Executive Summary In a postconflict environment, attracting new foreign and domestic firms is central to private sector development. New decisions about investment (in existing or new firms) usually depend on the availability of five basic factors: political and economic stability and security; clear unambiguous regulations; reasonable tax rates that are equitably enforced; access to finance and infrastructure; and an appropriately skilled workforce. In Afghanistan, these conditions are lacking. The challenges facing the government of Afghanistan in addressing these constraints and in turn attracting further foreign and domestic investment cannot be underestimated. But, as the experience of other reconstruction efforts shows-for example, in Bosnia and Herzegovina and East Timorreform can be achieved. This report was prepared to assist the government of Afghanistan in addressing its private sector development challenges. It is based on a survey of 338 firms and draws on numerous recent studies on Afghan private sector issues.
Chapter 1 Country Overview: In a postconflict environment, attracting new foreign and domestic firms is central to private sector development. Existing firms at the end of sustained conflict are typically state-owned, are highly undercapitalized, have weak or nonexistent management, have a deskilled and underemployed labor force, and are in need of significant new capital investment. As is the case in any business environment, particularly in postconflict countries, new investment decisions (into existing or new firms) usually depend on the availability of five basic factors: political and economic stability and security, clear unambiguous regulations, reasonable tax rates that are equitably enforced, access to finance and infrastructure, and an appropriately skilled workforce. In Afghanistan, these conditions are lacking. The challenges facing the government of Afghanistan in addressing these constraints and in turn attracting further foreign and domestic investment cannot be underestimated.
Chapter 2 The State of the Private Sector: Long years of conflict devastated Afghan industry. The fighting destroyed most of Afghanistan's production capacity and forced the flight of many skilled workers and managers. Sabotage of infrastructure crippled domestic and international distribution channels and cut off industry from its traditional markets. In addition, the Soviet-backed government in the 1980s worsened the situation by nationalizing large portions of the economy, imposing price controls, and attempting to set up a centrally planned economy. In response, many traditional industries, including carpet weaving, closed and moved to neighboring countries. Others, such as horticulture products, basically shut down because of the lack of suitable inputs. There was a brief recovery of agriculture (primarily horticulture and livestock) in the 1990s, which was wiped out by the drought of the late 1990s. Many of the large state-owned enterprises (SOEs), such as the cotton and transportation companies, continued to exist but by the end of the 1990s were essentially moribund.
Chapter 3 Today’s Investment Challenges: The Afghan government has taken a number of steps to improve the business environment and attract investment. Tax reform is a notable example. Afghanistan is now at number seven of 155 countries in the 2005 Doing Business rankings for paying taxes (World Bank 2005). The gross profit tax is 21.4 percent (compared with 35 percent for the region and 46 percent in the OECD), and the average medium-size company makes two payments and spends about 80 hours per year complying with taxes. Currently, entrepreneurs do not see tax administration as a big issue because there is little enforcement. But as the economy grows and becomes more formal, it will benefit from having an efficient system in place. As already mentioned in chapter I, Afghanistan has made the process of registering a business, if not actually starting operations, simple. Labor regulation is another area where Afghanistan has made significant progress. It ranks 25th in the 2005 Doing Business list. Regulations governing hiring, firing, and working hours all give Afghan firms more flexibility than firms have in most other countries of the world, particularly among its neighboring countries. The government has made important strides toward creating an enabling investment climate, but much more remains to be done, particularly in removing informal barriers to new entry, improving infrastructure, and reducing uncertainty.
Chapter 4 Accelerating Private Investment: What needs to be done Despite adverse conditions, the entrepreneurial spirit is alive in Afghanistan, investment opportunities are being exploited, and jobs are being created. However, performance levels are still modest compared with the range of emerging opportunities. Much more needs to happen in the enterprise sector if it is to fulfill expectations and make a substantial contribution to job creation and improvement in the dismal human development indicators of Afghanistan. The challenges highlighted in chapter III-that the private sector is often oligopolistic, works through social and political networks, and is anticompetitive-need to be addressed. The key challenge is to broaden participation in the market by removing barriers to new entry and creating conditions that will encourage those already in the market to invest more.
Annex The Investment Climate Survey, Managers' Perceptions of Major Constraints, and Doing Business in Afghanistan
Afghanistan Reconstruction Trust Fund The multilateral Afghanistan Reconstruction Trust Fund (ARTF) was set up in May 2002 to provide support to Afghanistan.
World Bank Program Website maintained by the World Bank Office in Kabul, a launching pad to all information on World Bank activities in the country (strategy, projects, publications, etc.)
Development Data A wide range of social and economic measures on Afghanistan, including links to the World Bank's most important online development databases.
Analysis and Research Compilation of all the World Bank's publications on Afghanistan, with 'search' options and links to analysis and research on other South Asian countries.
World Bank Program in South Asia Launching pad to all information on World Bank activities in Afghanistan, Bhutan, Bangladesh, India, Maldives, Nepal, Pakistan, and Sri Lanka.
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