]Islamic Republic of Afghanistan Ministry of Commerce and Industries

Private Sector Development General Directorate

Statement on Industrial Policy

May 2012/ Sawr 1391

Industrial Policy

May 2012/ Sawr 1391

Foreword by His Excellency Minister Ahady

Afghanistan has grown strongly since the fall of the Taliban. This growth has been driven by a number of factors, chief among them assistance from our international partners and the return of the Afghan Diaspora, which will begin to wane. If Afghanistan is to have the bright, prosperous future that we all hope for, these sources of growth need to be replaced. Our new Industrial Policy and the associated Position Paper are important steps towards creating a more sustainable future. This Industrial Policy is grounded in a thorough understanding of where Afghanistan finds itself, its strengths and weaknesses. It is also cognisant of recent developments in thinking about how best to develop industry and services. As a result, it sets out a much more activist role for government than has been the global norm in past decades. It acknowledges the need for sound, sensible government for stable macroeconomic policies, for fiscal stability and a strong enabling environment for business but it also acknowledges that there are occasions where government can act to assist industry leading it to achieve goals more rapidly than industry on its own is capable off. One of its strengths is its modesty. We are not looking to leap overnight into the forefront of industrial nations; our aim is not to embark, foolishly in my view, on a series of grand projects of the sort that have proved disastrous and expensive elsewhere. Instead we have identified our existing strengths and key sectors marble, carpets, gemstones and jewellery to name a few to supply us with this growth. In each of these areas, Afghanistan has proved itself able to compete in key sections of the value chain. In each of these areas, this policy sets out action to move industry higher up the value chain and repatriate activity from our neighbours that should rightfully be done here. Afghan carpets should not be being sold to the world with a Made in Pakistan label attached to them. It is time for us to recapture this business. This is not to say that this policy lacks ambition - the SME sectors alone are expected to generate US$1 billion in extra GDP and create a million new jobs in the next six years - rather, it is to acknowledge existing potential and existing enterprise: in the end, it is the private sector that will create a prosperous future for Afghanistan and the role of the government is to act as a catalyst, a facilitator, a regulator and as a policy maker. Its realism is a strength not a weakness. This policy sets out key actions that government will take to assist with the development of the economy. Obviously, it will not succeed unless our partners in implementation donors and the private sector take concurrent action. I am looking to the private sector to work with us to implement it, for companies to share knowledge and expertise generously where this has been generously provided to them by government or our donor partners. If we are to succeed, it will be because we have worked together on the basis of a shared vision. I look forward to working with you all to ensure that this occurs.

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May 2012/ Sawr 1391

Anwar-ul-Haq Ahady Minister of Commerce and Industry

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May 2012/ Sawr 1391

OVERVIEW 1. This policy outlines the principles and the main policies that the Government of Afghanistan (GoA) will follow in seeking to further develop Afghanistans industry and services. The policy reflects the vision of the Afghan Government and Ministry of Commerce and Industry of a socially responsible market economy in Afghanistan, in which sustainable and equitable growth is private sector led and leads to increased employment, higher living standards and the reduction of poverty, in which competition operates for the benefit of consumers and they are protected from sub-standard products and services and anti-competitive practices. 2. This policy recognizes the intense debate currently occurring on the role of Government in encouraging industrial development in which traditional laissez faire orthodoxy has given way to a recognition that well considered interventions by government can lead to higher growth. Given the newness of this debate and the controversy surrounding the provision of subsidies and tariffs, the response of the Government of Afghanistan to this debate, and the rationale for the principles and policies adopted are to be found in a companion document, A Position Paper on Industrial Policy in Afghanistan. As well as explaining why the Government has arrived at the position it has, this paper also seeks to expedite implementation by setting out concrete steps that need to be taken in order to facilitate development in key sectors of Afghanistans economy. It also describes in detail the mechanisms through which this implementation will take place. 3. The Government acknowledges the difficulties facing industry in Afghanistan and the many barriers that businesses need to overcome in order to succeed. These issues are being addressed elsewhere in Getting the Basics Right, the Enabling Environment Road Map and the ANDS. This policy does not seek to repeat the initiatives being undertaken under these policies. 4. This policy recognizes that while Afghanistan has enjoyed strong recent growth, this is partly based on aid flows, diaspora investment, catch-up growth in areas like cellular phones and economic activity associated with ISAF that is unlikely to be sustained at current levels. As these flows reduce, Afghanistans private sector will need to expand rapidly if it is to provide the jobs and opportunities that Afghanistan needs to ensure its stability and prosperity. 5. This policy acknowledges the need to increase the pace of reform particularly in the area of streamlining export and import processes and reducing the regulatory burden on businesses - in order to ensure that this occurs. THE ROLE OF GOVERNMENT 6. The Government needs to perform a number of key roles if the economy is to flourish. These include: Ensuring macro-economic and fiscal stability;

