Governance and the lnvestment Climate in Yemen

Transcription

1 Middle East and North Africa Governance and the lnvestment Climate in Yemen Working Paper Series No. 28 September 2002 The World Bank Produced by the Office of the Chief Economist by Arup Banerji and Caralee McLiesh Summaries in Arabic and French

2 Governance and the Investment Climate in Yemen by Arup Banerji Social and Economic Development Group Middle East and North Africa Region Caralee McLiesh Private Sector Development and Infrastructure Vice Presidency September 2002 Discussion papers are not formal publications of the World Bank. They represent preliminary and often unpolished results of country analysis and research. Circulation is intended to encourage discussion and comments; citation and the use of the paper should take account of its provisional character. The findings and conclusions of the paper are entirely those of the authors and should not be attributed to the World Bank, its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent.

3 Acknowledgments We are grateful for the cooperation and guidance provided by the Ministry of Planning and Development, and the Ministry of Trade and Industry of Yemen, and for valuable comments and suggestions throughout the process from Edourad Al-Dahdah, Mohammed Al-Sabbry Claus Astrup, Dipak Dasgupta, Monali Chowdhurie-Aziz, Julia Devlin, Georges Ghorra, Ingrid Ivins, Jennifer Keller, John Macgregor, Nadir Mohammed, Elisabeth Sherwood, Masakazu Someya and John Speakman. Any remaining errors or omissions are our own. The survey on which this paper is based was carried out in Yemen by Mohammed Al-Hawiri and Abdel Karim Al-Sieyaghi (Sana a University), under the general supervision of Nadir Mohammed and Mohammed M. Al-Sabbry.

4 Table of Contents Summary Introduction... 1 The backdrop to private sector activity in Yemen...1 Overview of the survey and results Survey and Sample Characteristics...3 Sample Composition Obstacles to Growth and Productivity...6 Overall ranking of obstacles...6 Regional variation in business obstacles...8 Firm Size and the Business Environment Bureaucratic Interaction...11 Entry Costs...11 Delays and informal payments for ongoing operations...12 General efficiency of government services Availability of Factors of Production and Infrastructure...15 Land...15 Credit and Financial Transactions...16 Labor...18 Quality of Infrastructure Socio-Political Factors: Security, Stability and Participation...20 Violent incidents...20 Predictability of rules...21 Participation in Policy Formulation Conclusion...22 References...23 Appendix...24 Tables Table 1. Composition of the sample... 4 Table 2. Distribution of relocated firms... 4 Table 3. Legal organization of firms... 4 Table 4. Distribution of firms by sector... 5 Table 5. Rank 1 obstacles, by firm size Table 6. Entry costs Table 7. Delay in bureaucratic interactions Table 8. Efficiency of government services, by Governorate Table 9. Ownership and multiple claims to land Table 10. Efficiency of financial transactions Table 11. Skilled labor Table 12. Time to obtain foreign worker license Table 13. Disruption of infrastructure services (days)... 20

5 Figures Figure 1a. Obstacles to business, Yemen... 7 Figure 1b. Obstacles to business, Yemen versus small firms worldwide... 7 Figure 2. Ranking of business obstacles... 8 Figure 3. Informal payments in bureaucratic transactions Figure 4. Firm ratings of government service efficiency: international comparisons Figure 5. Method of Dispute Resolution Figure 6. Sources of finance Figure 7. Method of resolving payment disputes Figure 8. Employee turnover and reasons for turnover Figure 9. Violent incidents in previous 3 months, by governorate Figure 10. Perceptions that rules are unpredictable, by governorate Figure 11. Influences over policy formulation Appendix Figures Figure A. Business obstacles by region Figure B. Business obstacles by size Appendix Tables Table A. Perceptions and experience Table B. Distribution of sample firms by sector Table C. Determinants of export status Table D. Does corruption pay? Informal payments and delays in bureaucratic interaction Table E1. Tests for equivalence of responses by region, size and age Table E2. Tests for equivalence of responses by sector, ownership and export status Table F. % Firms reporting moderate-severe obstacle by category Table G. Correlations between growth and obstacles to business Table H. Impact of access to financing on growth Table I1. Determinants of business obstacles (roads, ports, financing, macro stability, corruption) Table I2. Determinants of business obstacles (time, informal payments)... 31

