In the last chapter we examined various factors that need to be considered in deciding whether aspects of the provision of particular services could be decentralized. The main purpose of this chapter and the next is to provide a framework for actually implementing a reform process. In these chapters we place a lot of stress on the sequencing of reforms, including privatization, by considering a series of questions. In this chapter we argue that decentralization is only one of several possible ways of improving the performance of agricultural support services. Given appropriate circumstances, improving the internal efficiency of central government organizations or increasing the external competition they face may prove to be effective, especially if the government also takes actions to improve the market environment. In the next chapter we consider the actions required if the decision to decentralize is actually taken.
4.1.1 Defining objectives
A long-term view
It is important to start the reform process by having well-defined objectives of what the process is intended to achieve. Given that, in many instances, reform or decentralization is a reaction to a fiscal crisis generated by public sector enterprise expenditures far exceeding revenues, it is not surprising to find that often only short-term objectives such as the reduction of the fiscal deficit are considered. However, reform frequently presents an opportunity to restructure enterprises or the whole economy in ways that help to achieve long-term objectives such as sustained long-term economic growth and employment, changes in income distribution, improved access to basic needs, etc. These opportunities may be missed if a crisis management approach is adopted designed to achieve short-term objectives only.
Reasons justifying reform
An initial step in a reform process is to establish whether a case for reform exists. As indicated in Chapter 1, public sector organizations have been established to provide a wide array of agricultural services and for a wide variety of economic, social and political reasons. Over time, three basic reasons emerge that may justify reform:
The original reasons are no longer valid. For example, a centralized parastatal may have been set up because no private entrepreneurs were willing to undertake a particular activity but over the years that may have changed.
Other instruments are now available for the provision of the service or for achieving a particular objective that are likely to be more cost-effective than using public sector provision in its original form. For example, variations in local demands or needs for services may favour a decentralized delivery system. The disaggregation of provision into its funding, production, regulation and consumption components is of importance here.
Even if the objectives remain unaltered and instruments remain unchanged, reform and/or decentralization of the parastatal may lead to a more cost-effective delivery of its objectives.
If none of these basic reasons apply then there seems little point in considering reforms any further. Thus the first obvious step in the process is to establish:
Whether the need for the services that the central government provides still exists
The costs incurred in providing these services
Whether more cost-effective methods of providing these services exist or can be created.
4.1.2 A supra-ministerial approach
An over-arching view
If individual sponsoring ministries were left to answer these questions the chances are that, given their vested interests, they would opt for the status quo, and argue for the continuation of the current system. Thus most countries that have had successful decentralization and privatization reform programmes have found it advisable to establish some form of central authority to oversee the process (Adam, et al., 1992). This may take the form of a high-level, supra-ministerial Parastatal Reform Commission. Such a commission must have analytical capabilities to answer these questions and this may require outside assistance in either doing the analysis and/or in training local personnel in appropriate policy analysis work. Recruitment of appropriate personnel and of competent advisers is therefore extremely important (Guislain, 1997). However, perhaps of even more importance, the commission must have sufficient authority and political clout to override the desires of individual ministries or government departments and to see the reform process through to a successful conclusion. At the same time, clear distinctions must be drawn between the responsibilities of the political authorities that will define the reform programme and set its priorities and the reform agency that implements the programme.
Virtually any reform is likely to involve losers as well as gainers and thus, as indicated above, a prerequisite for any successful reform is a political commitment at the highest levels to take the necessary steps to initiate, implement and maintain the reform process. From a political viewpoint, in many countries centralized parastatals are still seen as an important means of retaining control of strategic areas of the economy, or particular functions. In others, they are seen as valuable instruments for dispensing political patronage. In these situations there is likely to be a relatively small but, nevertheless, powerful constituency of supporters benefiting from the present system who would strongly oppose any decentralization proposal unless they were assured that their present benefits would be protected after any such move (Bennell, 1997). In these situations a government may consider decentralization to be, at best, a necessary evil to be undertaken only when parastatal losses become unbearable or when it is demanded as part of donor conditionality.
