Private Sector Development and Economic Growth:
Lessons from the U.S. Experience in Afghanistan

Afghanistan experienced double-digit growth in GDP, an increase in per-capita income in the first decade of reconstruction, and the robust expansion of certain key sectors. Reductions in growth resulting from the 2014 political and security transition, however, confirmed the lack of sustainability of an economy largely dependent upon the presence of international advisors and financial aid.

Uncertainty and insecurity discouraged economic activity, including domestic and foreign investment, trade expansion, and formalization of the informal economy. Corruption in Afghan government institutions, weak regulatory and contract enforcement mechanisms, and changing administrative and tax policies posed significant challenges for private sector growth. Moreover, private sector growth continued to be inhibited by limited access to factors of production, including land, capital, and labor, and by poor infrastructure.

Early investments in the foundational elements of the economic system enabled many of the successes that did take place and set the stage for future development. These necessary building blocks included the creation of the new currency, establishment of instruments for currency and exchange rate management, reform of tax and customs policies, agreements to avoid deficit spending, and establishment of an effective system for public financial management, along with institutional reforms and laws that reduce structural and procedural bottlenecks to private investment.

Afghanistan was not the post-conflict country it was labeled in 2001, and the positive trajectory of progress assumed did not anticipate the growth of an insurgency that kept the country in a state of insecurity and uncertainty. U.S. officials’ optimistic expectations of the pace and potential for progress did not always reflect the realities of the Afghan economy and the operating environment, nor the capacity constraints of both Afghan and U.S. institutions. This led to overly ambitious targets and unrealistically short timeframes for projects and results.

Afghanistan has not fully benefitted from trade given its environmental constraints, as well as the slow progress in increasing productivity, value, and removing barriers to competition. Infant industries, bureaucratic trade processes, poor physical infrastructure, and predatory or unfair trade practices by neighboring economies has hurt Afghanistan’s trade performance.

Afghanistan’s imports in 2017 outweighed its exports by a ratio of seven to one due to factors such as poor trade governance, institutional dysfunction, poor infrastructure, low productivity, low levels of human capital, and low value added.

Well-documented corruption, along with cumbersome administrative processes and uncertainty about government tax and other policies, continued to pose obstacles to investment, business expansion, and collection of revenues by the government. Fear of government regulatory and tax-collecting institutions reinforced Afghan firms’ historical inclination to stay informal and small rather than risk expanding, hampering both government revenues and private investment.

The influence exerted by the political economy networks established during several decades of conflict, war, and dislocation had significant negative effects on private sector development. Many of the business elite who dominated the Afghan market were strongly connected to political power, enabling them to access contracts, tax exemptions, trading security, and money-laundering channels.

The introduction of a market economy imposed a massive change on the Afghan government and society, which was accustomed to the state directing rather than stewarding economic activities, and was unprepared for the rapid transition. This new order was not welcomed by many in the Afghan civil service, leading to obstruction and derailment of initiatives intended to strengthen the enabling environment for business.

Due to a lack of understanding and uneven enforcement of market principles, the market economy was conflated with unfair competition, monopolization of markets by politically well-connected firms, unfair trade practices by regional neighbors, and administrative corruption. Because of its ambivalence toward the market economy, the Afghan government also had a hard time articulating and implementing an effective overall private sector development strategy.

Many recipients of grants and subsidized loans reported that they had helped them with their businesses. Some businesses came to expect continued financial and technical support, which led to the creation of dependencies. In cases of grants from donor projects, which were essentially “free money,” ambiguity, confusion, or false expectations were created. Some grants and technical assistance also ended up supporting businesses that were not commercially viable because their products or services were not in high demand or could not compete with cheap imports. These businesses survived only by obtaining support from other donor projects.

Civil-military coordination was made difficult by institutional and cultural differences. Personnel often had very different views of their own roles and missions, and lacked understanding of or confidence in the other’s expertise and capabilities. U.S. forces were also not accustomed to the distinct culture and priorities of the civilian development agencies responsible for private sector development.

Capacity and organizational constraints within U.S. institutions were often at odds with their program and overall objectives. The major human resource constraint was short tours of duty and the resulting staff turnover rates – which led to increasingly limited pools of qualified applicants, delayed activities, and a lack of continuity and institutional memory. There was also low institutional tolerance for risk that precluded allowing development personnel to leave their offices and bases to monitor projects and assess general conditions.

The U.S. and international community followed a core theory that economic growth would help reduce poverty, increase employment, and enhance overall well-being for the population, thus contributing to stability and security.

