State Fragility, Business, and Economic Performance

The inability of states to perform for the benefit of their populations has been a matter of concern for citizens and the wider community. The case of fragile states that are in crisis and lag in social and economic development has created a real sense of urgency to find constructive ways to improve the situation. In 2023, more than 100 million people are on the run from conflict and crisis (UNHCR, 2023). Armed conflict is pushing a growing minority of the global population into a deeper crisis. For example, the armed conflicts in Ethiopia and Somalia have resulted in untold suffering and hardship for millions of people. It destroyed lives and livelihoods, devastated infrastructure, and disrupted international supply chains and trade. Conflict and instability have led to limited aggregate supply and skyrocketing inflation in food and fuel prices.

Recognizing and accommodating diverse ethnic, religious, and language identities has become the new feature of twenty-first-century politics. In many parts of the world, people are mobilizing around old grievances involving ethnic, religious, or cultural identities and demanding acknowledgment and recognition by a wider society. They are protesting discrimination, marginalization from social and economic opportunities, and demanding social justice. Political scholars and leaders have long argued against explicit recognition of cultural identities because they pose threats to social harmony. Effective constitutions have two basic elements: A system of government with a set of institutions to make and implement laws and policies and people’s shared acceptance that the constitution is authoritative. Authoritarian constitutions are window dressing that provide lip service to the rule of law and other fundamental freedoms without the intention to enforce them.

Institutions are a set of formal and informal rules governing the actions of individuals and organizations as well as the interaction of participants in the development process. Formal institutions include laws, regulations, and rules that establish the basis for production, exchange, and distribution. An important explanation for state fragility is the state’s incompetence in economic management and lack of administrative capacity to translate goals into resource allocation. It could also mean that commitments for resource allocation are not credible. In many fragile states, conflict leads to institutional voids and people engage in novel and informal partnerships to compensate for these institutional gaps. Existing institutions become inefficient and fragmentary, and people must work together to fill these organizational gaps.

State fragility causes severe development challenges due to weak institutional capacity, poor governance, conflict, and political instability. When states fail, population is displaced, human capital is depleted, and the nation’s aggregate production and per capita incomes decline. For example, while GDP growth in low-income countries averaged 2.35% (2018–2021), fragile states registered a mere 0.8% during the same period. In the context of many African countries, fragility and conflict have been a major impediment to reducing poverty. The probability of being poor largely depends on whether you are born in a fragile state or not. By 2030, while 78% of non-fragile states come close to achieving the goal of ending extreme poverty, only 19% of fragile states are expected to achieve that goal (Baier, Kristensen & Davidsen, Poverty and fragility: Where will the poor live in 2030? In Future development, Brookings, 2021). Increased poverty further elevates the risk of conflict leading to a self-reinforcing trend (fragility trap) that keeps countries away from political stability and any hope of reducing poverty.

Industrialization is a process of social and economic change that transforms society from an agrarian economy to that based on the application of modern technology (Ocampo in: O’Connor and Kjollerstrom (eds) Industrial Development for the Twenty-First Century, Zed books, London, 2008; Tregenna in: Szirmai, Naude, and Alcorta (eds) In Pathways to Industrialization in the Twenty-First Century: New Challenges and Emerging Paradigms, Oxford University Press, London, 2013). Even though the industrial sector includes manufacturing, mining, and construction, it is largely associated with manufacturing. Since the industrial revolution, manufacturing has driven output and employment due to improvements in mechanization. Manufacturing is an important engine of economic growth and structural transformation. It enables a shift in resources from low-productivity activities such as rural agriculture and informal services to activities that increase productivity and output, largely due to improvements in the division of labor and changes in technology (Kaldor, Causes of the slow rate of economic growth of the United Kingdom: An inaugural lecture, Cambridge University Press, 1966; Ocampo, The quest for dynamic efficiency: Structural dynamics and economic growth in developing countries. In Beyond reforms: Structural dynamics and macroeconomic vulnerability, Stanford University Press, 2005). High-productivity jobs are often associated with higher wages (Weiss, Industrial policy in the twenty-first century: Challenges for the future. In A. Szirmai, W. Naude, amp; L. Alcorta (Eds.), Pathways to industrialization in the twenty-first century: New challenges and emerging paradigms. Oxford University Press, 2013). Manufacturing also has positive ramifications on the rest of the economy by stimulating demand for primary goods and services (trade, finance, transportation). Moreover, it generates externalities in technology development, skill formation, and learning that enhance the economy’s overall competitiveness. Fragile states have weak productive capacities and tend to produce and export standard products with limited diversity and sophistication. For example, in livestock products, African countries export low-value-added products such as live animals, leather and hides (18 billion USD in 2012) while importing processed and high-value-added content such as dairy, prepared edible products (99 billion USD in 2012) (Yameogo et al., Food Policy, 49, 2014). Their chances of participating in global value chain activities are partly limited by a weak enabling environment, and a feeble private sector.