However, in other situations decentralization may be seen as a way of gaining political support. For example, it may be anticipated that the decentralized or privatized enterprises will provide substantially better and/or cheaper services than the central government. A divestiture that leads to widespread share ownership might also prove to be politically popular. These changes are most likely to occur after a change of government if the new party owes no favours to the current parastatal constituency. World Bank (1995) experience suggests that unless the political will is strong, the reform process will be ineffective. They argue that political desirability, feasibility and credibility are necessary political conditions for successful parastatal reform.
Reform must be politically desirable to the leadership; that is, the political benefits must outweigh the political costs. This is most likely to occur either after a change in government when previous beneficiaries of the centrally provided service are no longer in power, or when a fiscal crisis makes subsidies to parastatals unsustainable and reform becomes imperative. In the latter case this may be because of conditionalities imposed by donors - making the desirability of reform relative rather than absolute. However, even in this case, if the reform provides financial savings for the government and improves the countrys economic performance it will increase the desirability of the reform process.
The desirability of pursuing a reform process can be increased by actively creating constituencies that can anticipate benefits from reform. Examples are consumers who may expect lower cost food, farmers who will receive higher or more prompt payment, or traders and businesses who will benefit from increased business opportunities or lower costs. The analysis undertaken in establishing the case for reform should be able to identify the likely beneficiaries. Learning from the comparative experience of countries that have successfully undertaken reforms can be of assistance in this regard. Active steps can then be taken to make the potential beneficiaries aware of these expected benefits. However, it is important to remember that if these benefits are not delivered the credibility of the reform process is likely to suffer.
The reform must be politically feasible in the sense that the leadership can obtain the support of other government bodies whose cooperation is critical to success. This may include the legislature, the civil service (particularly in sponsoring ministries), and state and provincial levels of government that may be responsible for implementing the reforms. The leadership must also be able to overcome the opposition of those who will potentially lose from the reforms. This particularly applies to workers in public sector organizations that are grossly overstaffed and who fear that they may lose their jobs. This may require assisting them to find work in other sectors, compensation for retrenchment, and perhaps changes in labour laws to make protests less effective or illegal. There is also likely to be opposition from those that are benefiting from other forms of patronage and rents generated by centralized parastatal activities. Sometimes this can be overcome by offering the previous beneficiaries privileges in the reformed enterprise such as a management buy-out on favourable terms.
The government needs to achieve political credibility regarding the reform process. This is perhaps of limited significance when only one or two agricultural parastatals are to be reformed but it is particularly important when the proposed reforms envisage a series of operations extending over a significant time period. In these circumstances, the government will rapidly lose credibility if it fails to keep promises made at the start of the reform process. Loss of credibility will also occur if it engages in policy U turns that impose costs or losses on those who have made investments or taken actions on the basis of previously announced policies. A previous record for policy consistency will help to establish reputation.
The prospects for a successful reform are likely to be considerably enhanced if the donors themselves are able to achieve a coordinated position and approach to the government with regard to the reform process. Moreover, the donors should be willing to consider the economic, social and political concerns that the government and other various stakeholders may have regarding the reform process. Although comparative experience with other reform processes is valuable, the actual situation in each country is likely to be sufficiently different that reform proposals have to be tailored to the specific needs of that country. Moreover, it is important for donor officials to appreciate that many have very limited experience of the countries in which they are operating and most will not be associated with a country for a sufficient period of time to live with the consequences of their actions.
Getting the timing right
Obviously, given the complexity of the various issues raised above, it may take time for a reasonably strong political consensus on reform to emerge. In the meantime, fiscal imbalances and inefficient services may continue. In these circumstances, donors may become impatient and insist on reforms as a conditionality for further grants or loans. The result is that in many countries reform has occurred by default with parastatal organizations being starved of resources and a vacuum being created in terms of the provision of services that it is hoped will be filled by private sector enterprises. In the longer term this is indeed occurring in some countries but often there have been high short- and medium-term costs in terms of unforeseen and/or unplanned crises, the breakdown of essential services and the absence of safety nets to protect those most adversely affected by the process.
