From Crisis to Growth in Africa

From Crisis to Growth in Africa?

This book is concerned with the problem of achieving sustained economic growth in a number of African countries. The contributors analyse the development and assess the future prospects of thirteen countries, almost all of which have gone through a structural adjustment programme designed to remove the imperfections that make it difficult for the market system to work in an optimal fashion. The thirteen countries examined are divided into three groups:




the war-stricken economies: Angola, Guinea-Bissau, Ethiopia and Eritrea the reform strugglers: Kenya, Cape Verde, Zambia, Tanzania, Mozambique and Zimbabwe the growth seekers: Uganda, South Africa and Lesotho.

This work spans the areas of development economics, growth theory, development studies, African studies, economic history and political economy. Scholars and policy makers working in any of these areas will find it a valuable resource. Mats Lundahl is Professor of Development Economics at the Stockholm School of Economics. His previous publications with Routledge include Peasants and Religion (2000), New Directions in Development Economics (1996), Economic Crisis in Africa (1993), Markets or Politics? Essays on Haitian Underdevelopment (1992) and Agrarian Society in History (1990).

Routledge studies in development economics

1 Economic Development in the Middle East Rodney Wilson 2 Monetary and Financial Policies in Developing Countries Growth and stablization Akhtar Hossain and Anis Chowdhury

7 The South African Economy Macroeconomic prospects for the medium term Finn Tarp and Peter Brixen 8 Public Sector Pay and Adjustment Lessons from five countries Edited by Christopher Colclough

3 New Directions in Development Economics Growth, environmental concerns and government in the 1990s Edited by Mats Lundahl and Benno J. Ndulu

9 Europe and Economic Reform in Africa Structural adjustment and economic diplomacy Obed O. Mailafia

4 Financial Liberalization and Investment Kanhaya L. Gupta and Robert Lensink

10 Post-apartheid Southern Africa Economic challenges and policies for the future Edited by Lennart Petersson

5 Liberalization in the Developing World Institutional and economic changes in Latin America, Africa and Asia Edited by Alex E. Fernández Jilberto and André Mommen

11 Financial Integration and Development Liberalization and reform in subSaharan Africa Ernest Aryeetey and Machiko Nissanke

6 Financial Development and Economic Growth Theory and experiences from developing countries Edited by Niels Hermes and Robert Lensink

12 Regionalization and Globalization in the Modern World Economy Perspectives on the Third World and transitional economies Edited by Alex F. Fernández Jilberto and André Mommen

13 The African Economy Policy, institutions and the future Steve Kayizzi-Mugerwa

19 Finance and Trade in Developing Countries Edited by Rohinton Medhora

14 Recovery from Armed Conflict in Developing Countries Edited by Geoff Harris

20 Contemporary Issues in Development Economics Edited by B. N. Ghosh

15 Small Enterprises and Economic Development The dynamics of micro and small enterprises Carl Liedholm and Donald C. Mead 16 The World Bank New agendas in a changing world Michelle Miller-Adams 17 Development Policy in the TwentyFirst Century Beyond the Post-Washington Consensus Ben Fine, Costas Lapavitsas and Jonathan Pincus 18 State-Owned Enterprises in the Middle East and North Africa Privatization, performance and reform Edited by Merih Celasun

21 Mexico Beyond NAFTA Edited by Martín Puchet Anyul and Lionello F. Punzo 22 Economies in Transition A guide to China, Cuba, Mongolia, North Korea and Vietnam at the turn of the twenty-first century Ian Jeffries 23 Population, Economic Growth and Agriculture in Less Developed Countries Nadia Cuffaro 24 From Crisis to Growth in Africa? Edited by Mats Lundahl

From Crisis to Growth in Africa? Edited by Mats Lundahl

London and New York

First published 2001 by Routledge 11 New Fetter Lane, London EC4P 4EE Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Routledge is an imprint of the Taylor & Francis Group This edition published in the Taylor and Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 2001 Editorial selection and material, Mats Lundahl; individual chapters, the respective contributors All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication Data From crisis to growth in Africa? / edited by Mats Lundahl. p. cm. “Essays … presented at the conference ‘From crisis to growth in Africa?’ at the Stockholm School of Economics on 7–8 May 1999”—Pref. Includes bibliographical references and index. ISBN 0-415-25417-5 (alk. paper) 1. Africa—Economic policy—Congresses. 2. Africa—Economic conditions—1960—Congresses. I. Lundahl, Mats HC800 .F763 2001 338.96—dc21 ISBN 0-203-99565-1 Master e-book ISBN

ISBN 0-415-25417-5 (Print Edition)

2001019299

Contents

List of figures List of tables Notes on contributors Preface 1

Introduction

ix x xii xv 1

MATS LUNDAHL

PART I The war-stricken economies

23

2

25

Angola: a history of oil, war and economic policy RENATO AGUILAR AND ÅSA STENMAN

3

Guinea-Bissau: a rocky road to reform and stability

41

RENATO AGUILAR AND ÅSA STENMAN

4

Ethiopian reforms: government legitimacy, economic growth and development

52

GÖTE HANSSON

5

Eritrean reforms: a struggle for sustained independence and economic growth

73

GÖTE HANSSON

PART II The reform strugglers

95

6

97

Kenya’s growth prospects: the basic constraints JÖRGEN LEVIN AND NJUGUNA S. NDUNG’U

viii Contents 7

Cape Verde: reform policy and growth in a small remote island economy

110

YVES BOURDET

8

Explaining Zambia’s elusive growth: credibility gap, external shocks or reluctant donors?

132

STEVE KAYIZZI-MUGERWA

9

From stagnation to growth in Tanzania: breaking the vicious circle of high aid and bad governance?

147

ANDERS DANIELSON AND GUN ERIKSSON SKOOG

10

The Post-Washington Consensus in Mozambique

169

HANS FALCK

11

Investment, productivity growth and structural adjustment in Zimbabwe

194

DICK DUREVALL

PART III The growth seekers

215

12

217

Has Uganda taken off? ARNE BIGSTEN

13

Can South Africa break the deadlock?

229

MATS LUNDAHL

14

Foreign dependency and high-speed growth in Lesotho

248

LENNART PETERSSON

Epilogue: development cooperation with Africa in the twenty-first century

268

IFTEKHAR HOSSAIN AND MARIO CARLOS ZEJAN

Index

278

Figures

5.1 6.1 6.2 6.3 7.1 7.2 7.3 7.4 10.1 10.2 10.3 10.4 11.1 11.2 11.3 14.1

14.2 14.3

Economic system dimensions Changes in relative prices, 1980–97 Indicators of the foreign exchange market Financial indicators Domestic public debt (in millions of escudos and in % of GDP), 1991–7 Banking system financing of the fiscal deficit and inflation, 1991–7 Exchange rates (1990:100) and real trade situation, 1990–7 Real GDP growth, 1989–97 (1989:100) Real effective exchange rate, 1990–7 (1990:100) Overall deficits and grants received in % of GDP, 1990–7 Budget revenue and expenditure, 1990–7 Exports and imports, 1990–7 (US$ million) Gross fixed capital formation as a share of GDP The share of public investment in total investments (in nominal values) Indexes of private sector profits and private gross capital formation Real GDP growth of Lesotho, South Africa and sub-Saharan Africa, excluding Nigeria and South Africa, 1970–97 (1970:100) Private consumption and gross domestic investment in Lesotho, 1970–97 (1995 prices) Growth performance in agriculture and secondary industries 1970–98 (1995 prices)

79 101 102 104 117 119 120 123 185 185 187 188 200 200 203 249

251 260

Tables

2.1 GDP growth 1993–8 2.2 Inflation rates 2.3 Real exchange rates; readjusted kwanzas per dollar; January 1994 prices 2.4 Selected fiscal indicators 3.1 GDP growth rates 3.2 Quarterly fiscal revenues 4.1 Norms of legitimacy and the Ethiopian situation in 1997 4.2 Selected economic indicators 4.3 Some indicators of economic performance in 1997–8 4.4 The regional and urban–rural distribution of the Ethiopian population in 1994 4.5 Distribution of recurrent budget among regions in 1993/4–1997/8 (%) and the regional distribution of the Ethiopian population in 1994 4.6 Distribution of the total national regional capital budget (%) 4.7 Regional gross enrolment rates in 1995/6 (%) 5.1 Structure of the Eritrean economy in 1993–7 (% of GDP at factor cost) 5.2 Economic performance in 1992–7 5.3 Some indicators of economic performance in 1997 and 1998 6.1 Sectoral and overall growth rates, 1990–8 7.1 Budgetary situation (in % of GDP), 1990–7 7.2 Fiscal deficit (in % of GDP), 1990–7 7.3 Composition of imports and exports, 1990–7 7.4 Gross domestic product by sector, 1991–7 (% change) 7.5 Unemployment and level of education, 1996 8.1 Average growth of real GDP for selected African countries (%), 1975–97 8.2 Average growth in export unit values for selected African countries (%), 1975–97 8.3 Changes in macroeconomic aggregates 1990–8 (%) 9.1 Economic indicators, selected years