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Creating a competitive enabling environment including ensuring security, providing proper infrastructure and an effective regulatory and policy environment; Providing public goods and resolving market failures; Ensuring competition is effective; Protecting the consumer and the environment; Coordinating the actions of government and key stakeholders; and Ensuring social stability.

7. In seeking to develop Afghan industry and services, it is important to avoid getting in the way of the private sector. Often Government intervention is not the best solution to a problem. Better - more effective and less costly solutions can often be arrived at by analysing why the private sector is failing to deliver a solution and amending the incentives faced by business to facilitate a private sector resolution of the problem. OBJECTIVES OF THE POLICY 8. The objective of the Industrial Policy is to increase the rate of growth of Afghan industry and in the service sector. 9. In order to ensure that this occurs in a manner that maximises the welfare of Afghans and Afghanistan, it is important that this is done in a way that is socially and environmentally sustainable. As a result, in implementing this policy, priority will be given to actions that result in pro-poor growth. In addition, environmental safeguards will be built into all government programs occurring under the aegis of this policy. SCOPE OF THE POLICY 10.In some countries industrial policy is cast very broadly to cover areas such as mining and agriculture. These sectors, where they involve the production of raw material for further industrial processing, are not covered in this policy. They are, instead, covered by government policies developed in the MoM, and MAIL and MRRD respectively. 11.The following industrial sectors are also excluded: Banking and insurance Telecommunications Media Aviation

These are the responsibility of still other Ministries the Central Bank, the Ministry of Communications and Information Technology and the Ministry of Transport. In addition, there is limited scope and even less need for government intervention to assist these industries (aside from creating an efficient legal framework, appropriate infrastructure etc.). LEARNING FROM FAILURE ELSEWHERE 12.The Government acknowledges the vast sums that have been wasted in countries around the world in the pursuit of the creation of industries 2

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which were never likely to be competitive. There is a lot of poor industrial policy. Failures in this area have been very costly both in terms of sums lost and the opportunity cost of the funds invested which often could have been spend more productively on improving basic health, education and public infrastructure. 13.The Government is mindful of the need to avoid replicating these mistakes and its industry policy, therefore, focuses primarily on assisting businesses to move up the value chain in areas where Afghanistan is already competitive and where for clearly identifiable reasons the private sector will struggle to do so in a timely manner. RECENT DEVELOPMENTS IN INDUSTRIAL POLICY 14.In order to avoid wasting public resources, the Government has therefore proceeded to develop Afghanistans economy by identifying a number of sectors where it believes assistance would not be wasted and to which it believes priority should be given. It did this by drawing on recent work by the World Bank and the Growth Commission which sets out a role for government beyond that envisioned by the so-called Washington consensus1. The core idea behind this new approach is that countries that have grown at "superior rates" often had proactive industrial policies grounded in public private dialogue focused on encouraging comparative advantage.2 15.This new industrial policy advocates using the following criteria to identify sectors where assistance may be warranted: The sector is one in which tradable goods and services that have been produced for about 20 years in dynamically growing countries such as Pakistan and India - with similar endowment structures but higher per capita incomes; It is one in which Afghanistan is likely to have a competitive and/or a comparative advantage; Domestic private firms have already spontaneously entered parts of the value chain; There are clear reasons/barriers preventing Afghan companies and individuals from entering into segments of the value chain or rapidly moving up it; The sector is labour-intensive; The sectors current growth rate either in Afghanistan or globally is high; The barriers to entry are low; Raw materials are easily accessible in Afghanistan; Many of the right level of skills needed to be competitive in the industry already exist;