In the World Banks (1995) view, there is little point in attempting parastatal reforms in countries where the political conditions are not right. In these cases there are, however, certain measures or preliminary steps that governments may be willing to take that will eventually assist parastatal reform. These include actions such as:
Introducing fiscal and monetary reforms that reduce the fiscal deficit and also make any parastatal subsidies and losses more transparent
Liberalizing international trade to generate competition for parastatals and to create a constituency lobbying for continued and increased trading opportunities
Removing barriers to entry which again increases competition and creates a lobby for a level playing field
Starting financial sector reforms that will help to develop more effective financial markets and services. As argued earlier, this is of vital importance for successful private sector development.
4.2.2 The political impact of different forms of decentralization
Decentralization changes the balance of power within the system of governance. This is an essential feature to bear in mind in judging the chances of success of decentralization policies. Various forms of decentralization affect the balance of power differently. Deconcentration shifts the balance of the power within an organization in favour of front-line managers. It may result in improved efficiency. It also strengthens the position of top managers vis-à-vis their external constituency. At local level, the higher efficiency of a deconcentrated but centrally controlled (as opposed to a centrally operated) administration, tends to increase the central governments hold over the territory, and correspondingly tends to decrease the scope for local autonomy. Central administration bureaucrats may try to turn devolution policies into deconcentration policies to conserve their power and influence.
Delegation to public agencies shifts power outside the government administration. With proper accountability, transparency and hard budgets (see Section 4.3.2) performance becomes more visible. Agents are fully responsible for all aspects of the delegated activity and they cannot blame another department for their own weaknesses. Separate budgets and accounts mean that costs are more easily identified. There are fewer impediments to professionalism (as long as independent personnel policies are allowed) because the implementing agency is different from the supervisory agency. In principle all this should improve accountability. However, not being constrained by government employment regulations (but not enjoying the opportunities for independence they offer) government-appointed managers are more exposed to the influence of the external political constituency. Opportunities for patronage are generally greater. Delegation to private enterprise offers less opportunity for external political interference, although it can occur in large organizations. Philanthropic NGOs with their own resource base tend to be less influenced by political interference. This may be one of the reasons why governments sometimes resist the idea that NGOs should be supported with public funds.
In the case of deconcentration and delegation, the central government is in control of the use of resources, and the external coalition of forces that influences the policy of the central administration can still play its role. Devolution changes the balance of power to a much more significant extent, since it affects the very nature of the external and internal coalitions of government organizations along the full range of the system of public administrations. By increasing the power of local governments, devolution creates a plurality of external and internal coalitions, each local government having its own. Devolution mobilizes the local political pressure groups, and democratic representation gives a chance to different local groups to acquire representation and empowerment. Effective devolution requires that politicians responsible for the lower levels of governments are elected, and that central authorities respect their priorities in the use of resources. Devolution policies are part and parcel of the system of checks and balances, which characterizes a democratic system of governance. Devolution is also referred to as democratic decentralization (Box 4.1).
Box 4.1 Democratic decentralization
Democratic local government
a political system in which meaningful authority is devolved to local bodies that are accountable and accessible to their citizens, who in turn enjoy full human and legal rights in exercising political liberty
Source: Blair (1997).
Whether effective devolution results in empowering poor people or women is by no means automatic, and therefore devolution to local governments per se cannot be considered a sufficient condition or a reliable formula to handle poverty alleviation or gender issues. The impact of devolution to local government on the social and economic conditions of poor people depends on local socio-economic, cultural, and political circumstances. When local societies are highly stratified and distribution of income and wealth is very uneven, and/or strong cultural factors leading to social discrimination still exist, devolution policies may worsen the conditions of poor and marginalized people. In India, for example, the autonomous development of the panchayat raj was strongly opposed by politicians at federal and state government level until the 73rd Amendment of the Constitution (1993) on two grounds:
It would hamper the human and economic development prospects of scheduled and other lower castes
The political life of the panchayats would be captured by the party bureaucracies, reducing the reforms impact on local initiatives and local autonomy.
Broadly speaking, so far the world-wide experience of the impact of devolution on poverty is not encouraging.