26 28 29 31 42 43 57 60 61 64 66

67 68 85 86 91 102 115 116 121 123 125 133 133 141 150

Tables xi 9.2 9.3 9.4 9.5 10.1 10.2 10.3 10.4 10.5 10.6 10 A.1 10 A.2 10 A.3 11.1 11.2 11.3 11.4 11.5 11.6

11.7 12.1 14.1 14.2 14.3

Savings-investment identity (% of GDP) Balance of payments, selected years (US$ mn, current prices) Government operations, % of GDP, selected years Indicators of ‘aid dependence’ in Tanzania; official development assistance as percentage of variables except as indicated Washington Consensus: goal and instruments Post-Washington Consensus: broadened sets of goals and instruments Expenditure on education and health, 1991–7 Government finances 1993–7 (annual percentage changes) Gross output, 1993–7 (real rates of change) Macroeconomic indicators, 1990–7 (%) Government finances, 1993–7 (in billions of meticals) Balance of payments, 1993–7 (in millions of US dollars) Monetary survey, flows, 1993–7 (in billions of meticals) Macroeconomic indicators: actual and projected values Real gross fixed capital formation in different assets (1990:100) GFCF as a share of GDP for different sectors Investment indicators, 1985–97 Index of labour productivity, 1985:100 in constant 1990 dollars Correlation coefficients for capital–labour ratio, output–labour ratio, output and labour over the period 1990–5 Yield in kg per hectare for various crops in the communal and commercial sectors Indicators of economic performance, 1987–97 (index and %) Long-term capital, net, and unrequited transfers, 1987–98 Growth performance, 1987–97 and 1998 Foreign ownership and employment in manufacturing companies operating in Lesotho, 1987 and 1997

151 152 153 154 170 171 181 186 189 190 191 191 192 197 199 201 204 208 209

210 221 256 258 262

Contributors

Renato Aguilar is Associate Professor of Economics, Department of Economics, Göteborg University. He has worked with Sida and other international agencies in Africa and Latin America, producing a long series of papers and reports in subjects ranging from macroeconomic adjustment policies to poverty. His most recent publications include ‘The Evolution of the New Private Sector: The Case of Angola’ in T. Addison (editor), Underdevelopment, Transition and Reconstruction in Sub-Saharan Africa, and ‘Problemas Prácticos en la Medición de la Pobreza’ in El Trimestre Económico, Vol. LXV. Arne Bigsten is Professor of Development Economics, Department of Economics, Göteborg University, and has been visiting researcher to the universities of Oxford and Nairobi. His research has concerned income distribution, poverty and growth, rural development, trade and aid and economic policy, particularly in Kenya, Uganda, Ethiopia, Tanzania and Zambia. He has undertaken projects for, among others, the World Bank, United Nations, OECD, ILO, WIDER and Sida. He has written or edited about a dozen books and numerous articles. His most recent book (with Steve Kayizzi-Mugerwa) is Crisis, Adjustment and Growth in Uganda, 1999. Yves Bourdet is Associate Professor at the Department of Economics, Lund University. He has published on issues of trade, trade policy and development. His publications include The Economics of Transition in Laos – From Socialism to ASEAN Integration and International Integration, Market Structure and Prices, and he has edited Internationalization, Market Power and Consumer Welfare. Anders Danielson is Associate Professor at the Department of Economics, Lund University. He has written widely on development economics, particularly public finance, foreign aid, classical growth and the debt problem. His publications include the Political Economy of Development Finance, The Economic Surplus and Towards Sustainability in Central America and the Caribbean (editor, with G. Dijkstra, in press). Dick Durevall is Senior Lecturer at the School of Economics and Commercial Law, Göteborg University, and Senior Lecturer at University of Skövde. He has mainly written on development macroeconomics. His recent publications

Contributors

xiii

include ‘Does Market Liberalisation Increase Total Factor Productivity: Evidence from the Manufacturing Sector in Zimbabwe’ in Journal of Southern African Economies (2000), and ‘Inertial Inflation, Price Stickiness and Indexation: Evidence from Brazil’ in Journal of Development Economics (1999). Gun Eriksson Skoog is Evaluation Officer at the Department for Evaluation and Internal Audit, Sida. She holds a Ph.D. in economics from the Stockholm School of Economics, where she is a research associate. Her research, which falls in the area of new institutional economics, concerns systemic change, economic development and institutional evolution, with a particular focus on post-socialist transition in Tanzania. Her most current publication is The Soft Budget Constraint: The Emergence, Persistence and Logic of an Institution (2001). Hans Falck is Assistant Professor at the Department of Economics, School of Economics and Management, Lund University. He has written on foreign aid and development issues. Göte Hansson is Professor of International Economics, School of Economics and Management, Lund University, and the Dean of the Faculty of Social Sciences at the same university. He is External Research Fellow at the Centre for Research on Economic Development and International Trade (CREDIT) at Nottingham University. Göte Hansson has written widely on trade, trade policy and development issues. His publications include Social Clauses and International Trade (1983), Harmonization and International Trade (1990), The Ethiopian Economy 1974–1994: Ethiopia Tikdem and After (1995, 1997), and he has edited Trade, Growth and Development – The Role of Politics and Institutions (1993). Iftekhar Hossain is Economic Advisor at the Environment Policy Division at Sida. He has taught at the University of Stockholm, University of Helsinki and the Swedish School of Economics in Helsinki. He has worked for the UN University/World Institute for Development Economics Research (WIDER). His recent publication (co-editor) is Development that Lasts (1997). Steve Kayizzi-Mugerwa is Associate Professor of Development Economics, Göteborg University, and Research Fellow and Project Director at the World Institute for Development Economics Research (WIDER) of the United Nations University, Helsinki. He has worked at the African Development Bank, Abidjan, and also collaborates with Makerere University, University of Nairobi as well as the University of Zambia. His recent publications include Crisis, Adjustment and Growth in Uganda, A Study of Adaptation in an African Economy (with Arne Bigsten) and as editor of The African Economy: Policy, Institutions and the Future. Jörgen Levin is a Research Fellow at the Department of Economics, Görebro University. He has worked on various issues related to structural adjustment in Kenya. His most recent publication is ‘Adjustment to External Shocks: Kenya 1986–95’ in African Development Review, Vol. 12.

xiv

Contributors

Mats Lundahl is Professor of Development Economics at the Stockholm School of Economics. His research has dealt mainly with East and Southern Africa, Latin America and the Caribbean. His previous publications with Routledge include Peasants and Religion (with Jan Lundius) (2000), New Directions in Development Economics (editor, with Benno Ndulu) (1996), Economic Crisis in Africa (editor, with Magnus Blomström) (1993), Markets or Politics? Essays on Haitian Underdevelopment (1992), Agrarian Society in History (editor, with Thommy Svensson) (1990) and Incentives and Agriculture in East Africa (1990). Njuguna S. Ndung’u is a Senior Lecturer, Department of Economics, University of Nairobi, and a Principal Analyst at Kenya Institute for Public Policy Research and Analysis (KIPPRA). He has worked on various issues related to growth, investment, external and domestic debt sustainability in SSA, and on macroeconomic policy issues on Kenya. His most recent publication is ‘The Exchange Rate and Monetary Policy in Kenya’ in African Development Review, Vol. 12. Lennart Petersson is Senior Lecturer at the Department of Economics, School of Economics and Management, Lund University. His main research interest is international trade and regional integration and location of industry in Southern Africa. Recent publications are The Dependent Economy: Lesotho and the Southern African Customs Union and Post-Apartheid Southern Africa: Economic Challenges and Policies for the Future (editor). Åsa Stenman is Desk Officer for Angola at the Africa Department at Sida and also a Research Student in Economics at the Department of Economics, Göteborg University. She has been working with Angola and Guinea-Bissau for many years, mainly focusing on socioeconomic issues, economic policy and international cooperation. Her most recent publications include ‘From Humanitarian Assistance to Poverty Reduction in Angola’ with M. Adauta and B. Ekman in T. Addison (editor), Underdevelopment, Transition, and Reconstruction in SubSaharan Africa. Mario Carlos Zejan is Chief Economist of Swedish International Development Cooperation Agency (Sida). He has several publications on issues of macroeconomic adjustment, growth, multinational enterprises and international investment. Most recently he has published Foreign Direct Investment. Firm and Host Country Strategies (with Magnus Blomström and Ari Kokko).

