MALAWI COUNTRY ECONOMIC A Narrow Path MEMORANDUM to Prosperity A Narrow Path to Prosperity MALAWI COUNTRY ECONOMIC MEMORANDUM © 2023 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attri- bution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. Cover image: “Mbee” by Robert Kalolo Cover design, interior design and typesetting: Piotr Ruczynski, London, United Kingdom 8 KEY FINDINGS FROM THE COUNTRY ECONOMIC MEMORANDUM 1 Over the past 30 years, Malawi’s per capita gross domestic product (GDP) has increased by over 50 percent, a growth trajectory comparable to that of other countries in the region but insufficient to significantly raise living standards and close the gap to its neighbors. Some peer countries have managed to triple their per capita GDP over this time resulting in dramatically reduced poverty rates. Analysis using the World Bank’s “Long-Term Growth Model” shows that there is no single solution to reaching the Malawi 2063 growth targets. Rather, reaching upper middle-income status in the next 40 years will require simultaneously increasing the effectiveness and efficiency of public investment, catalyzing private investment and enhancing economy-wide efficiency. 2 Malawi’s disappointing economic growth outcomes can be attributed to pol- icy choices that have worsened an already unfavorable external environment and resulted in significant fiscal and external imbalances. Weak fiscal planning and implementation make budgets an ineffective guide to resource allocation. Unsustainable debt, driven by high fiscal deficits, is a drain on economic growth. Inadequate management of external balances promotes costly balance-of-pay- ments crises. Each of these is determined by policy choices. Macroeconomic policy reforms, including those currently under implementation, hold the key for Malawi to move from a vicious cycle to a virtuous one. 3 Government policies over many decades have aimed to promote food self-suf- ficiency rather than commercial farming, leaving most Malawians in an underperforming agricultural sector. Farming for themselves provides only a third of the typical rural household’s income. Even farming much more pro- ductively, in current systems, presents no route out of poverty for the majority. Untapped potential for further growth and job creation in agriculture primarily comes from scaling up agricultural commercialization. With the right policies com- mercial farmers create increased local demand, stimulating rural off-farm labor markets. Transforming the rural economy also requires a more market-driven approach and more efficient and targeted support. 4 Malawi was among the countries hardest hit by the COVID-19 pandemic. Eighty- five percent of firms lost sales, the fifth-highest incidence among 48 countries in the Business Pulse Survey. However, it was the series of shocks since 2020 that have been particularly damaging, as sales have continued to decline through 2022. Two- thirds of businesses surveyed in 2022 believe that increased non-labor input costs (such as for energy and fuel) negatively affected their profits, while foreign exchange unavailability undermined profitability for more than three-quarters of firms. 5 Market distortions and a lack of firms’ competitiveness result in low dynamism and unrealized productivity gains. Low overall productivity levels and large gaps between productive and unproductive firms suggest that many firms are not using their resources efficiently to compete and grow. Firms face significant barriers, including in accessing finance, information, and international markets. The private sector would also benefit from better access to electricity, lower levels of corrup- tion, and a more stable policy environment. This would in turn bolster growth. 6 For exports to drive growth, Malawi needs to depart from a pattern where chronic trade imbalances and restrictive trade policies reinforce each other. Significant policy barriers and foreign exchange rationing not only reduce access to inputs but also act as a tax on exports, creating disincentives for firms to trade. These distortions hinder diversification into non-traditional exports with higher value added. They also drive informal trade and smuggling. This is further exacer- bated by imports (and scarce forex) primarily being directed toward consumption goods rather than intermediate goods necessary for participation in global and regional value chains. 7 Malawi has high potential to significantly increase non-traditional agricul- tural exports and mining. The soybean, macadamia and groundnut value chains have developed industrial-scale production and processing capacities capable of servicing regional and global markets. Recent discoveries of energy transition minerals present transformative opportunities for increased exports, and in turn foreign exchange generation, fiscal revenues, and growth if these are managed responsibly. Benefiting from this significant economic potential requires sustained implementation of policies geared toward export-led growth, rather than creating additional barriers to trade and investment. 8 Unlocking economic growth in Malawi requires the alignment of political incen- tives with development goals. Eleven case studies of recent Malawian successes highlight growing non-traditional agricultural value chains, well-executed pub- lic sector reforms, and Government strategies that were effectively implemented. These successes required institutional changes through empowered and com- mitted leadership, effective management, the aligning of financial incentives with performance, and fostering strategic public-private dialogue. A feedback loop between more conducive sectoral governance and macroeconomic reform can bring Malawi closer to the growth ambitions stated in the Malawi 2063. Contents 10 Acknowledgements 12 Abbreviations 14 Overview 32 CHAPTER 1 From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 33 Slow growth is at the root of Malawi’s high poverty rate 35 Malawi’s Economic History since Independence Has Been Defined by Stagnation, Shocks and Brief Growth Bursts 43 Malawi’s Long-Term Growth Outlook 45 Macroeconomic Policy and Institutions Drive Growth Outcomes 53 Macroeconomic Policy Reforms to Get Malawi Back on Track 56 ANNEX 1.1  Specification for the Long-Term Growth Model analysis 58 CHAPTER 2 Commercializing Agriculture and Improving the Prospects for Rural Employment 59 Introduction 62 Understanding Rural Economy Dynamics in Malawi: Employment Opportunities and Challenges for Rural Households 65 Agricultural Commercialization Can Be a Source of Growth and a Pathway Out of Poverty 71 Drivers and Constraints to Rural Economic Development 74 Policy Reforms to Advance Agricultural Commercialization and Support Rural Labor Markets 78 CHAPTER 3 Unlocking Core Constraints to Private Sector Productivity Growth 79 Improving Private Sector Performance is Central to Addressing Malawi’s Jobs Challenge 80 Unpacking the Performance of Malawi’s Firms 84 A Management Implementation Gap Holds Malawian Firms Back 85 A Series of Shocks since 2020 Exacerbated Existing Structural Weaknesses and Has Devastated Malawi’s Private Sector 87 The Financial Sector Currently Does Not Sufficiently Support Private Sector Growth 88 More Needs to Be Done to Even the Playing Field and Address Anti-Competitive Behavior 89 Policy Reforms to Increase Firms’ Productivity and Strengthen Capabilities 91 ANNEX 3.1  Data Sources Used for Firm-level Analysis 93 CHAPTER 4 Increased Trade Can Help Stabilize the Economy and Drive Industrialization 94 Improving Trade Performance Can Unlock Malawi’s Economic Potential 96 An Overview of Malawi’s Trade Performance in Six Facts 104 Trade and Industrial Policy Choices Are Central to Malawi’s Weak Trade Performance 109 How Malawi Can Achieve Its Export Potential 117 Policy Reforms to Increase Exports and Bring in Foreign Investment 119 CHAPTER 5 Can This Time Be Different? Building on Past Successes to Kickstart Growth 120 Focusing on the “how” of enabling growth through reforms 122 Regulatory Weaknesses, Corruption, and the Lack of Government Effectiveness Have Structural Causes 126 Malawian Successes Overcame Governance and Institutional Constraints 135 Scaling Success Has the Potential to Change the Greater Picture 137 Financing Malawi’s Growth and Economic Development Needs to Take Malawi’s Governance Dynamics into Account 140 How to Systematically Scale Governance and Implementation Successes for Economic Growth 143 ANNEX 5.1  Summary of Successful Cases 145 References 150 APPENDIX A  List of CEM Background Papers BOXES 38 1.3  Malawi’s economic trajectory lags behind that of Figure top growth performers 38 Box 1.1  Selection of comparator countries 40 1.4  Malawi’s savings rate is volatile but generally below Figure 48 Box 1.2  How deficit budgets, weak implementation, and its peers underreported deficits drive public debt 40 1.5  Two short-lived investment booms only brought Figure 51 1.3  Weak external balance management combined Box Malawi to the regional average with inadequate sectoral governance leads to Malawi’s 41 1.6  Structural transformation reduces agricultural Figure periodic fuel crises employment 70 2.1  International best practice for large scale Box 41 1.7  Quickly growing countries industrialize much faster Figure commercialization to inform Malawi’s Mega-Farm than peers initiative 41 1.8  Services play an increasing role in most economies Figure 72 2.2  Reforming the Affordable Inputs Program (AIP) can Box 42 1.9  Malawian industry workers are as productive as unlock significant resources for more productive uses Figure those among aspirational peers; there are just fewer of 83 3.1  Reducing gender gaps between entrepreneurs has Box them the potential to boost firms’ productivity 42 1.10  Services workers are much more productive than Figure 95 4.1  Can Malawi’s new National Export Strategy achieve Box those in agriculture but Malawian services workers still its ambitious targets? lag peers 113 4. 2  Recent trade policy reforms could contribute Box 42 1.11  African farmers have become much more Figure to commercialization and increased investment in productive recently but not in Malawi agribusiness, but have been partially implemented 43 1.12  In contrast to higher achievers, Malawi’s exports Figure 117 4.3  The Drivers of Smuggling at Malawi’s Borders Box are in decline 44 1.13  The LTGM illustrates scenarios of Malawi’s Figure potential future FIGURES 46 1.14  Malawi’s macroeconomic policy challenges are all Figure interconnected. 14 O.1  Malawi’s economic trajectory lags that of top 47 1.15  Malawi’s debt trajectory was not uncommon Figure growth performers Figure among peers over many years, but growth in high-cost 16 O.2  In contrast to higher achievers, Malawi’s exports borrowing over recent years has led to debt distress Figure are in decline 48 B.1.2.1  Where does debt come from? 17 O.3  Structure of the Country Economic Memorandum Figure 50 1.16  Malawi has entered its fourth acute BoP crisis in as Figure 19 O.4  Even major productivity improvements could not Figure many decades Figure reduce poverty sufficiently 51 1.17  A history of policy reversal 19 O.5  Agricultural income is typically a small share of Figure 51 B.1.3.1  Small mismatches with major effects Figure total income Figure 21 O.6  Malawian firms experienced some of the most 60 2.1  Significant productivity improvements would not Figure raise incomes by much Figure widespread sales losses globally 22 O.7  Rather than rebounding, sales for most firms 60 2.2  Even substantial productivity improvements only Figure lead to modest poverty gains Figure continued to drop into 2022. 22 O.8  Malawian banks have higher returns on assets 62 2.3  Share of household types by IHS wave Figure 63 2.4  Typology of Malawian households Figure (ROA) and equity (ROE) than those in neighboring Figure countries (2011 – 21) 63 2.5  Agricultural income is typically a small share of Figure 22 O.9  Lending to Government has increased dramatically Figure total income. in recent years, crowding in out private sector credit 64 2.6  Processing, sales, and trade of agricultural Figure 23 O.10  A vicious cycle of restrictive trade policies and Figure products are the most commonly reported enterprises weak outcomes 65 2.7  Commercial farming households are heavily Figure 24 O.11  The current account deficit has deteriorated in Figure concentrated in the North and Central Regions recent years 72 B.2.2. 1  Expenditure on fertilizer subsidies has had only Figure 24 O.12  Malawi’s exports composition is dominated by Figure a weak relationship with maize production tobacco and services 80 3.1  Malawian entrepreneurs tend to be young Figure 25 O.13  Malawi’s borders are “thicker” than those of many Figure 80 3.2  Becoming an entrepreneur is a necessity rather Figure other countries in the region than a choice 33 1.1  Despite periods of acceleration, Malawi’s economic Figure 81 3.3  The gap between the most and least productive Figure growth has not been transformational and profitable Malawian firms is significant 37 1.2  Malawi’s economic trajectory is on a par with that Figure 81 3.4  The productivity gap is greatest for retail and Figure of many structurally similar countries services firms 82 3.5  The gap between the most and least productive Figure 101 4.16  Intermediate imports as percent of GDP is Figure firms increases with age relatively lower for Malawi compared with its peers 82 3.6  Younger firms are significantly less productive than Figure 102 4.17  The level of intermediate goods imports has Figure older firms been slowing down, while that for consumption 83 3.7  Medium and large firms and exporters are most Figure goods has been increasing productive 102 4.18  Inward FDI flows for Malawi and comparison Figure 86 3.8  Malawian firms experienced some of the most Figure countries, 2011 – 2021 widespread sales losses globally 103 4.19  Malawi’s FDI vs. other sources of external finance Figure 86 3.9  Rather than rebounding, sales for most firms Figure (2011 – 2021) continued to decline into 2022 103 4.20  Malawi ‘s composition of inward FDI flows Figure 87 3.10  Malawian banks have higher returns on assets Figure (2011 – 2021) (ROA) and equity (ROE) than those in neighboring 103 4.21  Most FDI projects have been in services sectors Figure countries (2011 – 21) 106 4.22  The long journey to an export license for a Figure 87 3.11  Lending to government has increased Figure Malawian agricultural exporter dramatically in recent years, crowding out private 106 4.23  Malawi’s borders are “thicker” than those of many Figure sector credit other countries in the region 88 3.12  Vested interests and cronyism are seen as Figure 109 4.24  Real income (welfare) implications from AfCFTA Figure central to policy implementation for Malawi in 2035 88 3.13  Malawi is similar to comparators in terms of Figure 110 4.25  Output changes due to the AfCFTA in 2035 Figure the degree of market dominance 111 4.26  Deeper trade agreements could lead to GDP gains Figure 94 4.1  Malawi’s goods exports have been in decline Figure 111 4.27  Malawi could increase exports significantly through Figure 94 4.2  Malawi’s NES export growth targets were not Figure deeper trade agreements, especially with the EU achieved 114 4.28  Seven priority mining projects Figure 95 4.3  A vicious cycle of restrictive trade policies and Figure 121 5.1  While excelling over its peers on some dimensions, Figure weak outcomes on others Malawi’s governance arrangements are just 96 4.4  The current account deficit has deteriorated in Figure average recent years… 137 5.2  Feedback loop between enhanced sectoral and Figure 96 4.5  …resulting in dangerously low reserves Figure macroeconomic governance 97 4.6  Malawi’s historical trend in trade openness from Figure 1990 to 2020 97 4.7  Malawi’s services exports have spiked since 2016 Figure TABLES 98 4.8  Malawi’s exports composition is dominated by 27 O.1  Overview of eleven Malawian success stories Figure tobacco and services Table 98 4.9  Malawi’s declining export performance and 30 Table O.2  Top policy priorities by chapter 54 1. 1  Top five macro-fiscal policy priorities Figure volatility in other exports Table 98 4.10  Malawi’s number of differentiated exports is Figure 57 Table A1.1.1  LTGM Input Variables diminishing 77 Table 2.1  Top five agricultural policy priorities 98 4.11  Malawi’s number of markets reached declined Figure 84 Table 3.1  Malawian firms use good basic managerial practices for most of its exports sectors in recent years but do not widely implement many professional solutions 99 4.12  Export survival rates are low and stagnant Figure 90 3.2  Top five private sector policy priorities Table 99 4.13  Malawian exporters have been declining, while Figure 92 A.3.1.1  Overview of sample for each data source Table GVC firms show more stability 107 4.1  Costs by corridor to and from Lilongwe Table 99 4.14  Firms that are linked to GVCs build stronger Figure 111 4.2  Expected impact of full AfCFTA implementation on Table export relationships Malawi’s imports, revenues and tariff rate 100 4.15  Export response to RER movements: slow to Figure 117 4.4  Top five trade policy priorities Table increase but fast to fall 142 5.1  Top five governance and implementation priorities Table 10 Acknowledgements This Country Economic Memorandum was prepared by a multisectoral team led by Jakob Engel (Senior Country Economist and Task Team Leader) under the guidance of Abha Prasad (Practice Manager). The team is grateful for guidance and support throughout the process from Nathan Belete (Country Director), Asad Alam (EFI Regional Director), Hassan Zaman (EFI Regional Director), Hugh Riddell (Country Manager), Aghassi Mkrtchyan (Lead Country Economist), and William Battaile (Lead Country Economist). The report benefited from excellent peer reviewer comments by Paul Brenton, Soujanya Chodavarapu, Madhur Gautham, Deborah Isser, and Richard Record. Contributing authors by chapter are as follows: Chapter 1 on macroeconomic policy and growth was prepared by Hayaan Nur, Yalenga Nyirenda, Yumeka Hirano, and Jakob Engel. Valuable feedback on the Long-Term Growth Modelling analysis was received from workshop participants from the Ministry of Finance and Economic Affairs, the National Planning Commission, the National Statistics Office, and Statistics Norway. Chapter 2 on agriculture and rural labor markets was prepared by Dipti Thapa, Paavo Eliste and Blessings Botha. It benefited from inputs and feedback by Miles McKenna, Hayaan Nur, Time Fatch, Bobojon Yatimov, Lina Cardona Sosa, Francisco Obreque, Holger Kraay, as well as Todd Benson, Joachim De Weerdt and Jan Duchoslav from the International Food Policy Research Institute (IFPRI). A previous version of this analysis was published in the December 2022 edition of the Malawi Economic Monitor. Chapter 3 on firm productivity and the private sector was prepared by Reyes Aterido, Efrem Chilima, and Jakob Engel. It benefited from contributions and feedback by Arti Grover, Sudhir Shetty, Innocent Njati Banda, Ryan Kuo, Yumeka Hirano, Hayaan Nur, and Dr Henderson Gondwe (independent consultant). Chapter 4 on trade was prepared by Jakob Engel, Aleksandar Stojanov, and Lawrence Edwards (University of Cape Town), with contributions and feedback by Javier Aguilar, William Mwanza, Paul Brenton, Efrem Chilima, Ankur Huria, Peter Kusek, Miles McKenna, Hayaan Nur, Yalenga Nyirenda, Ana Fernandes, Osama Nawab, Priyanka Kher, Martin Brun (Universita Autonoma de Barcelona), Grain Malunga (independent consultant) and Olivier Jammes (independent consultant). Chapter 5 on governance and institutions was prepared by Hayaan Nur, Michael Roscitt, Jonathan Said and Jakob Engel, with inputs from Odete Muximpua, Chikondi Nsusa, Neema Mwingu, Collins Zamawe, Chiho Suzuki, Elizabeth Venables (AgDIV), Jan Duchoslav (IFPRI) and Lyton Chithambo (Press Corporation). The full list of background papers can be found in Appendix A. Henry Chimbali, Elizabeth Mangani, Karima Ladjo, Tinyade Kumsinda and Towera Kachingwe Mpando provided assistance with external communications, design and additional production and administrative support. Peter Kjaer Milne and Ella Hoffman provided editorial review. Cover image: “Mbee” by Robert Kalolo. Acknowledgements 11 The team would also like to acknowledge numerous government officials for providing inval- uable comments and suggestions throughout, including representatives from State House, the Ministry of Finance and Economic Affairs, the Reserve Bank of Malawi, the Ministry of Trade and Industry, the Ministry of Agriculture, the Ministry of Mines, the National Planning Commission, the Competition and Fair Trade Commission, and the Malawi Trade and Investment Centre. The team is also indebted to inputs received from dozens of interviewees and workshop participants from the private sector, civil society organizations, and academia. The contri- bution of numerous development partners is also greatly appreciated, including from FCDO, EU, AfDB, USAID, IMF, UNDP, the UN Resident Coordinator’s Office, GIZ, KfW, as well as the Flanders delegation, and the Embassies of Norway, Ireland, Iceland, and the United States. The team is grateful to the Malawi Revenue Authority for kindly facilitating access to cus- toms trade data, the Ministry of Trade and Industry for sharing relevant information on the African Continental Free Trade Area negotiations, the Malawi Energy Regulatory Authority on the fuel price build-up and the Ministry of Finance and Economic Affairs for provid- ing detailed fiscal data. The findings, interpretations and conclusions expressed in this publication do not neces- sarily reflect the views of the World Bank’s Executive Directors or the countries they rep- resent. The report is based on information current as of November 30. The World Bank team welcomes feedback on the Country Economic Memorandum. Please send comments to Jakob Engel (jengel@worldbank.org). 12 Abbreviations ADMARC  Agricultural Development and Marketing ha  Hectares  Corporation   HIPC  Highly Indebted Poor Country  AfCFTA  African Continental Free Trade Area  HIV  Human Immunodeficiency Virus  AgDiv Feed the Future Malawi Ag Diversification HS  Harmonized System (multipurpose Activity international product nomenclature) AIDS  Acquired Immunodeficiency Syndrome  ICT Information and Communcation Technology AIP  Affordable Inputs Program  ID Identification BEC  Broad Economic Categories (product IFMIS  Integrated Financial Management nomenclature)  Information System  BMGF  Bill and Melinda Gates Foundation  IFPRI  International Food Policy Research Institute  BoP  Balance of Payments  IFS International Financial Statistics BPS  Business Pulse Survey  IHS  Integrated Household Survey  CAGR Compound Annual Growth Rate ILO  International Labour Organization  CC City Council ILOSTAT International Labour Organization CCDR  Country Climate and Development Report  Department of Satistics CD1  Currency Declaration Form  IMF  International Monetary Fund  CEM   Country Economic Memorandum  LAPA Local Authority Performance Assessment CEO  Chief Executive Officer  LGFC  Local Government Finance Council  CET  Common External Tariff  LTGM  Long-Term Growth Model  CFTA Competition and Fair Trading Act LWB  Lilongwe Water Board  CFTC  Competition and Fair Trading Commission  LWSP Lilongwe Water and Sanitation Project CHAI  Clinton Health Access Initiative  MACRO  Malawi AIDS Counselling and Resource CI  Confidence Interval  Organization  COGA  Control of Goods Act  MDAs  Ministries, Departments, and Agencies  COMESA  Common Market for Eastern MERA Malawi Energy Regulatory Authority and Southern Africa  MFMod  Macro-Fiscal Model  COVID-19  Coronavirus Disease 2019  MoA  Ministry of Agriculture  DARS  Ministry of Agriculture Department for MoE Ministry of Natural Resources, Energy, Agricultural Services  and Mining DRG Department of the Registrar General MoFEA  Ministry of Finance and Economic Affairs  DSA  Debt Sustainability Analysis  MoH  Ministry of Health  EGPAF  Elizabeth Glaser Pediatric AIDS Foundation  MoLG  Ministry of Local Government  EITI  Extractives Industry Transparency Initiative  MoTI  Ministry of Trade and Industry EIU The Economist Intelligence Unit MPO  Macro-Poverty Outlook  EnDev Energizing Development Program MRA  Malawi Revenue Authority  ESCOM  Electricity Supply Corporation of Malawi  MSME  Micro, Small, and Medium-Sized Enterprises  EU  European Union  MT Metric Tons FAO  Food and Agriculture Organization  MTDS  Medium-Term Debt Management Strategy  FDI  Foreign Direct Investment  MWI Malawi FISP  Farm Input Subsidy Program  MWK  Malawi Kwacha  FS  Funneling Survey  NES II  National Export Strategy II  FY Financial Year NES  National Export Strategy  GATS  General Agreement on Trade in Services  NGOs  Non-Governmental Organizations GDP  Gross Domestic Product  NOCMA National Oil Company of Malawi GESD  World Bank Malawi Governance to Enable NPC  National Planning Commission  Service Delivery Project  NSO  National Statistical Office  GVCs  Global Value Chains  NTB  Non-Tariff Barrier  Abbreviations 13 ODA  Official Development Assistance  SME  Small and Medium-Sized Enterprises  OECD  Organization for Economic Co-operation SOE  State-Owned Enterprise  and Development  SSA  Sub-Sahara Africa  PBG Performance-Based Grant STRI  Services Trade Restrictiveness Index  PEPFAR  President’s Emergency Plan for AIDS Relief  TEU  Twenty-Foot Container Equivalent Unit  PFM Public Financial Management TFP  Total Factor Productivity  PO  Producer Organization  ToT  Terms-of-trade  PPP  Purchasing Power Parity TRIST  Tariff Reform Impact Simulation Tool  PSIP Public Sector Investment Program UNDP  United Nations Development Program  PTA  Preferential Trade Agreement  UNESCAP United Nations Economic and Social Q4 Fourth Quarter of a Year Commission for Asia and the Pacific RBM  Reserve Bank of Malawi  US United States of America REER Real Effective Exchange Rate US$   United States Dollar  RER  Real Exchange Rate  USAID  United States Agency for International RFA Road Fund Administration  Development  RHS Right-Hand Scale WBES World Bank Enterprise Survey RIAPA  Rural Investment and Policy Analysis (data WBG  World Bank Group  and modelling system)  WDI   World Development Indicators  RISE Regulatory Indicators for Sustainable Energy WEF World Economic Forum ROA  Returns on Assets  WEO  World Economic Outlook  ROE  Returns on Equity  WGI  Worldwide Governance Indicators  SADC  Southern African Development Community  WITS  World International Trade Solution  SCTP  Social Cash Transfer Program  WTO World Trade Organization 14 OVERVIEW Malawi urgently needs a new development model to alter its current economic trajectory As Malawi enters its seventh decade since independence, the country is at a critical junc- ture in its development journey. The “poly-crisis” facing the country between 2020 – 2023 has negatively affected lives and livelihoods. Per capita gross domestic product (GDP) growth has been negative during this period, resulting in an increase in poverty levels from an already high baseline. At the start of the 2023/24 lean season, more than one in five Malawians were estimated to be experiencing acute and severe food insecurity. A series of shocks worsened large fiscal and external imbalances, leading to the necessity of external debt restructuring, fiscal consolidation and sustained shortages of essential commodities, including pharma- ceuticals, food, fertilizer, and fuel. The scarcity of foreign exchange in the official market has undermined businesses, fostered illicit trade and smuggling, suppressed imports, and led to the withdrawal of trade finance. While economic reforms are starting to take shape, they have yet to decisively propel the country onto a more rapid development trajectory. Higher levels of sustained growth are urgently needed. Over the past 30 years, Malawi’s per capita gross domestic product (GDP) has increased by over 50 percent, a growth tra- jectory comparable to that of other countries in the region (Figure O.1). However, some peer countries have managed to triple their per capita GDP over this time, leading to sub- stantial reductions in poverty rates. Additionally, given its significantly lower baseline, this has meant Malawi has not been able to catch up to its more prosperous neighbors. In turn, growth has been insufficient to significantly raise living standards. There have been periods Figure O.1  Malawi’s economic trajectory lags that of top growth performers Real GDP per capita in 2017 constant US$ purchasing power parity 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 90 19 1 92 19 3 19 4 19 5 19 6 19 7 98 20 9 00 20 01 20 2 20 3 20 4 05 20 6 20 7 20 8 20 9 10 20 11 20 2 20 3 20 4 20 5 20 6 20 7 18 20 19 20 0 20 21 20 22 e 9 9 0 1 23 0 1 9 0 1 0 9 1 9 0 1 9 9 0 0 1 2 20 19 20 20 19 19 19 20 Malawi Sub-Saharan Africa Ethiopia Lao PDR Nepal Rwanda Source: World Bank WDI (1990 – 2021) and staff calculations based on World Bank Macro-Poverty Outlook (2023). Overview 15 in Malawi’s post-independence history when annual per capita GDP growth exceeded 4 percent, most notably in the 15 years following independence (1964 – 1979) and during the boom following debt relief in the context of the Heavily Indebted Poor Countries (HIPC) ini- tiative (2006 – 2011). Unfortunately, these periods were interrupted by stretches of very slug- gish growth, resulting in modest overall economic gains and largely stagnant poverty rates. Malawi has, however, made significant strides in many areas of human development. Since 1990, life expectancy has increased by more than 20 years, driven in part by signifi- cant progress in reducing infant and child mortality and successful efforts against commu- nicable diseases. According to the Human Capital Index, Malawi is ranked between Iraq and Botswana, both upper middle-income countries. Malawi’s Government recognizes the importance of economic growth as a catalyst of socio-economic progress and has set clear targets in its development vision, the Malawi 2063. These objectives include achieving lower middle-income status by 2030 and upper middle-income status by 2063. However, Malawi remains off track to reach these goals and has been unable to sustain an inclusive economic expansion sufficient to significantly reduce poverty and improve the wellbeing of the average Malawian citizen. The Malawian Government has recently made several difficult decisions to address this crisis, acknowledging the need for tough but important reforms to stabilize and bolster the macroeconomic foundations for growth. This includes significant movement towards aligning official and parallel exchange rates and increasing the flexibility of the kwacha. Additionally, progress has been made in debt restructuring. Fiscal consolidation measures have been announced, including reforms to improve the efficiency and sustainability of the Affordable Inputs Programme, the country’s fertilizer subsidy. Collectively, these steps in- dicate an acknowledgement of the need for difficult but important decisions to stabilize the macroeconomy and help create foundations for inclusive, sustained growth, and they are supported by Malawi’s economic history. Previous growth episodes were characterized by temporary macroeconomic stability, fiscal solvency, and a relatively favorable business environment. However, the question remains: will this prove to be just another crisis or a genuine turning point in Malawi’s economic journey? Four core challenges: declining exports, low savings and investment, a slow shift of workers out of subsistence agriculture, and high climate vulnerability Malawi’s export performance has weakened in recent decades from an already low base, in contrast to most other peers (Figure O.2). The integration into global and region- al value chains has proven highly beneficial for countries in East and South Asia, as well as some high-growth African nations like Ethiopia and Rwanda. For countries with small domestic markets on a global scale, such as Malawi, leveraging trade makes sense. Driven by strong commodity exports, Malawian exports (as a share of GDP) during the 1990s were ahead of regional averages and those of structural and aspirational peers.1 This trend has 1.  Peer countries were selected for facing similar structural economic challenges to Malawi, including a geogra- phy that makes trade inherently costly, an economy dominated by agriculture, high vulnerability to shocks and similar policy challenges, such as fiscal, monetary, and external imbalances. We selected nine countries grouped into “structural peers” and “aspirational peers”. Structural peers, including Burundi, Madagascar, Niger, Uganda, and Zimbabwe, fulfil the characteristics above and have similar growth outcomes as Malawi. Aspirational peers share many of the same structural characteristics. However, Ethiopia, Lao PDR, Nepal, and Rwanda, which were selected as aspirational peers, have embarked on much more comprehensive economic transformation over the past three decades. Overview 16 reversed, with Malawi now exporting less than 40 percent of the output typical for an African country. The low level of exports paired with high import demand has significant macroeconomic consequences, perpetuating foreign exchange shortages and causing mi- croeconomic impacts as firms miss out on the productivity gains associated with exporting. Figure O.2  In contrast to higher achievers, Malawi’s exports are in decline Merchandise exports as a share of GDP, percent 35 30 25 20 15 10 5 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 20 20 20 20 20 20 20 20 19 20 20 20 20 19 20 20 19 19 19 19 19 19 19 20 20 20 20 20 20 19 20 20 20 Malawi Sub-Saharan Africa Structural Peer Aspirational Peer a Source: World Bank staff calculations based on World Bank WDI based on World Trade Organization, World Bank WDI based on World Bank National Accounts, and World Bank MPO. a. Excluding Lao PDR. Malawi exhibits one of the lowest savings rates in the world, driven by high levels of government consumption, and limited household and commercial saving. Malawian savings amounted to 11.0 percent of GDP in 2019.2 At the time, only seven out of 161 coun- tries with available data reported lower figures, and this rate is expected to have declined further since then. The investment rate stood at just 12.3 percent in 2019, barely half of the regional norm of 22.2 percent. This made Malawi the country with the seventh-lowest investment rate globally. Aspirational peers invested more than 2.5 times as much of their output as Malawi, supporting considerably stronger growth. The sluggish movement of workers out of agriculture and into industry and services has contributed to these disappointing outcomes. The process of structural transforma- tion, marked by workers seeking and securing opportunities beyond agriculture, can spur the commercialization and professionalization of the economy and underpins productivity growth in the medium term. Furthermore, it can make scarce resources such as land and water available to the most productive farmers. So far, these shifts have proceeded slowly in Malawi, though the change since the 1990s has been comparable to that of the region. The share of workers in agriculture has decreased by 14 percentage points, compared with 12 percentage points in Sub-Saharan Africa, albeit from a lower baseline. 2.  Malawi has not published a national accounts expenditure series, which includes savings and investment rates, since it rebased its GDP in 2020. The 2020 rebasing led to a 38 percent upward revision. Savings and invest- ment figures presented here are based on pre-rebasing national accounts. Overview 17 Malawi is also one of the countries most prone to climate change, and how the coun- try addresses these risks will increasingly define its economic trajectory. According to the World Bank’s Country Climate and Development Report (CCDR, World Bank 2022a), climate change is anticipated to impose large costs on the economy, with disproportionately impact on already vulnerable households. These impacts on GDP are estimated to range from 3 to 9 percent by 2030. Beyond the Figure O.3  Structure of the Country Economic broader economic effects, climate shocks directly contrib- Memorandum ute to increased poverty. Agriculture, the mainstay of most vulnerable Malawian households, is more exposed to climate Restoring Macroeconomic Fundamentals shocks than other economic sectors, and housing and living Chapter 1 conditions suffer in the aftermath of floods and droughts. This Country Economic Memorandum (CEM) argues for a significant shift in policy to enable a virtuous cycle of Structural Reforms to Promote Growth sustained and inclusive economic growth, outlined in five building blocks (Figure O.3). Chapter 1 identifies pol- Agricultural Enabling Private Catalyzing Exports Commercialization Sector to Drive and Foreign icy priorities to restore the macroeconomic fundamentals and Rural Labor Productivity Growth Investment for growth through fiscal reform, debt sustainability, ex- Markets (Chapter 2) (Chapter 3) (Chapter 4) ternal rebalancing, and monetary stability. The following three chapters address three core structural constraints to growth and propose key reforms to accelerate agricul- tural commercialization and improve rural labor markets Implementing Malawi's Growth Agenda through Improved Governance (Chapter 2), enable the private sector to drive productivi- ty growth (Chapter 3), and catalyze exports and foreign in- Chapter 5 vestment (Chapter 4). Acknowledging that implementing key growth-enhancing policies — be they macroeconomic or structural — are the result of complex political economy and governance arrangements, Chapter 5 focuses on how past Malawian successes can inform future sectoral policies, re- forms, and strategies to achieve the goals outlined in the Malawi 2063. CHAPTER 1:  Restoring macroeconomic stability is a precondition for higher and sustained rates of growth that can significantly reduce poverty Improved fiscal, debt, external, and monetary policy can be instrumental in setting Malawi up for more rapid economic growth. The disappointing growth and development outcomes of recent years stem from sustained macroeconomic imbalances that have wors- ened an already unfavorable external environment. Malawi is exceptionally vulnerable to climate change, terms-of-trade shocks, and other natural and human disasters. As a land- locked country, it relies on neighboring nations to access commercial ports. While Malawi’s government has limited control over these structural dynamics, it can shape macroeco- nomic policy to establish foundations for either absorbing or exacerbating these shocks. Unfortunately, past macroeconomic policies have often increased the country’s structural vulnerability, incurring a significant opportunity cost in terms of foregone growth. For the past decade, Malawi’s fiscal position has continued to deteriorate, with weak fiscal planning and implementation rendering budgets ineffective as guides to resource allocation. While significant budget deficits have been planned for, budget overruns have exacerbated negative budget outturns. Easily predictable expenditure items have repeat- edly exceeded their allocation, pointing to institutional rather than technical causes of budget overruns. Financial management systems have proven ineffective in containing ex- penditure to budget ceilings. Non-adherence to public financial management (PFM) laws Overview 18 and procedures has led to frequent reports of expenditure overruns and contractual com- mitments surpassing approved ceilings. Without effective budgeting, prioritizing the most growth-effective expenditures becomes impossible. Malawi is currently grappling with a public debt crisis driven by the accumulation of high-interest external debt and expensive domestic borrowing used for financing fis- cal and current account deficits, rather than investments. External debt contracted on commercial terms with plurilateral development banks starting in 2018 was initially not disclosed. High interest payments put pressure on fiscal space for critical public spending. The speed and manner in which Malawi resolves its public debt crisis will have signifi- cant implications on its economic growth trajectory. It is therefore critical for the coun- try to minimize the time during which it bears the costs of being in restructuring, such as increased bond yields and financial disruption, without yet receiving the benefits of de- creased debt stocks. Initial financing assurances from the main official creditors represent an important step in this process. Mismanagement of external balances have resulted in a costly Balance of Payments (BoP) crisis in Malawi, the fourth such crisis in 30 years. Outside of Malawi’s four BoP crises since 1990, Malawi recorded an average GDP growth of 6.1 percent a year, but growth was only 1.6 percent a year during these crises. A large and increasing trade imbalance, ex- acerbated by periodic terms-of-trade shocks, has been the primary driver of BoP imbal- ances. These shocks have been exacerbated by Malawi’s narrow import and export baskets, leading to rising trade imbalances. The adequate management of Malawi’s external balanc- es is critical to sustained economic growth. Exchange rates can serve the critical function of absorbing trade and other BoP shocks. However, Malawian authorities have tended to mute this balancing channel by attempting to maintain unsustainable currency pegs. This has led to a scarcity of foreign reserves and the allocation of foreign exchange through ad- ministrative measures, along with frequent shortages of essential imports. Repeatedly, ex- change rate misalignment has been associated with the dualization of the exchange rate, opening arbitrage opportunities and providing incentives for informal trade. To break away from old growth patterns, Malawi must abandon old ways. Analysis us- ing the World Bank’s “Long-Term Growth Model” shows that there is no single solution to reaching current growth targets. Rather, getting back on track and reaching upper mid- dle-income status in the next 40 years will require simultaneously increasing the effec- tiveness and efficiency of public investment, catalyzing private investment and enhancing economy-wide efficiency. Getting macroeconomic policy right is foundational in this re- gard. This requires achieving debt sustainability and improved debt management, sus- tained fiscal reforms, increasing the efficiency of public investment, and ensuring a more resilient external balance. Stabilizing the macroeconomy will in turn attract increased pri- vate investment, enabling the country to leverage its growing and competent workforce. CHAPTER 2:  Agricultural commercialization can drive structural transformation and support the transformation of the rural economy Malawi’s economy remains highly dependent on agriculture, with the sector playing a critical role in the country’s overall economic performance. In 2021, it is estimated that over three-quarters of all adults derived their livelihoods from agriculture, contrib- uting approximately 23 percent to the total GDP. The sector is also critically important to the food security of households and the nation as a whole. Given these factors, agriculture will remain central to Malawi’s development for years to come. Overview 19 However, rural households in Malawi have had few opportunities to increase their in- comes. Ninety-four percent of all poor households in Malawi are in rural communities, and the rural poverty headcount ratio at the national poverty line (57 percent) is almost three times that found in urban areas (19 percent). Fewer than 7 percent of households can generate enough income from their farming to meet their basic needs, contributing, on average, 30 percent of the total income of the typical farming household. The median farming household surveyed in the most recent Integrated Household Survey (2019/20) derived MWK 16,190 (about Figure O.4  Even major productivity improvements could US$20 in nominal terms) in value per capita annually from not reduce poverty sufficiently their efforts. Income poverty rate at current average levels of productivity and productivity of most productive 10 percent, percent Even with significantly higher levels of productivity, Maize a farmer with extremely small landholdings is likely to remain in poverty and struggle to meet basic needs. Rice New analysis in this CEM (Benson and De Weerdt, 2023) Cassava shows that if all farming households were to attain the Sweet Potato agricultural productivity levels of the top 10 percent most productive farming households, the poverty rate would Groundnut not significantly reduce (Figure O.4). Consequently, most Soya farming households turn to other forms of employment off their own farms to avoid or escape poverty including Tobacco through ganyu labor, by operating a household enterprise 0 10 20 30 40 50 60 70 and through other longer-term employment (Figure O.5). However, under current conditions, non-farm rural em- Current average At best 10 percent ployment does not provide sufficiently high incomes to lift Source: World Bank staff calculations based on IHS (2019/20) analysis in households out of poverty either. Benson and De Weerdt (2023). Figure O.5  Agricultural income is typically a small share of total income Average per capita annual income, in current MWK (’000) Farming Non-Poor Poor Larger Land Smaller Land 0 20 40 60 80 100 120 140 160 180 200 220 Ganyu Longer-term employment Household enterprise Agricultural income Other regular inocme Social transfers Source: World Bank staff calculations based on IHS (2019/20) analysis in Benson and De Weerdt (2023). In this context, a shift in the rural economy is needed to sustainably reduce poverty. Successful commercial farming creates demand for labor, contributing significantly to ru- ral markets. While this transformation is not yet happening at scale across Malawi, there are pockets of agricultural commercialization. The share of commercially oriented farm- ing households among all Malawian households has remained low but relatively steady over time, despite challenges such as shrinking landholdings with, at best, limited improve- ments in levels of agricultural productivity. However, with effective market development and increased agricultural productivity, the share of Malawian households that are com- mercially oriented farming households can be expected to grow. Overview 20 Productive alliances, characterized by strong farmer organizations, links to offtake markets, improved access to finance, and an enabling environment, can help make markets work for commercializing smallholders. The productive alliance model starts with strengthening or building producer organizations to allow smallholders to seize mar- ket opportunities and have their voices heard, receive more information, reduce costs, and reap the rewards that come from selling in volume. Productive alliances’ efforts to improve the enabling environment, including reforms to land tenure security, standards, and certi- fications, are all geared toward improving agricultural commercialization. Productive alli- ances can therefore promote greater inclusion, especially for women. The Government of Malawi has recently intensified efforts to promote and develop large- scale farms in the country through its “mega-farms” initiative. This marks a potentially significant shift in the Government’s approach to economic development and the transfor- mation of the agriculture sector, towards a greater emphasis on supporting land access and consolidation, along with the rehabilitation of idle or underutilized land on a larger scale. However, there are critical binding constraints to the realization of the agricultural growth and rural transformation vision, including an inefficient use of agricultural expenditures and trade restrictions. While Malawi’s agriculture sector requires signif- icant investments to boost resilience and productivity, a conducive policy framework is paramount for unlocking the commercialization potential of Malawian farmers — and ul- timately for sustained growth. A central challenge in this regard is the dominance of fer- tilizer subsidy schemes in policymaking. Despite consuming about 40 percent of scarce agriculture budget resources in recent years, the Affordable Inputs Program has done lit- tle to stimulate the process of agricultural transformation necessary for Malawi to gener- ate higher economic growth and create more jobs. Existing constraints also stem from the legacy of past policy interventions, including prevailing trade restrictions, that dampen in- centives for greater commercialization. These factors continue to impact how Malawi’s key agriculture sector institutions function, despite numerous attempts at reform. Malawi’s agriculture sector has largely been shaped by policies that have promoted food self-sufficiency rather than commercial farming. As a result, the sector harbors untapped potential for further growth and job creation. Presently, only a small minor- ity of the population engages in commercial farming, hindered by an unfavorable policy environment that fails to incentivize broader employment creation. This policy environ- ment, paired with the inability of its public sector institutions to implement reforms, are key challenges to realizing the country’s vision for agricultural growth and rural economic transformation. Addressing these challenges requires a comprehensive agenda focused on effective coordination, sequencing, and targeting of policies and investments, struc- tured around three pillars: • Pillar 1: Remove barriers to stimulate private sector engagement in the agri-food sector, such that private investments can complement scarce public resources. • Pillar 2: Repurpose existing policies and support programs such as input subsidies to foster efficiency and equity in the rural agricultural market and better serve the expansion of rural employment and growth. • Pillar 3: Foster commercially oriented agricultural production and marketing systems that can expand opportunities for and participation of farmers in produc- tive agricultural value chains and lead to broader rural economic transformation in Malawi. Overview 21 CHAPTER 3:  Supporting private sector growth by addressing core constraints to firms’ productivity Malawi is facing numerous escalating challenges that make a focus on job creation and private sector-led growth a necessity. With the population growing at about 2.5 per- cent per year, the economy is not growing at a sufficient pace to provide decent jobs for the roughly 400,000 young Malawians entering the labor market annually (International Finance Corporation 2021). Nine out of ten Malawian firms are either small or micro-enter- prises and operate within the informal sector (FinMark Trust, Imani Development, and AESA 2019). Productivity is low for most firms in Malawi, with the majority producing little sur- plus to invest and grow. Large productivity gaps between firms ae indicative of significant barriers, including in firms’ ability to access finance, information, and international markets. The ongoing crisis has further exacerbated the challenges faced by firms and height- ened the country’s urgent jobs challenge. The impact of the COVID-19 pandemic, lead- ing to weakened demand, combined with electricity, fuel and forex shortages, have had a particularly detrimental impact on the private sector. Many firms find themselves with few buffers and limited access to finance to cushion successive strains. Between 2019 and 2020, 84 percent of firms reported a decline in sales. Among the 48 countries captured by the Business Pulse Surveys, only four suffered more widespread sales losses (Figure O.6). The contraction in sales was also severe, with an average loss in sales of 44 percent. Figure O.6  Malawian firms experienced some of the most widespread sales losses globally Share of firms reporting a decrease in sales and average sales decreases relative to one year earlier as of Q4 2020, percent 100 80 60 40 20 0 −20 −40 −60 −80 Pa zan e ne a M M kist ia Le sia Po enia Su blic b va nd rica ov ia oz ol an pu or Ph ong we Ghone pu ia ee a et a at an l m la ad ro s a o M b i h La nd Ro ypr ic L Br e ra ly Ta ürk ia an a ia M al Cr alta Sl El Bul am ne e er u ar ia ng in m us Po ma a rtu lia Ar ma a ut am ia p ia rd s M ton y ak alv ria o n In Ke al Ho Af ia Zi Ma na Gu ithu azi ba w n iy do ny M Mo ura Jo ine Gr ati Vi gu c Se iqu Es ar i e i ag cc Ge da Sl lays Re tv C bl ca Ita T rg g en So an So Z s ilip ol g h b Hu Ben Re ad Si T sc m la am do ov S ga a ra ni la n o Ni ec Cz Percent of firms with decreased sales Average sales decrease Source: Business Pulse Survey. Rather than rebounding, sales for most firms continued to drop into late 2022 (Figure O.7). Two-thirds of businesses surveyed in October 2022 reported that increased energy and fuel costs had negatively affected their profits, while forex unavailability was seen as a threat to profitability by more than three-quarters of firms. Larger enterprises were less likely to have a continued decline in sales. However, these firms nonetheless recorded the largest average decreases in sales. Manufacturing firms exhibiting the highest likelihood of substantial declines relative to retail and services firms. Overview 22 Market distortions and a lack of competitiveness in the Figure O.7  Rather than rebounding, sales for most firms private sector contribute to the absence of a dynamic continued to drop into 2022. cycle wherein unproductive firms are replaced by more Average change in sales relative to one year earlier in Q4 2020 and Q4 2022 by sector, percent efficient new firms. Large productivity gaps between pro- ductive and unproductive firms suggest that firms are not Micro using their resources efficiently to compete and grow. A productive firm in the 90th percentile is 37 times more pro- Small ductive than a firm in the 10th percentile. Moreover, young Med/Large firms, on average, are significantly less productive than old- er firms, suggesting that new entrants are not spurred by Manufacture competition to replace stagnant unproductive firms. Retail Sercives Firms’ capabilities are key to productivity growth, but managerial systems are inefficient, and there is a nota- −50 −40 −30 −20 −10 0 ble deficiency in the level of digitization among firms. 2019 to 2020 2021 to 2022 While Malawian enterprises are aware of good basic man- agerial practices, this often does not necessarily translate Source: Business Pulse Survey. into how businesses are operated. For instance, while man- agers maintain financial records, the methods employed are often rudimentary, relying on paper-based systems. This limits their ability to analyze data and translate financial insights into improved business processes. Despite the general availability of digital options and an RBM order that all businesses must offer digital payment, eighty-four percent of businesses primarily receive payments in cash. With limited access to finance, firms are unable to withstand shocks and grow. Ninety- five percent of firms express difficulties in accessing financing, citing high interest rates and repayment risks as their main concerns. Paradoxically, while the financial sector has remained stable and profitable amid recent crises, outperforming regional comparators (Figure O.8), this success is largely attributed to extensive lending to the government, crowding out cred- it available to the private sector (Figure O.9). Due to low-risk appetite, financial institutions provide limited supply of credit to the private sector and charge high rates to private sector borrowers. Key factors constraining lending to smaller and informal firms include lack of col- lateral and proper credit referencing, ID card challenges, and the informality of most firms. Figure O.8  Malawian banks have higher returns on Figure O.9  Lending to Government has increased assets (ROA) and equity (ROE) than those in neighboring dramatically in recent years, crowding in out private countries (2011 – 21) sector credit ROA and ROE in percent for Malawi and regional comparators Credit to Government and the Private Sector, in MWK billion 3.0 Malawi 2.5 South Africa 2.0 Zambia 1.5 1.0 Tanzania 0.5 Mozambique 0.0 15 16 17 18 19 20 21 22 23 0 5 10 15 20 25 30 20 20 20 20 20 20 20 20 20 ROA ROE Net Credit to Government Credit to Private Sector Source: Chilima and Gondwe (2023) based on World Bank and RBM data. Source: World Bank with data from RBM. Overview 23 Malawian firms face considerable barriers to formalization, entry, and growth, partial- ly due to significant distortions that constrain competition in many sectors. Entrenched corruption, uncompetitive practices, cumbersome tax administration, and an unpredicta- ble regulatory environment favor incumbents and stifle growth of existing businesses. Many sectors, including construction, telecommunications, retail, insurance, and agro-processing, have a high degree of market concentration, creating risks for collusion. State-owned enter- prises (SOEs) often compete with the private sector, enjoying significant regulatory, financial, or other advantages. The existing legal and regulatory apparatus limits the Competition and Fair Trading Commission’s (CFTC) capabilities to address anti-competitive behavior effectively. For Malawi’s private sector to drive growth, significant reforms are needed. Strengthening firms’ capabilities requires improved management training and support services. Considering the energy and forex constraints faced by firms, the Government may also want to consider pri- oritizing key industries in terms of access to essential services and forex allocations. To improve access to finance, and in the context of wider debt sustainability reforms, there is an urgent need for the public sector to reduce borrowing demands. Simultaneously, banks must reduce operat- ing costs through cost-sharing of technology investments, automated service provision, efficient credit referencing, and timely resolution of court cases. Finally, it is critical to improve the legal and operational capacity of the CFTC for more robust competition enforcement and advocacy. CHAPTER 4: Increasing trade can help restore macroeconomic stability and drive industrialization Malawi’s continued lack of economic diversification has been central to its macroeco- nomic challenges. The country has faced persistent difficulties in enhancing export per- formance, relying heavily on tobacco exports, with diversification efforts proceeding only slowly and exports declining. Increasing exports would generate more forex, addressing pervasive shortages in the Figure O.10  A vicious cycle of restrictive trade policies economy. This underscores the importance of Malawi devel- and weak outcomes oping and implementing a robust strategy to integrate into global markets while improving its macroeconomic stability. Large policy barriers and forex Malawi must break the vicious cycle in which structur- rationing al factors and restrictive trade policies reinforce each Low growth other, perpetuating a low-level equilibrium (Figure O.10). and weak Difficulties to access inputs Large policy distortions and forex rationing not only reduce macro and attract fundamen- access to inputs but also to essential goods like health and tals investors food products. The economy also suffers from a lack of in- vestment and high trade costs due to poor logistics and in- frastructure. These issues, compounded by the structural barriers of being a small, landlocked country, reduce overall economic resilience and negatively impact Malawi’s mac- roeconomic environment through low levels of foreign Low exchange earnings resulting from low export levels. Con- Low investment levels of in skills, sequently, Malawi requires an export-oriented strategy to resilience capital and logistics stimulate economic development and overcome the coun- Continued try’s structural challenges. By diversifying the economy, lack of capitalizing on opportunities in key sectors, and address- diversifica- tion and ing long-standing issues, Malawi can unlock its full poten- competitive- ness tial and position itself for sustainable and inclusive growth. Source: World Bank staff. Overview 24 Six stylized facts characterize Malawi’s trade performance: 1. Malawi’s exports have declined significantly in the past decade, resulting in low forex earnings and driving Malawi’s macroeconomic imbalances. The decline in exports has resulted in a wors- ening current account balance and dwindling reserves. Double-digit current account imbalances (in terms of percentage of GDP) between 2013 and 2021 have led to the accumulation of substan- Figure O.11  The current account deficit has deteriorated tial external liabilities (Figure O.11). This has resulted in recent years in a gradual deterioration in net reserves, especially in Current account, percent of GDP the post-COVID-19 years. 