In large part due to contracting and management incentives, U.S. and other economic programs focused on outputs rather than outcomes, measuring success in the number of jobs created, regardless of their stability, and other discrete measurable outputs. There was no overarching mechanism for targeting endemic poverty.

An unrealistic view of what was possible in a conflict environment encouraged the setting of unrealistic goals, which in turn resulted in an inefficient use of resources on projects that did not deliver on their objectives. In retrospect, it was unrealistic to expect sustainable economic growth in an environment in which an insurgency and other forms of insecurity and uncertainty were increasingly present.

Institutional reforms and laws that reduce procedural bottlenecks to private investment and ensure property rights should be undertaken concurrently with these other foundational efforts.

The U.S. government sought to encourage the development of a robust, private sector-driven, open market economy with open external trade, with the Afghan government acting as a steward for the economy, rather than the lead. This was a sensible policy choice given the new Afghan state’s limited resources, the tradition of trade, and general economic principles. However, Afghanistan’s market economy was rolled out quickly and without adequate groundwork among key stakeholders, including mid-level officials and the citizenry. There was limited buy-in and no national consensus. Opposing interests within the bureaucracy and ambivalence toward the market economy resulted in a lack of effective overall private sector development strategy.

The U.S. government tried to spend too much money, too quickly in Afghanistan. It might have been more effective to have less money per year over the course of more years, and to relax the pressure to spend – the “burn rate” – as a metric for commitment, progress, or engagement. Doing so could have reduced opportunities for corruption and may have contributed to creating more confidence in the future, something that is often lacking in a post-conflict environment.

The technical and financial assistance provided to Afghan institutions and firms relied mainly on Western technocratic models that often failed to consider how powerful Afghan social groups and institutions influenced public policy and the functioning of markets.

Similarly, because of insufficient understanding of or interest in mitigating the networks of well-connected individuals, privatization of the state-owned enterprises failed to generate the investment in productive ventures that was the main rationale for privatization, it also fostered corruption by enabling the capture of resources by those individuals and allied government officials. The implicit toleration of corruption and often unintentional U.S. support for corrupt officials undermined support for private sector development initiatives from the Afghan population.

Private sector development cannot be seen as isolated from the development of the rule of law and good governance; they go hand in hand. Perhaps as much as the unstable political and security situation, weak and corrupt institutions were a source of uncertainty that discouraged economic activity.

Considering the significant physical and institutional challenges facing Afghanistan, as well as the high levels of uncertainty, the quick lowering of barriers to trade was likely to have some negative consequences.

A more flexible, pragmatic approach with greater allowances for promoting priority Afghan sectors might have allowed more competition and domestic production for the internal market, eventually allowing Afghanistan to become more open and able to compete in regional and global markets.

Grant and loan programs created disincentives for firms to borrow from market-based financial institutions. Grant programs also acted at times as “free money” for unprofitable enterprises, which then expected continued financial or technical support and led to firms making investment decisions that were not economically viable or sustainable.

Much of the U.S. enterprise-level support was not well-suited to the Afghan environment. Senior technical experts often lack expertise in Afghanistan or even in post-conflict or developing economies, and were unable to provide effective guidance and support.

Technical innovations had the potential to improve the efficiency of government institutions, but were insufficient by themselves to resolve the most fundamental constraint to private sector development: ensuring a reasonably facilitating, minimally corrupt, enabling environment.

While U.S. officials were in overall agreement on a private sector-led development model at the strategic level, different views at the more tactical and operational levels, combined with unclear mandates and competing institutions’ inter-and even intra-institutional rivalries, made it more difficult to translate that model into results.

Human resource policies, especially short tours of duty and security restrictions that limited mobility, impeded the ability of U.S. government personnel to implement and monitor projects, as well as constrained understanding of the environment and building relationships with local partners.

Assessing the effectiveness of private sector development support in generating economic growth, including whether that support led to increased stability, was extremely challenging.

Most private sector development-related monitoring and evaluation was tied to specific projects and did not capture the long-term or lagged impact, especially where there was a change in the contractor or NGO implementing an activity. This not only limited understanding of effectiveness, but also encouraged aid officials and implementing agencies to focus resources on only the outputs that could be counted within a project period.

In both the public and private sectors, the combination of available opportunities and the training and educational opportunities provided by the United States and its international partners led to increased human capital and institutional capacity. Capacity building was imperfect, but it yielded results. While individuals benefitted, the full, long-term return for Afghanistan awaits the establishment of peace and stability.

a. The interagency working group should include members from all agencies with a significant private sector development role and given a clear mandate.