Preface

The essays in the present volume were originally presented at the conference ‘From Crisis to Growth in Africa?’ at the Stockholm School of Economics on 7–8 May 1999. They constitute the sequel to a similar exercise in 1991, subsequently (1993) published by Routledge, titled Economic Crisis in Africa: Perspectives on Policy Responses, edited by Magnus Blomström and Mats Lundahl. The origin of both volumes is a program of cooperation in macroeconomic and development between the Swedish International Development Cooperation Agency (Sida) and the Departments of Economics at the Universities of Lund and Göteborg and the Stockholm School of Economics. All the authors in the present book have been involved in this program. I am grateful to Sida for sponsoring the conference. Thanks are also due to Lilian Öberg for taking on all the practical duties on this occasion and to Carin Blomkvist for preparing the manuscript for publication. Finally, the quality of the text has been improved by the constructive criticism offered by two anonymous referees. Remaining errors rest with ourselves – the authors. Stockholm, June 2000 Mats Lundahl

1

Introduction Mats Lundahl

In a recent provocative article, John Sender (1999) argues that the economies of sub-Saharan Africa have done much better than what is generally taken for granted, especially if a perspective encompassing a few decades is taken. Most notably, a number of indicators related to the provision of basic needs show considerable progress. Thus, life expectancy in 1995 was on average ten years longer than in 1960, and would have been even longer had it not been for AIDS. The mortality rate in the under-five years of age group had fallen by about half. The position of women was considerably better on a number of counts. In terms of anthropometric measures they are no longer at a disadvantage in relation to men. Also, fifty years ago, less than 10 per cent of all adult females are likely to have been literate, a figure which in 1995 had increased to almost 50 per cent. Female school attendance had increased dramatically on both the primary and secondary levels, presumably one of the factors behind the reduction of infant mortality and fertility, and since 1980 this also had resulted in rapidly increasing female enrolment on the tertiary level. Statistics related to the provision of physical infrastructure, for example length of roads and paved roads, electricity production and to communications (newspapers, radios, TV sets) also show considerable development since 1950. Sender also reviews crop statistics and argues that figures pointing to a declining production trend are hardly compatible with the progress that undeniably has taken place in terms of life expectancy, weight and height for age, etc., and highlights that from 1965 to 1995 the annual compound growth rate of sub-Saharan agriculture was something like 2.34 per cent, accelerating to 3.1 per cent between 1984 and 1996. For some individual crops, like maize and rice, he presents even higher growth figures, among other things as a result of increased factor productivity, deriving for example from increased use of irrigation and fertilizers. Still, there is considerable consensus among economists that the story of the African economies during the postwar period is hardly a success story. On the contrary, the optimism that could be found in the 1950s and 1960s, around the various independence dates of the new nations, over the following decades was increasingly turned into pessimism and dismay as it was discovered that a process of economic decline was at work. In 1995, a mere 6 per cent of the population of sub-Saharan Africa lived in countries with higher per capita incomes than ever before (Freeman and Lindauer 1999: 2, 27).

2

From crisis to growth in Africa?

The present book is concerned with the problem of achieving sustained economic growth in a number of African countries. Their economic record is presented in the form of a number of essays, each one focusing on an individual nation. The basic questions that the book attempts to answer is how far they have advanced in their endeavors and what their future prospects look like. Almost ten years ago a team that included most of the authors of the present book carried out a similar exercise. The point of departure for that (1991) could be stated in a single sentence: ‘Sub-Saharan Africa is in a deep economic crisis.’ (Blomström and Lundahl 1993: 1). This crisis had many intertwined ingredients. Growth figures were stagnant or negative, government budgets and foreign payments showed deficits, and the performance of agriculture had problems keeping ahead of the growth of the population. Unemployment was rising and expenditure on education, health care, etc. was decreasing. Politically, instability, inefficiency and corruption were some of the most salient characteristics. One of the results of the African economic crisis was the implementation of structural adjustment programs in virtually all the countries examined, programs intended to enhance the capacity of the African economies to increase the living standard of their populations. The present book examines the situation of a number of economies that have already completed this exercise and of others that are still involved in it. Which has their experience been? Is it likely that the tendency that Benno Ndulu and Stephen O’Connell (1999: 41) point to as hopeful: that ‘where civil strife has been avoided, Africa has seen a broad tendency towards rapid growth for several years after 1995’, will spread across the continent in the near future, or will the trend indicated by Paul Collier and Jan Willem Gunning (1999a: 3) – ‘Since 1980, aggregate per capita GDP in sub-Saharan Africa has declined at almost 1 per cent per annum … 32 countries … [being] poorer now than in 1980’ – carry the day? The case studies gathered in the present book intend to shed some light on this problem. The countries examined have been divided into three groups. First, there are the obvious non-starters, those involved in internal or external warfare (Angola, Guinea-Bissau, Ethiopia and Eritrea), where resources are spent on issues other than economic development. Second, there are a number of countries that are still struggling with the reform processes involving structural adjustment and related measures (Kenya, Cape Verde, Zambia, Tanzania, Mozambique and Zimbabwe). Third, we have countries that have by and large emerged from the acute reform phase and which should now be growing if the reforms have been successful (Uganda, South Africa and Lesotho). The results are hardly encouraging. The four war-stricken economies are all among the poorest in Africa, but this does not deter them from squandering scarce resources on completely counterproductive efforts, for dubious political reasons. Even in the case of Angola, with its oil revenues, the political situation has blocked economic development completely. In the other three countries – Guinea-Bissau, Ethiopia and Eritrea – the reform process that had been initiated became blocked by belligerent activities, at the cost of increased marginalization and economic and social retrogression. The countries struggling with reform present a mixed picture. In Kenya, where structural adjustment has been attempted for two decades, the process has not really

Introduction 3 taken off, or, rather, it has been a failure. Again, political factors, not least corruption and misrule, have blocked the road to progress. In Guinea-Bissau, a number of reforms have been carried out, but the results have been disappointing, and the extent of government intervention in the economy has increased drastically. Zambia has performed even worse, with negative growth during the 1990s and lack of government credibility, both in general and specifically, when it comes to reform efforts. The commitment to reforms can also be questioned in the case of Tanzania, where state softness and aid dependence make it difficult to obtain substantial results. Mozambique has implemented more or less all the reforms to which the country has been committed and the growth rate has been high during the past decade, with a trend that appears to point upwards. From this point of view, the country may qualify as a ‘growth seeker’. A huge budget deficit, however, remains to be dealt with. More important yet, the flood catastrophe at the beginning of 2000 is likely to have set development back considerably. Zimbabwe – another borderline case that seemed to do well for quite some time – has failed to sustain growth, for reasons that are largely connected with suspect political measures and lack of industrial development. During the first half of 2000, the political situation has grown drastically worse as a result of the notorious ‘land reform’ and Mugabe’s desperate maneuvers to retain power and crush the opposition. Shortages have appeared. The exchange rate has been fixed at a completely unrealistic level, which has emptied the currency reserve, and the tobacco harvest that could bring in foreign currency is in danger of never being sold. Again, political factors have got in the way of economic development. As we move into the third group of countries, those which in some sense have completed the structural adjustment episode and which are waiting for a result in terms of high and sustained GDP growth, the situation, which on average falls short of expectations, differs from country to country as well. In spite of a good growth record, Uganda has not yet reached the point where expansion may be said to be sustained by a high investment rate, lessened aid dependence and increasing manufacturing output. South Africa, which has undergone a radical transformation since the apartheid period, has not fared well either. The country needs growth to be able to carry out its ambitious redistribution policies, but GDP has a hard time expanding faster than the population, which in the worst case may lead to increased political conflict in the future. Lesotho, finally, has the best recent growth record in the group, but largely for ‘artificial’ reasons, connected with the mammoth Lesotho Highlands Water Project, which, once it has been completed, risks to bring the structural vulnerability of the country’s economy to the surface. The conclusion to be drawn from the case studies contained in the present book is hardly that Africa has overcome the economic crisis that characterized the continent at the beginning of the 1990s and embarked on a self-sustained growth path. Far from that: ‘African economic performance has been markedly worse than that of other regions’ (Collier and Gunning 1999b: 64). The ‘old’ problems plaguing Africa continue to be present (Freeman and Lindauer 1999: 2): … massive drops in modern sector employment as a share of the labor force; real wages of urban workers falling to subsistence levels; reverse migration from

4

From crisis to growth in Africa? cities to rural areas; loss of shares of world trade and foreign investment; absolute poverty rates climbing above 50 percent; and declines in food production per capita. All this has happened while … [sub-Saharan Africa] received the largest influx of foreign aid relative to GDP in the world, repeated IMF and World Bank programs, and a sizeable increase in expenditures on schooling.