Partnership arrangements with CSOs strengthen the democratic process further, diversify the political arena, and help to mobilize more human and financial resources and improve participation and empowerment of local people. Partnerships with CSOs offer the advantage that, at the lowest level of CSOs, there is a much closer relationship between the beneficiaries of the services rendered. They are in fact partners in development through their contribution to the cost of the services and participation in the decision making process, and the managers of the service delivery mechanisms. At the level of the intermediary organizations that consolidate the plans of the grassroots organizations and channel the funds, managers have a more cohesive constituency, particularly when common interest groups are members of the intermediary organization and have voting power in their board. The role of the leaders of the grassroots organizations in the process of decision-making by the intermediary organization is actually an important indicator of its performance that can be monitored and evaluated.
As long as the intermediary organization is small and individual leaders of grassroots organizations are members of their general assembly, rather than represented by a delegated person, the close relationship with the ultimate beneficiary will hold. At higher levels however, the external coalition tends to diversify, the internal coalition becomes more complex, and other influences may acquire dominant influence, including the bureaucracy of the apex organizations themselves.
With privatization, both central and local politicians are likely to lose direct control over service provision. However, they may still have an influence through the exercise of regulatory powers or if they finance service provision. Moreover, with privatization, politicians are freer to criticize the performance of service providers that they are no longer responsible for the service. This may increase the support they receive from certain parts of the electorate.
Local politicians are accountable to local constituencies and may have different priorities from the central government. An important implication of the political impact of devolution concerns policy synchronization issues, that is the possible divergence between the central government and local governments with respect to policy objectives of particular interest to the central government. In rural areas, these may affect agricultural research and extension, specific crop development programmes, water supply, irrigation, transport infrastructure, education and health. In some cases, the local governments may retain the responsibility to provide a service, but their accountability will be split. For example, local governments would respond to the electorate for the quality and quantity of local services provided (water supply, sanitation, for example), and to the central government with respect to activities which are government priorities (healthcare, for example). In theory, the principle of jurisdictional spillover would guide the distinction.
Once the case for reform is made, and the political commitment affirmed, the next step is to decide on feasible ways of achieving a cost-effective service that meets the new objectives. It is important that this process takes into consideration the whole system and closely associated systems in which the parastatal is currently operating (producers, informal traders and businesses, consumers, etc.), rather than focusing narrowly on the parastatal itself (FAO, 1991b). This is because reform is likely to affect all of these groups and it is important that they are incorporated into the reform process to improve its effectiveness. Part of any reform strategy is almost bound to include macroeconomic, trade, competition and financial sector reforms if these have not been undertaken earlier.
4.3.2 Can the internal efficiency of the public sector organization be improved?
The first logical step in determining ways of achieving a more cost-effective service is to examine whether the internal efficiency of the centralized parastatal can be reformed. This will help to determine whether the parastatal should be liquidated or decentralized in some form. There are three major components to the process of improving internal efficiency, namely, introducing hard budgets, changing the incentive structure and regulatory framework, and investing in new capital or training. Each of these will be considered in turn.
The introduction of hard budgets
A hard budget implies that the parastatal:
Receives no subsidies, transfers or special privileges, such as tax exemptions, procurement set asides or favourable access to foreign exchange, and must pay its bills or debts on time
Has its access to credit decided by independent banks on the basis of commercial principles without government guarantee, and on market determined terms
Has its prices set by the market or, for monopolies, through regulations which approximate economic prices so that the organization does not earn monopoly rents.
This definition needs to be modified somewhat where parastatals are required to perform social or non-commercial functions as part of their remit. One intention in attempting to introduce hard budgets for public sector agricultural support service providers is to make the explicit and implicit subsidies provided through the organization more transparent. This has two effects:
It makes the subsidies easier to cap
It provides the government with information that allows it to make more rational decisions as to whether certain non-commercial functions should continue to be provided by the parastatal.
An initial step in this process is to clarify the organizations objectives. Once this is done it is easier, in principle, to separate commercial and social functions. In some cases these different functions are best done by separate organizations. This allows for a clearer definition of objectives and makes it easier to establish and monitor performance indicators. However, as indicated below, there are other situations where it may be more cost-effective to combine commercial and social functions.
With the development of separate management accounts for each function it may be possible to develop formulae or cost-accounting procedures that establish the subsidy required to finance the parastatals social, or non-commercial objectives. Subventions from the sponsoring ministry can then be determined by these formulae. Similarly, the revenues generated from commercial functions can be more readily compared with their costs to identify areas for cost cutting or for price adjustment.