In this view, Governments should not try to pick winners. Instead, their role is to create effective enabling environment, provide public goods, correct for market failures etc. 2 See Should Industrial Policy in Developing Countries Conform to Comparative Advantage or Defy it? A Debate Between Justin Lin and Ha-Joon Chang , Development Policy Review, 2009, 27 (5): 483502; Growth Identification and Facilitation: The Role of the State in the Dynamics of Structural Change, Justin Yifu Lin and Clestin Monga; and http://www.growthcommission.org/index.php? Itemid=169&id=96&option=com_content&task=view

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The technology requirements are moderate or Afghanistan has the ability to introduce the technology quickly and cost-effectively; Afghanistan has the ability to compete across multiple parts of value chain; and Afghanistan has the potential to rapidly move up the value chain.

16.These are sectors where it is likely that Afghanistan will have or will shortly develop a competitive or comparative advantage. They are ones in which it is likely Afghanistan will be able to compete with imported goods or successfully export goods and services. 17.The Government acknowledges the key role that exports play in driving productivity and prosperity and it further acknowledges that while import substitution is important, given the size of the Afghan market and the degree of protection provided by expensive transport links and slow and costly export processes, import substitution does not provide the same imperative to constantly improve productivity and will be accorded a lower priority. Priority Sectors 18.Using the above criteria, the Government has identified the following SME sectors to which it will give priority: - Carpets - Cashmere - Agri-processing - Gem stones - Marble quarrying, cutting, polishing - Construction materials The challenge for Afghanistans government is to assist industry to move up the value chain in these sectors more quickly and cost-effectively than it would have done on its own. 19.The recent diversification of the light industrial sector into areas as varied as the production of motor-cycles and washing machines demonstrates that the private sector, un-aided by government, has the drive and capacity to create a vibrant manufacturing base even in the face of stiff competition from imports. The challenge for the government is to identify not only where it can intervene to support the private sector, but also why it should there is little point in using public money to encourage businesses to do things that they were going to use their own money to do. 20.The Government will work with its development partners and the private sector to assist businesses to move up the value chain in the above areas. In further prioritising among the industries in the above list, the Government will give priority to those in which pro-poor growth is likely and where some domestic private firms have already entered spontaneously. In these sectors, it will try to identify: (i) the obstacles that are preventing these firms from upgrading the quality of their products; or (ii), the barriers that limit entry to those industries by other private firms 3.
3

This could be done through the combination of various methods such as the value-chain analysis or the Growth Diagnostic Framework suggested by Hausmann, Rodrik, and Velasco (2008). The

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21.The Government also acknowledges the potential of the service sector particularly transit, transport and logistics to leverage Afghanistans traditional role as the cross-roads of Central Asia and the development corridors associated with the creation of a large scale mining to contribute substantially to growth. 22.The participation and enthusiasm of the private sector as a partner in developing these sectors is critical. Often the private sector is best placed to develop solutions to the difficulties faced by businesses in these industries, or to respond to changed incentives. Given this, the USING THE PRIVATE SECTOR government will look, in the first TO IMPROVE PRODUCTIVITY IN instance, to correct market failure FISH FARMING by determining whether it can act to In Bangladesh, the government change the incentives faced by the traditionally sought to improve the private sector, enabling it to deliver productivity of fish farming through the required services. extension services under which public 23.Even where changed incentives will not deliver a solution, because bringing private sector experience and skills to bear on a problem being faced by an industry or sector is often critical to the development of solutions, a private public partnership may be a better course of action than government provision or intervention. As a result, due consideration will be given to this as a possible option. Additional Sectors
servants provided advice to farmers. Unfortunately extension service officers had few incentives for good performance and a dysfunctional working culture prevailed. An analysis of the private sector and the incentives faced by it showed that private input suppliers (such as nurseries) had a commercial incentive to provide useful advice to farmers as a means of improving their performance and of differentiating what they did from their competitors. They were provided with information on improving client productivity which they pushed out with spectacular results. There are many similar examples where service delivery by the private sector is more effective than direct public provision

24.A number of other sectors have been identified which have potential but which did not meet some of the criteria above. These include: Three non traditional sectors - the film industry; tourism and fashion. These sectors are tiny, but may present opportunities for the future and the government will monitor the development of them and may in the future provide limited incentives to domestic pioneer firms or foreign investors that work within them in order to compensate for the non-rival, public knowledge created by their investments. Transport shielded manufacturing for the domestic market (those products, such as cement, in which transport costs are prohibitive) the Government will encourage manufacturers to improve their productivity in order to position themselves for increased competition when transport cost begin to fall.

government can then implement policy to remove those binding constraints and use pilots experiments to test the effects of releasing those constraints so as to ensure the effectiveness of scaling up those policies at the national level (Duflo 2004).