There are many reasons for this, some general, others specific for particular countries, as our case studies point out, some specific for Africa as a continent, others results of policy measures (Collier and Gunning 1999b). Reforms operate on many levels, and success in terms of, for example, macroeconomic stabilization is not the same as successful creation of incentives on the micro level, and micro incentives may not do the trick if there is no supply of entrepreneurs, domestic or foreign, who are willing and capable of responding. Institutions take time to change and good governance is not forthcoming unless not only the willingness but also the adequate democratic control mechanisms exist. It can hardly be argued that Africa has yet overcome its crisis. The next decade will be the witness of a continued debate of how the continent’s problems have arisen and how they should best be solved. In this process, foreign aid may have a role to play. The efficiency of the aid received by Africa has been a hotly debated issue in the past and will presumably continue to be so also in the immediate future (World Bank 1998). Aid fatigue has been spreading in wide donor circles after the demise of Communism, which did away with the main political motive for dispensing aid, and the bad African economic record has added to it. This means that aid will have to find forms that are at least partly new, not least when it comes to striking a balance between needs, on the one hand, and a good track record as far as reforms and economic performance are concerned, on the other. With this, let us turn to the main findings of our case studies.

1 The war-stricken economies Angola The main fact to keep in mind when it comes to Angola is that the country has suffered from war of varying intensity during the last thirty years. Angola has a turbulent history. The country was robbed of large part of its population through the slave trade. It experienced a large inflow of Portuguese after World War II and this resulted in harsh and discriminatory policies against the African population. Then, the colonial power withdrew, rapidly and in an unorganized way. A devastating civil war with a great deal of external intervention followed. Three peace accords have failed and Angola anew plunged into an intensified civil war in December 1998. In terms of natural resources Angola is rich, but due to the history of colonization and war on the one hand and mismanagement and erroneous policies on the other, the available resources have not been used to build a solid foundation for economic and social development. The economy remains eminently dual, with the oil sector as a growing enclave without much contact with the non-growing rest. Over the past ten years, a macroeconomic environment has evolved that is characterized

Introduction 5 by a huge fiscal deficit, large extra-budgetary flows, high or even hyperinflationary (four-digit) price rises, large balance of payments deficits and accumulating debt arrears. The incomes from the oil production have not been used for investment in human capital and physical infrastructure necessary for a broad-based and sustainable economic growth. Oil and war have both contributed to create an extremely centralized political and economic power. The war and power structures that have developed over time have also had a negative impact on the human rights situation and the democratic process. Renato Aguilar and Åsa Stenman examine the future perspectives for Angola. Are there any possibilities of breaking the vicious circle of war, excessive centralization, a deteriorating policy environment and distortionary short-run policy cycles? In the discussions with the main international financial institutions, two key issues have been raised: the exchange rate policy and the transparency of the oil finances. These are sensible issues since they touch upon the incomes of influential groups in Angolese society. Thus, Angola’s main development problem is political. The country has the resources needed to change the situation radically in the short run. If the political will to arrive at an agreement exists, the government should be able to take measures that would improve the situation for the population, especially the poorest and most vulnerable groups. Thus, the main challenge in the near future is, without doubt, that of finding a solution to the conflict and stop the war. Another urgent task is to correct the major macroeconomic imbalances, but it should be possible for the government to do this in parallel with the efforts directed at putting an end to bellicose activities. It is even plausible that this would contribute to the resolution of the conflict. If Angola is to implement some model of broad-based development and improve the pattern of income and wealth distribution (allegedly the objective of the leaders), it will be necessary to diversify production and spread the dynamics and fortune of the oil sectors to other parts of the economy as well. The investment with the highest rate of return both in economic and social terms then probably is social infrastructure. If part of the income from oil production could be used to rebuild the health sector and the educational system, this would constitute an important building block in the construction of sustainable and equitable development in Angola. Guinea-Bissau Guinea-Bissau is one of the smallest and poorest countries in Africa. Between independence, in 1974, and the recent civil war, however, the country has enjoyed a relatively peaceful development, especially in comparison to some of its neighbors. Efforts to reform the economy and the public administration began in the late 1980s. The reform process was very slow and suffered several setbacks during the first years, and began to make progress only in the mid-1990s. After the 1994 elections the International Monetary Fund (IMF) approved an Enhanced Structural Adjustment Facility credit in support of the government’s reform program whose main targets were price stability, reduction of the fiscal deficit, alleviation of the debt burden and economic growth. After a reshuffle of the government in June 1997, the reform process accelerated and

6

From crisis to growth in Africa?

the economic prospects appeared relatively positive. However, the war between the rebelling army and troops loyal to the sitting president, reinforced by troops from Senegal and Guinea-Conakry, which started in June 1998 put a severe brake on this process. Aguilar and Stenman, in their chapter on Guinea-Bissau, examine the prospects of the country in a postwar situation. Before the war, among other things as a result of its membership in the Union Monétaire Économique Ouest-Africaine (UMEOA), Guinea-Bissau had obtained relatively good results in terms of price stability, government budget and debt service. A so-called decision point, i.e. a starting point, for the formal inclusion of the country in the Heavily Indebted Poor Countries (HIPC) program should have been reached during the summer of 1998 and an agreement should have been signed with the IMF with respect to a new Enhanced Structural Adjustment Facility. After the war which ended in February 1999, the international financial institutions and the bilateral donors have assumed a flexible position in order to make it possible for Guinea-Bissau to resume the HIPC process without excessive setbacks. A debt reduction through this program could be quite effective since the multilateral debt represents over half the total debt burden, and the need is small in absolute terms. A large and fast reduction is also crucial for Guinea-Bissau’s possibilities to improve its public finances and balance of payments. In the wake of the war, the reconstruction of the country will be at the top of the political agenda. The capital city needs to be physically rebuilt. The public administration needs qualified manpower, since many well-educated officials left for Portugal, France and Cape Verde. The development of the agricultural sector is also important for the country’s growth prospects. Increased agricultural production can contribute to the alleviation of the balance of payments deficit both through decreased imports and increased exports. Right now, cashew nuts are by far the largest source of export earnings in spite of efforts to grow and export, for example, citrus fruits. Exports need to be diversified if the country’s vulnerability is to be reduced. However, it is important that the development of the agricultural sector is not pursued at the cost of the physical environment and the traditional social systems, since this would clearly have negative effects on the long-term growth prospects. Finally, Aguilar and Stenman identify five areas that are deemed to be crucial for Guinea-Bissau in the long run: education, health, infrastructure, an efficient channel for aid funds from donors to the domestic economy, and agricultural development. Ethiopia The civil war in Ethiopia came to an end with the fall of the Mengistu government in 1991. The following year a series of economic and political reforms began to be carried out by the new government. Göte Hansson examines the implementation of these reforms and the relation between the reforms and the political legitimacy of the Ethiopian government. The picture that emerges is a mixed one. The economy has in the main fared comparatively well. GDP per capita has grown with something like 3–4 per cent per annum, and investment has increased at a steady pace. The budget deficit has been

