POVERTY THE WORLD BANK REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise SEPTEMBER 2010 · Number 32 56746 Reform and Regional Integration of Professional Services in East Africa Nora Dihel, Ana Margarida Fernandes, Aaditya Mattoo, and Nicholas Strychacz Professional services matter for development in East Africa. Business services, including professional services, are among the most dynamic services sectors; and are a key input for other sectors. Greater use of professional services by East African firms is associated with higher labor productivity. But there is a large gap between the potential contribution these services could make and the meager contribution they make today. National markets for professionals and professional services in East Africa remain underdeveloped, whereas regional markets are fragmented by restrictive policies and regulatory heterogeneity. An effective reform agenda will require policy action in four areas: education, regulation of professional services, trade policy, and labor mobility at both the national and international levels. Professional services matter for development in East Africa: costs that are considered to be the most significant im- · Even though the share of business services in the GDP pediment to economic growth in Africa. of East African countries is small, the sector is among · Engineering services--encompassing civil, mechanical, the most dynamic. Over the period 2001­07, business and electronic engineering--contribute to the devel- services have grown at 8 percent a year in Kenya, 14 opment of infrastructure, the dynamism of manufac- percent a year in Tanzania, and nearly 18 percent a turing, and engagement in the emerging knowledge year in Uganda (World Bank 2010). economy. · Business services are key inputs for other sectors, and · Professional services also could become an important greater use of professional services is associated with avenue for export diversification by some East African higher labor productivity. Input-output tables suggest countries. that they are among the top fifth of economic sectors But there is a large gap between the potential contribu- in terms of direct and indirect usage (World Bank tions these services could make and the meager contribution 2010). they do make at present. Policy makers in East Africa have · Business skills and services, such as accounting and le- recognized the critical importance of developing profession- gal services, play a critical role in reducing transaction al services. Along with reforming backbone services like 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise telecommunications, banking, and transport, governments With the exception of accounting technicians in Kenya, are adding professional services to their lists of priorities. Im- East Africa faces a middle-level skills vacuum. Middle-level proving and expanding these services will require both na- professionals can play a crucial role in providing services to tional reform and international cooperation, including cre- groups of clients who often are underserved. Skills mis- ating a more integrated regional market. matches seem to be a serious issue in all examined countries. This note presents the results of extensive information For example, accounting associations in Kenya and Tanzania gathering and analysis of these largely unexplored segments report that there are jobless accountants, despite high de- of the East African economy. It shows why national markets mand for qualified accounting professionals. for professionals and professional services there remain un- derdeveloped, at the same time that regional markets are High Demand for Professional Services fragmented by restrictive policies and regulations. To turn this sector around, the note calls for policy action in four ar- Evidence from recent firm-level surveys1 in East Africa sug- eas: education, regulation of professional services, trade pol- gests that a surprisingly large number of formal sector firms icy, and labor mobility. in all sectors use professional services.2 A large proportion of the demand for accounting and auditing services seems to Striking Differences in the Levels of derive from mandatory legal requirements pertaining to fi- Development of Professional Services nancial reporting and taxation. In many cases, the relation- ship between the use of externally outsourced professional In terms of availability and wages, there are striking differ- services and firm size exhibits an inverted U-shape: use in- ences in the levels of development of professional services creases with firm size until a certain point, after which it de- across countries in East Africa. Professionals are relatively clines. Whereas smaller firms rely primarily on external serv- abundant in Kenya, whereas there is a relative scarcity of ice providers, more than a fifth of the largest firms rely professionals in Rwanda. However, per capita availability of exclusively on in-house engineers and lawyers. Uganda is professionals in each of those countries is only a fraction of broadly representative of the pattern of service use by firms that in more advanced African economies, such as Mauritius of different sizes (figure 2). and South Africa (figure 1). Market structures show elements of both