Parastatals often obtain implicit subsidies through their ability to obtain credit on favourable terms from government sources and commercial banks. If funds have to be obtained on the basis of commercial principles then this again has the effect of making the public sector organizations true costs more transparent. Similarly, if the parastatal is typically required to operate at market-determined prices then any requirement by the government that the parastatal supplies products or services at below-market prices must be met by an explicit subsidy rather than an undefined, implicit one.
Unfortunately, implementing a hard budget regime may be fraught with practical difficulties:
It may be very difficult to separate commercial and social functions when both are using shared facilities. For example, a parastatal engaged in cereal marketing may be required to maintain a strategic reserve of cereals for emergency purposes. If this is integrated with its normal marketing and storage practices there may be no logical way to allocate the joint costs involved in the operation. Nevertheless, reasonable or fair cost and subsidy allocations can usually be negotiated between informed parties with relatively equal bargaining power
Bargaining power may be uneven. Classic principal-agent problems may emerge because parastatal managers may use their superior knowledge to present their accounts in ways that maximize the subventions required from the government, knowing that the government has insufficient information to successfully challenge this
A hard budget also requires the government, through the sponsoring ministry, to pay its required subventions to the parastatal fully and on time so that the parastatal can meet its commitments and pay its bills. Frequently there is insufficient budgetary flexibility to achieve this, especially when governments have conditionalities imposed upon them to restrain domestic credit creation.
Nevertheless, the hard budget principle, by exposing the true financial costs of providing certain services, may force a government to reconsider its priorities while providing it with information, albeit imperfect, to do this. It is therefore important to persevere with the establishment of this principle. It is an unwillingness of some governments to face up to these realities which allows parastatals to continue to operate with soft budgets and this inevitably leads to continuing inefficiencies.
Once the functions of the parastatal have been clarified and suitable cost accounts developed, in theory it should be possible to provide senior management with an improved incentive structure by linking their rewards to performance through performance contracts (Box 4.2). However, the World Bank (1995) suggests that, in practice, performance contracts rarely improve incentives, and may do more harm than good. Several arguments are advanced to support this position, the main one being that they do not reduce the managers information advantage. In other words, even with improved accounts, managers typically can negotiate targets that are easy for them to achieve. Moreover, by encouraging the setting of many targets and changing them, or their relative importance, over time the managers can ensure that each target has little impact. Frequently the targets used in performance contracts, for example output targets or partial productivity measures such as labour productivity, do not necessarily lead to improved overall economic performance. Managers can further impede the monitoring process through delaying the return of essential and audited data.
Box 4.2 Performance contracts
Performance contracts are defined as:
negotiated agreements between the government and SOE [parastatal] wherein quantifiable targets are explicitly specified for a given period and performance is measured against the targets at the end of each period (World Bank, 1995).
Effective monitoring is made more difficult when the quality or rank of civil servants negotiating the contracts, or monitoring them, is inferior to those representing the parastatal, especially when the latter have political power. One way round this problem may be to bring in external agents, such as professional auditors, to strengthen the governments position vis-à-vis the parastatal.
If targets are relatively soft, and bonuses are paid for their achievement, managers have little incentive to improve performance further. At the same time, sanctions for poor performance are rarely enforced. Governments themselves often undermine the credibility of performance contracts by arbitrarily changing the terms of the services expected from public sector organizations without making concomitant changes to the performance contract. Moreover, the government may renege on the contract if its fulfilment requires the government to take actions that have a high political cost, such as sanctioning the retrenchment of redundant workers as a cost-reducing measure. Finally, there is likely to be limited commitment to performance contracts if they are perceived to be donor driven or imposed as a conditionality.
Despite these various drawbacks, some form of monitoring and encouraging improved performance is essential if parastatals are to perform effectively in the absence of true competition. This section has highlighted some of the pitfalls that must be avoided if this is to be done successfully. Of course, the stronger the competition faced by a parastatal and the harder its budget constraints, the more the parastatal will have to strive for efficiency in order to survive and this strengthens the case for introducing hard budgets and effective competition.
