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Why Afghanistan's private sector is struggling

Despite long-standing international efforts to revive the Afghan economy, a new report says the country's private sector still hasn't managed to fulfill its potential as a driver of economic growth. DW examines why.

After achieving remarkable growth over the past decade, Afghanistan's economy has floundered in the past two years as international investors and aid organizations have drastically scaled back operations following the withdrawal of most international troops.

And as a new report shows, concerns are mounting that the country's private sector will not be able to make up for the loss of international assistance anytime soon - a development that could bolster an increasingly resilient Taliban insurgency and further dampen democratic prospects.

"In its current state, the Afghan private sector is not the engine of economic growth or instrument of social inclusion it has the potential to be," said researchers from the Stockholm International Peace Research Institute (SIPRI) and the International Council of Swedish Industry (NIR), in a summary of the report released on October 12.

Why has it failed?

Among the key factors undermining an effective and sustainable private sector are unequal access to economic resources, flawed public services and goods, the adverse security situation, and predatory government activity, said the researchers.

An Afghan farmer separates rice from grain chaff at his farm on the outskirts of Jalalabad on January 20, 2015 (Photo: Noorullah Shirzada/AFP/Getty Images)

Afghanistan's economy has a complex mix of informal, formal, illicit and aid-sustained elements

Afghanistan's economy is a complex mix of informal, formal, illicit and aid-sustained elements, with the private sector contributing a mere 10 to 12 percent to the country's official gross domestic product (GDP), according to SIPRI - a product of a decades-long mix of protracted conflict, low state capacity, foreign interference and external aid dependence.

Since 2002, foreign countries have poured vast sums of money into state-building and establishing democratic institutions in Afghanistan. The United States alone has spent about $100 billion in non-military funds to rebuild the country, according to US government data.

Other countries, too, have chipped in tens of billions of dollars in assistance. For instance, total foreign aid to Afghanistan in 2010 was estimated at around $15.7 billion - equivalent to 98 percent of GDP, according to the World Bank. But why didn't this translate into the development a strong private sector?

The authors of the newly published report argue that the introduction of formal market institutions following the ousting of the Taliban in 2001 has not decisively broken with preceding economic patterns, processes or players in the landlocked South Asian nation.

They say, for instance, that the administration of former President Hamid Karzai - who governed until 2014 - allowed the post-intervention conflict and aid economy to create new revenue channels for an existing and emerging oligopoly. "Lack of interest and incapacity by political authorities have resulted in weak formal economic institutions, largely unaccommodating economic policies and regulatory failure."

Moreover, neither government nor donors have been sufficiently focused on fostering key areas such as trade and transit, agriculture and the extractive industry, said the researchers, adding that during the first decade of international engagement the bulk of donor attention focused on security or on other developmental challenges. As a result, they added, critical infrastructure remains largely absent, particularly in rural Afghanistan - a factor that inhibits economic activity and integration.

A 'politicized' economy

In the absence of a free market with functioning state regulation, the oligopoly and local power holders have determined access to economic resources in many markets across the country.

This is why Alexey Yusupov, Director of the Afghanistan office of the German foundation Friedrich-Ebert-Stiftung (FES), argues that politics and policies in Afghanistan must be read - at least partially - through the lenses of private connections, both in terms of kinship and individual ties. "There is a symmetrical tendency of politics becoming privatized and big business becoming politicized," the expert told DW.

Yusupov argues that most of the private sector is still made up of large family companies and conglomerates of banks, hotels, air carriers and service providers. "The owners of these private companies have profited enormously from market interventions, preferential treatment and foreign funds. But they also take advantage of their political connections which are deeply ingrained in the fabric of Afghan society," said the FES analyst.

A difficult endeavor

In their report, the Sweden-based experts also expressed concerns about the high unemployment levels and the fact that informal institutions tend to, among other groups, marginalize women, who make up around half of the potential labor and entrepreneurial force. In fact, formal employment is extremely low in the country and has contributed to the current exodus of young Afghans, especially to neighboring countries and Europe.

Afghanistan Opferfest Eid al-Adha in Kabul

Maintaining a business in the conflict-ridden country is easier said than done, say experts

But maintaining a business in the conflict-ridden country is easier said than done, as Yusupov explained. "Business is often not stable and the capacity for medium-term planning is low. A bad year or a security-related incident such as extortion, racket, kidnapping of family members of employees can terminate an enterprise very quickly."

Moreover, production costs are high and even the simplest manufacturing or agricultural products are easier to import than to produce. "This means you mostly have trade and services as main activities, both of which are highly dependent on the security situation and trade on the relations with neighboring countries," the Afghanistan expert added.

Economy is 'deadlocked'

These constraints are compounded by extra-market conditions such as a deteriorating security situation, concerns over the national unity government's longevity and effectiveness, lingering and rampant corruption, and an external aid flows that distort the domestic marketplace.

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As a result, Afghan entrepreneurs who are able to run profitable businesses as well as avoid criminal pressure and governmental regulations, tend to take their money out of the country. "The majority of private entrepreneurs secure their profits in Dubai, buy property in Pakistan or Iran, keep their capital fluid and quickly moveable," said Yusupov.

The SIPRI study also pointed to the fact that given the country's informal and illicit economies - which account for 80 to 90 percent of total economic activity - and a weak fiscal regime, the government's ability to collect tax revenue and provide essential public services and goods is severely limited. "Consequently, the country's economy is largely deadlocked," said the authors of the study.

"This in turn erodes government legitimacy and hampers state-building efforts, including the creation of the conditions needed to stimulate economic growth. Indeed, the lack of suitable conditions for the private sector may even be driving anti-government sentiment," said the analysts, adding that, "Clearly, at its current capacity levels and in the present environment; the Afghan private sector cannot make use of the country's economic potential."

What next?

Abdullah Abdullah (R) and Ashraf Ghani Ahmadzai (Photo: Xinhua/Ahmad Massoud)

'At the end of the day, the key is the government,' says expert Michael Kugelman

Given the grim outlook, the authors of the report urge both national authorities and the international community to take a series of steps, which include curbing corruption, increasing investment in infrastructure critical to the economy, prioritizing women's full and equal participation in the workforce and developing strategic industries.

But Michael Kugelman, South Asia expert at the Washington-based Woodrow Wilson Center, stresses that while the key obstacles may be simple to identify, they are very difficult to do away with. "At the end of the day, the key is the government," he told DW.

Kugelman argues that the public sector needs to get more behind the private sector, in ways that involve scaling back government intrusion in markets and creating a more effective market environment. "None of this will be easy, and particularly as the security situation continues to worsen. But you can't expect constant and fruitful economic transactions - a key essential for the private sector - if the country's stability continues to worsen."

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