oligopoly and Although professionals in East Africa receive low nominal competition. Accounting and auditing services are dominat- wages relative to their counterparts in developed and other ed in all countries by the large affiliates of the "Big Four" developing countries, professionals in Kenya and Uganda are multinational firms.3 In Kenya, however, local mid-size ac- comparatively well paid when their wages are adjusted for counting firms are gaining market share at the expense of purchasing power--reflecting perhaps their scarcity relative the Big Four, after initially working as subcontractors for to the demand for their services. A wage premium for pro- them. The engineering and legal sectors are dominated by fessionals over the earnings of other workers with a univer- domestic providers--often small firms and microenterprises. sity degree is evident in all East African countries. The combined capacity of these small firms, though large, is Figure 1. Professional Density in Africa, 2008 a. Accountants b. Lawyers Mozambique Malawi Rwanda Tanzania Uganda Mozambique Malawi Uganda country country Tanzania Rwanda Zambia Zambia Kenya Botswana Botswana Kenya South Africa Mauritius Mauritius South Africa 0 20 40 60 80 100 120 0 20 40 60 80 100 120 accountants per 100,000 inhabitants (n) lawyers per 100,000 inhabitants (n) Source: World Bank Surveys of Market Conditions in Professional Services in Eastern and Southern Africa, 2009. Note: East African countries are indicated by dark-blue bars. 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 2. Use of Professional Services in Uganda, by Sector, 2009 in these contracts, with the limited exception of Kenyan firms in a few Tanzanian and Ugandan projects and Ugandan 100 firms in a few Rwandan projects. 90 80 Explaining Skills Shortages and Skill 70 Mismatches in Professional Services-- percent 60 Weakness in Education 50 40 First, professional education is expensive in all East African 30 countries. Although skills premia for professionals exist, and 20 internal rates of return to education are high in the region, 10 the median cost to become a professional worker ranges 0 from US$14,000 to US$26,000. This makes attaining pro- 19 9 99 19 9 99 19 9 99 ­9 ­9 ­9 fessional qualification unaffordable for the majority of the 1­ 1­ 1­ an an an 20 20 20 th th th population in these countries, especially given the underde- e e e or or or m m m accounting legal engineering veloped nature of the markets for educational loans. employees (n) Second, the weaknesses in secondary education across East African countries limit students' ability to acquire pro- external use internal use fessional skills. The general erosion of mathematics skills in Source: World Bank Survey of Users of Professional Services in East Africa, all countries explains the declining number of applicants in 2009. science, engineering, and technology courses, leading to shortages in the engineering sector. Third, the capacity and quality of professional education too scattered to meet demand for sizable and possibly more institutions are limited. In several East African countries, in- sophisticated projects. stitutions that offer specialized postgraduate courses and ones that offer academic and professional training courses Limited Trade in Professional Services for middle-level professionals are entirely absent. Fourth, there is an absence of links between educational The heterogeneity of professional endowments and the earn- systems, employers, and users of services. This absence leads ings differentials across countries for each profession suggest to the production of nominally qualified but effectively un- that there is substantive scope for trade in professional serv- employable professionals. Stakeholders from the private sec- ices in East Africa. Foreign professionals and foreign profes- tor emphasize the severe lack of coordination among em- sional firms could help address the underdevelopment of the ployers, professional associations, and educational institutions sectors and the region's unmet demands. However, data from with regard to the content of educational programs for ac- World Bank regulatory surveys of professional services in East countants and engineers. Africa in 2009 (World Bank 2010) suggest that foreign pro- fessionals in Kenya, Tanzania, and Uganda represent less than Explaining the Underdevelopment of 10 percent of the total number of professionals in accounting Professional Services--Domestic Regulation and engineering. In Rwanda, by contrast, foreign professionals account for more than 60 percent of the total number of pro- Domestic regulation of the entry and operations of profes- fessionals. In legal services, there are virtually no foreign pro- sional services firms often undermines competition and con- fessionals in any of the East African countries. strains the growth of strong professional services sectors in Similarly, in terms of commercial presence, there is only East Africa. Kenya, Tanzania, and Uganda seem to impose a limited presence of foreign engineering firms and there is particularly severe entry restrictions on engineering and legal an almost complete absence of foreign legal services firms in services. Rwanda remains on the light side of regulation in East Africa. Evidence