This is a question that always comes up in the design phase of an LED intervention to be run by local governments in Africa. The answer is still unclear to me and that is why I would love to hear your views on this issue? Other investments that local governments can make to stimulate LED are less controversial. It is obvious that local governments have a mandate to improve local infrastructure that will facilitate economic activity, or to attract inward investment through facilitating regulations or engaging in territorial marketing, or to work with educational institutions to improve local labour skills levels.
However, when it comes to how local governments should support the local business sector to flourish, things become more complicated. Undoubtedly local producers and Small and Medium Enterprises often face major market failures preventing them from success despite the obvious job and income creation benefits they would bring to the locality. The case for intervention by local governments is, therefore, that if such market failures in access to land, finance, skilled labour force, market information, etc, are addressed, then positive outcomes will flow to the enterprises as well as the locality. Access to finance is most often the most critical constraint identified by local businesses and hence comes the role of local government.
Nonetheless, the case against local government support mainly centers on the threats of government failure in "picking winners" and deadweight and displacement effects. Local government officials most often lack business skills and therefore are not best placed to pick out the enterprises or projects most likely to succeed in the marketplace. Also, it is very difficult for them to avoid funding deadweight projects i.e. ones that would have gone ahead in the first place, with or without government funding. Finally, it is again very difficult to assess whether jobs created in the locality will not displace jobs in a neighboring locality, thereby leading to a zero net effect for the country.
Of course local governments in most developed countries do indeed provide financial support to local firms. For example, in the UK, Local authorities and Regional Development Agencies have traditionally provided financial assistance to industry in various ways including soft loans, wage subsidies, rent concessions and guarantees, rate holidays and grants. They not only facilitate access to finance in conjunction with financial service providers (e.g. through preferential loans, venture capital or credit guarantee schemes) but even provided direct grants to enterprises. The UK Grants for Business Investment scheme operated by the previous Labour government, was disbursed by England's Regional Development Authorities to SMEs and local businesses.
However, a very complex and rigorous appraisal and award system were put in place to avoid the risks of government failure as much as possible. The aid was restricted to either disadvantaged areas of the country or to SMEs as they face particular difficulties in attracting investment. Enterprises had to show that the grant would be funding of last resort and that they had tried and failed to access commercial sources of funding. A rigorous appraisal process was put in place with various tests to ensure that projects chosen for support maximise long term job creation, job quality, research and development, productivity increases and impact on the regional and national economy. In compliance with EC State Aid rules, the grants also could not be given if there was no incentive effect i.e. that the investment would have gone ahead without the grant (to avoid the deadweight effect). The project had to also show that it would not displace jobs from elsewhere in the country (to avoid the displacement effect). Funds could not be targeted towards sectors where the EC does not have a comparative advantage – so agriculture, ship building, coal, steel and synthetic fibres sectors were excluded. Finally, funds could not be targeted towards specific types of economic activity within the manufacturing and service sectors (to avoid the government trying to "pick winners") .
Faced with arguments for and against local government intervention, we are still left unsure, especially in Africa, as to whether local governments should risk supporting local firms financially. Is it realistic, given human capacity constraints in African local governments, that rigorous appraisal systems can be put in place to avoid the risks of government failure? Is it desirable that local governments in Africa spend precious funds on such complex initiatives with a high risk of wasting resources? Should they instead concentrate on the safer aspects of LED such as infrastructure improvement, skill development, attracting inward investment or supporting local firms but through non financial means (regulatory improvements, facilitating access to land and market information, etc)? I would be interested to hear your views and experiences.
Emma Wadie Hobson