6 موجز تلخ ص ه ذ ه ا ل د ر اس ة ن ت اي ج اس تطلاع ا ر اء ت م أي ن اءه ط رح أسي ل ة ع ل ى 947 شرآة يمنية بشا ن نظام الا دارة العامة وم ن اخ الاستثم ا ر بشك ل عام. وعلى الرغم من أن الق ط اع ا ل خ ا ص ا ليمن ي ا ل صغي ر ا لنط اق ج د ا ونق ص تو ف ر ا لمع لوم ات شكلا ت ح دي ات ه ام ة أث ن اء جم ع ا لمع لوم ات ف ا ن ا لبي انات توفر م ص د ر ا ث ري ا للا د ل ة بش ا ن م جمو ع ة آبي رة ومتنو ع ة م ن ا لقيو د ا لت ي تع يق تنم ي ة ا لقط اع ا ل خ ا ص ف ي اليم ن. وتش مل العقبات الري يسي ة أم ا م ا لنش اط الا قت ص ا د ي ا لفس ا د و ع د م ا لتيق ن م ن ا لسي اس ات الاقتص ادية (وه ي ن تاي ج شبيهة با لنت اي ج ا لت ي ت م ا لتو ص ل إ ليه ا ف ي ب ل د ا ن أ خ ر ى ف ي المنطقة) على الرغم من وجود مفاجا ت أي ض ا م ث ل الاه تم ا م ا لع ا م ب استق ر ا ر الا قت ص ا د الكلي. وتختلف حدة آل عقبة متصورة باختلاف المناطق. بشكل عام تسجل ا لش رآ ات ف ي ص نع اء و ا ل ح دي دة ) ف ي ا ليم ن ا لش م ا ل ي س ابق ا) و ج و د معو ق ات أآب ر مم ا هو مو جو د ف ي تع ز (على الحدود مع ا ليم ن ا ل جنوب ي س ابق ا) و ع د ن وحض رموت/المكلا ) في اليمن الجنوبي سابقا). ويب دو أ ن م ن بي ن ا لقيو د ا ل ري يسي ة ا لت ي تعيق تنم ية القط اع الخاص العقبات أمام زيادة حجم الشرآات القا ي م ة و ليس م ج ر د و جو د حو ا ج ز أم ا م د خو ل ش رآ ات ج دي دة إ ل ى ا لس وق نظ ر ا لا ن ا لش رآ ات الا آ ب ر ح جم ا (التي تعرف في اليمن با نها الشرآات التي يعمل بها أآثر من عشرة موظفين) تذآ ر بش كل ع ام وج ود حواج ز أآبر أمام التشغيل والن مو م ن ت لك ا لت ي تو ا ج ه ا لش رآ ات ا لمتوسط ة و ا ل صغي رة (على نقيض النتاي ج المسجلة في بلدان أخرى). وعلاوة على ذلك فا ن القضايا المتعلقة بنظام الا دارة العامة قد تكون عاملا ري يسيا معيقا لنمو الشرآات بحيث من الا ر ج ح آثي ر ا أ ن تعتب ر ا لش رآ ات ا لكبي رة ا لفس ا د والتهريب/الا غراق الحاجز الري يسي أمامها.

7 Résumé Ce document résume les conclusions d une enquête qui a posé à 947 entreprises yéménites des questions sur la gouvernance et le climat d investissement en général. Même si la taille très réduite du secteur privé et le peu d information dont dispose le Yémen sont des défis importants à sa collecte, les données obtenues offrent une source très riche de faits observés qui empêchent le développement du secteur privé dans ce pays. Les obstacles majeurs aux affaires sont la corruption et l incertitude de la politique économique (similaires aux conclusions relatives à d autres pays de la Région), même si l on y trouve des surprises également, comme par exemple une préoccupation universelle à propos de la stabilité macro-économique. La sévérité des obstacles rencontrés diffère considérablement entre régions. Généralement, les entreprises de Sanaa et Hodeïda (dans l ancien Yémen du Nord) connaissent des obstacles plus importants que ceux rencontrés à Taïz (à la frontière avec l ancien Yémen du Sud), Aden et Hadramaout/Mukalla (dans l ancien Yémen du Sud). Une contrainte primaire au développement du secteur privé semblerait être constituée par les obstacles au renforcement des entreprises existantes, plutôt que par les barrières à l entrée de nouvelles entreprises car en général les grosses entreprises (qui sont définies au Yémen comme celles ayant plus de dix employés), indiquent généralement des barrières plus importantes à l exploitation et la croissance que les petites et moyennes entreprises (contrairement aux résultats enregistrés dans d autres pays). De plus, les problèmes de gouvernance peuvent être un facteur important qui empêche la croissance des entreprises, les grosses entreprises ayant plus de chance de classer la corruption et la contrebande/le dumping comme étant leurs principaux obstacles.

8 Summary This paper summarizes findings from a survey that asked 947 Yemeni firms questions about the overall governance and investment climate. Although Yemen s very small scale private sector and poor information availability presented significant challenges to gathering information, the data provide a rich source of evidence on an array of constraints to private sector development in Yemen. Major obstacles to business include corruption and economic policy uncertainty (similar to findings in other countries in the region), although there are surprises as well, such as an universal concern with macroeconomic stability. The severity of the perceived obstacle differs significantly between regions. Generally, firms in Sana a and Hodeidah, (in the former North Yemen) record greater impediments than those in Taiz (on the border with the former South Yemen), Aden and Hadramout/Mukalla (in the former South Yemen). A primary constraint to private sector development appears to be obstacles to scaling up existing firms, rather than only barriers to entry since in general, large firms (defined, in Yemen, as more than ten employees) tend to report greater barriers to operation and growth than medium or small firms (contrary to the results recorded in other countries). Moreover, governance issues may be an important factor impeding firm growth, with large firms significantly more likely to rank corruption and smuggling/dumping as their top barrier.

