration, utility connections) which would help remove sector-specific barriers to investment. Since many times various ministries and agencies might not see investment proposals in the same way, close coordination between the investment promotion agency and the other public institutions is essential. 1.131 Several institutions in Burkina Faso provide cross-sector support services for trade and exports. Export promotion is the mandate of the Ministry of Commerce. Several other institutions are in charge of providing support services. These are: (i) l’Office National du Commerce Extérieur (ONAC) ; (ii) la Chambre de Commerce d’Industrie et d’Artisanat du Burkina Faso (CCIA); and (iii) la Maison de l’Entreprise du Burkina Faso (MEBF; Table 1-22). In addition, there are specialized bodies, such as the Salon National de l’Artisanat de Ouagadougou (SIAO), and the associations of various agricultural sub-sectors. However, there is no agency in charge of investment promotion, although some of the above institutions exert investment promotion functions. Table 1-22: Export Promotion Institutions Organization Support Services Organizational Sources of Funds Structure ONAC - Training/ Technical Parastatal, linked to the - Government budget Assistance Ministry of Commerce - Service fees - Trade Point - Donors (CCI) CCIA - Representation of private Semi-private - Membership fees sector interests organization, linked to - Service fees - Trade fairs the Ministry of (warehousing, issuance - Promotion of commercial Commerce of certificates of origin, exchanges etc) MEBF - One-stop shop Private not-for-profit - Government budget, - Cheques Conseils Association - cost-sharing by - Matching Grant Fund beneficiary firms - donors (EU, IDA) Source: World Bank, DTIS 2007a. 1.132 The ONAC97 provides a series of export promotion services, but its effectiveness at promoting exports has thus far been limited due to overlap with other institutions, and a 97 ONAC was created in 1974 with the objective of promoting exports. Since 1998, it has had a 12-member board of directors, 9 of whom are private sector representatives. During the first two decades of its existence, ONAC’s funding was secured through a 0.25 percent levy on all imports and exports. This allowed the organization to 72 lack of adequate budgetary means and appropriate technical expertise. ONAC operates with 48 staff. ONAC has a mandate to provide the following services: (i) training and technical assistance services; (ii) financial support for participation in international trade fairs and foreign trade missions; (iii) market research and analyses; and (iv) information services on export products and markets (CAPES, 2003 and Dahourou, 2008). Because its current subsidies are insufficient, ONAC has not been able to offer all the services in its mandate. Furthermore, some of the services overlap with those offered by the Chambre de Commerce and the private sector – in particular, training. This suggests that streamlining its functions to concentrate on services that cannot be provided by the private sector may improve its use of budgetary resources.98 Figure 1- 28 shows that there is a positive correlation between export promotion budgets and exports per capita. It also underlines that despite an export promotion budget which is higher than those of Ghana, Tanzania or Niger, Burkina’s exports per capita are lower than those of comparator countries, suggesting ONAC’s underperformance.99 ONAC’s lack of technical expertise is further reinforced by the fact that the current legal base prevents it from hiring or contracting appropriate experts at sufficiently motivating salary conditions. 1.133 A Trade Point and FASONORM were added to ONAC as separate service providers – the former to facilitate trade, and the latter to define standards and certifications. The Trade Point is designed as a trade facilitation center. It provides electronic information: (i) on export prospects to local exporters; and (ii) on local products to international buyers. It provides information on export market entry regulations and conditions of trade, subscriptions to databases, and assistance for website design. Its website is linked to the international network of Trade Points. In Burkina, as in other countries, the performance of Trade Points has been mixed – they have had trouble keeping up with the accelerated development of electronic information services and being responsive to evolving client needs. FASONORM was created in order to define product standards and provide product certification services for the domestic and export markets, but it is still an embryonic entity. It is expected that its activities will be scaled-up with financial and technical support from the European Commission (World Bank, DTIS 2007a). 1.134 Another agency that facilitates trade, the Chambre de Commerce d’Industrie et d’Artisanat (CCIA),100 has an extensive membership network, but exporters do not always benefit from its services. The Chambre is an independent association administered in majority by private sector representatives that has close ties with the Ministry of Trade. It represents several economic sectors, to which it provides consulting, representation and administrative services. Membership is mandatory for all enterprises formally registered. It is partly financed by membership fees, income from its warehouses, and a number of services that it provides. establish an elaborate structure and provide a range of services. However, the impact of its services on exports was difficult to assess, and a levy on exports was contrary to its objective of export promotion. Therefore, the levy was abolished in 1995, and henceforth ONAC’s funding has come from annual government budget allocations. This funding has declined dramatically since 1995 (World Bank, DTIS 2007a). 98 A significant portion of ONAC’s training courses was sponsored by international organizations such as the WTO, UNIDO, UNCTAD, and ITC. Training is an area where there is a growing supply of private service providers. Therefore, it is not efficient for ONAC to compete with them. 99 Newfarmer et al. (2009) estimate that for every US$1 in the export promotion agency budget, there is an additional US$38 in Sub-Saharan Africa, US$100 of exports in Eastern Europe and Asia, US$70 in Latin America and the Carribean, US$5 in OECD countries, and US$53 in the Middle East and North Africa. 100 It was created in 1948. 73 However, some sectors – such as agriculture and exporters – are not represented, nor have they a strong voice. The CCIA depends on payments by operators for services provided, which has encouraged the emergence of monopolistic behaviors. For example, the warehousing at Ouaga Inter must be paid to the CCIA even if the merchandise remains in the vehicle – and there is monopoly on transit guarantee (World Bank, DTIS 2007a). Figure 1-28: Correlation of Exports to Export Promotion Budgets101 Source: Newfarmer et al., 2009. 101 The Lowess smoother used involves running a locally weighted regression of the log of exports of goods and services per capita on the log of the export promotion agency budget per capita for small subsamples of data. Data is based on a survey of 88 countries that had operational export promotion strategies and replied to a questionnaire covering five parts: institutional structure, responsibilities of the agency, the strategies followed, resources and expenditure, and activities and functions. Bandwidth = .8. ARM = Armenia; AUS = Australia; AUT = Austria; BFA = Burkina Faso; BGD = Bangladesh; BGR = Bulgaria; BLZ = Belize; BOL = Bolivia; BRA = Brazil; BWA = Botswana; CHE = Switzerland; CHL = Chile; CIV = Côte d’Ivoire; COL = Colombia; CRI = Costa Rica; CZE = Czech Republic; DEU = Germany; DMA = Dominica; DNK = Denmark; DOM = Dominican Republic; DZA = Algeria; ECU = Ecuador; EGY = Arab Republic of Egypt; ESP = Spain; EST = Estonia; FIN = Finland; FJI = Fiji; FRA = France; GBR = United Kingdom; GHA = Ghana; GRD = Grenada; GTM = Guatemala; GUY = Guyana; HKG = Hong Kong SAR, China; HND = Honduras; HUN = Hungary; IRL = Ireland; ISL = Iceland; ISR = Israel; JAM = Jamaica; JOR = Jordan; KEN = Kenya; KHM = Cambodia; LBN = Lebanon; LTU = Lithuania; LVA =Latvia; MAR = Morocco; MDA =Moldova; MEX = Mexico; MLT = Malta; MOZ = Mozambique; MUS = Mauritius; MWI = Malawi; MYS = Malaysia; NER = Niger; NIC = Nicaragua; NLD = Netherlands; NOR = Norway; PAN = Panama; PER = Peru; PRI = Puerto Rico; PRT = Portugal; PRY = Paraguay; RWA = Rwanda; SLE = Sierra Leone; SLV = El Salvador; SVK = Slovakia; SVN = Slovenia; SWE = Sweden; THA = Thailand; TTO = Trinidad and Tobago; TUN = Tunisia; TUR = Turkey; TWN = Taiwan, China; TZA = Tanzania; UGA = Uganda; URY = Uruguay; VEN = República Bolivariana de Venezuela; WBG = West Bank and Gaza; YEM = Yemen; YUG = the former Yugoslavia; ZAF = South Africa; ZMB = Zambia. 74 Box 1-10: What is required for Successful Export Promotion? Seven factors have been identified as important for a successful export promotion effort: 1) There must be an appropriate enabling environment for exports. The following factors tend to create an anti- export bias: (i) an overvalued exchange rate; (ii) a tariff structure that leads to high nominal and effective rates of protection; (iii) significant non-tariff barriers to trade due to costly customs procedures; (iv) inappropriate quality controls; (v) excessive administrative barriers; (vi) a lack of trade finance; and (vii) a weak trade supporting infrastructure. 2) The export promotion/development agency should be autonomous, but needs high level government support. This helps the agency gain the confidence and trust of the business community, while having sufficient political clout to influence policymaking. 3) The strategy of the export promotion agency must be demand-driven. The agency should have a large share of the executive board in the hands of the private sector, but it should also have a large share of public sector funding. The board should be comprised mainly of experienced exporters, and be headed by a respected business leader. A single and strong agency should be preferred to the proliferation of agencies with export promotion activities. 4) The agency needs to strike an appropriate balance between offshore and onshore objectives and activities. Trade promotion organizations have tended to focus on offshore activities, such as market research and information gathering, trade representation and trade fairs. Those activities are generally ineffective unless appropriate attention is given to the onshore objective of enhancing competitiveness by assisting firms on issues such as pricing, quality, standards, access to appropriate inputs, and applying relevant business models. In particular, agencies in developing countries are better off focusing on onshore activities. Moreover, the agency should focus on nontraditional exports or have some broad sector orientation rather than attempt to promote exports overall. It should focus on firms that are not yet exporters, rather than on established exporters. 5) Proper staffing is crucial. An effective trade promotion organization requires staff with commercial experience from the private sector. Therefore, it must be able to offer salaries and conditions that will attract such staff. 6) Adequate funding must be made available. While donor financing can initially be useful, the agency must be sustainable, which requires adequate funding from domestic sources. Charging for services through user fees – probably on a cost-sharing basis – is one important source of revenue and discipline to ensure that the services are relevant and of value to clients. Other activities with important externalities – such as those which enhance the country’s reputation for quality – should be covered through a line item in the government budget and member dues. 7) Ensure monitoring and evaluation of results. The effectiveness of trade promotion activities must be monitored and periodically evaluated in order to ensure that lessons are learned, strategies are refined, and best practices are applied. Source: De Wulf, 2003 and Newfarmer et al., 2009. 