from World Bank­supported civil all three sectors. Each country grants exclusive rights over works procurement contracts since 1994 reflects the lack of certain activities to certain professions. Licensing and educa- integration of the East African market for engineering serv- tional requirements and quantitative constraints also inhibit ices. Domestic companies generally win most of the con- competition. Regulations affecting the operations of legal tracts, except in energy and mining and transportation and engineering providers (conduct regulations) include re- (where non-African companies have the lion's share). There strictions on prices and fees, advertising, form of business, is essentially no intra-East African foreign firm participation and interprofessional cooperation; and they are particularly 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise heavy when compared with those in emerging economies any type of foreign professionals in Kenya, Tanzania, and and in countries of the Organisation for Economic Co-oper- Uganda; de jure or de facto nationality requirements to prac- ation and Development. tice domestic law in Kenya and Tanzania; limited recognition World Bank firm-level surveys of private providers of pro- of foreign-licensed professionals; and work permit issues in fessional services in East Africa reveal that restrictions on most East African countries. multidisciplinary activities are an important constraint in the Trade in professional services through the establishment of accounting sector, whereas regulations on fees and prices are foreign commercial presence (mode 3 in GATS) is also limit- the major constraints in the engineering and legal sectors. ed by different types of restrictions across countries in the re- Nontransparent procurement procedures hurt both ac- gion. The entry of foreign law firms is not permitted in Kenya counting and engineering services providers, and inappropri- or Tanzania. In those countries and in Uganda, local members ate standards hurt accounting services providers (figure 3). of international law networks face restrictions on using the network's brand name. The restrictions imposed on account- Explaining the Segmentation of Markets for ing firms are even more stringent, with branches of foreign Professional Services--Trade Barriers firms being prohibited in Kenya, Uganda, and even the more liberal Rwanda. Kenya and Tanzania also prohibit ownership Trade barriers limit competition and the efficiency of profes- or control of foreign accounting and auditing firms by profes- sional service providers in East Africa. Countries in the re- sionals not licensed locally. Foreign firms providing engineer- gion differ in terms of their openness to trade: Kenya and ing services encounter fewer restrictions in East Africa. Tanzania generally exhibit the most restrictive policies on All East African countries restrict cross-border trade trade in professional services, whereas Uganda is relatively (mode 1 in GATS) in certain types of professional services, open and Rwanda is much more so. such as advice on matters relating to domestic law, audits, Trade in professional services through the movement of tax and tax representation. natural persons (mode 4 in the General Agreement on Trade in Services [GATS]) across national borders is restricted in Reforming Markets for Professional Services East Africa by explicit trade barriers, regulatory require- ments, and immigration policies. Chief among those are dis- The East African regional market for professionals remains cretionary limits through labor market tests on the entry of generally underdeveloped and fragmented by restrictive Figure 3. Restrictiveness of Regulation in East Africa--Top Constraints, by Sector, 2009 (4 = major obstacle; 1 = no obstacle) 3.5 restrictiveness of regulation 3.0 2.5 2.0 1.5 1.0 0.5 0 en lic ti y en lic itie ry n es g n ts ds es g re tivi ar tiv na sin sin tio tio em b em b t pr cy es t s en pa ac plin ric ric ar ur pu ur pu ac li ita ita en en m nd ip /p /p i oc of oc of ed ed re isc isc lic lic es es ta ui pr y cr cr ls fe fe tid tid of nc of eq ac ac n ca of of ul ul d re d tr ee ee m m ni of of n n pa en tio tio ch sp sp d d on on ns ns em ee ee la la te tra tra ns ns gu gu sp sp of ur tio tio re re oc n ric ric tio pr st la st ic gu re re bl re pu accounting legal engineering regulatory barrier Source: World Bank Survey of Providers of Professional Services in East Africa, 2009. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise policies and regulatory heterogeneity. Given these limita- tion on services and services providers) to accom- tions and constraints, policy reform is necessary to allow de- plish the same goals at lower economic cost. velopment of the market for these professions. As noted ° Countries impose restrictions on the ownership struc- above, an effective reform agenda will require policy action ture of professional services firms; the scope of collab- in four areas: education, regulation of professional services, oration within the profession and with other profes- trade policy, and labor mobility at both national and inter- sions; and, in some cases, the opening of branches, national levels. franchises, or chains. These countries should eliminate regulations that are clearly