NOTE NUMBER 280

privatesector
P U B L I C P O L I C Y F O R T H E
NOVEMBER 2004

Anarchy and Invention

Tatiana Nenova and How Does Somalia’s Private Sector Cope without Government?
Tim Harford
S o m a l i a h a s l a c ke d a re c og n i ze d g ove r n m e n t s i n c e 1 9 9 1 — a n u n u s u a l l y
Tatiana Nenova
l o n g t i m e . I n ex t re m e l y d i f f i c u l t c o n d i t i o n s t h e p r i vat e s e c t o r h a s
([email protected])
is an economist for the d e m o n s t r at e d i t s m u c h - va u n t e d c a p a b i l i t y t o m a ke d o. To c o p e w i t h
joint World Bank–
t h e a b s e n c e o f t h e r u l e o f l aw, p r i vat e e n t e r p r i s e s h ave b e e n u s i n g
T H E W O R L D B A N K G R O U P PRIVATE SECTOR DEVELOPMENT VICE PRESIDENCY

International Finance
Corporation Corporate f o re i g n j u r i s d i c t i o n s o r i n s t i t u t i o n s t o h e l p w i t h s o m e t a s k s ,
Governance Department. o p e r at i n g w i t h i n n e t wo r k s o f t r u s t t o s t re n g t h e n p ro p e r t y r i g h t s , a n d
Tim Harford (tharford@
ifc.org) is an economist
s i m p l i f y i n g t r a n s a c t i o n s u n t i l t h ey re q u i re n e i t h e r. S o m a l i a ’s p r i vat e
for the World Bank and s e c t o r ex p e r i e n c e s u g g e s t s t h at i t m ay b e e a s i e r t h a n i s c o m m o n l y
International Finance
t h o u g h t f o r b a s i c s y s t e m s o f f i n a n c e a n d s o m e i n f r a s t r u c t u re s e r v i c e s
Corporation.
t o f u n c t i o n w h e re g ove r n m e n t i s ex t re m e l y we a k o r a b s e n t .
Somalia is the quintessential failed state. After cation, a cross-border financial system—does
the autocratic regime of Siad Barre fell in 1991, the state seem to be sorely missed. But even here
the country collapsed into civil war. Peace has the private sector has developed creative
been established in some regions, but Somalia approaches that partially substitute for effective
has only a limited government in the Northwest government. As a result, Somalia boasts lower
and no recognized government in the South. In rates of extreme poverty and, in some cases, bet-
these circumstances the private sector has been ter infrastructure than richer countries in Africa
surprisingly innovative. Competition thrives in (table 1).
markets where transactions are simple, such as
retail and construction. In more complex sec- Private firms make do
tors, such as telecommunications and electricity Somali entrepreneurs have used three methods
supply, the private solutions are flawed but to compensate for the lack of effective govern-
impressive: coverage has expanded since the ment regulation (table 2). First, “importing gov-
1980s, and prices are attractive compared with ernance” by relying on foreign institutions—for
those in other African countries. example, for airline safety, currency stability,
Only when it comes to public goods or to pri- and company law. Second, using clans and
vate goods with strong spillover effects—roads, other local networks of trust to help with con-
monetary stability, a legal system, primary edu- tract enforcement, payment, and transmission
A N A R C H Y A N D I N V E N T I O N HOW DOES SOMALIA’S PRIVATE SECTOR COPE WITHOUT GOVERNMENT?

Table Selected development indicators for Somalia and comparator economies

1 Indicator
Per capita household income (US$), 2002
Somalia
226
West Africaa
501
Neighboring
countriesb
438
Gini coefficient, 1997c 40 45 47
Population living on less than PPP$1 a day (percent), 1998d 43 50 52
Roads (thousands of kilometers per million people), 1997 3 3 3
Telephones (per 1,000 people), 2002 15 9 10
2 Population with access to safe water (percent), 2000 21 59 60
Adult illiteracy rate (percent), 2003 81 49 35

a. Benin, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Republic of Congo, Democratic Republic of Congo, Côte d’Ivoire, Gabon, The Gambia, Ghana,
Guinea, Guinea-Bissau, Liberia, Mali, Mauritania, Niger, Nigeria, Senegal, Sierra Leone, and Togo.
b. Djibouti, Ethiopia, and Kenya.
c. The Gini coefficient ranges from 0 (perfect equality) to 100 (perfect inequality).
d. PPP dollars are U.S. dollars adjusted for purchasing power parity.
Source: World Bank, World Development Indicators database.