1.135 A third institution, MEBF102, acts as an intermediary for business support services. It contracts out these services to private providers in order to build up the local market for business support services. Two donors have decided to entrust their support programs to the MEBF: (i) the European Commission with its Chèque Conseil program, which provides subsidies for a number of consulting services; and (ii) IDA, which provides partial financing for a broad range of training and technical assistance services. It is expected that other donors will entrust their programs to the MEBF, providing a financial base for the secretariat. One of the key 102 It was established in 2002. 75 challenges facing MEBF will be to secure its financial sustainability in light of the short lifecycle (3-5 years) of most donor programs. 1.136 In the absence of a specialized agency for investment promotion, several other bodies are in charge of designing the overall roadmap for investment promotion and facilitating the public-private dialogue on investment issues. For example, the Conseil présidentiel pour l’investissement was created in 2007 to define the overall strategy for attracting foreign and domestic investment (both public and private). The Conseil économique et social has a consultative role on a wide number of economic issues. La Commission nationale des investissements is in charge of examining issues related to the implementation of the Investment Code. Le Bureau des mines et de la géologie du Burkina (BUMIGEB) is in charge of promoting investment in the mining sector, and l’Office national du tourisme de Burkina (ONTB) is in charge of promoting investment in the tourism sector (UNCTAD, 2008). Export Promotion Instruments 1.137 The Burkinabè exporters do not benefit of any specific financial support, and they have difficulty obtaining loans from financial institutions for the financing of their projects. Access to finance is cited as one of the main constraints facing Burkina exporters. The problem is exacerbated by the fact that financial institutions mistrust the export business, because its income flows are not sufficiently secure (purchase contracts, solvency of the buyer) and can at any time be jeopardized by inclement weather, non-compliance with the required norms and standards, or late delivery. Furthermore, the failure in the 1980s and 1990s of public enterprises such as FLEX FASO and UCOBAM (which specialized in the export of fruits and vegetables), has made banks more cautious in dealing with these types of contracts and the kind of products exported with their funding (Dahourou, 2008). 1.138 Typically, it is easier for large national companies or subsidiaries of multinationals operating in agro-business to obtain credit lines to finance their production cycle, than it is for smaller exporters. Companies such SOFITEX, SN CITEC, MABUCIG, and FASO COTON are able to obtain the necessary financing due to their financial strength, transparent methods of management, and mastery of sales conditions at the international level. Similarly, individual major exporters of raw products such as sesame, shea butter, cashew, and cereals, also have sufficient access to finance either directly or through pre-financing from their foreign partners. By contrast, smaller exporters, individuals or grouped in associations, need to develop partnerships with intermediaries in the country for the pre-financing of their season. For example, in the area of fresh or dried fruits and vegetables, there are several firms run by European companies that pre-finance a part of the season and centralize deliveries for export to foreign markets. It is the European companies that own the purchase contracts. The two leading firms in the world in the purchasing and processing of shea butter have representatives in Burkina Faso that pre-finance the season (Dahourou, 2008). 1.139 Matching-grant funds are emerging instruments to support export promotion in Burkina Faso. Support services for export-oriented farmers and farmers’ associations are emerging. For example, a matching-grant fund has been put in place under the 2007 World Bank’s Agricultural Diversification and Market Development Project (PAFSP). This project emphasizes capacity-building within a number of selected agricultural value chains (cattle, meat, mangoes, onions and chicken). Coordination with the Maison de L’Entreprise is expected to 76 strengthen the capacity-building activities. Thus far, the matching-grant fund and the chèques conseils services have produced adequate results. More than 5,000 persons have been trained. At least 300 requests for advisory support services have covered topics such as company management, corporate governance, business plan development, and trade promotion. La Maison de l’Entreprise also set up a one-stop-shop to assist maximum 50 exporters, but this capacity seems to be limited (Dahourou, 2008).103 Box 1-11: Instruments for Export Promotion in Tunisia The main agency responsible for export promotion in Tunisia is the Centre de Promotion des Exportations (CEPEX). This structure was established in 1973 as part of the Ministry of Commerce, to provide technical and financial support to Tunisian exporters. In 1997, the Conseil Supérieur de l’Exportation et de l’Investissement (CSEI) was created and is presided over by the Head of State. There was a sudden and substantial decline in Tunisia’s exports in the late 1990s. This revealed the country’s vulnerable export position, which was based primarily on garment assembly firms that operated as sub-contractors for buyers in a small number of European markets. The Government concluded that CEPEX had failed to prevent the export decline and that a new export promotion approach was required. A subsequent request to the World Bank for assistance led to the creation of the Fonds d’Accès au Marché d’Exportation (FAMEX) in 1999. FAMEX has a strictly limited mission: (i) to help existing exporters introduce new export products or enter new export markets; (ii) to help garment manufacturers graduate from sub-contractors to independent garment exporters; and (iii) to encourage entrepreneurs to become exporters. FAMEX manages a matching-grant fund that provides partial financing for the development and execution of export plans. FAMEX does not provide these services itself, but acts as an intermediary between its clients and a network of local and international consultants. Breaking with a long tradition of strict control of parastatals, the Government agreed to an arm’s- length relationship, allowing FAMEX to be managed as an independent private sector agency. FAMEX has been instrumental in expanding Tunisia’s export base by supporting Tunisian exporters who have: (i) introduced new products – notably engineering and consulting services and food products; and (ii) entered new markets in Europe, sub-Saharan Africa, the Middle-East, and North America. Based on these results, the Government decided to continue the program with a World Bank-financed FAMEX II. The Tunisian experience offers interesting lessons on the key factors for the success of an effective export promotion program: x Well-defined objectives; x Protection of the decision-making process from political interference; x An effective management structure comprised of a small team of highly-qualified experts, who are remunerated according to private sector standards; x Emphasis on establishing effective links with strategic export markets; x Utilization of cost-sharing and outside expert services; x Assessment on the basis of specific results. Source: World Bank, DTIS 2007a. 1.140 The existing employer training tax (taxe patronale d’apprentissage) may be a useful tool for promoting skills development programs for exporters. This tax is levied on the payrolls of enterprises – annual proceeds are about US$4.6 million. These proceeds are transferred to the Burkinabè Treasury. However, they could be used to fund a program to reinforce technical, marketing and general management skills in the private sector. 103 Matching grants that are provided to private exporters may be targeted to: (i) explore export markets; (ii) identify the requirements of target export markets in order to improve product quality; and (iii) identify outside firms that have the required expertise (World Bank, DTIS 2007a). 77 Implementation of the program would involve a mechanism built in to establish sustainability over the long-term.104 Clear private sector ownership and transparent procedures would attract additional funding from other sources. In Côte d’Ivoire, the national training levy scheme received substantial donor support once the Government had committed itself to reform its management structure and provide direct oversight and control to private sector representatives (World Bank, DTIS 2007a). 1.141 Some support structures have attempted to raise additional revenues by selling trade services for a fee. This approach has its limits – it may create unfair competition to purely commercial providers of support services, thereby obstructing rather than promoting private sector development. Standardization and Quality Certification 1.142 The development of a national quality system is essential in order to add value to traditional exports and to promote new exports. This implies the enhancement of the quality and standards of exported products to meet consumers’ demands and environmental standards in developed countries.105 1.143 Standardization and quality promotion systems are being developed in Burkina. In 2007, the legal framework was partially set up to establish a national system of standardization, certification, accreditation, and quality promotion. A national quality policy is currently being developed. This policy is expected to render the law adopted in 2007 operational, establishing a national system for the standardization, certification and accreditation of the Burkinabè products. This system will help firms identify the product requirements of the targeted market and comply with the characteristics of those markets. 1.144 The national standardization body, FASONORM, has had limited activities due to a lack of adequate financial and human resources. FASONORM is part of ONAC and is responsible for developing product standards and providing certification for both domestic and export markets. It has adopted standards for fruits and vegetables, cereals, beans and cowpeas. However, exporters do not always rely on them, because they primarily seek external certification such as EUREGAP for the EU market. There are plans to restructure FASONORM. 1.145 Product certification involves several bodies, which may delay timely product shipping due to numerous and lengthy procedures. It is performed by a number of administrative departments, in conformity with the technical regulations issued by the ministries. The Department of Plant Protection and Packaging (DPVC) is in charge of certifying plants’ 104 International good practices indicate the following success factors for such schemes: (i) the unimpeded transfer of the levy proceeds into a secured account needs to be ensured in order to prevent misappropriation of the funds; (ii) the scheme needs to be managed by a professional management team, which should be provided with complete management and financial autonomy, based on transparent decision-making procedures; (iii) a solid governance structure needs to be put in place, including a tri-partite board with oversight responsibility; (iv) the scheme should not provide skills development services itself, but rather act as an intermediary; (v) there should be no restrictions on service providers – private, public, NGO and institutional entities should all be eligible, and allocations should be made on a competitive basis (World Bank, DTIS 2007a). 