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Textiles a nascent, non-cotton based textile industry is developing in Afghanistan. The Government will look to support this through, in the first instance, refurbishing and leasing out government owned sites e.g. in Herat and Kabul - which have previously hosted and were specifically designed for the production of textiles. Light manufacturing a number of entrepreneurs have recently begun producing appliances and motor bikes in Afghanistan. At the moment, this involves the assembly of imported parts. The entrepreneurs would like to begin manufacturing parts here for these sectors. In looking to see if Government is able to assist this process, it first needs to convince itself that this is possible and then determine whether there is an appropriate role for it in doing this (i.e. does the private sector require assistance or would government end up funding activity that would happen anyway?). Transit, transport and logistics there is a great deal of potential for Afghanistan to leverage its traditional role as the cross-roads of Central Asia to create a dynamic and vibrant transportation and logistics industry.

25.In addition to the above, the Government will pay close attention to successful self discoveries by private enterprises and provide support to scale up those industries where this is warranted this will generally be where there is a need to offset the very high risk of operating in a cumbersome/hostile and backward environment, where the potential for growth and job creation is high and where groups who are underrepresented in the work-force, such as women and youth, are likely to benefit. Other Dimensions of Industrial Policy 26.The following aspects of industrial policy will be dealt with elsewhere: Policy on Government research and development this is being developed and implemented by sectoral ministries such as MAIL. Policy on encouraging innovation. Policy on encouraging the Afghan Diaspora to return and invest in Afghanistan.

KEY BENEFICIARIES 27.Key beneficiaries include: Producers/businesses who will benefit from increased support, improved productivity and augmented markets. Consumers the focus on job creation will bring with it poverty reduction and increased prosperity. Government increased growth should bring stability and growth in tax revenues.

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SMEs SMEs, as a priority sector, will be the recipients of increased support and improved policy. Women, young people and inhabitants of rural areas given the focus on SME and rural growth, it is hoped that the implementation of this policy will result in increased employment for these groups.

LEARNING FROM ELSEWHERE 28.In adopting this approach, Afghanistan is cognisant of some of the lessons learned from previous industrial policy implementations: As was noted above, modern industrial policy involves the active involvement of government in the amelioration of risk, the development of markets, the provision of public goods and addressing the constraints to private sector growth. Successful industrial policy also requires government to ruthlessly cut support to losers 4. Therefore, a certain amount of policy experimentation will be required: if progress is to be made, governments need to accept that not every project will succeed and it should have policy on how to deal with failure. In particular, the GoA should construct policy and associated incentives to ensure that entrepreneurs bear a portion of the possible losses associated with a project as well as being rewarded for success. All policy needs to be informed by local constraints, potential, institutions, comparative advantage and commercial opportunities, all of which are particular to a time and place. While the approach of successful industrial policy has been remarkably varied, they all shared key elements (incentives which tracked markets, property rights which meant that entrepreneurs (those taking the risks) were rewarded for their success). In implementing an industrial policy, constraints present at every level need to be identified. However, it is critical to identify the binding constraint first for technical reasons 5 and also because of limited government capacity and focus. Governments, if they are to succeed in fostering industrial growth need to coordinate policies that are the responsibility of several government ministries.