anticompetitive and that Reforms at the National Level may harm consumers by preventing providers from Reforms at the national level should focus on the develop- developing new services or cost-efficient business ment of framework conditions that address skills shortages models. and skills mismatches and that attempt to facilitate the ° Advertising prohibitions are imposed by most East growth of professional services. African countries on many of their professional Reforms related to education should focus on the follow- services sectors. These countries should allow adver- ing issues: tising of professional services that facilitates compe- · Financial constraints prevent individuals from acquir- tition by informing consumers about different prod- ing a professional education, so developing new and ex- ucts and that can be used as a competitive tool for panded means of financing higher education (such as stu- new firms entering the market. dent loans schemes) should be a priority. · Weaknesses in African educational systems mean that Reforms at the International Level students are poorly equipped to acquire professional The fragmentation of regional markets for professional serv- skills, so enhancing the quality and capacity of schools ices and professional education by restrictive policies and (especially in mathematics, sciences, and technical stud- regulatory heterogeneity prevents countries from taking ad- ies) should be a key item on the policy agenda. vantage of gains from trade based on comparative advantage, · Given the capacity constraints and quality limitations as well as gains from enhanced competition and economies of professional education institutions, improving exist- of scale. Policy action is required in the following key areas. ing institutions and encouraging the creation of new ones Steps must be taken to relax the explicit trade barriers ap- is necessary. plied to the movement of natural persons, establishment of com- · Policy action to encourage closer collaboration and con- mercial presence, and cross-border supply of professional servic- sultation between employers, professional associations, es; and those applied through discriminatory procurement. and educational institutions could help professionals ac- Examples of possible reforms are (1) articulating the eco- quire the job market­relevant skills and the crucial nomic and social motivation for nationality and residency re- practical training. quirements; (2) developing transparent criteria and proce- Reforms also should focus on incremental, qualitative im- dures for applying any quantitative restrictions on the provements in domestic regulation: movement of professionals, such as economic needs tests; (3) · Disproportionate cumulative entry requirements should be minimizing restrictions on the forms of establishment al- relaxed. For example, narrowing the scope of exclusive lowed; and (4) developing a transparent and consistent tasks in certain professions would contribute to accom- framework for accepting professionals with foreign qualifi- plishing this goal. The argument in favor of exclusive cations. The reduction of explicit trade barriers should be rights is that they can lead to increased specialization complemented with the reform of immigration laws. and guarantee a higher quality of service. But exclusive Trade liberalization should be coordinated with regulatory rights that create monopolies can have adverse price cooperation at the regional level. Trade barriers ideally would and allocation effects, especially if they are granted for be liberalized on a most-favored-nation or nonpreferential services for which adequate quality can be provided at basis because that would generate the largest welfare gains. a lower cost by middle-level professionals. But such liberalization may not be technically feasible or po- · Disproportionate restrictions on competition should be litically acceptable, especially when impediments arise from eliminated. differences in regulatory requirements. Deeper regional in- ° Price regulations are supported by the East African tegration through regulatory cooperation with neighboring countries' professional associations who claim that partners who have similar regulatory preferences can useful- they are useful tools to prevent adverse selection ly complement nonpreferential trade liberalization. Regional problems. Countries could adopt less-restrictive integration also would enhance competition among services mechanisms (such as increased access to informa- providers, enable those providers to exploit economies of 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise scale in professional education, and produce a wider variety gional market for education by differences in regulation of services. Regional integration brings further benefits in can prevent the emergence of regional hubs for higher that a larger regional market is able to attract greater domes- education, so smoothing these regulatory differences tic and foreign investment; and regionalization may help may lead to a greater variety of higher education serv- take advantage of scale economies in regulation, particularly ices becoming available at lower costs. The Inter-Uni- where national agencies face technical skills or capacity con- versity