105 The existence of a national quality system is important in the light of the Agreement on Technical Barriers to Trade (TBT) and the Agreements on Sanitary and Phytosanitary measures (SPS). Typically, National Information Points (NIP) are set up in WTO countries to inform on standards, technical regulations and procedures for assessing compliance with standards and technical regulations (Dahourou, 2008). 78 phytosanitary status. The Department of Veterinary Services is in charge of certifying the sanitary status of animal products and products of animal origin. The Inspectorate of Quality and Metrology (IQM) issues national compliance certificates for foodstuffs, plants, animals and products of animal origin. The Burkina Mines and Geology Bureau is responsible for the certification of precious metals (Dahourou, 2008). 1.146 There are several control laboratories in Ouagadougou and Bobo Dioulasso. These are: (i) the National Public Health Laboratory; (ii) the Laboratory of the Food Technology Department of Ouagadougou and Bobo; (iii) the National Livestock Laboratory; and (iv) the Quality Control and Metrology Laboratory. Inspection and conformity control are ensured by: (i) the Inspectorate of Control and Metrology; (ii) the Department of Plant Protection and Packaging (DPVC); and (iii) the Department of Animal Health. 1.147 At the firm level, only a few business associations and SMEs have incorporated quality control systems within their operations. These are: (i) the Burkina Association for Quality Management; (ii) the former Burkina Association of Quality Circles; and (iii) SMEs operating in the food sector and exporting to the European market. The establishment of a quality system at the firm level is expensive, and sometimes requires additional investments in equipment, production space, packaging, and hygiene standards for operations (Dahourou, 2008). Obviously, the setting up of quality tools systems would improve the production process and the final quality of exportable products. The real challenge lies in raising awareness and implementing campaigns targeted toward exporters on the importance of standards and product quality. Box 1-12: Capacity-Building Programs to Support Quality Promotion The Quality Program (2002-2005) of the WAEMU supported capacity-building of the national quality system through equipment and training. The objective of the program was to contribute to the regional integration process through the establishment of: (i) regional cooperation in the area of quality promotion; and (ii) a regional system for accreditation, certification and standardization. In addition, the program carried out dissemination activities regarding quality control and the strengthening of technical support services for quality management involving the private sector. This EURO12.5 million program was implemented in seven WAEMU countries. In Burkina Faso, it aimed: (i) to upgrade the testing laboratories by supplying equipment for their accreditation; (ii) to support National Standardization Organization (FASONORM) activities; and (iii) to assist selected firms in setting up quality systems for ISO 9001 certification. The second phase of the program, amounting to EURO14 million, included WAEMU countries, ECOWAS and Mauritania. It was launched during the second quarter of 2008. Its objective was to ensure continuity of the actions taken during the first phase. The main activities undertaken under the first phase of the program included, among others, the adoption of several implementing regulations on accreditation and metrology, training activities on the financial management of laboratories, good practices for laboratory management and accreditation procedures, the ISO/CEI 17025 standards, the European regulation on the development of tracking system within firms, the weighing and measurement systems, and the training of phytosanitary and animal inspectors. Source: Dahourou, 2008. 79 VAT Reimbursement Mechanisms for Exporters 1.148 VAT refund mechanisms on inputs used for exports are lengthy and can have a significant impact on firms’ cash flows. According to two recent IMF studies106, it takes 10 months on average to settle a VAT reimbursement in Burkina Faso, whereas the international standard is one month.107 The IMF describes reimbursement delays as a real “export tax.� Companies that produce for local markets can deduct the VAT paid on inputs before submitting the VAT collected on their sales. An exporter does not collect taxes on its foreign sales, but it still pays VAT on inputs (World Bank, DTIS 2007a).108 1.149 VAT reimbursement delays affect the mining companies. They pay for expensive goods and services such as drilling. This can cost more than US$10 million per year, even during the pre-feasibility period. It can take seven years of investment before production starts. The VAT (18 percent) on such an amount comes to US$1.8 million. Companies may wait one year to be reimbursed. This delay significantly diminishes their cash flow (World Bank, DTIS 2007a). Practical Arrangements to Boost Competitiveness Special Economic Zones 1.150 Currently, there are several industrial zones in Burkina. The oldest are located in Ouagadougou, Gounghin and Bobo Dioulasso. A booming cotton industry and a good connection to railway infrastructure led to the emergence of other industrial zones in the towns of Koudougou, Banfora and Dédougou Solenzo, where several ginneries were set up. In 2004, the Ministry of Commerce, Promotion of the Enterprise and Handicraft (MCPEA) conducted a study on the reorganization of the Ouagadougou and Bobo Dioulasso industrial zones. It showed that the occupancy rates of these zones were relatively high – 55 percent in the Kossodo zone and 64.4 percent in the Bobo Dioulasso zone. The Chamber of Commerce, Industries and Handicraft in Ouagadougou has recently set up two business zones (ZAD). They are intended for SMEs in the areas of trade, handicraft and manufacturing. A few food processing firms have also been set up in the Ouagadougou ZAD (Dahourou, 2008). 1.151 Apart from the ginning mills, the export performance of firms operating in these zones remains uneven. A number of firms that benefited from state subsidies failed to be sufficiently profitable to survive. They failed due to management problems and a relatively high cost structure for operations. The ones that have managed to remain in business are part of multinational groups – food companies, beverages and tobacco. 1.152 Establishing a special economic zone (SEZ) to attract foreign investment and develop export-oriented activities may be an option for export diversification, but a careful examination of its feasibility is essential for its success. The SEZ development should not be seen as a substitute for broader efforts to integrate into international trade and carry out 106 IMF, 2005, VAT Refunds: A Review of Country Experience; IMF, 2006, Burkina - Nouvelles étapes de la réforme des administrations fiscale et douanière. 107 For example, the government owed SOFITEX around CFAF10 billion at the end of 2005. 108 The VAT system incorporates the principle of reimbursement as a fundamental element. In industrial countries, the amounts reimbursed to firms can reach 50 percent of the total collected. However, in least developed countries (LDCs), the amount is normally less than 10 percent. After the Ministries of Finance in LDCs have collected these revenues, they seem reluctant to release them (World Bank, DTIS 2007a). 80 economy-wide reforms. These SEZs can be tools for promoting foreign investment, creating jobs, and generating exports. They may also stimulate the creation of a business-friendly environment within the economic zone, develop infrastructure, and encourage linkages with domestic SMEs. SEZs would have a demonstration effect for the whole economy, encouraging exports and technology transfers. However, they may create expensive enclaves vis-à-vis the rest of the economy. 1.153 A special economic zone regime involves legislative, regulatory and administrative arrangements that need to be carefully analyzed. In particular, the legislative process may require an analysis of the current legal and regulatory framework. It may imply the adoption of a legislative act that establishes the regime and defines the governance and administration of the zone, the forms of funding, the investment regime and operations. Alternatively, this process may build on the existing legal framework. Depending on the overall government strategy, options and opportunities, the SEZ status can be granted to certain selected areas (Box 1-13). Feasibility studies are required in order to: (i) assess the viability of such a regime; (ii) analyze the legal and regulatory framework; (iii) evaluate the existing opportunities; (iv) determine the land availability; (v) select the site; (vi) evaluate infrastructure needs; and (vii) estimate investment costs and profitability. 81 Box 1-13: Characteristics of Special Economic Zones Several countries worldwide in the 1970s and the 1980s set up special economic zones to stimulate investment, foster trade and create jobs in an area free of all customs duties and taxes. The concept of special economic zones was originally based on the following principles: i) A geographically limited area, usually fenced and secure; ii) A single administrative structure; iii) Eligibility of companies, based on physical location in the area; iv) Building for rapid customs tax-free services and storage. Many types of special zones have emerged over the years, depending on the facilities and infrastructure they were providing. These include free trade zones, free export zones, company zones, free port zones, industrial zones, and special technology zones. To give greater boost to export, it is preferable that: i) All types of enterprises – whether they are commercial or manufacturing companies – be admitted into the zone irrespective of whether or not their status is that of an exporting company; ii) A legal framework be set up that facilitates the administration of the zone in order to regulate and foster competition between the different zones of the country; iii) An autonomous institution be responsible for the management of the zone in order to ensure a proper distribution and monitoring of the spaces granted (see Table 1-23 below). Table 1-23: SEZ Characteristics Concept of extra-territoriality Outside domestic customs territory Eligible for national certificates of origin Eligible to participate in national trade agreements Eligibility for benefits No minimum export requirement Manufactures and services Foreign and local firms Expansion of existing enterprises Private developers of zones Foreign or local ownership No limitations Equal treatment Sales to the domestic market Fully liberalized rather than on a case by case basis Treated as imports into domestic market, subject to payment of import duties and taxes Purchases from the domestic market Treated as exports from domestic market Labor policies Full consistency with ILO labor standards Dispute settlement mechanism Source: FIAS, 2008. 