Entrepreneurship is an activity that results from the perception of a business opportunity and subsequent creation of an organization to pursue it. Agents of entrepreneurship (individual entrepreneurs or firms) make difficult or complex decisions about the allocation of resources in an environment of uncertainty (Bygrave and Zacharakis, Entrepreneurship, John Wiley & Sons, 2010). The coordination of these resources (often achieved through innovation) gives rise to new products, processes, markets, business models, or services. Innovation is an essential ingredient for successful entrepreneurship. In fragile states, the business sector often operates in an institutional vacuum where governments lack the ability to make or enforce rules. Markets find it difficult to effectively function in an environment of persistent disruption and disorder. Firms maybe afraid of putting too much capital at risk and shift the composition of their assets from fixed capital stocks to more liquid ones. In most fragile states, there is limited access to external financing and entrepreneurs have to rely on internally generated funds to commence or expand their businesses. Ethiopia is a factor-driven economy with a) low rates of entrepreneurship activity, b) high proportion of opportunity-driven entrepreneurs, and c) low youth participation rates. Entrepreneurs face rigid bureaucratic conditions, political and economic instability, corruption, lack of access to credit, and underdeveloped infrastructure. In many countries, private sector investment is crowded out by the public sector and has limited access to credit or foreign exchange. Services now account for an increasing share of GDP in most fragile states and appear to be the future path to growth.

Trade is essential for maintaining a dynamic economy. It enables the acquisition of quality goods, and services that are either not available at home or not available at competitive prices. Companies also learn about advanced technical methods used abroad. Besides providing consumers with a variety of goods and services, trade increases incomes and employment. Case studies reviewing the experience of the twelve most rapidly growing countries over the past few decades show the important contribution of trade in raising employment and incomes. Fragile states account for about 2% of global trade and tend to depend on the export of a limited number of commodities (subject to high price volatility) for their foreign exchange revenues: oil and minerals, agricultural products, and low skill manufactures and services. Net food imports constitute a higher percentage of their economy. They are vulnerable to changes in trade due to their limited diversification. Changes associated with trade can contribute to conflict in several ways. High export prices for oils, minerals, and similar commodities can raise the risk of conflict by creating an incentive to appropriate rising revenues through fighting (it provides the means to finance conflict). A ten percent increase in the price of oil or minerals is likely to raise the number of conflict events by two percent. It is important to realize that the effect of commodity prices on conflict varies by the type of commodity. A rise in the price of certain commodities such as oil, minerals that are valuable, capital-intensive, geographically concentrated, and subject to easier appropriation can increase conflict, while increases in the price of agricultural commodities, livestock (labor-intensive, produced over wide areas, difficult to control) can reduce conflict by raising the opportunity cost participating in a rebellion.

Technology is the practical application of sciences to industry or commerce and requires some specialized expertise to address a particular need. Technology and the process of industrialization bring about social and economic integration as people from different areas and backgrounds collectively engage in productive activities that require teamwork and collaboration. Technological progress occurs according to the laws of natural selection whereby new technologies replace older ones and new, efficient, and better products substitute for mature ones. The winners are those firms that produce competitive products that meet the expectations of the market. Developing countries must pursue technology policies that contribute to enhancing domestic technological capability. Key indicators of science and technology investments include scientific publications, R&D expenditures, patent filings, and venture capital deals. Innovations rooted in developing countries have the advantage of fitting the specific needs of low-income consumers and can result in higher demand in local and foreign markets. Such innovations can support the development of low-income countries and hasten the speed of industrialization and catch-up. However, at present, many countries face the twin dilemmas of unsupportive government policies and less focused/less knowledgeable firms on/about innovation.

Over the last few decades, several East Asian countries have recorded very high rates of growth and managed to improve the quality of lives of millions of people. There has never been such a fast expansion in economic growth within a reasonably short period of time. This is often described as the “East Asian Miracle” because socioeconomic development that took advanced countries centuries was achieved within a generation. Even though the East Asian miracle is associated with the four tigers: Hong Kong, China, S. Korea, Singapore, and Taiwan, other countries in the region such as China and Malaysia have also joined the group. During the past four decades, China achieved spectacular growth that helped lift over 700 million people out of poverty.