of funds. Third, simplifying transactions until Water: access but not cheap or safe
they can be carried out with help from neither Public water provision is limited to urban areas, but
the clan nor the international economy. a private system extends to all parts of the country
as entrepreneurs build cement catchments, drill
Telecommunications: networks link up private boreholes, or ship water from public sys-
Many local companies have teamed up with tems in the cities. Prices naturally rise in times of
international giants such as Sprint (U.S.) and drought. Traditionally, destitute families have not
Telenor (Norway), providing mobile phones had to pay for water, while the slightly better-off
and building new landlines. Vigorous competi- borrow funds from relatives. Nevertheless, after sev-
tion has pushed prices well below typical levels eral years of drought the United Nations estimates
in Africa, and Somalia now has 112,000 fixed that many families in the Eastern Sanaag have debts
lines and 50,000 mobile subscribers, up from of US$50–100 for water. Moreover, access to safe
17,000 lines before 1991. Yet not all is well. water is low even by African standards because nei-
Calling every phone subscriber in Hargeisa, in ther regulators nor the market have been able to
the Northwest, would require connections from persuade merchants to purify their water.
four telephone firms. But firms in Mogadishu
have now agreed on interconnection standards, Air travel: outsourcing safety
and those in Hargeisa appear to be following In 1989 the national carrier (partly owned by
suit. The negotiations were brokered by the Alitalia) operated just one airplane and one inter-
Somali Telecom Association, set up with the national route.2 Today the sector boasts about 15
help of the United Nations and International firms, more than 60 aircraft, 6 international des-
Telecommunication Union (ITU) and head- tinations, more domestic routes, and many more
quartered in Dubai.1 flights. But safety is a concern. Airports lack
trained air traffic controllers, fire services, runway
Electricity: simple solutions yield results lights, and a sealed perimeter against stray ani-
Entrepreneurs have worked around Somalia’s mals, and checks on aircraft and crew are inade-
lack of a functioning electricity grid, payment quate. The makeshift solution: international
systems, and metering. They have divided cities outsourcing. Somali carriers lease planes, often
into manageable quarters and provide electric- with crews from Eastern Europe (the largest,
ity locally using secondhand generators bought Daallo Airlines, leases a Boeing from the United
in Dubai. They offer households a menu of Kingdom, to boost customer confidence). And
choices (daytime, evening, or 24-hour service) they operate out of Djibouti, Dubai, and Nairobi,
and charge per lightbulb. using the facilities there to check aircraft safety.
Private courts: quick but limited U.S. dollars are harder to forge, do not need to
A recent effort to endow Mogadishu with a func- be carried around in large fragile bundles, and,
tioning court collapsed when the court tried to most important, retain their value. The feeble
levy taxes and take over the privately run port of capabilities of the central bank have allowed free
El Ma’an. In any case Somalia lacks contract law, entry into the currency exchange business,
company law, the concept of limited liability, which is as close to perfectly competitive as is
and other key pillars of commercial law. In some ever likely to be possible.
cases Somalis have used offshore registration of
businesses to import legal concepts and services. International fund transfers: hawala system
3
More commonly, disputes are settled at the clan The hawala system, a trust-based money transfer
level, by traditional systems run by elders and system used in many Muslim countries, moves
with the clan collecting damages. US$0.5–1 billion into Somalia every year. A per-
Such measures are free—and fast by interna- son in New York wishing to send money to his
tional standards. In a case involving the oppres- family in Tog-waajale gives the hawala agent in
sion of minority shareholders in a large livestock New York the sum in cash, paying a 5 percent
company, out-of-court talks were preferred, the commission. The agent deposits the cash in a
company continued to operate successfully, and local bank account to be transferred to the com-
the dispute was settled amicably. But clan-based pany bank account in Djibouti or Dubai, then
systems deal poorly with disputes outside the alerts the clearinghouse in Hargeisa, which
clan. In a dispute involving the telecommunica- passes details on to Tog-waajale. When the recip-
tions company Aerolite, the interclan commit- ient shows up, the local agent quizzes him about
tee of elders awarded the plaintiff from a weaker his clan lineage using questions provided by the
clan an unfairly small settlement, and since it relative overseas as security against fraud. The
was not enforced, he received nothing. transaction is usually completed within 24 hours.
Hawala networks are unregulated and do not
Currency: perfect competition for dollars always keep records of transactions, but they are
Sharp inflation in 1994–96 and 2000–01 coming under pressure from efforts to combat
destroyed confidence in three local currencies. money laundering.3

