Should local governments in Africa provide financial support to local firms?
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
Are there costless LED actions?
I would think that given their limited resources, African local governments can hardly afford to give financial assistance to local firms even if they wished. However there are a lot of non-financial assistance that local governments can provide and these alone can go a long way in improving the performance of local firms. These type of measures include actions such reforms aimed at improving the business environment as well as sometimes simple things such as a completely costless campaign to drive home to all local stakeholders the importance of local businesses. A mayor whose LED strategy consists in a sincere show of respect, a listening hear and open-door attitude to local entrepreneurs can achieve a lot! Just that can make miracles. I think it will be useful at one point to discuss these completely free/costless LED actions that can be initiated by a small local government.
Costless LED Actions are arguably the best!
Dear Momo Mengue,
I really agree with what you have said. I think in any context, such costless LED actions as a change in attitude by government officials or reform of business regulations often achieve the best results with very little costs. In the African context, these are especially effective given the shortage of finances and capacity within local governments.
There is often an urge, however, to support local producers or micro enterprises financially because access to finance is a huge constraint they face. Local governments in Mozambique, for example, are doing this through the OIIL fund (see the Mozambique country page on LEDNA for more info). In principle this makes a lot of sense because microfinance institutions are currently not targeting those clients. In practice, however, due to capacity constraints within local government, this type of financial support most often achieves sub optimal results.
A better option, in my view, would be to use local governments' scarce funds to incentivise a microfinance provider to locate in the area or to target previously unserved groups of producers or enterprises. This would leave the complex business of running the actual access to finance programmes to the experts - the microfinance providers.
I hope that through LEDNA these issues can be thoroughly discussed and experience shared so that the best programme and policy decisions are made to support local producers and enterpreneurs.
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