82 Box 1-14: Free Zone in Madagascar Senegal and Liberia set up free industrial zones as early as the 1970s. The impact on their economies has been somewhat mixed because of red tape, high cost of production factors (water, electricity, communication), and labor policies. Other countries, such as Madagascar, Mauritius and Kenya, set up export zones that had a positive impact in terms of job creation and export volume. In 2005, 80 percent of exports from Madagascar, 2.4 percent of exports from Ghana, and 34.4 percent of exports from Mauritius came from special economic zones. In the late 1980s, Madagascar decided to opt for an export-led growth strategy. This was followed in 1990, by the introduction of a special scheme for free zone companies. Tax breaks – combined with low wages and trade preferences granted on the US and EU markets – have triggered a continuous growth of the Malagasy Free Zone. According to the Free Zone association, at the end of 2004, there were 180 firms in business with over 100,000 employees. However, this boom has been interrupted by the final dismantling of quotas on clothing products since the beginning of 2005. Investors sought primarily to take advantage of low labor costs in Madagascar. Cadot and Nasir (2001) report that the monthly wage for an unskilled textile industry machine operator in Madagascar is less than one-third of the equivalent wage in Mauritius, around half that in China, and only about 60 percent of the average wage in India. Although labor productivity is apparently much lower in Madagascar than in Mauritius or China (and equal to that in India), unit production costs are among the lowest in the world, and lower than in the other three aforementioned countries. Many Asian countries had already saturated their quotas. Therefore, the choice of Madagascar helped circumvent the textile quotas imposed by the developed countries under the MFAs. The Central Bank of Madagascar (2002) reported that clothing accounted for 90 percent of the Free Zone’s production in 2001. Madagascar enjoys duty-free and quota-free access to the European and American markets. Clothing exports are concentrated on the American and European markets, which are the top two markets worldwide for these products. Although trade preferences played an important role in the success of the Free Zone, they would not have been taken up had it not been for the tax breaks granted under the EPZ scheme. There were negligible amounts of exports in Madagascar at the beginning of the 1990s. Since then, growth in Free Zone exports has been remarkable. Sales to the American market, which were marginal until 2000, have driven growth in the 2000s. In 2006, the EU and the US each absorbed half of the exports. The share of the Free Zone in total exports rose steadily to reach nearly 50 percent in 2005-2006, a proportion unequalled in any other Least Developed Country (LDC). The Free Zone accounted for most of the boom in Madagascar's goods exports from 1995 to 2006. With the exception of Lesotho, Madagascar has been the only successful African new exporter of manufactured goods during the past ten years. At the beginning of the 1990s, Madagascar exported almost exclusively agricultural products (mainly coffee, vanilla, cloves and shrimp). Subsequently, the share of these products fell to less than half of total exports. By contrast, the share of manufactured products was negligible at the beginning of the 1990s, but grew steadily to eventually reach half of total exports. This growth mainly involved exports of clothing products, i.e. exports from the Free Zone. Although the total amount (UD$500 million in 2006) might seem relatively modest by world standards, by 2001 Madagascar had become the number two African clothing exporter in sub-Saharan Africa, behind only Mauritius. Source: Cling, Razafindrakoto and Roubaud, 2007, Export processing Zones in Madagascar: The impact of the dismantling of clothing quotas on employment and labor standards. Clusters and Growth Poles 1.154 Clusters and growth poles may be options to boost exports and growth. Clustering implies firms coming together to achieve greater profitability and competitiveness. The firms in the clusters may pool: (i) production means (processing of surplus production by one to avoid 83 losses by the other); (ii) training; or (iii) backstopping. There are two categories of clusters that may be considered: (i) clusters created by firms and other actors in the same field; and (ii) clusters that emerge as a result of public policies, such as technological centers, industrial parks, business incubators or export processing zones. Like clusters, growth poles highlight the importance of location and the economies of agglomeration, but they differ in how growth is achieved. They emphasize attracting firms to a region through tax incentives, infrastructure development and other business support facilities. The Government acts as a master planner, targeting industries and locations using a wide range of incentives, even in regions far from principal economic centers. Clusters use market-based solutions by leveraging existing economic activities in a particular location. Clusters are much less top–down, and place less emphasis on concentration of physical infrastructure. Supportive institutions and R&D facilities in a cluster evolve gradually to respond to firms’ needs. Government plays a catalyst role, providing a productive business environment across various sectors (World Bank, 2009b). Box 1-15: Examples of Clusters in Sub-Saharan Africa The key characteristics that determine firms’ competitiveness in the clusters are: (i) market access; (ii) flexibility and availability of human capital; (iii) impact of intermediate consumption; (iv) technological windfalls; and especially (v) the combined action of firms to come together to work for a common interest (Nadvi, 1999). Several African countries have developed this approach, and have thereby managed to increase the volume of their production and export high value-added products in sectors ranging from agribusiness to high technology (see Table 1-24 below). Table 1-24: Clusters in Sub-Saharan Africa Cluster Country Number Size Products Markets Of (Number of enterprises employees) Lake Kenya 24 (large 250-6,000 Cutting of Flowers Domestic/international Naivasha enterprises) Lake Uganda 17 (fishery Production of Domestic / Victoria plants) fish/processing international (Europe) Nnewi Nigeria 85 < 12 on the Auto parts Domestic and West average Africa Suame Ghana +9,000 5-10 Manufacture/ auto Domestic and West Magazine repairs Africa According to a study by Zeng, which covers 11 clusters in Sub-Saharan Africa, the development and success of these clusters is based on the ability of companies to increase their activities through diversification into increasingly sophisticated products to achieve economies of scale. This is mainly the result of: (i) establishing a value chain of supply- production-distribution; (ii) acquiring know-how and technology through adaptation and dissemination; (iii) developing technical vocational training; and (iv) developing intra-firm partnerships and joint actions. Source: Dahourou, 2008. 1.155 Setting up clusters involves identifying sectors with growth potential, and comparing various value chain options to identify their most appropriate location. In particular, due diligence should involve a review of: (i) the potential income-enhancing sectors; 84 (ii) the existing industrial zones arrangements as potential cluster locations; and (iii) the potential of different regions and chains of value to foster the emergence and development of additional companies. Specific and sustainable measures for exporters should be put in place for tangible medium and long-term results. 1.156 The public and private actors in Burkina indicate that there are opportunities for developing growth poles. Such opportunities exist in: (i) Bagré: to leverage infrastructure investments already in place and Government’s commitment towards its development, (ii) Bobo- Dioulasso (Hauts-Bassins region) to leverage the agro-pastoral potential, the existing industries and economic infrastructure, the existing population center and the proximity to Côte d’Ivoire, (iii) Cascades region: to exploit the existing horticulture and cashew production, economic infrastructure and industries and proximity to Côte d’Ivoire, (iv) Mana, Youga, Kiéré, Essakane, Perkoa: around the existing mining areas where the local economic development initiatives need to be strengthened, and (v) Tambao, a potential manganese mine: where there is potential to support the establishment of a public-private partnership (PPP) for a new railway investment. In addition, a growth pole approach may support the streamlining of the existing regulatory and institutional framework for investment promotion and facilitation (Boxes 1-16 and 1-17). 1.157 Institutional support by the Government and the development partners is often decisive for the success of the clusters or growth poles. In setting up clusters or growth poles in Burkina Faso, attention should be paid to: (i) securing land tenure for farmers in the agribusiness poles; and (ii) establishing appropriate infrastructure to support economic activities such as transport, electricity, water, telecommunications and broadband internet for poles dedicated to services. 1.158 Moreover, a sufficient supply of persons with adequate skills is imperative. Special emphasis should be placed on the creation of vocational training centers capable of providing technical training to food industries in the agribusiness poles, industrial and other types of maintenance, and specific training for services, finance, call centers, and networking. Therefore, it is necessary that the approach to cluster development target the development of human capital and innovation. 85 Box 1-16: Potential of the Hauts Bassins and Cascades Regions The Hauts-Bassins region is made up of three provinces: Houet, Tuy and the Kénédougou. The largest town is Bobo Dioulasso, which accounts for more than half the population in the region. The region has: x Agro-pastoral potential: cotton, cereals, livestock, sesame, cashews, fruits and vegetables. x Economic infrastructure: an industrial zone already established at Bobo and the prospect of creating two other zones; an airport that could be used for transporting goods; a multimodal platform for transit which is directly connected to the railway, linking the town to the port of Abidjan in Côte d’Ivoire; a fruit packing terminal. The reopening of road and railway links with Côte d’Ivoire is an opportunity which should further boost the region, which suffered greatly from the Ivoirian crisis. x The electric power station connecting the country to Côte d’Ivoire could serve as a means for reducing cost factors. x A pool of enterprises in the region, with a higher concentration in Bobo Dioulasso: the roster of firms at the Chamber of Commerce indicates the existence of 4,120 companies, of which 65 percent are in trade, 26.2 percent are service providers and 8 percent are in manufacturing. Small and medium-sized processing industries are numerous (oil, dairy, beverages, fruits and dried vegetables) and coexist with large processing units such as CITEC (cotton seed, oil cake, soap), SOFITEX (cotton ginning), BRAKINA (beverages and mineral water), FILSAH (cotton spinning), and DAFANI (nectar, fruit juice concentrates). Industries in the fields of metallurgy, mechanics, chemistry and derivates are also operational. x Support structures (field offices of the Chamber of Commerce and the Maison de l’Entreprise) and a laboratory are in place. The Cascades region is located in the extreme southwest of Burkina Faso and has two provinces: Comoé and Léraba. This region has: x Agricultural potential: the region is the second highest producer of fruits and vegetables (mango and banana) in the region (after the Hauts Bassins), and is the highest producer of cashew nuts in Burkina. This product is exported in massive quantities to India and Europe. Sugar cane also has potential. Emphasis could be placed on the development of processed cereals, dried fruits and vegetables, and cashew shelling. x Economic infrastructure: the railway and road linking Burkina to Côte d’Ivoire extend throughout the region and are in good condition; a special industrial zone could be created to promote the emergence of processing SMEs. x Existing agro-industrial enterprises: although the region has no industrial zones, it has some large firms such as SOSUCO, (sugar), SOPAL (alcohol and molasses), SOFITEX (cotton), and SN-GMB (packaging of imported wheat flour). The existence of several export-oriented associations and cooperatives could enable partnerships with these large firms. Source: Dahourou, 2008. Box 1-17: A Pilot Growth Pole Project in Bagré The potential for developing the Bagré as an agro-industrial growth pole lies with: x Considerable and largely untapped availability of water and, hence, considerable areas that can be irrigated. x Possibility to develop other activities such as fish farming and livestock production. x The