Investment in physical capital
Sometimes the reason for poor performance is a simple neglect of capital investment. This is frequently the result of government policies that have placed a low priority on the needs of the organization and of the agricultural sector, leaving it to operate with technically obsolescent equipment, or unable to finance the purchase of spare parts for, or repairs to, its plant or machinery. From an economic viewpoint the obvious solution is for the government to re-examine its investment priorities and to allow the parastatal to invest, or at least maintain its equipment in good running order, providing the anticipated rate of return reflects the opportunity cost, or scarcity value, of investment funds. Of course, the governments own limited funds or borrowing capacity may influence this scarcity value. If the parastatal has an appropriate legal status an alternative source of investment funds may be from commercial sources on hard budget criteria. One constraint on this is that while the investment may have a satisfactory social rate of return, its financial return may be low because of the nature of the service being provided. Again, this problem would be solved if the government adequately compensated the parastatal for providing these social functions.
One difficult problem to resolve is whether investment should be undertaken if there is a likelihood of the organizations assets being divested at a later stage. Potential arguments in favour of going ahead with investment is that the efficiency of the organization will be improved and, if it was ever to be divested, this improved efficiency should be reflected in the sale price. One argument used against such investment is that it is unlikely that the potential improvement in efficiency will be realized unless the governance problems that surround most organizations can be resolved. This argument suggests that investment should be delayed until hard budget procedures have been adopted. Another argument is that any improvement in efficiency is likely to strengthen the resolve of those with vested interests in opposing further change to the status of the organization. If investment does improve the efficiency of the parastatal then the urgency for further reform is indeed reduced. Moreover, this improved efficiency may create constituencies of those interested in acquiring the assets of the organization, for example through a management buy out (MBO).
In the past, donors have been very willing to finance investments in parastatal infrastructure. More recently, however, there has been some reluctance to do this. In part this is because, reflecting the arguments outlined above, some donors feel that such investments are wasted unless the governance of public sector organizations can be improved. Other donors, however, now appear to oppose the continued existence of parastatals on dogmatic grounds, regardless of their actual or potential performance. In doing this they tend to forget that there are some areas, such as some types of agricultural research, where parastatals may remain the most cost-effective form of organization.
Investment in human capital
Another reason for the poor performance of public sector organizations relates to the remuneration and training offered to key personnel. In some countries parastatal salary scales are linked to those in the civil service and, more importantly, the same terms of employment apply. On the one hand this makes it difficult to offer senior personnel rewards that match those offered in the private sector for similar levels of responsibility and commercial judgements. On the other hand, it is frequently difficult to fire managers or employees who are under-performing. The result is that parastatals are often staffed by people who are poorly motivated and of mediocre quality. They are also often inadequately trained either because there is little incentive offered or because the parastatal management does not offer training opportunities.
There is unlikely to be a solution to these problems until the parastatal can offer a remuneration package similar to that in the private sector, but this has to provide penalties for poor performance as well as rewards for success. In some circumstances this may require a change in the legal status of the parastatal. Once such a structure is in place, an important component in improving the internal efficiency of the parastatal will be investment in training and human capital formation. If there is no likelihood of the quality of management being improved then this will strengthen arguments in favour of divestment of control and/or ownership of the parastatals assets.
4.3.3 Market development
Improving the market environment
Regardless of the improvements that can be made to the internal efficiency of an organization, a key factor determining its effectiveness will be the potential and actual competition it faces. However, in many countries there will also need to be a substantial improvement in the market environment before this competition is truly effective. The quality of the market environment is also of critical importance to the performance of previous parastatals if the decision is made to divest their ownership and/or control to the private sector. Following Smith (1992), some of the key areas where action may be required to create an environment that encourages private and voluntary sector activity are discussed below. Because many of these will take time to implement fully it is important that they are considered early in the reform process.