Estalishmet of Industrial Development and Investment Fund 29.Despite progress achieved in private sector over the past ten years, industries in Afghanistan, still face multiple challenges. One of the main challenges is getting access to credit with reasonable interest rate. This in turn has unabled most of the Afghan enterprenuers to be competitive with the regional economies. For this reason, Afghanistans net exports have
4

This was one of the key reasons for the success of South Koreas export oriented industrial policy: failure to show significant progress towards becoming internationally competitive within a short time frame (e.g. two years) resulted in the sacking of senior executives, the removal of subsidies and the redirection of capital. Taken together these actions created powerful incentives (indeed some have argued they replicate market based incentives). 5 See Dani Rodrik, One Economics, Many Lessons, Princeton University Press, December 2008

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widely been negative. Without having a holistic policy and effective implementation mechanism, it is extremely difficult to support the newly established domestic industries in Afghanistan, particularly Small and Medium Enterprises (SMEs), which consist over 90 percent of Afghanistans economy6. More specifically, firms, at large, face three main obstacles to receive loans from commercial banks, operating in Afghanistan. First, compared to the regional countries and in the world at large, the interest rate in Afghanistan is too highover 17 percent 6. While in India SME Equity Bank lends loans to SMEs at the rate of 3-13.75 percent and SME Bank in Pakistan lend loans to SMEs at a maximum markup of 4 7.For this reason, it is extremely difficult for Afghanistans enterprises to generate enough profit not only to pay off their loans, but also make revenue for themselves. In addition, with such high interest rateover 17 percentAfghan entrepreneurs cannot compete with regional trading partners, who already have comparative advantage in producing goods and services. Secondly and equally important, the duration of the loansprovided by commercial banks in Afghanistanis relatively short-term compared to regional countries. Commercial banks in Afghanistan require borrowers to repay their loans within a year. Duration-wise, the short-term loans is not sufficient for entrepreneurs. A firm, for instance, purchase equipments and machineries with the loans it has received from a commercial bank. Within a year, it is almost impossible for most of the Afghanistans firms make enough return to pay off their liabilities. Finally, not having enough collateral is another problem facing firms in Afghanistan. Any firm, regardless of its size, has to have collateral in order to receive loans from commercial banks. Otherwise, commercial banks in the country are highly reluctant to lend money for SMEs mainly due to lack of collateral. Unlike other countries, to date, no Investment and Industrial Banks exist in Afghanistan to provide loanswith reasonable interest rate for SMEs to develop and gradually compete with the regional economies. Considering the limited resource, it is extremely difficultif not impossibleto establish an investment and industrial bank in the country. However, there are some potential alternatives to such bank; creating an Industrial Development and Investment Fund is a realistic and pragmatic option. Given the situation in Afghanistan and availability of funds by the donor community, establishing an Industrial Development and Investment Fund seems feasible. Currently multiple donors, operating in Afghanistan, are seeking for effective and sustainable projects. In addition, experiences elsewhere indicate
6 8

Bank of India, http://www.bankofindia.com/smeborrowers.aspx . Daily times, www.dailytimes.com.pk page=2008\06\03\story_3-6-2008_pg5_10

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that both developed and developing countries have adopted similar approach to overcome the problems experienced by SMEs in their relevant countries. India, Iran, Suadia Arabia, and some European Countries are among those economies which have already established SME Funds. Therefore, it is highly vital for Afghanistan to establish such an Industrial Development and Investment Fund, aiming to provide financial resources for the newly established industries with fair interest rate and relatively reasonable terms. The task of the Industrial Development and Investment Fund shall be simple and straightforward: it must provide short, medium and long term loans to potential and capable firms with interest rate, not exceeding 7 percent and the loans shall be given in transparent and professional manner. Ministry of Commerce and Industries in consultation with other stakeholders will adopt affective mechanism to ensure effective implementation of the Investment and Industrial Support Fund, once this policy is approved by the Cabinet of the Islamic Republic of Afghanistan. TYPES OF INTERVENTION CONSIDERED 30.While the types of intervention most appropriate to Afghanistan will vary from sector to sector, in a number of areas the private sector faces similar constraints: Limited understanding of how to move up the value chain and how and where to acquire the expertise required to do so the focus here will be on increasing access to technical knowledge; in a number of areas such as marble and gem mining, donors have worked with trade associations to bring in critical skills and know-how which has enabled extractive techniques to be rapidly improved in a number of provinces. Spreading knowledge of existing innovation in Afghanistan and neighbouring provinces a much more considered understanding of commercial risks is possible when businesses are able to study how first movers have fared (those who first take the step and invest in innovation). Often businesses in one area are unaware of progress in another. As a result progress and innovation does not spread as rapidly as it might. The Government will act to help to improve the circulation of ideas within industry sectors. It will do this directly, through industry associations and its development partners. Limited access to secure, reliable water and power supply and industrial land this will be addressed through the GoAs infrastructure development plans and through the provision of serviced industrial land at fair and appropriate price. Risk aversion given an uncertain security environment, limited access to finance, limited access to insurance, poor understanding of the level of commercial risks involved in moving up the value chain and limited understanding of the technology involved many Afghan firms are reluctant to be the first to invest in a new area. To address this the government will seek to reduce the uncertainty and risks faced by companies by providing matching grants and/or equipment. It will then seek to disseminate the success of the investment/strategy to encourage other entrepreneurs to undertake similar investments.