9 Governance and the Investment Climate in Yemen Introduction In the cities and towns of Yemen, private businesses are generally small, reluctant or unable to grow in size, selling directly to customers, and preponderantly in the service sector rather than in manufacturing. And most cross-country "expert" surveys of governance place Yemen in the bottom third of the world especially when considering the "rule of law." 1 This paper explores the intersection of these two results, by drawing on an unique survey of perceptions of the business environment by a stratified random sample of 947 Yemeni firms. The backdrop to private sector activity in Yemen The Republic of Yemen is a country of about 18 million people, nestled in the mountains and desert at the foot of the Arabian peninsula. It is one of the poorest countries in the Middle East, with a PPP per capita income of just $780 in 2000, putting it on par with sub-saharan countries such as Mali, Niger, Nigeria and Zambia. Yemen emerged as the product of the unification, in 1990, of two very different nations the Yemen Arab Republic, or North Yemen, and the People's Democratic Republic of Yemen, or South Yemen. North Yemen, until 1962, was an almost autarkic Imamate; it then lived through the chaos of a bruising eight-year civil war, followed by two decades of being a highly protected economy. South Yemen, on the other hand, consisted for a century and a half of the thriving British port city of Aden and a collection of traditional feudal states; after independence in 1967, it became a socialist state on the Soviet model, with almost no private activity permitted. The private sector, therefore, was essentially illegal in pre-independence South Yemen. In the North, private activity was permitted but was highly regulated and crowded out by government enterprises. The 1990s, therefore, brought about the unification of two very disparate socio-economic systems. The decade was also marked by an increasing importance of oil to the unified economy. 2 Today, the non-extractive formal private sector in Yemen is small and stagnant, dominated by very small firms with relatively low productivity. 3 Most striking is the fact that, as of 1999, the entire country had only 288 firms (less than one percent of all manufacturing establishments) with more than 10 employees. About 95 percent of firms had three or fewer employees, numbers virtually unchanged from For example, in the : Kaufmann, Kraay and Zoido-Lobaton (2002) indicators, Yemen is in the 8th percentile for rule of law indicators, 14th percentile for political stability/no violence, and between the 25th and 33rd percentile for government effectiveness, control of corruption, voice and accountability and regulatory quality indicators. Rule of law is among the most robust determinants of economic growth in a large cross-section of countries--see Knack and Keefer (1995). In general, institutional quality (or good governance) significantly affects economic growth--see Mauro (1995), Barro (1991), Alesina et al. (1996), and Brunetti, Kisunko, and Weder (1998a). 2 Oil exports began in 1987, but by 2000, were already over 90 percent of all Yemen's exports. See World Bank (2002). 3 Excluding oil, gas and refining, the industrial sector contributed less than 10 percent of GDP in Within this, the non-oil manufacturing sector was less than 5 percent of GDP (down from 12.6 percent of GDP in 1995). The private service sector comprised around 28 percent of GDP in 2000, and of this, about 18 percent of GDP was concentrated in trade and transportation.

10 - 2 - Overview of the survey and results The survey on which this paper is based was conducted in November 2001, and attempted to cover a very large number of firms in five major governorates three in the former North Yemen, and two in the former South. Given resource constraints, the survey opted to poll a larger number of firms essentially a large representative sample of firms in each governorate rather than to ask a large number of questions to a smaller number of firms. The low incidence of foreign investment and exports for Yemeni firms is clearly evident in the sample. Firms with foreign participation comprise only 10% of respondents. State ownership stakes are even more rare, at 1.4% of the sample. Only 3.5% of respondents export. The likelihood of exporting increases significantly with firm size, and is not significantly associated with region, experience or ownership once size is accounted for. Although certain obstacles vary according to ownership and export status, as well as sector, in most cases these effects become insignificant once other factors such as region, size and age are accounted for in multivariate models. The survey results point to four broad results for Yemen: Based on firm s perceptions as well as their actual experience, there are five main areas of impediments to growth and productivity: macroeconomic and policy instability; problems with tax rates and administration; poor governance, especially corruption; lack of security and rule of law (smuggling, violence, dispute settlement); and inadequate infrastructure, especially electricity services. Although firms in all governorates record these obstacles, there is a regional pattern that emerges in terms of the severity of the obstacles. In general, obstacles are greater in the geographical north of the country: firms in Sana a and Hodeidah, (in the former North Yemen) record greater impediments than those in Taiz (on the border with the former South Yemen), Aden and Hadramout/Mukalla (in the former South Yemen). There are exceptions: for example electricity is a significantly greater constraint in both the port cities of Aden and Hodeidah. Nevertheless, the general patterns suggest that a deeper analysis of the historical evolution of institutions in different regions may be valuable. The size of the firm matters, and scaling up may be difficult. In general, "large" firms (in Yemen, this is defined as more than 10 employees) tend to report greater barriers to operation and growth than medium or small firms. This relationship is inverse to that recorded in other countries, in which smaller firms tend to report greater constraints. 4 In combination with fact that there are very few large firms in Yemen, this suggests significant barriers to firm growth. Governance issues may be an important factor impeding firms. Large firms are significantly more likely to rank corruption and smuggling/dumping as their top barrier. Firm age is associated with barriers on a case by case basis. Business licensing is perceived to be a significantly greater obstacle for newer firms, whereas older firms perceive tax administration to be significantly greater barrier. Older firms also have a significantly higher incidence of making informal payments to public officials. As with the firm size effect, this result may be less from firm experience or ability in expediting services, and more about prominent firms attracting attention: the data show that informal payments are not associated with fewer reported delays in services. 4 See, for example, Brunetti, Kisunko, and Weder (1999), which is based on the results of the World Business Environment Survey.

