The African Economy

Policy, Institutions and the Future

Steve Kayizzi-Mugerwa

• Publisher: Taylor & Francis
• Year: 2002
• Print ISBN: 9780415183239
• eBook ISBN: 9781134672172
• Edition: 1
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

This book offers an in-depth analysis of the current state of the African economy and makes constructive suggestions about its future direction. The contributors argue that despite enduring challenges such as food security and employment creation, Africa faces a brighter future in sustainable growth provided that governance and policy- making are effectively employed to maintain peace, achieve greater regional collaboration and encourage private sector competitiveness.

1
INTRODUCTION

Steve Kayizzi-Mugerwa

Africa at the end of the twentieth century is in some ways quite different from when the century began or when, half-way through it, the struggles for independence were embarked on in the various countries. Its cities have expanded, modern communications have speeded up the acquisition of knowledge and conducting of business, and a sizeable elite enjoys a standard of living at par with any in the richer world. However, in terms of poverty, gross inequalities in resource distribution and disease, things have changed very little, and seem to have worsened in comparison with other regions. The century will thus have a mixed review: Africa achieved its independence from colonial powers, but its new leadership was often inadequate. Its poverty worsened even as more of its people acquired better education. Civil wars displaced vast populations, while diseases continued to ravage the rural areas and the cities. These plus a heavy debt burden and the policy conditionalities of the multilateral donor agencies have led to loss of economic and political self-determination.

Still, a number of evaluations concur on one issue, namely that the 1990s have witnessed a convergence of factors bound to have important implications for Africa’s future. The end of the Cold War reduced Africa’s strategic interest to the West, and seemed at first to unleash conflicts all over the continent, with some fearing the demise of the African nation state. This has also compelled African countries to seek their own solutions to economic and political problems in an unprecedented burst of activity referred to in some circles as an ‘African renaissance’. Countries seem to be on their way to transcending the era of structural adjustment, putting in place long-term strategies for development. Moreover, in the rapidly changing global economy, even developed countries are looking for new modes of co-operation with Africa based on mutual partnerships (African Development Bank 1997, Kifle et al. 1997, Kayizzi-Mugerwa 1998, Kayizzi-Mugerwa et al. 1998, Swedish Ministry of Foreign Affairs 1997).

What then are Africa’s economic policy priorities at the end of the decade? A statement made by twelve African leaders at the end of a regional meeting in Kampala, January 1998, to discuss economic development made the following list: ‘education and professional training, rural transformation, private sector development, the development of infrastructure, conflict prevention and resolution and public sector reform and good governance’ (PANA News, 26 January 1998).

The study is divided into three parts: Part I concentrates on policy issues, with a focus on credibility, reputation and learning. Part II looks at institutions in the broader sense, including the performance of the evolving social, political and macroeconomic structures. Part III looks at the future, in terms of political economy, the performance of agriculture, the environment– development nexus, and the implications of private sector expansion.

POLICY

Until recently, with the emergence of economic crisis, East Asia’s spectacularly rapid pace of development, with average growth rates of close to 10 per cent, made Africa’s modest recovery inconsequential by comparison. In the 1950s, Africa’s level of development was at par with those of countries like Malaysia, Indonesia and Taiwan. Today the two regions are in most respects incomparable. How do countries become tigers? That is, how do they sustain growth rates of 6– 10 per cent? In Chapter 2, ‘Looking for African tigers’, written before the Asian economic crisis, Arne Bigsten highlights some of the salient features of economic success.

Recent experience has shown, Bigsten argues, that many poor countries and regions have been able to close the gap between them and the rich countries, indicating a growth advantage to being relatively poor. The question then is why have the forces of convergence eluded Africa, even though it is capital-scarce, implying potentially high returns on investment? Three factors are identified: a high level of risk, including that related to policy reversal; high levels of aid inflows which have distorted the governments’ ability to signal their intentions; and the relatively poor human capital endowment that holds down the efficiency of investment.