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Difficulties accessing export markets many of Afghanistans neighbours are suspicious of Afghan products and the reliability of Afghan businesses as commercial partners. The Government will work with donors, business associations and regional governments to improve access to foreign markets for Afghan goods and services. This assistance will take a number of forms from encouraging businesses to attend major sector trade shows, to export development grants and the building of critical infrastructure such as cool stores at airports. Limited access to finance this is a major issue for most Afghan businesses looking to expand their operations. A number of government and donor funded initiatives to support access to finance already exist (see the Position Paper for further details). In addition to these measures the Government will investigate options to provide general and specialised SME financing e.g. Contract Performance Guarantee Funds (for the construction sector), Export Insurance Funds etc.

31.The Government will avoid the following types of intervention: Highly complex schemes especially those requiring substantial capacity, effective discretionary action, and a high level of integrity in the government bureaucracy. The creation of new SOEs SOEs have a very poor track record in Afghanistan and it seems unlikely that the capacity exists within government to establish new SOEs and reverse the current patterns of weak management, limited commercial acumen, losses and cross subsidies. Fiscal incentives are costly and rarely achieve their stated policy objectives. For this reason, the government will not provide fiscal incentives for enterprises. However, the government can provide the enterprises with either five years tax holidays or seven years accelerated depreciation. There are two major arguments for

accelerated depreciation. First, it reduces tax liabilities and increases the cash sources of firms that purchase new assets. Second, it stimulates the incentive to purchase new assets. These effects are distinct. Because it increases investors cash sources, accelerated depreciation is similar to a lower tax relief itself. The difference between accelerated depreciation and general tax relief is that accelerated depreciation increases the cash holdings only of firms that actually purchase new assets, where the general tax relief also benefits firms that do not necessarily acquire new assets.
Blanket subsidy schemes - carry potentially high costs and distort investment, consumption and resource allocation decisions. These will be avoided. At the opposite extreme, tailor made schemes for individual firms will also be avoided as they give rise to incentives for lobbying and corruption and almost inevitably fail to achieve their stated policy objectives.

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Excessive, non-time bound protection of domestic activities via high and variegated import tariffs - for reasons discussed further below, the creation of moderate, time bound tariff walls will be considered as a last resort in particular industrial sectors.

32.Industry sector specific interventions for the key sectors listed above are spelled out in more detail in the associated Action Plans. Examples of Current Interventions 33.The Government acknowledges that much successful work has already occurred in this area. It is determined to build on this success and ensure a wide understanding of the reasons behind it. Examples of successful interventions include the following: In August 2009, an Afghan company recently began producing Eastern Afghanistans first potato chips using machinery supplied by USAID. Given the demonstrated profitability of this venture, other companies are looking to invest in similar equipment - it turns out that tariff protection which had been repeatedly called for over the years in this area was not necessary. The Italian Government has recently provided the technical expertise required to move marble quarrying away from wasteful explosives based extraction to more effective wire and saw block extraction. This has greatly reduced waste, improving productivity, profit and quality, and improving environmental protection and standards. Donor assistance has enabled the countrys first cutting and washing factory, the Afghan Craft Cut and Wash Facility, to open in Jalalabad where it provides employment to 400 Afghans. A number of privately sector developed facilities have opened in the wake of the Jalalabad facilitys success. EXEMPTIONS PROCESSES TO ITS TARIFF POLICY AND STREAMLINING TRADE