11 Survey and Sample Characteristics The structure of the Yemeni private sector presents significant challenges to measuring the impediments to firm growth and productivity. Firms are overwhelmingly small scale, with less than 1% of firms employing more than 10 workers. Detailed quantitative and objective information to assess obstacles (such as on financial performance, investment, contact with administrative officials, taxation, registration and permits, customs delays, and so on) is frequently unavailable. The Yemen firm survey attempts to address this challenge by asking a combination of experience- and perceptions-based questions. The questions on experience enable valid international benchmarks and objective evidence of barriers. Perceptions-based questions tend to have much higher response rates. Including questions on firm perceptions also offers the advantage of enabling a rank of the relative importance of different business obstacles, which can be more problematic with only experienced based questions (for example, it is difficult to assess whether three days of customs delay are worse for business than one day of power disruption). Importantly, the correlation between firm perceptions and actual experience is positive and significant (Appendix Table A). For example, firms that have experienced telephone and power service disruptions are significantly more likely to perceive telephones and electricity as constraints. Similarly, perceptions of the legal system and dispute settlement is closely correlated with actual time to resolve disputes. Even with this approach to the survey questions, however, high numbers of non-respondents in a few questions (in particular relating to financial questions such as profits or precise amounts of informal payments) suggest caution in generalizing certain findings. Sample Composition The population frame for the survey consists of over 17,000 firms registered with the Yemen Chamber of Commerce as at October Therefore, the survey only covers "formal" sector firms. The sample was stratified by five governorates: Sana a, Hodeidah, Aden, Taiz, and Hadramout. Firms were randomly selected within these strata. A total of 947 firms in 5 governorates responded to the survey. Table 1 summarizes the sample characteristics. The classifications for size follows the Yemen Industrial Survey, with small firms defined as 3 or less total employees, medium (4 to 9 total employees) and large (10 or more total employees). The classification in itself indicates the general lack of scale in the private sector: In other countries the definition for large firms is usually at least 100 plus employees. Only 30 firms in the sample have over 50 total employees, and only 11 report over 100 total workers. 5 As far as location, the majority of large firms (68%) are located in Sana a, where the average number of total workers is The median number of employees is 2, but in reflection of the small number of very large firms the average is Small firms have an average of 1.7 employees, for medium firms the average is 5.4, and large firms have 60.3 employees. 6 Large firms tend to have marginally more experience (mean is 15.7 years), although the difference in average age is not statistically significant. The sample average age of firms is 14.2 years, and the median age is 10 years.

12 - 4 - Table 1. Composition of the sample Location N Valid % Size (total employees) N Valid % Age N Valid % Sana'a Small (<3 employees) est and earlier Aden Medium (4-9 employees) est Taiz Large (>10 employees) est Hodeidah Hadramout No response/can't say 96 No response/can't say Yemeni firms are mobile. Almost 14% of the sample (131 firms) originally started business in a previous governorate, with 39% of them now located in Sana'a (Table 2). Firms now located in Hadramout are less likely to have started in a different governorate, whereas firms now located in Hodeidah are more likely to have started in a different governorate, as evidenced by multivariate logistic regression analysis. The analysis also revealed that medium and large firms are significantly more likely to have relocated from another governorate. Table 2. Distribution of relocated firms Location Now Location of Start-up Sana'a Aden Taiz Hodeidah Hadramout Dhamar, Ibb, Hodeidah, Marhweet Sana'a, Sadda, Marib, Al-Jouf, Hajjah, Amran Hadramout, Al-Mahra, Shabwah Aden, Lahej, Al-beida, Al-Dhaleh, Abyan The most common legal organization for firms in the sample is by far single proprietorship (83.5%), followed by partnership (10.7%) (Table 3). Partnerships and corporations are more likely as firm size increases. The majority (66%) of corporations are located in Sana a, with 12% in Aden, 7% Taiz and the remaining 15% in Hodeidah. Table 3. Legal organization of firms Legal organization of the company Firm Size (total employees) N Valid % Legal organization small medium large Single Proprietorship Single Proprietorship Partnership Partnership Corporation Corporation Cooperative Cooperative 2 Other Other No response/can't answer Table 4 (next page) shows the sector of operation of the firms in the sample. The majority of the firms in the sample operate in the services sector, largely in the trade and other services categories. Manufacturing firms account for 22.6% of the sample, comprised mainly of other manufacturing, garments and consumer goods. Construction, electricity gas and water, and agriculture are the largest sub-sectors defined within the other sector category. 7 7 A new classification of conglomerate was added to account for the 73 firms that provided more than one primary sector. Twenty-two firms were missing data on their sector. Table B in the Appendix summarizes the distribution of firms by sector with the double counting originally reported by firms.