availability of electricity supply. x The existing road infrastructure and reasonable access to large consumer domestic and regional markets (Ouagadougou, Ghana, Togo and Niger); x The existing policy and legal framework establishing Bagré as a Zone d’utilité publique which enhances access to land for investors and clarifies the land tenure situation that would allow potential investors secure access to land. Nevertheless, the success of such a growth pole is dependent on a series of regulatory and administrative reforms in the Bagré area and country-wide, as follows: x Provide long-term land tenure security to private investors. A new land law has been passed recently which permits to do so through long-term lease. The operational system to allow the granting of such leases needs to be put into place; x Develop an efficient and flexible management system for the irrigation infrastructure (water distribution, operations and maintenance of the distribution system): the authorities and the Maitrise d’Ouvrage de Bagré would need to establish a management of the irrigation system (operation and maintenance) with the necessary technical/managerial capacity and sufficient autonomy and flexibility; x Develop sustainable infrastructure and other services: energy (electricity or fuel), communication/connectivity, input suppliers or providers of maintenance and repair services; banking facilities; collective productive infrastructure (storage, cold chain); technical advisory services (quality): A matching grant program would help alleviate cost for private service providers and encourage them to operate in Bagré. x Undertake country-wide policy interventions, in particular: o Streamline the investment and export promotion institutional framework. o Continue regulatory reforms and capacity building for implementation: investment legislation, tax and customs regimes, governance, cross-border trade facilitation, implementation of the new land tenure legislation, revision of the Mining Code and the Mining Policy to strengthen participation of local communities. o Strengthen the policy and regulatory framework for PPP to attract private investments in infrastructure. The Tambao railway investment could be a pilot PPP project that the World Bank Group could support under a growth pole program. Source: Authors. 86 Conclusions and Policy Recommendations 1.159 In the context of the current global crisis, Burkina Faso faces the daunting task of increasing its export competitiveness and reducing its dependence on cotton production. Despite good growth performance, the country has recently been exposed to a decline in cotton prices, which puts an additional strain on government finances and the external account. Burkina has outperformed several landlocked countries in Sub-Saharan Africa. Nevertheless, it lags behind comparable commodity exporters from Latin America and Asia. The country’s diversification challenge lies in promoting increased agriculture productivity by: (i) identifying income-enhancing opportunities outside of cotton production; and (ii) gradually developing capabilities to produce higher value-added products. 1.160 A number of macro and microeconomic constraints hamper private sector development. At the macroeconomic level, the recent euro appreciation makes the REER less competitive for exports. Although evidence regarding the REER misalignment is mixed, the widening of the current account deficit is an indication that the REER may be overvalued. At the microeconomic level, Burkinabè firms have relatively low productivity and high unit labor costs compared to some of their main international competitors. Moreover, the firms’ performance is impaired by: (i) poor access to finance and electricity; (ii) burdensome taxation; (iii) unfair competition from the informal sector; (iv) corruption; (v) inadequate transport infrastructure; (vi) lack of access to ICT service; (vii) lack of skills; and (viii) health issues. 1.161 Burkina’s export sophistication is low. Its export basket is dominated by unprocessed cotton, which increases the country’s exposure to terms of trade shocks and international cotton price volatility. Sesame is another low income potential product in the country’s export basket. Scaling-up the non-cotton and non-sesame exports would require specific policy interventions. Products that could be considered include: (i) dried fruits and vegetables; (ii) leather of hides or skins; (iii) cotton seed oil; (iv) sugar; (v) soap; (vi) manufactures of wood; (vii) decorative art; and (viii) gold. 1.162 Export and investment promotion are market-driven processes, but the government could play a facilitator role in addressing information asymmetries and other market failures. The existing export and investment promotion instruments have not proved to be very effective in supporting the emergence of new productive opportunities. The investment policy framework is generally favorable to foreign direct investment, but there is room for improvement. Burkina could create a better enabling environment for foreign and domestic investment by streamlining the investment code and the fiscal incentives, and by improving governance and increasing coordination with the WAEMU policies in the fields of competition, taxation, and telecommunications. Unfortunately, Burkina does not currently have coordinated export and investment promotion strategies. ONAC is in charge of export promotion, but it lacks the financial and human resources to be effective in promoting exports. An investment promotion agency has not yet been set up. Some instruments to promote exports, such as matching-grant funds, have been implemented to support capacity-building in agriculture. However, there is a need to streamline tax administration with regard to VAT reimbursement for exporters, standardization, and product quality systems. 1.163 Losses in competitiveness stemming from the recent euro appreciation and the fluctuations of the euro vis-à-vis the dollar require price risk management mechanisms. In 87 addition, exchange rate competitiveness and adequacy of international reserves will need to be carefully examined in light of the current adverse shocks. Uncertainty in cotton production and prices highlight the importance of having a sustainable strategy to mitigate risk and stabilize incomes for both producers and consumers. Donor support could be sought for the replenishment of the existing smoothing fund. 1.164 Burkina can leverage its existing capabilities to diversify incrementally into products that have high-income potential and growing world demand. Table 1-19 provides a list of candidates to diversification. This could also help develop ancillary activities and even stronger capabilities to transform the economy into one that is industrial-based. Policies that facilitate diversification in specific sectors (products) may also require sector-specific interventions.109 Therefore, a strategic approach to encouraging diversification would: x Ensure that production factors such as capital, labor, land, and technology support: (i) those sectors in which Burkina Faso has a long-term capacity to compete, such as cotton; (ii) the most productive firms in those sectors; and (iii) the emergence of new sectors. x Address constraints on doing business, in particular: (i) access to finance; (ii) cost of backbone services (electricity, transportation); (iii) tax policy and tax administration; (iv) governance; and (v) human capital development (training). x Enable the development of private sector driven export and investment promotion. 1.165 An export promotion strategy would expand the reach of existing products and facilitate the gathering of demand-side information, while enabling support for a private- sector led strategy. The Government intervention should avoid picking new winners. Moreover, this strategy should aim at harmonizing export promotion efforts and actions included in various sectoral or cross-cutting policies. 1.166 To complement export promotion efforts, an investment promotion vision would target attracting increased foreign direct investment. It would identify sectors that could benefit from a proactive investment promotion campaign, help define sectoral policies for attracting foreign direct investment. The strategy would provide an umbrella to improve the overall regulatory and institutional framework for attracting foreign direct investment. 1.167 Finally, the report recommends the following actions: Export Promotion x Redefine the role of the “taxe d’apprentissage� to support skills development for exporters, and strengthen the use of MEBF matching-grant funds. x Accelerate VAT reimbursement by: (i) simplifying procedures; and (ii) keeping VAT receipts in a special account for reimbursements or exempting only exporters. 109 For example, the policy interventions utilized to scale-up exports of gold will be different from those utilized for fresh fruits and vegetables. In fact, in the case of gold, those interventions would be location-specific. Gold mining would require large-scale road infrastructure. By contrast, fresh fruit would require: (i) feeder roads that connect farmers to markets; (ii) post-harvest technologies; (iii) refrigeration and cold chain facilities for speedy air transport to distant markets; and (iv) phyto-sanitary standards. Establishing marketing networks would be a crucial public service in the case of fruits but not gold, because the later would have no difficulty in attracting investors and buyers. 88 x Strengthen the ONAC mandate and functions to act as a single specialized agency for export promotion in closer consultation with the private sector; x Update the Trade Point database to improve domestic exporters - international buyers matches; x Transform FASONORM into a specialized standardization and certification institute to improve the national quality system; x Establish a strategy council, at the level of the PM, to coordinate investment and export promotion policies and lead reforms to improve the overall business environment (taxation, governance, infrastructure, sectoral constraints in agriculture, mining and other sectors). x Develop a technical committee for cooperation among various government ministries to ensure coordination with investment and sectoral policies, such as the programs dedicated to the promotion of various agriculture value chains and products (le Projet d’Appui au Développement de l’Agriculture du Burkina Faso, le Projet d’Appui aux Fillières Agro-Sylvo-Pastorale, le Projet d’Appui aux Fillières Agricoles). Investment Promotion x Revamp the investment legislation by: o Eliminating the ex ante investment authorization and replacing it with a simple self-declaration of investment; o Eliminating the “carte de commerçant étranger� and the minimum capital requirement for foreign investment; o Streamlining the Investment Code – in particular, the provisions on capital transfers, investment-state dispute settlement and guarantees against and compensations in case of expropriation. x Transpose and enforce all WAEMU directives, particularly with regard to competition policy and law, tax policy (VAT), mining codes (incentives) and telecommunications; x Streamline tax and customs regimes o Reduce the frequency of tax payments; o Limit fiscal incentives where a cost-benefit analysis predicts economic surplus; o Create transparency and predictability of the tax system.. x Set up an investment promotion agency (marketing, start-up facilitation, aftercare services) reporting to the PM, with private sector participation, well coordinated to other agencies ONAC, CCIA, private sector organizations). 