5 0 2. Malawi’s overall export performance has been worsening, large- −5 ly due to the dominant role of only one declining crop — tobac- co — in its export basket (Figure O.12). This double burden −10 of over-reliance on a single commodity and the volatil- −15 ity of its other exports not only exposes the country to −20 fluctuations in global commodity prices and demand 10 12 13 14 15 16 17 18 19 06 07 08 09 20 21 11 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 dynamics, but also results in inadequate and unstable foreign exchange earnings. This has resulted in limit- Primary and Secondary Income Trade Balance Current Account Balance ed diversification. The number of products exported by Malawi declined by 24.3 percent between 2015 and Source: World bank staff calculations based on IMF WEO 04/2022 and NSO data. 2020. Malawi has also experienced a reduction in the Note: Indexed price change is calculated as the weighted average price number of markets reached. change of reported commodity imports/exports in the preceding year. Weights are assigned according to the preceding year’s trade value. 3. Exports and exporters exhibit low survival rates. The overall number of exporters has dropped over the past decade, Figure O.12  Malawi’s exports composition is dominated mainly due to the stronger decline in entry rates than by tobacco and services exit rates, resulting in higher concentration. Moreover, Exports by sector, in US$ (‘000,000) the survival rate of new entrants is relatively low. On 1,600 average, only 20 percent of new exporters manage to 1,400 survive into the subsequent year over the period from 1,200 2006 to 2022, and 5.7 percent survive past the third year. 1,000 800 4. Malawian exporters lose more from exchange rate appreci- 600 ations than they gain from depreciations. A declining real 400 200 exchange rate is generally expected to improve export 0 competitiveness. However, Malawian exports do not in- 6 07 08 09 10 11 12 13 14 15 16 17 18 19 20 20 1 22 crease quickly during real exchange rate depreciations 2 0 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 but fall rapidly during appreciations. There are several Tobacco Agriculture Others goods causes for this differentiated response. First, supply con- Textiles Services straints reduce exporters’ capacity to scale up. Second, finding new clients can be difficult and expensive for Source: World Bank staff calculations based on MRA transactions data for goods exports and WDI data for services. firms. Third, during periods of overvaluation, exporters Note: Services exports do not include the category “maintenance face additional constraints as spreads between official and repair.” and parallel market exchange rates emerge, acting as a de facto tax on official exports. This implies that an exchange rate policy that is good for exporters minimizes periods of appreciations (like during fixed exchange rate episodes). Depreciations provide exporters with a boost, but this takes time to fully materialise. 5. Malawi “under-imports” intermediate goods necessary for GVC participation, while consumption goods use up an increasing share of forex. Countries that import intermediates tend to be better performers in terms of exports, as they contribute to technology transfer and Overview 25 productivity enhancement. However, Malawi imports fewer intermediate goods than peer countries, indicating a weaker integration of intermediate products into the pro- duction process. In recent years, the growth rate of consumption goods has surpassed that of intermediates. 6. Foreign investment, a key ingredient for export growth, has declined from an already low base. Malawi’s FDI inflows to GDP ratio in 2021 was less than 0.36 percent, significantly low- er than the regional average of 2 percent or more. More generally, the importance of FDI as an external finance source has steadily diminished over the past decade, while remittances and ODA have emerged as the primary sources of external financing. Malawi’s trade and industrial policy is central to its weak trade performance. The prev- alence of non-tariff barriers (NTBs) constitutes a major constraint to export growth, result- ing in Malawi having particularly “thick” borders (Figure O.13). Thicker borders indicate greater price differences between producer and consumer prices, implying higher trade costs and potential barriers to trade for Malawi. Many of these policies yield unintended consequences that are at odds with the Government’s goals of improving economic diver- sification and resilience. Examples include administratively burdensome import and export licenses for numerous goods, export permits, mandatory conversion of export proceeds, and an onerous regime of mandatory standards. The presence of further NTBs at the bor- der and in neighboring transit countries such as Mozambique, Tanzania, and Zambia add to the costs of trade for Malawian exporters and importers. Central to this is the lack of coordination between Malawi and its neighbors to address barriers encountered by trad- ers. Such policies are likely to reduce both the number of firms exporting and the total value of exported goods. Malawi’s challenge in attracting FDI is correlated with its relatively high legal barriers to FDI. When compared to its regional peers in the Southern African Development Com- munity (SADC), Malawi falls within the lowest quartile on the SADC Investment Climate Scorecard, which is based on Figure O.13  Malawi’s borders are “thicker” than those of the OECD FDI Regulatory Restrictiveness Index. Further- many other countries in the region more, in comparison to global standards, Malawi’s level of Bilateral Border Thickness (percent ad valorem), 2015–2018 averages FDI restrictiveness is more than three times higher than the Congo, Tanzania global average according to the same OECD methodology. Dem. Rep. The African Continental Free Trade Area (AfCFTA) pre- Angola Mozambique sents a timely opportunity for Malawi to expand its trade Zambia beyond its proximate markets. To reap the benefits of AfCFTA, Malawi must focus on trade facilitation and the rationalization of NTBs. The anticipated real income gains Zimbabwe in 2035 are estimated to be as high as 1.8 percent relative to Namibia the baseline. Malawi stands to realize significant benefits Botswana in several sectors, including processed food, agriculture, and trade services, balancing out losses in manufacturing. Importantly, the implementation of the AfCFTA agreement Eswatini in Malawi is expected to have minimal impact on customs Lesotho tax revenues. South Africa 11–57 57–94 New agriculture export crops have shown significant 94–138 potential as drivers of exports and for increasing up- 138–479 stream and downstream value addition. Soybeans rep- Source: Arvis et al. (2020) based on World Bank-UNESCAP database resent a particularly notable example of this diversification (2015 – 18 averages). Overview 26 process, emerging as the second-largest export and the most advanced value-adding sec- tor in Malawi. Notably, investment in the soybean value chain means that it is now capa- ble of fostering a downstream industry for the viable in-country production of multiple products. Macadamia has also emerged as a dynamic export growth sector, with Malawi currently ranking as the eighth-largest exporter globally. Malawian groundnuts are also increasingly processed for international markets, building on production arrangements from the tobacco value chain. Sustaining the prosperity of these burgeoning export sec- tors will necessitate the creation of an enabling environment that supports export growth and attracts increased investment. Malawi’s mining sector, while currently insignificant, can play a transformational role in driving export growth and addressing foreign exchange constraints. Recent discov- eries of energy transition minerals such as rare earths, niobium, rutile, and graphite, were spurred by global demand driven by climate change and geopolitical events. They offer opportunities for growth in exports, revenues, and sustainable social and economic devel- opment. Seven priority mining projects, including those for “green minerals” essential for the sustainable energy transition, are progressing, indicating a likely increase in the sector’s contribution to GDP. However, the scale of its contribution to Malawi’s economy remains uncertain given potential delays and the uncertainty of global commodity price dynamics. Several challenges must be navigated to transform Malawi’s mining potential into tan- gible economic and social benefits. Critical issues include the scaling up of infrastructure, refining the fiscal regime, reducing the time required for mining permits and licenses effec- tively, and addressing environmental and social challenges. Infrastructure limitations, par- ticular access to sufficient and reliable energy and adequate transport links through roads, ports, and railways, will also prove challenging. It will also be important to ensure the fis- cal regime can balance the dual priorities of maximizing revenues over many years and maintaining the necessary production incentive for industry actors. How these issues are addressed influences the sector’s contribution to the economy and the benefits for ordi- nary Malawians. Transparent contract negotiations, recourse to sufficient expertise, and a fiscal regime that supports stability are key for maximizing the mining sector’s potential. Benefiting from this potential requires sustained implementation of policies geared toward export-led growth, rather than creating ever more barriers to trade. This in- cludes addressing the significant policy distortions that create uncertainty for investors and raise costs for exporters and importers, as well as leveraging the AfCFTA to develop value chains for growing sectors, such as agro-processing, mining, and tourism. Finally, it will be important to increase the competitiveness of Malawi’s key corridors jointly with neigh- bors, including through the implementation of trade facilitation and coordinated border management reforms. CHAPTER 5:  Malawi’s path to prosperity is as much about the “how” as the “what”: the governance and implementation agenda To address the macroeconomic and structural constraints that have resulted in Malawi’s low-growth equilibrium, it is important to also understand the political economy under- lying these constraints, including instances when these dynamics have been thwarted. While Malawi is a peaceful, democratic, and lawful nation compared with its peers, political dynamics create strong incentives for policies that address short-term needs, while under- mining the ability to credibly commit to long-term structural reforms, and a macro-fiscal trajectory needed to spur inclusive growth and structural transformation. Overview 27 Past analyses of the political economy of core governance constraints impeding Malawi’s growth focus on three interlinked issues: (i) fraught state-business rela- tionships; (ii) decentralized short-term rent seeking; and (iii) isomorphism. Mistrust between the state and business interests is rooted in Malawi’s history and deals-based political arrangement. It leads to a disinterest in creating opportunities for private sector growth, in a lack of state capability for economic development, and is reflected in over- bearing regulation. At the same time, political elites are focused on the extraction of rents in the short term, rather than enabling growth of available rents. This is reflected in per- vasive corruption. In addition, while committed to making processes look legitimate and in line with international best practices, this often only happens at surface level with un- derlying informal arrangements remain unchanged — a dynamic referred to as “isomor- phism”. This is reinforced by development partners that have expended significant effort to improve governance arrangements but have often provided pre-formulated fixes with- out sufficient attention to local dynamics. Among all these governance and institutional challenges, genuine achievements can go unnoticed. Chronicling success can be a key element of accountability. Most critically, cases of success hold valuable lessons that are integral to continue positive outcomes and to scale success. In turn, this CEM identifies 11 “success stories” where generally adverse con- ditions were overcome to attain positive outcomes through the effective governance and reform of: (i) value chains; (ii) public entities and SOEs; and (iii) public programs. Selection was based on a nomination process among the CEM team, with input from external advi- sors. This resulted in the following selection (Table O.1): (i) Three agricultural value chains: groundnuts, macadamia, and soybeans; (ii) Four episodes of public institutions that were successfully reformed: Lilongwe Water Board, Phalombe District Council, Press Corporation, and Road Fund Administration; and (iii) Four public programs: Malawi’s response to the AIDS epidemic, the widespread distri- bution of stoves to achieve clean cooking goals, results-based financing of local gov- ernment development efforts, and the early years of the Farm Input Subsidy Program. Table O.1  Overview of eleven Malawian success stories Category Case Positive Outcomes Achieved Value Groundnuts Tobacco companies, assisted by a partnership with USAID, laid the groundwork to build a vertically Chains integrated groundnut value chain. Three improved varieties were released and are now produced at scale. Two large companies have contracted about 7,000 farmers to produce locally processed groundnuts. Macadamia With 10,000 hectares planted, Malawi became the eight-largest macadamia exporter globally. Eight major producers with over 2,000 permanent employees grow and market macadamia alongside 4,000 smallholders. Soybeans Soybeans have emerged as the second-largest export and the most advanced value-adding sector in Malawi. Over 300,000 tons of production, exporting US$133 million worth in 2021 and 700,000 tons of industrial level processing capacity represent a fivefold increase over a decade. Public Lilongwe With World Bank support, the Lilongwe Water Board (LWB) launched its “Pathway to Success Entity Water Board Program” to address capacity gaps. Through this, LWB increased access to water supply services, Reforms continuity of supply, revenue, cost recovery, customer service delivery, and reduced wastage. Phalombe In the 2021 Local Authority Performance Assessment (LAPA), Phalombe achieved an education District sector score of 60 percent, almost double the national average. It evidenced “home-grown” inno- Council vations, like partnerships with local businesses, and high levels of accountability. Overview 28 Category Case Positive Outcomes Achieved Public Press In 1995, the National Assembly passed the Press Trust Reconstruction Act, which redefined Press Entity Corporation Trust’s charitable objectives and Press Corporation’s privately organized corporate governance. Reforms The transformation enabled joint ventures with local and foreign partners and made the company (cont.) profitable. Road Fund The Road Fund Administration (RFA) has established a track record of sound financial performance Administration and good governance. It has enhanced and diversified revenues through initiatives like the Road Toll Program and become the most creditworthy SOE with 10 years of clean audits. It has success- fully placed bonds in local capital markets. Public HIV/AIDS Malawi has achieved a reduced number of HIV infections (from 28,000 to 20,000), increased Programs response awareness of those who are HIV positive (88 percent), a high linkage rate to HIV treatment (98 per- cent), and a high success rate among those treated (97 percent) between 2016 and 2021. Clean cook- In 2020, Malawi officially achieved its goal of migrating 2 million households to cleaner cooking ing stove alternatives. This success was driven by outstanding sectoral governance, placing Malawi a joint distribution fourth among 53 countries evaluated by the “Regulatory Indicators for Sustainable Energy”. Under government leadership, with development partner support and aligned private sector involvement, millions of households now use more efficient and less polluting cookstoves. Local gov- Supported by a World Bank grant, the Government has increased the transfer of district devel- ernment opment funds for the 28 rural District Councils in 2020. The amount districts receive is based on results-based the annual LAPA score and districts that do not fulfil minimum access conditions are not eligi- financing ble. Having entered the second LAPA round in 2021, districts have produced across-the-board improvements with the largest increases among previously least performing districts. Early years of FISP succeeded in raising awareness among Malawian farmers of the value of inorganic fertilizer. FISP In the years after FISP was introduced in 2004/05, Malawi significantly increased maize production and achieved national food sovereignty in most years. Government facilitation rather than control have led to groundnuts, macadamia, and soyabeans becoming the primary cash crops for many farmers, with upstream and downstream industries emerging. While not yet reaching the scale of tobacco, all three value chains have seen significant growth in recent years. In all three cases, suc- cessful coordination and alignment among a diverse set of stakeholders was achieved. To achieve scale, value chains often needed both the know-how and marketing capacity of major commercial firms and the production scale that only smallholders can achieve. However, the Government and development partners also played important roles in the scale-up of all three value chains. This shows the importance of three main ingredients: strong market demand, government support rather than control, and a long-term vision. Malawi is a small market that cannot be isolated from global forces. However, the three profiled value chains are indicative of the large welfare gains that further growth can provide for average Malawians. Finally, they show that successful support is rooted in active dialogue between public stakeholders, private companies, smallholder interests, and development partners. The cases of Lilongwe Water Board, Phalombe District Council, Press Corporation, and Road Fund Administration show that public entities are reformable and can de- liver on their mandates across sectors. Public enterprises do not tend to turn around by themselves; the Government and development partners have been key facilitators in these cases. Lilongwe Water Board’s transformation process was led by the Corporate Management Team, which was supported by the World Bank in its “Pathway to Success Program”. The RFA board, which guided its transformation, also seats members from the private sector, public office holders, and civil society, all appointed by the Ministry of Finance. The formula for successful public enterprise reform includes dedicated and empowered leaders finding adapted operational solutions, building on a conducive fi- nancial environment. Overview 29 Finally, the four cases of successfully implemented strategies provide tangible evidence that public policy goals can be both ambitious and achievable, with positive impacts on millions of Malawian citizens. All four cases deviate from the common belief that Malawi produces high-quality strategies but typically fails to implement them. Malawi’s response to the AIDS epidemic, the widespread distribution of cooking stoves to achieve clean cook- ing goals, results-based financing of local government development efforts, and the early years of the Farm Input Subsidy Program (FISP) all involved the central government and international support, while the private sector was actively leveraged for clean cooking and FISP. Overcoming the most pressing problems also requires financial prioritization, either by finding adequate development partner finance or by prioritizing interventions in Malawian budgets. All successes gained traction with the Government communicating am- bitious but achievable targets rooted in a clear public agenda, such as the target of 2 mil- lion cleaner cooking alternatives to households. These 11 successful cases have not been immune to the typical challenges affecting Malawian governance. What sets these cases apart is their ability to overcome or work around these challenges. Leadership and effective management are a cornerstone of virtually all 11 cases. While in most cases such leadership was provided by the Government, some suc- cess stories were at points coordinated by other entities when given the space. Having access to suitable finance is another commonality among successful cases. Value chains demand patient debt and equity finance for producers, public entities require the right financial in- centives to perform, and ambitious government programs need sufficient financial backing. Scaling these successes has the potential to enable a virtuous feedback loop with wider macroeconomic and sectoral governance. Strengthened productive sectors will empower the Malawian private sector. In turn, an empowered private sector will have stronger lever- age to insist on better macroeconomic policy or on more open trade policies. At the same time, the private sector will be a key beneficiary of enhanced macroeconomic governance. Low inflation, the ability to trade, and a solvent public sector will lift critical constraints to their business expansion. Similarly, better performing public enterprises will mean that they become less of a drain and potentially even a contributor to the treasury. This will help enable necessary fiscal reforms. At the same time, enhanced macroeconomic stew- ardship will make targets for public enterprises both better defined and more achievable. Meanwhile, demonstrated public success through the achievement of sectoral targets will nurture the public trust and accountability necessary to improve macroeconomic govern- ance and even at times take difficult and initially unpopular decisions. Governance and institutional reforms are inherently difficult and past advice and re- form support has failed often. The analysis of case studies shows the importance of lead- ership to any reform process, and emphasizes the need to promote it in more targeted ways. The choice of leaders is likely to be deeply engrained in the political economy of the wider system. However, existing leaders can be made more effective by promoting their missions and providing them support. For example, for state-owned enterprises (SOEs), public sign- ing ceremony of Shareholders Letters of Expectations between the Ministry of Finance and SOE leaders is an encouraging sign of the promotion of effective leadership. Results-based financing has demonstrated its potential to align financial incentives with performance and should be considered as an approach more widely. Fostering coalitions for change and strategic public-private dialogue can help overcome fraught state-business relationships. A number of initiatives already evidence this approach, including the Presidential Delivery Unit’s “Private Sector Labs”, the Presidential Private Sector Council, and the Public Service Reforms Agenda. Strengthened secretariats are key ingredients to continue their momen- tum into implementation. Overview 30 Going Forward: What are the Priority Actions needed to start a virtuous cycle of macro stability and growth? The current crisis offers an opportunity to rebalance and transform the economy, but this will require doing things differently. Over the past decades, many opportunities have been squandered and large amounts of domestic and external resources have been poorly used as Malawi has fallen behind many of its peers. In addition, the changing external envi- ronment, with declining aid flows, rising geo-economic fragmentation, and the increas- ing frequency of climate-related disasters creates significant new challenges. These will make catching up more difficult. The cost of further delays to much-needed reforms could be devastating for the country and its people. However, the building blocks to achieve this transformation are well understood among Malawian policymakers and the wider society, even if there is disagreement on the details of specific policy solutions. To support this process, the CEM identifies the top 10 priority reforms, emerging from the five chapters. These aim to support a successful shift from “business as usual” by strengthening the necessary macroeconomic fundamentals, supporting a bold structur- al reform agenda, and learning from past successes to improve policy implementation and economic governance. The implementation of these reforms would not only mark a depar- ture from growth patterns since independence but can also have transformative effects on the standard of living of Malawians, helping to reduce persistently high poverty levels and creating new opportunities. This can provide the foundation for Malawi to achieve its vi- sion and become an inclusively wealthy and self-reliant nation. Table O.2  Top policy priorities by chapter Short-Term Actions Medium-Term Implementation Sector Policy issue (the next 3 – 6 months) (before the end of 2025) Creating the Ending the cur- Create a sustainable and well-supported Maintain a market-determined macroeconomic rent BOP crises and exchange rate regime, by institutionaliz- exchange rate and strategically use offi- fundamentals strengthening foun- ing a market-based and -clearing foreign cial reserves, external public debt, and (Chapter 1) dations to prevent exchange pricing mechanism. financial openness to manage external future crises balances. Proceeding with Demonstrate that Malawi can oper- Enhance legislative accountability to robust fiscal reforms ate within its budget in FY 2023/24 by budget estimates and fully implement implementing fiscal consolidation meas- IFMIS across Government. ures, increasing domestic revenue, and improving forecasts of pre-determined expenditure. Agricultural Fostering agricul- Consistently implement COGA, promote Minimize discretionary interventions in Commercializa- tural markets and public-private partnerships for commer- agricultural markets and ensure predict- tion and Rural appropriate market cialization, and increase transparency for ability for domestic and foreign investors. Labor Markets institutions government interventions in the market. (Chapter 2) Reforming agricul- Proceed with AIP 2.0 reform process to Repurpose agricultural expenditures tural expenditures to reduce the fiscal burden, maximize fer- by reducing subsidies and investing in foster efficiency and tilizer use efficiency through better tar- growth-enhancing areas, including cli- equity in the rural geting by using a finalized beneficiary mate adaptation. agricultural market registry, and improve the timeliness of input procurement and distribution. Enabling Improving access to Address the crowding out of the pri- Reduce the operational costs of com- the Private finance, especially vate sector from commercial borrowing, mercial and development banks through Sector to Drive for smaller firms including by setting clear and credible de-risking, cost-sharing of technology Productivity targets for the reduction of Government investments, automated service pro- Growth domestic borrowing. vision, efficient credit referencing, and (Chapter 3) timely resolution of court cases. Overview 31 Short-Term Actions Medium-Term Implementation Sector Policy issue (the next 3 – 6 months) (before the end of 2025) Enabling Strengthening the Expedite the enactment of the Invest in the capacity of CFTC and asso- the Private ability of the CFTC to Competition and Fair Trading Bill and cor- ciated judiciary institutions, support Sector to Drive enforce the compe- responding regulations. the outreach and enforcement sys- Productivity tition regulatory and tems associated with the amended Growth legal framework to Competition and Fair Trading Act, and (Chapter 3) enhance the welfare embed competition principles in broader cont. of consumers and public policies. foster competitive enterprises. Catalyzing Incentivizing exports The Ministry of Trade and Industry The government together with the legis- Exports by reducing non-tar- reviews existing NTBs and develops lature ensures through enhanced inter- and Foreign iff barriers strategy for phasing these out, especially nal review and external consultations Investment in sectors where Malawi has a compar- that all future trade policy measures are (Chapter 4) ative advantage (agriculture, agro-pro- developed jointly with industry and focus cessing, mining, tourism) on maximizing export growth, attracting investment, and incentivizing exports to use official channels. Enhancing The government together with the legis- The Ministry of Lands, Housing and the attractive- lature ensures that any legislation under Urban Development together with the ness of Malawi to discussion such as the Crops Bill, and legislature and the Ministry of Trade and export-oriented and export licensing procedures, create a Industry aligns foreign ownership and import-substituting conducive and predictable policy envi- lease structures of land to international FDI in sectors where ronment that supports domestic and for- standards and streamlines the process the country has a eign investment and are aligned with the for obtaining licenses and permits. potential compara- implementation of the COGA. tive advantage Implementing Promoting and Publicize and reward strong public sector Focus the implementation of public ser- Malawi’s enabling effective performance and the leaders behind it vice legislation currently undergoing Growth Agenda leadership revision on incentivizing improved per- through formance among senior public servants Improved and executives. Governance (Chapter 5) Creating appropriate Scale up results-based financing within Create concerted action among public, financial incentives government systems, with a focus on private, and international stakeholders to strengthen lead- harmonization of financing across gov- around results-based financing architec- ership and program ernment and development partners tures in line with clear sectoral targets implementation within common platforms. and with high-level political backing. 32 From Stagnant to Thriving: CHAPTER 1 Overcoming Macroeconomic Constraints to Malawi’s Growth KEY FINDINGS 1 Over the past 30 years, Malawi’s per capita gross domestic product (GDP) has increased by over 50 percent, a growth trajectory comparable to that of other countries in the region. However, Malawi’s growth has been insufficient to significantly raise living stand- ards and close the gap to its neighbors. Some peer countries have managed to triple their per capita GDP over this time. Tepid growth outcomes have been due to the slow movement of workers out of agriculture and into industry and services, very weak export growth, and low levels of savings and investment. 2 Malawi is off-track relative to the growth ambitions stated in the Malawi 2063 and requires comprehensive reforms to put them back within reach. Analysis using the World Bank’s “Long-Term Growth Model” shows that there is no single solution to reaching current growth targets. Rather, getting back on track and reaching upper middle-income status in the next 40 years will require simultaneously increasing the effectiveness and efficiency of public investment, catalyzing private investment and enhancing economy-wide efficiency. 3 Malawi’s disappointing economic growth outcomes can be attributed to policy choices that have worsened an already unfavorable external environment and resulted in signifi- cant fiscal and external imbalances. Malawi is exceptionally vulnerable to climate change and terms-of-trade shocks, and as a land-locked country, it depends on its neighbors to access commercial ports. While the Government has limited control over these structural dynamics, its macroeconomic policy can create foundations for either absorbing or exac- erbating these shocks. Malawi’s recent history shows that this is decisive: past growth episodes were marked by temporary macroeconomic stability, fiscal solvency, and a rel- atively favorable business environment. 4 Weak fiscal planning and implementation have made budgets an ineffective founda- tion for resource allocation. Unsustainable debt, driven by fiscal deficits, external balance shortfalls, and governance challenges, are a drain on economic growth. Inadequate man- agement of the external sector promotes costly balance-of-payments crises. These dynamics have had mutually reinforcing impacts that have resulted in a vicious cycle of macroeconomic underperformance and deepening crises. 5 The current crisis presents an opportunity for a change from “business as usual”. Focusing macroeconomic policy on long-term sustainable growth, starting with improved fiscal, debt and external balance management, is central to transforming this cycle of cri- ses into one of opportunities. This requires achieving debt sustainability and improving debt management, implementing robust fiscal reforms, increasing the efficiency of public investment, and strengthening external resilience. In addition, Malawi needs a surge in pri- vate investment to capitalize on its growing and highly competent workforce. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 33 SLOW GROWTH IS AT THE ROOT OF MALAWI’S HIGH POVERTY RATE The Malawi 2063 (NPC 2020) development strategy recognizes that the development and prosperity of Malawi depend on the achievement of sustained economic growth. While Malawi has made strides in improving key human development outcomes, such as life ex- pectancy, access to education, and health over the years3, poverty reduction aims remain significantly off-track. The Malawi 2063 recognizes the importance of economic growth as a catalyst of socio-economic progress and sets a clear target: achieving upper middle-in- come status by the year 2063. This Country Economic Memorandum (CEM) analyzes what it would take to achieve higher and sustained growth. Special attention is given to what can be done in both the short term (3 – 6 months) and the medium term (the next two years) to get Malawi’s economy back on track. This, in turn, can help improve and refine cur- rent and future policies and interventions, including those in the Malawi 2063 “Multi-Year Implementation Plan, 2021 – 2030” (NPC 2021). Economic growth in Malawi since independence has been too slow to substantially improve the economic welfare of the average Malawian (Figure 1.1). The quality of statis- tical records has changed over time. Nevertheless, most sources agree that Malawi’s econ- omy has grown only slightly more quickly than its population since Malawi’s independence in 1964. Per capita production has roughly doubled from a low base since independence, translating into an annual real per capita growth of only 1 percent.4 Figure 1.1  Despite periods of acceleration, Malawi’s economic growth has not been transformational GDP per capita in 2017 constant US$ purchasing power parity 1,600 1,400 1,200 1,000 800 600 400 Post-Independence 1980s Millennium Post-HIPC Recent Post- 200 Honeymoon Period Stagnation Crises Boom Stagnation COVID 0 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 20 20 20 20 20 19 19 19 19 20 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 19 20 19 20 20 Source: World Bank World Development Indicators (1990 – 2021), staff calculations based on World Bank Macro-Poverty Outlook (10/2023), and staff calculations based on Maddison Project Database 2020 (1964 – 1989). 3.  Life expectancy at birth increased by 20 years to 63 years between 1990 and 2021. It now exceeds the regional average of 60 years. Meanwhile, in 2021, 87 percent of the relevant age group completed primary education, out- performing the regional average of 71 percent. This is up from just 30 percent in 1990. Access to health services improved, too. For instance, the World Health Organization estimates that 93 percent of all one-year-olds in 2021 have been immunized against diphtheria, tetanus, and pertussis, up from 87 percent in 1990 and ahead of the Africa region average of 71 percent. 4.  When available, this report uses growth estimates from the World Bank’s World Development Indicators (WDI). Tracking production and incomes over a long period is challenging, as production and consumption pat- terns are not static. Using different schemes for benchmarking makes production figures sensitive to different price changes. Looking at the Maddison Project Database, World Bank National Accounts Data, the IMF World Economic Outlook database, the Penn World Table 10.0 and the World Bank WDI, we find that depending on the source, real per capita GDP is between 30 and 220 percent higher today than at independence and has grown between -4 and 70 percent since democratization in 1994. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 34 Per capita growth has been negative since 2020 due to a severe macroeconomic crisis. Malawi is experiencing the effects of longstanding balance of payments (BoP), fiscal, and monetary imbalances. Many of these have been noted in previous CEMs (and other reports). This CEM primarily documents the increased acuteness of these imbalances, and the ris- ing cost of inaction. Macroeconomic imbalances come on top of recurrent external shocks, to which Malawi is exceptionally susceptible, in part due to the weakness of the economy. The increasingly severe climate-related disasters that Malawi faces put additional stress on public spending, the trade balance, and pressures for monetary financing, creating addi- tional challenges for macroeconomic adjustment. Slow economic growth is at the heart of persistently high poverty rates. Economic growth reduces poverty because it tends to lift income levels across the income distribution, lifting those living close to poverty lines out of poverty (Adams 2003). The relationship is strong enough that most other factors are secondary when modeling monetary poverty: a 1-percent- age-point increase in economic growth is generally found to be associated with a 2 – 3 percent decrease in the proportion of people living in poverty (Bourguignon 2003; World Bank 2001).5 Due to slow economic growth, Malawi defies a global and regional trend of decreasing poverty levels. At the national poverty line, 50.7 percent of Malawians remained in poverty as of 2019, virtually unchanged over the past decade. Despite being home to only 0.24 per- cent of the world’s population, Malawi is home to 2.0 percent of the world’s extreme poor. The recent World Bank “Malawi Poverty Assessment” (World Bank 2022d) highlights slow structural transformation as a driving force of stagnating poverty levels since 2010, as non- farm sectors were unable to absorb the surplus of labor resulting from population growth. In addition to their effects on the overall economy, climate shocks directly affect pov- erty. The probability of a household being poor increases by 14 percentage points after experiencing a climate shock (World Bank 2022d). Agriculture, the mainstay of most vul- nerable Malawian households, is more exposed to climate shocks than other economic sec- tors. Housing and living conditions suffer in the aftermath of floods and droughts. Most households have few options to mitigate the negative impacts of shocks, with limited help available from the Government or non-governmental organizations (NGOs), closely circum- scribed savings, and almost non-existent access to credit. This chapter argues that these disappointing growth and development outcomes are the result of policy choices that have exacerbated an already unfavorable external en- vironment and geography. Malawi is exceptionally vulnerable to climate change, terms- of-trade (ToT) shocks, and other natural and human disasters. Moreover, as a land-locked country, it depends on its neighbors to access commercial ports. While the Government of Malawi has limited agency over these structural dynamics, it can direct macroeconomic policy to create foundations for either absorbing or exacerbating shocks. Improved fiscal, debt, external, and monetary policy choices can be instrumental in setting Malawi up for more rapid economic growth. For example, while Malawi is structurally dependent on im- ports of price-volatile commodities such as chemical fertilizers and fuel, a rigid exchange rate long prohibited adaptation to import price shocks through this channel. Similarly, Malawi’s low fiscal revenues are a genuine challenge in meeting developmental needs. As such, policy choices have done little to address and mitigate the country’s structural vul- nerability, and have had a significant opportunity cost in terms of foregone growth. 5.  Often lower elasticities are estimated for African countries. This is primarily a mechanical phenomenon, as high poverty levels mean that similar elasticities imply a larger absolute reduction in poverty at the same poverty line. This does not negate the centrality of growth to poverty reduction (Christiaensen and Hill 2019, 43). Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 35 This chapter provides a comprehensive analysis of the country’s economic trajectory and explains what is needed to achieve higher levels of growth over the coming years and decades. The second section delves deeper into Malawi’s economic history, identify- ing both periods of higher growth and benchmarking Malawi’s performance against that of a selection of peer countries. It then examines two salient economic aspects present in almost every rapidly growing country, namely structural change and export growth, to create the foundations for a more detailed discussion of these issues in later chapters. The third section presents the results from a long-term growth modeling exercise benchmark- ing Malawi’s current trajectory and various alternative scenarios against the ambitions ex- pressed in the Malawi 2063. This is followed by an analysis of how policy choices related to public debt management, fiscal policy, and the external balance have resulted in, and mu- tually reinforced, Malawi’s current macroeconomic crisis. The chapter concludes by pro- posing priority macroeconomic policy reforms to put the Malawi 2063 back on track. MALAWI’S ECONOMIC HISTORY SINCE INDEPENDENCE HAS BEEN DEFINED BY STAGNATION, SHOCKS AND BRIEF GROWTH BURSTS Malawi’s post-independence growth history can be divided into six periods. These pe- riods are characterized by structural departures from the economy’s previous overall tra- jectory. During a post-independence “honeymoon” (1964 – 1979), Malawi’s economy was on an upward trajectory. At 4.1 percent, per capita economic growth was robust and com- parable to many other countries recently freed from colonial rule. However, this was fol- lowed by a period of stagnation from 1980 to 1994. In a typical year during this period, per capita GDP declined by 1.0 percent. Unfortunately, the advent of multiparty democracy in 1994 did not coincide with a change in the country’s economic fortunes, as Malawians ex- perienced various crises amid political transition until 2005. More stability ensued after the write-down of the majority of Malawi’s external debt in the context of the Highly Indebted Poor Country (HIPC) Initiative in 2006, enabling real per capita growth of 4.0 percent until 2011. However, by 2012, Malawi’s economy had again begun to stagnate. This was driven by increased macroeconomic volatility following the “Cashgate” scandal and the withdrawal of budget support, as well as increasingly frequent external shocks. Per capita GDP growth slowed to just 1.2 percent. Since 2020, Malawi has entered a period of economic decline, with per capita growth shrinking as the country has struggled to recover from the impacts of the COVID-19 pandemic amid acute macroeconomic imbalances. Two periods stand out in terms of growth performance: the post-independence hon- eymoon (1964 – 1979) and the post-HIPC boom (2006 – 2011). During these periods, per capita growth exceeded 4 percent, while it averaged just 0.2 percent during the remaining years. Growth episodes were marked by temporary macroeconomic stability, fiscal sol- vency, and a relatively favorable business environment. Both the post-independence hon- eymoon and the post-HIPC boom were not without major external shocks. Between 2006 and 2008, international fertilizer prices more than doubled, constituting a major terms- of-trade (ToT) shock for Malawi. During the 1964 – 1979 honeymoon, Malawi also experi- enced its first post-independence recession in 1968 but the economy quickly rebounded. Key to absorbing external shocks has been relative macroeconomic stability. For in- stance, in the post-HIPC era, inflation was kept mostly in single digits through, among other measures, an unsustainable peg of the Malawi kwacha. Consequently, while Malawi made some improvements in terms of total factor productivity during the time, Malawi’s economy Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 36 primarily grew on the extensive margin. Initially robust donor support, high growth rates throughout the region driven by a commodity boom and relatively abundant liquidity fol- lowing the 2006 debt relief helped to sustain investment until macroeconomic imbalanc- es became binding towards the end of the period. Once Malawi’s government was able to borrow again, budgets grew by a third in terms of their share of GDP and the share of pub- lic resources having to be expended on interest decreased. This allowed some reallocation to public investment resulting in a state-led investment boom. Economic success in the post-independence and post-HIPC eras can also be linked to political developments, such as a relatively disciplined bureaucracy leading to rent-seeking structured around longer time horizons (Cammack and Kelsall 2011). When bureaucrats claim benefits over the me- dium term rather than seeking immediate rents, they gain a stake in the performance of the economy (see Chapter 5). Periods of unsustainable expansion also set Malawi up for subsequent economic prob- lems. Both the post-independence honeymoon period and the post-HIPC era started the process of unsustainable public debt accumulation that would weigh the economy down many years into the future. This was driven in part by structural budgetary indiscipline. Both episodes are also times when the current account was starkly negative, driven by an overvalued exchange rate. This brought with it shortages of strategic imports such as fuel. Such pegs not only necessitated external financing to keep foreign exchange available but also enabled monetary policy — including monetary financing — that was too accommo- dative, creating imbalances that would lead to surging inflation when market-based ex- change rates fed through into the real economy. Periods of economic expansion did not result in the accumulation of sufficient buffers, with many structural growth constraints remaining unaddressed. The Malawian government has attempted to steer its economic development through numerous plans since independence. Malawi’s first development plan, the Nyasaland Development Plan (1962 – 1965), focused on creating functional state institutions. Subsequent plans were dominated by President Hastings Kamuzu Banda’s economic ambitions before the structural adjustment agenda took hold in the 1980s. While previous plans included growth targets, the Vision 2020, launched in 1998, was the first to strive for middle income status. The Malawi 2063 that was launched in 2021 seeks to make Malawi “an inclusively wealthy and self-reliant industrialized upper middle-income country” by 2063. Stronger linkages to budgets, political economy improvements, and stronger alignment of development partners are needed to make the Malawi 2063 more relevant for Malawi’s economic trajectory than previous plans. As the comprehensive analysis of Malawi’s his- tory in development planning shows, a disconnect between development plans and out- comes stems from a failure to translate strategic plans into national and sectoral priorities, as well as resource allocation (Masanjala 2023). Underlying macroeconomic frameworks were often overly optimistic and not based on the economy’s capacity. Other factors that derailed plans include a political order characterized by clientelism (see Chapter 5), and a failure to incentivize the private sector to work towards the vision (see Chapters 3 and 4). Development partners, whose funds account for most development spending, often con- tribute to the ineffectiveness of development planning by bypassing central planning min- istries. Their plans and ambitions not only strongly influence the national agenda but can take precedence over national aspirations. The legacy of the current decade, whether as a time when macroeconomic fundamen- tals were created for long-term growth or as the start of another period of economic decline comparable to the 1980s, will largely hinge on the direction of macroeconomic Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 37 policy. Malawi’s economy has been in crisis since 2020. While external events bear some responsibility, sustained macroeconomic imbalances and persistent microeconomic chal- lenges have exerted a more significant impact on Malawi. Most importantly, the current crisis could present an opportunity for reform and for a departure from “business as usu- al.” However, many aspects mirror those of the 1980s, including escalating public solvency and balance of payment challenges, along with persistently high inflation. Malawi’s economy is on a trajectory that is comparable to structurally similar countries, but growth is too low to significantly improve welfare Malawi’s per capita real economic growth between 1990 and 2022 has been insufficient to catch up on regional averages (Figure 1.2). At the end of 2022, Malawians produced 56 percent more per capita than they did in 1990, while the average African produced just 32 percent more. However, given Malawi’s significantly lower baseline — average African in- comes in 1990 were more than three times larger than in Malawi — this did not result in significant economic convergence. The literature on convergence shows that it tends to be easier for lower-income countries to achieve rapid economic growth (Islam 2003). Figure 1.2  Malawi’s economic trajectory is on a par with that of many structurally similar countries Real GDP per capita in 2017 constant US$ purchasing power parity 4,000 3,600 3,200 2,800 2,400 2,000 1,600 1,200 800 400 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 20 2 e 23 2 20 20 20 20 20 20 20 20 19 20 20 20 20 19 20 20 19 19 19 19 19 19 19 20 20 20 20 20 20 19 20 20 20 Malawi Sub-Saharan Africa Burundi Madagascar Niger Uganda Zimbabwe Source: World Bank WDI (1990 – 2021) and staff calculations based on World Bank Macro-Poverty Outlook (2022). A group of peer countries — Burundi, Madagascar, Niger, Uganda, and Zimbabwe — was picked for their structural similarity to Malawi (see Box 1.1). Burundi, Madagascar, and Zimbabwe are poorer today than they were in 1990, but of these only Burundi has a low- er per capita GDP than Malawi. Niger’s economy has seen limited expansion since 1990 (18 percent increase in per capita GDP) while Uganda, starting from an even lower baseline than Malawi, expanded its output by 253 percent. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 38 Box 1.1  Selection of comparator countries Peer countries were selected for facing similar struc- For this CEM, we selected nine countries grouped into tural economic challenges to Malawi. First, this includes “structural peers” and “aspirational peers.” Structural a geography that makes trade inherently costly through peers meet the criteria outlined above and exhibit similar large distances to major trading routes, such as being growth outcomes as Malawi. Aspirational peers share many landlocked or, in the case of Madagascar, an island. of the same structural characteristics. However, Ethiopia, Second, the economies of peer countries, as of 1990, Lao PDR, Nepal, and Rwanda, which were selected as aspi- were to a similar degree dominated by agriculture, with rational peers, have undergone a much more comprehen- the exception of Zimbabwe where agriculture dominated sive economic transformation over the past three decades. employment but was a minor share of production in the They had a comparable starting point in 1990 as Malawi but 1990s. Third, a high vulnerability to shocks is a defining fea- were better able to decrease their reliance on subsistence ture of Malawi’s economy that peers share. Malawi is one agriculture through a focus on macroeconomic stability and of the countries that is most vulnerable to climate change. export-led growth. Consequently, real per capita produc- How the country addresses these risks will increasingly tion among aspirational peers is on average 3.1 times higher define Malawi’s economic trajectory (World Bank 2022a). today than it was in 1990. While several aspirational peers Peer countries also exhibit many of the policy challenges, have less democratic governance system than Malawi, such as fiscal, monetary, and external imbalances, that most existing evidence indicates a long-term link between define Malawi’s recent economic developments. Lastly, democratic governance and growth given greater invest- socio-economic similarities, such as being on the same ment in human capital, more stability, and greater eco- continent and largely spared from violent conflicts, were nomic freedom (Acemoglu et al. 2019; Doucouliagos and considered salient characteristics. Ulubaşoğlu 2008). A few countries were able to achieve much higher growth despite similarly challenging circumstances While Malawi’s per capita GDP has increased by half since 1990, some otherwise structurally similar countries have grown by at least 150 percent during the same time (Figure 1.3). Lao PDR is the top performer in the group, quadrupling per capita GDP since 1990. Ethiopia started its period of high growth later but was the world’s fastest growing country during the 2010s, more than tripling its per capita economic output in the process. Figure 1.3  Malawi’s economic trajectory lags behind that of top growth performers Real GDP per capita in 2017 constant US$ purchasing power parity 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 20 2 e 23 2 20 20 20 20 20 20 20 20 19 20 20 20 20 19 20 20 19 19 19 19 19 19 19 20 20 20 20 20 20 19 20 20 20 Malawi Sub-Saharan Africa Ethiopia Lao PDR Nepal Rwanda Source: World Bank WDI (1990 – 2021) and staff calculations based on World Bank Macro-Poverty Outlook (2022). Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 39 Nepal and Rwanda are stories of rapid turnaround. Both were involved in conflicts dur- ing the 1990s and among the smallest economies in their respective regions. None of their growth experiences were without setbacks and the cases illustrate that countries do not need to get everything right to embark on rapid economic growth. Some of these setbacks were caused by external shocks, such as the Gorkha earthquake in Nepal in 2015 that killed nearly 9,000 people. Moreover, even though they managed to significantly improve av- erage incomes, some of these countries now face comparable macroeconomic challeng- es as Malawi, such as Ethiopia’s ongoing BoP crisis or Lao PDR’s increasing debt burden. Aspirational peers illustrate that long-term growth often requires a clear growth vision and the alignment of macroeconomic and sectoral economic policy design and imple- mentation with that vision. These countries were able to attract the investment necessary for the rapid expansion of their productive capacities based on clear targets that motivated significant policy reforms. Their growth experiences were often also marked by deliberate planning to prioritize growth and the determined implementation of these plans. In con- trast, policies in Malawi have often been reactive and have not addressed root causes of the country’s economic stagnation despite the articulation of well-designed growth and development strategies (Masanjala 2023). The high-level Growth Commission, looking at a wider set of countries, found that while all governments “are sometimes clumsy and some- times errant,” leadership and effective government are a necessary requirement for high economic growth (Commission on Growth and Development 2008, p. 6). Each country’s growth story also has its idiosyncratic components that may provide valua- ble lessons for Malawi. Lao PDR has leveraged its proximity to Thailand and China to advance its own success, while Rwanda transformed an otherwise difficult starting point — a small, land-locked country with a history of conflict — through strong economic governance. Ethio- pia shows how a country can achieve moderate levels of industrial growth despite a challeng- ing geography (being landlocked in a conflict-affected region) and possessing its own complex political economy, and Nepal illustrates how to bounce back from frequent natural disasters. Growth requires investment, which has not been forthcoming for Malawi The majority of investment typically comes from domestic savings, which have been low in Malawi. Malawian savings amounted to 11.0 percent of GDP in 20196 (Figure 1.4). At the time, only seven out of 161 countries with available data reported lower figures. This came after a rebound in savings rates from a low of 3.6 percent in 2016. Structural peers tend- ed to save more than Malawi, which experienced a rapid deceleration of savings since the onset of the COVID-19 pandemic. This is driven by high levels of government consumption and limited household and commercial saving. The expansion of social safety net coverage is unlikely to have driven decreases in savings since much of the underlying expenditure is internationally funded, meaning it does not replace national savings. Moreover, available evidence, including from Malawi, suggests that recipient households increase rather than reduce their savings in response (Bastagli et al. 2016). Malawi’s investment rates have been chronically low with the exception of two brief investment booms immediately following democratization and in the post-HIPC years. Gross fixed capital formation as a share of GDP stood at just 12.3 percent in 2019, barely half 6.  Malawi has not published a national accounts expenditure series, which includes savings and investment rates, since it rebased its GDP in 2020. The 2020 rebasing led to a 38 percent upward revision. Savings and invest- ment figures presented here are based on pre-rebasing national accounts. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 40 the regional norm of 22.2 percent (Figure 1.5). That made Malawi the country with the sev- enth-lowest investment rate among 171 economies globally, only ahead of Zimbabwe among its peers (which was battling an episode of hyperinflation). Aspirational peers invested more than 2.5 times as much of their production as Malawi, supporting strong growth. Averages hide the diversity in financing strategies that aspirational peers have for their investment. While Ethiopia and Rwanda attract significant foreign financing, Nepal’s unusually high savings rates mean that even its robust rate of domestic investment does not complete- ly absorb them. Malawi has in the recent past made some steps towards closing legal and regulatory gaps to enhance the investment environment, including ratifying the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards. However, ma- jor hurdles, especially for prospective foreign investors remain, such as limited access to land and comprehensive capital controls (see Chapter 4). Additionally, the misapplication of official policy and law, whether due to weak institutional capacity, rent-seeking or the government’s fiscal interests, has negatively influenced perceptions of Malawi’s investment environment (International Finance Corporation 2021). Figure 1.4  Malawi’s savings rate is volatile but generally Figure 1.5  Two short-lived investment booms only below its peers brought Malawi to the regional average Gross national savings as a percentage of GDP Gross fixed capital formation as a percentage of GDP 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 20 20 20 20 20 20 20 20 20 20 20 19 19 19 19 20 20 20 20 20 19 20 19 19 19 20 19 20 20 20 20 19 20 20 Malawi Sub-Saharan Africa Malawi Sub-Saharan Africa Structural Peer a Aspirational Peer b Structural Peer Aspirational Peer a Source: World Development Indicators. April 2021 release for Malawi, Source: World Development Indicators. April 2021 release for Malawi, latest for peer countries. latest for peer countries. a. Excluding Burundi and Zimbabwe; b. Excluding Lao PDR. a. Excluding Lao PDR. Structural transformation — a hallmark of rapidly developing economies — has been slow in Malawi So far, shifts associated with structural transformation have only proceeded slowly in Malawi. Low-income countries tend to have the vast majority of their population working in agriculture (Herrendorf, Rogerson, and Valentinyi 2013). This is also where a large share of production takes place. The main type of enterprise is the smallholder farm with self-em- ployment dominating (Kuznets 1973). All episodes of significant economic development have included structural transformation, marked by a migration of a large share of work- ers from agriculture to jobs in the industrial and services sectors, typically within private Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 41 enterprises. This signifies a shift in the focus of the econo- Figure 1.6  Structural transformation reduces agricultural my toward more productive industrial and services sector employment activities and is often accompanied by a move toward more Employment in agriculture as a share of total employment, percent productive firms within the same sector. Internationally 85 comparable International Labor Organization (ILO) esti- mates indicate that 62 percent of Malawian workers con- 80 tinue to be employed in agriculture (Figure 1.6). This is more 75 than the average for the region (52 percent) and the aver- 70 age for low-income countries (60 percent). 65 Countries with similar growth outcomes to Malawi main- 60 tain an even higher share of their workforce in agricul- ture, while rapidly growing countries have seen workers 55 move into industrial jobs. Burundi (86 percent), Madagascar 50 (74 percent), and Niger (71 percent) still have higher shares 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 21 20 20 of their population working in agriculture. Rapidly growing 20 20 20 19 20 20 19 20 19 19 19 20 20 20 economies have especially distinguished themselves by cre- Malawi Sub-Saharan Africa ating jobs in industry (Figure 1.7). Stagnant or declining in- Structural Peer Aspirational Peer dustry employment shares globally, as is the case for Malawi Source: World Bank WDI, based on International Labor Organization and its structural peers, have given rise to debates around ILOSTAT ILO modeled estimates database. premature deindustrialization (Rodrik 2016). However, as- pirational peers show that countries can diverge from these trends. Services sector jobs have been on an upward trajectory across the region, among aspirational peers and, to a lesser extent, structural peers (Figure 1.8), absorbing the majority of labor freed up in agriculture. Figure 1.7  Quickly growing countries industrialize much Figure 1.8  Services play an increasing role in most faster than peers economies Employment in industry as a share of total employment, percent Employment in services as a share of total employment, percent 14 40 13 36 12 32 11 10 28 9 24 8 20 7 16 6 5 12 4 8 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 21 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 21 20 20 20 20 20 20 20 20 20 20 19 20 19 20 20 20 19 19 20 20 19 19 19 19 19 19 20 20 20 20 20 20 Malawi Sub-Saharan Africa Malawi Sub-Saharan Africa Structural Peer Aspirational Peer Structural Peer Aspirational Peer Source: World Bank WDI, based on International Labor Organization Source: World Bank WDI, based on International Labor Organization ILOSTAT ILO modeled estimates database. ILOSTAT ILO modeled estimates database. The shift in employment patterns out of agriculture has lifted people into jobs that tend to be an order of magnitude more productive. The value created per worker in industry and services among aspirational peers is roughly in line with the levels observed in Malawi (Figure 1.9 and Figure 1.10). Thus, their faster progress in increasing economy-wide produc- tivity has been driven more by moving workers into the sectors where they are most pro- ductive than by more rapid advances in within-sector productivity. Conversely, structural Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 42 peers show that their higher levels of industrial and services productivity are no guarantee for structural transformation when other obstacles exist in reallocating workers to new sec- tors (see Chapter 2 for a more in-depth discussion of Malawi’s rural employment patterns). Figure 1.9  Malawian industry workers are as productive Figure 1.10  Services workers are much more productive as those among aspirational peers; there are just fewer than those in agriculture but Malawian services workers of them still lag peers Industry (incl. construction), value added per worker in constant 2015 US$ Services, value added per worker in constant 2015 US$ 12,000 8,000 7,000 10,000 6,000 8,000 5,000 6,000 4,000 3,000 4,000 2,000 2,000 1,000 0 0 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 20 20 20 20 20 20 20 20 19 20 19 20 20 20 19 19 20 20 19 19 19 19 19 19 20 20 20 20 20 20 Malawi Sub-Saharan Africa Malawi Sub-Saharan Africa Structural Peer a Aspirational Peer b Structural Peer Aspirational Peer a Source: World Bank WDI, based on World Bank National Accounts and Source: World Bank WDI, based on World Bank National Accounts and International Labor Organization ILOSTAT database. International Labor Organization ILOSTAT database. a. Excluding Madagascar; b. Excluding Lao PDR. a. Excluding Lao PDR. Shifting employment out of agriculture has contributed to making the sector much more productive among aspirational peers on a per-worker basis. Meanwhile, increased population pressures depress agricultural productivity in Malawi relative to its peers (Fig- ure 1.11). Opportunities outside of agriculture can spur the commercialization and profes- sionalization of agriculture as farmers serve expanded local markets and underpins productivity growth over the me- Figure 1.11  African farmers have become much more dium term. Additionally, non-agricultural opportunities productive recently but not in Malawi can make scarce resources such as land and water avail- Agriculture, forestry, and fishing, value added per worker in constant able to the most productive farmers. However, in the ab- 2015 US$ sence of such employment opportunities, as in the case of 1,600 structural peers, labor productivity in agriculture can suf- 1,400 fer despite the availability of enhanced technical inputs. 1,200 1,000 800 While rapid developers leverage trade, Malawi’s 600 export performance has been declining 400 Increased global trade has been a key ingredient for all 200 rapidly growing countries, and Malawi’s aspirational 0 peers more than tripled the role of exports in their econ- 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 20 20 20 20 19 20 20 19 20 omies (Figure 1.12). In particular, the integration into global 19 19 19 20 20 20 value chains (GVCs) has been a boon to countries experienc- Malawi Sub-Saharan Africa ing strong catch-up growth. For example, in Ethiopia, firms Structural Peer a Aspirational Peer b participating in GVCs are more than twice as productive Source: World Bank WDI, based on World Bank National Accounts and as similar firms that participate in regular, non-GVC trade International Labor Organization ILOSTAT database. (World Bank 2020). However, the global trading environment a. Excluding Madagascar; b. Excluding Lao PDR. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 43 is becoming increasingly challenging, with global growth in Figure 1.12  In contrast to higher achievers, Malawi’s trade sluggish since the global financial crisis of 2008 and exports are in decline new threats emerging, including trade conflicts among large Merchandise exports as a share of GDP, percent economies and the arrival of new labor-saving technologies. 35 Leveraging trade makes particular sense for countries 30 with small domestic markets in global terms. Malawians 25 earn only 0.01 percent of global income, which is insuffi- cient to support most modern value chains. At US$25 tril- 20 lion, the global market for merchandise exports is more than 2,000 times larger than Malawi’s domestic market. 15 Thus, the potential gains for Malawian firms from targeting 10 international markets and for all Malawians obtaining the best inputs and goods available globally are especially high. 5 0 Malawi’s export performance has nevertheless been de- 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 clining over recent decades. With strong commodity ex- 20 20 20 20 20 20 19 19 19 19 20 20 20 20 19 20 20 ports, Malawian exports as a share of GDP in the 1990s were Malawi Sub-Saharan Africa ahead of regional averages and those of structural and as- Structural Peer Aspirational Peer a pirational peers. This relationship was reversed, with Ma- lawi exporting less than 40 percent of the output that is Source: World Bank staff calculations based on World Bank WDI based on World Trade Organization, World Bank WDI based on World Bank typical for an African country. This has immediate mac- National Accounts, and World Bank MPO. roeconomic consequences, including external balance and a. Excluding Lao PDR. foreign exchange challenges, as well as microeconomic im- pacts. Exporting firms tend to become more productive over time, while firms relegated to the domestic market have fewer incentives to increase their competitiveness. These issues are discussed in more detail in Chapters 3 and 4. MALAWI’S LONG-TERM GROWTH OUTLOOK Economic models can help in understanding the potential impact of different growth drivers that could be affected by economic policy. This CEM uses the World Bank “Long- Term Growth Model” (LTGM), which depicts a baseline scenario showing the most likely outcome if growth fundamentals are carried forward into the future (Loayza and Pennings 2023). In addition, we present four additional scenarios that represent fundamental shifts in government policy (Figure 1.13). The model sets itself apart from other economic mod- eling exercises in the forecasting of long-term average growth rates to be expected given growth fundamentals (see Annex 1.1 for a more detailed discussion of the technical formu- lation and input variables).7 This also distinguishes the LTGM from the National Planning Commission’s “Foresighting Project” (NPC forthcoming).8 The LTGM concurs with modeling under the National Planning Commission’s “Fore- sighting Project” that, under current fundamentals, the Malawi 2063 goals are likely to be missed by a significant margin. The Foresighting model expects lower middle-income 7.  The World Bank conducts other economic modeling exercises, including through its Macro-Fiscal Model (MFMod), which informs the biannual Macro-Poverty Outlook (MPO) for each country. MFMod provides a compre- hensive macroeconomic forecast without scenario elements. An adaptation of MFMod to take into account climate change dynamics is presented in the Malawi Country Climate and Development Report (CCDR, World Bank 2022a). 8. The NPC’s model integrates an economic module that already is significantly more complex than the LTGM into a much larger model aimed at giving a comprehensive account of Malawi’s development trajectory. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 44 Figure 1.13  The LTGM illustrates scenarios of Malawi’s potential future Real 2018 US$ per capita 4,500 Exceeding the Malawi 2063 goal is just about con- Upper middle-income ceivable under current fundamentals but requires true “business unusual”—a wave of private and pub- 4,000 lic investment, enhanced public investment efficien- Lower middle-income cy, and a reform trajectory that rivals Rwanda’s over the past decades. 3,500 The ambition to be declared an upper middle-income country by 2063, as laid out in the Malawi 2063, would constitute a serious departure from Malawi’s history. Economic growth rates of between 6.5 and 8 3,000 percent would have to be sustained over decades, ri- valling some of the world’s top performers. While initially barely perceivable, reforms that en- 2,500 hance economic efficiency would carry their mo- mentum far into the future. A steep reform trajecto- ry resembling Rwanda’s from 1995-2018 and focus- ing on market efficiency, infrastructure, and institu- 2,000 tions could make Malawians 44 percent wealthier under otherwise similar fundamentals. A public investment drive could initially lift per cap- 1,500 ita growth rates a percentage point over baseline levels. However, even if this investment drive is fi- nanced sustainably by rerouting consumption ex- penditure rather than crowding out private invest- 1,000 ment, the GDP-boosting effects would taper out. Low-income Carrying growth fundamentals forward for a baseline scenario yields average real growth rates of between 500 3.5 and 5.7 percent, already a departure from recent- ly recorded figures and slightly exceeding the recent stagnation period (from 2012–2019) rather than con- 0 tinuing the post-COVID-19 slump (2020–2023). 60 66 72 78 84 90 96 02 08 14 20 26 32 38 44 50 56 62 20 19 19 20 20 19 20 20 20 20 19 19 20 20 20 20 19 19 Historical GDP per Capita Baseline Investment drive Reform like Rwanda Malawi 2063 Ambition Busines Unusual Source: World Bank analysis using the LTGM. status to be achieved by 2048, with income levels significantly below the upper middle-in- come target by 2063. Similarly, the LTGM model presented here sees lower middle-income status achieved by 2046 under baseline assumptions, with income levels slightly more than one-third of the envisioned value by 2063. Required growth levels to reach the 2063 goal are very ambitious but not without inter- national historical precedent. To achieve the 2063 goal, Malawian per capita incomes would have to increase by 5.1 percent between 2024 and 2063. Some aspirational peers have achieved this over extended periods. For example, Ethiopia’s per capita GDP expanded by 5.6 percent on average between 2000 and 2022, despite this period including a civil war and the impacts from the COVID-19 pandemic. The “2063 Goal Scenario” assumes that, while other fundamentals remain the same, investment is increased to the level where the 2063 goal is achieved. While initially ramping up investment to slightly above 20 percent of GDP (a figure in line with regional norms) would be enough to achieve the desired growth lev- els, toward the end of the modeling period Malawi would have to reinvest more than half of its GDP to achieve its production goals — a figure that is clearly unattainable. The “Investment Drive Scenario” shows that while increasing public investment at the expense of reduced consumption is important, growth effects fade when not backed by a private investment surge. For this scenario, a permanent increase in public investment to 7.3 percent of GDP was assumed, while private investment remained unaffected. This en- tails financing investment by reducing government consumption and redirecting external grants to avoid crowding the private sector out of the limited available funds. Historically, the vast majority of public investment has been financed through development assistance. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 45 However, mobilizing assistance at the necessary scale for this scenario may pose challeng- es. A surge in public investment can lift growth by 1 percentage point over baseline levels in the short and medium term. However, the growth effects would diminish over time, as increased funds are needed merely to maintain the existing public capital stock, and the scenario does not assume complementary accelerated private sector development. None- theless, per capita production would be 21 percent higher than at baseline, assuming a 20 percent reduction in government consumption. Embarking on reforms that enhance the efficiency of the economy would yield long- term benefits. According to the literature and empirical analysis, five reform domains affect total factor productivity (TFP) growth (Kim and Loayza 2019): innovation, educa- tion, efficiency, infrastructure, and institutions. Malawi has made significant strides in sev- eral of these domains, although Rwanda has demonstrated even more reform momentum. The “Reform Like Rwanda” scenario is based on the assumption that Malawi embarks on a TFP-boosting reform path that resembles Rwanda’s trajectory from 1995 to 2018. This involves, notably, providing adequate electricity, controlling corruption, and improving regulatory quality to enhance economy-wide efficiency. While these reforms would take time to generate growth effects, they are projected to lift income levels by 44 percent over baseline by 2063. The “Business Unusual” scenario assumes the reorientation of all economic policy to- ward increasing economic growth, demonstrating that a determined multi-pronged approach can put the Malawi 2063 goals just within reach. In addition to the ambitious ef- ficiency-enhancing reforms described in the “Reform Like Rwanda” scenario, the “Business Unusual” scenario assumes a focused prioritization of productive investments. On the pub- lic side, this entails embarking on an investment trajectory akin to the one outlined in the “Investment Drive” scenario, while also rigorously prioritizing essential infrastructure over less productive investments. This, in turn, is expected to boost the efficiency of public in- vestment by 30 percent. A critical aspect of the “Business Unusual” scenario is ensuring that public investment crowds in, rather than crowds out, private investment. Private in- vestment is assumed to surge to 17.3 percent, a rate not uncommon, as Uganda, a structural peer, achieves similar levels. However, achieving this from Malawi’s current status, would require a realignment of macroeconomic and sectoral policy to prioritize the promotion of investment. It requires the promotion of domestic savings funneled efficiently to pro- ductive firms operating in a vibrant business environment through a well-functioning fi- nancial sector (see Chapter 3). Foreign investors will also need to play a pivotal role due to scarce domestic resources and efficiency constraints (see Chapter 4). However, based on the LTGM simulations, such a comprehensive turnaround is the only scenario that puts the Malawi 2063 growth goals within reach. MACROECONOMIC POLICY AND INSTITUTIONS DRIVE GROWTH OUTCOMES Getting macroeconomic policy right is essential to move Malawi from a cycle of cri- ses to sustained and rapid economic growth. On top of slow growth, Malawi is experi- encing a monetary crisis with inflation close to 30 percent and diminished trust in central bank targets. In addition, Malawi’s public and external debt is in distress (International Monetary Fund and International Development Association 2023). Malawi’s unsustainable debt is rooted in an unsustainable fiscal trajectory, evidenced by a fiscal deficit of 11.8 per- cent of GDP in FY 2022/23, as well as an acute BoP crisis. These crises reinforce each oth- er and keep Malawi in a cycle of macroeconomic underperformance. Fiscal reform, debt Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 46 sustainability, external rebalancing, and monetary stability are key components of promot- ing economic growth (Figure 1.14). Each of these aspects is primarily determined by poli- cy choices. In turn, a substantial shift in policy is critical for Malawi to move from a cycle of crises to one of opportunities. Figure 1.14  Malawi’s macroeconomic policy challenges are all interconnected. Turning a Cycle Low Growth Revenues Crisis of Crises Unstable Investment Environment Inefficient Investment Unavailable Inputs Fiscal Monetary Crisis Monetary Crisis Enhanced Economic Financing Revenues Growth Enhanced Investment Environment Efficient Investment High Interest Expenditure Twin Forex Deficits Exchange Rate Availability Pressures Overspending Fiscal Reduced Monetary Reform Monetary Stability Financing Debt BOP Crisis Crisis Import Reduced Interest Financing Expenditure Reduced Twin Reduced Needs Deficits Devaluation Pressures Reduced Deficits Debt External into a Cycle Sustain- Balancing of Opportunities ability Reduced Import Financing Needs Source: World Bank staff. The current crisis presents an opportunity to consistently implement improved mac- roeconomic policy. This section provides details on policy drivers in three critical areas: the management of public debt, the management of fiscal balances, and the management of external balances. Each problem is individually introduced, describing the evolution of the policy issue, its connection to economic growth, and policy options for resolution. Subsequently, an examination explores how implementing policy in a coordinated and consistent manner across these (as well as related policy areas) can generate addition- al synergies. Unsustainable debt, driven by fiscal deficits, external balance shortfalls, and governance failures, is a drain on economic growth. Malawi is in the midst of a public debt crisis. Malawi’s latest IMF-World Bank Debt Sustainability Analysis (DSA) shows both Malawi’s external debt and overall debt as be- ing in distress (International Monetary Fund and International Development Association 2023) in light of ongoing restructuring negotiations. Furthermore, Malawi’s external debt Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 47 is assessed as being unsustainable. Breaches of sustainability thresholds occur both on li- quidity and solvency indicators,9 with the headline figure of total public sector debt esti- mated at 75.2 percent of GDP at the end of 2022. Malawi’s debt crisis is driven by the accumulation of high-interest external debt and expensive domestic borrowing. These were used to finance continued fiscal and current account deficits, which drove the sharp rise in public debt. Domestic debt covers the re- sidual budget deficits that are not covered by concessional external financing. Nominal in- terest rates of up to 33.0 percent on 10-year Treasury notes indicate the high costs of this strategy, despite significant efforts to suppress rates through monetary financing. External debt contracted on commercial terms with plurilateral development banks starting in 2018, which was initially concealed, temporarily covered external balance shortfalls. However, at this stage external debt has reached a level of unsustainability such that it points to gov- ernance weaknesses. At contracted terms, the DSA projects that a majority of export reve- nues would have to be used to repay external loans in the near term. Costly debt reduces discretionary fiscal expenditure. The high levels of debt require large debt servicing costs, putting pressures on fiscal space for critical public spending. Interest ex- penses in FY2022/23 account for 39 percent of domestic revenue. Interest payments have be- come a larger expense than any single sector, including education, agriculture, and health, and the share is expected to increase further in the absence of any significant restructuring. High interest payments leave little room for discretionary investment spending, while low public solvency makes raising finance even for financially viable investment projects challenging. Ultimately, the extent to which government borrowing contributes to long-term growth largely depends on its strategic use. Figure 1.15 shows that Malawi’s debt accumulation patterns, with debt relief around the turn of the century and rapid re-accumulation since Figure 1.15  Malawi’s debt trajectory was not uncommon among peers over many years, but growth in high-cost borrowing over recent years has led to debt distress Gross public debt as a percentage of GDP 110 100 90 80 70 60 50 40 30 20 10 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 e 23 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Malawi Sub-Saharan Africa Structural Peer Aspirational Peer Source: World Bank staff calculations based on IMF WEO 10/2023. 9.  DSA liquidity indicators refer to the present value of the debt service-to-exports ratio and of the debt ser- vice-to-revenue ratio. The two primary solvency indicators are the present value of the debt-to-GDP ratio and of the debt-to-exports ratio. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 48 the 2010s, are broadly in line with regional trends and those observed among peers. When public borrowing is directed toward growth-enhancing initiatives where the benefits sig- nificantly outweigh the financing costs, public debt can be a net gain. In many cases, how- ever, accumulated debt has predominantly become a drain. This explains a complex and idiosyncratic relationship between public debt and long-term economic performance (Eber- hardt and Presbitero 2015). The speed and manner in which Malawi resolves its current public debt crisis has sig- nificant implications for its economic growth trajectory. Given Malawi’s current debt levels, there is a consensus that debt restructuring is needed to revert to debt sustainabil- ity. Economic performance of debtor countries typically improves significantly after debt relief operations, but only if these involve debt write-offs (Reinhart and Trebesch 2016). The speed of restructuring is critical as a country tries to minimize the duration of bearing the costs of being in restructuring, such as increased bond yields and financial disruption, while not yet reaping the benefits of decreased debt stocks. Simultaneously, formulating the appropriate reform package, including measures to support fiscal consolidation and enhance growth, is critical to avoid a serial default (Kose et al. 2022). Weak fiscal planning and implementation make budgets an ineffective guide to resource allocation Weak fiscal planning and implementation contribute to continued deficits. Over the last decade, Malawi’s fiscal position has deteriorated, culminating in the current fiscal cri- sis. Despite the stated intentions of successive governments to reform fiscal policy, there has been insufficient action to curb shortfalls. While significant budget deficits have been planned for, budget overruns have exacerbated negative budget outturns (Box 1.2). Box 1.2  How deficit budgets, weak implementation, and underreported deficits drive public debt Debt levels can be predicted based on budgeted defi- increases cannot be explained with reported fundamen- cits, reported deficits, and continued budget support. . tals, pointing to the additional unreported use of fiscal In the previous CEM (Record, Kumar, and Kandoole 2018), resources. the authors analyzed whether reported debt levels are explained by reported budget deficits. We extend this anal- Figure B.1.2.1  Where does debt come from? ysis to also predict debt levels under budgeted deficits and Predicted and actual debt levels as a share of GDP without the withdrawal of budget support after the 2013 “Cashgate” scandal under otherwise equal fundamentals 80 such as GDP growth and exchange rates. 70 Rapidly increasing debt levels in all scenarios after 60 2019 are an indication of poor budget planning, while 50 a spread between the scenarios under budgeted and reported deficits are a sign of budget implementation 40 shortcomings. Recent approved and released budget 30 deficits were too high to contain the accumulation of pub- 20 lic debt. Additionally, budgeting has not sufficiently taken account the withdrawal of budget support in the wake of 10 the “Cashgate” scandal. Had budget support been main- 0 tained at 5.3 percent of GDP — the norm between 2007 and 20 7 08 09 10 11 12 13 14 15 16 17 18 19 20 20 1 22 e 2 0 23 20 20 2013 — debt levels would have decreased until 2019 with the 20 20 20 20 20 20 20 20 20 20 20 20 20 same expenditure levels. Actual Debt/GDP With budgeted deficits A large and increasing spread between reported debt With reported deficits With stable budget support levels and those implied by reported deficits are an indication of weaknesses in fiscal governance. These Source: World Bank staff calculation based on MoFEA data. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 49 Easily predictable expenditure items have repeatedly exceeded their allocation, point- ing to institutional rather than technical causes of budget overruns. On the revenue side, the Malawian authorities frequently applied significant optimism in the prediction of grant inflows. Expenditure overruns were driven by interest expenditure and compensation of employees, which are largely predetermined and therefore should be easily forecastable at the start of the financial year. Low trust in budget institutions prompted development partners to establish paral- lel systems to deliver assistance. Since the 2013 “Cashgate” scandal, external budget sup- port and grants have been significantly reduced, with adverse effects on the funding level of government operations. Despite the prospect of resumed budget support and significant technical assistance from development partners, the authorities have not been able to re- establish a system where most development partners have confidence that contributions effectively lead to development impacts. Financial management systems have not been effective in containing expenditure to budget ceilings. The Government’s Integrated Financial Management Information System (IFMIS) should play a key role in containing expenditure. Ministries, departments, and agen- cies (MDAs) are required to conduct all processes pertaining to the implementation of the state budget in the IFMIS. However, non-compliance with IFMIS procedures has resulted in frequently reported expenditure overruns and contractual commitments to expenditure in excess of their approved ceilings. Aggregate overruns and the accumulation of arrears are the direct consequences of such procedural shortfalls. Despite elaborate budgeting institutions, these have proven ineffective in ensuring that budgets serve as a useful guide to actual resource allocation in Malawi. The Ministry of Finance (MoF), MDAs, and the legislature all have designated roles in the budgeting pro- cess.10 Non-compliance with these processes undermines the entire system. For instance, limited scrutiny of budget outturns and the resultant lack of any disciplinary action by the legislature removes incentives for MDAs and the MoF to adhere to ceilings agreed upon with the legislature. This, in turn, hampers the ability to prioritize and rationalize expend- iture, including on potentially substantial implicit subsidies currently delivered through budgetary mechanisms, as much as through the state-owned enterprise and other para- statal sectors. Without effective budgeting it is impossible to prioritize the most growth-enhancing expenditures. Certain government expenditures have significantly greater impacts on rais- ing growth and the standard of living of Malawians than others. Governments equipped with effective mechanisms to prioritize the most efficient expenditure items are more adept at promoting growth. The various stakeholders involved in the budgeting process offer potential entry points for improvement. While any substantive reform typically includes improved performance by the MoF, the legislature or civil society could potentially con- tribute to a virtuous cycle through increased pressure on policymakers. However, institu- tionalizing enhanced accountability is a medium-term endeavor, and rebuilding trust in systems requires a demonstration period. 10.  In principle, the MoF prepares a fiscal framework, prioritizes MDA demands for resources, and then oversees budget implementation. MDAs prepare credible cash flows and spend funds under MoF guidance. The legislature scrutinizes both budget estimates and outturns. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 50 Inadequate management of external balances promotes costly BoP crises Malawi’s BoP crises have been correlated with phases of weak economic growth. There have been four acute BoP crisis periods starting in 1992, 1997, 2012, and 2022 (Nur 2023; Figure 1.16). These crisis periods are marked by a shortage of foreign currency reserves to pay for imports or to service foreign liabilities, leading to a forced depreciation of the Malawi kwacha. Figure 1.16  Malawi has entered its fourth acute BoP crisis in as many decades Nominal official exchange rate in MWK per US$, real effective exchange rate indexed (2010 = 100, RHS), BoP crisis periods indicated in grey 1,200 220 1,100 200 1,000 180 900 160 800 140 700 120 600 100 500 80 400 300 60 200 40 100 20 0 0 01 90 01 991 01 92 01 3 0 94 01 95 01 96 01 97 01 8 01 999 0 00 /2 1 1/ 2 01 003 01 004 01 005 01 06 1/ 7 01 008 01 09 01 10 01 011 01 012 01 013 01 014 01 15 01 16 01 017 01 018 01 019 01 20 01 021 01 022 3 01 0 0 00 0 00 99 99 02 0 0 20 0 9 9 9 19 /19 0 9 0 0 0 /2 /2 /1 /2 /2 /2 /2 /2 /2 /2 /2 /2 /1 /1 /2 /1 /1 /1 /2 /1 /2 /1 /2 /2 2 /2 2 /2 /2 /2 1/ 1/ 1 0 Nominal official Real effective (right scale) Source: World Bank staff calculations based on IMF IFS. A large and increasing trade imbalance, intensified by periodic ToT shocks, has been the primary driver of BoP imbalances. With a trend of rising imports and decreasing exports, Malawi’s trade imbalance has been rising. Recurring ToT shocks, exacerbated by Malawi’s narrow import and export baskets, lead to spikes in the trade imbalance, such as when oil and fertilizer prices quickly rose after the COVID-19 pandemic and with the on- set of Russia’s invasion of Ukraine. The money that Malawi earned (primary income) and received (secondary income) from abroad, along with one-time transfers for investment (capital transfers), was not enough to make up for the fact that Malawi purchased more im- ports than it sold in exports to other countries. To deal with this issue, Malawi had to rely on financial solutions (its financial account), such as by increasing borrowing. Malawi went into each BoP crisis with a managed exchange rate and only overcame these crises after floating the kwacha. Exchange rates can serve the critical function of absorbing trade and other BoP shocks. By making imports more expensive, they lim- it import demand, while also incentivizing the retention of foreign exchange in Malawi. Exchange rate speculation can assist price discovery in a well-developed system, balanc- ing current transactions over a longer time horizon (Hayward 2018). In a floating exchange rate regime with developed markets this leads to exchange rates closely approximating random walks. In turn, the current foreign exchange rate becomes the most reliable pre- dictor of future exchange rates, incorporating all available information on the underlying international value of a currency (Rossi 2013). It also makes the generation of additional foreign exchange more attractive by increasing the domestic purchasing power of exports. However, the Malawian authorities have tended to not take advantage this balancing chan- nel (Figure 1.17). The consequence is the scarcity of foreign exchange at any price and the Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 51 Figure 1.17  A history of policy reversal The evolution of Malawi’s exchange rate regime 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 20 20 20 20 20 20 20 20 19 20 20 20 20 19 20 20 19 19 19 19 19 19 19 20 20 20 20 20 20 19 20 20 20 Peg/Managed float/Stabilized arrangement Float BOP Crisis Source: World Bank staff calculations based on data from IMF Annual Reports on Exchange Arrangements and Exchange Restrictions. allocation of foreign exchange through administrative measures, as well as frequent scarci- ty of essential imports (see Box 1.3). Exchange rate misalignment also repeatedly coincided with the dualization of the exchange rate, creating arbitrage opportunities and providing incentives for informal trade (see Chapter 4). Box 1.3  Weak external balance management combined with inadequate sectoral governance leads to Malawi’s periodic fuel crises One of the most prevalent symptoms of Malawi’s BoP cri- Since the price of fuel is closely regulated, financing can ses is the unavailability of fuel. The unavailability of foreign also not be profitably obtained on parallel markets. The exchange has wide-ranging effects across the Malawian Automatic Fuel Price Mechanism, which was developed economy, including challenges in importing essential medical in response to the 2011 fuel crisis, operates under the supplies. However, one of the most visible symptoms is the assumption of a unified, market-determined exchange rate. scarcity of fuel, evident in empty fuel pumps. Most recently, Furthermore, adjustment to changes in international prices fuel pumps ran dry across the country starting in April 2022, can be slow, indicating policy implementation shortcomings. with stocks repeatedly running out since. Industry customers Intervention leads to shortages with limited cushioning of report unfulfilled demand since the second half of 2021. consumers from price shocks. World Bank analysis shows Unavailability of foreign exchange combines with weak that, with some delay, administered fuel prices closely track sectoral governance to cause these shortages. Since the economic costs of fuel. This means that the stated pol- Malawi imports the vast majority of motor fuels, a severe icy goal of interventions, such as cushioning consumers scarcity of foreign exchange means that motor fuels also from price shocks through the Price Stabilisation Fund, is not become unavailable. The sector receives some official achieved. In addition, when the administered price of fuels is financing support, but since official international liquidity below economic costs of fuel, public entities such as MERA tends to be low during crises, such support is circumscribed. and NOCMA in the fuel sector tend to accumulate debts. Figure B.1.3.1  Small mismatches with major effects Economic costs of fuel and pump prices 2,400 MERA/NOCMA arrears and shortages 2,000 1,600 1,200 800 400 PSF accrues consumer funds 0 09 018 11/ 18 01 18 03 019 05 019 07 019 09 019 11/ 19 01 19 03 020 05 020 07 020 09 020 11/ 20 01 20 03 021 05 021 07 021 09 021 11/ 21 01 21 03 022 05 022 07 022 09 022 11/ 22 01 22 03 023 05 023 07 023 09 023 3 02 0 20 0 20 0 20 0 20 0 20 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2 07 Average shadow price  Average actual price Source: World Bank staff calculations based on MERA data and State of New York Transportation Fuels Spot Prices data Note: Averages are taken between diesel and petrol. The Shadow Price is calculated as international landed costs of fuel at the median Foreign Exchange Bureau selling rate plus the proportional taxes calculated based on the international landed costs plus the fixed taxes and levies contained in the official price build-up. It does not contain financing levies or levies for the Price Stabilisation Fund. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 52 The adequate management of Malawi’s external balances is critical to sustained eco- nomic growth. While Malawi recorded average GDP growth of 6.1 percent in years out- side crises since 1990, growth during BoP crisis years was only 1.6 percent. At the same time, Malawi never fully experienced the benefits associated with trust in the long-term viability of external balances or the institutionalization of growth-enhancing external sec- tor policies, such as openness to foreign direct investment (FDI) and a highly liquid foreign exchange market. There is scope to improve the management of official reserves, external debt, and fi- nancial openness to promote external resilience. Official foreign exchange reserves have historically been low in Malawi and tend to be accumulated during BoP crises rather than providing a crisis buffer. Malawi has also decreased its foreign exchange holdings after mak- ing its exchange rate less flexible — a deviation from the conventional paradigm suggest- ing that more flexible exchange rate regimes require fewer reserves than fixed rates (Choi and Baek 2004). Similarly, public external debt incurrence is largely unaffected by crises, indicating that this channel does not actively cushion BoP shocks. Financial openness is chronically below regional and global norms, with the stance not softened as a policy tool to attract transfers during BoP crisis periods. Being dependent on foreign aid, Malawi has also struggled to smooth transfers through Official Development Assistance (ODA) with dips in the run-up to several of Malawi’s BoP crises. World Bank and IMF programs have not succeeded in institutionalizing more sustainable external balance management practic- es. Despite nine International Monetary Fund (IMF) programs since 1994 with external sta- bility as a program goal,11 there have been frequent reversals on targeted policy impacts.12 Macroeconomic policy requires support from sectoral policies. For instance, enhanced price stability enables the mobilization of greater domestic savings for investment. However, private investment will crucially depend on the prospects that businesses see for higher returns, requiring an improved business environment to translate into economic growth. At the same time, increased monetary stability would also allow more Malawians to rely on markets rather than their own agricultural plots for their livelihoods, in turn supporting structural transformation and agricultural commercialization. Similarly, external balanc- ing will alleviate critical foreign exchange constraints on exporting firms, contributing to a virtuous feedback loop between macroeconomic reform and export-led growth. All these examples highlight the importance of integrating macroeconomic, sectoral, and microe- conomic policies into a comprehensive reform agenda. Many of Malawi’s macroeconomic policy challenges stem from governance issues as much as from technical problems. Many principles of macroeconomic policy enjoy broad consensus among economists and policy makers and often the wider public, both in Malawi and abroad. For instance, fundamental ingredients of monetary stability such as central bank independence and abstaining from monetary financing are enshrined in Malawian law. The failure to achieve monetary stability in Malawi therefore points to implementation challenges rather than ambiguity on the technical level. Therefore, a dedicated chapter in this CEM addresses overcoming these types of implementation challenges (see Chapter 5). 11.  This has been explicitly the case since the introduction of explicit program goal recording, and implic- itly through Quantitative Performance Criteria and Structural Benchmarks on reserves and exchange systems before that. 12.  Likewise, there have been 10 World Bank Development Policy Operations (DPOs) in the same time frame, some of which have attempted to incentivize external stability. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 53 MACROECONOMIC POLICY REFORMS TO GET MALAWI BACK ON TRACK Malawi has the human capital required to achieve its growth ambitions, but what it cur- rently lacks is the investment to enhance productivity. Malawi’s population is expected to continue growing, with the share of working age Malawians growing at one percent per year, presenting a potentially strong demographic dividend. Moreover, Malawians are well-positioned to be productive, benefitting from relatively good health and education out- comes, as evidenced by the Human Capital Index, where Malawi ranks between Botswana and Iraq, two much wealthier countries. The main finding from the long-term growth mod- eling exercise is that the scarcity of capital is the limiting factor for Malawi to achieve higher growth levels. While initiating reforms that promote efficiency across the economy is cru- cial to sustain a long-term growth momentum, immediate and substantial growth can be attained by removing obstacles that constrain investment. This aligns with the chapter’s analysis of structural transformation dynamics, which shows that to thrive economically Malawians need to move from fields into factories, workshops, and offices — all of which require investment. Getting Malawi back on track will require determined macroeconomic reforms. This chapter delves into specific macroeconomic policy drivers of growth, while Chapter 5 pro- vides details on systemic governance reforms that can serve as the foundation for acceler- ated change. The analysis in this chapter showed that Malawi’s policy environment is not yet aligned with the requirements for rapid economic growth. To embark on the “Business Unusual” scenario, which is the only one compatible with envisioned growth targets, de- cisive reforms are essential. These reforms would not only mark a departure from growth patterns since independence but also have transformative effects on the standard of living of Malawians, helping reduce persistently high poverty levels. A successful departure rests on two principles that give rise to five priority actions each in the short and medium term (Table 1.1): 1. Prioritize growth within government: Prioritizing growth within government starts with making growth-enhancing public investment possible at scale. To accomplish this, government debt must be sustainable. In the short term, the only way to achieve this is by restructuring external debt, which should be achieved rapidly to minimize the peri- od during which the Malawian economy would suffer from low investment, while not yet benefiting from the growth-boost of debt relief. Given the experiences with two pe- riods of high debt, such restructuring should be accompanied by reforms to make debt sustainability last. This entails reforming debt management. It also requires enhanced fiscal credibility, which demands determined fiscal reform. A crucial first step toward fiscal reform is to demonstrate budget credibility in the current budget by adhering to what was approved. To make this more than a one-off achievement, Malawi will need to invigorate its budgeting institutions and rely on modern systems such as the IFMIS. However, the created fiscal space will only yield positive outcomes if the funds are in- vested productively. Prioritizing efficient investments means eliminating weak pro- jects by removing them from the Public Sector Investment Program (PSIP), which, in turn, requires robust screening and monitoring. Malawi will not have the means to im- plement all projects currently in the PSIP, even in the longer term. Allocations to less important projects mean that critical ones are neglected. Expenditure within projects that are known to be growth-enhancing also needs to focus on the capital investment itself rather than compliance with standards. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 54 The increasing impacts of climate change means that addressing key infrastruc- ture constraints must consider new climate-related risk factors. To achieve this, cli- mate change adaptation needs to be mainstreamed in government systems. As a large share of public investment is supported by development partners, aligning their activ- ities more closely to national priorities is essential to ensure rapid progress on growth targets. The focus of public expenditure on growth-effective investment presents both a political and technical agenda. While analyses, including previous and the forthcom- ing Public Expenditure Reviews, can offer technical insights, it is the responsibility of leaders to set investment targets, display less tolerance for inefficient expenditure (in- cluding untargeted subsidies), and demand that public expenditure aligns with nation- al economic development priorities. 2. Enable the private sector to prioritize growth: Since the Government alone cannot generate the necessary investments to accelerate growth, it is vital to facilitate pri- vate sector investment — as was demonstrated in the LTGM analysis in this Chapter. Following a 44 percent devaluation of the Malawi kwacha, coupled with the announce- ment of reforms to increase exchange rate flexibility in November 2023, Malawi should strive to maximize the economic benefits from exchange rate reform by institution- ally anchoring a market-determined and unified exchange rate. To crowd foreign ex- change into official systems, the authorities need to credibly commit to a transparent mechanism that ensures holders of foreign exchange, like prospective investors, re- ceive market-level rates. To sustainably relegate costly BoP crises to the past and foster trust in the new system, the strategic employment of key external balance manage- ment tools will be necessary. Unlocking rapid private sector growth from a macroe- conomic perspective requires the comprehensive prioritization of growth, including a strategic focus on the business environment that Malawi offers potential foreign in- vestors. Therefore, strategically increasing financial openness is important to increas- ing productivity and alleviating foreign exchange scarcities. In the medium term, all proposed macroeconomic policy changes should foster an investment climate that en- courages foreign as much as domestic investment. This assurance is essential for in- vestors to perceive Malawi as the vibrant and attractive market that it aspires to be. Table 1. 1  Top five macro-fiscal policy priorities Short-Term Actions Medium-Term Implementation Policy Issue (the next 3 – 6 months) (before the end of 2025) 1. Achieving debt sustainability Rapidly conclude negotiations with cred- Enhance public debt transparency and improving debt management itors to achieve sufficient reductions in through increased coverage, adhere to external debt levels and proceed with an annual borrowing plan and contain implementation of the country’s Debt debt levels to pre-defined targets. Strategy. 2. Proceeding with robust fiscal Demonstrate that Malawi can oper- reforms ate within its budget in FY 2023/24 by Enhance legislative accountability to implementing fiscal consolidation meas- budget estimates and fully implement ures, increasing domestic revenue, and IFMIS across Government. improving forecasts of pre-determined expenditure. 3. Enhancing efficiency in public Strengthen public investment manage- Reallocate Government expenditure and investment ment by phasing out investment projects development partner resources towards without evidenced impact from the PSIP investments that best alleviate key eco- and not entering any new projects into nomic constraints and promote resil- the PSIP in the FY2024/25 budget that ience to climate change. have not been screened and validated in line with PSIP procedures. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 55 Short-Term Actions Medium-Term Implementation Policy Issue (the next 3 – 6 months) (before the end of 2025) 4. Ending the current BOP crises and Support reserve accumulation and cre- Maintain a market-determined exchange strengthening foundations to pre- ate a sustainable and well-supported rate and strategically use official vent future crises exchange rate regime, by institutionaliz- reserves, external public debt, and ing a market-based and -clearing foreign financial openness to manage external exchange pricing mechanism. balances. 5. Prioritizing the promotion of produc- Evaluate all proposed major policy Increase financial and trade openness to tive private investment changes for their implication on Malawi’s make Malawi a more attractive destina- attractiveness for investment. tion for international investors. Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 56 ANNEX 1.1 Specification for the Long-Term Growth Model analysis The LTGM’s Technical Formulation The LTGM attempts to provide the simplest possible forecast of long-term average growth rates to be expected given growth fundamentals. The model is an adaptation of the Solow-Swan model for analyzing future growth paths. The LTGM is based on a single Cobb-Douglas production function and avoids multiple sectors as well as market balanc- ing — issues relevant to shorter-term forecasts. Investment rates are exogenous, as are TFP and demographics. However, some refinements of the LTGM concern demographics, which allow accounting for the demographic dividend, and human capital — two factors that be- come increasingly important the longer the modelling horizon. Overall, the model remains simple enough to be summarized in three formulas (see below) and for the model to be solved in an excel spreadsheet. All materials needed to replicate this growth modelling exercise can be found on the LTGM website: https://www.worldbank.org/en/research/brief/LTGM The LTGM can be summarized in three equations: 1. Production function Yt = At Kt1–β ( ht Lt ) β 2. Capital Accumulation Kt+1 = (1 – δ) Kt + It 3. Demographics and Labor Market Yt Yt Lt Wt ytPC = ---- = ---- ---- ---- = [ Lt kt1–β htβ ] ρt ωt Nt Lt Wt Nt Where: At: TFP; Kt: capital stock , ht: human capital per worker; Lt: number of workers; It: investment; Wt: working−age population; Nt: total population; ρt: labour participation rate; ωt: working-age-population to population ratio; kt: capital/worker Baseline assumptions were carefully selected (see Table A1.1). While a focus of the LTGM was to keep data inputs parsimonious to enable estimation for almost every country, includ- ing those with limited statistical capacity, economic judgement had to be exercised to select the most robust estimate among contradictory ones. The UN population projections show that across the Malawi 2063, Malawi will enjoy the once-off growth-boosting benefits of the demographic transition. Additionally, Malawi has impressive levels of human capital. Among structural and aspirational peers only Lao PDR, Nepal, and Zimbabwe, countries that were significantly wealthier than Malawi for sev- eral decades, outperform Malawi on the Human Capital Index. The recent Human Capital Review highlights progress on infant and child mortality and nutrition as a key contribu- tor to this success (World Bank 2023). It sees decreasing fertility, maternal and neonatal mortality, chronic malnutrition, and improving education as well as elevating the women’s Chapter 1  From Stagnant to Thriving: Overcoming Macroeconomic Constraints to Malawi’s Growth 57 empowerment agenda as key priorities to continue recent successes. Already realized fer- tility decreases that started in the 1980s also mean that this generation will likely consti- tute an increasing share of the total population until the 2060s. This demographic dividend and comparatively high human capital are key growth opportunities for Malawi. However, climate change will mean that achieving projected baseline growth levels will be challenging. The CCDR modelling shows that climate change could reduce GDP by 8 – 16 percent by 2050 (World Bank 2022a). This notwithstanding, building greater climate resilience to climate change can minimize impacts significantly. If Malawi prioritizes resil- ience given the stark warnings that recent shocks have delivered, such impacts are within the margin of error for this modelling exercise. Table A1.1.1  LTGM Input Variables Baseline Variable Assumption Source Justification Labour share 47.7% Penn World Sources agree that Malawi’s labor share is close to 50 percent. As a reliable ( β) Table 10 and comprehensive source, the Penn World Table was chosen. Capital 6.7% Penn World The Penn World Table is the only major source that calculates capital depre- Depreciation Table 10 ciation for Malawi. 6.7 percent is within the expected range between 5 and 10 percent calculated for peers. Initial Capital 127% of GDP MFMoD 2019 Sources diverge in their estimates of initial capital. MFMOD was chosen as this is a source where quality is regularly assured specifically for Malawi by a World Bank team. At only 17 percentage points lower, Penn World Table esti- mates are similar. Human Capital 2.0% sloping CEM team Initial human capital growth is estimated to be the average over the last Growth down to 1.2% estimates five years. However, such high growth rates were not sustained over the by 2040 long term by any country. Thus, a reduction to 1.2 percent growth, a value achieved by some of the historic top performers, was assumed for the medium term. TFP Growth 0.23% Penn World TFP growth in the LTGM excludes human capital growth making it not Table 10 directly comparable to more common calculations of TFP. TFP growth has been unstable over recent decades. TFP growth has been estimated to be very high in the early 2000s, but has likely been negative in recent years. The authors chose the 2010 – 2014 average estimated based on the Penn World Table 10 as this has the same order of magnitude as the regional norm (0.5 percent) and is likely to be reflective of long-term trends. Demographics UN UN The authors used the UN Population Division central estimates for all models Projections Population as this represents the premier source on population dynamics. Division Investment 14.3% of GDP World Bank This is the long-term average statistic for when Malawi still reported an National expenditure series (2010). This is the only major available source despite Accounts some uncertainty surrounding the estimate as it predates the latest rebasing of national accounts. 58 Commercializing Agriculture CHAPTER 2 and Improving the Prospects for Rural Employment KEY FINDINGS 1 Two thirds of all Malawian adults work in agriculture and the sector contributes signifi- cantly to GDP. However, high poverty rates show that there have been few opportunities to increase rural incomes. Ninety-four percent of all poor households in Malawi are in rural communities and the rural poverty headcount ratio at the national poverty line (57 per- cent) is almost three times that found in urban areas (19 percent). 2 Although Malawi’s economy remains among the world’s most dependent on agri- culture, the current structure of household agricultural production does not facilitate sustained poverty reduction for most farming households. Due to small landholdings, even if all farming households were able to achieve the agricultural productivity levels of the top 10 percent most productive households, the poverty rate would not see a signif- icant reduction. 3 Farming contributes only 30 percent to the total income of the typical farming house- hold, with these households only deriving about US$20 (in nominal terms) in value per capita annually from their endeavors. Other significant sources of income include casual, short-term ganyu employment, more formal, longer-term wage employment, and com- mercial enterprises. 4 Commercial agriculture is a driver of growth and job creation. While comprising only 7 percent of Malawian households, commercial farmers possess the potential to boost local demand for products and services, thereby stimulating rural off-farm labor markets. 5 Malawi’s agriculture sector has largely been shaped by policies emphasizing food self-sufficiency rather than commercial farming. Consequently, the sector has untapped potential for increased growth and job creation. However, commercial farm- ers have faced obstacles such as unpredictable government interventions in input and output markets, land tenure uncertainty, and an unattractive external trade regime. Addressing these policy barriers and improving institutional capacity to implement planned reforms are crucial steps for achieving agricultural growth and rural eco- nomic transformation. Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 59 INTRODUCTION Malawi’s economy remains highly dependent on agriculture with the sector playing a critical role in the country’s overall macroeconomic performance. Estimates indicate that in 2021, two in three adults derived their livelihoods from agriculture and the sector contributed about 23 percent to the country’s total GDP (Malawi Government 2022; see chapter 1). The agriculture sector will remain of central importance for Malawi to achieve its economic and human development objectives for years to come. The agriculture sector is critical both for household and national food security. Sub- sistence considerations continue to influence cropping patterns and shape households’ en- gagement with agricultural markets. Since ensuring food and nutrition security through the market is challenging, most farming households rely on their own production to meet the majority of their caloric needs (Benson and Edelman 2016).13 This situation, coupled with limited access to credit, creates incentives for poor Malawian households to under- invest in productive capital. Despite this, fewer than 7 percent of households can generate sufficient income from farming to meet their basic needs. On average, farming contributes only 30 percent to the total income of the median farming household, typically MWK 16,190 (about US$20 in nom- inal terms), in value per capita annually from their efforts (IHS 2019/20). Female-headed households face additional hurdles, experiencing limited access to agricultural resources and services, thereby exacerbating gender gaps in agricultural productivity and the abil- ity to meet basic needs through agriculture (Fisher and Kandiwa 2014). Malawian agriculture has consistently been characterized by low and stagnant pro- ductivity. Approximately 80 percent of farming households operate on the basis of just one rain-fed crop per year, leading to significant year-to-year variability in production. This is further exacerbated by factors such as limited use of improved agricultural tech- nologies, inputs, and practices; poor access to credit and markets; extremely small farmer landholdings compared to regional counterparts; and, increasingly, the impacts of climate change and variability. The average Malawian farm size is only 0.7 hectares (ha), signifi- cantly smaller than farms in neighboring countries. The agriculture sector is highly sus- ceptible to climate shocks, with recurrent extreme weather events, including dry spells and devastating tropical cyclones,14 impacting lives, livelihoods, and the country’s socio-eco- nomic infrastructure (Government of Malawi 2023). Notably, the second-biggest impact of climate change on the Malawian economy is through shocks to labor productivity (World Bank 2022a). Over the past 15 years, the value added per worker has not only remained below the regional average but shown minimal change (World Bank 2022c). This, in turn, affects Malawians’ livelihoods, food security, and resilience, particularly in rural areas. Even with adaptation measures in place, the negative impacts on labor productivity will persist, underscoring the need to shift labor away from agriculture by creating job oppor- tunities in other sectors. 13. As discussed in Benson and Edelman (2016), food security for Malawian households depends to a large extent on own production of food. 14. The effects of Tropical Cyclone Idai in 2019 placed Malawi in the top five countries most affected by extreme weather events, according to the Global Climate Risk Index. Tropical Storm Ana and Tropical Cyclone Gombe (both in 2022) resulted in 64 fatalities and 945,934 people affected; Tropical Cyclone Freddy in 2023 impacted more than 2,267,458 people, including more than 659,278 displaced, and 679 deaths. Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 60 Additionally, new analysis presented in this CEM shows that the welfare gains from in- creased productivity are indeed important, but they are limited for households with small cropland holdings (Benson and De Weerdt 2023). This indicates that even with sig- nificantly higher levels of productivity, a farmer with extremely small landholdings is likely to remain in poverty and struggle to meet basic needs. Benson and De Weerdt (2023) demon- strate that if all farming households could attain the agricultural productivity levels of the top 10 percent most productive households, household incomes would increase (Figure 2.1) and the poverty rate would be reduced. However, the impacts would not be transformative, ranging from 1.9 to 9.7 percentage points, depending on the main crop planted (Figure 2.2). Furthermore, the volatility of crop prices means that even farmers with larger holdings can- not be confident that they will always generate sufficient income from their crop produc- tion. To meet the basic needs of their members, most farming households, whether poor or non-poor, need to pursue additional economic activities alongside farming. Thus, while ag- riculture is set to remain Malawi’s largest employer over the next decade, it is insufficient to provide a viable pathway out of poverty for most rural Malawians. Figure 2.1  Significant productivity improvements would Figure 2.2  Even substantial productivity improvements not raise incomes by much only lead to modest poverty gains Average annual income (MWK) and income of the 10 percent most Income poverty rate at current average levels of productivity and productive farmers, percent productivity of most productive 10 percent, percent Maize Maize Rice Rice Cassava Cassava Sweet Potato Sweet Potato Groundnut Groundnut Soya Soya Tobacco Tobacco 0 50 100 150 200 0 10 20 30 40 50 60 70 Current average At best 10 percent Current average At best 10 percent Source: World Bank staff calculations based on IHS analysis in Benson Source: World Bank staff calculations based on IHS analysis in Benson and De Weerdt (2023). and De Weerdt (2023). To achieve meaningful advances in human and economic development, it is impera- tive to address critical constraints to growth in the agriculture sector and support the expansion of broader rural employment opportunities. Poverty predominantly persists in rural Malawi, where the vast majority of the country’s population (84 percent) resides, and 94 percent of all poor households are found (World Bank 2022d). The past 15 years of poverty stagnation have resulted in a significant increase in the absolute number of poor Malawians.15 Prioritizing improvements in rural labor market outcomes to foster a more robust and vibrant rural economy holds the key to reducing poverty in Malawi. 15. However, this masks progress against poverty in the Rural North, where the poverty rate reduced 24 percent- age points between 2016 and 2019. It also conceals notable falls in urban poverty between 2004 and 2010 (World Bank 2022d). Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 61 Most farming households are already turning to alternative employment opportuni- ties beyond their own farms to mitigate or escape poverty. Rural Malawian households adopt various diversified livelihood strategies, including engaging in casual labor, secur- ing longer-term wage employment, managing household enterprises, and, to a lesser de- gree, receiving regular income payments such as pensions and social protection transfers. Additionally, the overvaluation of the kwacha (see Chapter 1) has skewed producer incen- tives in recent years, discouraging exports and pushing smallholders into subsistence farm- ing and/or seeking off-farm opportunities for income generation. This has also hindered downstream job creation, such as through processing and value addition activities. Fur- ther analysis is needed to better understand the restrictions that are dampening producer incentives and the factors driving them.16 Moreover, many of these households lack the re- sources or skills necessary to create or secure employment that provides sufficient income. Under current conditions, non-farm rural employment does not yield incomes high enough to lift households out of poverty. Nonetheless, income from off own-farm activities consti- tutes most of the income of most rural households, with 73 percent of farming households deriving more than half of their annual income from off-farm sources. A small but growing share of commercially oriented farmers is uniquely positioned to support the transformation of rural markets and drive economic growth within ru- ral communities. Presently, this group currently comprises only 7 percent of all Malawian households. However, these households can contribute to sharp and permanent reductions in rural poverty facilitated by: (i) a much smaller but significantly more productive share of rural households engaged in farming, achieving much higher incomes than currently ob- served; and (ii) a larger group of workers, particularly in rural communities, gaining access to substantially expanded options for generating income to meet the basic needs of their households, especially outside of agriculture. Given Malawi’s current situation, there is no single magic bullet for sustained growth and prosperity. Instead, a comprehensive agenda is needed, emphasizing effective coor- dination and sequencing of policies and investments. In this context, policies promoting market-led growth, land tenure security, and deepened financial markets in rural areas are critical for realizing the envisioned transformation of food systems in Malawi. No other sector holds the same potential to meet the country’s job creation challenge (International Finance Corporation 2021). This chapter outlines a future vision of a diversified, more commercially oriented agri- culture sector as a source of growth, development, and job creation in Malawi. The fol- lowing section highlights employment opportunities and challenges for rural households in Malawi, providing insights into why the agriculture sector is currently underperforming. The following section discusses viable pathways out of poverty, propelled by an emerging cohort of commercial farmers who are predominantly youthful, productive, and entrepre- neurial. These farmers are creating increased demand for innovation, capital investment, and service provision in the agrifood sector. This section is followed by a discussion of the drivers and constraints shaping rural economic development. The chapter concludes with recommendations aimed at informing policy reforms and transcending business-as-usual in Malawi’s agrifood sector. 16. For example, based on FAO MAFAP data until 2018, the negative market price support (i.e., implicit taxation) was significantly larger in absolute terms than the public expenditures support provided (subsidies and other public goods) to promote productivity and production, with the overall producer support being negative.  Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 62 UNDERSTANDING RURAL ECONOMY DYNAMICS IN MALAWI: EMPLOYMENT OPPORTUNITIES AND CHALLENGES FOR RURAL HOUSEHOLDS Understanding the full diversity of income-generating activities that rural Malawians engage in is crucial to developing viable strategies to enhance incomes and reduce pov- erty. Households across the rural-urban divide can be categorized into four groups based on economic, residential, and demographic characteristics. These are: (i) commercially ori- ented smallholder farmers;17 (ii) other productive rural households; (iii) households that are not economically productive; and (iv) productive urban households (Figure 2.3). Each of these types of households plays a dedicated role in rural economies and impacts how agricultural and non-agricultural labor markets interact. Interactions between local and national economies is also important in shaping rural labor market dynamics, as is the level of skill required for higher Figure 2.3  Share of household types by IHS wave returns. To develop viable strategies to boost rural incomes, Percentage share of households it is essential to understand the appropriate policy options 100 that can enhance what households reap from farming and to focus on increasing the returns that these households 80 receive from their non-farm work. 60 Furthermore, Malawians engage in a wide range of live- lihoods and economic activities. First, it is necessary to 40 revise the common assumption that agriculture is the cen- tral livelihoods for rural households across Malawi, and 20 that their welfare is primarily dependent upon the quali- ty of their household annual crop production. While crop 0 2004/05 2010/11 2015/16 2019/20 production remains central to their welfare, the ability to secure sufficiently remunerative off-farm employment of- Commercial smallholders Other productive ten holds greater significance. Poor farming households, Not economically productive Urban despite their efforts, are still unable to consistently meet Source: World Bank staff compilation based on Benson their basic needs by combining these income streams. and De Weerdt (2023). Second, in developing strategies for rural economic and human development in Malawi, accelerating agricultural production growth, particu- larly through increased productivity, and increasing the returns to farming is a neces- sary but incomplete solution. Equal emphasis should be placed on enabling workers in rural households to qualify for and secure good off-farm jobs. Without an increase in the number and quality of such employment opportunities, the economies of most ru- ral communities across Malawi are likely to stagnate, and poverty will deepen among households living in them. 17. A smallholder commercial farmer is broadly engaged in agricultural production for the market. These farm- ers are typically net sellers, i.e., able to meet food consumption needs while also producing a surplus to sell. For the purposes of this report, households are categorized as commercially oriented if their consumption level is above the food poverty line and reported selling more than one-quarter of their harvested maize annually. Although the total value of crop production that was sold could have been used to define households in this cat- egory, maize was used for analytical simplicity. Eighty-eight percent of farming household in Malawi produce maize and the crop is planted on over 70 percent of the cropland of farming households. In addition, gross sales as a share of maize harvested was used, given that information on food crop sales and consumption is not suf- ficiently harmonized in the IHS to determine annually whether a household is a net maize seller or a net maize purchaser. Information on crop sales is collected on a seasonal basis, while information on food purchases is based on food consumption recall over the previous seven days. Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 63 Figure 2.4  Typology of Malawian households Shares calculated as percentage of overall population covered in the 2019/20 IHS 5 survey. Poverty rate is defined as the share of households falling under the national per-capita basic needs poverty line. Rural Commercially- Oriented Not Stallholder Other Economically Urban Farmers Productive Productive Households Share of population 7% 64% 13% 16% Poverty rate 27% 40% 100% 12% At least one person with some 48% 33% 18% 57% secondary schooling in household Produces crop 100% 86% 90% 31% Cropland area used 1.07ha 0.60ha 0.54ha 0.17ha Cropland per household member 0.28ha 0.16ha 0.10ha 0.05ha Share renting in some land 20% 9% 7% 6% Crop producers hiring 41% 20% 5% 46% gricultural labour Source: World Bank staff compilation based on IHS analysis in Benson and De Weerdt (2023). Note: Commercial Smallholders are defined as those households that are not ultra-poor (i.e., consumption below the food poverty line) and that sell more than one-quarter of the maize they harvested. Not Economically Productive Households are ultra-poor and more than half of their members are not working age (aged 15 to 64). Urban Households are residents of urban centers and rural towns. Other Productive Households are rural households that do not fall into the Commercial Smallholder or the Not Economically Productive Household categories. The average farming household in Malawi is already heavily dependent on off-farm employment, which provides around two-thirds of their income (Figure 2.5). Work- ers in farming households have three principal sources for off-farm employment, each with its own advantag- Figure 2.5  Agricultural income is typically a small share es and challenges:  of total income. In current MWK (’000) per capita per year • Casual, short-term “ganyu” employment is the ba- 220 sic component of the income of most farming house- holds. Ganyu employment allows workers in farming 200 households to focus on farming during the rainy sea- 180 son and then pick up temporary work or reengage in a 160 household enterprise after the harvest. During the dry 140 season, ganyu labor is the main coping strategy used by 120 poor Malawian households to meet their food security needs (Whiteside 2000). Poor farming households are 100 almost 40 percent more likely to engage in ganyu labor 80 than members of non-poor farming households, while 60 those with smaller landholdings are 20 percent more 40 likely to do so than those with larger cropland hold- ings. Although non-farming households engage in ga- 20 nyu labor while they seek to secure more remunerative 0 longer-term wage employment, farming households Farming Non-Poor Poor Larger Land Smaller Land primarily rely on this income source to meet their food Ganyu Longer-term employment security needs, especially during the dry season when Household enterprise Agricultural income there is a labor surplus. Most ganyu labor is linked di- Other regular inocme Social transfers rectly or indirectly to agriculture, both on-farm and off- Source: World Bank staff calculations based on IHS analysis in Benson farm, such as working on other people’s fields, engaging and De Weerdt (2023). Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 64 in processing and trade, and working in the rural retail sector. Smallholder farmers en- gaged in ganyu labor might sacrifice productivity on their own farm while working on oth- er people’s fields, because this is when the demand for labor is at its highest. Furthermore, demand for ganyu labor in farming communities in the dry season is lower than during the cropping season, while the supply of workers competing for ganyu labor opportunities at that time of year is large, suppressing wages. Despite this, ganyu labor is occupying an in- creasing share in household incomes, rising from 18 to 37 percent between 2010 and 2019. • More formal, longer-term wage employment can provide a steady income stream for households, but relatively few farming households have members engaged in wage employment. This is noteworthy, given that only 10 percent of all working-age individ- uals in Malawi receive a salary, and the overall share of working-age individuals with wage employment has declined over time. This indicates significant obstacles to expand- ing formal labor markets across the country, particularly for members of farming house- holds. While 24 percent of those working-age individuals in non-farming households have wage employment, only 7 percent of those in farming households do. Surprisingly, despite most agricultural production occurring at the smallholder farmer level, the most com- mon type of wage employment is found in the agri-food sector, encompassing everything from on-farm production to trade, processing, and marketing. Longer-term salaried work opportunities are rare, and there is a surplus of potential workers for employers offering wage employment in the sector, leading to strong downward pressure on rural wage lev- els. Despite this, the overall share of income from household businesses and wage jobs has increased from 3 to 11 percent since 2010, although it remains low. • Commercial household enterprises offer off-farm opportunities to a significant subset of farming and non-farming households in Malawi. In part because wage em- ployment opportunities are so rare, more than one-third of farming households have members that operate at least one commercial enterprise, such as charcoal or firewood production or traditional straw or wood products, while 45 percent of non-farming households have some form of household enterprise. Enterprises centered on process- ing, sales, trade of agricultural products, and/or selling their own production are the most reported type (Figure 2.6). Farming households with relatively small cropland holdings are more like- Figure 2.6  Processing, sales, and trade of agricultural ly to operate enterprises. The enterprises that mem- products are the most commonly reported enterprises bers of farming households operate are often only Percentage share of all household enterprises available during the dry season, reflecting the strong Transportation seasonality of agricultural production. For instance, Agricultural Charcoal and less than one-third of household enterprises oper- processing & trade firewood production ate 12 months a year. However, many households do 23.6% 12.3% not have the capital or skillsets needed to create en- 4.8% terprises that can generate returns to labor that pro- vide sufficient income to cover the basic needs of their households. Moreover, enterprises with higher remu- 17.4% neration may need to be situated in areas with ade- Other quate demand and purchasing power for their prod- ucts or services. often near urban centers. Additionally, 23.3% these enterprises might rely on public services, such as Food and drink 18.6% electricity, transportation, communication, and infor- production & sales mation services, for commercial success. Household Non-agricultural enterprises requiring significant capital to launch will trade be constrained by Malawian households’ poor access Source: World Bank staff calculations based on IHS analysis in Benson to credit (see also Chapter 3). and De Weerdt (2023). Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 65 Poorer households are more likely to engage in off-farm employment, especially relying on types of off-farm work with lower entry barriers such as temporary ganyu employ- ment and household enterprises. While these opportunities supplement their farming in- come, they often yield lower earnings compared to employment requiring specialized skills. Many households equipped with sufficient labor are still unable to meet their basic needs, as current rural labor market conditions do not offer the off-farm employment opportu- nities needed to reliably provide the required income to meet basic needs. Malawi has the third-highest working poverty rate globally according to International Labour Organization estimates, and as the share of households that will need to find off-farm employment to supplement their incomes and escape poverty increases, pressures on rural labor markets will increase. To accommodate this supply increase, fundamental shifts in the functioning of rural labor markets need to occur. AGRICULTURAL COMMERCIALIZATION CAN BE A SOURCE OF GROWTH AND A PATHWAY OUT OF POVERTY There are emerging geographic pockets of agricultural commercialization in Malawi. Despite an agriculture sector experiencing reduced landholdings and limited productiv- ity improvements, the share of commercially oriented farming households has remained relatively stable over time. Nationally, the share of commercializing smallholders is low at 7 percent, showing little change since 2004/05 (Figure 2.7). However, there are significant Figure 2.7  Commercial farming households are heavily concentrated in the North and Central Regions Maps by district, and major urban centres of households that fall into rural households, percent Commercially oriented farming households Other productive rural households Not economically productive households less than 5 less than 50 less than 5 5–10 50–70 5–10 10–15 70–80 10–20 more than 15 more than 80 more than 20 7 percent 63.6 percent 13.4 percent of households of households of households nationally fall nationally fall nationally fall in this cotegory in this cotegory in this cotegory Source: World Bank staff calculations based on IHS analysis in Benson and De Weerdt (2023). Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 66 spatial disparities indicating localized commercialization in Malawi. For instance, while the rural Central Region has a similar number of households compared with the rural Southern Region, the share of commercially oriented households in 2019/20 was almost three times higher in the Central Region (11.8 percent) than in the Southern Region (4.6 percent). The share of commercially oriented farmers is also higher than the national average in the Northern Region (10.6 percent). Importantly, the share of commercially oriented farmers in the Central Region increased steadily from 8.2 percent in 2004/05 to 11.8 percent in 2019/20. Similarly, this share rose from 7.5 to 10.6 percent in the Northern Region over the same period. However, in the Southern Region, the share of commercial- izing farmers declined from 6.1 to 4.6 percent between 2004/05 and 2019/20. These trends highlight that agricultural commercialization exists in localized pockets in Malawi, even though these pockets may be too small to be evident in nationally representative data. This is likely to occur in areas with better access to land and irrigation, closer proxim- ity to urban markets, and major trade routes. Select commercialized farmers produce much of Malawi’s main exports: tobacco, sugar, tea, and soybeans. With effective mar- ket development and increased agricultural productivity, the share of Malawian house- holds engaged in commercially oriented farming can be expected to grow. In this context, promoting agricultural commercialization necessitates targeted sup- port programs for those farming households and organizations capable of significantly increasing productivity and hence production. These include the subset of farmers with relatively larger cropland holdings concentrated in the mid-altitude plateau areas of the Central and Northern Regions, those living near large irrigation and anchor farm schemes, particularly in the Southern Region, or those seeking economies of scale by joining farmer organizations. Out of a total of 1.1 million businesses classified as micro, small and medium enterprises (MSMEs) in the country, an estimated 188,000 are in agriculture, and 15,000 are in agro-processing, with most relying on agricultural inputs or producing food products (International Finance Corporation 2021). The model of rural economic development in which a vibrant commercial farming sec- tor animates rural non-farm economic activities operates as follows: As the productiv- ity of commercial farming households rises, their farm production expands, leading to higher incomes. With increased income, they demand more goods and services pro- duced by their less agriculture-focused neighbors. These goods and services are typically labor-intensive, require limited capital, and are usually not marketed outside of the local community. They include construction and building repair services, transport, education, health, social services, furniture and handicraft-making, and food and beverage process- ing, among others. This, in turn, stimulates rural off-farm downstream labor markets for a wide range of input suppliers, transporters, agro-processors, domestic food manufactur- ers, and other related service providers, already central to most rural economic activity. Successful commercial farming creates demand for labor, playing a pivotal role in rural markets. This consumption linkage also diffuses many of the economic gains from more productive farming to other rural households, deepening local markets, accelerating local economic activities, and improving access to food for economically active households in these communities, including the poor. As this pattern of rural economic development unfolds, non-farming households in- creasingly derive higher returns from their non-farm activities compared to their low-productivity farming. Many households producing goods and services for the lo- cal market expand their activities to serve wider markets, driving some specialization in local rural employment patterns and boosting their income. In so doing, many will transition from being poor, subsistence-oriented households engaged in some farming Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 67 to becoming non-farming households specializing in livelihoods outside of agricultural production. Moreover, large shares of the cropland currently used by these less agricul- ture-focused rural households, could increasingly become available for more productive use by commercial smallholder farming households, further accelerating agricultural and rural economic growth. Land tenure security will be crucial to realize this poten- tial, as commercial agriculture requires farmers to have the right incentives for longer term investments in their land. However, the driving force behind this potential phe- nomenon — commercially oriented smallholder farmers — must be central to any pol- icies and programs that seek to foster rural economic transformation and assure food security for Malawi (Benson 2021). Several factors present challenges to this model of rural economic development in Malawi. The ongoing prevalence of subsistence-oriented agriculture raises questions about the feasibility of such a development approach for communities without significant chang- es to policy and market functioning. This is pertinent as the broader political and economic context, along with the local structure of agricultural production, are important determi- nants of the impact of this improved agricultural productivity on poverty (Benson 2021). In Malawi, this is limited by: (i) Access to land and the dominance of customary communal land tenure systems that constrain the ability of commercially oriented farming households to significantly ex- pand the areas they farm; (ii) Significant labor bottlenecks for commercially oriented smallholder farming house- holds operating at scales that require labor (especially short term, seasonal labor) be- yond what is available in their household, given that rainfed and largely unmechanized farming systems demand labor at specific points in the cropping season — and com- munity members who might supply that labor may have a strong economic preference to work on their own crops (Benson 2021); (iii) Limited markets that provide reliable commercial incentives for farming households for inputs, outputs, and consumption goods. Stability in seasonal price patterns is a critical component in establishing reliable commercial incentives for farming house- holds (Timmer 2015). Despite these challenges, there are several complementary pathways to achieve agricul- tural commercialization in Malawi. The three primary avenues analyzed in this chapter are: (i) medium-sized family farms, as evidenced in neighboring countries; (ii) the devel- opment of appropriate farmer organizations and strengthening their access to markets through productive partnership models; and (iii) the development of anchor farm models where large commercial farms will partner with smallholders to provide them with access to agricultural inputs, training, and markets. Agricultural commercialization through medium-sized family farms There is growing evidence from the region that emerging commercially oriented, small- and medium-size farmers can become a significant source of demand for innovation, capital investment, and service provision, which together can drive productivity growth and job creation. For example, medium-scale commercializing farms (5 – 100 ha) now control roughly 20 percent of total farmland in Kenya, 32 per- cent in Ghana, 39 percent in Tanzania, and over 50 percent in Zambia. In Tanzania, Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 68 medium-sized farms generated 13 million labor days per year. This trend often indi- cates increased interest in land by urban-based professionals or well-off rural peo- ple. Approximately half of these farmers obtained their land later in life, financed by non-farm income. A greater share of savings in urban areas is being re-invested in farming and agribusiness (Jayne et al. 2019). Commercially oriented households are more likely to be headed by men and by younger individuals than are other pro- ductive rural households. While there has been a large increase in the share of fe- male-headed households in the general population, such households are significantly underrepresented in the commercially oriented farming household category. Com- mercially oriented farming households, in turn, scale up and specialize in farming, while less productive farming households increasingly rely on off-farm employment for their livelihoods. Current trends indicate that in Malawi there is little evidence of a restructuring of em- ployment patterns is occurring at scale (Benson and De Weerdt 2023). To successfully transition from primarily agricultural to non-agricultural livelihoods, such households will need to obtain sufficient income from non-agricultural employment, so that rainfed farm- ing conducted on their cropland holdings increasingly is seen as a poor economic choice for workers in the households. Thus far, only a relatively small share of Malawian house- holds has successfully made this transition out of agriculture. While such transitions in household economies will be difficult for many, the current trend of declining average ag- ricultural landholdings, low crop productivity, and a rising prevalence of food insecurity makes such changes increasingly necessary. Over time, the share of commercially oriented farming households in Malawi has shown slow but steady growth. The slow pace of this growth underscores the need for more concerted efforts to build the capacity of these households for engaging in high- er-productivity commercial agricultural production and to improve the enabling envi- ronment, especially through improved markets. There are certain policy components to strengthening agricultural markets in Malawi that can provide reliable commercial in- centives for farming households. These include ensuring predictable government engage- ment in agricultural marketing and trade, providing public services to enable markets to operate more efficiently, adopting policy stances that are supportive of agricultural mar- ket traders, and expanding participation in regional markets by farmers and other actors in Malawi’s agricultural commodity value chains. Despite the challenges outlined above, commercially oriented smallholder farming households are not diminishing. Instead, there remains an open window of opportunity for this model of rural economic development to establish itself in Malawi. Smallholder commercialization through the development of farmer organizations and productive partnership models Productive alliances, characterized by strong farmer organizations, links to offtake markets, improved access to finance, and an enabling environment, can help make markets work for commercializing smallholders. The productive alliance model starts with strengthening or building Producer Organizations (POs) to allow smallholders to seize market opportunities and have their voices heard, receive more information, reduce costs, and reap the rewards that come from selling at scale. Productive alliances link POs with off-takers to assure access to markets and partnerships. “Off-takers” — companies that buy produce and refine it, such as commercial-scale oil mills and the dairy industry — are Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 69 operating at low capacity largely because of inconsistent supply.18 If farmer POs orientate their production to meet this demand, it would result in a mutually beneficial, commercial relationship between farmers and buyers. Productive alliances empower farmers to respond to competitive calls for funding proposals (for example, where POs are awarded matching grants based on farmer contributions). This boosts production levels and promotes own- ership by the farmers. Productive alliances connect farmers to finance to boost the production capacity of farmer producer organizations. Their efforts to improve the enabling environment, in- cluding reforms, land tenure security, standards, and certifications, are all geared toward improving agricultural commercialization. Productive alliances can promote greater inclu- sion, especially for women. The most vulnerable members of the farmer POs are the ones profiting most from commercial partnerships with buyers. Ideally, such collaborative part- nerships provide an opportunity for women to compete on levels of productivity with men by providing them with access to inputs, technologies, and markets (Davis et al. 2023). Such efforts have increased the volume and value of sales commercialized with improved farm- er access to finance and markets. The types of value chains also spur the hopes for a vir- tuous cycle of economic transformation: while some value chains are in traditional export goods, others predominantly serve a local market, creating local economic feedback effects. Large scale agricultural commercialization through anchor farm or megafarm models: making large-scale agriculture work for smallholder farmers Recent debates have focused on the value of large-scale commercialization through anchor farms19 or “megafarms” to accelerate local agricultural development for neigh- boring smallholder farming households. Estates are believed to cover 1.35 million hec- tares, constituting about 25 percent of the country’s arable land (Deininger and Xia 2018). In this model of rural economic development, large commercial farms partner with neigh- boring smallholder farming households to provide them with access to agricultural inputs, training, and more lucrative markets (Gondwe et al. 2022). Thus, whether an anchor farm approach will foster rural development is entirely dependent on the design and extent of their engagement with neighboring households. Productive megafarms that fail to both directly and indirectly expand employment opportunities for workers in neighboring rural communities and do not contribute to increased economic activity within those commu- nities will not propel Malawi toward its development vision. Empirical evidence on the impact of Malawi’s estates20 on local communities and small- holders is scarce and largely inconclusive, reflecting the variety of outcomes possible across projects, locations, and times. Existing literature suggests that 70 percent of estate leases have expired, reducing government revenue by up to US$35 million (Deininger and 18. In some cases, off-takers have been found to reduce operations to artificially manipulate the prices of pro- cessed products. For example, there is research that points to soybean crushers operating below capacity to keep factory-gate prices of soya low and retails prices of cooking oil high. Therefore, there may be more to low utili- zation of processing capacity than unreliable supply. 19. Large-scale farms in Malawi are generally between 500 to 5,000 hectares. 20. The agricultural sector in Malawi, while dominated by household-level production, includes a significant footprint of commercial estates involving relatively larger areas of land obtained through freehold ownership or through long-term leasehold arrangements. Recent studies estimate that estates in Malawi occupy 1.35 million ha (Deininger and Xia 2017), while IHS5 analysis suggests that farming households cultivated a little under 2.5 million ha; it is estimated that only about 40 percent of estate land is currently being cultivated (Deininger and Xia 2018). Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 70 Xia 2018). Recent studies on the performance of large farms and their impacts on surround- ing communities and smallholder farmers in both Malawi and across the region reveal mixed impacts.21 The Government of Malawi has recently intensified efforts to promote and develop large-scale farms in the country.22 This signals a potentially significant shift in the Gov- ernment’s approach to economic development and the transformation of the agriculture sector — from a focus on input subsidies to support more productive smallholders to greater support for land access and consolidation, as well as the rehabilitation of idle or underuti- lized land at scale. The further development of stronger domestic agri-food value chains will create opportunities for small, medium, and large players across the sector. Recommendations from recent analysis suggest several actions that the Government of Malawi can take to support both smallholders and large farms. Currently, unpredictable government interventions in output markets and insufficient incentives to support large- scale production are negatively impacting the performance of large farms (Gondwe et al. 2022). Other studies point to the need for greater public investment in transportation infra- structure, which could help farmers of all sizes by improving access to inputs and input markets (Julien, Bravo-Ureta, and Rada 2019) . Programs to support managerial skills and foster diversification are also commonly recommended (Joseph, van Dijk, and Krisztin 2023). Importantly, the private sector is likely best suited to lead the operations and management of megafarms, with the Government fostering a conducive environment for investors. When assessing megafarm-centered strategies, close consideration must be given to the degree of inclusive consumption linkages and positive spillovers to neighboring communities. The stronger these linkages, the greater the potential for poverty reduction and enhancement of rural employment through a partnership between the larger farm and the local community. Box 2.1  International best practice for large scale commercialization to inform Malawi’s Mega-Farm initiative Anchor farms control a significant share of cropland in arable land and sufficient water, and strong institutions and Malawi and therefore agricultural support programs in systems to manage and protect land and water rights, are Malawi could be better designed to help build stronger paramount. Investors also prefer a country where govern- linkages between the larger farms, nearby farmers, and ments support trade openness, and where farmers already local communities. The constraints that anchor farms face have relatively high agricultural productivity (Mazzocchi et are not so different from those of commercializing farming al. 2018). Other positively correlated factors include the eco- households. The conceptual framework of commercializa- nomic size of the investors’ countries, institutional capacity, tion presented here suggests that the anchor farm model good governance, and security and safety in the destination could energize local economic activity if its design is based country (Kareem 2018). on close engagement with nearby communities. Secure property rights and land governance have proven Analysis of the determinants of large-scale land invest- to be essential in supporting legal land consolidation and ment globally highlights the need for both natural the endogenous transformation of rural economies from endowments and an enabling environment. Availability of smallholder systems to large-scale commercial farming. 21. While some suggest significant negative impacts on the absolute value of agricultural output of smallholders located in proximity to estates, others find that the yields of most food crops are generally higher on small-scale farms than on large-scale farms in Malawi (Gondwe et al. 2022). Similar studies conducted in neighboring coun- tries have found varying and occasionally conflicting results, highlighting the limited transferability of results from one country to another and further motivating more data collection and analysis in the Malawian context (Joseph, van Dijk, and Krisztin 2023). The local context and supporting policies play a key role in enabling posi- tive spillovers for smallholders in proximity to estates. 22. In December 2022, Greenbelt Authority CEO, Eric Chizungu, reported the Government had helped to estab- lish five megafarms — one each in Karonga, Nkhata Bay, Nkhotakota, Mangochi, and Chikwawa. The Greenbelt Authority is believed to be managing the development and operations of each site. Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 71 When these systems are in place, smallholders can volun- the potential income losses by protecting rural households tarily supply the large farms with land and labor. Analysis from welfare losses through social safety net programs and by the Food and Agriculture Organization (FAO) also sug- income transfers (Ma, Lin, and Sexton 2022). Subsidy pro- gests that investments that involve local farmers as equal grams, generally speaking, should be (re)assessed to ensure business partners, leaving them in control of their land, have that they are producing the desired impacts (Ma, Lin, and the most positive and sustainable effects on local econo- Sexton 2022). For example, programs to support mechaniza- mies and social development (Liu 2014). In such cases, local tion may be best at improving productivity of medium farms, communities and individual farmers may need strong exter- rather than small or large farms (Qiu, Choy, and Luo 2022). nal support to facilitate and conclude investment deals. Lastly, prospective investors need to be able to access Attention should also be paid to women’s contracting patient capital, as financial returns to investment are opportunities and future access to employment; otherwise, unlikely to materialize in the first years. While some projects inequality may be exacerbated (Fitawek et al. 2020). may be commercially viable for multinational companies to Governments will also need to adapt social protection able to access finance, other investors may need assistance programs. The often-seasonal nature of large-scale produc- in identifying funding mechanisms and structuring potential tion and labor demand, and low wages paid to surplus labor, deals. Financial institutions, development partners, NGOs, and may not facilitate savings and sufficient investments in other research organizations can play important roles in this pro- economic activities to significantly improve welfare and food cess. Building relationships, sharing market intelligence, and security in some households in local communities (Fitawek facilitating investment (concessional and blended finance) can and Hendriks 2021). Proactive government policies can offset all be catalytic to large-scale investment in agriculture. DRIVERS AND CONSTRAINTS TO RURAL ECONOMIC DEVELOPMENT The policy environment is the binding constraint to the realization of the agricultural growth and rural transformation vision laid out in the section above. While Malawi’s agriculture sector needs deep investments to boost resilience and productivity, a condu- cive policy framework is central to the realization of the commercialization potential of Malawian farmers — and ultimately for sustained growth. Existing constraints also pertain to the legacy of past policy interventions that reduce incentives toward greater commer- cialization and continue to impact how Malawi’s key agriculture sector institutions func- tion despite numerous attempts at reform. Central to this is the dominance of fertilizer subsidy schemes in policymaking (see Box 2.2). Given Malawi’s fiscal pressures, necessary policy adjustments cannot incur additional costs. Repurposing current policies therefore presents an opportunity with marginal finan- cial consequences. In particular, there is a need to rethink subsidy programs, for these to incentivize farmers to adopt good practices (e.g., climate-smart agricultural practices and those that can improve soil health). Such steps could further unlock a range of financing options that government support programs could leverage, such as those related to har- nessing carbon markets (BioCarbon Fund 2022). Key constraints to creating rural transformation through market integration and in- creased commercialization pertain largely to market access. These include the high transaction costs that farmers face (particularly for transportation) and the high risk that traders may not be around when the produce is ready to be sold. On the other hand, trad- ers cannot be sure whether there will be enough suppliers in a given market to justify the high costs of traveling to farms. Potential traders can also be deterred by government in- tervention, which prioritizes controlling the actions of existing traders often without ac- knowledging the efficiency that their profit orientation brings. As a result, few farmers can profit from seasonally high demand for their produce, and trade is less effective in reduc- ing price differentials both within the country and over time. Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 72 Box 2.2  Reforming the Affordable Inputs Program (AIP) can unlock significant resources for more productive uses Malawi’s agriculture sector has been shaped by policies nutrition and soil health outcomes. Furthermore, it crowds that have often failed to incentivize employment crea- out productive investments and consumes a significant tion and greater commercialization and instead perpet- share of available foreign exchange resources. uated the country’s continued slow pace of economic Recognizing this, the Government of Malawi has begun transformation. The Affordable Inputs Programme, the cur- implementing reforms to the AIP. These include: (i) reduc- rent version of Malawi’s input subsidy, is a classic example of ing the overall budget and the number of beneficiaries; and how misguided policy programs can cause more harm than (ii) improving targeting by focusing on productive farmers, good. The AIP has consumed around 40 percent of scarce thus link the poorest segment (with limited land and labor) to agriculture budget resources on average in recent years. scaled up social protection programs and commercial ori- Yet it has done little to stimulate the agricultural transforma- ented one to other programs. It will be important to reduce tion that Malawi needs to generate higher economic growth the number of beneficiaries by focusing on farmers and and create more jobs, with AIP expenditure only weakly cor- regions that have the most potential in terms of productiv- related to total maize production (Figure B.2.2.1). In fact, if ity gains, while supporting those that fall short through social anything, it has contributed to the status quo of the current protection programs. Further efforts to promote private sec- low-return maize-based farming systems that have trapped tor participation in fertilizer procurement and distribution many rural households in poverty and contributed to poor would also likely improve the implementation of the program. Figure B.2.2. 1  Expenditure on fertilizer subsidies has had only a weak relationship with maize production Subsidy in US$ million, maize in million metric tons (MT) 300 5 250 4 200 3 150 2 100 1 50 0 0 8 1 0 98 9 00 01 02 2 03 04 05 5 06 07 08 09 10 11 12 13 14 15 16 17 18 19 23 99 0 3 4 6 7 8 9 20 21 22 00 00 00 00 99 00 00 00 199 00 00 01 00 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 19 9 20 20 20 20 20 20 20 20 20 2 2 1 2 1 2 2 2 2 2 2 2 2 Total subsidy Annual maize requirement (right scale) Maize harvest (right scale) Source: IFPRI 2022. The necessary policy and institutional conditions to support market-based competition in the agriculture sector in Malawi are not in place. Parastatals such as the Agricultural Development and Marketing Corporation (ADMARC) have been characterized by poor gov- ernance, financial mismanagement, and distortion of markets. Furthermore, the private sector in Malawi has increasingly been disincentivized from engaging in (both local and ex- port) agricultural input and output markets, including through government price interven- tion policies and trade restrictions in key commodities such as maize. Additionally, rather than smoothing prices, control measures have contributed to price volatility in Malawian markets being among the highest in the region (Benson 2021). Incentivizing select crops has led to low crop diversification, exposing smallholders to significant market risks, along with reduced resilience and income prospects (Ada Ignaciuk, Maggio, and Sitko 2018). Malawian farmers who practice crop diversification Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 73 are more likely to have a diverse diet, along with a more stable food supplies and income (Mango et al. 2018). In Malawi, aside from maize, entire communities continue to depend on tobacco earnings, and this dependence exposes them to large risks related to price swings. The ever-decreasing size of land and the frequency of land fragmentation are also instilling a serious bottleneck to promote any sort of commercialization. Land laws and policy, characterized by tenure insecurity and usufruct claims, incentivizes increased fragmentation. Rural development policy that historically focused on reducing rural to urban migra- tion hindered the switch to market-based off-farm livelihoods at scale, which has left Malawians working in less-productive agricultural jobs, with adverse effects on pov- erty levels (World Bank 2016, World Bank 2022d). The relatively slow urbanization pro- cess and slow structural transformation in Malawi compared with other African countries has been accompanied by sluggish growth of jobs in the manufacturing and service sec- tors (see Chapter 1). Malawi has high and urgent investment needs for resilience and support for vulnerable households coping with climate change impacts. The recent “Malawi Country Climate and Development Report” (World Bank 2022a) shows that climate change induced reduc- tions in the value of crops is as much as 25 percent without adequate adaptation measures. Changes in the availability of water for rain-fed cropping is the main factor. Climate change will invariably make it harder for the country to transition from low-productivity, subsist- ence agriculture to a more productive and commercially oriented sector. To foster agricultural growth, buyers and sellers alike must be able to rely on the mar- ket to support their livelihoods. Progress on agricultural commercialization and growth requires the integration of household risks and vulnerability issues — including break- ing the cycle of household food insecurity. This requires holistic solutions to make mar- kets more reliable, efficient, and equitable for buyers and sellers alike. Low-productivity subsistence farming will continue to be dominant in smallholder farming systems across Malawi if farming households perceive that they cannot rely on the market to supply ad- equate food for their families. There are several potential drivers of change that may foster the emergence of commer- cially oriented farmers, particularly those that may help promote more efficient and equitable markets. Increasing market participation is an important first step in deter- mining the degree of smallholder commercialization and, in this regard, Malawi’s grow- ing contingent of commercializing farmers, though small, is a key driver of change. Further supporting the engagement of farming households in market-oriented agriculture is crit- ical, and while historically market liberalization policy agendas aimed at stimulating and enhancing agricultural commercialization have been widely promoted in the region, they have not necessarily served as drivers of change in Malawi. To date, many smallholder pro- ducers are unable to benefit from commercialization opportunities presented by liberal- ized markets (Wollverton and Neven 2014). Engendering a more open market therefore needs to be complemented by other policies that enable the engagement of the most vul- nerable groups, such as strategic support programs and social protection measures for re- source-poor farming households. A more vibrant rural economy will be of little help for those who do not have the capacity to participate in it. Recent evidence suggests that the agrifood system in Malawi of late is largely being driven by the domestic market. Domestic-market-oriented value chains, import-substi- tutable and less-traded value chains together contributed to 79 percent of growth in the Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 74 agriculture sector from 2009 to 2019. Less-traded value chains dominate agrifood sys- tems with the largest initial size and high growth rate, and exportable value chains have had the lowest growth rate (2.4 percent). Domestic consumption and dietary change are therefore crucial drivers of this transformation. In turn, promoting specific markets for subsectors or commodities such as horticulture, cattle and milk and fishery value chains, in addition to maize, can help achieve broad and more inclusive development outcomes.23 In tandem, urbanization anchored in the modernization of locally relevant value chains should be considered as a pathway for inclusive development of both urban and rural ar- eas, as it can serve to simultaneously raise farm incomes, create off-farm income-earning opportunities, and create specialized urban hubs that can boost economic growth (Benson and De Weerdt 2023). Just as critical is capitalizing on Malawi’s core comparative advantage: its large, youth- ful, and capable population. The relatively high level of entrepreneurship in the context of limited wage employment options and seasonal agricultural production can be an im- portant resource to draw upon as the Malawian economy continues to develop. Placing Malawi’s young, entrepreneurial farmers at the center of policies and strategic programs by prioritizing investments in labor-complementing technologies is key. Related to this is capitalizing on the use of digital technologies among youth, which can serve as a key driv- er for structural transformation, with great potential to address challenges pertaining to accessing inputs and technology, financial services, and markets for farmers as they tran- sit to commercial value chains. Furthermore, in contrast to perceptions, which depict ru- ral households as a relatively undifferentiated mass, Malawian farming households are highly heterogenous. Understanding the variation among smallholder farmers — a subset that is uniquely positioned within rural communities to serve as an engine of local eco- nomic growth — can help better target strategies (Benson 2021). This would also help de- sign support programs that can capitalize on the strengths of such an evolving workforce to sustainably improve the welfare of rural communities and promote longer-term rural economic development. POLICY REFORMS TO ADVANCE AGRICULTURAL COMMERCIALIZATION AND SUPPORT RURAL LABOR MARKETS There are narrow but viable pathways for sustained growth and prosperity, which are best capitalized upon through a comprehensive agenda that focuses on the effective coordination, sequencing, and targeting of policies and investments. However, Malawi’s current policy environment paired with insufficient implementation capacity and a gen- eral lack of transparency and accountability in its governance are key challenges to real- izing the vision for agricultural growth and rural economic transformation laid out in this chapter. Based on the analysis in the chapter, several considerations stand out as critical for the Government of Malawi to help guide prioritization to foster and sustain a vibrant and more commercially oriented agriculture sector that can serve as a source of growth and job creation in Malawi. These opportunities for agricultural growth are organized around three pillars. 23. This is evidenced by comparing sources of future growth using an IFPRI-RIAPA model. Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 75 Pillar 1: Stimulate private sector engagement in the agri-food space by removing barriers and drawing in private investment and financing to the sector. In the longer term, productive and stable agri-food markets are most likely to be achieved through solutions that include private sector engagement to promote higher productivity and production of commer- cially oriented farmers, coupled with increased purchasing power of consumers through more remunerative off-farm employment. This includes enhanced private sector engage- ment in agricultural research and the provision of agricultural advisory services. Priorities in this regard include steps to propel needed adaptations in the structure of the economy, including measures to: • Foster private sector-led markets and market institutions, particularly to expand on the recent achievements of agribusiness investments in agricultural commercial- ization and improving the relative cost-competitiveness of smallholder production systems in Malawi. This would require reducing the uncertainty of the government policy-making process, including Government’s commitment to the full implementa- tion of the Control of Goods Act (COGA), along with a careful, inclusive review and re- vision of the draft Crops Bill. Discretionary interventions, such as through attempts at price controls or selective enforcement of existing regulation should be minimized to facilitate a crowding in of market participants to foster competition. • Improve access to agricultural inputs through private sector mechanisms. An ex- panded network of agricultural input suppliers ensures the availability of the inputs necessary to raise the crop productivity of farming households. For example, private seed multiplication and rapid variety approval could help in a context of limited pub- lic funds and the weak ability to administer efficient outreach and extension services. Pillar 2: Repurpose existing policies and support programs such as input subsidies — with- out major fiscal repercussions — to foster efficiency and equity in the rural agricultural market and better serve the expansion of rural employment and growth. This will entail fostering a conducive policy framework through coordinated reforms to existing sectoral, multi-sectoral, and macroeconomic policies, given that broader investment climate issues are relevant in the agri-food sector as well. Opportunities exist for sectoral policy inter- ventions for agri-food systems that come at no cost or a relatively low cost and have poten- tially significant impacts and high returns. This includes measures to: • Target agricultural investments, policies, and programs to the subset of farming households and neighboring agricultural enterprises that can generate significant- ly more production through higher productivity, even if this will be politically chal- lenging to implement. • Establish social safety nets and cash transfers, including for enhancing food secu- rity, to allow less productive households that do not generate sufficient returns from agricultural growth-focused investments and programs — generally those with small- er landholdings — to ensure that they can access what they need for a dignified life, and enabling them to also add resources to the local economy. • Establish well-designed climate-smart agricultural support programs that not only offer social protection and a way for vulnerable households to make a living when oppor- tunities for ganyu are scarce, but also strengthen the natural resource base and enhance resilience against the increasing threats from climate change. Climate action is a criti- cal part of the solution to put Malawi on a path toward sustainable and inclusive growth. Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 76 The expansion of Malawi’s Social Cash Transfer Program (SCTP) may offer a potential starting point, given the Government’s demonstrated capacity to implement the program. Pillar 3: Foster commercially oriented agricultural production and marketing systems on small, medium, as well as large farms that can expand opportunities for and participation of farmers in productive agricultural value chains and lead to broader rural economic trans- formation in Malawi, regardless of the specific commercialization pathway. Specific rec- ommendations under this pillar include the following: • Support and strengthen farmer organizations, which are critical for the emergence of productive partnership arrangements, as it makes smallholders more attractive business partners for agri-businesses and off-takers. • Fast-track farmer-relevant macroeconomic adjustments. Of the macroeconomic adjustments recommended in Chapter 1, some have special relevance for the ability of current smallholding households to move to a market-based livelihood. The flexi- bility of the exchange rate is necessary for price signals from international markets to reach farmers so that they can produce the most profitable crops. Monetary and fis- cal adjustments are needed to reduce the price risks farmers face when switching to more market-based livelihoods. Currency that maintains its value and the provision of essential public infrastructure and services that are relevant to commercial farm- ers are needed for farmers to rely on their sales proceeds. • Promote regional market integration by alleviating barriers to trade as outlined in Chapter 4, paired with more efficient logistics and trade corridors to bring produce to regional and global markets. This would enable commercialization of agriculture in both directions: farmers can be reached through the local network and their pro- duce can access expanded markets through regional corridors, incentivized through regional market integration measures. • Revitalize commercial farming enterprises or estates that are operating under long-term leasehold land tenure arrangements. Policies are needed to incentivize estate owners to either use their land or to release it to others who can better do so. Furthermore, better and up-to-date knowledge of the characteristics, productivity, and financial performance of estates is needed to ensure that the agricultural resources of the country controlled by estate holders are being used effectively. • Increase farm-level productivity by promoting effective soil, irrigation and wa- ter management, along with the adoption of innovative farming technologies that also improve resilience against climate-related shocks, and related risk manage- ment practices. • Invest in critical physical infrastructure, including storage facilities and cold chains, transport and road infrastructure, as well as energy. Key recommendations are summarized in Table 2.1. Chapter 2  Commercializing Agriculture and Improving the Prospects for Rural Employment 77 Table 2.1  Top five agricultural policy priorities Short-Term Actions Medium-Term Implementation Policy Issue (next 3 – 6 months) (before the end of 2025) 1. Fostering markets and appropriate Consistently implement COGA, promote Minimize discretionary interventions in market institutions public-private partnerships for com- agricultural markets and ensure pre- mercialization, and increase transpar- dictability for domestic and foreign ency for government interventions in the investors. market. 2. Reforming agricultural expenditures Proceed with AIP 2.0 reform process to Repurpose agricultural expenditures to foster efficiency and equity in the reduce the fiscal burden, maximize fer- by reducing subsidies and investing in rural agricultural market tilizer use efficiency through better tar- growth-enhancing areas, including cli- geting by using a finalized beneficiary mate adaptation. registry, and improve the timeliness of input procurement and distribution. 3. Strengthening farmer organizations Proceed with review of Cooperatives Act Review regulation and information sys- and promotion of electronic coopera- tems to support the crowding in of tive registry. domestic and international traders to purchase farmer cooperative out- puts though improved information systems on cooperatives and fewer restrictions on commercial practices of cooperatives. 4. Improving access to agricul- Finalize fertilizer and seed regulations to Implement new fertilizer and seed laws, tural inputs through private sector improve productivity and catalyze pri- that will: (i) improve the steady and reli- mechanisms vate sector and identify innovation in able distribution and accessibility of fer- delivery to promote input use efficiency tilizers and seeds through engagement and private sector participation. with the private sector, (ii) encourage market-oriented approaches that can ensure better prices, quality, and availa- bility of inputs in the market, and (iii) facil- itate collaboration with the private sector in research and development to develop and introduce climate-resilient inputs and practices. 5. Facilitate the move to off-farm liveli- Continue the rollout and scaling up of Focus land reforms on increasing land hood strategies cash transfer and climate-smart pub- tenure security and enabling the renting lic works projects to address current of land to the most productive farmers. livelihoods needs while encourag- ing the development of a local off-farm economy. 78 Unlocking CHAPTER 3 Core Constraints to Private Sector Productivity Growth KEY FINDINGS 1 Market distortions and a lack of private sector competitiveness result in the absence of a dynamic cycle of where unproductive firms are replaced by more efficient new firms. Low overall productivity levels and large gaps between the most and least efficient firms suggest that many firms are not using their resources efficiently to compete and grow. Significant bottlenecks, including in accessing finance, information, and international markets, are compounded by problems of electricity access, corruption, and political instability. 2 The COVID-19 pandemic and the series of shocks since 2020 have had a devastating impact on the private sector. Eighty-five percent of firms lost sales, the fifth-highest inci- dence among 48 countries in the World Bank Business Pulse Survey. However, it was the subsequent shocks since 2020 that have been particularly damaging, as sales have con- tinued to decline through 2022. Two-thirds of businesses surveyed in late 2022 believe that increased non-labor input costs negatively affected their profits, while foreign exchange unavailability was seen as a threat to profitability by more than three-quarters of firms. 3 With limited access to finance, firms are unable to weather shocks and grow. This is reported as the leading constraint faced by firms, with high interest rates and repayment risks cited as the main concerns. Due to a low-risk appetite, financial institutions pro- vide limited credit to the private sector and charge high rates, in excess of 30 percent, to borrowers. Instead, credit to government has soared, resulting in a highly profitable and well-capitalized financial sector. 4 Increasing firms’ capabilities is key to productivity growth, but an implementation gap constrains efficient management. While Malawian enterprises are aware of and often use good basic managerial practices, this frequently does not translate into how businesses are in fact operated. 5 Significant reforms are needed for Malawi’s private sector to drive growth. Management training and support services are essential, including strengthening digital access. To improve access to finance, there is an urgent need for the public sector to reduce borrowing demands. Banks will need to reduce operating costs, as well as improve iden- tification systems and develop a credible credit referencing system. Finally, it is critical to improve government capacity to strengthen competition enforcement and advocacy. Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 79 IMPROVING PRIVATE SECTOR PERFORMANCE IS CENTRAL TO ADDRESSING MALAWI’S JOBS CHALLENGE The ongoing crisis has further exacerbated the difficulties faced by firms, and height- ened the need to focus on private sector-led growth. The 2019 Malawi FinScope MSME Survey estimated that there were almost 1.6 million enterprises in the country, employing about 1.8 million people, with nine out of ten Malawian firms either small or micro-en- terprises and operating in the informal sector (FinMark Trust, Imani Development, and AESA 2019). The majority operate in the wholesale and retail trade, as well as various ag- riculture-related services. Productivity is low for most firms in Malawi, with the majority producing little surplus to invest and grow. The combined impact of the supply- and de- mand-side shock following the COVID-19 pandemic, followed by electricity, fuel and for- eign exchange shortages from 2022 onward, have had a particularly detrimental impact on the private sector. Most firms have few buffers and limited access to finance to bridge successive strains. The private sector is central to addressing Malawi’s urgent jobs challenge. With the pop- ulation increasing at about 2.5 percent per year, the economy is not growing fast enough to provide decent jobs for over 400,000 young Malawians entering the labor market annually (International Finance Corporation 2021). Only one in ten Malawians over the age of 15 has a wage- or salary-paying job. Women, especially, struggle to find decent jobs, in part due to their relative under-enrolment in secondary and tertiary education, with most ending up at less productive, informal MSMEs. Malawian firms face considerable constraints to growth. Macro-fiscal fundamentals, ac- cess to reliable power, and access to markets, have been identified as critical bottlenecks for Malawi’s private sector, which in turn would drive structural transformation (Internation- al Finance Corporation 2021). Malawian businesses report many issues typical for low-in- come countries as their top concerns, including access to finance. However, problems of electricity access, corruption, and political instability stand out in their reported severity, even among peers. With such impediments to growth, most businesses remain either micro or small enterprises. To help accelerate growth and support the country’s structural transformation, a bet- ter enabling environment for firms’ growth and entrepreneurship is needed. To this end, this chapter addresses four questions: 1. What are the salient characteristics of Malawi’s private sector? 2. How have the series of recent shocks beginning with the COVID-19 pandemic impact- ed firms? 3. What is the role of two key determinants of firms’ performance, the access to finance and competition dynamics (Section 3.6), in constraining the productivity growth of firms? 4. How can these constraints be addressed to strengthen private sector-led growth? This analysis draws on the analysis of three main sources of survey data (Aterido 2023; FinMark Trust 2023). These are the World Bank Business Pulse Surveys (BPS 2020 and 2022), Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 80 the “Funneling Survey” (FS), a pilot survey implemented in 2022 to test various methods of measuring firms’ capabilities, such as knowledge of technical skills, business practices, and entrepreneurs’ personal and psychological traits, and the FinScope survey of 2019 with a follow-up MSME Tracker Survey in 2022 (see Annex 3.1 for an overview of data sources). This is complemented by comparisons with the 2014 World Bank Enterprise Survey. All four of these datasets have slightly different samples, and the BPS, FS and FinScope surveys are all not fully representative of Malawians firms, though the FinScope survey is representa- tive of MSMEs. They nonetheless provide both novel and recent insights into key issues re- lated to firms’ performance. UNPACKING THE PERFORMANCE OF MALAWI’S FIRMS Most Malawian entrepreneurs are young and resil- Figure 3.1  Malawian entrepreneurs tend to be young ient. About two in five business owners are classified as Age categories of business owner, percent youths, being aged 35 years or younger (FinMark Trust 2023, Figure 3.1). The vast majority of entrepreneurs op- Tracker 2022 erate a micro or small business that they have started as one of the scarce opportunities available to improve FinScope 2019 their livelihood (Figure 3.2). Especially women are enter- 0 20 40 60 80 100 ing entrepreneurship, with the primary aim of providing for their family and for a lack of better opportunities. The 18–24 years 25–34 years 35–49 years ≥ 50 years inheritance of businesses plays virtually no role in moti- vating entrepreneurship. Source: FinScpoe 2019 and MSME Tracker Survey 2022. Figure 3.2  Becoming an entrepreneur is a necessity rather than a choice Main motivation to start a business by gender, percent To make more money/provide for my family Saw an opportunity Could not find a job/unemployed To be my own boss/have my own business Wanted to/was interested in it/use my skills Interested in particular product or service Inherited the business Poverty Lost my job Other Took over from previous owner/manager 0 5 10 15 20 25 30 35 40 45 Female Male Source: MSME Tracker Survey 2022. Malawi’s firms are, for the most part, relatively unproductive. Growth occurs when pro- ductive firms access adequate inputs, labor, and capital. If productive firms thrive, wages rise, and consumption increases, creating more demand, and in turn generating a virtuous Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 81 cycle. To calculate firms’ performance, a proxy of labor productivity, sales per worker, is used.24 Annual sales per worker among surveyed firms ranged from US$4,600 (BPS) to US$12,200 (FS). Even among the larger enterprises in the 2014 Enterprise Survey, firms earned only US$20,200 per worker. These levels are insufficient to ensure that quality in- puts can be purchased, profits are generated, and workers are compensated adequately. Small Malawian firms concentrate on services and larger ones generally are in retail, while manufacturing firms are a small minority. At least 74 percent of firms captured by the surveys of smaller firms specialize in retail or services, with the majority operat- ing small-scale service businesses. Even among the larger firms in the 2014 Enterprise Survey, only 29 percent man- Figure 3.3  The gap between the most and least ufacture products. productive and profitable Malawian firms is significant Measures of labor productivity in US$ (’000) Market distortions and a lack of firms’ competitive- 12 ness result in the absence of a robust cycle of creative destruction. Large productivity gaps between produc- 10 tive and unproductive firms suggest that firms are not 8 using their resources efficiently to compete and grow. Although productivity is low for most firms in Malawi, a 6 firm in the 90th percentile is 37 times more productive, in 4 terms of sales per worker, than a firm in the 10th percen- tile (Figure 3.3). The median of firms’ sales per worker in 2 the BPS is just three times the annual minimum wage of 0 MWK 600,000 and its profit per worker is double the min- 10pc 25pc 50pc 75pc 90pc imum wage. In contrast, the 90th percentile firms’ sales Sales per worker Profit per worker and profit per worker are 22 and 14 times, respectively, the annual minimum wage. High levels of dispersion are Source: Business Pulse Survey, Funneling Survey. also recorded for profits per worker. This can be a sign of misallocation within an economy, suggesting that re- Figure 3.4  The productivity gap is greatest for retail and sources do not flow to the enterprises that can make the services firms most of them. Moreover, the gap between the most pro- Gap between firms at the 80th and 20th percentile according to labor productivity measures, percent ductive and least productive firms widens when firms are older. Finally, young firms on average are less pro- 20 ductive than older firms, suggesting that new entrants are not spurred by competition and do not replace stag- 15 nant, unproductive firms. 10 The dispersion of productivity can also be seen with- in industries, and especially in services. A manufactur- 5 ing firm in the 80th percentile is between seven (BPS) and eight (FS) times more productive than another in the 20th 0 percentile (Figure 3.4). The difference is between 13 (BPS) Manufacturing Wholesale & Retail Other services and 17 times (FS) for wholesale and retail firms, and 9 (BPS) Sales per worker Profit per worker and 20 times (FS) in services. High dispersion in a sector can signal the existence of frictions that prevent the efficient Source: Business Pulse Survey, Funneling Survey. 24.  Labor productivity is typically defined as the value added per unit of labor (worker or hours worked). Using revenues, instead of value added, does not capture efficiency in the use of intermediary inputs. Certain industries, especially services, do not use as many intermediate inputs and may appear less productive. Furthermore, labor productivity does not capture the role of capital. Capital-intensive industries employ less workers and exude higher labor productivity. However, past surveys have shown that the correlation between sales per worker and value added per worker has historically been very high in Malawi. Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 82 allocation of resources between firms in the same industry. For comparison, in the United States, firms in the 90th percentile are only twice as productive as firms in the 10th percen- tile (Hsieh and Klenow 2009).25 A process of creative destruction does not seem to be particularly strong in Malawi, as low productivity firms remain, and young firms tend to be significantly less produc- tive than established ones. The productivity dispersion widens along the age spectrum: the productivity of the 80th percentile of firms is higher for older firms relative to younger firms in the 80th percentile. In contrast, the productivity of the bottom 20th percentile is flat regardless the age. In the case of sales per worker, the 20 percent most productive older firms have 3.3 times higher sales per worker than the 20 percent most productive young firms. The bottom 20 percent of old firms are only 0.3 times more productive that the bot- tom 20 percent of young firms (Figure 3.5). Profits per worker follow the same pattern and have a similar order of magnitude. In fact, half of firms improve little over time. The results of productivity linear regression reporting margins on age shows that younger firms are less productive than older firms by a significant gap (Figure 3.6). This finding, together with the evidence of non-productive firms remaining in the economy, indicates that the dynamic of entry and exit is not leading to significant aggregate productivity gains. Figure 3.5  The gap between the most and least Figure 3.6  Younger firms are significantly less productive productive firms increases with age than older firms Sales per worker distribution by age, labor productivity in US$ (‘000) Prediction of sales per worker by firms’ age, log of sales per workers in 2019 in US$ (‘000) 8 0.8 6 0.6 4 0.4 2 0 0.2 1 2 3 4 5 > 5 to 10 > 10 Years in operations 0 Median 20th percentile 80th percentile Young Mature Old Source: Business Pulse Survey. Source: Business Pulse Survey. Retail enterprises, as well as medium and large firms and exporters, are most productive while manufacturers, micro-enterprises and young firms are least productive (Figure 3.7). When controlling for firm size, the manufacturing sector is underperforming, both as measured by sales per worker, as in the BPS, or by profit per worker in the FS. Retail firms are more productive. In both datasets, the magnitude of the coefficient is large, and results are significant at the 1 percent level. A firm in retail is likely to be 8.1 (BPS) or 7.6 (FS) per- cent more productive than a firm in manufacturing. Moreover, male-led firms tend to be more productive (see Box 3.1). 25.  However, other factors can contribute to this dispersion as well. Bloom, Sadun, and Van Reenen (2012) show how management practices contribute to larger productivity differences, and Foster, Haltiwanger, and Syverson (2008), just to cite a few, show similar effects due to technology adoption.  Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 83 Figure 3.7  Medium and large firms and exporters are most productive Predictors of productivity Manufacturing Retail Services Micro Small Medium/Large Lilongwe Blantyre Other Young Mature Old Non−exporter Exporter Male−led Female−led -0.4 -0.2 0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 Source: Business Pulse Survey. Note: Margins reported. All coefficients are sianificant at 1 or 5% level excent for location. Box 3.1  Reducing gender gaps between entrepreneurs has the potential to boost firms’ productivity Female entrepreneurs’ sales and profits in Malawi are narrows gender gaps, differences in the labor that women much lower than those of their male peers. Recent anal- have access to more than outweighs this. Women tend to ysis of household data shows that women constitute about put less time into their enterprises themselves, often being half of entrepreneurs in Malawi but their sales and profits disproportionally burdened with domestic responsibilities. are lower by 46 and 31 percent, respectively (World Bank While their own time is just as productive as that of their 2022c). This mirrors a pattern found across the continent male peers, the workers that women tend to be able to hire (World Bank 2019b). generate lower sales. Men tend to hire a larger number of male workers from outside their own household and pay Less than one-third of this gap is due to differences in them higher wages, widening the gender gap in sales. Men endowments. Malawian women are constrained in the also tend to be more mobile with their business, having to be resources that they can bring into their businesses. For less concerned about their safety and about cultural norms, example, in agriculture men tend to be more productive further exacerbating disparities. farmers, meaning they can invest more savings from their agricultural production in their businesses, while women Malawian women have lower levels of financial inclusion are more reliant on smaller gifts for start-up capital. Women than men. Women are less likely to own bank accounts, also tend to be less endowed with skills and experience, evi- use a mobile phone for financial transactions less often, and denced by lower education and younger age, on average. save and borrow less often from a financial institution. This also provides them with less scope to invest and grow their Two-thirds of the gender gap in sales is driven by con- businesses. The assets that women do possess are often straints on how women can conduct their businesses. less secure, especially land on which tenure is uncertain, Women spend more on raw materials and earn higher with women less likely to have their names on land titles and returns on raw material expenditures than male entre- less decision-making control over their land. preneurs do. While more productive use of raw materials There are several potential reasons why micro-enterprises lag behind. The small size of the vast majority of firms could be explained by entrepreneurs’ lack of desire to expand, or by their insufficient capability to do so. But external factors, such as market failures, to which small firms are likely to be more vulnerable, matter as well, especially in Malawi. Market fric- tions impede appropriate access to the resources needed for production and micro-enterprises Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 84 are less capable of overcoming obstacles to access them. If the allocation of the factors of production is costly, the flow of resources to more productive firms is inefficient. As a result, productive firms fail to thrive and pressure to compete weakens. When competition is weak, less productive micro-enterprises are not incentivized to either grow or exit. The picture emerging of Malawian firms as primarily small, unproductive, and ser- vice-oriented corroborates that many dynamics associated with structural transfor- mation have not yet started. In addition to people moving out of agriculture, structural transformation and growth take-off are characterized by a move into larger and impersonal enterprises oriented toward international markets (see Chapter 1). However, the average Malawian enterprise tends to still be operated by one person with at most a few employ- ees, providing a locally consumed service. A MANAGEMENT IMPLEMENTATION GAP HOLDS MALAWIAN FIRMS BACK Better management improves firms’ performance. Controlling for sector size, location, age, exporter, and gender, firms with better management practices are likely to have higher sales per worker. An increase by one standard deviation in a firm’s management score (an indicator that combines measures of keeping business records, monitoring business per- formance, and setting business targets) is associated with nearly 30 percent higher sales per worker. It is notable that, almost across the board, Malawian enterprises use good basic managerial practices. Regardless of size or sector, at least 79 percent of firms have per- formance indicators, short- or long-term goals and keep records of finances. It has been shown that such basic managerial practices can enhance business performance, putting the locus of control over the performance of businesses to managers (Mano et al. 2012). However, awareness of these sound managerial practices often does not translate into processes on the ground (Table 3.1). While managers record their finances, this often hap- pens in relatively rudimentary ways on paper. This limits their ability to analyze the data and translate financial insights into improved business processes. At the same time, while managers tend to formulate performance indicators, the minority uses them strategically to make human resource decisions. While enterprises tend to have defined goals, the process to achieve them can also face challenges. The processes of solving problems, learning, and im- proving after a problem emerged is only a standard procedure for one in five Malawian firms. Table 3.1  Malawian firms use good basic managerial practices but do not widely implement many professional solutions Share of companies reporting the practice by size and sector, percent All Micro Non-Micro Services Manufacturing Has performance indicators 81 79 86 84 79 Has short- or long-term goals 82 80 89 84 81 Keeps records of finances 88 81 99 88 88 Fixes a production problem and improves 20 12 31 23 17 Promotes only on performance and ability 27 14 53 34 21 Manages finances by hand 59 85 25 49 69 Manages finances w/ standard computer 39 15 70 47 30 Manages finances w/ platform or sp. software 3 1 5 4 1 Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 85 All Micro Non-Micro Services Manufacturing Management score 38 31 54 42 35 Uses internet, social media platforms 40 40 70 50 40 Invests in digital technology 20 10 20 20 20 Adjusted digital technology 30 30 40 40 30 Updated digital functions 70 60 90 70 70 Share of sales using digital platforms 14 9 19 17 11 Most frequent payment method is digital 0 0 0 0 0 Most frequent sales method is digital 10 0 10 10 0 Digital score 20 20 20 20 20 Source: Business Pulse Survey, merged across waves. Due to limited access to digital services, Malawian businesses largely stay offline. Even during the pandemic, only 11.7 percent of sales were made online. Only some firms adjusted their business models during the pandemic, with 18 percent investing in digital technolo- gies. Less than half of firms use the internet or social media at all, with online marketing (27 percent of firms), sales and payments (21 percent), and business administration (11 per- cent) the most popular technologies. A full 84 percent of businesses primarily receive pay- ments in cash, despite the general availability of digital technologies and an RBM order that all businesses must offer digital payment (Kondowe 2018). Moreover, the use of dig- ital technologies, such as digital payments or the use of digital communication and mar- keting techniques, was not associated with higher sales per worker. This is in contrast to the global picture where firms’ productivity and the adoption of digital technologies are closely correlated (Cirera et al. 2021). A SERIES OF SHOCKS SINCE 2020 EXACERBATED EXISTING STRUCTURAL WEAKNESSES AND HAS DEVASTATED MALAWI’S PRIVATE SECTOR In light of many of the structural challenges and constraints discussed above, Malawian firms were among the most severely impacted globally during the initial COVID-19 shock (Figure 3.8). Between 2019 and 2020, 84 percent of firms reported a decrease in sales. Among 48 countries captured by the Business Pulse Surveys, only four countries suffered more widespread sales losses. The compression in sales was also severe, with an average loss in sales of 44 percent. However, the stringency of COVID-19 controls is unlikely to be the only factor leading to this decline. Among 180 counties where the “Lockdown Stringency Index” measured the severity of control measures, Malawi ranked 120th at the end of 2020, before many measures were lifted throughout 2021 and 2022 (Hale et al. 2021). Sales de- creases were also most prevalent among manufacturing firms and the smallest enterpris- es, sectors where COVID-19 control measures are typically assumed to be least relevant and least strictly enforced. The depth of sales decreases was most severe in services and small enterprises, which is more in line with global patterns (Olczyk and Kuc-Czarnecka 2021). Sales for most firms continued to drop into late 2022. By the end of 2021, real per capita production globally had rebounded past the levels recorded before the pandemic. While employment levels lagged behind, firms’ sales even in countries that had significant macro- economic difficulties, such as Zambia, had surpassed pre-pandemic levels by the middle of Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 86 Figure 3.8  Malawian firms experienced some of the most widespread sales losses globally Share of firms reporting a decrease in sales and average sales decreases relative to one year earlier as of Q4 2020, percent 100 80 60 40 20 0 −20 −40 −60 −80 Pa zan e ne a M M kist ia Le sia Po enia Su blic b va nd rica ov ia oz ol an pu or Ph ong we Ghone pu ia ee a et a at an l m la ad ro s a o M b i h La nd Ro ypr ic L Br e ra ly Ta ürk ia er u ar an a ia M al Cr alta ne e ia Sl El Bul am ng in m us Po ma a rtu lia Ar ma a ut am ia p ia rd s M ton y ak alv ria o n In Ke al Ho Af ia Zi Ma na Gu ithu azi ba w n iy do ny M Mo ura Jo ine Gr ati Vi gu c Se iqu Es ar i e i ag cc Ge da Sl lays Re tv C bl ca Ita T rg g en So an So Z s ilip ol g h b Hu Ben Re ad Si T sc m la am do ov S ga a ra ni la n o Ni ec Cz Percent of firms with decreased sales Average sales decrease Source: Business Pulse Survey. the year (Hoy et al. 2022). However, this was not the case in Malawi. By late 2022, 68 percent of Malawian firms had still not recovered in terms of sales. Firms across sectors recorded large sales decreases, with the likelihood being the highest among manufacturing firms. The severe macroeconomic crisis lies at the heart of Malawian business challenges. Es- calating foreign exchange shortages and rising input costs put pressure on already strained enterprises. Two-thirds of businesses surveyed in 2022 believed that increased non-labor input costs negatively affected their profits, while foreign exchange unavailability was seen as a threat to profitability by more than three-quarters of firms. Three-quarters of firms also reported difficulties in accessing finance, which could be used to overcome such crises (World Bank 2022b). All Figure 3.9  Rather than rebounding, sales for most firms three are at least in part a result of macroeconomic poli- continued to decline into 2022 cy (see Chapter 1). Average change in sales relative to one year earlier in Q4 2020 and Q4 2022 by sector, percent While Malawian managers are generally optimistic, they Micro are losing hope of an imminent rebound. Asked for a base- line scenario, managers expected a 22 percent increase in Small sales over the next six months in November 2020. However, this was followed by widespread decreases in sales through Med/Large 2022 (Figure 3.9). This is reflected in the more recent ex- pectations that Malawian businesses have for future sales Manufacture growth, which declined to 7 percent in the October 2022 Retail BPS. Even in an optimistic scenario, many firms do not ex- pect to recover past their pre-COVID-19 sales levels within Sercives half a year anymore, with a reported expected sales growth of 36 percent. Such a decline in the outlook of businesses −50 −40 −30 −20 −10 0 is an adverse indication for Malawi’s economic future, as 2019 to 2020 2021 to 2022 managers who do not expect growth will be risk-averse and delay investment or hiring decisions. Source: Business Pulse Survey. Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 87 THE FINANCIAL SECTOR CURRENTLY DOES NOT SUFFICIENTLY SUPPORT PRIVATE SECTOR GROWTH With limited credit available, firms are unable to weather shocks and grow, and the diffi- culty of accessing finance at affordable rates is generally the most prominent constraint listed by firms across surveys. Access to capital is one of the channels that allows firms to in- vest, acquire better technology, and become more productive. On the one hand, firms lack ca- pacity: only 61 percent of firms in the BPS had a bank account, and 37 percent of these use the same account for business and personal transactions. At the height of the pandemic, in late 2020, 95 percent of firms complained about having difficulties in accessing financing with high inter- est rates and repayment risks the main concerns. With the cash available, 84 percent of firms could not cover costs for more than one month, with liquidity concerns greatest for small firms. Sixty-five percent had outstanding liabilities, and 40 percent of businesses were already in ar- rears or expected to be in the next 6 months. By 2022, financial conditions had improved slight- ly: 69 percent of firms still lacked financial access and fewer firms expected to fall in arrears. However, the percentage of firms with outstanding liabilities increased from 65 to 68 percent. This is in part because access to credit for the private sector is crowded out by high lev- els of government borrowing, reducing firms’ ability to cushion recent shocks. Only 10 percent of medium enterprises, 5 percent of small enterprises, and 3 percent of micro-en- terprises have credit from a commercial bank (FinMark Trust, Imani Development, and AESA 2019). Commercial banks’ financial intermediation is low, with a high degree of con- centration: an estimated 90 percent of loans are channeled to a handful of large firms (International Finance Corporation 2021). Due to a low-risk appetite, financial institu- tions provide limited supply of credit to the private sector and charge high rates: banks’ net interest margins averaged 11.5 percent over the past decade to private sector borrow- ers (Chilima, Banda, and Gondwe 2023). Overall, the financial sector has managed to remain stable and profitable throughout recent crises, performing better than its regional comparators (Figure 3.10). Overall, banks are also well capitalized, with Malawian banks having the highest bank-to-asset ratio among countries in the region (Chilima, Banda, and Gondwe 2023). However, this has been driven by high levels of lending to the Government, crowding out private sector credit (Figure 3.11). Increased credit demand from the Government because of sustained and growing government deficits has reduced the probability of firms being able to access credit at competitive rates. As Figure 3.10  Malawian banks have higher returns on Figure 3.11  Lending to government has increased assets (ROA) and equity (ROE) than those in neighboring dramatically in recent years, crowding out private countries (2011 – 21) sector credit ROA and ROE as a percent Credit in MWK billion 3.0 Malawi 2.5 South Africa 2.0 Zambia 1.5 1.0 Tanzania 0.5 Mozambique 0.0 15 16 17 18 19 20 21 22 23 0 5 10 15 20 25 30 20 20 20 20 20 20 20 20 20 ROA ROE Net Credit to Government Credit to Private Sector Source: Chilima and Gondwe (2023) based on World Bank and RBM data. Source: World Bank with data from RBM. Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 88 a result, commercial banks are discouraged from lending to the private sector due to their reli- able access to government paper. In addition, this discourages them from seeking new lending opportunities. Key factors constraining lending to smaller and informal firms include lack of collateral and proper credit referencing, ID card challenges and the informality of most firms. MORE NEEDS TO BE DONE TO EVEN THE PLAYING FIELD AND ADDRESS ANTI-COMPETITIVE BEHAVIOR Improving the competitive environment for firms can result in lower prices for consum- ers, higher quality goods and services, productivity growth and, in turn, GDP and wage growth. It can motivate within-firm growth by driving companies to expand their capabili- ties (Aghion and Howitt 1992; Bloom, Sadun, and Van Reenen 2012) and can drive between- firm growth as more productive firms leverage their competitive advantage to gain market share (Bartelsman and Dhrymes 1998; Olley and Pakes 1996). Finally, it can support market dynamism by strengthening entry and exit dynamics (Eslava et al. 2013; Hopenhayn 1992). Malawian firms face considerable barriers to entry and growth in part due to signif- icant distortions that constrain competition in many sectors. As discussed earlier, the expected cycle of creative destruction that helps drive productivity growth does not oper- ate effectively in Malawi. This is supported by some indicators of competition dynamics. According to Economist Intelligence Unit measures of the role of vested interests and cro- nyism in distorting decision-making, Malawi (along with Lao PDR, Nepal and Zimbabwe among its peers) has the worst possible score (Figure 3.12). However, in other areas its per- formance is in the middle range among comparators: for example, in terms of the extent of market dominance, Malawi’s score, while declining between 2012 – 13 and 2017 – 18, is similar to most of its peers (Figure 3.13). Figure 3.12  Vested interests and cronyism are seen as Figure 3.13  Malawi is similar to comparators in terms of central to policy the degree of market dominance Degree to which vested interests and cronyism distort decision-making, Extent of market dominance, 1 – 7 (best) 0 – 4 (worst) Ethiopia Ethiopia Lao PDR Lao PDR Madagascar Madagascar Malawi Malawi Nepal Nepal Rwanda Rwanda Tanzania Tanzania Uganda Uganda Zimbabwe Zimbabwe 0 1 2 3 4 5 0 1 2 3 4 5 2012–2013 2017–2018 Source: Economist Intelligence Unit. Source: World Economic Forum Global Competitiveness Index. While competition appears to be quite robust at the level of micro- and small enter- prise, many sectors have a high degree of market concentration, creating greater risk of collusion. For example, in the financial sector, just three pension companies control 62.9 percent of the total assets of the industry, and two insurers account for 97.6 percent Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 89 of gross premiums written for life insurance, while the two largest banks held 46.2 per- cent of the total assets and 50.1 percent of the loans in 2021 (Chilima, Banda, and Gondwe 2023). Just two mobile network operators dominate the market, creating significant risks for anti-competitive behavior. Beyond market structure, government interventions impact competition in numer- ous sectors (International Finance Corporation 2021). Interventions in the agro-process- ing, fertilizer, road construction and freight transport industries protect incumbents and discourage involvement by investors, especially from abroad. Furthermore, state-owned enterprises (SOEs) often compete with the private sector while having significant regula- tory, financial, or other advantages over competitors. The existing legal and regulatory apparatus gives the Competition and Fair Trading Commission (CFTC) only limited capabilities to develop and implement pro-competi- tive regulatory reforms and address anti-competitive behavior. Other sector regulators, such as the Malawi Energy Regulatory Authority or Malawi Communications Regulation Authority, frequently have concurrent jurisdiction over competition and consumer protec- tion matters. To address this, the CFTC has entered into Memorandum of Understandings with various sector regulators. However, not all cases that should be handled jointly are so. Lack of human and financial resources can additionally hold the CFTC back from com- prehensively fulfilling its mandate. There is a lack of a unified vision for the role of gov- ernment-owned commercial activities in Malawi’s competition framework and no clear national agenda to use competition to address the market power of large and often politi- cally connected firms. This comes in addition to challenges with the Competition and Fair Trading Act (CFTA). When fines are imposed these tend to be so low as to be ineffective in deterring anti-competitive behavior (MK500,000 or financial gain if greater). A bill to amend the CFTA has been drafted. Political economy and competition dynamics, including how they have thwarted private sector growth, are discussed in more detail in Chapter 5. POLICY REFORMS TO INCREASE FIRMS’ PRODUCTIVITY AND STRENGTHEN CAPABILITIES To achieve its economic growth ambitions outlined in the Malawi 2063, Malawi must energize its private sector. Chapter 1 illustrated that Malawi needs strong private sector growth to unlock its economic growth ambitions under the Malawi 2063. Small, unproduc- tive, service-, and domestically oriented firms are unlikely to be the driver of such rapid growth, thus requiring a transformation of how Malawi’s private sector runs. While the potential for more private sector dynamism exists, the Malawian authorities need to create a conducive environment for the private sector to achieve growth (Table 3.2). Malawian entrepreneurs require access to the tools they need to enable them to suc- ceed. These tools include digital technologies and production inputs, whether they are imports such as fuel or locally produced services such as electricity. Many producers will also require secure access to land, which is not always granted by the Land Act. With a young and dynamic population, the reasons that Malawi is still largely at the sidelines of digital transformation are likely rooted in structural issues, including insufficient teaching of digital skills and the large costs of reliable mobile and internet services in Malawi. The unavailability of imported inputs is rooted in Malawi’s macroeconomic challenges, which Chapter 1 discusses in detail. To enhance the provision of public services, Malawi needs to undertake comprehensive reforms of its public entities, as detailed in Chapter 5, to improve their efficiency and effectiveness. Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 90 Giving Malawian women entrepreneurs the same opportunities as their male counter- parts would benefit everyone. In a difficult operating environment, Malawi will need to draw from the full pool of entrepreneurial talent that it has available. Management process- es have been shown to be a key determinant of financial success and are likely to become even more so in an improved operating environment. Thus, providing all talent regardless of gender the same opportunities to improve is likely to pay off. However, to scale their businesses, Malawian entrepreneurs will also need access to capital, which only better functioning financial markets can provide. Given the current situation where most entre- preneurs, and especially women entrepreneurs, can only provide limited collateral, innova- tive solutions are needed to ensure they can still access loans that enable them to scale up. Rapid growth of Malawi’s private sector hinges on efficient financial intermediation. Shifting financing from the Government to the most productive private enterprises is a com- plex policy process that demands determination and meticulous planning. The more effi- ciently this process works, the lower the financing costs for borrowing enterprises. Thus, efficiency-enhancing reforms in the financial sector will benefit the wider public. Preparing more enterprises to be ready to absorb prospectively higher private sector financing vol- umes, such as through incubation and information programs, can play a role to make the reorientation of financial intermediation successful. Promoting competition in Malawi benefits both consumers and businesses. Competition stimulates enterprises to deliver the best goods and services at competitive prices, enhanc- ing the welfare of Malawian consumers. Moreover, businesses that emerge in a competitive environment tend to be more productive and internationally competitive. Achieving this lev- el of competition requires robust legal support and an empowered competition watchdog. Table 3.2  Top five private sector policy priorities Short-Term Actions Medium-Term Implementation Policy Issue (next 3 – 6 months) (before the end of 2025) 1. Ensuring that those firms that can Publish a transparent allocation and pri- Address underlying infrastructure and make the most productive use of oritization process for foreign exchange, macroeconomic constraints that result fuel, forex, and energy can access it fuel and power that enables the most pro- in frequent scarcity of key inputs. ductive firms to access sufficient inputs. 2. Improving entrepreneurship out- Update financial regulations to promote Support business incubation through comes, especially for women more opportunities for non-collateral training in financial management, finan- dependent loans, efficient collateral reg- cial reporting, and developing business istries, and reliable ID systems to offer plans and strategies with a focus on larger volume loans necessary for trans- implementation capacity. formational business growth. 3. Increasing access to digital Reduce the cost of mobile phone owner- Strengthen education and worker train- technologies ship and broadband services by rationaliz- ing programs focused on digital literacy ing tax and levy policies, and by promoting (for all users) and digital skills (for more infrastructure sharing to encourage wider specialized careers). access for low-income citizens. 4. Improving access to finance, espe- Address the crowding out of the pri- Reduce the operational costs of com- cially for smaller firms vate sector from commercial borrowing, mercial and development banks through including by setting clear and credible de-risking, cost-sharing of technology targets for the reduction of Government investments, automated service pro- domestic borrowing. vision, efficient credit referencing, and timely resolution of court cases. 5. Strengthening the ability of the Expedite the enactment of the Invest in the capacity of CFTC and asso- CFTC to enforce the competition Competition and Fair Trading Bill and cor- ciated judiciary institutions, support the regulatory and legal framework to responding regulations. outreach and enforcement systems asso- enhance the welfare of consumers ciated with the amended Competition and and foster competitive enterprises Fair Trading Act, and embed competition principles in broader public policies. Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 91 ANNEX 3.1 Data Sources Used for Firm-level Analysis There are four main sources of data informing the analysis in this chapter. Business Pulse Survey (BPS) data are used to provide evidence on the impact of the COVID-19 pan- demic and to assess the capacity of firms to cope with and adjust to the series of recent crises. The data from the first round of the BPS (wave 1) were collected in the 4th quarter of 2020, when the impacts of the shock were already clearly evident. A state of emergency had been declared in March 2020 and, although a lockdown was not enforced, in April 2020 gatherings were prohibited, schools were closed, and a curfew was compulsory. Following the economic downturn due to the health crisis, Malawi’s economy briefly rebounded but in 2022 a series of external shocks and a BoP crisis severely weakened the economy again. Consequently, firms continue to suffer setbacks just as the COVID-19 pandemic was reced- ing. A follow-up survey (wave 5) took place between the end of October and mid-Novem- ber 2022 when restrictions had been lifted and supply chains were largely restored, but the country was suffering from other external shocks. The BPS are an excellent resource to understand firms’ resilience and firms’ capacity to adjust. A particular strength of the data is the comprehensive information regarding finance, firms’ capabilities, and technology adoption. But there are limitations. First and foremost is the lack of representability of the surveys. The survey was designed to monitor the impact, adjustment, and recovery of firms. To this end, there is a question asking the total value of sales in 2019 (before the COVID-19 pandemic). To assess impact and recovery, the survey asks the percentage of decrease (or increase) in sales with respect to the same period in 2019 and with respect to 2022. The Funneling Survey (FS) was a pilot survey implemented in 2022 to test various meth- ods of measuring firm capabilities such as knowledge of technical skills, business prac- tices, and entrepreneur’s personal and psychological traits. In addition, the data have information on sales, total expenditures, profits, and financial access. The FS does not in- clude firms smaller than four employees or firms larger than 100 but does include infor- mal firms. There are three independent necessary processes for registering a business: (i) registration at the Department of the Registrar’s General (DRG); (ii) tax registration at the Malawian Revenue Authority (MRA); and (iii) registration at the local City Council (CC) to obtain a business license. Enforcement is very limited, but registration with DRG or MRA are necessary to access formal credit. Thus, the definition of formality is whether the firm is registered with DRG or MRA. The FS analysis exploits the richness of firms’ capabilities data to look at the correlation of firms’ performance with their capabilities. Although neither the BPS nor the FS are representative, they provide novel informa- tion on topics not covered by the World Bank Enterprise Survey (WBES). The analysis builds on previous work, including Record et Al. (2016), using the 2009 and 2014 WBES. In the BPS there are 61 percent of micro firms (one to five employees, including the owner) in wave 2 and 79 percent in wave 5. The FS incudes only firms with four or more employees (but no larger than 100) and it has 33 percent of micro firms. More than half of the firms in WBES and FS are small (six to 20 employees), while only 26 percent in the BPS wave 2 and 15 percent wave 5 are small firms. Both datasets have a smaller share of medium firms com- pared with the WBES. Finally, the BPS has 2 percent large firms (55 establishments). Thus, micro firms are overrepresented in the BPS in comparison to the FS, while the opposite is true for small firms. The share of manufacturing is higher in the WBES compared with both Chapter 3  Unlocking Core Constraints to Private Sector Productivity Growth 92 the BPS and FS, while retail firms are lower and services higher in the FS in relation to both the WBES and BPS. Finally, the share of women-led establishments is around 30 percent in the BPS and FS, but only 16 percent in the WBES. The FinScope survey was instituted to generate representative data on Malawi’s MSME. The survey focusses on MSME owners and their financial service needs. The objectives of the survey were to (i) assess the size and scope of MSME in Malawi, (ii) describe the levels and landscape of access to financial products and services, (iii) identify the drivers and barri- ers to financial access, (iv) identify binding constraints to MSME development and growth, and (v) structure the MSME sector into market segments and identify the needs of each. The MSME Tracker Survey was instated as a follow-up to the FinScope Survey in 2019. While the data is more recent, it loses its representativeness of MSMEs in Malawi, with especial- ly urban enterprises overrepresent. Methodological details can be found in the accompa- nying reports (FinMark Trust, Imani Development, and AESA 2019; FinMark Trust 2023). Table A.3.1.1  Overview of sample for each data source Business Business MSME WB Pulse Pulse Tracker Enterprise Survey, Survey, Funneling Survey, Survey Wave 2 Wave 5 Survey FinScope Survey, 2019 2022 Share Share (n) Share (n) Share (n) Share (n) Share (n) (unweighted) (weighted) (n) Share Manufacturing 197 40% 205 10% 278 15% 46 12% 423 14% 22% 264 26% Retail 212 43% 793 40% 942 50% 112 28% 2,208 74% 69% 514 50% Services 84 17% 993 50% 678 36% 240 60% 362 12% 9% 248 24% Micro n/a n/a 1,209 61% 1,509 79% 167 33% 1,607 54% 74% 916 89% Small 289 55% 508 26% 282 15% 291 58% 1,203 40% 23% 106 10% Medium 141 27% 218 11% 96 5% 47 9% 183 6% 3% 4 1% Large 93 18% 52 3% 23 1% n/a n/a 0 0% 0% 0 0% Woman-owned 83 16% 548 29% 646 34% 145 29% 1,225 41% 49% 328 32% Formal n/a n/a n/a n/a n/a n/a 414 82% 735 25% 11% 385 38% Total 523 100% 1,990 100% 1,910 100% 505 100% 2,993 100% 100% 1,026 100% 93 Increased Trade CHAPTER 4 Can Help Stabilize the Economy and Drive Industrialization KEY FINDINGS 1 Malawi’s chronic trade imbalance has worsened significantly in recent years, resulting in a consistent foreign exchange shortfall. Low levels of investment and high trade costs due to policy barriers, inefficient logistics and poor infrastructure, compounded by the structural challenges of being a small, landlocked country reduce overall economic resil- ience and negatively impact Malawi’s economy. 2 Malawi’s export performance has been worsening, largely due to its heavy reliance on one declining crop — tobacco. The double burden of being overly dependent on a single commodity and the volatility of its other exports not only exposes the country to fluctu- ations in global commodity prices and demand dynamics, but also results in inadequate and unstable foreign exchange earnings. 3 For exports to drive growth, Malawi must break the vicious cycle in which chronic trade imbalances and restrictive trade policies reinforce each other. Large policy distortions and foreign exchange rationing not only reduce access to inputs, but also act as a tax on exports, creating incentives for smuggling and informal trade, and hindering diversi- fication into non-traditional exports with higher value added. This is further worsened by scarce foreign exchange primarily supporting the import of consumption goods rather than the inputs necessary for participation in global and regional value chains. 4 Malawi has high potential to increase exports in non-traditional agricultural exports such as soybeans, macadamia, and groundnuts, as well as in mining. Recent discoveries of energy transition minerals, including rare earths, niobium, rutile, and graphite, present opportunities for increased exports, and in turn foreign exchange generation, fiscal reve- nues, and growth — if these are managed responsibly. 5 Given its dependence on its neighbors both as export markets and to reach ports, reduc- ing trade and transport costs will be essential for Malawi to leverage trade for growth. Central to this will be advancing trade facilitation and customs reforms, and especially the removal of non-tariff barriers especially along key corridors. Integration through the African Continental Free Trade Area could bring significant benefits to Malawi, particularly in the processed food, agriculture, and trade sectors. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 94 IMPROVING TRADE PERFORMANCE CAN UNLOCK MALAWI’S ECONOMIC POTENTIAL Malawi’s weak trade performance is central to its broader macroeconomic challenges. Chapter 1 shows how Malawi outperformed its peers in exports during the 1990s and early 2000s, but has since fallen behind. It also shows that improvements to Malawi’s external performance, paired with broader macroeconomics reforms, can help transform a self-re- inforcing cycle of crises into a cycle of opportunities. The country’s lack of economic diversification presents a significant obstacle to un- locking Malawi’s full economic potential. The economy faces numerous structural con- straints. Malawi is a landlocked country with large distances to ports, a small domestic market, and few natural resources. The country has faced persistent challenges in enhanc- ing export performance, relying heavily on tobacco exports, with diversification efforts proceeding only slowly and exports declining (Figure 4.1). While the 2013 – 2018 National Export Strategy (NES) achieved some of its intermediate targets, such as launching the “Buy Malawi” Initiative and accession to the World Trade Organization (WTO) Trade Facilitation Agreement, it failed to attain its core aim of building Malawi’s productive base and export capacity through the development of export clusters, building a conducive environment for competitiveness, strengthening supportive institutions, and investing in competencies, skills and knowledge relevant to exporting (Ministry of Trade and Industry 2013). The NES set a target of increasing export values by 13 percent between 2013 and 2017. However, the average annual growth rates during this period were -9.0 percent for goods, 16 percent for services, and -6.2 percent overall (Figure 4.2). Figure 4.1  Malawi’s goods exports have been in decline Figure 4.2  Malawi’s NES export growth targets Annual export growth, 3-year rolling average, percent were not achieved Compound annual growth rate (CAGR), percent 10 20 8 15 6 10 4 5 2 0 0 −5 −2 −10 Export of goods Exports of Exports of goods −4 services and services 09 10 11 12 13 14 15 16 17 18 19 20 21 22 Avg. 2006–2011 Avg. 2014–2017 Avg. 2018–2022 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Source: World Bank staff calculations based on MRA transactions data Source: World Bank staff calculations based on MRA transactions data for goods exports. for goods exports and WDI data for services. Malawi’s Government has set ambitious targets for export growth with its new National Export Strategy II (NES II, Ministry of Trade 2021) and the importance of increasing ex- ports is also central to the Malawi 2063 (Box 4.1). As foreign currency shortages continue to constrain the economy, increased exports have the potential to become a vital source of foreign exchange. This underscores the importance of Malawi developing and implementing a robust strategy to increase export competitiveness, integrate into global markets, and sta- bilize its macroeconomy. To achieve the aims of the NES II, Malawi needs to adapt its domes- tic policies and create an enabling environment that fosters and incentivizes export growth. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 95 Box 4.1  Can Malawi’s new National Export Strategy achieve its ambitious targets? Malawi’s new National Export Strategy (NES II) was The NES II sets ambitious targets. Overall, the NES announced as a successor strategy to the previous NES, II aims to improve Malawi’s export competitiveness, which for the most part missed its targets. It focuses on expand its export markets, and promote sustainable promoting export competitiveness and expanding exports and inclusive economic growth.The NES II has several more specific objectives, including increasing traditional from 14.6 to 20 percent of GDP by 2026. The strategy has exports by 25 percent and non-traditional exports by 50 four goals: (i) increasing exports of “made in Malawi” prod- percent, expanding the volume of exports by 10 percent, ucts; (ii) reinforcing export readiness and competitiveness of reaching 125 markets, and attracting 20 new firms to Malawian firms; (iii) enhancing domestic investment and the enter the export market annually. The strategy also aims business environment; and (iv) improving implementation. to strengthen trade agreements by negotiating eight The priority sectors are agriculture (including forestry and new trade agreements, increasing the total from 32 to fishing), manufacturing, mining and services. 40 agreements. In recent years, the decline in exports and lack of diversification has been caused in part by restrictive policies that have yielded few positive impacts. In addition, persis- tent foreign exchange shortages have made it difficult and often impossible for producers to access necessary intermediate inputs (see also Chapter 1). Policy has often focused ex- cessively on increasing administrative regulations which contribute to non-tariff barriers (NTBs),26 impacting importers and exporters, as well as the promotion of import substitu- tion over export-led growth. These amplify existing constraints and prevent the private sector from growing and becoming more competitive. To achieve its development aspirations, Malawi must Figure 4.3  A vicious cycle of restrictive trade policies and break the vicious cycle in which structural factors and weak outcomes restrictive trade policies reinforce each other, perpet- uating a low-level equilibrium (Figure 4.3). Large policy Large policy barriers and foreign exchange rationing not only reduc- barriers and forex es access to inputs, but also to essential goods such as rationing health and food products, putting the poorest at risk. In Low growth addition, these barriers act as a tax on exports, as official and weak Difficulties to access inputs exports face a price disadvantage in foreign markets, af- macro and attract fundamen- fecting their competitiveness. This reduces income from tals investors exports and creates disincentives for firms to trade, hin- dering improvements in export diversification and com- plexity. The economy also suffers from a lack of investment and high trade costs due to poor logistics and infrastruc- ture. These issues, compounded by the structural barri- ers of being a small, landlocked country, reduce overall Low economic resilience and negatively impact Malawi’s mac- Low investment in skills, levels of roeconomy through insufficient foreign exchange earn- resilience capital and logistics ings resulting from low exports. This chapter argues for Continued an export-oriented strategy to stimulate economic devel- lack of diversifica- opment and overcome these structural challenges. By di- tion and versifying the economy, leveraging opportunities in key competitive- ness sectors, and addressing long standing issues, Malawi can unlock its full potential and position itself for sustainable and inclusive growth. Source: World Bank staff. 26.  NTBs describe all measures that restrict imports or exports of goods or services through mechanisms other than the simple imposition of tariffs. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 96 This restrictive environment prevents growth in emerging sectors such as agri-business, mining, and tourism. Recognizing that Malawi cannot achieve complete domestic self-suf- ficiency in all sectors, it is imperative to strategically target and allocate scare resources to- wards areas where growth can realistically occur. By adopting a step-by-step approach toward developing more complex exports and attracting investments in key industries, Malawi can capitalize on its comparative advantage in agro-processing, mining and tourism, and gradually expand its economic potential. Over time, these efforts will generate spillo- ver effects within the domestic economy, fostering stronger linkages with local businesses and providing them with significant benefits through access to regional and global markets. The chapter addresses how Malawi can create a more diversified and resilient econ- omy through trade, while strengthening its macroeconomic environment. The next sec- tion summarizes key stylized facts on Malawi’s trade performance. The third section then addresses the underlying policy causes of its sluggish trade performance. It then explores potential ways Malawi can enhance its trade performance to fulfill the Government’s objec- tives of diversifying the economy and increasing exports. The final section presents policy recommendations derived from the analysis. AN OVERVIEW OF MALAWI’S TRADE PERFORMANCE IN SIX FACTS 1. Malawi’s exports have declined significantly in the past decade, resulting in low foreign exchange earnings and driving Malawi’s macroeconomic imbalances The decline in exports has resulted in a worsening current account balance and dwin- dling reserves. Double-digit current account imbalances (in terms of percentage of GDP) between 2013 and 2021 have led to the accumulation of substantial external liabilities (Figure 4.4). This has resulted in a gradual deterioration in net reserves, especially in the post-COV- ID-19 years (Figure 4.5). Figure 4.4  The current account deficit has deteriorated in Figure 4.5  …resulting in dangerously low reserves recent years… Official gross and net reserves, months of import cover Current account, percent of GDP 6 5 4 0 2 −5 0 −10 −2 −15 −4 −20 9 9 0 0 1 1 2 2 3 3 02 02 02 02 02 02 01 01 02 02 /2 /2 /2 /2 /2 /2 10 12 13 14 15 16 17 18 19 06 07 08 09 20 21 /2 /2 11 /2 /2 20 03 09 03 09 20 20 20 20 20 20 20 20 20 03 09 20 03 09 03 09 20 20 20 20 20 Primary and Secondary Income Trade Balance Net international reserves Gross official reserves Current Account Balance Source: World Bank staff calculations based on RBM data. Source: World bank staff calculations based on World Development Note: Net reserves subtract predetermined short-term drains, such as Indicators (2023) short-term swaps. The decline in exports stems from decreasing volumes along established trade links while volumes for new export relationships stagnated. Incumbent firms exported few- er existing products to previously established markets (also called the intensive margin) Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 97 between 2009 and 2022 (Edwards, Engel, and Stojanov 2023). Similarly, net entry of firms and expansion by incumbent exporters into new markets (also called the extensive mar- gin) failed to continue the previous growth into the post-2009 period. These dynamics are also reflected in Malawi’s level of trade openness, as measured by the overall share of exports relative to GDP. Openness has declined over the past two decades, reflecting the worsening of its export performance (Figure 4.6). This decline indi- cates that Malawi’s goods exports have underperformed, relative to the country’s level of economic development. However, this decline in goods exports has been partially offset by growth in the services sector, as well as a small increase in agricultural exports. Growth in the services sector,27 and especially transport services, has been strong, with an annual aver- age growth rate of 20.0 percent since 2016, making it the primary source of export growth and helping balance out the decline in goods exports (Figure 4.7). Figure 4.6  Malawi’s historical trend in trade openness Figure 4.7  Malawi’s services exports have spiked from 1990 to 2020 since 2016 Share of GDP, percent US$ (‘000,000) 60 120 50 100 40 80 30 60 20 40 10 20 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 20 20 20 20 20 19 19 19 19 20 20 20 20 19 20 20 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Goods exports Services exports Goods imports Services imports Transport Travel Source: World Development Indicators. Source: WTO services data. 2. Malawi’s exports are highly concentrated, with little progress achieved toward diversification Malawi’s overall export performance has been worsening, largely due to its heavy reli- ance on one declining crop — tobacco. Despite the Government’s efforts to promote diver- sification, tobacco exports account for between 30 and 45 percent of the country’s total goods and services exports in recent years (Figure 4.8). Other non-tobacco agricultural exports, while showing significant overall growth, also demonstrate high volatility. This double burden of over-reliance on a single commodity and the volatility of its other exports not only exposes Malawi to fluctuations in global commodity prices and demand dynam- ics, but also results in inadequate and unstable foreign exchange earnings (Figure 4.9). 27.  Service exports in this study exclude the category “Maintenance and repair services” due to limitations in the available data. The data for this category was only captured in the Balance of Payments (BoP) survey con- ducted in 2021, covering 2019 – 2021, without normalizing the previous years’ estimates. Consequently, a kink is observed in the data for 2019. Prior to the survey, data collection relied on administrative sources and esti- mations, and the normalization of estimates based on the survey results was not carried out, resulting in a dis- crepancy in the data for 2019. “Maintenance and repair services” encompass the maintenance and repair work carried out by residents on goods owned by non-residents, as well as vice versa. This includes activities such as the maintenance and repair of ships, aircraft, and other transportation equipment. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 98 Figure 4.8  Malawi’s exports composition is dominated by Figure 4.9  Malawi’s declining export performance and tobacco and services volatility in other exports US$ (‘000,000) 2006=1 1,600 4 1,400 1,200 1,000 3 800 600 400 2 200 0 1 06 20 7 08 09 10 11 12 13 14 15 16 17 18 19 20 20 1 22 2 0 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Tobacco Agriculture Others goods 0 Textiles Services 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Source: World Bank staff calculations based on MRA transactions data for goods exports and WDI data for services. Note: services exports do Agriculture Tobacco Others goods not include the category “maintenance and repair”. Note: Services exports do not include the category “maintenance and Source: World Bank staff calculations based on MRA transactions data repair”. for goods exports. Malawi’s heavy reliance on tobacco as its main export commodity has resulted in lim- ited diversification. Out of over 5,000 existing products in the Harmonized System (HS) classification, Malawi exported 218 products in 2020. This represents a marked reduction of exported products by 24.3 percent compared with 2015, when the country exported 288 products (Figure 4.10). This places it above some peers, such as Niger and Rwanda, but far behind Lao PDR, Madagascar and Uganda. While Malawi reached fewer markets, African markets proved the most resilient. Most Malawian exports, but especially tobacco, have experienced a decline in the number of markets that they access (Figure 4.11). These patterns suggest challenges in accessing new markets and imply high exit rates for firms operating in those sectors. The share of Malawi’s exports destined for African countries rose from 37 to 45 percent between 2006 and 2022, driven by food and manufactured goods exports. Figure 4.10  Malawi’s number of differentiated exports Figure 4.11  Malawi’s number of markets reached declined is diminishing for most of its exports sectors in recent years Number of product HS 6 digits, 2005 – 2020 Number of markets, 2006 – 2022 500 90 80 400 70 300 60 200 50 100 40 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 20 0 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 2005 2010 2015 2020 Agriculture Tobacco Others goods Structural Peer Aspirational Peer Malawi Source: World Bank staff calculations based on MRA transactions data Source: World Bank staff calculations based on WITS-Comtrade data. for goods exports. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 99 3. Exports and exporters exhibit low survival rates To achieve and sustain export-led growth, Malawian firms will need to not only successful- ly enter new export markets and products, but also survive and grow as exporters. Export diversification can be driven by the entry of new firms into exporting or by firms exporting into new markets and selling new products. However, often export survival, i.e., maintaining these trade relationships, is a key challenge for exporting firms (Carrère and Strauss-Kahn 2017). The overall number of exporters has dropped over the past Figure 4.12  Export survival rates are low and stagnant decade, mainly due to the stronger decline in entry rates Percent than exit rates, resulting in higher concentration. The de- 80 cline in the number of exporters can be attributed to dimin- ishing entry rates, although exit rates have also decreased. 60 Moreover, the survival rates of new entrants are relatively low. On average, only 20 percent of new exporters manage to sur- 40 vive into the subsequent year over the period 2006 – 2022, and 5.7 percent survived past the third year (Figure 4.12). Global 20 value chain (GVC) firms, i.e., firms that both export and import, tend to be larger and export more diversified goods than their 0 peers that only export. They also show more stability (Figure 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 20 20 20 20 20 20 20 20 20 20 20 20 4.13). Over the 2006 – 2022 period, the one-year survival rate 20 20 20 20 of GVC firms was 35 percent compared with 11 percent for Entry rate Exit rate non-GVC firms. The three-year survival rate was 13 percent 1-yr Survival rate 2-yr Survival rate 3-yr Survival rate for GVC firms, whereas only 2 percent of non-GVC entrants Source: World Bank staff calculations based on MRA transactions data continued to export for three successive years (Figure 4.14). for goods exports. Figure 4.13  Malawian exporters have been declining, Figure 4.14  Firms that are linked to GVCs build stronger while GVC firms show more stability export relationships Number of exporting firms Annual average, percent 1,000 100 800 80 60 600 40 400 20 200 0 Entry rate Exit rate 1-yr Survival 2-yr Survival 3-yr Survival 6 07 08 09 10 11 12 13 14 15 16 17 18 19 20 20 1 22 2 0 20 20 rate rate rate 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Importing and exporting Export-only Non-GVC firms GVC firms All firms Source: World Bank staff calculations based on MRA transactions data Source: World Bank staff calculations based on MRA transactions data for goods exports. for goods exports. 4. Malawian exporters lose more from exchange rate appreciations than they gain from depreciations Though a declining real exchange rate can have strong negative macroeconomic and societal impacts, it is generally expected to improve export competitiveness. When the real exchange rate (RER) depreciates, production costs for domestic firms fall relative to for- eign competitors. This enables local firms to become more competitive in other markets and increase their likelihood of exporting. In fact, having a ‘competitive currency’ to encourage Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 100 export success is a common policy recommendation and often demanded by exporting firms (Frieden 2015), but the literature is not conclusive on its outcomes. Developing coun- tries have often experienced delayed realizations of the maximum effects of depreciations (Bayoumi 1996; Colacelli 2009; Hooper and Marquez 1993; Pirzada 2019).28 Historically, Malawian exports increased gradually following RER depreciations but fell rapidly during appreciations, hindering the country from taking advantage of this mechanism for increasing its competitiveness. During most periods in its history, Malawi has maintained a fixed nominal exchange rate, which has resulted in an appreciation of the RER in real terms (see Chapter 1). While these gradual appreciations reduce exports by undermining competitiveness, new econometric research conducted for this CEM (Brun, Stojanov, and Engel 2023) indicates that export recovery is slower when the depreciation eventually occurs. In Malawi, the reaction to an appreciation is fast (Figure 4.15): more than 50 percent of the correction occurs in the first year. A depreciation makes Malawian ex- ports more competitive, resulting in an increase in exports. However, the reaction is slow- er: it takes four years to process 50 percent of the long-term correction. By the end of the first year, only 16 percent of the long-term increase happened. This implies that an ex- change rate policy that is good for exporters minimises periods of appreciations (like dur- ing fixed exchange rate episodes). Depreciations provide exporters with a boost, but this takes time to fully materialise. Figure 4.15  Export response to RER movements: slow to increase but fast to fall a. 1 percent RER appreciation b. 1 percent RER depreciation Change in exports, percent Change in exports, percent 0.4 0.4 0.3 0.3 0.2 0.2 0.1 0.1 0 0 −0.1 −0.1 −0.2 −0.2 −0.3 −0.3 −0.4 −0.4 −0.5 −0.5 0 1 2 3 4 0 1 2 3 4 Years Years Estimate Confidence interval at 95 percent Source: World Bank staff calculations based on MRA transactions data for goods exports. Note: These figures report estimates for short-run export responses to RER appreciations and depreciations. Exports are deflated by US GDP implicit price deflator. RER is constructed with geometrically weighted averages of nominal exchange rates and price indices of Malawi’s trading partners. Figure (a) depicts response after a 1% real effective exchange rate appreciation. Figure (b) depicts response after a 1% real effective exchange rate depreciation. Confidence intervals at 95% are reported as shaded area. Export responsiveness to RER depreciations exhibits greater strength in those sec- tors characterized by undifferentiated products, higher labor intensity, and reduced dependence on private capital. The elasticities of exports with respect to real exchange rates during depreciations highlight that undifferentiated products and sectors with higher 28.  Recent studies have delved into this by exploring asymmetric reaction to exchange rate changes (Bahmani- Oskooee and Harvey 2022; Brun, Gambetta, and Varela 2022; Cheung and Sengupta 2013; Demian and di Mauro 2018; Šimáková 2018). Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 101 labor intensity are more likely to experience significant increases in exports than other sec- tors. In addition, sectors that rely less on credit react more strongly in response to real ex- change rate changes, whereas sectors with greater reliance on credit demonstrate a slower response, suggesting an inadequacy of access to finance. In addition, the elasticity of ex- ports to changes in the real exchange rate is influenced by various factors, including export destination, product, and firm characteristics. Notably, the export response to bilateral ex- change rate movements is lower for exports to African countries and neighboring nations, as well as for smaller firms, non-GVC firms, and manufactured goods. There are several causes for this differentiated response. First, supply constraints reduce exporters’ capacity to scale up. Second, finding new clients can be difficult and expensive for firms, especially for those with a narrow potential customer base. Furthermore, dur- ing periods of overvaluation, exporters face additional constraints as spreads between offi- cial and parallel market exchange rates emerge, acting as a de facto tax on official exports. This is in line with a growing literature that shows that there is a significant heterogeneity in export response following depreciations.29 5. Malawi “under-imports” intermediate goods necessary for GVC participation, while consumption goods use up an increasing share of foreign exchange As for any small economy dependent on agricultural exports, access to imports plays an important role in Malawi’s trade competitiveness. In general, smaller developing countries tend to import more as domestic firms seek to gain access to intermediate in- puts or capital goods that cannot be produced domestically or for which domestic quality is lower. To foster sustainable export-led growth, importing intermediate inputs and capi- tal goods plays a crucial role, as they contribute to technol- ogy transfer and productivity growth (World Bank 2020c). Figure 4.16  Intermediate imports as percent of GDP is The import basket is therefore a good reflection of domes- relatively lower for Malawi compared with its peers tic production capacity and competitiveness for a small Percent of GDP economy like Malawi, as firms often do not have access 20 70 to inputs from the domestic market (unlike firms in larger economies). Moreover, firms in low-income countries that 60 use intermediate inputs in their production tend to be more 15 50 productive and efficient than those that source only from 40 the domestic market (ibid.). 10 30 Malawi imports fewer intermediate imports than peer 5 20 countries due to both foreign exchange constraints and 10 other barriers to accessing imports. Only Madagascar and Niger exhibit a similar or lower level of reliance on interme- 0 0 da i oRs r r da diate (Figure 4.16). Countries that import intermediates tend aw ca ge aD an an P as Ni al oL Rw M Ug ag to be better performers in terms of exports, as they are able La ad M to generate higher export values on average. Therefore, im- proving access to intermediate imports for producers may Intermediate imports Goods trade (right scale) be a potential avenue for improving Malawi’s export com- Source: World Bank staff calculations based on WITS reported imports petitiveness and economic performance. data using BEC classification for intermediates. 29.  Structural attributes of the products, conditions under which they are produced, or firms’ characteris- tics may affect responses to similar contexts, and can explain the capacity to yield the benefits from better price-competitiveness (Brun, Stojanov, and Engel 2023; Demian and di Mauro 2018; Dhasmana 2015). Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 102 Malawi’s imports consist primarily of intermediates Figure 4.17  The level of intermediate goods imports has and consumption goods. These imports are essential for been slowing down, while that for consumption goods has food security, health, transport, and overall economic been increasing competitiveness. However, the growth rate of consump- Evolution of intermediate and consumption good imports, 2006=1 tion goods surpasses that of intermediates (Figure 4.17), 4 indicating that productivity may not be improving as de- 3 sired, as exports are stagnating. Given that consumption goods also comprise critical items such as pharmaceuti- 2 cals and food products, the Government must manage its 1 import expenditures carefully and ensure sufficient for- 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 20 eign exchange is available for firms that need inputs for 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 production. This highlights the importance of nurturing Consumption goods Intermediate goods a private sector that can generate export revenues to pur- Source: World Bank staff calculations based on MRA transactions data for chase imported goods. goods exports based on WITS reported imports data using BEC classification. 6. Foreign investment — a key ingredient for export growth — has declined from an already low base Foreign direct investment (FDI) is a crucial factor in economic growth, as it contrib- utes to increased productivity, innovation, and technology transfer, in turn creating better jobs. In addition to supporting economic diversification, FDI also helps domestic firms become more competitive and expand their export capabilities. By enabling access to intermediate goods and attracting further strategic FDI, countries can increase their participation in regional and global value chains, which in turn can drive industrializa- tion and support the structural transformation of economies. As discussed in Chapter 1, increasing FDI will be an essential ingredient for the cap- ital formation needed to achieve higher and sustained Figure 4.18  Inward FDI flows for Malawi and comparison growth rates. countries, 2011 – 2021 Share of GDP, percent Malawi’s inward FDI flows and stocks are below its peers. 10 Inward FDI flows to Malawi, as a share of GDP, experienced a spike in 2014, but have been smaller those of than its 8 peers’ since 2016 (Figure 4.18). Compared with peer coun- tries, Malawi’s FDI inflows-to-GDP ratio in 2021 was less 6 than 0.36 percent, significantly lower than the regional av- 4 erage of 2 percent or more. Overall, FDI in smaller coun- tries such as Malawi tends to exhibit volatility and scarcity, 2 whereby the realization of even a single investment can have a significant impact. 0 11 12 13 14 15 16 17 18 19 20 21 20 20 20 20 20 20 20 20 20 20 20 The importance of FDI as an external finance source has steadily diminished over the past decade, while remit- Malawi Comparison Average Aspirational Comparison Average tances and ODA have emerged as the primary sources of finance. In 2021, the bulk of financial inflows into the coun- Source: Harmonized Bilateral FDI Database, WBG. try consisted of ODA and remittances, overshadowing the Note: FDI flows are on a net basis (capital transactions’ credits less debits significance of FDI inflows (Figure 4.19). The decline in in- between director investors and their foreign affiliates). The “comparison average” group includes Burundi, Madagascar, Niger, and Uganda. The ward FDI flows can be attributed to a decrease in intra-com- “aspirational comparison average” group includes Ethiopia, Lao PDR, pany loans, leaving equity (excluding reinvested earnings) Nepal, and Rwanda. The spike in the early 2010s includes the investment from Vale under the as the only substantial inflow in recent years (Figure 4.20). Nacala Rail Project. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 103 Figure 4.19  Malawi’s FDI vs. other sources of external Figure 4.20  Malawi ‘s composition of inward FDI flows finance (2011 – 2021) (2011 – 2021) Share of GDP, percent Share of GDP, percent 30 12 25 10 8 20 6 15 4 10 2 5 0 0 −2 −5 −4 13 14 15 16 17 18 12 19 12 13 14 15 16 17 18 20 19 21 20 21 11 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 FDI Inflows Remittances ODA Received Intra-company loans Equity other than Reinvested earnings Total Reinvested earnings Total Source: World Development Indicators. Source: International Monetary Fund, BoP. This is also reflected in a declining number of FDI projects. Between 2008 and 2022, a total of 52 greenfield FDI projects in Malawi were announced, according to the FDI markets database, meaning that the average year only saw the announcement of 3.5 projects. The dominant sector among these investment announcements was communications and finan- cial services (Figure 4.21). The largest number of projects came from India (7), followed by the United Arab Emirates (6), South Africa (5) and China (4). Figure 4.21  Most FDI projects have been in services sectors Number of FDI projects, 2008–2022 Communications Financial services Others Business services Food & Beverages Building materials Coal, oil & gas Real estate Metals 0 1 2 3 4 5 6 7 8 Source: fDi Markets data. Note: The “Others” group includes one project each in the following sectors: Chemicals, Consumer products, Healthcare, Industrial equipment, Pharmaceuticals, Renewable energy, Software & IT services, Transportation & Warehousing. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 104 TRADE AND INDUSTRIAL POLICY CHOICES ARE CENTRAL TO MALAWI’S WEAK TRADE PERFORMANCE Malawi’s geography and its economic structure already pose significant challenges to the country’s trade competitiveness. Being a small, landlocked nation with limited re- sources, the development of a competitive private sector is inherently challenging. These challenges are further amplified by the lack of strong domestic demand, low production ca- pacity, inadequate human capital, and a labor force with comparatively low wages. Several additional policy measures compound this. These include numerous NTBs, thick borders, and the slow pace of trade and transport facilitation reforms, and significant investment and services trade restrictions. The high cost of trade restrictions The persistence of trade restrictions and, in particular, the persistence of numerous NTBs, only compounds the structural challenges. While tariffs have declined significantly in recent years and are comparable to those of most peers, the proliferation of NTBs consti- tutes a key constraint to export growth. Many of these policies have unintended conse- quences that are inconsistent with the Government’s goals of improving the diversification and resilience of the economy. Creating a domestic policy environment that facilitates ex- port growth and improved exporter competitiveness requires reducing barriers that im- pede the ability to reach foreign markets. This includes a number of measures, including the following: • Malawi has imposed import restrictions on 24 product categories, necessitating import licenses. In addition, a complete ban on all meat products, with a few excep- tions, has been implemented.30 These restrictions can affect the affordability of essen- tial goods for the poor. They also reduce access to crucial inputs for the private sector, exacerbating the challenges faced by businesses, while domestic procurement for in- puts remains limited and insufficient for meeting the demands of the market. • Exports licenses also create more cumbersome procedures for exporters. Malawi has officially imposed export restrictions and requires export licenses for the follow- ing group categories: hides and skins, maize, wood timbers, poultry, gems, and petro- leum, among others. Such restrictions can reduce the incentives for firms to export through official channels, creating an illegal parallel market. • Currently, export permits are required for many crops. This creates some challeng- es towards aligning with the initial objective of the revised Control of Goods Act (2018), which aimed to improve the predictability of export restrictions related to food commod- ities. The Act was designed to regulate exports based on different public interest thresh- olds, only allowing intervention when public interest in a restriction was established through national food balance sheets. However, the Ministry of Trade and Industry often lacks the necessary information to make timely decisions based on Food Balance Sheets, 30.  The restricted import list includes items such as clothing, sugar, gold, live fish, bees, beans (excluding tinned beans and bags weighing less than 90kg), compound products containing flour, eggs, groundnuts, maize, oil seeds, potatoes, rice, rupoko, bananas, and meat. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 105 which moreover only include select grains. This hinders the effectiveness of these impor- tant reforms. As a result, licensing requirements persist, undermining the goal of creating a more efficient and transparent system for export restrictions in the agriculture sector. • Furthermore, in 2021, the Reserve Bank of Malawi (RBM) reinstated the mandato- ry conversion of 30 percent of export proceeds as a means to maintain an adequate supply of foreign exchange within the country. However, this policy has significant implications for the economy as it restricts the private sector’s ability to strategical- ly allocate resources. Moreover, this policy sends a negative signal to international in- vestors, who value flexibility and autonomy in managing foreign currency earnings. It is crucial for policy makers to strike a balance between ensuring foreign exchange availability and fostering a favorable investment climate. • In addition, the RBM has recently implemented a new directive mandating the declaration of exports using a reintroduced CD1 form. This form had been discon- tinued in the past but has now been reinstated through a new directive. According to the law, it is now compulsory for exporters to declare their exports using this form. • Another significant development pertains to the introduction of a new directive by the Malawi Revenue Authority (MRA), announced in the 2023 budget and now gazet- ted in regulations. This directive requires all exporters to obtain a certificate confirming their use of a bonded export warehouse for their shipments. However, the establishment and licensing of these warehouses, as well as ensuring their widespread availability, en- tails a complex process that is likely to result in delays and increased costs for the private sector. Such procedures often have unintended consequences, such as driving more firms toward informality and smuggling, and facilitating the emergence of illicit trade flows. While often intended to bolster Malawi’s trade balance, these measures frequently create direct and indirect negative impacts for exporters. Expanded licensing and en- forcement regimes were justified with the need to reduce food insecurity and promote the repatriation of export proceeds. However, the lack of clarity surrounding the implementa- tion of these policies, combined with an existing onerous export licensing system, creates further hurdles and uncertainty for exporters. In a context where each additional day that a product is delayed prior to being shipped reduces trade by more than 1 percent (Djankov, Freund, and Pham 2010), such policies are likely to reduce the number of firms exporting, as well as the total value of goods exported. The negative impact on agricultural trade is particularly high. In Malawi, the persis- tence of ad-hoc export restrictions and export licensing procedures results in significant underinvestment by the private sector in agro-processing and deters new investors. The complexity of the export licensing process is illustrated in Figure 4.22, as reported by one medium-sized agricultural exporter. On average, assuming no delays on the part of the exporter, this process takes a minimum of four weeks, but often longer. This is due both to the large number of administrative requirements and to the lack of coordination across government ministries. During these delays, goods planned for export may perish (espe- cially agricultural goods), or importers could change their mind and select a producer who can deliver sooner. While the envisioned Malawi National Single Window31 has the poten- 31.  The National Single Window (NSW) is an electronic platform system interconnected with international trade and transport stakeholders to fulfil all imports, exports, and transit border control procedures. Government bor- der control agencies are linked to the NSW platform to process transactions but operate in the background, with workflow management of their organizations integrated into the NSW. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 106 tial to accelerate some steps, the administrative requirements are likely to remain burden- some for exporters as many of these measures are likely to remain. Figure 4.22  The long journey to an export license for a Malawian agricultural exporter MRA: Application and approval Ministry of Agriculture: Letter of no RBM: CD1 Form Granting from private custom control objection as well as submission and (new since 2023) of export warehouse (new since 2023) review of 6 supporting documetns license Phytosanitary and fumigation Ministry of Trade Ministry of Trade and Industry: certificates from research and Industry: Submission and review of center and trading company Wholsaler's license 11 supporting documents Source: CEM consultations with private sector. “Thick” borders and the slow pace of regional trade and transport facilitation and integration Malawi’s borders are relatively “thick”, leading to higher transport costs compared with peer countries such as Zambia, Zimbabwe, Botswana, and Namibia (Figure 4.23). Thicker borders indicate greater differences between pro- ducer and consumer prices, implying higher trade costs Figure 4.23  Malawi’s borders are “thicker” than those of and potential barriers to trade for Malawi. An underdevel- many other countries in the region oped inter-modal transport network and poor logistics in- Bilateral Border Thickness (percent ad valorem), 2015–2018 averages frastructure are hindering service delivery, performance, Congo, Tanzania and economic integration, with transport costs in Malawi Dem. Rep. among the highest in the region. Angola Mozambique While the behind-the-border NTBs discussed in the pre- Zambia vious section contribute to these thick borders, and the presence of further NTBs at the border and in neighbor- Zimbabwe ing transit countries such as Mozambique and Tanza- nia, adds to the costs of trade for Malawian exporters Namibia and importers. This significantly constrains their oppor- Botswana tunities to access regional markets. Due to the country’s landlocked position, Malawian exporters and importers are heavily reliant on road transport, with roads used for Eswatini 99 percent of passenger services, 70 percent of domestic Lesotho freight and 90 percent of international freight (World Bank South Africa 11–57 2023). Imports and exports tend to come via the ports of 57–94 Beira, Nacala, Durban and Dar es Salaam, with most car- 94–138 go transported by road. Beira and Durban together han- 138–479 dle 75 percent of all import and 80 percent of all export Source: Arvis et al. (2020) based on World Bank-UNESCAP database traffic. Rail connections, including the railway to Naca- (2015 – 18 averages). la, remain underutilized despite their cost-effectiveness (Table 4.1). This may, however, change following significant investment along the Naca- la corridor to improve the port at Nacala, as well as to streamline cross-border coordi- nation on policy and regulatory issues. Coordination between Malawi, Mozambique and other countries in the region is im- proving gradually but the lack of common approaches in many areas still contributes the prevalence of NTBs. While the core corridor infrastructure has been built, its condi- tion varies significantly across countries and is impacted by the effects of overloading, the Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 107 Table 4.1  Costs by corridor to and from Lilongwe US$/TEU Imports Exports Corridor 2018 2021 2018 2021 Gateway (Port) Costs (US$/TEU) Beira – Lilongwe 514 557 414 463 Dar es Salaam – Lilongwe 595 595 395 395 Durban – Lilongwe 624 553 435 394 Nacala – Lilongwe 595 557 586 514 Way (Road and Rail) Costs (US$/TEU) Beira – Lilongwe 2,700 2,325 1,500 1,325 Dar es Salaam – Lilongwe 4,700 3,305 4,055 2,575 Durban – Lilongwe 4,965 4,450 3,800 2,900 Nacala – Lilongwe (Road) 2,976 2,795 2,587 1,395 Nacala – Lilongwe (Rail) 1,760 2,897 2,349 1,340 Total (Gateway + Way + Logistics) Costs (US$/TEU) Beira – Lilongwe 3,214 3,497 1,914 2,003 Dar es Salaam – Lilongwe 5,295 3,900 4,450 2,970 Durban – Lilongwe 5,589 8,788 4,235 4,449 Nacala – Lilongwe (Road) 3,571 3,912 3,173 2,699 Nacala – Lilongwe (Rail) 2,867 3,492 2,935 2,369 Source: TradeMark East Africa (2022). Note: TEU = Twenty-foot equivalent unit, based on the volume of a 20-foot-long intermodal container lack of a sustainable asset management strategy for road repair, and the effects of climate change (World Bank 2023). Transport policies and standards are often not harmonized. These include road-user charges, third-party (cross-border) motor insurance schemes, and vehicle overland control systems, standards, and cross-border road permits. Lack of en- forcement of rules (e.g. overloading) and ‘informal’ road fees, all increase the cost of trade. This is further exacerbated by significant border delays, a lack of backhaul loads (i.e. trucks deliver goods without necessarily finding a load of freight to carry on their return, caus- ing importers to pay a premium), high fuel costs and inadequate infrastructure investment (International Finance Corporation 2021). Ideally, the introduction of streamlined and harmonized procedures, risk manage- ment principles to reduce inspections, and automation would accompany infrastruc- ture improvements to create modern borders. However, where border posts are being rehabilitated often as one-stop border posts, the infrastructure is developed in advance leading to mismatches that reduce operational efficiency and particularly impact agricul- tural trade. Recent analysis of key obstacles along the Nacala Corridor connecting Malawi and Mozambique highlight the following barriers (Smith 2020): • Customs documentation and administrative procedures: These include non-stand- ardized systems for declaring imports and paying applicable duty rates; incorrect tariff classification; limited and uncoordinated customs working hours; different in- Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 108 terpretations of the Rules of Origin; non-acceptance of certificates of origin; applica- tion of discriminatory taxes and other charges on imports originating from member states; and cumbersome procedures for verifying originating imports whose origin status is disputed. • Immigration procedures: Such as non-standardized visa fees and cumbersome and duplicated immigration procedures. • Quality inspection procedures: These include delays in the inspection of commercial vehicles; cumbersome and costly quality inspection procedures; unnecessary quali- ty inspections (also of products certified by internationally accredited laboratories); non-standardized procedures for quality inspection and testing; and varying proce- dures for issuing certification marks. • Transiting procedures: These involve non-harmonized transport policies, laws, regu- lations and standards, including road-user charges, third-party (cross-border) motor insurance schemes, vehicle overland control systems, vehicle regulations and stand- ards, and cross-border road permits, as well as prohibitive transit charges. • Roadblocks: In particular, this refers to the practice of stopping commercial vehicles at various intra-country roadblocks, even when there is no evidence that the trans- ported goods are illegal or being smuggled. Finally, small-scale traders are often significantly impacted by current systems and procedures. Cross-border traders, especially women, often lack awareness and knowledge about border procedures and are frequently harassed or subjected to requests for bribes. These smaller informal traders handle a significant volume of trade but generally fall out- side official trade statistics. Experience in the region suggests that in this context of ambig- uous rules, traders provided with information opt to minimize risk by making behavioral changes, including to adjust border crossing times (World Bank 2020a). Reducing poten- tial risk faced by small-scale traders may require multiple types of interventions, including displaying key information at a visible place at customs offices, increasing safety measures at the border (including cameras, help lines, and better access to information), and imple- menting a simplified trade regime for low-volume shipments. Services trade and investment restrictions Trade in services in Malawi faces significant restrictions that may be hindering growth of the high-productivity services sector and of FDI. Compared with other African coun- tries, Malawi is among the most restrictive countries, according to data from the OECD’s Services Trade Restrictiveness Index (STRI). The STRI indicates that Malawi is relatively more protectionist in most sectors, with the exception of transport and finance. This sug- gests potential for reform, particularly in sectors such as telecommunications and profes- sional services. The STRI shows that Malawi has among the lowest scores, particularly in terms of ICT, professionals, health, distribution, and tourism. It also ranks below most of its peers in terms of finance, transport, and communications. Out of the broad set of regulations and measures available in the database, around 150 of them were selected to compute the index. The STRI provides comparable information on services trade policies under three out of the four modes of supply in the General Agreement on Trade in Services (GATS), namely Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 109 cross-border supply (mode 1), commercial presence (mode 3), and presence of natural per- sons (mode 4). In addition, consumption abroad (mode 2) is available for health services. Malawi’s relatively poor performance in attracting FDI is correlated with its relatively high degree of legal barriers to FDI. Compared with its regional peers in the Southern African Development Community (SADC), Malawi ranks in the lowest quartile on the SADC Investment Climate Scorecard, which is based on the OECD FDI Regulatory Restrictiveness Index. Malawi’s level of FDI restrictiveness is over three times higher than the global aver- age on the same OECD methodology. Some of Malawi’s regulatory barriers to FDI driving these results include limitations on commercial land ownership and leasing, and limits on foreign equity ownership in several sectors including telecommunications, pharmacies, domestic water transport, and radio and TV broadcasting. The domestic capacity for many higher-skill services is weak in Malawi and requires the importing of expertise from abroad. By facilitating the importing of services, Malawi can enhance the productivity and competitiveness of domestic firms. This approach will not only bridge the gap in services availability but also empower domestic firms to leverage the expertise and resources offered by foreign service providers, thereby boosting their over- all performance. The increase in the importance of services means that sectoral linkages between services and goods production will grow stronger. This is particularly important in the case of Malawi, where services play an important role in the economy in terms of their value added to GDP and their employment shares (van de Marel and Shepherd 2020). HOW MALAWI CAN ACHIEVE ITS EXPORT POTENTIAL Malawi can leverage the AfCFTA to bring significant benefits The benefits of joining the AfCFTA can be significant for Malawi. Intra-AfCFTA trade is predicted to increase with the full implementation of the trade agreement (World Bank 2020b). This offers an opportunity for Malawi to expand its trade beyond its proximate mar- kets. African countries have identified regional trade integration as a key driver of economic development and this can be an important building block for the overall economic devel- opment of the continent. Malawi is a member of several regional trade agreements, includ- ing the SADC and the COMESA, two partially overlapping regional agreements that have a Common External Tariff (CET). The country also became a member of the AfCFTA in 2021. To reap the welfare benefits of the AfCFTA, trade facilitation and elimination of NTBs will be important for Malawi. Specifically, for Malawi, the removal of NTBs is projected to yield a positive impact on real incomes of 1.2 percent by the year 2035, while the adjust- ment of AfCFTA tariffs is expected to result in a welfare im- pact of 0.6 percent, compared with a baseline without an Figure 4.24  Real income (welfare) implications from AfCFTA (Figure 4.24). In addition, the implementation of AfCFTA implementation for Malawi in 2035 the AfCFTA is expected to result in a 3.7 percent reduction Change relative to the baseline, percent in moderate poverty rates (at PPP US$5.50/day) and a 1.6 percent decrease in extreme poverty rates (at PPP US$1.90/ Reforming tariffs, NTMs and trade facilitation day) over the same time frame. Tariffs and NTMs More specifically, Malawi stands to reap significant ben- Tariffs only efits in several sectors — in particular processed food, 0 0.0 0.5 1.0 1.5 2.0 agriculture, and trade services. By 2035, the cumulative change in output compared with the baseline scenario is Source: World Bank, 2020. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 110 projected to reach US$758 million (Figure 4.25), with particular gains for the agro-process- ing and trading sectors, as well as for textile and apparel producers. However, continental integration through the AfCFTA could significantly hurt certain manufacturing sub-sectors. In turn, ensuring that appropriate trade adjustment mechanisms are in place to cushion those losing out from continental integration will be particularly important. Figure 4.25  Output changes due to the AfCFTA in 2035 By economic activity, cumulative difference with respect to baseline scenario, US$ (‘000,000) Processed foods Agriculture Trade services Textiles and wearing apparel Other financial services Insurance, real estate services Wood and paper products Communication services Road and rail transport services Water transport services Air transports services Construction Petroleum, coal products Recreational and other services Other business services Education, health, public sector Energy intensive manufacturing Chemical, rubber, plastic products Fossil fuels Manufactures, n.e.s. −600 −400 −200 0 200 400 600 800 Source: World Bank 2022. An analysis using the Tariff Reform Impact Simulation Tool (TRIST) 32 shows that the implementation of the AfCFTA agreement in Malawi is expected to have minimal im- pact, if any, on import flows and customs tax revenues (Jammes 2023). This outcome can be attributed to two factors: first, the low proportion of imports originating from African countries, excluding South Africa, which constrains the potential for significant import growth from AfCFTA member countries. Second, Malawi already maintains a low lev- el of effective tariff protection, leaving little room for further tariff reduction and subse- quently limiting the impact on customs tax revenues. In turn, the fiscal revenue impact of AfCFTA implementation on Malawi is relatively low, with a 7 percent loss in tariff revenues (Table 4.2). In the absence of South Africa, this impact decreases to a mere 0.1 percent de- cline. The overall change in revenues is less than 1.5 percent. 32.  TRIST is an Excel-based tool that can be used by policy makers to analyze the adjustment implications of trade reform (Brenton et al. 2009). It is free and easy to use, transparent, with a simple underlying trade model, and flexible, in that it can quickly address different trade policy scenarios. While TRIST was developed to simulate the short term implications of trade reform on fiscal revenue, TRIST can be extended to estimate the initial impact of trade reform on domestic production and employment in import competing sectors, as well as on poverty. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 111 Table 4.2  Expected impact of full AfCFTA implementation on Malawi’s imports, revenues and tariff rate Impact on imports Collected Tariff rate Percent change in imports 0.1 Collected applied tariff rate pre 2.9 Percent change in tariff revenue -7.0 Collected applied tariff rate post 2.9 Percent change in Total revenue -1.5 Percent change in collected applied tariff rate -0.1 Source: Jammes (2023). In addition, Malawi has the potential to broaden its network of Preferential Trade Agreements (PTAs), which can lead to substantial benefits, especially when these agree- ments are deeper. Notably, the EU, China, the United States, and the Republic of Korea, among other developed nations, exhibit similar demand and supply patterns in relation to the Malawian market. Strengthening trade ties with these countries (and particularly with the EU, China, and the United Kingdom), can have a significant impact on both GDP and exports (Figure 4.26 and Figure 4.27). Positive but smaller effects can also be expect- ed from stronger trade linkages with the United States, Japan, and the Republic of Korea. Currently, for example, 30 percent of Malawi’s export value does not enter the United States tariff-free, and across major export destinations Malawi faces an applied weighted tariff of over 5 percent on its products, whereas Mozambique, Tanzania, and Zambia have rates closer to zero (International Finance Corporation 2021). Figure 4.26  Deeper trade agreements could lead Figure 4.27  Malawi could increase exports significantly to GDP gains through deeper trade agreements, especially with the EU Change in GDP, percent Change in exports, percent EU28 EU28 China China United Kingdom United Kingdom United States United States Japan Japan Korea, Republic of Korea, Republic of 0 0.1 0.2 0.3 0.4 0.5 0.6 0 4 8 12 16 20 Deep Medium Shallow Deep Medium Shallow Source: Calculation based on World Bank Deep Trade Agreements Source: Calculation based on World Bank Deep Trade Agreements Toolkit and Database 2023. Toolkit and Database 2023. Deeper forms of trade integration can reduce trade costs and NTBs as they go beyond traditional trade policy. Such agreements would enable institutional and policy reforms required to facilitate operations fragmented across borders. Deep trade agreements cover legal and regulatory frameworks, harmonize customs procedures, and establish the rules related to intellectual property rights. These would contribute to reducing the risks asso- ciated with GVC investment and facilitate the establishment of flexible networks of firms required for GVCs to thrive. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 112 Supporting the development of emerging agro-processing value chains In recent years, new agricultural export crops have shown significant potential to support increased and more diversified exports, as well as to increase upstream and downstream value addition. This has been driven by a number of lead firms involved in the tobacco, tea and sugar subsectors investing in macadamia, legumes, and groundnuts and developing im- proved seed varieties to commercialize. These firms can build on their long-term relation- ships with contract famers, as well as their existing buyer relationships and access to new technologies (see Chapter 5). In line with existing efforts to further commercialize agricul- ture and move away from a dependence on smallholder production (see Chapter 2), these recent efforts could significantly boost exports while also developing up- and downstream value chains. Considering the current dominance of tobacco, any growth in these other val- ue chains would make an important contribution to diversify Malawi’s export basket. Soybeans represent a particularly notable example of this diversification process, emerg- ing as the second-largest export in 2021 and the most advanced value-adding sector in Malawi (see also Chapter 5). In 2013, only US$0.5 million worth of soybean was export- ed, equivalent to just 0.1 percent of tobacco exports. Nationwide production stood at just 80,000 tons. This was mostly consumed at the household level, as an additional ingredient for porridge, and purchased by the three small processors at that time, which only had a capacity for 40,000 tons of raw beans. These processors were mainly producing cooking oil, cake as a by-product for chicken feed, and small amounts of soya chunks. In 2023, how- ever, soybean production is estimated by the Government to stand at 380,000 tons.33 This level of production would equate to a 17-percent compound annual growth rate over the past 10 years. Meanwhile, exports surged to US$133 million in 2021, equivalent to 30 per- cent of tobacco exports. By comparison, sugar and tea only accounted for 17 and 16 per- cent of tobacco exports, respectively. It is estimated that by the end of 2023, Malawi will have installed processing capacity at the industrial level (excluding cooperative-level and household-level processing) of 700,000 tons of raw beans per year, an 18-fold increase compared with 10 years ago. There are now seven major processors, and an eighth con- templating entry. Products being produced on an industrial scale are soy chunks, soy lec- ithin, corn-soy blend, chicken feed, fish feed, and cooking oil. Soya milk production has started at the household and cooperative levels and is being assessed for its potential for production on an industrial scale. Soybean is arguably the only value chain at present that has the potential for multiple downstream products to be viably produced in-country. This has created the foundation for Malawi’s first mature industry that includes extensive processing by multiple players, and not just raw or semi-raw commodities (as is the case with sugar, tea, coffee and many other crops). While it is now the most advanced industry to catalyze a wider broad-based economic transformation, the soybean industry cannot drive this industrialization process alone and other sectors, such as groundnuts, food processing and the services sector, will need to develop similar capacities. Macadamia and groundnuts have also become a dynamic export growth sectors. By the end of 2023, Malawi will have 10,000 hectares of planted macadamia trees, positioning it to be one of the top global producers. The latest figures place Malawi as the eighth-largest macadamia exporter globally. Currently, macadamia nuts are husked and exported in their 33.  