34.The Government reconfirms its commitment to an open economy characterised by generally low tariffs, as reflected in its desire to join the WTO and its accession to the South Asia Free Trade Area. It acknowledges as well that there are some very significant non tariff barriers to trade and it recognises the need to work to reduce these. 35.The Government acknowledges that many of the problems caused by industrial policy elsewhere relate to the imposition of inappropriate tariff and non-tariff barriers. It acknowledges as well the manner in which tariffs and other protection create vested interests which have an incentive to maintain them in ways which punish Afghan consumers and other businesses. However, it also acknowledges that carefully considered tariffs have worked in other countries as part of a strategy for encouraging growth. 36.The Government recognises that the imposition of tariffs and non-tariff barriers needs to be approached with a great deal of caution. Decisions of this sort need to be mindful of the full economic consequences of tariffs 11

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and non-tariff barriers. Commentary tends to focus on the jobs created in the protected industry and usually overlooks the jobs lost in other areas due to reduced spending there because these loses are largely invisible and the loss of competitiveness in some areas (where the protected good is an input into the production of goods for exports). It also overlooks the very real costs imposed on citizens who are forced to pay more for goods and the distorted incentives that tariffs and non-tariff barriers create. 37.One of the key findings of recent work on industrial policy is that protection is most effective where companies face strong incentives to improve productivity either by being forced to export, or by being faced with progressively increasing competition. Many of the costs associated with the imposition of tariffs can therefore be reduced if these tariffs and any non-tariff barriers are: Moderate and applied in areas where there is a plausible reason for believing that the industry will rapidly become competitive; Sharply time limited if an industry cannot become competitive in 5 years it is unlikely that it ever will be, particularly where the technology involved is relatively simple, as its competitors will probably continue to innovate and improve productivity. As a result tariffs will be posed for a specified period usually of less than five years; Progressively reduce in value to the level prevailing before the tariff was imposed; Effectively targeted: prior to deciding whether to impose tariffs, the Government of Afghanistan will undertake a careful assessment of the following: How big a gap is there between the technology which the tariff protected industry requires and the current level of technological development? Where the gap is large, it is unlikely that the industry will become competitive and it will not apply tariffs. Are there economies of scale? Where there are, the case for tariffs is stronger as, in the absence of tariffs, it will be much harder for a company to achieve the required scale. What is the cost structure of imported goods and the proposed tariff protected goods? Where will costs fall and why? Where this gap is large and no plausible explanation is available for how and why it will fall, tariffs should not be applied. What is the cost to consumers and how does this compare to the numbers of jobs created over the proposed protection period (if possible, this figure should be net of jobs lost due to reduced spending in other areas)? Where the net cost to Afghanistan is large, tariffs should not be applied.

38.The above tariff regime, if applied will put pressure on protected industries to rapidly become competitive. As well as increasing productivity, this opens up the possibility of export and minimises the impost on consumers and other businesses. 12

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39.The Government acknowledges the need to ensure that actions taken in implementing this policy are compatible with its international obligations particularly under its accession to the South Asian Free Trade Area which commits it to reduce tariffs to 5% by 2021. It believes that under SAFTA and similar agreements it is able to provide temporary tariff protection to infant industries. 40.The GoIRA will also consider providing sharply time limited, 5 years tax holidays or 7 years quick depreciation to the first few firms willing to enter a new sector where a case has been presented to Cabinet that this, either on its won or in addition to time limited tariff protection, is critical to the success of the proposed investment. 41.Most other forms of support the provision of expertise, sharing knowledge do not distort incentives in the way that tariffs do. Tariffs should be seen as one amongst many policy options and, before making a decision to impose them, other policy levers should be examined to see if they are preferable. As a result, the Government of Afghanistan will, in general, rely on coordinated government and donor support for target industries e.g. training, assistance with securing necessary equipment and technical expertise etc rather than tariffs. 42.Afghanistan still does very poorly in terms of the ease of trading across its borders. There are very real consequences for this failure: crops rot at border ports because they are unable to cross in time, businesses go bankrupt because they are unable to import key components. Perhaps the most significant reforms that the Government of Afghanistan can make is to improve its performance in this area and ensure that its neighbours do likewise. SUSTAINING GROWTH 43.Sustaining growth is more difficult than igniting it 8. If industry is to be a sustainable driver for economic growth, industrial activities should be sustained through encouraging innovation and creativity to continually improve production, quality and competitiveness. 44.Given this, the Government will establish business incubator facilities. These facilities, which provide serviced office space, access to low cost business development services and advice on how to grow, will be established first in Kabul and then in other major provincial centres. They are designed to provide a low cost, secure environment in which entrepreneurs will be able to develop their ideas. 45.A number of development partners are interested in establishing challenge funds which would provide seed funding for business development which entrepreneurs could apply for. 46.The timely enactment and effective implementation of the recently developed Competition Bill will also contribute to encouraging productivity growth and general business efficiency. 47.While business development is the responsibility of the private sector, support from the government is often essential to expediting private
8