Changing the policy stance is also important. Bigsten argues that inward orientation, characterised by trade restrictions, has been a major impediment to growth. More recently, however, countries that have pursued a more open stance have experienced rapid rates of growth. On the subject of governance, Bigsten argues that governments need to care about the incentive structures they put in place. The policies of price and exchange rate controls tilted incentives in favour of powerful groups in urban areas, and generally against the farmers in the countryside. Sidelining the majority explains the paucity of growth to a large extent.

Bigsten concludes that Africa’s problems are not immutable. Many countries are now importing much more than they export, thanks partly to the repatriation of flight capital. He also notes that the public in Africa is more vocal than before, while civil society has a real meaning in a growing number of countries. If these changes are supported by parallel ones in the political sphere, then Africa could embark on sustainable growth. This might not be at the speed of the tigers, but certainly at the more indigenous and steadier pace of the African elephant.

In Chapter 3, ‘Investment, macroeconomic policies and growth’, Kupukile Mlambo and Temitope Oshikoya develop further the themes introduced by Bigsten by looking more explicitly at factors influencing private investment in Africa. They show that while explanations advanced by the endogenous growth literature are persuasive, capital accumulation is of cardinal importance to growth. The general fragility of the growth process in Africa is blamed on the continent’s low rates of capital accumulation. Though comparable with those of East Asia in the 1960s and early 1970s, at about 20 per cent, African savings rates were less than 20 per cent in the 1990s, while those of East Asia were above 30 per cent. The evolution of investment rates has been largely similar. Failure to attract private foreign investment is especially marked. In the mid-1990s, Africa was able to attract only 5 per cent of the global capital inflows to developing countries.

Mlambo and Oshikoya then survey the empirical evidence. They argue that studies that have tried to establish a quantitative relationship between investment and output growth in Africa have yielded conflicting results. Mlambo and Oshikoya concur with Bigsten with regard to the important role of the policy environment. They argue that policy uncertainty is bad for investment. Since most investment is irreversible, investors will avoid making long-term commitments. Africa’s large foreign debt is also seen as a serious impediment to credibility. It constitutes a claim on the countries’ future income, and thus reduces the funds available for investment.

Mlambo and Oshikoya conclude that although earlier policy reforms lay the foundation for long-term growth, they do not constitute a sufficient condition for increased investment. It is important that African countries pursue a strategy that emphasises the pivotal role of the private sector in development, one supported by the public sector’s provision of an enabling business environment. This includes an adequate supply of infrastructure services, functioning legal institutions and an efficient financial sector.

In Chapter 4, ‘Aid and economic reform’, Howard White identifies the links between aid and the pace and extent of economic adjustment. He departs from the double paradox identified by Streeten (1987): if reforms are so beneficial why aren’t they carried out anyway, and why should countries be paid for implementing them? White argues that Streeten’s paradox is resolved if it is accepted that there are important mechanisms by which aid can facilitate the reform process.

White notes, however, that the fact of the failure of conditionality is not the same thing as saying donors should not finance reform. That the relative neglect of how it is that aid can support reform is one possible factor behind the general failure to do so. Evidence from the aid literature suggests that aid has a number of positive impacts on the reform process. For example, aid to support government expenditures is important in the early stages of reform, since the reform programme may require restraint of non-aid-financed expenditures. In the macroeconomic area, aid was crucial in bringing inflation down in countries like Zambia and Uganda, since it enabled an increased supply of imports. In Ghana, aid helped the country build up its foreign exchange reserves before the opening up of the foreign exchange market. It was also necessary for financing the poverty alleviation programme that helped reduce domestic discontent. White concludes that while aid is not sufficient to ensure reform, it is a necessary ingredient of the reform process.