Providing a relatively stable environment with potentially profitable opportunities
Most individuals and organizations are risk-averse, and prefer to invest in economic activities where the outcome is reasonably predictable. The state can assist this in three main ways:
By providing an economic and political environment which is perceived by potential investors to be relatively stable. One important aspect of this is the governments macroeconomic policies. These can provide a relatively constant, and low, inflation rate and stable exchange and interest rates. These can all have a marked effect on the profitability of private investments in the agricultural sector if international forces determine domestic prices
Establishing a reputation for policy consistency. The government should announce its policy intentions clearly and unambiguously and avoid frequent changes or U-turns in policy direction. This is of particular relevance when liberalization or state decontrol is occurring and the private sector is required to undertake activities previously provided by the state
Protecting the domestic environment from the worst excesses of exogenous sources of instability and uncertainty, such as weather-induced output variations and fluctuations in world prices. A strong case can be made for government actions to reduce the impact of these on the domestic environment but this can be done in ways that does not require a direct, or massive, government presence in economic activities.
An effective and low-cost legal code and accessible legal system
An important pre-requisite for reducing transaction costs and encouraging private sector investment is for the state to provide an effective, low-cost and accessible legal system where property rights and contractual arrangements can be clearly established and redress can be obtained easily for contract infringement. A well-defined legal code for both domestic and foreign private investors is also invaluable. A review of laws governing business activity is an essential pre-requisite for the success of any privatization scheme (Guislain, 1997). At the same time, there is a need to ensure that the private sector is operating in the overall national interest and, as discussed below, this may require legislation to outlaw anti-competitive practices.
Positive attitude to private sector activities from the bureaucracy
The state is composed of individuals, groups and coalitions each often more concerned with pursuing their own self-interests than the common good. Parts of the bureaucracy may be hostile towards decentralization or private sector development, perhaps because they feel it threatens their own jobs. Equally, other parts of the bureaucracy may wish to tax the private sector heavily to generate revenues. Rather than these negative attitudes, what is desirable is a bureaucracy that considers that it is in its own long-term interest to foster the growth of the private sector as a means of increasing wealth and tax revenue. This normally requires firm guidance and direction from the highest political levels. It may also require the dismantling, or redeployment, of those parts of the bureaucracy which are no longer performing a useful economic role. This latter is obviously a painful process, but directly unproductive resources can damage agricultural sector development through their claims on government revenues, and their resistance to private sector growth.
Minimum of regulations consistent with orderly service provision
A regulatory framework is often an effective way of dealing with the many sources of externalities that abound in the agricultural and food sectors, and also in controlling restrictive and other anti-competitive practices. But regulations also keep bureaucrats employed, they are always a potential source of economic rents, and may increase the transaction costs of private sector firms. There are many instances, however, where groups of economic actors can internalize these externalities through self-regulation. For example, exporters of a particular product may find it in their own interests to develop common quality standards and brand names that protect the reputation of a countrys produce. Thus the government needs to continually assess the relevance of the current regulatory framework to find the optimal balance of government regulation and self-policing activities.
A level playing field
Private or voluntary sector development is likely to be severely hampered if private firms or organizations are expected to compete with parastatals that are allowed more favourable treatment by the state. The introduction of all of the elements of hard budgets for parastatals outlined earlier should remove many of these potential biases. However, there are many other sources, such as restrictions imposed by national and local bureaucracies that, if removed, would allow the private sector to compete on an equal footing with parastatals and thus enhance competition. It should be noted that this is a two-way process, in that the effective operation of many parastatals is hampered by restrictions that prevent them operating in a competitive manner.
Encouraging voluntary group activities
Voluntary group activity by trade and producer associations may overcome some, or many, of the problems of market failure by providing collective or club goods for their members. These associations can also perform many other valuable functions, such as acting as information exchanges, dealing with dispute resolution and providing self-insurance facilities for their members. Thus, in general, their development should be welcomed and encouraged. However, there is sometimes resistance by politicians or bureaucrats to this. One concern is their potential activity as pressure groups lobbying for changes favourable to their members, or even as mass movements articulating demands which the government views as a threat to its legitimacy.
Another concern is that the associations may engage in anti-competitive activities such as attempting to form cartels, engaging in other restrictive practices, and raising barriers to entry. To counteract these tendencies, governments need to develop effective restrictive practice and anti-monopoly legislation capable of differentiating between actions that will improve the private sectors contribution to overall development and social welfare, and actions that are likely to hinder it.