Introduction 7 under reasonable control and the deficit on the current account of the balance of payments has not been particularly alarming. International reserves have been built up from an extremely low level. The rate of inflation has remained below 10 per cent. The Ethiopian economy that emerged from the Mengistu period was characterized by regulations on all levels. A number of new laws and policies have been introduced to break up that system. State-owned enterprises have been privatized, a new investment code has been introduced, one which, however, puts some restrictions on foreign participation, and the market for foreign exchange still retains a number of controls. Also, observers fear that companies controlled by the ruling party will distort markets and put severe obstacles in the way of private firms trying to compete with them. Clearly, a lot more remains to be done on the deregulation front. Still, it would be unfair to argue that the reform process is not under way. When the new government assumed power, a program of geographic regionalization and decentralization was launched to get away from the excessive concentration of power to the central level that characterized the Mengistu regime. Here, however, a lot remains to be done. Above all, on a per capita outlay basis Addis Ababa remains a favored location, and some other regions appear to receive favored treatment as well, albeit on a far smaller scale. Thus, the risk remains that the capital will continue to concentrate industry and trade activities also in the foreseeable future while peasant farming and pastoral activities continue to dominate in most of the country. The social situation in Ethiopia remains poor, even though the share of the social sectors in total actual government spending appears to have increased. It is a bit worrying that in the successive budgets the allocated shares have been declining. For a country as poor as Ethiopia, the development of human resources via education should be a priority. However, as it seems, it is not realistic to expect much advance in the years to come, even though the resources allocated to education have increased. Enrolment rates are low and biased, mainly towards the capital but also towards other urban areas. This, in turn, means that there is a high probability that the urban bias in terms of capital–labor ratios and the proportions of skilled to unskilled labor will be reinforced in the future. This is in clear contrast to the government’s declared intention of a rural-based development strategy. The main problem facing Ethiopia today is, however, not economic, regional, educational or social. It is the border war with Eritrea, which broke out in 1998 and does not seem to be coming to any immediate end. What this will cost the country in terms of development foregone is difficult to say, but it appears clear that the war effort will nullify a lot of what has already been achieved on the economic front. What this will imply in terms of growth is difficult to say, but there is a significant risk that Ethiopia will slide back to ‘square one’, where the process started in 1991, if resources are spent on war instead of peaceful production. Eritrea Eritrea is one of the youngest and poorest countries in the world. Its creation was a direct consequence of the fall of the Mengistu government in Ethiopia in 1991, after thirty years of Eritrean liberation struggle. Two years later, after a popular

8

From crisis to growth in Africa?

referendum, the sovereign state of Eritrea was proclaimed. Göte Hansson analyzes the political and economic challenge that the new state had to meet. On the political side, a constitution had to be forged and the road to democracy had to be paved. The constitution was ready in 1997, but democracy is still a long way off, naturally enough, given the lack of political party tradition and the low level of education. More important yet, the young nation emerged with a highly centralized economic system – a legacy from the Mengistu period – in a situation where the administrative capacity was weak on all levels. Markets were not allowed to work without government interference with prices and industrial production. State ownership was strong outside the agricultural sector. Incentives to produce were lacking and so was competition, not least because the Eritrean economy on the eve of independence had been a virtually closed one. In fact, the entire economy was in shambles. The new Eritrean government set out to reform the economy, away from the centralized end of the spectrum, aiming for a more open, market-oriented and privatized system. The country has introduced its own currency, trade has been liberalized and foreign exchange controls have been relaxed. Privatization is, however, proceeding at a slow pace. It is difficult to know what to make of the available macroeconomic figures. As it seems, growth from 1992 to 1997 was quite high, with the exception of the drought years 1993 and 1995, and the rate of inflation has not been excessively high. The budget deficit, however, has been quite substantial, no less than 22–29 per cent of GDP, before grants, and the current account of the balance of payments showed a tendency towards deterioration between 1995 and 1997. In a sense, all this is, however, now irrelevant. The reason is simple: the war with Ethiopia that began in 1998, and as Hansson points out, as a result, all of a sudden a clear case for regional economic integration was thus turned into disintegration. The war has inflicted enormous costs on both sides and put developments back in Eritrea with several years, perhaps even decades. The future looks gloomy indeed. It will not be easy to create the kind of trust and cooperation between the two countries that is necessary if a rapid reconstruction process is to get under way.

2

The reform strugglers

Kenya Kenya was one of the first African countries to launch a structural adjustment program, in 1980. The first five years did not see much progress, since the Kenyan authorities proved unwilling to carry out the program, and between 1985 and 1991 implementation turned out to be poor. As a result, in 1992 a new program had to be negotiated with the IMF. In spite of improved implementation in 1992–5, tension between the Kenyan government and the donor community, which led to the temporary suspension of aid in 1992, continued. Corruption and bad governance had emerged as important issues and in 1997 the disbursement of IMF funds was again suspended, a state of affairs that still continues. It is no exaggeration to state that economic reform in Kenya has been a disappointment. This is highlighted in the chapter by Jörgen Levin and Njuguna

Introduction 9 Ndung’u. Little liberalization of foreign trade took place from 1980 to 1992, and it was only for two years, 1992–3, that any progress could be noted. Thereafter, the trade regime again turned against the exporters. Furthermore, monetary and exchange rate policies were inconsistent. High interest rates to combat inflation made for a rapid capital inflow in 1995 which resulted in a real appreciation of the Kenyan shilling and difficulties for the exporters. Finally, government support to manufacturing exporters has been weak. Corruption in the management of the physical infrastructure has affected their competitiveness negatively. Liberalization of financial markets has not been successful. It was undertaken in a situation where macroeconomic stability – fiscal discipline and containment of inflation – was lacking, and as a result it failed to make the rate of interest rise to a market-determined level. Although the situation has improved somewhat in recent years, a lot still remains to be done, and it is not likely that liberalization will be successful as long as fiscal and monetary discipline is lacking. The Kenyan government has tried to liberalize the labor market, but the attempts have met with failure. The setting of minimum wages makes adjustment in the face of liberalization and employment creation difficult and forces increasing numbers to live below the poverty line. The poorest groups have seen little change in their life situation, and the lack of specific anti-poverty measures has contributed to aggravating the situation. In the case of Kenya, the economic reform process has been a failure. Implementation has been slow and uneven. Bad governance and corruption put a dead hand on many efforts and as a consequence investor confidence is low and growth is suffering. Today, the country is far from being a success story. Cape Verde The small island nation of Cape Verde has been struggling with reforms since 1991. After one and a half decades of socialist rule the need for drastic change was great, and the government emerging from the democratic elections that year set about to open up the economy and create a dynamic private sector, a process which still goes on. Yves Bourdet analyzes the major components of reform in his chapter. In the first place the role of the state is being redefined. More scope is left to the market both in terms of resource allocation and income distribution and the state is mainly concerned with stabilization issues, notably increasing government revenue and curtailing expenditure. Second, attempts have been made to increase competition in both product and factor markets. Price controls have been removed on all items except basic foodstuffs, private property rights have been strengthened and state-owned enterprises have been either privatized or liquidated. Measures have been undertaken to ensure increased flexibility in the labor market and foreign direct investment has received guarantees against expropriation. Finally, imports have been liberalized and efforts are made to promote exports. In practice, fiscal policy has, however, been expansive in Cape Verde. Although the tax base has been broadened and tax revenue increased, the budget deficit has been growing, not shrinking, and has had to be financed either out of the proceeds

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From crisis to growth in Africa?