The working group should comprise personnel from USAID, State, DOD, Commerce, Agriculture, Treasury, Trade and Development Agency, and other technical agencies, as appropriate. It should have a clear administrative mandate, with defined responsibilities and accountability mechanisms.

b. The interagency working group should reach consensus on the respective roles and responsibilities of civilian and military institutions in private sector development, as well as the role development plays in contingency operations.

If the military is going to have a CERP-like program, USAID or other development professionals should be formally incorporated into the planning and implementation of its activities.

c. The interagency working group should draw on existing analysis, supplemented by a rapid but in-depth assessment to outline a strategic approach to rebuilding the host nation economy, and to anticipate the likely impact of U.S. funds and material resources.

This approach would help to set realistic projections and evaluate the capacity of the host nation to absorb aid and other financial flows. Resisting the inevitable pressure to spend large amounts of money at the start of operations will pay dividends in higher-quality programming over time.

d. The interagency working group should draw from intelligence and other sources to understand the host nation’s political economy networks, and should use that information to make an informed decision regarding the tradeoffs and implications for who receives financial and other support.

Some of the anticompetitive and antisocial behavior in Afghanistan might have been reduced by not empowering strongmen, or at least by negotiating limits on them. At the same time, there will inevitably be unpalatable tradeoffs to achieve political and security aims.

e. The interagency working group should take the necessary steps to understand the host nation’s historical and social conditions and traditions, and to identify and mitigate possible areas of contention, resistance, and circumvention.

The adoption of conventional free markets or other principles should be tempered by the consideration of pragmatic and well-thought-out mechanisms that provide domestic firms a reasonably level playing field. Above all else, pragmatism toward long-term objectives and a realistic roadmap for moving toward a market economy, rather than adherence to ideology, should be the guiding principle.

USAID should eliminate or reduce its use of grants and below-market loans to enterprises, which set up perverse incentives and dependency. Instead, the agency should increase funding for market-oriented, flexible models, such as loan guarantees to private commercial banks.

As risk reduction is key to encouraging domestic and foreign investment in an uncertain post-conflict environment, USAID, State, DOD, and OPIC should more explicitly address the need to mitigate risk and uncertainty.

Where possible, USAID or other financing entities should partner with a local, established financial institution that has an understanding of local market dynamics, as well as the ability to assess and verify the eligibility of the borrower and regularly monitor performance.

The U.S. government should examine the veracity of these claims and, as appropriate, support the Afghan government in pursuing diplomacy, policies, and programs to mitigate them.

The U.S. government should support the Afghan government technically and diplomatically in its attempt to use WTO-allowed tariffs to promote domestic production for internal consumption and export in areas of comparative advantage and consistent with good economic policy.

The simple existence of laws and regulations is insufficient; it is how they are implemented by courts, government officials, and police that matters. Early attention to anticorruption is crucial; leaving it until later risks that it will become entrenched.

For projects that provide technical and financial support to key private sector development ministries, USAID should require proof that they have taken proactive measures to tackle corruption in taxes, certification, and other regulatory processes. All project staff should be held accountable for anticorruption measures within their projects.

International best practices need to be filtered, modified, and presented in accordance with local knowledge and perspectives. USAID and other agencies should support the development of material that reflects the unique constraints and opportunities of the recipient market. The desire for speed in implementation should not be an excuse to skip the sometimes time-consuming process of local consultation.

USAID should devise a framework for evaluation that allows the U.S. government to fully understand the long-term outcomes of projects and programs, allowing for the inherent lag in impact. It is impossible to evaluate impact at the end of a project when the ultimate impact may be several months or even years down the road. As a consequence, programming often focuses on outputs rather than outcomes.

USAID should be prepared to advocate for taking sufficient time to plan for rigorous monitoring and evaluation, which may be difficult at the start of an intervention when there is intense pressure to “do.” Finally, USAID should find technical solutions for cases where it is not able to physically monitor projects, rather than relying on third-party monitoring.

Current human resource policies acknowledge the personal stress of being posted in a conflict environment and attempt to mitigate this stress with short tour lengths; at the same time, however, it is widely accepted that short tours have an impact on effectiveness. In a complex contingency operation such as in Afghanistan, one-year tours of duty in the field are inadequate, especially at the senior level. Agencies should consider a 3- to 5-year period of commitment, additional regional and language study preparation time, and maintaining a pool of dedicated and experienced personnel using the “Afghan Hands” model.

For economic growth and private sector development initiatives that require long-term engagement, Congress may wish to consider creating a long-term fund. The fund would guarantee a predictable stream of support and potentially ease the pressure on the implementing agencies to spend quickly, which often led to inefficiency and waste, as well as assure recipient local institutions of an enduring source of support.