89 Appendix 1: Methodologies to Calculate the Exchange Rate Misalignment PPP Methodology 1. The PPP methodology provides the first basic estimate of misalignment However, this methodology is imperfect. In order to understand the competitiveness in the Burkina economy, this methodology helps track and assess the evolution of REER. This is particularly important since the introduction of the euro in 1999. Essentially, the REER is the trade-weighted geometric product of the bilateral effective exchange rates and takes into account both changes in the bilateral exchange rate and in inflation differentials between Burkina Faso and its main trading partners. In other words, it is the weighted average of Burkina’s currency relative to the basket of currencies adjusted for the effects of inflation. REER is very important especially in the context of understanding the price signals facing the tradable sector, especially cotton, and is a good measure of Burkina’s overall competitiveness in the international economy. The single equation estimation 2. A second technique widely used to assess the misalignment of the exchange rate is the single equation estimation. This methodology considers that the equilibrium real exchange rate is driven by a vector of economic fundamentals. Studies have been conducted for both WAEMU and for Burkina Faso. Some studies find devaluation resulted in an undervaluation that persisted until 2003. The difference between their results and other studies may be due to an inadequate intercept for Burkina Faso. This may have resulted from the panel estimation, which could bias the results toward undervaluation. 3. Other empirical work for the WAEMU zone as a whole using time series econometrics finds it difficult to obtain a single-equation estimation of the REER as a function of a vector of economic fundamentals (Zafar, 2005).The estimates for the equilibrium REER for Burkina Faso depend on the choice of model, the methodology, the estimation technique, and the sample. Roudet et al (2007) argue that because the panel results are an average of the individual cointegrating vectors, some countries could differ significantly from the average. Chudik and Mongardini (2007) used a panel of non-oil exporting countries in Africa, and find that the REER was undervalued by about 20 percent for the WAEMU region. 4. However, the Chudik and Mongardini (2007) panel may suffer from a heterogeneity problem because these countries may differ in important respects, such as structure or nature of trade shocks. Also, the deviation of the REER from its equilibrium value is statistically sensitive to econometric specification, especially with this methodology. Thus, one can obtain a large range of estimates conditional on the methodology. Finally, there is no consensus on the econometric methods of addressing the large structural break in the time series due to the 1994 devaluation. Thus, the results from the econometrics of single equation estimation must be interpreted cautiously. While the single equation estimates are useful, the diverging opinions on their usefulness suggest the existence of some methodological problems. 90 Trade equations methodology 5. A third methodology involves the use of trade equations or trade elasticities to establish a quantitative relationship between the real exchange rate, imports, exports, and the resource balance (Hinkle and Montiel, 1999).This methodology has been extensively used to determine exchange rate misalignment and overvaluation. 6. The model is the standard reduced-form partial-equilibrium trade model. The basic theoretical framework is built on the national accounting identities: x Y = C + S = C + I + X – M = C + I + RB x S – I = X – M = RB where Y is GDP, C is consumption, S is savings, I is investment, X is exports, M is imports, and RB is the resource balance. Essentially, the resource balance equals the savings- investment balance and is the mirror image of the net resource transfers needed to finance it. More precisely, it equals the net resource transfer between the home country and abroad. x RB = - (NFI + NT + NCF + ¨ RES = - (NRT + ¨ RES) where NFI is net factor incomes, NT is net transfers, NCF is net capital flows, ¨ RES is the change in external reserves, and NRT is the net resource transfer. 7. Independently, one determines a target resource balance which, in cases of countries like Burkina, is an estimate of the sustainable level of concessional aid flows available to the country in the medium term coupled with a reasonable projection of private flows. Consequently, one needs to determine the real depreciation required by a country to achieve the targeted resource balance, or in other words, the adjustment needed for the REER to move from its current level to its target level and for the current account to be equal to the capital account. The equilibrium REER is the one that corresponds to the target resource balance. 110 A target external reserve level is projected, and an assumption made that aid flows pose no debt servicing problem. Next, one can determine the appropriate price elasticities and pass-through ratios for exports and imports and use them to solve the trade elasticities equation. The difference between the current account benchmark and the projected current account will determine the adjustment that is needed. One has to examine the level of composition of capital and other flows to determine a sustainable medium-term trend or pattern of flows. 8. The advantages of this approach are many. The model is easy to understand and reveals the linkages between the exchange rate and the trade balance. Thus the combination of minimal data requirements, readily available parameter estimates, and transparency are practical advantages in assessing a country’s performance during a time of balance of payments crises. Its significant drawback is that uses a partial equilibrium approach for determining equilibrium values for the REER, imports, and others without looking at the full spectrum of macroeconomic variables. 110 The current account balance and the resource balance are related, with the current account being the resource balance plus net transfers, or in other words the change in net foreign assets. (Hinkle and Montiel, 1999) provide a full explanation. 91 However, given the paucity of data in Burkina Faso, a full general equilibrium (CGE) model is difficult to build. 9. To estimate the model, time series econometrics are used. They help derive the equilibrium exchange rate and estimate the misalignment. In order to determine the estimates of constant elasticity of trade and the current account equilibrium conditions, the trade equations were solved. The price elasticities of import and export demand exports with respect to the real exchange rate and the income elasticities of import and export demand were obtained econometrically based on the following equations: 4) log X = ĮX + ȕX log REER + ȘX log Y + İ 5) log M = Įm + ȕm log REER + Șm log Y + İ where X is the volume of goods and services exports, REER is real effective exchange rate, M is import volume and Y is domestic and foreign real income, and the coefficients ȕX and ȕm are the price elasticities and ȘX and Șm are the income elasticities. The models are log- linear. CPI-based real effective exchange rates are used to proxy relative prices in both the export and import equations. An appreciated exchange rate has a negative impact on exports while stronger income translates into greater imports. 10. The goal is to find a sustainable current account path where there is medium-term equilibrium consistent with external balance (sustainable capital flows) and internal balance (non-inflationary full employment). One assumption is that the full employment level is independent of the external balance, and output is set as an exogenous potential level. Price elasticities of domestic demand for imports and foreign demand for exports impact the trade balance. Theoretically, exports will increase if the exchange rate depreciates and world demand increases, having a positive effect on the current account balance. 11. A Hodrick-Prescott filter was used to compute the long-run trend values. This method was then applied to solve for the fundamental equilibrium exchange rate (FEER). The coefficients from the estimated the trade equations were used, together with long-term trend values of the exogenous values to find the yearly solution for the REER where the current account was in equilibrium. The lack of stationarity of the variables mandated the use of cointegration techniques and unit root analysis. Traditional estimation and inference procedures based on traditional F and t tests do not apply in the presence of non-stationary variables. The optimal lag lengths were determined using the Akaike Criterion. The augmented Dickey-Fuller test was used to examine whether one can reject the null hypothesis of a unit root at traditional significance level of 5 percent. The regressions were run on first differences in order to have a stationary series. Two step Engle-Granger was performed with an examination of the residuals. Since the study applies the partial-equilibrium approach to the calculation of the EREER, sensitivity analysis is performed to see what happens to the equilibrium real exchange rate. Annual data on GDP, CPI, and balance of payments statistics was gathered using IMF and World Bank datasets, including the IFS and WDI. Data spanned from 1980 to 2007. The log of the real effective exchange rate deflated for CPI was taken as the best measure of relative prices. 92 12. In the literature the definition of current account sustainability is somewhat arbitrary. Following Williamson, a current account that complies with conventional sustainability rules and the stabilization of the debt-to-GDP at a certain level is followed. Furthermore, a sustainable current account involves a reasonable projection of private capital flows and an inclusion of errors and omissions. The focus is on the adequate “structural� level of capital inflows. In this regard, it is important to distinguish cyclical and structural determinants of the current account and the corresponding magnitude of sustainable deficits. The consensus is that double digit current account deficits, with a significant component of borrowing are not sustainable in the long-run. For the analysis, a “structural� deficit of 6 percent of GDP was considered compatible with longer-term sustainability. 13. The econometric results confirm the theoretical assumptions (see Table A1-1). The estimated import elasticities are in line with conventional wisdom and empirical work for a range of developing countries. The unit root tests confirmed that all the series were nonstationary in levels. ADF statistics calculated for first differences were all above their critical values. Engle- Granger residual tests confirmed stationarity. The series were found to be integrated in the order of I(1). The low supply response is typical of the response in many developing countries where price signals have a lagged effect on agricultural production. The Marshall Lerner conditions are met since the price elasticities are greater than unity.111 In this context, it is important to note that low elasticities require larger changes in the exchange rate to restore current account balance. Table A1-1. Econometric Results: Elasticities Dependent Variables Independent Variable 1 Independent Variable 2 REER (ln) Income (ln)/1 Exports (ln volume) -0.3 0.07 Standard errors 0.003 0.004 Imports (ln volume) 1.1 -1.7 Standard errors 0.005 0.004 1/ Foreign income is used for import elasticity and domestic income for export Note: OLS estimation, number of observations: 28, series from 1980 to 2007. Due to log nature, coefficients represent elasticities. T-stats by definition are 1 divided by standard errors Significance at 5% confidence level; all adj R-squared above 0.95 111 These conditions say that, in order for a currency devaluation to have a positive impact in trade balance, the sum of price elasticity of exports and imports (in absolute value) must be greater than 1. 