In Chapter 5, ‘Aid-constrained trade reform in Kenya’, Jörgen Levin analyses the impact of trade reforms undertaken under donor conditionality. Though the Kenyan economy dominates the region, it has become increasingly difficult for it to make inroads in international markets. Trade policy reforms were initially resisted, but became inevitable following external shocks and an aid embargo in the early 1990s. A general equilibrium model is used to conduct policy and external shock experiments, under the assumption of a 50 per cent tariff reduction. The experiments include the impact of aid compensation of the revenue shortfall arising from the tariff reduction, terms of trade shocks with and without aid, and the impacts of increasing government expenditure with or without aid.

Levin argues that while the efficiency gains of lowering tariffs might appear small, there are a number of associated dynamic effects. Notably, important incentives are created for producers of tradables. Still, the increase in economic activity is not able to compensate fully for the loss of tariff revenue. Kenya’s example shows that while foreign aid inflows enabled a more gradual implementation of the new tariff structures, it had, via the appreciation of the exchange rate, serious costs in terms of delays to the reallocation of resources to tradable sectors.

Chapter 6, ‘Monetary policy effectiveness in Zambia’, by Abraham Mwenda, looks at the conduct of macroeconomic policy in Zambia in a period of economic liberalisation. From an insular and controlled economy, the country has in recent years made one of the more dramatic policy transformations in Africa. A key reform has been the switch from direct monetary instruments such as credit and interest rate controls to indirect ones, including open market operations. The current and capital accounts were liberalised and the Bank of Zambia became the key player in monetary policy, with the prime objective of inflation control.

In an empirical investigation, Mwenda analyses the impact that switching to indirect instruments has had on monetary policy effectiveness in reducing and stabilising the growth of money supply and inflation. This is done by checking for structural breaks in money supply behaviour and by trying to determine whether the change resulted in significant reductions in the growth and stability of broad money supply and inflation.

Mwenda concludes that indirect monetary control brought about significant reductions in inflation, accompanied by a reduction in the variability of both money supply and inflation. However, there was a general failure to meet targets. This was due to weak fiscal controls, especially failure to implement a cash budget. Other demands, including the need to service foreign debt and to accumulate reserves, negatively affected the value of the kwacha. To succeed, indirect monetary control must be accompanied by well designed measures to address problems related to slow learning and system inefficiencies.

Chapter 7, ‘Minimum wages and trade regimes: CGE results for Zimbabwe’, by Ramos Mabugu and Margaret Chitiga, looks at the impact of minimum-wage legislation under changing trade regimes. The authors conduct simulations by assuming a 5 per cent increase in the minimum wage under foreign exchange controls and a liberalised regime, representing roughly the experience of the country. Not unexpectedly, this reduces the employment of unskilled workers across the board, as sectoral production costs go up. The decline is compensated somewhat by higher demand for food and services, sectors which are relatively low skill intensive. However, higher unskilled wages are partly at the expense of skilled wages. The impact on the tradable sector is also negative. In the liberalised regime, the sectoral impacts, though negative, are milder.

Mabugu and Chitiga conclude that while trade reforms are expected to benefit export-oriented sectors, by reallocating labour from the importable sector, this outcome has not materialised in Zimbabwe. Except for mining, all sectors have seen reductions in employment levels. It may well be that labour market distortions have been more serious than anticipated.

INSTITUTIONS

Part II of the book focuses on the economic and political aspects of African institutions. African institutions range from the Pan-African and regional institutions that governments have tried to set up over the decades to rural based non-government organisations with a fairly limited and localised development agenda such as savings clubs. Among the lessons of structural adjustment are that policy efforts undertaken within a weak institutional framework are bound to achieve very little and that economic policies cannot make much headway if they neglect politics.

In Chapter 8 Victor Murinde discusses ‘Financial institutions and the mobilisation of resources for development’. He argues that there is considerable scope for capital mobilisation within domestic markets but that this has not been easy to do in the past owing to the excessive controls under which the financial sector has had to operate. Central banks became mere appendages of government, failed to innovate, and their regulation and supervision of the banking system and the rest of the financial sector remained poor.