Production is hard to estimate accurately because of extensive rust disease on the downside and an increase in cultivated land on the upside. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 113 shells for cracking in South Africa. However, at least one producer, Gala, is exploring invest- ing in a local cracking facility, a US$20 million investment that would increase value added in country. Production and exports are expected to grow in the coming years, as additional trees mature and yields improve. This will require continued support for cracking nuts and related infrastructure, livelihood alternatives for households around estates to deter theft and conflict, and a stable macroeconomic policy environment that enables continued im- porting of materials needed for investment. This will help to ensure the ability of key value chain actors to engage with smallholder farmers. Malawian groundnuts are also increas- ingly processed for international markets, building on production arrangements from the tobacco value chain. Newly released varieties have been released and commercial produc- tion of inputs is commencing in conjunction with quality assurance processes along the value chain that ensure that Malawian groundnuts meet stringent international standards. To ensure the continued thriving of these new export sectors, it will be important to create an enabling environment for export growth. This includes the development of a common, long-term vision and roadmap, and frequent dialogue between industry and the Government as well as among the main industry actors, focused on achieving export growth and (where feasible) replacing existing imports. The Government also needs to strengthen consultations and collaboration with industry experts so that the policies it imposes do not have consequences that constrain production and export growth. Furthermore, policy uncertainty around emerging bills and regulations that fail to take into account the needs of the industry could undermine investment. This includes, among others, recent legisla- tive initiatives around the Foreign Exchange Bill, the Tobacco Control Act, the Land Act, the Crops Bill, and export mandate regulations. It will also require the continued imple- mentation of the Control of Goods Act (COGA) and its application to a wider range of crops (see Box 4.2). As Chapter 5 shows, such reforms in the governance of productive agricul- tural sectors have the potential to galvanize broader macroeconomic improvements and could be replicated in further agro-processing sectors. Box 4. 2  Recent trade policy reforms could contribute to commercialization and increased investment in agribusiness, but have been partially implemented In part, the recent dynamism in the agribusiness sector there has been some inconsistency in its implementa- is also the result of policy changes to remove arbitrary tion, as well as continued evidence of ad-hoc measures. export bans. In the past, these discouraged agricultural com- The approach relies on comparing the national food bal- mercialization but the Government has taken an important ance sheet with national food requirements, and domes- step to revise the Control of Goods Act (COGA) to improve tic prices with export parity prices, as provided for in the predictability. The previous COGA provided discretion- threshold for safeguarding food security in the Act. In ary powers to the Ministry of Trade and Industry to control December 2021, the Government issued an order allow- the import and export of goods into and from Malawi. This ing for maize exports. While this represents an important often led to the ad-hoc and untransparent implementation reform to regulate exports based on clearly defined pub- of import and export controls, resulting in unpredictability in lic interest grounds and data, there is still a need for further the market, high levels of discretion by officials, and deterring consolidation of this process. The institutional framework increased investment and trade. Ad-hoc export bans con- that underpins implementation needs to be strengthened tributed to Malawi having the highest maize price variability to allow for timely generation of accurate data, mecha- in the region (Edelman and Baulch 2016). To provide clear and nisms for coordination and the sharing of data among rel- transparent procedures for exports and imports, Parliament evant stakeholders, awareness of the provisions of the passed an amended COGA on May 15, 2018, and gazetted amended COGA, capacity of staff in the relevant ministries, regulations on July 26, 2020, thereby operationalizing the departments and agencies, and the effective monitor- new Act. The regulations to the Act clarify thresholds that ing of informal exports. There is also a need to ensure that must be met for bans or licensing measures to be permitted, public-private dialogue is sustained to support implemen- based on specific public interest justifications. tation. Of particular concern has been the continued inci- With the amended COGA, the Government has initiated dence of ad-hoc measures, such as the recent revocation a data-driven approach to maize trade policy, though of export licenses. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 114 Creating the foundations for mining to generate exports and revenues Malawi’s mining sector can play a key role in driving export growth and addressing fiscal and foreign exchange constraints. This is recognized in the Malawi 2063, which sees mining as a central driver of industrialization, especially if sufficient levels of investment in domestic value addition can be achieved. However, currently the sector still plays a rel- atively minor role, accounting for less than 1 percent of GDP, and with exports averaging between US$100 million and US$158 million in recent years. In the coming years, Malawi’s mining sector holds promise as a crucial catalyst for eco- nomic and social development. Recent discoveries of energy transition minerals, includ- ing rare earths, niobium, rutile, and graphite, present opportunities for increased exports (and in turn foreign exchange generation), revenues and growth (Malunga 2023). Demand for these minerals has been significantly increased by the energy transition requirements driven by climate change. In addition, demand for uranium has surged due to Europe’s energy shortages, which have Figure 4.28  Seven priority mining projects reshaped the outlook for nuclear power. Demand for these Mining projects minerals is expected to continue growing, thus aligning with Main cities Malawi’s mining potential, resources, and project profiles. Railways Kayelkera Karonga uranium Currently, seven projects are moving ahead, with many of these likely to produce the so-called “green miner- als” necessary to support the energy transition (Figure 4.28). This includes the following projects: • Feasibility study completed: Rutile in Kasiya, rare earths Muzu in Songwe, niobium in Kanyika; • Feasibility study ongoing or at advanced exploration: Graph- ite in Malingunde, heavy mineral sands in Makanjira and rare earths in Kangankunde. Kanyika niobium Finally, the Kayelkera uranium mine may be recommis- Kasungu sioned in light of renewed investor interest. Makanjira Kasiya ilmenite The nation’s robust mining portfolio is likely to at least par- rutile tially materialize. There are proven, declared, and reviewed reserves, with investment decisions nearing and all projects Lilongwe Malingunde progressing. Furthermore, most of these projects are charac- graphite Mangochi terized by relatively low technological complexity and require well-known and standardized processes in terms of extrac- Balaka tion, processing, and metallurgy. They are also of manageable Kangankunde scale, without the complexities associated with mega projects. rare earths The current mining projects have the potential to attract Songwe rare earths a large increase national industrial investment. There is a Blantyre strong potential for increasing the annual mining contribution to GDP substantially, including through indirect contributions to other sectors and through the supply of rural infrastruc- ture. Minerals produced from across these projects has the potential to gradually replace tobacco as Malawi’s dominant export over the medium term. Mining company estimates Source: Mulunga (2023). Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 115 indicate that Kayelekera could resume production as early as 2025, and other projects could come online from 2027 onward. However, past mining projects in Malawi and elsewhere in the region have often failed to deliver on their promise and it will be important to ensure that Ma- lawi does not fall victim to the “presource curse”.34 While projections from mining firms indi- cate that the sector could play a significant role in the economy, these projections need to be treated with caution at this stage, given the many variables that could influence the material- ization of these benefits. Several factors could impede the transformation of this potential into tangible benefits for Malawi’s economy, and its contribution to the economic and social development of the country. The region provides plentiful examples of countries that had limited success in converting subsoil wealth into above ground sustainable prosperity (Cust and Zeufack 2023). Salient factors for Malawi include a lack of adequate infrastructure needed for pro- ject development, a tax regime that does not sufficiently align mining company interests with a public interest in maximizing resource revenue, and long processes for obtaining mining permits, licenses, and agreements, as well as environmental and social challenges associated with certain projects. As revenues start to materialize Malawi will also have to decide how to manage them, as the link between mining rents and long-term growth and prosperity can be vary. The fiscal regime can become a contentious issue within Mining Development Agreements, leading to prolonged negotiations. The design of an appropriate fiscal regime that incentiv- izes production while maximizing the financial benefit for the public is challenging and most countries in Sub-Sahara Africa fail to capture the full share of resource rents (Cust and Zeu- fack 2023). Often there are design trade-offs between inflexible fixed-rate royalties which are relatively easy to administer and more progressive profit- or cash flow-based taxes which in theory are better able to calibrate the tax rate to the extracted rents but which are difficult to enforce (Fleming, Manley, and Lassourd 2022). Malawi’s current tax regime is likely to yield very different effective taxes on the profits of different mining projects. Additionally, projects are often delayed as elements of the fiscal regime, rather than being a transparent and fixed proposition by the law, become a negotiation issue. The review and approval process of en- vironmental and social impact studies and obtaining mining licenses can also be extended. Access to infrastructure also poses challenges for project development in Malawi, particularly regarding roads, ports, and energy (Malunga 2023). This aspect is critical for at least three projects: Kayelekera Uranium (requiring power infrastructure), Kanyika Graphite (requiring power and road infrastructure), and Makanjira Heavy Mineral Sands (requiring power and road infrastructure). A further risk factor relates to social and envi- ronmental management requirements. Three projects (Kanyika Niobium, Kasiya Rutile, and Malingunde Graphite) need resettlement processes, which involve significant risks and po- tential impacts that need to be carefully managed, and consequently might impact project schedules and expected costs. In addition, part of the Malingunde Graphite project area is located in wetlands, further complicating environmental management. Moving ahead it will be important to ensure that these assets belonging to the country are not squandered, and that this opportunity is seized. Production delays are common and price fluctuations can create significant uncertainty around likely revenue and export 34.  The “presource curse” refers to lower growth and debt crises following resource discoveries due to elevated expectations which can generate pressure to borrow and spend (Cust and Zeufack 2023). Subsequently, delayed production, falling commodity prices, or less than expected taxes can all lead to fiscal disappointments. The risk of fiscal challenges is compounded in countries with weak institutions. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 116 outcomes. This means incentivizing investment, ensuring that the country maximizes the fiscal gains from these resources over many years, and that these resources are spent ef- fectively to benefit the population. This will require a stable fiscal regime, as well as care- ful assessments of the potential impact of different incentives. The Government is currently reforming the legal and institutional structure to support the mining sector. In this context, it will be important to ensure that expertise is sought to support negotiations and that all contracts are made public. Malawi’s participation in the Extractives Industry Transparency Initiative (EITI) can create an important institutional framework in this regard. Eliminating trade restrictions and addressing logistics and trade facilitation constraints along key corridors Given its dependence on its neighbors both as export markets and to reach ports, reducing trade and transport costs will be essential for Malawi to leverage trade for growth. This will require accelerating and deepening many ongoing trade facilitation and connectivity re- forms. Given the large number of ministries, departments and agencies (MDAs) involved, it will also require strong cross-government cooperation and working closely with the private sec- tor to better understand the core constraints that firms face when importing and exporting, as well as strengthening cooperation with neighboring countries, in particular Mozambique. The large prevalence of NTBs both behind and at the border make taking advantage of export opportunities particularly challenging and constrains the development of regional value chains. Moreover, the process around new policies and measures, which impact firms and producers that would like to export, strongly discourages the domestic and foreign investment necessary to develop new areas of comparative advantage. Better understanding the impact of these barriers on different sectors and types of firms is essen- tial. The significant prevalence of smuggling is often used as a justification for imposing increased regulation and further procedures for exporting firms (see Box 4.3). However, these often have the unintended consequence of deterring law-abiding firms from export- ing while shifting more trade into the informal sector. Central to increasing trade this will be advancing on trade facilitation reforms. Key pri- orities that have been identified include the implementation of the Malawi National Single Window, the simplification of trade documentation (especially for smaller traders), strong- er risk management systems so the Malawi Revenue Authority (MRA) can focus limited re- sources on the riskiest imports (for example, through expanding the Malawi Authorised Economic Operator Program), and the implementation of regional transit procedures. Automation of trade documentation and procedures is needed to lower transaction costs by enabling data sharing. For Malawi, sharing data with Mozambique would bring signif- icant benefits, as data would be captured in the port and transmitted to the point of final clearance. These reforms would contribute to ensuring that the significant investment that has been made in recent years to develop and operationalize One-Stop Border Posts can in fact lead to reductions in trade time and cost. Finally, the ongoing modernization of the Nacala Corridor has the potential to signif- icantly reduce trade and transport costs. These efforts will increase the reliability and operational efficiency of the corridor and the port, to provide increased comfort for firms to rely on this service and shift from road to rail, especially for transporting the country’s agricultural exports, as well as potentially mined resources, and reduce the costs of bulk imports such as fertilizer, fuel, and consumer goods. The recently established Nacala Devel- opment Corridor Management Committee can support progress in these areas, including Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 117 Box 4.3  The Drivers of Smuggling at Malawi’s Borders Measuring illicit trade is difficult, but there are indi- money laundering, avoiding the costs of bribes, and avoiding cations that it plays a significant role in Malawi. the potential costs of punishment and customs enforcement. Methodologies to estimate illicit trade include looking at While the to smuggle imports is typical for the region, mirror trade statistics (differences in the reported exports Malawian exporters are also incentivized to resort to illicit of the exporting country and the reported imports of the trade. With a weighted mean tariff rate on imported goods importing country), abnormal pricing, and studying asso- of 6.2 percent in 2020, Malawi is roughly in line with regional ciated illicit financial flows (Cobham and Janský 2020). norms (5.7 percent in Sub-Sahara Africa in 2017). However, These methodologies are also sensitive to mis-invoic- exporters face multiple incentives to smuggle exports, includ- ing, which is also likely to be prevalent in Malawi’s trade. ing (i) until recently, an implicit export tax exerted through the Anecdotal evidence such as reported convictions and mis- exchange rate regime, especially in combination with man- matching mirror trade statistics point at the significance of datory conversions at the official exchange rate, (ii) high and smuggling in Malawi. therefore costly non-tariff barriers, (iii) below-market-price price controls and subsidies on key commodities including Traders tend to resort to smuggling when the benefits maize, fertilizer and increasingly fuel, and (vi) stringent capi- of trading through official channels do not outweigh the tal controls. Enforcement measures can deter some smug- costs. Typically, smuggling predominantly affects imports, gling, but many are willing to continue to take legal risks and where traders attempt to avoid taxes and tariffs. Smuggling pay bribes when the financial and time savings of remaining exports is often a specific response to policy interventions, outside the formal trading system are large. At the same time, such as subsidies, implicit or explicit export tariffs, and costly care must be taken to not make exporting even more costly non-tariff barriers. These need to be significant enough to by increasing onerous compliance measures that further outweigh the benefits of trading officially. These benefits increase the incentive to revert to illicit trade. Scaling up risk- include the creation of stable, longer-term trade relationships based approaches to trade, where much of the enforcement between companies, the provision of documents that certify action is focused on transactions most prone to fraud, is one the origin and specification of goods, avoiding the costs of way to minimize costs for compliant firms. by facilitating agreement through a framework for monitoring corridor performance, de- veloping corridor improvement initiatives and fostering economic development along the corridor (World Bank 2023). Lastly, the revitalization of the Sena line to the port of Beira could strengthen this corridor, improving multi-modal network connectivity and increas- ing corridor competition. POLICY REFORMS TO INCREASE EXPORTS AND BRING IN FOREIGN INVESTMENT As shown in this chapter, there is potential to significantly grow exports, if the right pol- icy choices are taken to encourage investment and facilitate trade. This will require the sustained implementation of policies geared toward export-led growth, rather than creat- ing ever more barriers to trade. To ensure the effectiveness of such policies, it is essential to focus on the needs of the private sector to drive this agenda. It is recommended that national trade and industrial policies currently under review incorporate these principles. Key recom- mendations to strengthen the role of trade as a drive of growth are summarized in Table 4.4. Table 4.4  Top five trade policy priorities Short-Term Actions Medium-Term Implementation Policy Issue (the next 3 – 6 months) (before the end of 2025) 1. Addressing low foreign exchange The RBM continues the progression The RBM publishes its foreign exchange availability and high rates of illicit toward a sustainable, well-supported, allocation process and makes use of of- trade and smuggling and market-based exchange rate ficial systems attractive for all foreign ex- regime, and phases out mandatory con- change transactions by ensuring access version requirements. at a transparent and competitive rate, while minimizing direct and indirect costs and enforcing sanctions against violations. Chapter 4   Increased Trade Can Help Stabilize the Economy and Drive Industrialization 118 Short-Term Actions Medium-Term Implementation Policy Issue (the next 3 – 6 months) (before the end of 2025) 2. Incentivizing exports by reducing The Ministry of Trade and Industry The government together with the legis- non-tariff barriers reviews existing NTBs and develops a lature ensures through enhanced inter- strategy for phasing these out, especially nal review and external consultations in sectors where Malawi has a compar- that all future trade policy measures are ative advantage (agriculture, agro-pro- developed jointly with industry and focus cessing, mining, tourism) on maximizing export growth, attracting investment, and incentivizing exporters to use official channels. 3. Enhancing the attractiveness of The government together with the legis- The Ministry of Lands, Housing and Malawi to export-oriented and lature ensures that any legislation under Urban Development together with the import-substituting FDI in sectors discussion such as the Crops Bill, and legislature and the Ministry of Trade and where the country has a compara- export licensing procedures, create a Industry aligns foreign ownership and tive advantage conducive and predictable policy envi- lease structures of land to international ronment that supports domestic and for- standards and streamlines the process eign investment and are aligned with the for obtaining licenses and permits. implementation of the COGA. 4. Strengthening the foundations for Accelerate the development of mining Ensure the fiscal regime, revenue man- the development of an efficient and projects under negotiation by identify- agement instruments, environmental transparent mining sector that can ing critical bottlenecks, streamlining and and social management standards, and drive growth and address fiscal and expediting permitting processes, and community development agreements foreign exchange constraints. improving government coordination and support quick and transparent contract capacity to effectively negotiate multiple negotiations that result in enduring and agreements concurrently. fair agreements for Malawi and facilitate the attraction of new investments. 5. Supporting regional integration The Ministry of Trade and Industry The Ministry of Trade and Industry to facilitate the development of implements the National Single Window adopts and implements agreed AfCFTA regional value chains in priority and and Coordinated Border Management at protocols with a time-bound plan, facil- comparative advantage sectors and key border crossings, cross-border tran- itates digital trade, and explores the improving trade facilitation systems sit and data-sharing agreements, as well negotiation of new trade agreements to reduce trade costs, strengthen as risk management measures such as with priority trade partners. compliance, and increase revenues the use of Inland Examination Centers, Authorized Economic Operators, and Post Clearance Audit at key border agencies. 119 Can This Time Be Different? CHAPTER 5 Building on Past Successes to Kickstart Growth KEY FINDINGS: 1 Unlocking economic growth and developing state capacity requires the alignment of political incentives with development goals. While Malawi has comparatively high levels of voice and accountability, political stability, and rule of law, there is room for improve- ment in regulatory quality and implementation, control of corruption and rent-seeking, and the effectiveness of government to set an enabling environment for private sec- tor-led growth. 2 The state has a central role in creating the conditions for inclusive growth and job cre- ation. However, in recent decades, decentralized short-horizon rent-seeking and an imperative to maintain deals-based support have perpetuated high levels of corruption and governance outcomes that are unconducive for growth. In addition, isomorphism hinders government effectiveness by prioritizing the appearance of good practice over underlying arrangements on how government decisions are made and implemented. 3 Eleven case studies highlighted in this chapter show significant improvements in govern- ance arrangements in Malawi’s recent history. These improvements relate to supporting the growth of agricultural value chains, managing public entities, and delivering public programs. Achieving these outcomes required a change from business as usual, including through empowered and committed leadership, effective institutional management, align- ing financial incentives with performance, and fostering strategic public-private dialogue. 4 Scaling success by building on these existing cases and applying lessons to other sec- tors and programs can directly promote more rapid economic growth. Strengthened productive sectors will empower the Malawian private sector. This private sector in turn can hold macroeconomic policy-making to account, while being a key beneficiary of enhanced macroeconomic governance. Similarly, better performing public enterprises will mean that they become less of a drain, while some can become increased contribu- tors to the country’s public finances. This will help enable necessary fiscal reforms. 5 Accelerating Malawi’s growth will require a better business environment and policy pre- dictability that incentivize the private sector to invest. Improved management of public resources will need to be anchored by restored macroeconomic stability and debt sus- tainability. Enhancing the investment readiness of state-owned enterprises through targeted governance improvements can make them sustainably deliver better on their mandates. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 120 FOCUSING ON THE “HOW” OF ENABLING GROWTH THROUGH REFORMS Central to the premise of this CEM is the understanding that aligning political incen- tives with developmental ends is key to unlocking rapid and sustained growth (World Bank 2017). The previous four chapters have shown the urgency of comprehensive macro- economic and structural reforms, and laid out a comprehensive set of policy recommen- dations. That effective governance and institutional arrangements are central to economic development is one of the most consistent findings in development economics and political science. While at times different names have been attached to this, such as “inclusive in- stitutions” in Acemoglu and Robinson (2012) or “inclusive elite bargains” in Dercon (2022), there is near unanimity that the traditions and institutions by which authority in a country is exercised constitute the root cause of differential economic development. The governance of a country is shaped by structural conditions, historical legacies, and the evolution of its political settlement. Malawi’s political settlement is characterized by competition among a small elite ensuring the stable flow of rents, fragmentation along co-ethnic, regional, and traditional authority lines, high dependence on development partners, and a narrow so- cial contract structured around food security, and maize in particular (World Bank 2018). According to the World Bank’s Worldwide Governance Indicators (WGI), Malawi is a peaceful, democratic, and lawful nation compared to its regional peers (Figure 5.1).35 Malawi scores well on the Voice and Accountability, Political Stability and No Violence, and Rule of Law dimensions. Based on a definition of governance as “the process through which state and nonstate actors interact to design and implement policies within a given set of formal and informal rules that shape and are shaped by power” Malawi has solid foun- dational characteristics on those three dimensions (World Bank 2017, 41). However, Malawi fails to translate these advantageous overarching arrangements into other governance dimensions that directly affect the economy. Malawi’s current po- litical settlement creates strong incentives for policies that address short-term popular needs, while undermining the ability to credibly commit to long-term structural reforms and a fiscal trajectory needed to spur productive structural transformation. This is ex- pressed through scores on the Government Effectiveness, Regulatory Quality, and Control of Corruption dimensions, which have been largely on a par with regional peers over the past few decades. Government Effectiveness and Regulatory Quality have also declined rather than caught up with those of higher performers, while the Control of Corruption dimension oscillates strongly, driven by the revelation of major corruption scandals and political promises to address graft. As Chapter 1 shows, this governance performance is as- sociated with growth outcomes that are in line with that of many structural peers, but in- sufficient to reduce poverty levels. To advance from a difficult starting point, Malawi needs to align governance arrange- ments with the aim of accelerating economic growth in strategic areas. As a landlocked, resource-scarce country, Malawi needs to efficiently and productively organize its main re- source: its people. To excel economically, Malawi will need to explore governance strate- gies that enable it to make more of its endowments, such as being “a Haven for the Region” 35. The WGI are a set of six aggregate indicators that measure the quality of governance in countries worldwide (Kaufmann, Kraay, and Mastruzzi 2010). The indicators cover over 30 data sources on the perceptions of citizens, experts, and professionals. These include insights from the Afrobarometer, expert judgements from organizations such as Freedom House, and professional opinions such as those expressed in the World Bank’s and African Development Bank’s Country Policy and Institutional Assessments. The indicators are reported in standard normal units ranging from approximately -2.5 to 2.5 and explicitly account for margins of errors by providing confidence intervals. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 121 or creating “a Transparent and Investor-Friendly Environment for Resource Prospecting” as Paul Collier (2007, 60 – 62) describes options to become wealthier for countries such as Malawi.36 Among aspirational peers discussed throughout this CEM, Rwanda probably best exemplifies commitment to these strategies. While leaving much to be desired, especially on the Voice and Accountability dimension, it an extremely difficult starting position following the 1994 genocide with strong Regulatory Quality, Control of Corruption, and Government Effectiveness, outperforming Malawi and the region by some margin on these dimensions. Figure 5.1  While excelling over its peers on some dimensions, on others Malawi’s governance arrangements are just average Worldwide Governance Indicator scores with 90% confidence interval Voice and Accountability Political Stability and No Violence Rule of Law 0.5 0.5 0.5 0 0 0 -0.5 -0.5 -0.5 -1.0 -1.0 -1.0 -1.5 -1.5 -1.5 19 6 20 8 20 0 20 2 04 20 6 20 8 20 0 20 2 14 20 6 20 18 20 0 22 19 6 20 8 20 0 20 2 20 4 20 6 20 8 20 0 20 2 20 4 20 6 20 18 20 0 22 19 6 20 8 00 20 2 04 20 6 20 8 20 0 20 2 20 4 20 6 20 18 20 0 22 0 1 0 1 0 1 0 1 1 9 0 9 0 9 0 9 0 1 9 0 1 9 0 1 0 1 2 0 1 2 1 2 20 19 19 19 20 20 20 Regulatory Quality Control of Corruptio Government Effectiveness 0.5 0.5 0.5 0 0 0 -0.5 -0.5 -0.5 -1.0 -1.0 -1.0 -1.5 -1.5 -1.5 19 6 20 8 20 0 20 2 04 20 6 20 8 20 0 20 2 14 20 6 20 18 20 0 22 19 6 20 8 20 0 20 2 20 4 20 6 20 8 20 0 20 2 20 4 20 6 20 18 20 0 22 19 6 20 8 00 20 2 04 20 6 20 8 20 0 20 2 20 4 20 6 20 18 20 0 22 0 1 0 1 0 1 0 1 1 9 0 9 0 9 0 9 0 1 9 0 1 9 0 1 0 1 2 0 1 2 1 2 20 19 19 19 20 20 20 Malawi Sub-Saharan Africa Source: Staff calculations based on World Governance Indicators, 2022. This chapter focuses more on the “how” than the “what” of enabling growth through reforms. It addresses the question of how and why Malawi sustains governance arrange- ments promoting a low-growth equilibrium despite strong performance on some key indi- cators, and explores how such constraints can be overcome on the basis of past growth and 36.  These strategies are intended to imply, in the case of the former, setting policies clearly superior to those of neighboring countries, in turn attracting regionally traded services and exporting them in the region. In the case of the latter, it suggests establishing an adequate governance framework to not fall victim to the resource curse for low-income countries that have significant amounts of undiscovered resources. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 122 reform successes. The next section looks at explanations for Malawi’s regulatory shortcom- ings, corruption, and lacking government effectiveness, drawing on the academic and poli- cy literature. It identifies fraught state-business relationships, decentralized short-horizon rent-seeking, and isomorphism as key drivers. The third section covers 11 cases of success where these constraints were overcome in growing agricultural value chains, the reform of public entities, and in effectively implementing sectoral strategies. The fourth section outlines a framework for how enhanced sectoral performance interacts with macroeconomic govern- ance to promote more rapid economic growth. Because of ample evidence that financial in- centives matter for effective governance, the fifth section discusses how to finance Malawi’s growth ambitions in a context of very limited fiscal space. The final section translates these findings into an actionable pathway for enhanced governance to drive economic growth. The scholarly literature acknowledges that Malawi can deliver growth when incentives are aligned.37 Malawi has had periods of growth (as discussed in Chapter 1), and there are economic sectors that have been and continue to be conducive to growth. The 11 case stud- ies in the following section discuss such areas of effectiveness. REGULATORY WEAKNESSES, CORRUPTION, AND THE LACK OF GOVERNMENT EFFECTIVENESS HAVE STRUCTURAL CAUSES Three interlinked issues have been identified in the literature on Malawi’s political economy of growth as central governance constraints: (i) fraught state-business rela- tionships; (ii) decentralized short-horizon rent-seeking; and (iii) isomorphism. Mistrust between the state and business interests is rooted in Malawi’s history and political arrange- ment based on narrow patronage deals. This leads to a disinterest in creating opportunities for private sector-led growth, a lack of state capability for economic growth, and is reflected in overbearing regulation. At the same time, political elites are focused on the extraction of rents in the short term, rather than enabling the growth of available rents. This is reflected in endemic and inefficient types of corruption. In addition, while committed to making pro- cesses look legitimate and in line with international best practices, this often only happens at a surface level with underlying informal arrangements unchanged. The literature calls this “isomorphism” and identifies it as a driver of government ineffectiveness. Development partners have expended significant effort to improve governance arrangements, but these have often provided pre-formulated fixes without sufficiently adapting these to Malawian dynamics. Such approaches have often driven isomorphic institutions that don’t fulfill their function, enable corruption, and shield the Government from pressures to improve. Fraught State-Business Relationships Lead to Bad Regulation Between independence and the 1990s, Malawi’s economy was characterized by a dom- inance of the state in the conduct of business (Chingaipe and Leftwich, 2007). Key export sectors — the drivers of short periods of growth take-off — were closely regulated by the Gov- ernment or had strong involvement by state-owned enterprises (SOEs). Press Holdings, a com- pany formed to run the Malawi Congress Party newspaper, became a sprawling conglomerate 37.  Cammack and Kelsall (2011), for example, find that a disciplined technocracy and the centralization of rents drove economic development between 1965 and 1979 (post-independence) and between 2004 and 2009 (Bingu wa Mutharika’s first term). Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 123 with interests in 17 subsidiaries and 23 associated companies by the 1980s (Cammack and Kelsall 2011). At times, Press Holdings alone had a gross turnover of about one-third of GDP (Makuyana and Odhiambo 2014, 26). Agricultural trading was largely monopolized by ADMARC until reforms in the context of Structural Adjustment Programs reduced direct state involvement. However, despite official liberalization, much of this legacy remains. The markets for the key export com- modities tobacco and tea remain structured markets38 and Malawi’s 71 public enterprises con- tinue to play an important role in key sectors of the economy (U.S. Department of State 2022). Since political liberalization, rents have been decentralized but are tied to a “powerbroker” business elite with little interest in investing in state capacity and growth (Said and Singini 2014). Such powerbroker business elites often operate in import trading and agricultural indus- tries, and regularly win government contracts. Chinsinga (2012) argues that inadequate target- ing and intransparent procurement procedures for agricultural input subsidies enable political patronage (see Chapter 2). The powerbrokers use their connections to shape policy to their ad- vantage. Policy makers often oblige as they need powerbroker rents to sustain their political machinery and for personal gains. Many perceive economic policy as a zero-sum game to dis- tribute domestic market surpluses, in turn over-extracting rents rather than growing what is available. Opening up opportunities to unaffiliated businesses through export-oriented reforms or promoting market entry would threaten these established interests. Meanwhile, regardless of the party in power, “the state is used to offer jobs, deals, and contracts to those in business and society on whom it depends for retaining power” (Dercon 2022, 157). Selectively enforced price controls and export bans are often used to settle scores with private traders (Dercon 2022). The result of this “powerbroker” relationship is an atmosphere of mistrust that prompts overbearing regulation. The dependence of policy makers on powerbroker business ac- tors gives them a motive for distrust. Arrangements with powerbrokers are based on nar- row patronage deals rather than being organized by an innate common interest informed by political ideology or long-term party policy. The offer of a more attractive deal can eas- ily lead to a shift from agreed terms. Leftwich (2009) contrasts this with collaborative in- stitutional arrangements where two-way transparency and reciprocity in relations leads to intentions and commitments that are held to be credible. This political economy is ex- acerbated by many within the business elite being perceived as ethnically distinct. At the same time, with a long history of suppressed private sector growth, there are scant suc- cesses to point to where enhanced private sector competitiveness led to increased wealth. The result is often the popular diagnosis of overbearing regulation (The Economist 2022). Policy makers preserve wide-ranging and discretionary powers over business that would be better served by a more stable and parsimonious set of rules, as this provides leverage over powerbrokers who are otherwise presumed to defect from deals. Decentralized Short-Horizon Rent-Seeking Leads to the Most Inefficient Types of Corruption International evidence suggests that the direct costs imposed by corruption creates only part of the damaging effects of corruption — it is uncertainty about the level of costs that can make corrupt practices especially inefficient (Olken and Pande 2012). In other regions, high levels of corruption are not necessarily incompatible with rapid eco- nomic growth (Banerjee, Mullainathan, and Hanna 2012). India, Indonesia, and Vietnam 38.  Structured markets are organized and formal places where market participants enter into regulated trading and financial arrangements. Examples are commodity exchanges. Structured markets often coincide with export mandates, where no commodity can be exported unless it is sold through a structured market. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 124 show that rapid economic growth can take place in contexts with high regulatory hurdles and comparatively high levels of corruption that, however, are highly predictable. While corruption can be perceived as an opportune tool to evade red tape, decentralized and unpredictable arrangements can make returns uncertain. Investors, both domestic and in- ternational, tend to shun such arrangements. In Malawi, both grand and petty corruption is widespread. There is no shortage of grand corruption scandals. Among the most prominent probably is the scandal termed “Cashgate” in 2013, in which around US$50 million was misappropriated through procurement scams. However, there are many other examples.39 At the same time, petty and every-day corrup- tion is a significant and widely recognized problem. For instance, in the 2019 Afrobarometer Survey, 30.4 percent of respondents stated that they had bribed the police to avoid a prob- lem during an encounter. Reforms at the turn of the century had little effect on underlying systems. Anti-cor- ruption measures approved in the 1990s, such as the establishment of the Anti-Corrup- tion Bureau, led to high scores in the WGI Control of Corruption dimension into the early 2000s (Kukutschka 2014). However, it turned out that such efforts had little effect on the underlying logic of the system, as they represented institutional changes satisfying exter- nal pressures rather than being based on a genuine shift in political interests (Bridges 2016). Inefficient types of corruption often result from a political settlement characterized by short-horizon decentralized rent-seeking.40 The most effective path to power, which is concentrated in a strong presidency, is co-opting elites that represent competing fac- tions organized by identity, such as ethnicity and religion, rather than ideology. Factions centered on a big man or woman from a small “bwana class” impervious to formal insti- tutional change find that the way to power is paying rents to maintain their deals-based support. These dispersed power configuration drive weak inclusive growth outcomes com- pared with peers such as Rwanda (Chinsinga et al. 2022). Nurturing growth of sources of rents, i.e., growing productive industries, is prevented by immediate imperatives exerted through the system. Isomorphism Leads to Low Government Effectiveness In addition to outright corruption, state resources often do not translate into devel- opmental gains due to insufficient government effectiveness.41 This is in part because presenting the impression of commitment, coordination, and cooperation, rather than 39.  For instance, in 2001, many development partners suspended aid to Malawi at least partially on corruption grounds. Hidden debts that started to be accumulated in 2018 facilitated Malawi’s current BoP crisis. While arrests were made and audits conducted, few high-ranking officers received punishments representing lasting deterrents, a finding consistent with evidence across low-capacity environments (Cuneo, Jetson, and Vannutelli 2023). 40.  Cammack and Kelsall (2011) and Roscitt (2013) track Malawian regimes across a centralization-time hori- zon space. They describe short-horizon decentralized rent-seeking as it gained prominence in Malawi’s com- petitive-clientelist political landscape after the democratic transition as a free-for-all situation that is especially damaging to economic growth. On the other end of the spectrum, highly centralized, longer-horizon rent seek- ing can promote the developmental utilization of rents. Cammack (2017) connects Malawi being stuck at the short-horizon decentralized end of the spectrum to its competitive clientelist political settlement 41.  Government effectiveness describes the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to such policies. Such commitment, in addition to effec- tive coordination in shaping expectations to enable complementary action and cooperation, defined as limiting opportunistic behavior to prevent free-riding, are also the “three Cs” of effective governance driving economic development according to the 2017 World Development Report (World Bank 2017). Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 125 its reality, is strongly incentivized. Prima facie evidence of this is the large number of high-quality planning documents that Malawian government institutions produce. Per- formance incentives often center around visible and formal elements of reform (Bridges and Woolcock 2017). This is the case in the competition for external funds, where norms and operational imperatives often lead to a focus on the formal adoption of policies rath- er than their implementation. With limited transparency and less developed civil society mechanisms for accountability, local stakeholders also often have to focus on what is pre- sented rather than on results. However, many deeper analyses find a different set of rules at play below a layer of best practice guidelines, something they call isomorphism. Especially government financial management has been described in this way.42 The Systematic Country Diagnostic (World Bank 2018) highlights the appearance of “good practice” financial management coinciding with widespread fraud and limited control. Similarly, the analysis presented in Chapter 1 identifies limited fiscal credibility as a key constraint. Beneath a veneer of accountability and good governance practices often lies an ineffec- tive bureaucracy. In contrast, aspirational peer countries show that actual commitment to economic development is not primarily expressed through elaborate policy documents. For example, Rwanda’s post-1994 development plans were supported by a fundamental shift in the political settlement. Ethiopia’s development plans expressed a significant change in the interest of political elites that coincided with systems aimed to effectively project state power for centuries (Dercon 2022). Poorly formulated development assistance can promote isomorphism and have other corrosive effects on Malawian governance arrangements. While foreign aid is linked to enhanced immediate outcomes in Malawi and elsewhere (De and Becker 2015), it may have differential effects on local governance arrangements. Moreover, institutional reform ap- proaches can incentivize ineffective arrangements (Bridges and Woolcock 2017). Attention should be paid to positively influencing underlying functionality rather than formulating reform initiatives that yield institutions that resemble those found in higher-performing peers. Bridges and Woolcock (2017) in turn advocate for a problem-driven approach, i.e., a process whereby problems are conceived by local stakeholders, including their contex- tual complexities, and reforms are elaborated through iterative feedback. Genuine local ownership also has the potential to alleviate issues of fragmentation in the delivery of de- velopment assistance. A flight of donors from government systems after the “Cashgate” scandal had little effect on isomorphism, while introducing many governance challenges. Several devel- opment partners ended budget support to Malawi after the discovery of widespread fraud during the “Cashgate” scandal in 2013. Others suspended budget support operations and only the World Bank and IMF resumed budget support in the ten years following the scan- dal.43 This flight from official systems has had adverse effects, particularly in terms of frag- mentation of the financing landscape and a weakening of the policy dialogue (DEval 2018). As development partners shifted off budget, they often ended up working in isolation with a reduced focus on directly strengthening government systems. At the same time, no fun- damental shift in the level of isomorphism has occurred, including for public financial 42.  Rakner et al. (2004) describe the budget process as a theatre that masks the real distribution and spending of Government resources. Bridges (2016) speaks about how institutional public financial management reform efforts in Malawi have encouraged Malawi to shape the form rather than the substance of effective governance institutions. 43.  The European Union and African Development Bank are considering the resumption of budget support in 2024. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 126 management (PFM). Challenges, such as inadequate commitment controls, difficulties to implement effective cash management, improper use of IFMIS, and large variances from budgets have persisted into the post-Cashgate era (Bridges and Woolcock 2017). MALAWIAN SUCCESSES OVERCAME GOVERNANCE AND INSTITUTIONAL CONSTRAINTS Among all these governance challenges, real achievements can go unnoticed. Especially in a region where negative narratives dominate, it is important to balance this with exam- ples where progress has been achieved.44 While governance successes in other countries have received dedicated volumes (see, for example, Alam, Mokate, and Plangemann 2016 on South Africa), this chapter provides the first such collection dedicated exclusively to Malawian governance achievements.45 Chronicling success provides more than uplifting stories in times of crisis; they pro- vide valuable lessons to continue and scale success. Narratives of accomplishment are critical to boost morale in an environment where meeting targets can go unnoticed. They are also a key element of accountability. Positive framing can provide guidance and sup- port to demoralized decision makers (Sheffer and Loewen 2019). Most critically, cases of success hold valuable lessons that are critical to achieving further positive outcomes and to scale these successes. This CEM identifies 11 success stories (or “positive deviants”) where generally adverse con- ditions were overcome to attain positive outcomes through the governance and reform of: (i) value chains; (ii) public entities and SOEs; and (iii) public programs. To qualify as a success story in this CEM, cases had to demonstrate a tangible impact on the lives of av- erage Malawians. For instance, for agricultural value chains to be included in the selection, they had to show substantial growth, far in excess of traditional value chains, over numer- ous years. A boom solely based on international prices or outside intervention was not eligi- ble. Selection was based on a nomination process among the project team, with input from external advisors, and resulted in the following selection: (i) three agricultural value chains: groundnuts, macadamia, and soybean; (ii) four turnaround episodes of public institutions: Lilongwe Water Board, Phalombe District, Press Corporation, and Road Fund Administration; and (iii) four public programs: Malawi’s response to the AIDS epidemic, the widespread dis- tribution of cooking stoves to achieve clean cooking goals, results-based financing of local government development efforts, and the early years of the Farm Input Subsidy Program. Each case was analyzed by a recognized expert. Experts were provided with a five-item questionnaire to guide the analysis: (i) the positive outcomes achieved; (ii) the actors in- volved; (iii) the challenges that were overcome and that remain; (iv) the future outlook; and (v) key lessons. Based on these five questions, case study authors from within and outside the World Bank summarized publicly available material, and generated insights from their own experience and that of key participants. These are summarized in Annex 5.1. 44.  This has given rise to an entire library of case studies that tracks developmental successes on the continent and beyond, though none of these focus on Malawian successes (Princeton University 2023). 45.  In 1989, the World Bank reviewed seven cases of success, including well-known instances such as the mac- roeconomic management of commodity booms in Botswana, as well as less recognized ones, such a program to organize gravity-fed water schemes in rural Malawi (EDI 1989). Malawi also featured in a later such volume through a case study of the successes of the initial years of the Farm Input Subsidy Program (FISP) (Chuhan-Pole and Angwafo 2011). Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 127 How to kickstart a new value chain — lessons from the groundnut, macadamia, and soybean value chain Name Positive Outcomes Catalysts Success Ingredients Challenges Groundnut Tobacco companies, • Recognition of global • Local Leadership: Exports are dominated Value Chain assisted by a partner- demand weakening Tobacco industry sup- by one company while ship with USAID, success- for Malawian tobacco ported by USAID. international demand fully laid the groundwork led the tobacco indus- • M arket Understanding: implies space for many to build a vertically inte- try to diversify into How the regional and more. Access to financ- grated groundnut value groundnuts. global groundnut market ing amidst high costs of chain. Three improved • USAID support and works and how to acquire market entry, unpredict- varieties were released exploration of legume financing for groundnut able regulation, and afla- and are now produced value chains facilitated ventures. toxin risks remain key at scale. Two large com- the process. challenges. panies have contracted • Partnership: Strategic about 7,000 farmers partnership and technical who produce locally pro- assistance from develop- cessed groundnuts. ment partners. • Technological advances: Focus on high quality seed production and managing risks including aflatoxin. Macadamia With 10,000 hec- • A shift away from tra- • Patient Capital: Long-term Conflict with local com- Value Chain tares planted by 2023, ditional crops such as investments from various munities and theft Malawi has become the tobacco. sources, ensuring continu- have been a hurdle for sixth-largest macada- • Long-term investment ity in growth. macadamia estates. mia exporter globally in and interest in com- • Community Engagement: Uncertainty over land ten- 2021. Eight major produc- munity engagement, Efforts like a commu- ure is problematic con- ers with over 2,000 per- support from various nity beekeeping project sidering the long-term manent employees grow institutional investors and collaboration with nature of macadamia and market macadamia and organizations such smallholder farmers fos- growing, as is the unsta- alongside 4,000 small- as USAID. tered more inclusive value ble macroeconomic holders. Local macada- chains. environment. mia processing is being explored. • Strategic Partnerships: Collaborations with investors, development organizations, and local communities allowed for technology trans- fer, financial support, and problem-solving. Soybean Soybeans have emerged • Rapidly growing global, • Local Leadership: Input Risks like potential policy Value Chain as the second larg- regional, and local providers, anchor farms, uncertainty, a global price est export and the most demand for soybeans, and processors drove the decline, illicit exports, and advanced value-add- and high prices for establishment of markets unutilized processing ing sector in Malawi. Over farmers. and know-how smaller capacity need to be man- 300,000 tons of produc- • Input providers, anchor producers could rely on. aged. The engagement of tion, exporting US$133 farms, processors, and • Demand-Side Oversight: Malawian industrial inves- million in 2021 and international support Global and local demand tors and SMEs, and a 700,000 tons of industrial for diverse soybean stronger common vision level processing capac- products. between the industry and ity represent a fivefold government are needed increase over a decade. • Public-Private to sustain growth. Partnerships: Alignment between private sector, NGOs, and public actors such as USAID. • Holistic approach: A com- prehensive understanding of the political economy, prioritizing the value chain and engaging public sec- tor partners. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 128 Groundnuts, macadamia, and soybeans have not only become the primary cash crops for many farmers, but they now also have upstream and downstream industries emerging. While not yet reaching the scale of tobacco, all three value chains have seen significant growth in recent years (see also Chapter 4). Groundnuts have been primarily commercialized by major tobacco firms, leveraging more than 7,000 smallholders in their networks to produce high-quality, trace- able, and exportable produce. Malawi has become the sixth-largest macadamia exporter global- ly in 2021, supporting eight commercial firms alongside 4,000 smallholder producers. Soybeans, which were marginal exports a decade ago, have swiftly become Malawi’s second-largest export. All three value chains have upstream and downstream value addition emerging. Malawi now has an installed industrial soybean processing capacity of 700,000 tons, with seven ma- jor processors producing various products including soy chunks, soy lecithin, corn-soy blend, chicken feed, fish feed, and cooking oil. The groundnut segment is becoming a vertically in- tegrated value chain, with downstream linkages such as the production of seeds and other inputs, and upstream linkages such as shelling and testing to unlock major export destina- tions. Macadamia are currently husked and exported in shell, but a major investment in lo- cal cracking capacity is underway. Successful value chains spark adjacent activity, such as the poultry and fish feed industry for which soybeans are a major input, honey and paprika which are being intercropped with macadamia, and the agro-input segment, where ground- nuts and soybeans are enabling new companies to emerge in inputs such as seed and inoculant. All three value chain successes coordinated and aligned the interests of a diverse set of stakeholders. To achieve scale, value chains often needed both the know-how and marketing capacity of major commercial firms, and the production scale that in Malawi only smallhold- ers can achieve. However, the Government and development partners also played important roles in the scaling up of all three value chains. The Ministry of Agriculture’s Department for Agricultural Services (DARS) constitutes a key linkage in the production of soybean and groundnut seed. Development partners providing financing in all three value chains at im- portant points in time, while also at times playing a critical value chain coordination role. Generating the required expertise and finding the right role for the Government are im- portant challenges that needed to be overcome. For instance, groundnut machine-shelling requires the updating of seed standards, which requires new expertise. At the same time, find- ing the right level of Government involvement in each segment is key to their success. Over- regulation, such as the setting of minimum farmgate price above market rates, can damage emerging value chains (see also Chapter 2). Policy support is needed, especially when val- ue chains are still in their infancy. Most of all, however, policy coherence and predictability are needed to unlock investments. Unpredictable interventions such as export bans under- mine the successful model of value chain development shown by these three value chains. The three cases show that value chain governance successes have three main ingre- dients: strong market demand, government support rather than control, and a long- term vision. Malawi is a small market that cannot be isolated from global forces. However, the three value chains introduced here also show the opportunity that this situation can provide for average Malawians. High global prices for soybean and its derivative products created the biggest surge in commercial opportunity for Malawian smallholders in a gen- eration in 2022/23, with global markets absorbing any domestic excess production — as long as the Government continues to play a supportive role. All three cases also show that successful support is rooted in active dialogue between public stakeholders, private companies, smallholder interests, and development part- ners. To achieve success at scale, it is imperative that each can play its dedicated role. Among Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 129 the key support areas where the Government can make a tangible difference is to provide a credible vision for the sector. Real coordination challenges exist between the players in a value chain. For instance, expanding processing capacity only makes sense when local production is adequate, which in turn depends on production inputs. Centrally providing an evidenced and committed signal when it makes sense to expand production capacity can help overcome such coordination challenges. All three cases also show that value chain growth does not happen overnight. This is most evident in the macadamia value chain where a tree takes the better part of a decade to bear fruit. The soybean value chain also took a decade to emerge from a fringe indus- try to becoming the major industrial crop it is today. Such long timelines require commit- ment, even in the face of adversity, as well as patient private capital. For these value chains, it was a long-term strategy of the private sector — primarily the diversification efforts of the tobacco industry and of Malawian and regional food processing companies — and of the public sector, primarily through the coordination efforts and market-building approach of two development partner projects that provided this sustained support. How to turn around a public entity — lessons from Lilongwe Water Board, Phalombe District Council, Press Corporation, and Road Fund Administration Name Positive Outcomes Catalysts Success Ingredients Challenges Lilongwe Under the Lilongwe The World Bank- • Local Leadership: • Changing the existing Water Water and Sanitation financed utility mod- Transformation led by the LWB work culture was a sig- Board Project, the Lilongwe ernization program Corporate Management Team, nificant challenge that Water Board (LWB) (Lilongwe Water and with involvement of engineers. was gradually overcome. launched its “Pathway Sanitation Project) • Demand-side Oversight: Focus • The presence of high to Success Program” and LWB’s “Pathway on customer needs and sat- levels of non-revenue to address capacity to Success Program” isfaction, efficiency, and cost water still presents an gaps. Over its course, acted as catalysts, recovery. ongoing challenge. LWB increased access addressing capacity to water supply ser- gaps, standard oper- • Change Management and • Political instability and vices, continuity of ating procedures, Training: Implementing new short-term contracts supply, revenue, cost water safety, and busi- work culture, training, and lead- created uncertainty at recovery, customer ness continuity plans. ership development. the top level of the LWB. service delivery, and Organizational change • Strategic Partnerships and • The ongoing need for reduced wastage. management was Financing: Collaboration with the an improved regulatory vital. World Bank and integration of framework and a contin- consultancies. ued focus on results to maintain progress after project completion in 2024. Phalombe In the 2021 The LAPA process • Local leadership: Especially • Coordination challenges District Local Authority and the Performance- the District Commissioner and with the central govern- Council Performance Based Grant (PBG) Local Councilors drove positive ment continue. Assessment (LAPA), mechanism were change. • General financial con- Phalombe achieved major drivers behind • Collective ownership and straints remain severe. an education sec- the success achieved accountability: Emphasis on tor score of 60 per- in Phalombe. The • While often addressed both were notable. comparatively well, pol- cent, almost double decentralized edu- the national average. cation system also • High-level commitment: icy inconsistencies and It evidenced “home- played a role, allowing Resource allocation for educa- oversight issues periodi- grown” innovations, Phalombe to innovate tion was present, ensuring that cally surface. like partnerships with despite overarching even in the face of financial chal- local businesses, challenges. lenges, education remained a and high levels of priority. accountability. • Performance and inspection reports: These were effectively used and shared. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 130 Name Positive Outcomes Catalysts Success Ingredients Challenges Press In 1995, the National Political leadership • Separation of political and eco- • A generally unfavorable Corporation Assembly passed exerted by the head of nomic dimensions: this enabled business environment the Press Trust the executive, in part- the restructuring into a commer- including the regulatory Reconstruction Act, nership with interna- cial operation. regime and lacking infra- which redefined Press tional organizations, as • Strategic collaboration: this structure affect Press Trust’s charitable well as legal certainty included joint ventures and inter- Corporation. objectives and Press through the Press national collaborations. • A lack of clear pol- Corporation’s pri- Trust Reconstruction icy direction saps vately organized cor- Act. • Focused management: sepa- ration of roles between owners confidence. porate governance. The transformation and management and adher- • Policies were imple- enabled joint ven- ence to corporate governance mented without suffi- tures with local and principles. cient contextualization foreign partners and • Focused leadership: key fig- during transformation. made the company ures included the president, the profitable. board, trustees, development partners and other strategic partners. Road Fund The Road Fund The leadership’s • Integrity and Teamwork: • Potential political influ- Administra- Administration (RFA) emphasis on integrity Fostered within the organization, ence on public pro- tion has established a and teamwork coin- supported by management. curement and contract track record of sound cided with strategic • High Compliance: Enforcement management in the road financial performance external support for of standards and respecting sector. and good governance. sustained reform. governance requirements and • Over-commitments, It has enhanced and laws. arrears, and Roads diversified revenues Authority debt present through initiatives • Support from the Board of Directors: Ensures all major deci- contingent liabilities. such as the Road Toll Program and become sions align with organizational • Growing concerns about the most creditwor- objectives. value for money cre- thy SOE with 10 years • Private Institution Mindset: ate a need to enhance of clean audits. It has Focus on operating as a finan- specialized, technical successfully placed cial institution with ISO certifica- capacity within the road bonds in local capital tion and emphasis on leadership industry. markets. and integrity. • Industry-wide practice of underbidding on ten- ders leads to fiscal risks and increased project costs. The cases of the Lilongwe Water Board, the Phalombe District Council, Press Corpora- tion, and the Road Fund Administration demonstrate that public entities are reformable and can deliver on their mandates across sectors. Over the past five years, the Lilongwe Water Board has increased its service coverage, reaching more people (89 percent in 2022 from 70 percent in 2017) more often (continuity of supply at 22 hours in 2022 from 16 hours in 2017), while at the same time increasing financial sustainability by enhancing revenue. Phalombe’s District Council showed that even Malawi’s fourth-poorest district can deliver high-quality services for its citizens by scoring far ahead of national averages in education sector performance. The example of Press Corporation shows that, with the right govern- ance arrangements, commercial public enterprises can be transformed from fiscal bur- dens into profitable pillars of the economy. Malawi’s Road Fund Administration shows that SOEs can be responsible guardians of public funds delivering critical services to the public. Public enterprises do not tend to turn around by themselves; the Government and de- velopment partners are key facilitators in these cases. Lilongwe Water Board’s transfor- mation process was led by the Corporate Management Team, which was supported by the World Bank in its “Pathway to Success Program”. Similarly, the initiative from Phalombe’s District Commissioner was complemented by incentives exerted by the performance-based grants provided through the Governance to Enable Service Delivery Project (GESD), which Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 131 intentionally leverages existing government systems to bring together national govern- ment entities (Ministry of Finance, Ministry of Local Government, National Audit Office) with local representatives (District Commissioner, District Council, Local Government Finance Council). The transformation of Press Corporation after the advent of democra- cy in 1994 resulted from pressure by the IMF and World Bank to reform, national political contention over the future of the enterprise, attention from the highest levels of national government, and guidance from the board of directors, representing private sector, gov- ernment, and civil society interests. The RFA board, which guided its transformation, also seats members from the private sector, public office holders, and civil society, appointed by the Ministry of Finance. Public enterprises are a magnet for rent-seeking, and can suffer from a lack of vision, while also facing unreasonable demands. As public enterprises steer large amounts of public funds, insulating them from adverse political economy pressures can be a challenge. For instance, RFA experienced pressures on public procurement and contract management to sidestep regulation, compromising its financial position. At the same time, inflated expec- tations of what a public enterprise can deliver from political stakeholders can stand in the way of public enterprises delivering on their core mandates. The ambition to rapidly expand Press Corporation fueled by short-term borrowing in the 1970s brought the company to the brink of financial collapse, necessitating the comprehensive overhaul that started in the 1980s and culminated in its transformation in the 1990s. Off-budget and unfunded road development project mandates that exceeded available financial resources also compro- mised RFA’s financial position during its transition period. Both issues are aggravated if a public enterprise lacks a defined vision, shared by its employees, management, and public stakeholders. Overcoming collective action problems between various stakeholders, ena- bling a productive work culture, and crafting a reliable policy environment were key chal- lenges in the transformation process of all studied public enterprises. Bringing donors on board for this vision was not always easy. As the experience of Press Corporation shows, the leadership at times did not agree with IMF-led reforms. The formula for successful public enterprise reform includes dedicated and empow- ered leaders finding adapted operational solutions, building on a conducive financial environment. Effective leadership has been a key part of the successful turnaround of Malawian public enterprises. When systems are not yet developed to ensure performance, the right people at the top can matter all the more. To enable leaders to make a difference, they need to be empowered by a clear mandate and by political conditions. The right lead- ers can make a difference in more socially oriented enterprises, as in Phalombe where the District Commissioner created a system of collective ownership and accountability, and public enterprises that provide services on a commercial basis, such as Lilongwe Water Board where a change management program included the training of technical skills and leadership development, promoting rapid improvements in the SOE’s professionalism. Often leaders will also need to be persistent to achieve overarching objectives, as was the case of the Minister of Finance insisting on GESD grants being performance-based, and withhold- ing funds from underperforming districts. However, change programs are not one-size-fits all and each enterprise has its own specific problems, including technical and governance challenges. A case in point is Press Corporation, where an intense dispute over its future in the 1990s was likely neces- sary to work out the idiosyncratic operational model that it runs today. Industry-specific issues require specialized knowledge and adapted solutions, as is the case with the indus- try-wide practice of underbidding in road sector tenders that leads to price variations dur- ing contract execution. Lastly, transformation processes are as much financial as they are Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 132 operational. For success to be maintained, financial incentives need to reflect operational priorities and implementing turnaround processes can come at an initial cost. Financial incentives from World Bank project financing played a key role in enforcing disciplined work toward performance goals in several projects. How to achieve policy goals — lessons from clean cooking, the HIV/AIDS response, the initial years of FISP, and local government finance Name Positive Outcomes Catalysts Success Ingredients Challenges AIDS Malawi has achieved a The acute HIV/AIDS • Local Leadership: The initiative • Continued infrastruc- Response reduced number of HIV crisis situation at the was led by the Malawi Ministry ture challenges and infections (20,000 from start of the 21st cen- of Health and other local human resource 28,000), increased aware- tury coincided with organizations. shortages. ness of those who are the availability of • Demand-Side Oversight: • Commodity manage- HIV positive (88 percent), technical and financial Implementation of various strat- ment issues continue. a high rate of HIV treat- support from inter- egies targeting different popu- ment (98 percent), and national entities such • Cases of activ- lations, including prisoners, and ity duplication a high success rate (i.e., as the Global Fund, mechanisms for locating and virally suppressed) among the U.S. President’s among implement- re-engaging individuals who ing partners occur those treated (97 percent) Emergency Plan for have stopped adhering to their between 2016 and 2021. AIDS Relief (PEPFAR), despite coordination HIV treatment regimen. meetings. Bill and Melinda Gates Foundation (BMGF), • Multi-Sector Collaboration: Clinton Health Access The HIV response involved var- Initiative (CHAI), and ious sectors such as Health, others. Education, Youth, Sports, and Culture, contributing to a broad and effective response. • Comprehensive Strategies: Integrating HIV service deliv- ery with Tuberculosis, Sexual and Reproductive Health Rights, Mental Health, and Nutrition promoted efficiency and improved health outcomes. Clean In 2020, Malawi offi- The confluence of • Local Leadership: The Ministry • While the outcomes Cooking cially achieved its goal of government leader- of Energy provided strong are promising, there disseminating 2 million ship, private sector leadership, and the National are concerns regard- cleaner cooking alterna- interest, donor sup- Cookstove Steering Committee ing sustainability and tives to households. This port, and NGO imple- was instrumental in leading pol- the complexity of success was driven by mentation capacity icy dialogue. future challenges. The very strong sectoral gov- were pivotal. • Demand-Side Oversight: ability to shift toward ernance, placing Malawi Coordinated action, involve- even cleaner cooking a joint fourth among 53 ment of smaller companies, solutions like gas and countries evaluated by and alignment of different electricity remains the Regulatory Indicators stakeholders helped drive the restricted, and mod- for Sustainable Energy change. elling suggests that (RISE). Under Government there is a need for leadership, with develop- • Locally Adapted Solutions: continued incentives ment partner support, and The use of locally designed and subsidies to con- aligned private sector inter- Chitetezo Mbaula stoves ena- tinue achieving goals. est (particularly among bled local production, creating a solution adapted to Malawi’s • Program focus must smaller companies), mil- also extend to related lions of households were environment. areas such as sustain- able to use more efficient • Innovative Financing and able forestry. and less polluting cook- Implementation: Programs stoves such as the porta- like Energizing Development ble Chitetezo Mbaula that is (EnDev) brought together var- commercially sold. ious development assis- tance funds, and innovative approaches like results-based financing were used. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 133 Name Positive Outcomes Catalysts Success Ingredients Challenges Local Gov- Supported by a World The introduction of • Early, high-level commitment: • The nascent nature ernment Bank grant, the govern- the PBG system has Leadership from key minis- of the system means Results- ment has increased the served as a signifi- tries ensured momentum, pro- it is still suscepti- based transfer of district devel- cant driver of change, tection, and alignment with ble to various chal- Financing opment funds for the 28 focusing on a results- accountability measures. lenges, including rural District Councils in based approach and • Innovative Incentive Structure: political interference 2020. The amount dis- aligning with Malawi’s Sparked local innovation, peer and potential fiscal tricts receive is based on decentralization learning, and adherence to constraints. the annual LAPA and dis- ambitions. This was development plans. • The ongoing momen- tricts that do not fulfil mini- aided by high-level tum and alignment mum access conditions are political commitment. • Financial Support and among various stake- excluded. Having entered Strategic Partnerships: World holders need to be the second round of LAPA Bank support and cross-min- effectively managed assessments in 2021, dis- isterial collaboration reduced to ensure long-term tricts have followed this fragmentation and provided success. with across-the-board substantial backing. improvements with the • Institutionalizing Within largest increases among Government Systems: Built previously least performing within existing structures, districts. strengthening accountability and ensuring alignment with national strategies. • Embracing Accountability and Transparency: Fostered transparency at all levels, utiliz- ing tools such as LAPA scores, and reinforced through public commitments. Early Farm FISP succeeded in rais- Strong political lead- • Local leadership: Vigorous • Failure to achieve Input ing awareness among ership mobilized political support. the government pol- Subsidy Malawian farmers of the domestic funding, icy goal of house- • Financing strategy: Mix of Programme value of inorganic fertilizer. only partially supple- hold-level food domestic and international (FISP) In the years after FISP was mented by develop- self-sufficiency. funding. introduced, Malawi signif- ment partners many • The program quickly icantly increased maize of which were in • Logistical efficiency: became fiscally production and achieved opposition. Acknowledging private com- unsustainable, requir- national food sovereignty panies’ capacity for timely ing better targeting in most years. delivery. and management. • The inability to make fertilizer use profita- ble at market prices prevented the grad- ual withdrawal of the subsidy. The four instances presented in this sub-section provide tangible evidence that public policy goals can be both ambitious and achievable, with positive impacts on Malawians. All four cases deviate from the commonly held belief that Malawi produces high-qual- ity strategies but typically fails to implement them. In 2020, Malawi achieved its goal of disseminating 2 million cleaner cooking alternatives to households with positive effects on the health of Malawians and the environment they inhabit, making it a global lead- er in this area. Due to effective and available treatment, contracting AIDS is not typical- ly a death sentence for Malawians anymore. The continued reduction of infections by 29 percent in the five years through 2021 is a gain in the quality of life of tens of thousands of Malawians. The provision of modern antiretroviral therapy not only underlies reduc- tions in infections but also means that 97 percent of those in treatment have suppressed viral loads, enabling them to lead full lives. In the early years, FISP was a key instrument to achieve national food sovereignty, coming from a situation where Malawi relied on food aid. While having since become an inefficient and unaffordable drain on fiscal space Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 134 and foreign exchange (see Chapter 2), in the early years FISP addressed acute problems with innovative solutions. The reform of local government finance through Performance- Based Grants (PBGs) revitalized local governance, supporting Malawi’s decentralization agenda (World Bank 2022b). The central government and international supporters were integral to all these suc- cesses, while the private sector was actively leveraged for clean cooking and FISP. All public policy goals were achieved under the leadership of the central government pursu- ing a clear agenda and leveraging international support. Different support was procured from different development partners, each playing to their various strengths. Clean cook- ing received significant resources from various bilateral development partners, the AIDS response leveraged international and local NGOs, while local government finance was re- formed with assistance from the World Bank. FISP was controversial among many devel- opment partners from the outset, resulting in it being primarily locally financed, but the Government found some support for select components from bilateral development part- ners. As a second generation “smart subsidy”, promoting private sector fertilizer markets was an explicit policy goal of the FISP. Private sector interests were also actively leveraged to achieve clean cooking goals. Overcoming coordination problems was as central to success as was adequate resourc- ing. Initial coordination challenges are reported in all instances. These include the dupli- cation of activities by implementing partners in the AIDS response, while clean cooking is increasingly transforming from a problem of supplying sufficient cleaner burning wood stoves to a problem spanning many sectors, including sustainable forestry and electricity supply. Overcoming the most pressing problems also requires financial prioritization, either by finding adequate donor finance or by prioritizing interventions in Malawian budgets. Achieving sectoral targets starts with a commitment, and requires bringing diverse stake- holders together, as well as financially prioritizing the most pressing problems. All suc- cesses gained traction with the Government communicating ambitious but achievable targets rooted in a clear public agenda, such as the 2 million target for cleaner cooking stoves, the 95- 95-95 target in the AIDS response (95 percent of HIV positive Malawians knowing their status, of which 95 percent are on treatment, of which 95 percent have suppressed viral loads), na- tional food sovereignty for FISP, and the delivery of fiscal decentralization for local government finance. Especially in the case of FISP and the AIDS response, the political stakes were high. These targets were backed up with workable agendas of how to achieve these targets and a credible signal that the Government was serious about them. This aided the co- ordination of the diverse set of stakeholders involved in each success, each of which has their own objectives. Aligning these objectives with the policy target meant allocating a dedicated role to each stakeholder. Chitetezo Mbaula (cleaner-burning woodstoves) were produced by local manufacturers, giving them a financial incentive to market and scale them as an often-subsidized cleaner cooking alternative. While financial prioritization is no guarantee for success — technically unrefined and badly governed programs can under- perform even with ample resources — it is often a necessary ingredient. For instance, pro- viding many additional years of life to millions of HIV-positive Malawians does not come cheap, with typical annual treatment costs of around US$140 even in Malawi’s efficient health system (Tagar et al. 2014). To achieve targets, it should be clear where such resourc- es come from, whether this is from the prioritization within limited government budgets, finding development partners that support the achievement of the target, or the resourc- es that Malawians are willing to pay at point of service. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 135 SCALING SUCCESS HAS THE POTENTIAL TO CHANGE THE GREATER PICTURE These successful cases have not been immune to the typical challenges plaguing Ma- lawian governance. For instance, the groundnut value chain suffers from bad regulation that is induced by fraught state-business relationships, as evidenced by minimum farmgate prices that are often uncompetitive. Meanwhile, the RFA’s procurement challenges may be indicative of decentralized short-horizon rent-seeking. Initial challenges facing DARS to provide sufficient basic seeds point to the choice of an operating model not sufficient- ly adapted to Malawian circumstances and thus low government effectiveness induced by isomorphic replication of unsuitable institutions. Current challenges with the Agricultural Inputs Program, a descendent of the FISP, which increasingly became affected by fraught state-business relationships, decentralized short-term rent-seeking (numerous document- ed cases of mis-procurement), and isomorphism (inability to keep the program within os- tensibly binding budget ceilings), show that initial success requires continued effort and commitment to be sustained. What sets these cases apart is their ability to overcome challenges. The outlined suc- cesses were not achieved because these value chains are exposed to a fundamentally differ- ent policy environment than other sectors but rather because actors found effective ways to thrive despite it. While there are some commonalities on how different sectors have achieved success, they all developed their own strategies. However, there are also many commonalities. Leadership and effective management are a cornerstone of virtually all of these cases. While in most cases such leadership was provided by the Government, some success stories were at points coordinated by other entities, such as the role of the AgDiv program in the development of the soybean and groundnut value chains. Having access to suitable finance is another commonality among successful cases. Value chains demand patient debt and equity finance for producers, public entities re- quire the right financial incentives to perform, while policy goals need sufficient finan- cial backing. Value chains work best in a context of high international demand, public entities require consistent demand for the services they provide, while civil society needs to demand change in how policy is formulated. The central Government remains inte- gral to any national governance success, highlighting the need to operate in a way that is informed by its agenda and interests, to synergize efforts, and to build on its systems and capabilities. The recipe for success is nevertheless not universal. For instance, un- locking productive value chains requires the Government to play a supportive and co- ordinating role rather than exerting outright control. Achieving policy goals requires Government to set a more strategic agenda. This comes on top of each case displaying its own characteristics. Building on the success of the 11 profiled value chains, public entities, and public programs has a direct bearing on Malawi’s growth trajectory. Growth of productive value chains requires market opportunities to be exploited, public sector coordination and support for sustainable market systems, and a long-term and patient approach. This demonstrates that fraught state-business relationships can be managed. Overcoming them can directly enhance Malawi’s productive capacity. The analyzed value chains have significant spillovers due to their labor intensity, their large scope for achieving nation- al-level scale, and low barriers to entry. This creates opportunities for farmers to im- prove their income, supports MSME development and increases the tax base. They also catalyze the expansion of adjacent sectors and thus directly influence economic growth. Making more SOEs meet their targets demonstrates that short horizon rent-seeking is Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 136 not an innate characteristic of the public sector but an issue that can be addressed with the right leadership, the right operational solutions, and with a conducive financial envi- ronment. The sustainable provision of essential services by reformed SOEs will contrib- ute to economic growth and enable the private sector to produce more, relying on these services, also leading to accelerated growth. Meanwhile, the Government performing on its sectoral targets exhibits that, with commitment, bringing relevant stakeholders to- gether and through effective financial prioritization, Malawi can craft its own adapted solutions exemplifying government effectiveness. A more effective government identi- fying and addressing key societal and economic problems will lay some of the founda- tions for economic growth. Enhanced macroeconomic governance is another necessary ingredient to achieve growth targets. As laid out in detail in Chapter 1, getting macroeconomic policy right is indispensable to enter a higher growth trajectory. Having only a few growing productive value chains, some better-run public entities, and the achievement of a few policy tar- gets is not enough for Malawi to experience the economic transformation that it strives for when the general environment for investment and growth remains inadequate. Many of Malawi’s most challenging macroeconomic policy issues are as much a matter of gov- ernance as of technical capacity. They are also a result of not directly anchoring mac- roeconomic policy-making in explicit efforts to grow the private sector. This reflects weaknesses in economic decision-making that have, for example, resulted in the con- tracting of unsustainable debt, repeatedly straying from carefully elaborated and negoti- ated budgetary targets, or insisting on an exchange rate that has little relevance for most voluntary transactions. Scaling these 11 successes has the potential to enable a virtuous feedback loop with mac- roeconomic governance (Figure 5.2). Strengthened productive sectors will empower the Malawian private sector. This private sector in turn can hold macroeconomic policy-mak- ing to account. For instance, an empowered private sector will have stronger leverage to in- sist on a more open and efficient trade environment. At the same time, the private sector will be a key beneficiary of enhanced macroeconomic governance. Kwachas that maintain their value, the ability to trade, and a solvent public sector will lift critical constraints to business expansion. Similarly, better performing public enterprises will mean that they become less of a drain, while some can become increased contributors to the country’s public finances. This will help enable necessary fiscal reforms. Enhanced macroeconomic stewardship will make targets for public enterprises both better defined and more achievable. For example, a conducive financial environment in which public entities need to excel will be significant- ly aided when macroeconomic stability ensues. Meanwhile, demonstrated public success through the achievement of sectoral targets will nurture the trust and accountability fun- damentals necessary to improve macroeconomic governance. In turn, enhanced macroeco- nomic governance will deliver the necessary prioritization and financial backing for sectoral targets to be achieved. Incremental governance improvements can reinforce much-needed macroeconom- ic reforms, anchoring them in governance arrangements that deter reversion. Chapter 1 argues that in order to attain a more rapid growth trajectory, the Malawian authorities should embark on a decisive macroeconomic reform agenda. This will in turn create the foundations for improvements in sectoral governance that further bolster macroeconomic reforms and increase their growth-enhancing impacts. The implication of the sectoral gov- ernance improvements chronicled in the 11 case studies is that their can be maximized in an improved macroeconomic environment. This would help sustainably anchor improved macroeconomic policy in a more conducive political economy. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 137 Figure 5.2  Feedback loop between enhanced sectoral and macroeconomic governance Improved operating Enhanced private environment sector accountability Strengthened Value Chains Boosting fiscal performance Higher productive capacity High Better Enhanced growth services fundamentals Improved Performing Economic Macroeconomic Public Growth Governance Entities More effective government Better and achievable targets Achieving Sector Targets More trust Advanced prioritisation and accountability and financial backing Source: World Bank staff. FINANCING MALAWI’S GROWTH AND ECONOMIC DEVELOPMENT NEEDS TO TAKE MALAWI’S GOVERNANCE DYNAMICS INTO ACCOUNT Financing Malawi’s economic growth will require significant resources to be spent ef- fectively. The Malawi 2063 multi-year implementation plan, published in 2021, puts the price tag of key interventions for the achievement of targets at MWK 3.0 trillion, or 4.7 times pub- lic development expenditure in 2023 and 2024 alone (NPC 2021). The “Business Unusual” scenario in the “Long-Term Growth Model” introduced in Chapter 1 — the only one com- patible with Malawi 2063 growth targets — sees economy-wide public investment increasing Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 138 to 7.2 percent of GDP and private investment to 17.3 percent. In 2023 Malawi kwacha this equates to about MWK 4.0 trillion, of which more than MKW 1.2 trillion would come from public funds. However, even such large investments will only translate into growth when they are spent effectively, which depends on governance. With the “Integrated National Financing Strategy”, Malawi has a comprehensive framework on how to govern the financ- ing of Malawi’s developmental ambitions (UNDP 2023). Facilitating private sector investment Chapter 1 has highlighted the importance of private investment to achieve growth targets, which is a function of improved state-business relationships. The value chain success stories show that overcoming governance constraints can attract significant invest- ment. Soybean and groundnut processing facilities cost billions of kwacha and, when well run, represent productive investments boosting the Malawian economy. While both value chains overcame governance constraints in their own ways, scaling such investments across more sectors of Malawi’s economy will require a general improvement of state-business relationships, sparking an improvement in the regulatory environment. Given Malawi’s limited fiscal space, almost all commercially viable investment will have to be done privately, incentivized by private returns. Malawi already is in debt dis- tress and thus the Government has limited scope to embark on new public investments. Even if dedicated reforms of public entities enable these to deliver, maximizing growth de- mands a division of labor where the private sector conducts effectively all commercially viable investment. However, this requires private entities to expect to profit from their in- vestments. This in turn requires implementing lessons from the three value chain success stories, given that investors will want assurance that the Government will play a support- ive role. Such an assurance would need to be integrated with policy coherence and predict- ability to foster trust that the envisioned returns are likely to materialize. Financial sector governance matters for the availability of finance. Pension reform led to the rapid accumulation of pension assets, which stand at MWK 1.7 trillion at the end of 2022 (Reserve Bank of Malawi 2022), illustrating the difference that regulation makes on the supply side. The macadamia value chain was one of the segments that leveraged this source for productive investment. Facilitating Government investment Chapter 1 shows that, to achieve growth targets, Malawi needs to increase the scope and quality of its public investment. Increasing the scope of public investment requires rais- ing income, reallocating public expenditure, and attracting additional external resources. Malawi’s recent “Domestic Resource Mobilisation Strategy, 2021 – 2026” presents a frame- work on how to increase revenues. At the same time, there is scope to reallocate public ex- penditure from less productive efforts to those enabling growth. For instance, the most recent “Public Expenditure Review” chronicles growth of the wage bill from an average of 2.5 percent of GDP between FY2008 and FY2013 to above 6 percent in more recent years (World Bank 2019). Reverting to previous levels of expenditure on compensation of employ- ees alone can free up resources in excess of the previously discussed public investment lev- els. Reform of agricultural support programs promises additional significant savings (see Chapter 2), while social sector spending can be made more efficient while still delivering improved services (World Bank, Government of Malawi, and Global Financing Facility 2020). Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 139 Attracting additional external resources starts with making Malawi’s PFM systems trustworthy. After the 2013 “Cashgate” scandal, development partners lost trust in Malawi’s PFM systems, withdrawing budget support. Analysis presented in Chapter 1 shows that this significantly weakened Malawi’s fiscal position. Because there has been no credible im- provement of systems at the scale needed to engender trust, development partners have established elaborate parallel delivery systems over the past decade, making it even harder to bring these back on budget. However, as the PBG success story shows, bringing develop- ment partner resources on budget in a transparent and effective way is feasible. Overcoming corruption issues rooted in short-horizon rent-seeking requires dedicated leadership, finding operational solutions that work in the given context, and financially incentivizing change. Migrating to digitized government-to-people payment modes, as targeted by the “Government Payments Roadmap” of 2017, can constitute a technical element of this pro- cess (Mwingu and Chilima 2022). Making the best financial choices requires prioritization within fixed budget ceilings. Chapter 1 and World Bank (2021) demonstrate the need to effectively prioritize the Public Sector Investment Program (PSIP). This includes abandoning spending on low-priority, low-impact projects. From a political economy perspective, this is a difficult process as it requires strategic re-contracting based on a shared vision that the timely implementation of a few projects is preferable to underachievement across many. However, success stories on the achievement of policy goals show that such challenges can be overcome with high- level commitment and bringing stakeholders on board for effective financial prioritization. Financing Malawi’s growth hinges on filling the implementation gap on the Medium- Term Debt Management Strategy (MTDS). Malawi’s new MTDS sees nominal public debt sloping down to below 50 percent of GDP by 2026 (Ministry of Finance and Economic Affairs 2022). While requiring fiscal discipline, boosted by increased revenue through the Domestic Resource Mobilization Strategy, in the near term, it will contribute significant- ly to Malawi’s resource envelope, which is constrained by public debt interest being the largest expenditure item (see Chapter 1). This will require a shift in the approach from the previous 2018 – 2022 MTDS during which public debt rapidly increased instead of declin- ing as planned. Examples of success in the achievement of sectoral goals show that the at- tainment of ambitious targets is possible, but that this requires deliberate action and doing things differently from a governance perspective. Facilitating public enterprise investment To date, RFA is the only SOE that is ready to attract market investment (World Bank 2021). Dedicated leadership fostered an enterprise that has both the balance sheet and the transparency to attract investors. This required enhancing its autonomy and insulating the enterprise from political pressures. The board contains skilled members of the private sec- tor who are focused on the mission of making RFA high-performing. Accessing private sector capital by SOEs can bring with it a host of stringent but ben- eficial requirements. Commercial investors can change the governance of an enterprise by expecting higher levels of accuracy, timeliness, and transparency in financial opera- tions (World Bank 2021). Operational capacity is in investors’ interest, as it is necessary to maintain financial flows. Initiated by a move to make SOEs investable, this can create an alignment of internal incentives with external ones. SOEs that perform on their man- dates while remaining investable demands financial and operational performance to maintain revenue. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 140 HOW TO SYSTEMATICALLY SCALE GOVERNANCE AND IMPLEMENTATION SUCCESSES FOR ECONOMIC GROWTH The 11 success stories present evidence that, with the right approach, current gov- ernance constraints can be overcome, stimulating economic growth. Achieving insti- tutional arrangements that align political incentives with developmental ends is critical to promote growth. This achievement is feasible across 11 cases of high-performing agri- cultural value chains, public entities, and public programs. By applying similar principles, this success can be scaled. Scaling success is especially urgent in: (i) economic sectors that are pivotal to economic growth, including other agricultural value chains, manufactur- ing, and the mining industry; (ii) public entities without which growth is unlikely to take off, including ESCOM and water boards; and (iii) in the achievement of strategic goals on which Malawi’s economic advancement hinges, and especially the Malawi 2063, as well as sectoral strategies such as Malawi’s Debt Strategy and the National Export Strategy II. In addition to directly contributing to growth, further successes have the potential to cata- lyze a positive feedback loop with enhanced macroeconomic governance, further pro- moting economic growth. By virtue of being positive outliers, the 11 success stories in this chapter are yet to be- come the norm. The preponderance of examples where significant reform is urgently need- ed illustrate that Malawi’s overall institutional arrangements are not yet at a place where they systematically promote success at scale. This is also reflected in Malawi’s tepid long- term growth performance (see Chapter 1). Governance and institutional reforms are inher- ently difficult and past efforts to support these reforms has often failed. The second section of this chapter showed that Malawi’s governance challenges are deeply rooted in Malawi’s history, and its societal and economic structure. However, as a selection of peer countries in Chapter 1 shows, growth take-offs can be sudden and sustained. In the case of Malawi, however, this requires doing things differently. The presented recommendations (Table 5.1) aim to provide an actionable approach on how economic governance could be done differently to foster more conducive condi- tions. Rather than prescribing specific policy actions, the recommendations attempt to foster a governance environment from which more growth-enhancing policy choices can emerge. They attempt to balance feasibility with the ambition needed to lift Malawi to a higher growth trajectory, and specificity with the need to change implicit governance ar- rangements. Because the Malawian authorities have often received recommendations from domestic and external stakeholder on what to do differently, often with limited traction, the set of recommendations resulting from the findings in this chapter attempts to capture actionable ways on how to do things differently. Proposed changes focus on: (i) how to in- vest in peer learning; (ii) how to promote and enable effective leadership; (iii) how to insti- tutionalize examples of ‘positive deviance’ within government systems; (iv) how to create appropriate financial incentives to strengthen leadership and program implementation; and (v) how to facilitate strategic public-private dialogue and coalitions. Two sets of recommendations focus on how to institutionally anchor and employ peers to scale success. Institutionalizing examples of success increases the likelihood of thus far limited success to scale, both within the discussed areas and to sectors where veritable suc- cess is yet to take hold. Systematically investing in learning exchanges between high-per- forming and lagging institutions, as a demonstrated method to achieve success, should be a priority. Learning exchanges can both be initiated between peers or facilitated by Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 141 institutions such as the National Planning Commission, but should be systematized. This can both provide tailwinds to those contributing to the success and be a guide to those looking for inspiration. In the medium term, the authorities can institutionalize success by isolating the mecha- nisms and institutional arrangements that drove high performance and embedding these targets within performance management. While peer learning exchanges can provide im- plementers with details, narratives of success such as the ones presented here can provide general guidance. Rigorously identifying institutional success factors can then lead to their integration into government systems. While institutionally anchoring reforms, Government can also garner increased support by more widely recognizing the contribution that peers can make in backstopping endeavors. Managing relations with institutions such as the National Assembly, the Anti-Corruption Bureau, or the National Audit Office can consume resourc- es and draw attention to potential gaps, but filling these gaps will be rewarded by the trust and resources that the public sector needs to be an effective facilitator of economic growth. The presented analysis shows the importance of leadership in any reform process, point- ing to the need to promote it in targeted ways. The choice of leaders is likely to be deeply en- grained in the political economy of the wider system. However, existing leaders can be made more effective by promoting their missions, and providing backing and support, including by prioritizing platforms that visibly promote those who have been the driving forces behind high-performing institutions. In the SOE space, the public signing ceremony of Shareholders Letters of Expectations between the Ministry of Finance and SOE leaders is an encouraging sign of the promotion of effective leadership. Leaders such as the CEO of Lilongwe Water Board were given an opportunity to provide evidence of their leadership to the wider pub- lic, while those from less financially sound SOEs were requested to exercise stronger lead- ership. This promising approach should be continued, expanded, and strengthened. At the same time, the legal framework to incentivize the performance of leaders has been under revision for some time. While formally approving strengthened public service legislation is an important milestone, it is during implementation that additional care must be taken that laws sufficiently incentivize performance among senior public servants and executives. Creating appropriate financial incentives to strengthen leadership and program imple- mentation was key to each of the 11 case studies, while aligning financial incentives with performance was also crucial. Prioritizing public expenditure is rarely easy or straightfor- ward from a political economy perspective. However, as demonstrated throughout this CEM, effective prioritization is essential for Malawi to have a chance to achieve its growth ambitions. For instance, Chapter 1 recommends enhanced prioritization of the PSIP, while Chapter 2 calls for the increased prioritization of agricultural expenditure. Providing high-level guidance on the available resource envelope, and thus where priorities lie financially, can promote this pro- cess. At the same time, results-based financing has demonstrated its potential to align finan- cial incentives with performance and should be considered as an approach more widely. For instance, calls to apply similar disbursement rules to the Constituency Development Fund, as already apply to the majority of district development financing, should be considered. Given the significant role of development partners in Malawi’s public financing structure, aligning their financing mechanisms with enhanced common platforms is essential. Overcoming fraught state-business relationships requires fostering coalitions, which can be facilitated through strategic public-private dialogue. Several initiatives already evidence this approach, including the Presidential Private Sector Council, the Presidential Delivery Unit’s “Private Sector Labs”, and the Public Service Reforms Agenda. Strengthened secretariats are key ingredients to continue their momentum into implementation. At the Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 142 same time, more opportunities for co-production46 between the public sector, the pri- vate sector, and civil society should be explored. This can include the organization of key stakeholders of value chains into working groups, or the leveraging of the third sec- tor (voluntary, independent, and civic organizations) to deliver public services. Giving every stakeholder a purpose (such as regulation, implementation, or information pro- vision) can enhance such co-production. In the medium term, such an approach should also give rise to stronger review processes for new regulations and policies. Given the am- bitions for economic growth voiced in the Malawi 2063, such processes needs to focus on how growth can be advanced. Table 5.1  Top five governance and implementation priorities Short-Term Action Medium-Term Implementation Area (3 – 6 months) (before the end of 2025) 1. Investing in peer learning Systematically invest in learning exchanges Embed success factors identified in perfor- between high-performing and lagging institu- mance management. tions (SOEs, local governments, MDAs). 2. Promoting and enabling Publicize and reward strong performance and Focus the implementation of public service effective leadership the leaders behind it. legislation currently undergoing revision on incentivizing performance among senior pub- lic servants and executives. 3. Institutionalizing exam- Rigorously identify the institutional factors Enable the scaling up of identified examples ples of ‘positive devi- supporting ‘examples of success to find entry of success and success factors within gov- ance’ within government points for integration within government sys- ernment systems, including via the Malawi systems tems (i.e. on budget and using Malawian PFM 2063 process, though prioritization, program- and accountability systems) ming, and budgets. 4. Creating appropriate Scale up results-based financing within gov- Create concerted action among public, pri- financial incentives to ernment systems, with a focus on harmo- vate, and international stakeholders around strengthen leadership and nization of financing across government results-based financing architectures in line program implementation and development partners within common with clear sectoral targets with high level polit- platforms. ical backing. 5. Facilitating strategic pub- Strengthen the ability of forums such as Institutionalize a robust review process within lic-private dialogue and the Presidential Private Sector Council, the the Government for all new regulations and coalitions Private Sector Labs and other Public-Private policies as to their economic impact on Dialogue mechanisms to influence policy. achieving growth objectives. 46.  While cooperation is about working together towards a common goal, co-production is a deeper, more inte- grated form of collaboration that involves shared decision-making, responsibility, and benefits. Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 143 ANNEX 5.1 Summary of Successful Cases Case Positive Outcomes Achieved Key Actors Value Chains Groundnuts Tobacco companies, assisted through a partnership with Central government (Ministry of Agriculture) USAID, successfully laid the groundwork to build a verti- Private companies (Pyxus and Global Ventures) cally integrated groundnut value chain. Three improved Smallholder farmers varieties were released and are now produced at scale. Development partners (including USAID) Two large companies have contracted about 7,000 farm- ers who produce locally processed groundnuts. Macadamia With 10,000 hectares planted, Malawi became the Private companies (eight major producers) sixth-largest macadamia exporter globally. Eight major Smallholder Farmers producers with over 2,000 permanent employees grow Development partners (including USAID, British and market macadamia alongside 4,000 smallholders. International Investment) Local macadamia processing is being explored. Local financiers (including Old Mutual) Soybeans Soybeans have emerged as the second-largest export Private companies (various input producers, pro- and the most advanced value-adding sector in Malawi. cessors, and output buyers) Over 300,000 tons of production, and exports worth Smallholder framers US$133 million in 2021 and 700,000 tons of indus- Development partners (including USAID and UNDP) trial level processing capacity are more than five-fold Central government (MoA, MoIT) increases over a decade. Public Entity Reforms Lilongwe Under the World Bank Lilongwe Water and Sanitation Pro- Parastatal (LWB) Water Board ject, the Lilongwe Water Board (LWB) launched its “Path- Development partners (World Bank) way to Success Program” to address capacity gaps. Over the course of this program, LWB increased access to wa- ter supply services, continuity of supply, revenue, cost re- covery, customer service delivery, and reduced wastage. Phalombe In the 2021 Local Authority Performance Assessment Local government (Phalombe District Council) District Council (LAPA), Phalombe achieved an education sector score Central government (MoF, MoLG) of 60 percent, almost double the national average. It evi- Development partners (World Bank) denced “home-grown” innovations, like partnerships with local businesses, and high levels of accountability. Press In 1995, the National Assembly passed the Press Trust Parastatal (Press Corporation) Corporation Reconstruction Act, which redefined Press Trust’s chari- Central government (the President, National table objectives and Press Corporation’s privately organ- Assembly) ized corporate governance. The transformation enabled Development partners (IMF, World Bank) joint ventures with local and foreign partners and Private companies (international strategic partners) made the company a profitable contributor to Malawi’s economy. Road Fund The Road Fund Administration (RFA) has established a Parastatal (RFA) Administration track record of sound financial performance and good Central government (MoF) governance. It has enhanced and diversified reve- Private companies (private sector board members) nues through initiatives like the Road Toll Program and become the most creditworthy SOE with 10 years of clean audits. It has successfully placed bonds in local capital markets. Public Programs AIDS Response Malawi has achieved a reduced number of HIV infec- Central government (MoH, tions (20,000 from 28,000), increased awareness of National AIDS Commission) those who are HIV positive (88 percent), a high linkage Development partners (including PEPFAR, BMGF, rate to HIV treatment (98 percent), and a high success CHAI) rate among those treated (97 percent) between 2016 and NGOs (including EGPAF, Lighthouse Trust, Baylor 2021. College, Jhpiego, Partners in Hope, MACRO) Chapter 5  Can This Time Be Different? Building on Past Successes to Kickstart Growth 144 Case Positive Outcomes Achieved Key Actors Clean Cooking In 2020, Malawi officially achieved its goal of dissemi- Central government (MoE) nating 2 million cleaner cooking alternatives to house- Private companies (SMEs such as Mbaula holds. This success was driven by outstanding sectoral producers) governance, placing Malawi a joint fourth among 53 Development partners (EnDev) countries evaluated by the Regulatory Indicators for NGOs (including Concern Worldwide, Maeve Sustainable Energy. Under government leadership, with Project) development partner support, and aligned private sec- tor interest, particularly smaller companies, millions of households were brought to use more efficient and less polluting cookstoves such as the Chitetezo Mbaula. Local Supported by a World Bank grant, the Government has Central government (MoF, LGFC) Government increased the transfer of district development funds for Local government (28 rural district councils) Results-based the 28 rural District Councils in 2020. The amount dis- Development partner (World Bank) Financing tricts receive is based on the annual LAPA and dis- tricts that do not fulfil minimum access conditions are excluded. 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P17655808b11570c3082bd0a8cfea6e06ec.pdf. ———. 2022b. “Malawi Economic Monitor. Planning Beyond the World Bank, Government of Malawi, and Global Financing Next Harvest. Advancing Economic Stability and Agricultural Facility. 2020. “Malawi Public Expenditure Review Commercialisation.” Washington DC. https://documents1. 2020. 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Findings Report.” Jammes, Oliver. “Assessing the Impact of the AfCFTA on Malawi’s Import Values and Fiscal Revenues Using TRIST.” Malunga, Grain. “Mining Sector Pipeline Rapid Assessment Malawi.” Masanjala, Winford. “The Evolution of Development Planning in Malawi.” Nur, Hayaan. “Mastering the Balancing Act: How Malawi Can Emerge from Its Perpetual Balance of Payments Challenges.”