Council for East Africa--a regional intergovern- straints. Regulatory cooperation to overcome regulatory het- mental organization established in 1980 with the aim erogeneity within the East African Community (EAC) of facilitating contact among the region's universities-- would be particularly useful in the following areas: already provides a forum to address these issues. · EAC countries have taken the first steps toward mutual Although the economic benefits of regional integration recognition of qualifications and licensing in professional are evident, the pace of integration is largely dependent on services by adopting the Common Market Protocol in EAC member-countries' political motivation and conviction 2009. Although some progress on mutual recognition that the various reforms are beneficial to their domestic con- has been made in accountancy, EAC countries should stituencies. So far, East African countries have committed continue to work toward implementing a regional themselves (at least in principle) to liberalization and deeper framework for mutual recognition in other profession- regional integration in a number of services sectors. Howev- al services, even if the process is lengthy and difficult. er, much more work is needed to accomplish that goal. The · Inappropriate standards can stifle demand for services. policy discussion and recommendations presented here are The development of an appropriate standard may be de- intended to facilitate more informed policy choices, which sirable at a regional rather than national level to exploit could lead to a reformed and dynamic professional services economies in regulatory expertise, prevent fragmenta- sector that contributes to East African development. tion of the market by differences in standards, and lim- it the scope for regulatory capture. Common regional About the Authors standards would reduce market participants' costs of operating across national borders. A framework for re- Nora Dihel is a trade specialist with the Africa Poverty Reduc- gional cooperation on accounting and auditing stan- tion and Economic Management (PREM) unit of the World dards already exists in the form of the Eastern Cen- Bank. Ana Margarida Fernandes is an economist in the Devel- tral and Southern African Federation of Accountants opment Research Group­Trade and Integration of the World (ECSAFA). All countries could benefit from the de- Bank. Aaditya Mattoo is research manager, Development Re- velopment of the ECSAFA Guide on Accounting for search Group­Trade and Integration. Nicholas Strychacz is a small and medium enterprises; and from common consultant in the PREM unit. training standards for accounting technicians such as This work is funded by the Multi-Donor Trust Fund for the Occupational Standards for Accounting Techni- Trade and Development, supported by the governments of Fin- cians in the ECSAFA Region or the accounting tech- land, Norway, Sweden, and the United Kingdom; and by the nician scheme recently introduced by the Association Bank Netherlands Partnership Program. The views expressed in of Accountancy Bodies in West Africa. this paper reflect solely those of the authors; and are not neces- · Regional cooperation in removing restrictions on the free sarily the views of the funders, the World Bank Group, or its ex- movement of labor (including visa and immigration laws) ecutive directors. is crucial for East Africa. The mobility of businesspeo- ple is a key factor in the promotion of free and open Notes trade. Through the Common Market Protocol, East African economies have committed themselves to en- 1. In 2009, the World Bank conducted two types of firm hancing labor mobility by streamlining immigration surveys, covering users and providers of accounting, legal, and temporary residence processes for foreign workers, and engineering services in Kenya, Rwanda, Tanzania, and but these commitments need to be implemented in Uganda. The survey instruments were developed by the practice. World Bank and were implemented in all countries by TNS · Regional cooperation to improve the financing and capac- Opinion, an international research group. The surveys are ity of professional education is desirable. Cooperation described in detail in World Bank (2010). among countries in sharing information and experi- 2. The fact that the firm-level surveys cover mostly firms ences to increase the recovery rate of student loans in the urban formal sector may help explain the high us- while increasing students' access to higher education age. could improve the impact of educational loan programs 3. The Big Four firms are Deloitte Touche Tomatsu, Ernst in East Africa. In general, the fragmentation of the re- & Young, Klynveld Peat Marwick Goerdeler, and PriceWa- 6 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise terhouseCoopers. They retain a partnership model that relies Reference on local members and their professionals to understand the language, rules, and operating procedures of the respective World Bank. 2010. "Towards an East African Reform and Regional Integra- tion in Professional Services." Washington, DC. market. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. It is produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at www.worldbank.org/economicpremise.