See D Rodrik, ibid, p. 27

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sector progress. Elsewhere governments have successfully provided integrated service support to assist companies build their competitiveness. Generally they provide a one-stop-shop delivering a combination of business advice, technical, marketing and export assistance and help build strategic alliances, to expand businesses opportunities to access markets and new technologies, obtain finance, improve their skills base. 48.With donor support the Government will establish Small Business Advisory Services (SBAS) and Manufacturing Advisory Service (MAS) centres to facilitate the development and expansion of existing business and industries. These entities will be based in Kabul (with regional services to be added over time). An SBAS will provide support service to individual businesses to address gaps in areas such as: Management capability; Financial and marketing skills; Access to start up /development capital; Utilisation of networks to create growth opportunities; and Development of a more international/export focus. 49.A MAS centre will provide a range of services to improve the competitiveness of the manufacturing sector and performance of companies in this sector. Services will include: Reducing cost and improving efficiency; Introducing best practice; Helping with developing and improving manufacturing strategy; and Developing supply chains. 50.The Government is already active in a number of areas such as expanding the provision of vocational training, increasing the supply of business development services, expanding the supply managerial training and encouraging entrepreneurship, all of which are growth sustaining. 51.One key reason why growth is sometimes unsustainable is that neither government nor the private sector give much thought to the likely competitive response of business elsewhere. Analysis of opportunities is often static and fails to recognise that businesses will not stand idly by while Afghanistan repatriates key parts of the value chain from industry in neighbouring countries. In developing sector action plans in high-potential sectors, the GoA will map out the likely competitive response of existing business and will work with the private sector to design an effective response to them.

IMPLEMENTATION 52.The General Directorate for Private Sector Development (GDPSD) of MoCI is charged with implementing this policy. The GDPSD will work with MoCIs Provincial offices and MoCIs development partners to develop a detailed implementation plan for this policy. 53.Ensuring the cooperation, understanding and active support of the private sector is critical to the successful implementation of this policy. As a 14

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result, the GDPSD will actively engage in dialogue with the private sector and will seek their input prior to the further development of policy measures. 54.The Government recognises the massive growth driving role that Kabul plays in the national economy. It will continue to build on this, particularly through working to improve infrastructure, increase access to land and power and support the development of SMEs in the Kabul area. 55.The Government also recognises that one of the key challenges that it also faces is the need to improve coordination and systematically move the focus of development from Kabul to the provinces where the bulk of the Afghan population lives. 56.Economic development activity is already occurring in many provinces. This activity, while often successful is rarely coordinated, ignores or is unaware of possible synergies and is not the outcome of a careful prioritisation of resource allocation to areas of where benefits and growth are likely to be greatest. To rectify this situation, MoCI will undertake a strategic planning process with provincial planning authorities and the provincial governor to improve provincial development plans by identifying within them activities and infrastructure that are critical to growth across a number of industrial sectors. The outcome of this process, provincial growth plans, will facilitate improved coordination and allow the direction of resources to high priority areas. MONITORING AND EVALUATION 57.A critical component of the implementation of this and any other policy is determining ex ante a measure of success. 58.The Ministry of Commerce has identified the following as the intended results of the implementation of the industrial policy: Both the services sector and the industrial sector maintain growth rates above 15% per annum resulting in them constituting over 80% of GDP generated by 2016 The value of the marble sector increases by $435 million by 2016 The value of the carpet sector increases by $400 million by 2016 The value of the gemstones and jewellery sector increases by $100 million by 2016 The value of import substitution attributable to this policy is $500 million by 2016

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