Public sector investments to enhance private sector performance
There are numerous ways in which government investment in infrastructure, research and development, and education and training can be instrumental in raising productivity in the agricultural sector. A well-developed public infrastructure, with investments in roads, railways, telecommunications, etc., can reduce transportation, arbitrage and transaction costs, and improve market integration. Government collation and dissemination of market intelligence and information can play a useful role in counteracting asymmetric information, although its role in assisting arbitrage operations is frequently over-stated. The extension and improvement of irrigation schemes and techniques can raise land productivity and increase the efficiency of water use. Agricultural research into new crop varieties, pest and disease control, improved animal husbandry techniques and investment in more effective extension techniques can raise agricultural productivity and output. Increased expenditure on rural education and training, including market awareness and business training can increase human productivity.
Each of these areas has substantial collective goods attributes that may make individual, or private sector, provision or funding difficult. Moreover, each helps to improve the institutional and physical infrastructure that encourages private sector investment and growth. A more careful assessment of the social rate of return to public investments in agriculturally-related areas might justify an increase in government expenditure in this area, and/or a more effective allocation of existing funds, as a pump primer to further private and voluntary sector development.
Tackling incomplete markets
One of the major factors hampering commercialization and the development of the private sector is the presence of fragmented and incomplete markets. The need to improve the physical infrastructure has already been mentioned, but there is often a need to improve the functioning of credit and finance markets to increase access to finance for working and fixed capital. These market development functions are all areas where donor support is likely to be forthcoming as ways of encouraging increased private and voluntary sector participation in the economy. One of the most frequently stated constraints facing small traders and businesses is an inability to obtain finance to expand their operations. The existence of established and well-organized financial markets also increases the number of methods available for the privatization of parastatals. Consequently, development of the financial sector needs to be given higher priority in countries that are attempting to encourage private sector development.
The operations of the foreign exchange market similarly need to be liberalized and developed to encourage both exports and the importation of a wide range of necessary inputs for production, transportation, processing and distribution, and to make it easier to obtain foreign funds for major investment purposes.
The domestic input and output markets may also be underdeveloped, sometimes because of limitations in the physical infrastructure, or financial and foreign exchange markets, but sometimes because of government intervention in these areas. Many countries lack effective commodity exchanges with facilities for forward contracts, hedging and insurance facilities.
One aspect associated with market development, but which is usefully dealt with separately is the issue of business training. This is of particular importance in areas where the private sector has previously been excluded because of a public sector presence, and relates both to technical aspects, e.g. fertilizer handling and storage, and to business expertise such as import or export contracts, etc. In some instances this training could be given most effectively by the public sector organizations currently engaged in these activities. In other instances techniques can be learnt from other parts of the business community or training institutions engaged in similar activities. Occasionally it may be necessary to request an international agency for training assistance in specific topics.
A step-wise and ordered approach to reform and decentralization is likely to pay long-term dividends. It is important to start by having well-defined long-term objectives and to place the reform of individual public sector organizations in the wider context.
A first step in the reform process is to establish whether there is a case for reform by examining if there is still a need for the service, the costs incurred in providing the service and whether more cost-effective methods of providing it exist or can be created.
It is also important to establish if there is a political commitment to reform and to develop a political consensus in favour of reform. This may take time to develop and the correct timing of reforms are crucial to their success. Different forms of decentralization will have varying political impacts and these also need to be considered when deciding the appropriate method of reform.
It is conceivable that some or all of the reform objectives can be achieved by improving the internal efficiency of public sector organizations through the introduction of hard budgets, changing the incentive and regulatory framework and investing in new capital or training. There are varying schools of thought on whether attempts to improve the internal efficiency of public sector organizations are worthwhile unless the governance system is radically altered.
An important factor in any reform process is to increase the potential and actual competition faced by organizations supplying agricultural support services. There are a variety of actions that can be taken that will contribute to improvements in the market environment and increased private and voluntary sector activities.
 This Chapter relies
heavily on material previously published in Smith (1999).|
 Literally: 'village rule'.
 World Bank (1995).
 In the presence of asymmetric information the principal who employs an agent to perform a task is often less well informed than the agent. This allows the agent to behave opportunistically.