from privatization or via the loans from the banking system, resulting in increasing debt levels. Up to 1994 the major impact of trade liberalization was increased imports, but thereafter, as it seems, export promotion measures (free zones and tax incentives) have had a strong impact on exports, the composition of which has changed from primary products to labor-intensive manufactures – largely the result of the opening of the free export processing zones. The result of the reform process in terms of GDP growth has not been overly strong in Cape Verde, on average 3.3 per cent between 1991 and 1997. This is explained largely by persistent droughts affecting agricultural output negatively, together with relatively low administered prices for foodstuffs. The growth rates in the secondary and tertiary sectors, on the other hand, has been above the average for the economy as a whole. Bourdet also examines the labor market. Unemployment is one of the worst problems facing Cape Verde, not least the failure of women, young people and persons with little education to obtain jobs in the formal sector, and this has contributed to containing wage rises in the private sector. Thus, Bourdet concludes, the results of reform have fallen short of the expectations in Cape Verde. The extent of government intervention in the economy has more than doubled since the beginning of the reform effort, the growth rate is low and stabilization policy has not reached its targets. Zambia Zambia is a country that has been doing extremely bad from the growth point of view, with per capita production falling at a rate of 3 per cent per annum on average in 1991–7, in spite of the reform promises given by the new government that took over in 1991 after over thirty years of Kaunda rule. The new power holders promised that a series of ‘tough policies’ would be carried out, including trade liberalization, privatization, removal of price and exchange rate controls, reform of financial institutions and a reduction of public employment. The policy package, however, failed to have the envisaged effects on economic performance. Steve Kayizzi-Mugerwa deals with this failure in terms of credibility and time inconsistency on the part of the government. The Movement for Multiparty Democracy won a landslide victory in the elections and almost wiped out the opposition. This meant that no agent of restraint on government behavior was immediately available. This may have been positive from the point of view that the reform program could be rapidly implemented, backed by substantial inflows of foreign aid. During the first three years the new government managed to carry out its policies in a relatively coherent fashion, but as human rights violations and corruption began to show their ugly heads, the issue of good governance drove a wedge between the Zambian government and the international donor community, and the barring of Kaunda from the 1996 elections, on dubious ‘technical’ grounds, and the declaration of a state of emergency in 1997 (lifted the following year) did nothing to improve the situation. The privatization process was disturbed by a considerable

Introduction 11 amount of political interference, with companies being transferred directly to the politicians themselves. In addition, the sale of the Zambia Consolidated Copper Mines was delayed and the company was stripped of assets. Already in 1996 Zambia’s donors decided to take a restrictive stance both on disbursements and new projects, imposing an aid embargo. The macroeconomic picture is not encouraging. The budget deficit increased almost sixfold in relation to GDP in just a couple of years at the beginning of the 1990s. This was funded by a fast increase in the money supply, and the rate of inflation jumped to almost 200 per cent. Thereafter a cash budget system was introduced which precluded spending beyond the existing revenue. The reforms began to have a positive impact in the mid-1990s. The rate of inflation came down, the rate of investment increased, and when, in 1998, some of the most pressing political and privatization problems were solved, Zambia’s relations with the donors improved. As has already been pointed out, the growth rate has been negative during the 1990s. Neither donors nor investors have been enthusiastic with respect to government behavior. Zambia has faced bad luck as well, for that matter, with drought and falling copper prices, but the manufacturing sector, for example, has had problems competing with cheap imported goods. Altogether the disappointing performance of the economy means that Zambia has a very long way to go before the country’s long-term goal, poverty eradication, can be reached. Tanzania Tanzania is another case of long-standing reform efforts, beginning in the early 1980s. At that time the country displayed a number of characteristics typical of economies of shortage – both structural problems and severe macroeconomic imbalances. Since then, considerable improvements have taken place on the stabilization front. The budget is balanced, inflation has come down, exports are expanding and the degree of state intervention in the economy has been reduced. Modest growth figures have been obtained – high enough to make per capita income increase. The road of reform has, however, been a slow and rocky one with many setbacks and difficulties of implementation on the ‘base level’. In their chapter Anders Danielson and Gun Eriksson Skoog raise the question of how genuine the commitment of the Tanzanian government to change really is. Could it be that reforms have been driven more by the prospect of further foreign aid than by a feeling that change is necessary for the improvement of economic performance and living standards? Beginning with the actual performance, GDP per capita has been growing by about 1 per cent per annum during the 1990s. Cash budgets were introduced in 1996 and this has produced a budget surplus. The current account deficit on the balance of payments has grown smaller, mainly as a result of falling imports, and inflation figures have shown a steady downward trend. However, private investment has been shrinking. Perhaps the major problem in the growth context has been that of the softness of the Tanzanian state, i.e. the state has been far from immune against the influence of interest

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From crisis to growth in Africa?

groups. The budget constraint of government enterprises has been soft. Informal rules have been more important than formal, and the degree of responsibility, transparency and accountability has been low in the public sector. These problems have survived the reform efforts to a varying degree, or, putting it differently, institutions contributing to the softness of the Tanzanian state have proved able to adapt to the changing circumstances. Not least, corrupt practices that saw the daylight during the socialist years have in no way been uprooted, and the traits connected with the so-called economy of affection still remain in place. Informal, social networks based on kinship and friendship often loom a great deal larger than impersonal market relations. Danielson and Eriksson Skoog argue that the softness of the state and dependence on foreign aid in the case of Tanzania reinforce each other in a vicious circle. The Tanzanian state and the foreign donors are locked into a lasting relationship which is difficult to break and which prevents growth from taking off. This relationship began in the 1970s when the large parastatal sector was being built up, and an abundance of foreign aid resulted in a number of badly scrutinized projects which should never have been started. As the Tanzanian economy ran into import problems in the 1980s, the focus of aid shifted from projects to import support, and a new dimension was added to the softness of the state: in its relations with the donor community, the authors argue, the reform process was simply another way of securing more aid, while the Tanzanian leaders were actually reluctant to weaken their powers and their grip over the economy. The ‘old’ system of red tape, inefficiency, corruption, etc. hence tended to prevail while the donors continued to pump aid money into Tanzania in the belief that reform was taking place. Mozambique The case of Mozambique is an ‘intermediate’ one. The country is one of the poorest in the world, but the growth rate has been high for the past decade. In his chapter, Hans Falck points out that Mozambique has implemented virtually all the reforms that form part of the standard reform package, but that more remains to be done. The so-called Washington Consensus requirements have by and large been met. The important macroeconomic variables have been stabilized, trade has been liberalized and extensive privatization of government companies has taken place since 1987. The main success in the area of stabilization has been that inflation has been brought under control, down to the one-digit level. Interest rates have been liberalized and allowed to rise. Also the official currency market has been unified with the parallel one and the overvaluation of the currency has disappeared. The budget deficit, on the other hand, has been a tougher nut to crack. Before grants it remains at a level between 20 and 30 per cent of GDP and has to be covered with aid flows. Tax revenues have increased substantially, but so has, unfortunately, current expenditure. On the liberalization front, the number of import tariff rates have been reduced and so have their levels. Some steps have been taken to abolish exemptions from trade taxes, although more remains to be done. The currency has been devalued. However, since the fate of exports is very much in the hands of weather conditions, the trade balance continues to be heavily in deficit, and so is the service balance.

Introduction 13 Foreign borrowing and debt relief have closed the gap, which has, however, narrowed over time. The Bank of Mozambique has been converted into a modern central bank, so far relying mainly on direct monetary instruments like credit ceilings but planning to move towards such indirect measures as free market operations and reserve requirements. The two main state-owned banks have been privatized. Parastatal companies showed the same defects in Mozambique as in most other African countries. Most importantly, they operated under a soft budget constraint, i.e. the government would bail them out regardless of the size of the losses they made. The traditional remedy for this state of affairs is privatization, and in Mozambique between 1989 and the end of 1997, 75 per cent of the country’s stateowned companies were either sold out or liquidated. This has contributed to increased efficiency and investment, but only marginally to government revenue. The reforms implemented have resulted in an average growth rate of close to 7 per cent per annum between 1987 and 1997 and forecasts point upwards. The structure of the economy has, however, undergone little change over the years. Still, the vast majority (80–90 per cent) of the population continue to work in agriculture, with all that this implies in terms of vulnerability. Thus, Mozambique has duly implemented virtually all the components of the Washington Consensus. Falck, however, argues that this is not enough for the country to get on to a sustained growth path. Joseph Stiglitz, the former Chief Economist of the World Bank, has suggested that a Post-Washington Consensus is needed if growth is to be ensured. According to this both the set of goals and the set of means must be broadened. Increased living standards, sustainable and equitable development as well as democracy are the main targets, and the instruments in addition to the traditional ones include competition policy (to complement privatization), financial regulation (to ensure an efficient mode of operation in the financial sector), investment in human capital and technology transfer. On this count, Mozambique has fared less well. Competitive markets do not emerge by themselves, and the Mozambican business legislation has been lagging behind the needs. As we have seen, more has been done in the financial sector. Regulation in general is difficult because of ubiquitous corruption in the public sector. The educational system remains undeveloped, although the government seems to be aware of the situation. In the technology field, finally, little headway has been made. Unfortunately, by a cruel vagary, the fate of Mozambique has recently changed. The flood catastrophe that hit the country at the beginning of 2000 has played havoc with both human lives and property on the one hand, and the production possibilities of the agricultural sector on the other. Much of the gains obtained so far have been wiped out by it. Exactly how much has been lost remains to be seen, but there is no question that there has been at least a temporary setback. Zimbabwe Zimbabwe went through a structural adjustment program, beginning in 1991. The aim of the program was to lay the foundations for rapid growth, by trade and

