introduce new activities, products, and services is greater than in other markets, which highlights the scope for market diversification and the potential for positive impact (see Table 2).

# **3. Why is it hard to be a first-mover in fragile states?**

# **_Market conditions in fragile states pose additional barriers, relative to other countries_**

Firms require five things to enable them to operate at scale and grow. First, they need access to markets and the know-how to produce for those markets. Second, they need a business-friendly investment climate, encompassing policy and regulation (including the quality of implementation), and the provision of public services and infrastructure. Third, to finance their growth, firms need access to finance—both working capital (including trade finance) and long-term capital. Fourth, they need appropriately skilled workers that are available in sufficient numbers for the scale of production required. And lastly, firms require the management skill to combine capital, labor, finance, and technology to produce for the market. However, all these elements are disrupted by the forces of fragility.<sup>14</sup> First, fragility disrupts market access. Internally, conflict and intra-group mistrust reduces internal trade, shrinking the size of domestic markets. Since most fragile states are low income and many have low populations, the size of the internal market is an important constraint to private enterprise.

Externally, fragility inhibits the creation of international trade networks–counterparties are reluctant to trade and enter into financial relationships with counterparties in fragile states. International efforts to combat the financing of terrorism and prevent money laundering have increased the financial and reputational risks that international banks face in dealing with fragile states. Many opt to reduce their risk exposure by avoiding financial relationships with these states.<sup>15</sup> This also deters foreign direct investment (FDI) and other close commercial relationships, which are critical to the transfer of technology. Levels of FDI to fragile states are lower than to other states, and even more so when the FDI in extractive industries is excluded.<sup>16</sup> Second, fragile states typically have weak governments, with limited capacity to raise taxes and hire competent staff, both of which are needed for the provision of public services and infrastructure. Fragile states are clustered near the bottom of the _Doing Business_ rankings on regulatory quality and efficiency. Poor infrastructure - lag in the provision of power, roads, ports, - can potentially be addressed, but much of it, such as electricity generation and distribution is intrinsically political, and the business market for its services is small. Credible firms may balk at irreversible investments and so the actors that stand to make the greatest difference may be aid agencies rather than the DFIs.

As a result of such problems, a higher share of firms, and by extension pioneers in fragile and conflict-affected countries, operate in services, where infrastructure requirements are less

> 14 International Finance Corporation, 2019. 15 World Bank Group, 2017.

> 16 World Bank Group, 2018b.

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