13 - 5 - Table 4. Distribution of firms by sector Sector N Valid % Manufacturing Services Other Conglomerate (>1 answer) No response Sector 2 digit N Valid % Heavy Industry Consumer Goods Garments Food and Beverages Leather & Shoes Other Manufacturing Tourism, hotels, restaurants Trade: retail/wholesale Transport and storage Finance and banking Personal services Other Services Agriculture Fishing Extraction (mining, oil) Construction Electricity, gas, water Other Conglomerate (>1 answer) No response In terms of ownership structure, the firms in the sample are almost entirely privately owned (only 10 firms, or 1.4% of respondents reporting any government ownership) and domestic (69 firms or 10% of valid respondents reported that foreign entities have an ownership stake in their firm). 8 8 Large firms are more likely to be government owned: six of the firms with state participation are large, 3 medium, and 1 small. Six are more than 10 years old, 2 are between 10 and 3 years old and 2 are less than 3 years old. Foreign participation is more likely in newer firms: 15% of firms less than 3 years old reported foreign ownership, compared with 10% of firms between 3 and 10 years old and 3% of firms over 10 years old. Large firms are more likely to be foreign owned: 13% of large firms report some foreign ownership, compared with 8% of medium and 7% small. Rates of foreign ownership are higher in Hadramout and Aden. Finally, only 23 firms (2.43%) reported to hold investments in other countries such as foreign subsidiaries or factories. Not surprisingly, both large firms and exporters are significantly more likely to hold investments in other countries. Reasons for investing abroad were: more attractive foreign opportunities (50%) and problems or obstacles to business in the domestic market (25%).

14 - 6 - The firms in the sample serve primarily the domestic market. Only 32 firms, or 3.5% of respondents are exporters. The majority of exporters (64%) are large firms and 23% are medium. By contrast, in Morocco, 56% of firms greater than 10 employees (in manufacturing sectors) are exporters. 9 Regression analysis was applied to determine the relative impact of different firm characteristics on whether or not it will export. The results are presented in Table C in the Appendix. Only size is significant determinant of whether a firm exports, confirming that larger firms are more export oriented. By contrast, location, age, sector and ownership do not significantly increase the likelihood of exporting in multivariate analysis. Similar analysis with the percentages of sales in exports as a dependent variable did not reveal any significant determinants. 2. Obstacles to Growth and Productivity Overall ranking of obstacles A central question of the survey asked firms to assess the extent to which different factors are constraints to their business. Figure 1a summarizes the responses of firms that report moderate to very severe obstacles for each of the potential constraints. Five main categories of barriers emerge: macroeconomic and policy instability, tax rates and administration, corruption, lack of security and rule of law (smuggling, violence, dispute settlement), and inadequate infrastructure, especially electricity. 10 The barriers reported by Yemeni firms are broadly similar to those reported by firms worldwide (in the World Business Environment Survey (WBES), but with some interesting differences (Figure 1b). 11 Yemeni firms are less likely than in the WBES sample to identify financing and tax administration as obstacles. On most other counts, however, the perception of obstacles by Yemeni firms was greater with the greatest differences being in corruption, infrastructure (for electricity), and the legal/judicial system. 9 MCI and World Bank (2001). 10 These results are broadly similar when obstacles are measured by firms reporting 'major to very severe' barriers. Macroeconomic instability, corruption, tax rates, and economic policy uncertainty remain in the top 5 most reported barriers. Smuggling and dumping becomes a somewhat greater obstacle when measure by just 'major and severe' obstacles, and competition becomes less important (these barriers move to rank 3 and rank 6 respectively). 11

15 - 7 - Figure 1a. Obstacles to business, Yemen Obstacles to Business (% of firms indicating moderate to very severe constraints: valid responses) 1. Macroeconomic instability 2. Corruption 3. Tax rates 4. Economic policy uncertainty 5. Unfair or informal competition 6. Smuggling and dumping 7. Crime, theft and disorder 8. Electricity 9. Tax administration 10. Legal system and dispute settlement 11. Access to Land 12. Cost of financing 13. Access to financing 14. Customs and trade regulations 15. Roads and Ports 16. Skills and education of available workers 17. Business licensing and registration 18. Telecommunications 19. Labor regulations Figure 1b: Obstacles to business, Yemen versus small firms worldwide Macro Instability/Inflation Corruption Policy Uncertainty Anti-competitive practices Crime/Theft/Disorder Electricity/Infrastructure Tax Administration Legal/judicial system Financing WBES Average (small firms) Yemen Sources: Yemen survey 2001, WBES survey