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From crisis to growth in Africa?

exchange rate liberalization, removal of domestic price controls, public sector reform, notably of public enterprises, reduction of the budget deficit and the rate of inflation, as well as the creation of a social development fund intended to protect poor and vulnerable groups likely to be hit by the adjustments. Dick Durevall discusses the impact of the liberalization measures on economic growth in Zimbabwe during the 1990s. The reform program as such was carried out to a varying extent. The foreign currency restrictions were gradually abolished up to 1994 but it took until 1997 before a new tariff system which did not discriminate against imports of inputs was in place. Also, reform was slow in the public sector and losses were beginning to show their ugly heads again in public enterprises in 1998. The budget deficit could not be cut to the envisaged extent, inflation turned out to move in the wrong direction, and the social development fund by and large failed to reach its targets. Exports grew slower than planned while investment was close to the planned levels, and in 1996 rose above the projected share of GDP. Finally, in 1997 and 1998 a combination of external shocks (notably a drop in exports) and domestic policy mistakes (reintroduction of price controls and an illplanned ‘land reform’) created macroeconomic instability. The result of all this was that the growth rate fell short of the plan figures, i.e. the structural adjustment program failed to be as beneficial as had been hoped for. Durevall proceeds to analyze the reasons for the failure to put the economy on a growth path. Beginning with investment, two categories performed strikingly well: equipment, plant and machinery, and transport, respectively – so well that Durevall speaks about a ‘virtual investment boom’ until 1997. Also, the sectoral composition shifted in favor of tradables, i.e. it behaved as one would suspect during structural adjustment. Investment, however, failed to produce any significant productivity growth. Labor productivity and total productivity both rose somewhat in manufacturing, but elsewhere little progress was seen. The reasons for this are not completely clear, but a number of factors seem to have interacted. In the first place, the short-run result of trade liberalization appears to have been a contraction and a deterioration of the balance of trade with the demand for domestic goods remaining low. The exposition to foreign competition forced domestic producers to replace their capital stock in order to produce better goods, not more goods. Finally, a number of bad investments seem to have been made. Durevall concludes that Zimbabwe has so far failed to obtain sustained growth, and that the failure to achieve good governance has a great deal to do with this. The manufacturing sector in particular remains insufficiently developed while emphasis has instead been put on doubtful ‘agrarian reform’. Good supportive government industrial policies are lacking. An agricultural sector where land productivity appears to be on its way down is not very likely to be able to pull the rest of the economy along, and it definitely does not help to occupy settler-owned farms and prevent work from taking place on the most productive units. The ‘agrarian reform’ episode should not be seen in isolation either. It forms part of a wider political pattern where Mugabe feels that he may be losing power and hence does not hesitate to resort to ‘unclean’ tactical moves in order to crush the opposition, destroying the economy in the process.

Introduction 15

3 The growth seekers Uganda Uganda emerged as one of the most successful countries from the structural adjustment episode of the 1980s. In his chapter Arne Bigsten poses the question of whether the country has in addition managed a takeoff into self-sustained economic growth. To answer this question he employs five different sets of criteria. The first deals with whether Uganda has reached macroeconomic stability and international competitiveness. A cash budget system has been introduced and government spending is tightly controlled, but revenue collection has not progressed beyond 11–12 per cent of GDP, which means that Uganda has not yet reached the point where it is no longer aid-dependent. Also, there is some doubt whether the funds spent actually reach the intended beneficiaries. On the international front, tariffs have been substituted for quantitative import restrictions and their levels have been lowered. Some new export products, notably horticultural ones, have been developed, but no manufacturing firms have managed to export and, what is worse yet, there are no signs that they will in the immediate future either. Domestically, the degree of competition has been increased by reducing the scope of parastatal marketing activities, but there is still some way to go. The banking system, for example, does not operate efficiently. On the educational side progress has been made with respect to primary education, but technical skills necessary for success in manufacturing are lacking. Health care is limited to a minor part of the population. Infrastructure development has concentrated on road transportation, while such fields as energy and telecommunications remain deficient. Uganda is still dependent on foreign aid, although this dependency, as measured by the aid/GDP ratio, has been reduced in recent years. Uganda has been the first country to qualify for debt reduction under the HIPC program managed by the World Bank and the IMF. This has alleviated the pressure on the government budget significantly and allowed the government to use the available funds for development purposes instead. Also, investment is financed out of domestic saving to an increasing extent. Finally, when it comes to the question of good governance, progress has been slow in such important fields as law and order, security of investment and transparency in the privatization process. Uganda cannot yet claim to possess a set of efficient government institutions that allow funds to be efficiently used on all levels. Nor has the government been particularly active in the field of redistribution in favor of poor groups, and the main beneficiaries of growth have been urban dwellers rather than the rural population. Uganda’s GDP growth record during the 1987–97 decade has been quite satisfactory, with rates generally ranging between 5 and 10 per cent per annum, and the policy environment is one of the best in Africa. Still, Bigsten concludes that the country has not yet embarked on self-sustained growth. The investment rate must be raised, Uganda is still aid-dependent, no manufacturing exports have developed, human capital development leaves a lot to be desired, and the political maturity and stability necessary for success is still not there.

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From crisis to growth in Africa?

South Africa The South African economy has fared less well than expected during the postapartheid period. When the old order broke down at the beginning of the 1990s, a wave of optimism swept the country and plans began to be made for a better and more equitable South Africa. The economic program of the Government of National Unity was based on redistribution in favor of the hitherto underprivileged majority. It was, however, apparent already from the beginning of the new order in 1994 that no serious redistribution could take place unless the growth rate of the South African economy could be made to accelerate from the dismal levels of the 1980s. Mats Lundahl reviews the South African growth experience and examines some of the main obstacles to growth in the near future. Historically, the country experienced high growth from the mineral discoveries during the last third of the nineteenth century until the 1970s, but as the internal economic contradictions of apartheid began to reveal themselves during the 1980s and South Africa was simultaneously ostracized from the international economic community, growth rates fell to the point where the economy finally began to contract. Beginning in 1993, figures have been better, but not that much better, and recent trends have pointed in the wrong direction. When it comes to speeding up growth, in the South African case there is no panacea. On the contrary, the economy is faced with a number of obstacles which have to be overcome. Crime rates are extremely high, which of course discourages potential investors, but even in the absence of crime the road ahead will not be an easy one. The present ANC government puts strong emphasis on signaling to the business sector that a responsible macroeconomic policy is in place which aims at controlling the budget deficit, reducing inflation and creating a positive environment for investors. At the same time, however, the economy refuses to grow. This is bound to have an impact on investor expectations as well. It is easy to envisage a vicious circle where the economy does not grow because no investment is forthcoming and no investment is forthcoming because the lack of growth limits the market. The obvious road out of this dilemma goes via international trade, but since South Africa has practiced extensive import substitution behind tariff walls since the 1920s it is not obvious where the country’s comparative advantage is to be found. Gold has run its course as a growth engine and today the search takes place mainly in manufacturing. As it seems, the most promising avenue is to be found in resource-intensive low-technology, medium-wage branches, which, however, are dependent on investment if they are to succeed, and investment is precisely the main problem. Also, there is considerable danger that incipient growth will be choked by stabilization efforts that aim at keeping the rate of inflation and the budget deficit down. South Africa will have to rely mainly on expenditure reduction and this will serve to keep demand back. Also, cost push inflation emanating from the labor market may nullify growth, and it is not likely that unions and employers will be able to strike a bargain that will keep wage increases down. What the future will bring is not easy to say. Should, however, the failure to grow continue and Thabo Mbeki’s government hence fail to deliver the promised welfareincreasing measures, the result may be that South African society is thrown into a