Murinde notes further that in addition to commercial banks, there is a need for the development of several other types of banks in order to expand services to areas such as merchant and investment banking, as well as venture capital financing. He also argues that financial dualism should be reduced by extending banking services to the countryside and helping to upgrade the informal services offered in the rural and urban areas. Looking at the development of financial institutions, Murinde expresses some pessimism regarding the efficacy of stock markets in delivering long-term financing for development. Still, he sees them as important in the revitalisation of the African economies, especially if done at the regional level. Similarly, the creation of supranational institutions such as regional central banks with a mandate to effect policy will be important in establishing credibility.

In Chapter 9, ‘Institutions and rural development in Uganda’, John Ddumba-Ssentamu focuses on rural institutions. Many African governments have identified rural development as their main policy concern. However, many years after independence the rural areas in Uganda remain undeveloped, with a critical shortage of modern services. Ddumba-Ssentamu argues that the slow progress is to be blamed on the lack of an adequate institutional framework. The long years of economic chaos in Uganda aggravated the situation by destroying infrastructure and rural markets, interrupting the introduction of new techniques.

Non-governmental organisations have increased activities to fill the gap left by the public sector. However, NGOs have sometimes been unable to meet the farmers’ requirements, partly owing to shortage of resources and partly owing to poor knowledge transfer. Ddumba-Ssentamu concludes that it is important for rural dwellers to take part in the policies that influence them. In Chapter 10, ‘Building African institutions: learning from South Asia’, Mariam S. Pal discusses the important issue of whether Africa can learn from the successful grass-roots institutions for credit lending and development pioneered in Bangladesh. She argues that a south–south transfer of knowledge and ideas might be far superior to the more traditional north– south transfer of ideas for development.

Pal argues that since much of the Grameen Bank’s approach is steeped in Bangladeshi culture, it is necessary to identify an ‘essential Grameen’, that is, the basic elements of the model which could be replicated. This includes a strict focus on low-income groups, compulsory regular savings, strong emphasis on training for members and bank staff, homogeneous group formation and integration of a socio-economic development agenda with banking for the poor. Pal then provides examples of the application of the Grameen model in Malawi and Burkina Faso. Pal concludes that, to succeed, the Grameen approach should be targeted to the poor, credit non-availability must be serious, and women must constitute an important proportion of the beneficiaries. Furthermore, financial sustainability must be a declared objective of the lending effort.

In Chapter 11, ‘Market power and productivity in Zimbabwean manufacturing’, Kupukile Mlambo and Thomas Sterner analyse the evolution of factor productivity in the presence of market power. In the course of a long international embargo, Zimbabwean industry acquired a degree of diversity via policies of import substitution. Indeed by 1982 the country was said to be on the road to industrialisation, with manufacturing accounting for 25 per cent of GDP. However, the resulting industrial structures were both monopolistic and oligopolistic. This continued to be the case well into the late 1980s.

Using a translog function to model variable costs and thereby calculate price–cost mark-ups, Mlambo and Sterner argue that the latter are significant across the sub-sectors of manufacturing. Total factor productivity was decomposed into the technical change effect, the returns to scale effect, and the price–cost margin effect. It was found that the productivity increases in some sectors were highly illusory since they were merely the effects of increased concentration. There are bound to be sharp profit declines as the cutting edge of competition sharpens.

In Chapter 12, ‘Regionalism in African development’, Peter Kimuyu looks at the rationale for regional co-operation in Africa and looks at reasons why outcomes have fallen short of expectations. In the expanding global economy, there is a fear that African countries may fail to benefit from the emerging configurations. Since they are individually weak, it is important that they establish viable regional co-operation to help them meet the challenges ahead.

Kimuyu argues that while theory predicts substantial benefits from regional co-operation, African attempts have failed because political motives have tended to o...

Table of contents

• Cover Page
• Half Title page
• Title Page
• Copyright Page
• Dedication
• Contents
• Figures
• Tables
• List of Contributors
• Preface
• Introduction
• Part I Policy
• Part II Institutions
• Part III The Future
• Index