16 - 8 - Figure 2. Ranking of business obstacles Ranking of Business Obstacles (% valid responses) 1. Tax rates 2. Electricity 3. Macroeconomic instability 4. Smuggling and dumping 5. Corruption 6. Access to Land 7. Tax administration 8. Telecommunications 9. Unfair or informal competition 10. Crime, theft, disorder 11. Economic policy uncertainty 12. Customs and trade regulations 13. Access to financing 14. Roads and Ports 15. Legal system and dispute settlement 16. Cost of financing 17. skills and education of available workers 18. Business licensing and registration 19. Labor regulations Rank 3 Rank 2 Rank 1 Firms were also asked to rank the top 3 barriers to their business, in order of priority. Figure 2 shows that similar patterns are evident when obstacles are measured this way: a high percentage of firms place taxes, electricity, macroeconomic stability, smuggling and dumping, and corruption in the top 3 barriers. Access to land emerges as a greater priority for many firms, whereas economic policy uncertainty appears somewhat less of a priority when firms are asked to name their top obstacle. Regional variation in business obstacles Is business environment uniform across regions in Yemen, or does the locality of the business make a difference? This question is significant for two reasons: to try and address a broad question of whether the institutional legacy of North versus South Yemen makes a difference today, more than a decade after unification; and to figure out the primary areas of intervention in the business environment, which may vary across regions. The survey provides an unique mechanism to examine these issues, given its size and the resulting fact that there are large (and thus statistically significant) numbers of responding firms in each of the five regions surveyed. Differences according to governorate in the rate of responses on obstacles were almost always statistically significant. Although the ranking of regions depends upon the question, in general firms in Sana a and Hodeidah (in the North) record greater impediments than firms in Taiz (in the North, but on the border with the South) Aden, and Hadramout (see Table E1, F and Figures in Appendix). These "North-South" differences are particularly marked for customs and trade regulations, roads and ports, the legal system and dispute settlement, labor regulations and business licensing. And access to land is significantly less of a constraint in Sana'a, Hodeidah and Taiz but greater in Aden and Hadramout.

17 - 9 - There are exceptions, in particular with resource constraints: for example electricity is a significantly greater constraint in Aden and Hodeidah, both commercial ports (as opposed to Mukalla in Hadramout, which is a fishing port). The significance of location in determining responses to business obstacles was confirmed by multivariate regression analysis (selected regressions reported in Table I1.) Firm Size and the Business Environment Do the size of firms in Yemen affect how they perceive the business environment and how they are affected by the obstacles? Much of the existing literature, from de Soto (1987) to later work mostly based on the WBES surveys, argue that smaller firms would face larger obstacles than larger firms. 12 For example, Beck, Demirgüç-Kunt and Maksimovic (2001) find that " the smallest firms are most adversely affected by all the constraints". This is borne out in recent surveys in the region, for example in Morocco and West Bank Gaza. 13 The analytical arguments for how size affects business constraints, however, are not unequivocal. Smaller firms may be argued to perceive existing business obstacles as more onerous because of three broad reasons: higher entry costs (including bribes to reduce bureaucratic barriers) with respect to scale (essentially the de Soto argument); the lack of socio-political networks, and thus the lower ability to either change either regulatory barriers or the application of these regulations in their favor, or to collude with other firms in influencing bureaucrats; lower ability to diversify the risks and costs inherent in a different domestic market by accessing production and sales opportunities in international markets. On the other hand, it may also be argued that larger firms may have more difficulties than smaller firms in developing countries, because of: inability to easily avoid taxes and regulations by becoming informal; greater visibility, and thus greater risks of being the target of bureaucratic and other extortion; more complex production processes may be more intensive in scarce resources such as financing, skilled labor and infrastructure. The results from the survey in Yemen show a contrast to the pattern found in the literature. Larger firms in Yemen generally identify themselves as more constrained that medium or small firms (see Appendix Table E1, F and the Appendix Figures). This result is consistent with other surveys in Yemen in the 2000 MSE baseline survey larger firms report greater obstacles for all except identifying business opportunities and lack of business information. In combination with the small scale nature of Yemen firms, this result highlights that obstacles to scaling up existing firms appear a primary constraint to private sector development over barriers to entry See, for example, Brunetti, Kisunko, and Weder (1999) and Beck, Demirgüç-Kunt and Maksimovic (2001). 13 See MCI and World Bank (2001) and Sewell (2001) respectively. 14 Age of firms is associated with some barriers on a case by case basis: e.g. telecommunications and business licensing is perceived to be a significantly greater obstacle for newer firms, older firms perceive labor regulations and tax administration to be significantly higher. (see Table E1, Figures in Appendix). Similarly, some responses vary according to sector, ownership status and export status on a case-by case basis. Many of these relationships do not hold in multivariate analysis, and no clear pattern emerges for differences in responses by these factors.