93 Table A1-2. Summary of Methodologies Estimating Misalignment Study Year REER Range Comments Used PPP and time series methodology; Zafar 2005 8 percent study done for overall CFAF zones but applicability to Burkina; finds significant appreciation of CFA franc in both CEMAC and WAEMU zones; finds misalignment tempered by BCEAO and lowered by increasing trade with higher inflation economies Using econometric methodology, the IMF 2007 15 percent paper finds that REER is aligned with its (depreciation) equilibrium; however, using trade balance methodology, study shows that 15 percent depreciation can bring Burkina current account to sustainable levels 20 percent The paper finds that the REER remained Chudik and 2007 (undervaluation) undervalued until 2003 Mongardini The paper finds that single-country Roudet et al 2007 9 percent estimators and the panel estimators give (overvaluation) different results for Burkina Faso. They find that single country estimates show 1 to 24 percent the REER may have been overvalued by (undervaluation) about 9 percent in 2006 in contrast with the results obtained using the panel estimators; the latter suggest an undervaluation ranging from 1 to 24 percent. Elbadawi et al 2007 25 percent The paper finds evidence of undervaluation 94 Appendix 2: Performance of Other Landlocked or Commodity Producing Countries Table A2. 1. Economic Diversification in fast growing landlocked or primary product exporters Lao PDR SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 711 Coffee,whether or not roasted 0.36 PP 1,936 2483 Wood of non-coniferous species 0.18 RB 3,667 2471 Sawlogs & veneer coniferous logs 0.19 RB 8,841 8451 Jerseys,pull-overs,cardigans 0.06 LT1 4,464 2483 Wood of non-coniferous species 0.08 RB 3,667 8423 Trousers,breeches etc.of textiles 0.05 LT1 4,789 2482 Wood of coniferous species,sawn 0.03 RB 11,578 2472 Sawlogs & veneer coniferous logs 0.04 RB1 2,287 2923 Veget.materials - primarily fibres 0.03 PP 2,334 8439 Other outer garments of textiles 0.03 ow Tech 5,408 Kyrgyz Republic SITC Product Description (1995) % Tech PRODY SITC Product Description (2006) % Tech PRODY 2882 Other non-ferr.base metal waste 0.18 RB2 6,030 2631 Cotton (other than linters) 0.081 PP 1,500 2631 Cotton (other than linters),uncarded 0.11 PP 1,500 2882 Other non-ferr.base metal waste 0.0797 RB2 6,030 2111 Bovine & equine hides 0.09 PP 5,653 6644 Cast,rolled,drawn or blown glass 0.0551 RB2 19,719 6899 Base metals,n.e.s.and cermets 0.08 RB2 3,279 542 Beans,peas,lentils etc. 0.045 HV 2,376 6821 Copper and copper alloys 0.06 RB2 4,900 2820 Waste&scrap metal of iron/steel 0.0442 RB2 5,711 Vietnam SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 360 Crustaceans and molluscs,fresh 0.29 PP 3,369 3330 Petrol.oils & crude oils 0.21 PP 5,316 3221 Anthracite,whether/not pulverized 0.12 PP 4,786 8510 Footwear 0.16 LT1 7,765 2320 Natural rubber latex; nat.rubber 0.06 PP 1,169 360 Crustaceans and molluscs,fresh 0.05 PP 3,369 2924 Plants,seeds,fruit for perfumes 0.06 PP 3,622 8219 Other furniture and parts 0.04 LT2 10,855 2919 Other materials of animal origin 0.04 PP 8,387 8439 Other outer garments of textiles 0.03 LT1 5,408 Sri Lanka SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 741 Tea 0.36 PP 1,655 741 Tea 0.14 PP 1,655 2320 Natural rubber latex; nat.rubber 0.12 PP 1,169 8439 Other outer garments of textiles 0.08 LT1 5,408 8439 Other outer garments of textiles 0.08 LT1 5,408 8462 Under garments,knitted 0.05 LT1 4,975 3344 Fuel oils,n.e.s. 0.07 RB2 5,032 8459 Other outer garments & clothing 0.05 LT1 6,020 8429 Other outer garments of text fabrics 0.05 LT1 5,624 8423 Trousers,breeches of textiles 0.04 LT1 4,789 Paraguay SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 2631 Cotton (other than linters) 0.36 PP 1,500 2222 Soya beans 0.33 PP 6,079 2222 Soya beans 0.30 PP 6,079 111 Meat of bovine animals, fresh 0.12 RB1 8,892 2483 Wood of non-coniferous species 0.06 RB1 3,667 813 Oil-cake & other residues 0.09 PP 5,718 813 Oil-cake & other residues 0.04 PP 5,718 4232 Soya bean oil 0.05 RB1 6,491 1211 Tobacco,not stripped 0.04 PP 3,317 2631 Cotton (other than linters) 0.05 PP 1,500 Guatemala SITC Product Description % Tech PRODY SITC Product Description % Tech PRODY 711 Coffee,whether or not roasted 0.45 PP 1,936 8451 Jerseys,pull-overs,cardigans 0.11 LT1 4,464 2631 Cotton (other than linters) 0.11 PP 1,500 711 Coffee,whether or not roasted 0.10 PP 1,936 612 Refined sugars and other products 0.09 LT1 4,020 573 Bananas,fresh or dried 0.07 HV 5,183 573 Bananas,fresh or dried 0.09 HV 5,183 8439 Other outer garments of textiles 0.05 LT1 5,408 752 Spices (except pepper and pimento) 0.06 PP 2,650 8459 Other outer garments & clothing 0.05 LT1 6,020 Source: Authors’ calculations based on data from WDI and COMTRADE. 95 Appendix 3: Product Space Methodology 1. Charting a far more complex terrain, Hausmann and Klinger (HK)’s, product space methodology links products to their exporters’ income levels with the additional advantage of pairing the possibility of exporting a new and more sophisticated product with the country’s capability to export it. Without directly assigning a numeric income value to a product, the HK methodology uses the relationship between products to hypothesize how difficult it might be for a low income country to diversify into a product exported by higher income countries. 2. HK construct a space of possibilities for export diversification by mapping all products that countries export onto a set or what they call product space or forest. At the SITC2 – 4 digit level of disaggregation, this forest has about 800 products or trees, and in Hausmann and Klinger’s terminology, each tree is occupied by a country’s firms that are like monkeys. Diversification occurs when the firms develop new capabilities to export (jump) income- enhancing products which they call ‘fruitier trees.’ 3. Hausmann, Klinger and Lawrence (2008) show that the common policy prescription that supports diversification in natural resource-based economies through the development of forward linkages or the value chain has not fostered greater processing of raw materials in too many countries. They find that ‘broad factor intensities do a much better job of identifying patterns of production and structural transformation… Structural transformation favors sectors with similar technological requirements, factor intensities and other requisite capabilities, not products connected in value chains,� (Hausmann, Klinger and Lawrence, 2008). 4. In an economy, diversification entails re-allocating resources from the production of a commodity currently produced towards those required by another product. In the case of income- enhancing diversification, this would involve transferring inputs to products with greater income potential (fruitier trees). Of course, this may be difficult in many cases or even impossible. Presumably, it should be easier for inputs to be transferred for the production of products whose trees that are in close proximity such as between those with fruit and vegetables. A map of the product space displays a core that is densely populated with trees whose products require relatively similar inputs such as various types of electronics (Figure A3.1). The jumps from one product tree to another will be short in the core of the product space. In comparison, the periphery contains clusters of trees whose products require relatively dissimilar inputs and are therefore far apart. An example would be a cluster of petroleum products or cocoa trees. The distance between trees does not vary among countries. 5. How easily a country can develop the capability to export a new product depends on its input specificity or how easily its current inputs can be reallocated towards the production of the new product. If the firms in a country are located far from the core, jumps to fruitier trees can be long and hence difficult. Naturally, being in a dense part of the product space is advantageous for catch up. 6. The distance between two trees depends upon the relatedness or similarity in the inputs, no matter how imperfect, needed to produce both products. Inputs include natural endowments, technological capabilities, land, labor, capital, institutions, etc. that a country needs to produce and export a product. As an example, a country that has a suitable environment (soil, climate) to produce vegetables is more likely to move into fruits as opposed to cement. The distance between fruits and vegetables will be shorter (or the proximity greater) than between vegetables and cement. The concept of distance (or proximity) between products is not an arbitrary number. 96 Its calculation uses the wealth of information available from actual trade data for all countries and is rigorous in the sense that any one country’s export mix is unlikely to make a significant difference to its value. Figure A3.1: The Product Space Diagram Source: Hidalgo, et. al. (2007) 7. More formally, the proximity between two trees is measured by the conditional probability that exporters that have a revealed comparative advantage (RCA) in product X also have a revealed comparative advantage in product Y. If a country’s RCA in a product lies between 0 and 1, Hausmann and Klinger assign it a value of 0; if it is larger than 1, it is assigned a value of 1. In this discussion, if a country has a RCA of 1, it is assumed to have developed a RCA in that product. 8. In their visual network representation of the 800x800 matrix, the unevenly forested product space displays a core comprised of clusters of metals, machinery and chemical trees occupied by high income countries. In contrast, closer to the periphery are clusters of trees such as garments, animal products, cereals, coffee and cocoa trees that are typically occupied by low income countries. It is important to note that the distances between trees or products are the same for all countries. Trees at the core tend to be higher PRODY. 97 Appendix 4: Burkina Faso’s Exports in the Product Matrix Framework Table A4.1: Burkina Faso’s Exports in the Product Matrix Framework – Classics and Emerging Champions SITC2-4 PRODUCT DESCRIPTION TECH PRODY LEVEL LEVEL LEVEL LEVEL SHARE SHARE SHARE SHARE Type DTIS digit CODE CODE DENSITY '000 US$ '000 US$ '000 US$ '000 US$ (00-04) 00-06 80-84 90-94 00-04 05-06 80-84 90-94 00-04 05-06 2631 Cotton (other than linters),not car PP 1,500 0.196 18,952 85,781 136,092 250,314 32.1 63.6 54.6 81.4 Classic x 2225 Sesame (sesamum)seeds PP 1,179 0.182 2,240 746 9,855 10,747 4.0 0.6 4.0 3.5 Classic x 579 Fruit,fresh or dried, n.e.s. PP 5,187 0.154 1,076 1,958 2,188 6,096 2.0 1.5 0.9 2.0 Classic x 545 Other fresh or chilled vegetables PP 5,477 0.153 2,152 7,650 3,320 2,115 4.0 5.8 1.5 0.7 Classic x 6116 Leather of other hides or skins LT1 2,156 0.156 522 2,656 4,042 2,772 0.9 2.2 1.8 0.9 Classic x Total 24,942 98,789 155,496 272,043 43 74 63 88 4233 Cotton seed oil RB1 3,173 0.145 2,368 289 - - 1.1 0.1 Emerging Champion x 611 Sugars,beet and cane,raw,solid LT1 4,516 0.182 11,282 4,165 - - 4.2 1.4 Emerging Champion x 620 Sugar confectionery and other sugar RB1 8,772 0.127 9 5 587 3 0.0 0.0 0.2 0.0 Emerging Champion x 2320 Natural rubber latex; nat.rubber & PP 1,169 0.162 834 0 - - 0.3 0.0 Emerging Champion 548 Vegetable products,roots & tubers,f PP 4,789 0.158 130 25 883 807 0.2 0.0 0.3 0.3 Emerging Champion x 2924 Plants,seeds,fruit used in perfumer PP 3,622 0.156 85 11 335 337 0.1 0.0 0.1 0.1 Emerging Champion 4249 Fixed vegetable oils,n.e.s RB1 5,377 0.140 524 587 428 748 0.9 0.4 0.2 0.2 Emerging Champion x 459 Buckwheat,millet,canary seed,grain PP 5,009 0.131 6 94 1,079 256 0.0 0.1 0.3 0.1 Emerging Champion x 440 Maize (corn),unmilled PP 6,430 0.129 154 4,484 256 0.3 - 1.5 0.1 Emerging Champion x 6115 Sheep and lamb skin leather LT1 2,526 0.162 38 230 4,822 1,785 0.1 0.2 2.2 0.6 Emerging Champion x 2911 Bones,horns,ivory,hooves,claws,cora PP 4,419 0.145 1 19 123 128 0.0 0.0 0.1 0.0 Emerging Champion 6581 Sacks and bags,of textile materials LT1 5,209 0.146 22 38 163 47 0.0 0.0 0.1 0.0 Emerging Champion x 6354 Manufactures of wood for domestic/d RB1 5,919 0.141 25 82 405 281 0.0 0.1 0.2 0.1 Emerging Champion 6978 Household appliances,decorative art LT2 8,725 0.113 26 45 118 129 0.0 0.0 0.0 0.0 Emerging Champion 8982 Other musical instruments; not 898. LT3 3,843 0.106 3 33 194 88 0.0 0.0 0.1 0.0 Emerging Champion 1222 Cigarettes RB1 12,204 0.118 9,441 3,098 - - 4.0 1.0 Emerging Champion 5541 Soap;organic surface-active product MT2 5,409 0.150 6 87 398 35 0.0 0.1 0.2 0.0 Emerging Champion 9710 Gold,non-monetary RB2 5,716 0.144 1,436 22,468 2,507 3,840 2.3 16.9 1.2 1.2 Emerging Champion x Total 2,467 23,723 40,450 16,293 4 18 16 5 Source: Authors’ calculations. 