Table Private sector coping strategies in Somalia

2 Strategy and application

Importing governance
Telecommunications
Example

Somali Telecom Association, set up with help of United Nations and ITU and headquartered in
Dubai, supports interconnection.
Finance Hawala system uses financial infrastructure outside Somalia for money transfers. Hajj traveler’s
checks written with Saudi banks.
Air safety Planes operate out of foreign airports and are checked there. Planes and crews are leased
from international suppliers.
Legal system Companies are often registered offshore.
Monetary stability Economy is de facto dollarized.
Using clan systems
Savings and insurance Rotating credit associations use clan links to convene and enforce.
Social insurance By tradition, destitute families do not pay for water. Families and clans extend credit to
others to pay for water during droughts.
Legal system Clan elders arbitrate disputes. System is less effective in cross-clan disputes but still used.
Simplifying transactions
Electricity and telecommunications Entrepreneurs divide up cities into manageable chunks and use flat tariffs (such as per light-
bulb) for electricity.
Finance Quiz on clan relationships used in place of sophisticated security.
A N A R C H Y A N D I N V E N T I O N HOW DOES SOMALIA’S PRIVATE SECTOR COPE WITHOUT GOVERNMENT?

Savings accounts and traveler’s checks failing. Government schools are of lower quality
Somalia has adopted the widespread African than private schools. Subsidized power is being
institution of rotating credit associations, which supplied not to the rural areas that need it but
rely on clan links for enforcement and provide to urban areas, hurting a well-functioning pri-
a safe haven for savings. More innovative is the vate industry. Road tolls are not spent on roads.
system of traveler’s checks for the pilgrimage to Judges seem more interested in grabbing power
viewpoint
Mecca, or hajj. Nobody would accept Somali than in developing laws and courts.
checks, so Somali firms set up accounts in Saudi A more productive role for government
is an open forum to
banks and write checks to pilgrims that can be would be to build on the strengths of the private
encourage dissemination of
cashed in any branch. sector. Given Somali reliance on clan and repu-
public policy innovations for
tation, any measures allowing these mechanisms private sector–led and
Gaps in private sector provision to function more broadly would be welcome; market-based solutions for
In some areas the private sector has made little credit and land registries would be a good start. development. The views
progress. The Somali road system, for example, And since Somali businesses rely heavily on insti- published are those of the
is limited and in poor condition. For a private tutions outside the economy, international and authors and should not be
supplier to build a road and collect fees to cover domestic policies supporting such connections attributed to the World
the costs is apparently too hard, partly because would help. Bank or any other affiliated
of prohibitive transaction costs and partly For governments and aid agencies, the capa- organizations. Nor do any of
because fee-paying users are not the only ones bility of some business sectors to cope under the the conclusions represent
who benefit from roads. most difficult conditions should give hope and official policy of the World
Primary education is another disappointing guidance in other reconstruction efforts. It may Bank or of its Executive
story. Some 71 percent of primary schools are take less encouragement than is commonly Directors or the countries
privately owned (typically by parents or com- thought for stripped-down systems of finance, they represent.

munities), but enrollment is just 17 percent. By electricity, and telecommunications to grow.

contrast, it is 82 percent in West Africa, where To order additional copies

countries are richer and more stable and the contact Suzanne Smith,

government is much more heavily involved in managing editor,

Room F 4K-206,
the economy. Notes
The World Bank,
Ideally, benevolent government would sort 1. “Somalia Telecoms Boom without Government,”
1818 H Street, NW,
out both problems. But government that is Somaliland Times, July 22, 2004.
Washington, DC 20433.
merely stronger might not help. Where munici- 2. United States Institute for Peace, Removing
pal governments along the Berbera–Hargeisa Barricades in Somalia: Prospects for Peace (Washington, D.C.,
Telephone:
road have the power to collect tolls, they do not 1998).
001 202 458 7281
spend them on maintenance. The failings of the 3. Abdusalam Omer, “Supporting System and
Fax:
education system are partly because half of Procedures for the Effective Regulation and Monitoring of
001 202 522 3480
Somalis are nomads. It is not clear that govern- Somali Remittance Companies (Hawala)” (United
Email:
ment would do much better, especially since the Nations Development Programme, Nairobi, 2003).
[email protected]
private schools are locally acknowledged to be
superior to those run by local government. Produced by Grammarians,
Rather than try to create a government system Inc.
from scratch, a better policy would be to
improve the network of higher-quality private Printed on recycled paper
schools.

Conclusion
The achievements of the Somali private sector
form a surprisingly long list. Where the private
sector has failed—the list is long here too—
there is a clear role for government interven-
tions. But most such interventions appear to be
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