18 The sharpest differences between large and small firms (Appendix figures) are only in three areas: issues relating to trade, labor and financing. Specifically, the six areas of greatest difference are customs and trade regulations (57% of large firms identifying them as moderate to severe barriers as against 24% of small firms), roads and ports (41% versus 21%), labor regulations (27% versus 11%), skills and education of available workers (49% versus 16%), cost of financing (53% versus 30%) and access to financing (62% versus 41%). Why may this be so? For one, it is important to note that "larger" firms in Yemen are still quite small the relevant category is "over 10 workers". Therefore, most of them may be as unable to access international markets or socio-political networks as their smaller peers. Similarly, scale advantages with respect to bureaucratic barriers, while present, may be a much smaller advantage when the distribution of size of the firms is small. On the other hand, the relatively greater visibility may render them more susceptible to bureaucratic regulations. While the firms in the survey are all "formal" in the sense that they are registered, they may be easily able to evade regulations that their larger peers cannot. And some smaller firms, by the very nature of their activity (for example, because they only sell to local markets), may not need to deal with some particularly onerous obstacles, such as customs and trade regulations. Finally, given that the major source of financing for Yemeni firms is self-financing (see Figure 6 later), this is one area where scaling up even to a small extent could make a difference. Analysis of the rankings of top obstacles also reveals significant differences by firm size (Table 5). While the five barriers most likely to be evaluated as rank 1 are almost identical by size category, the order of importance of these top barriers varies significantly by firm size. Larger firms emphasize governance issues: smuggling and dumping and corruption are significantly more likely to be ranked as the top obstacle by large firms. Smaller firms are more likely to rank resource and input constraints, including electricity and access to land, as their top obstacle. These results suggest that the institutional environment especially hinders the development of large firms. Table 5. Rank 1 obstacles, by firm size % firms ranking obstacle as No 1 Small % Medium % Large % 1. Electricity Tax rates Smuggling and dumping Tax rates Electricity Macroeconomic instability Macroeconomic instability Macroeconomic instability Corruption Smuggling and dumping Smuggling and dumping Tax rates Access to Land Corruption Electricity 8.91 Thus, a priori, the expected empirical association between firm growth and business obstacles is not entirely clear. On the one hand, severe business obstacles will inhibit firms ability to invest in profitable activities, and growth will decline. In this case higher reported obstacles will be associated with low growth firms. On the other hand, some barriers may be applied or become relevant only for higher growth firms. For instance, low growth firms operating a low levels of capacity may have less need for reliable infrastructure services. Or, successful high growth firms may attract unwanted attention from public officials, and face greater administrative delays and corruption. In this case, higher growth firms could be expected to report greater obstacles. In Yemen, as shown by Tables G and H in the Appendix, there does not appear to be a single clear association between obstacles and growth in firm sales or employees. Crime, skills of workers, and telecommunications obstacles are associated with higher growth firms. Problems with access to financing, however, is associated with lower growth, and the relationship remains significant once controlled for location, size, and age.

19 In summary of this section, Yemeni firms identify substantial impediments to their development. Macroeconomic and policy stability, governance problems, tax rates and administration and infrastructure services are viewed as particularly severe obstacles. The survey investigates these general assessments of business constraints in more depth, with further questions on the details of individual obstacles, as discussed in the remainder of this note. 3. Bureaucratic Interaction Entry Costs How difficult is it to set up a new business in Yemen? 15 Of the 123 firms with recent experience in establishing a business, a series of questions on the time and costs (both official and unofficial) of start-up were asked. Table 6 summarizes the descriptive statistics of the responses. Non response rates within the sub-sample are high, averaging around 30%, and are especially low for questions on unofficial costs of entry (average around 19%). The valid responses, however, indicate barriers to entry, albeit with a wide range of reported experiences. The median time to establish a new business is 3 months (mean 4.8 months), and responses range from 0.25 to 24 months. Each connection to infrastructure services and contact with licensing authorities takes a median of 1 month (mean between 1.6 and 2.2 months). Electricity connections emerge as a particularly large barrier in terms of time and costs, although again there is also an extremely high variation in responses. Firms report significant unofficial payments to establish a business. Median unofficial payments are between 12 and 60% of median official payments, and are highest for licensing and permits. In general non parametric tests indicate that these unofficial payments are statistically significant firms responded that they had established their business within the previous 2 years. There is a relatively low response rate for this question: 286 firms gave no response or could not answer whether they started in the previous 2 years. Some of these non responses may reflect that older firms thought the question was not relevant to them, that is, the non response is treated as equivalent to no. Nevertheless, it can be computed from another question on when the business was established that 163 firms had started within the previous 2 years.

20 Table 6. Entry costs Time, official costs and unofficial costs of establishing a business in Yemen Electricity Time (months) connection Telephone connection Water connection Business license Municipal permits start up N Minimum Maximum Median Mean Std. Dev Official Costs (rials) Electricity connection Telephone connection Water connection Business license Municipal permits start up N Minimum Maximum 500, , , ,000 50,000 3,000,000 Median 20,000 26,000 10,000 5,000 5, ,000 Mean 55,743 44,453 16,583 11,635 8, ,500 Std. Dev. 99,868 48,379 24,303 26,273 9, ,945 Unofficial Costs (rials) Electricity connection Telephone connection Water connection Business license Municipal permits start up N Minimum Maximum 70,000 30,000 20,000 50,000 20, ,000 Median 5,000 3,000 1,500 2,000 3,000 2,000 Mean 12,333 5,632 5,300 6,623 4,314 57,818 Std. Dev. 18,833 7,253 6,865 12,099 5, ,305 Delays and informal payments for ongoing operations Bureaucratic interactions for ongoing operations also involve significant delays and informal payments. Table 7 shows the distribution of responses on delays of dealing with government for various transactions. The questions apply to only firms with experience in these transactions over the previous two years: response rates vary from 12% of the total sample (government contracts) to 43% (getting licenses and permits). Delays vary significantly by governorate (Appendix table E1), although the ranking of regions varies depending upon the question. Not surprisingly given their ratings of general obstacles, Aden and Hadramout report greater delays in purchasing land and getting construction permits, but fewer delays in dealing with tax collectors. Regional variations remain significant in multivariate analysis (Appendix Table I2). For the case of government contracts, services, and permits, delays also vary by firm size (large firms report greater delays). Older firms are associated with significantly fewer delays for services and permits once other factors are accounted for in multivariate analysis.