98 Table A4.2: Burkina Faso’s Exports in the Product Matrix Framework – Disappearances and Marginals SITC2-4 PRODUCT DESCRIPTION TECH PRODY LEVEL LEVEL LEVEL LEVEL SHARE SHARE SHARE SHARE Type DTIS digit CODE CODE DENSITY '000 US$ '000 US$ '000 US$ '000 US$ (00-04) 00-06 80-84 90-94 00-04 05-06 80-84 90-94 00-04 05-06 2238 Oil seeds and oleaginous fruit. n.e PP 1,902 0.140 19,913 893 1,108 464 34.0 0.6 0.5 0.2 DISSAPPEARANCE x 813 Oil-cake & other residues (except d PP 5,718 0.136 1,421 530 1,025 25 2.6 0.4 0.4 0.0 DISSAPPEARANCE 2114 Goat & kid skins,raw (fresh,salted, PP 1,217 0.167 2,219 2,259 85 7 3.8 1.6 0.0 0.0 DISSAPPEARANCE x 2117 Sheep & lamb skins without the wool PP 2,349 0.153 251 36 832 0.4 0.0 0.4 - DISSAPPEARANCE x 2116 Sheep & lamb skins with wool on,raw PP 4,956 0.136 1,180 2,295 12 2.1 1.7 0.0 - DISSAPPEARANCE x 2111 Bovine & equine hides (other than c PP 5,653 0.121 520 190 38 6 0.9 0.1 0.0 0.0 DISSAPPEARANCE x 8997 Basketwork,wickerwork etc. of plait LT2 7,789 0.111 136 308 210 86 0.2 0.2 0.1 0.0 DISSAPPEARANCE x Total 25,639 6,511 3,309 588 44 5 1 0 2223 Cotton seeds PP 2,473 0.159 1,078 2,307 3,194 - 0.9 0.8 1.1 MARGINAL x 2633 Cotton waste (including pulled or g PP 4,117 0.142 120 146 65 - 0.1 0.1 0.0 MARGINAL x 6513 Cotton yarn LT1 4,262 0.136 1 2 1,989 1,215 0.0 0.0 1.0 0.4 MARGINAL 542 Beans,peas,lentils & other legumino HV 2,376 0.154 46 1 51 432 0.1 0.0 0.0 0.1 MARGINAL 752 Spices (except pepper and pimento) PP 2,650 0.152 20 6 29 1 0.0 0.0 0.0 0.0 MARGINAL 2221 Groundnuts (peanuts),green,whether PP 2,739 0.149 91 21 52 57 0.2 0.0 0.0 0.0 MARGINAL x 4312 Anim./veget.oils & fats,wholly/part RB1 5,465 0.121 56 393 777 0.1 - 0.2 0.3 MARGINAL 2112 Calf skins,raw (fresh,salted,dried, PP 4,065 0.129 34 219 20 2 0.1 0.2 0.0 0.0 MARGINAL x 12 Sheep and goats, live PP 1,079 0.118 300 486 16 623 0.5 0.3 0.0 0.2 MARGINAL x 11 Animals of the bovine species,incl. PP 4,391 0.101 2,326 429 138 148 3.4 0.3 0.1 0.0 MARGINAL x 8960 Works of art,collectors pieces & an LT2 8,542 0.118 110 148 349 614 0.2 0.1 0.2 0.2 MARGINAL x 1211 Tobacco,not stripped PP 3,317 0.170 73 46 - - 0.0 0.0 MARGINAL 1212 Tobacco,wholly or partly stripped PP 1,531 0.139 3 371 0.0 - 0.2 - MARGINAL 2922 Shellac,seed lac,stick lac,resins,g PP 987 0.165 40 43 39 0.1 - 0.0 0.0 MARGINAL 2732 Gypsum,plasters,limestone flux & ca PP 5,721 0.121 29 - - 0.0 - MARGINAL Total 5,536 8,516 13,219 7,216 7 4 5 2 Source: Authors’ calculations. 99 Appendix 5: Export Diversification-Technical Definitions Distance between a Pair of Products Distance between a pair of products With these calculations we can construct a matrix with all the minimum conditional probabilities for each pair of products. This matrix is a representation of the product space. It contains a numerical measure of revealed distance between each pair of products in the classification. In the fourth step we simply add all distances in a matrix-row to obtain a very straightforward measure called Product Path. Product Paths are a fixed measure for every product and they allow us to rank products according to their RCA potential. Because the RCA potential was constructed using conditional probabilities given the condition of having RCA, product path ranks products according to its potential to generate RCA in more products. This is an Export Diversification Potential. For example, the path of cocoa is one of the lowest in all the product classification, meaning that cocoa is not a good product from which a country can diversify and generate RCA in many other products. In the final step, we develop the concept of product density. It is obtained using previously calculated product distances and categorical variables. The concept of density recognizes that the more one pair of exporting products are related, the stronger the force to create RCA in one, given that the other had already attained it. The figure below presented by Hausmann and Klinger (2006) exemplifies this case. Using all goods without comparative adva ntage in initial period t, the density around goods also without RCA in t +1 is shown in brown, and those with comparative advantage in t +1 in green. This means that products with higher densities tend more to have revealed comparative advantage in the future. Finally, product densities vary for each year and country. 100 EXPY – SUMMATION OF THE PRODYS (WEIGHTED) The productivity level associated with a country’s i’s export basket, EXPY, is in turn defined by This is a weighted average of the PRODY for that country, where the weights are simply the value shares of the products in the country’s total exports. Source: Hausmann, Hwang and Rodrik (2005) PRODUCT SPACE DEFINITIONS The construction of our set of tools is based on Hausmann and Klinger (2006) and it has been developed in five steps. The first step is to identify the products on which each country experiences a revealed comparative advantage (RCA). For this, the Balassa-RCA Index is calculated for each country, commodity and year in our sample. In a given year (t), a country (c) has a revealed comparative advantage in a certain product (i) if the RCA Index is greater than 1. For example, Ghana has a revealed comparative advantage in cocoa because Ghana’s cocoa share in world cocoa exports is greater than Ghana’s share in total world exports. The second step is quite simple, and it consists in the creation of a categorical variable that identifies those products that have a revealed comparative advantage in each country’s export basket. In the third step, a measure that can identify revealed distance between products is constructed that can avoid any priors one might have as to the root cause of that similarity. Hausmann and Klinger (2006) call it product distance. Product distances (I) for each pair of products (i,j) are calculated using the minimum of two conditional probabilities: the probability of having RCA in product j, given that countries experience RCA in product i; and the probability of having RCA in product i, given that countries experience RCA in product j. 101 PRODY – THE INCOME-LEVEL OF A PRODUCT Hausmann, Hwang and Rodrik (2005) define the sophistication of each product in terms of the per capita incomes of the countries that export it. They construct this in steps. First, for each product exported, they calculate the weighted average of the GDP per capita of countries that export that product. The weights denote the revealed comparative advantage of each country that exports that product. In this way, they determine an “income level� for each product, which they call PRODY. “Rich countries export rich country products.� In this sense, the PRODY reflects the incomes of the type of countries that export the product, i.e. their capabilities embodied in all the factors that make them rich countries – technological sophistication, access to markets and capital, human capital etc. The productivity level associated with product k: *GDP_j „ Where xjk=Xj , is the value-share of the commodity in the country’s overall export basket. „ The denominator aggregates the value-shares across all countries exporting the good „ The index represents a weighted average of per-capita GDPs, „ Weights are the revealed comparative advantage of each country in good k Products and their Prody values over time SITC 2 Product Description Prody CODE 1980 84 371 Fish, prepared or preserved,n.e.s. i 3035 589 Fruit otherwise prepared or preserved 5869 711 Coffee, whether or not roasted 637 721 Cocoa beans, whole or broken, or raw 582 2320 Natural rubber latex; nat.rubber 910 2631 Cotton (other than linters),not carded 530 2876 Tin ores and concentrates 736 2927 Cut flowers and foliage 2286 3414 Petroleum gases and other gaseous hydrocarb. 4830 6116 Leather of other hides or skins 1063 6672 Diamonds, unwork, cut/otherwise work. 3088 6872 Tin and tin alloys, worked 11974 7764 Electronic microcircuits 11907 8451 Jerseys,pull-overs,twinsets,cardigans 2402 8510 Footwear 4202 102 REVEALED COMPARATIVE ADVANTAGE Revealed Comparative Advantage (1) Share of coffee in Uganda’s total exports Share of coffee in total World Exports Uganda has a RCA in coffee when the share of coffee in its total exports is larger than the share of coffee in global exports. In 2000-04: •Share of coffee in Uganda’s exports=36% RCA in Coffee >1 •Share of coffee in World exports= 0.001% •Uganda’s Share of Fresh Fish Fillet=12% RCA in Fresh Fillet >1 •Share of Fresh Fish Fillet in World exports= 0.0004%. •Share of Fresh Potatoes in Uganda’s exports = 0.0001% •Share of Fresh Potatoes in World exports = 0.0002%. RCA in Potatoes <1 103 Distance Distance Distance 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0 0.1 0.2 0.3 0.4 0.5 0.6 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 Shellac,seed lac,stick Fruit,fresh or dried, Other fresh or chilled lac,resins,g n.e.s. vegetables Beans,peas,lentils & Vegetables,prepared Crustaceans and Classics Classics Classics other legumino or preserved,n. molluscs,fresh,chil Groundnuts Spices (except Plants,seeds,fruit (peanuts),green,whether pepper and pimento) used in perfumer Soap;organic Vegetable Sheep and lamb skin Source: Authors’ calculations surface-active products,roots & leather product tubers,f Cotton (other than Plants,seeds,fruit Vegetables,prepared Emerging Champion Emerging Champion Emerging Champion linters),not car used in perfumer or preserved,n. Sacks and bags,of Spices (except Cotton yarn textile materials pepper and pimento) Soap;organic Other fresh or chilled Minerals,crude, surface-active vegetables n.e.s. Dissappearance product Dissappearance Dissappearance Under 104 Spices (except pepper Goat & kid skins,raw garments,knitted of and pimento) (fresh,salted, cotton Vegetable Closest Products to Classic: Fruit,fresh or dried, n.e.s. Closest Products to Classic: Sesame (sesamum)seeds Edible products and Marginals Molasses,whether or not Marginals Marginals products,roots & decolourize preparations n. Closest Products to Classic: Other fresh or chilled vegetables tubers,f Leather of other hides or Edible products and Edible nuts(excl.nuts skins preparations n. used for the Empty Empty Empty Appendix 6: Burkina Faso’s Classic Exports and Neighboring Products Distance Distance Distance 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.36 0.38 0.4 0.42 0.44 0.46 0.48 0.34 0.35 0.36 0.37 0.38 0.39 0.4 Sheep and lamb skin Goat & kid skins,raw Beans,peas,lentils & other leather (fresh,salted, legumino Leather of other bovine Edible nuts(excl.nuts Bran,sharps & other Classics cattle and Classics Classics Source: Authors’ calculations used for the residues derive Goat & kid skins,raw Cotton waste (including Sacks and bags,of textile (fresh,salted, pulled or g materials Bones,horns,ivory,hoove Edible nuts(excl.nuts used s,claws,cora Tobacco,not stripped for the Plants,seeds,fruit used in Suits,men's,of textile Emerging Champion Emerging Champion Emerging Champion perfumer Cotton seeds fabrics 105 Cotton Cotton (other than Groundnuts fabrics,woven,unbleache linters),not car (peanuts),green,whether d,not Hides and skins,n.e.s Sesame Other fresh or chilled waste and use (sesamum)seeds vegetables Dissappearance Dissappearance Dissappearance Other fresh or chilled Beans,peas,lentils & Vegetables,dried,dehydra vegetables other legumino ted or evap Beans,peas,lentils & other Leather of other hides or Sugar confectionery and Marginals Marginals Marginals Closest Products to Classic: Leather of other hides or skins legumino skins other sugar Closest Products to Classic: Cotton (other than linters),not car Closest Products to Classic: Oil seeds and oleaginous fruit. n.e Calf skins,raw Sugars,beet and Tobacco,not stripped (fresh,salted,dried, cane,raw,solid Empty Empty Empty