Support Businesses in Mozambique

revenues to keep its economic growth from declining. Further, if fiscal competition displaces activities and resources from their most productive uses to less productive ones, these will be negative-sum efforts. Subnational jurisdictions are likely to reduce their ability to finance local public goods and services, while not increasing their tax base.

A classic case of such fiscal competition is in Brazil, where states have historically been active in promoting economic development. One of the most controversial cases of unfettered fiscal wars among states is the Ford Motors plant in Bahia, originally planned to be built in Rio Grande do Sul. The package of incentives offered by Rio Grande do Sul included a R$210 million Brazilian reais ($R) (about US$200 million) loan from the state to Ford at extremely favorable conditions (6 percent interest, 15-year repayment period), additional state expenditures of R$234 million on infrastructure and public works, an additional assured loan from the national economic development agency (BNDES) of R$500 million, and exemption from local taxes for 10 years. In 1997, the state government tried to renegotiate the deal, claiming that the conditions were too generous for Ford and too expensive for the state. When Ford did not accept the new conditions proposed by the state, it moved to Bahia, which offered a package similar to the original one (Alves 2001). In the end, traditional subsidies used to attract (usually foreign) investors to regions lagging or suffering from trade adjustment have largely been ineffective, both because the level of necessary subsidy would be prohibitive and because of the beggar-thy-neighbor competition with competing regions.

Given all the factors at work in local economic development and their interactions, analysis of LED initiatives can prove difficult. Box 8.5 describes how a World Bank–financed project in Mozambique incorporated several features of the Duranton and Venables (2018, 2020) appraisal framework.

BOX 8.5 Applying the Duranton-Venables Framework to Design a Project to Support Businesses in Mozambique

The Economic Linkages for Diversification project in Mozambique aims to strengthen the performance of micro, small, and medium enterprises by developing both upstream and consumption linkages with extractive and large firms in the lagging regions of the country—the provinces of Cabo Delgado, Nampula, and Tete—while addressing and mitigating some of the drivers of fragility and conflict. The project is a good-practice example that includes several features of the Duranton and Venables (2018, 2020) framework.

(Box continues on the following page.)

BOX 8.5 Applying the Duranton-Venables Framework to Design a Project to Support Businesses in Mozambique (continued)

The project develops a clear narrative of the intervention based on an assessment of market failures through a firm-level survey of both formal and informal firms, and the country private sector diagnosis. It finds that information asymmetry, moral hazard, coordination failures, externalities, and spillovers inhibit matches between buyers and suppliers. For instance, local suppliers are unable to meet the quality standards expected by globally linked large buyer firms. Buyer-supplier relationships can be established with support programs such as providing access to more sophisticated customers (including large firms or multinationals) and encouraging buyer firms to facilitate exchange with local suppliers and public procurement programs.

The project also fully describes the direct effects expected in the context of the project. In the short term, the interventions to improve firm capabilities are expected to help firms strengthen their capacity, adopt higher quality standards, and attain better access to finance. In the long term, the trained firms are expected to have higher sales and employment and greater economic diversification. In addition, the project also targets indirect effects (but does not quantify or value these changes) to justify the intervention. For example, the project expects that the following effects will occur: • Local businesses and entrepreneurs will benefit from spillover effects of improved economic activity and increased linkages. • Sectoral clusters, business associations (including women’s associations), and private sector associations will benefit from the increased knowledge and economic activity. • Technicians and professionals across lagging regions will benefit from increased capacity of firms. • Business development service providers, professional organizations, and civil society organizations will benefit from increased capacity and opportunities for delivering on their mandates.

To ensure that the targeted region has complementary conditions for fostering firm growth, the project also includes interventions supporting localized infrastructure investments and digital solutions for private sector development. The benefits of these interventions will include better access to markets for firms, increased employment, reduced transaction costs, and increased inclusion of communities and the youth. Furthermore, the project is implemented in coordination with several other World Bank projects that focus on issues relating to governance and fiscal linkages, workers’ skills, spatial development, and so on.

Finally, displacement effects of the project are also considered. This is why the project takes a nationwide approach rather than focusing narrowly on the lagging region. That is, prioritization of lagging regions provides some edge to local firms, but it does not limit participation to those located within the region. Allowing firms from other regions to participate may displace activity from other parts of Mozambique; however, it would also let nationally competitive firms expand in lagging regions and create knowledge spillovers for local firms.

Source: World Bank staff synthesis of Economic Linkages for Diversification project in Mozambique.