21 Table 7. Delay in bureaucratic interactions Number of days delay to get/deal with: Connect to Get Licenses and Deal with Tax Get Government Buy Land/ Public Services Permits Authorities Contracts Clear Customs Constr. Permit Days N Valid% N Valid% N Valid% N Valid% N Valid% N Valid% days days days days days >100days Mean Median Data on informal payments for bureaucratic interactions are frequently missing: there are between 32 and 213 respondents for each question. However, of those who responded, a significant majority indicated the need to make informal payments for bureaucratic interactions (Figure 3). Figure 3. Informal payments in bureaucratic transactions Incidence of Irregular Payments % firms indicating informal payments (valid responses) Public Services (N=174) Licenses / Permits (N=213) Tax Authorities (N=208) Govt Contracts (N=32) Customs (N=73) Land/ Constr.Permit (N=40) The location of the firm matters. Firms in Hodeidah are significantly more likely to make informal payments for permits, tax and customs, whereas firms in Aden and Taiz are less likely to make informal payments for customs. Larger firms report a higher incidence of making informal payments than smaller firms, although this effect becomes insignificant in multivariate analysis (Appendix Table I2). Older firms have a significantly higher incidence of making informal payments for tax, permits and services, an effect that holds in multivariate analysis (Appendix Table I2). Evidence suggests that corruption does not have an efficiency payoff. As presented in Appendix Table D, both t-tests and nonparametric tests indicate that the firms making informal

22 payments do not experience fewer delays in bureaucratic transactions than firms than other firms. Therefore, the evidence that older and larger firms are more likely to make unofficial payments may be less a result of firm experience or ability in expediting services, and more about prominent firms (through age or size) attracting unwanted attention from public officials. General efficiency of government services In general, the sample firms were relatively positive in their rating of government efficiency. When asked to assess the efficiency of general government services, 4.9% respondents replied very efficient, 10.2% efficient, 42.5% responding somewhat efficient, 18.8% somewhat inefficient, and 14.9% inefficient and 8.8% very inefficient. Although perceptions of efficiency are lower than those in West Bank Gaza and East Asia, these figures compare favorably with other regional benchmarks (Figure 4). Figure 4. Firm ratings of government service efficiency: international comparisons General Efficiency of Government Services Inefficient/very inefficient Somewhat inefficient Somewat efficient Very efficient/efficient Yemen West Bank Gaza East Asia Transition South Asia Latin America OECD Source: Yemen Private Sector survey and WBES Firms in Aden, Taiz and Hodeidah rate government services as less efficient relative to other governorates (Table 8). Rating of government services do not vary significantly by firm size, age, sector or export status. Firms with foreign ownership are more likely to rate governments as inefficient. Table 8. Efficiency of government services, by Governorate Govt Services Sana'a Aden Taiz Hodeidah Hadramout Very efficient/efficient N % Somewhat efficient N % Somewhat inefficient N % Inefficient/Very Inefficient N %

23 Availability of Factors of Production and Infrastructure Land Land ownership is relatively uncommon. 287 (30%) of total respondents own their land, 640 (68%) rent land, 20 firms (2%) did not respond or couldn t answer (Table 9). Firms in Hodeidah and Sana a are most likely to own land (39.6% and 37.4% respectively), compared with Aden (33.7%), Taiz (23%), and Hadramout (12%). These differences are statistically significant in chi square tests (Table E1 in Appendix). Large firms are also significantly more likely to own their land (58.5%) than medium (29.1%) and small firms (25.5%). A similar significant effect holds for age: land ownership rates are 40% for firms established more than 10 years ago, 23.5% for firms between 3 and 10 years old, and 16% for firms less than 3 years old. Firms that rent land report that access to land is a greater obstacle than firms that do not, although the difference is significant only at p=.134. Firms that have claims on their land by others are significantly more likely to report access to land as an obstacle - the difference is statistically significant at the 5% level. Of those firms that own land, 93% have a title to the land, 5% do not have title and 2% did not respond. Differences in owning a title do not vary significantly by region, size or age. All of those firms that have title have registered it. Ownership of Land Table 9. Ownership and multiple claims to land No resp. /can't say Claims by others to land None One Two > Two Twenty-two firms reported that others have made claims on their land: 13 firms have 1 claim on their land by other people, 3 firms have two other claims on their land, and 6 firms have more than 2 claims on their land by other people. Claims are more likely in Sana a and Hodeidah, although with the small sample size it is difficult to draw general conclusions. Age and size are not associated with the likelihood of having claims by others on land, although exporters and manufacturing firms are more likely to report claims by others on their land. Figure 5. Method of Dispute Resolution Method of Dispute Resolution: Land % valid responses, N=27 No resp. /can't say Yes No Sana'a Sana'a Hodeidah Hodeidah Aden Aden Taiz Taiz Hadramout Hadramout Informal payments 7% Use of force 11% Formal Mediator 22% Courts 60%