Introduction 17 downward spiral of economic contraction and social turmoil, the outcome of which is indeed uncertain. Lesotho South Africa’s small neighbor, Lesotho, is a country which recently has experienced high GDP growth, close to 9 per cent per annum, during the decade beginning in 1987. High economic growth is not a new feature in Lesotho’s economy. Between 1972 and 1978 GDP grew by, on average, 12 per cent every year. As the intermediate years showed, however, growth is far from self-sustained. During the decade 1978–87 the average figure was a mere 3.4 per cent. Lennart Petersson analyzes the causes of high growth both during the 1970s and the 1990s. The two periods were fundamentally different. During the former period the sources were external. In South Africa real mine wages began to rise during the first years of the 1970s, after having remained virtually constant for six decades. This, in combination with a politically motivated reduction of migration from other neighboring states, increased the number of Basotho in South Africa and the amount of remittances back home. At the same time, Lesotho received substantial amounts of foreign aid and the receipts accruing to the country from the common revenue pool of the Southern African Customs Union quadrupled in real terms. These incomes generated growth in the secondary and tertiary sectors in Lesotho, notably in construction. Investment as a proportion of the gross national product increased from 10 to 16 per cent. Growth was demand-led, and demand was generated through the inflow of external funds. The driving forces behind the second period of high GDP growth were not the same as during the 1970s. In 1986, after many years of negotiation, South Africa and Lesotho finally signed the Lesotho Highlands Water Project (LHWP) agreement. The main purposes are to transfer water to the high-consumption Gauteng province and generate electricity for Lesotho. The project, which is going to be completed over a period of thirty years, led to an enormous boost of investment, which grew with close to 40 per cent per annum between 1987 and 1996. At the same time, foreign assistance, in the form of grants and loans, and foreign direct investment (mainly in export manufacturing) both increased, and so did customs union revenue, whereas the number of migrants to the South African mines was reduced from 1990 on and remittances fell to the corresponding extent. Even though demand played a significant role, the growth pattern that resulted was mainly generated out of the huge infrastructural investments of the LHWP, i.e. it was in a sense supply-driven. What both high-growth periods show is that growth has not been internalized in Lesotho. The country still remains dependent on external factors, notably what happens in South Africa, for its economic performance. The gigantic Lesotho Highlands Water Project has an extremely strong impact on investment, in particular on the construction sector, but this will be a transitory phenomenon. The growth of the export manufacturing sector, in turn, has proved sensitive to social and political factors, notably unrest. The hostility expressed against foreign (mainly Taiwanese and Chinese) firms at various times during the 1990s has resulted in

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From crisis to growth in Africa?

withdrawal of activities and reduced investment. This leaves Lesotho in a precarious position. Agriculture and animal husbandry cannot guarantee increasing real incomes, and a domestic entrepreneurial class capable of generating growth and employment in manufacturing is lacking. Lesotho must continue to attract foreign direct investment. If it fails, by and large only migration remains, but in South Africa the mining sector is in trouble. The probability that future growth rates will be substantially below those of the 1990s is high.

4 The role of aid In the final chapter, Iftekhar Hossain and Mario Carlos Zejan discuss the role of aid to Africa during the twenty-first century. Over the past decades the role has changed considerably. During the 1960s and the 1970s, the concept was one of supporting technologies and solutions that had worked in the industrialized world. Capital formation was regarded as the main determinant of growth. However, as it became evident that the mere inflow of aid did little to boost growth, factors like openness, human capital and institutions were pushed to the forefront. At the same time the awareness increased that aid could result in dependency and crowd out domestic development incentives. Africa at the beginning of a new millennium is not the same as it was in the 1960s or 1970s. Democratization has taken some steps forward in the continent, but the economies have fared less well, notably during the troublesome 1980s when real income fell. Import substitution has proved ineffective as an engine of growth, foreign debt levels are high and poverty indicators do not inspire too much faith in the near future. As the rest of the chapters in the present volume indicate, performance has been highly uneven and has varied from country to country. Some are involved in external or internal wars, wasting resources that could have been used for development. Others are struggling to carry out reform programs, in some cases programs that have been initiated already at the beginning of the 1980s, and a third group is trying hard to make their economies grow, after having implemented these programs. A major factor behind the reassessment of aid has been the end of the cold war and the demise of the Communist bloc in Eastern Europe. With this the main ‘political’ reason for providing foreign assistance disappeared. At the same time, aid fatigue has begun to spread among donors, fueled not only by increasing insight about corruption and the failure of aid to alleviate poverty and increase growth rates, but also by the entrance of the former members of the Soviet bloc among the recipients of aid. The nature of capital flows from developed to less developed countries has changed since the late 1980s. Foreign private investment has increased dramatically, but this flow has avoided Africa south of the Sahara almost completely, largely for the same reasons that have contributed to the reduction of aid flows. Not least has Africa failed to display the same rate of growth as the more dynamic areas of the developing world, notably those in Asia. Lack of openness and low levels of social capital appear to have played a major role here, and so may policy factors and poor performance of the public sector.

Introduction 19 The efforts made to change this situation, notably the structural adjustment programs, have met with a varying degree of success. In the main they have been instrumental in bringing about macroeconomic stability but have been far less successful in terms of growth and poverty reduction, with results varying from country to country. At the beginning of the twenty-first century, aid has to find new forms. The world is becoming increasingly globalized, but donor fatigue poses a major problem, not least for Africa. Increasingly, good governance, institutional capacity and past economic performance are brought to the forefront, and the writing is on the wall. The easiest way to make aid effective is to pick the best performing nations, support them and force other countries to adhere to similar policies if they are to share the pie. This entails a heavy risk that the poorer nations – those who need aid most desperately, but which have not performed particularly well – will suffer in the process. The role of the recipient governments in providing a sound policy environment and good governance in general is becoming more important than in the past. Here, the African record is not particularly encouraging. Naturally, in the African context poverty eradication, or at least alleviation, must be a development priority, and, here, aid may be useful. A new trend – one that attempts to avoid punishing the poorest – is that of ‘partnership’ and increased dialogue between donors and recipients, involving a greater degree of ‘ownership’ by the latter of projects and programs. This presupposes ‘good’ political trends in the direction of democracy, stability and development-oriented leadership so as to make it possible for the recipient countries themselves to take the lead and make aid what it was originally intended to be: a marginal contribution to the development effort.

5 Conclusions In one sense, the conclusion to be drawn from the chapters contained in the present volume is clear. It is not possible to contend that Africa has taken the step from crisis to growth, at least not to sustained growth. At best, the record is a mixed one even when the war-stricken economies are not counted. A number of countries are still struggling to complete the reform process. Some of them have suffered severe setbacks. Other countries have done what has been required of them. Still, they have not succeeded. The reasons for the failure vary from country to country. The individual chapters have provided the details. However, our findings also point to a number of further questions that we cannot attempt to answer here. It will have to suffice to raise them for future research. One such issue is why some countries that undertake all the stabilization and adjustment measures prescribed by the standard IMF/World Bank package still fail to grow. Could it be that there are elements in the Washington Consensus that act as obstacles to growth? Do austere fiscal and monetary policies serve as obstacles rather than as stimulants? To what extent should fulfilment of the targets set up be considered as necessary rather than sufficient conditions for growth? The signals emitted could be right, but it may still be the case that there is nobody to observe and act according to them. Entrepreneurship,

20

From crisis to growth in Africa?

for example, is a scarce factor in many countries, especially in the presence of risk. Thus, one of the recent studies by Collier and Gunning (1999b: 64) draws the following conclusions: Farm households have responded by devising institutions that have mitigated risk, by sacrificing income for security, and by retreating into untaxable activities, notably subsistence. Manufacturing firms have been less able to adapt and so have fared particularly badly. Drawing on the new literature on ‘social capital’, we argue that neither households nor firms have as yet sufficiently created the social institutions that constitute the social institutions that promote growth. If entrepreneurship is lacking, special measures may have to be devised to create it, presumably a long-term undertaking, but one without which no development would result. Lack of entrepreneurship constitutes a market failure. As our examples have shown, however, government failures continue to loom large. At the most fundamental level the willingness to change is completely absent. In other cases, halfhearted measures are carried out. This, in turn, may prove to be one of the explanations behind the inadequate response to policy incentives, i.e. it may be partly responsible for the absence of entrepreneurship, or make for weak responses when (for example foreign) entrepreneurship does in fact exist. Again, Collier and Gunning’s (1999b: 65) conclusions are worth quoting. For example: Product markets have been characterized by extensive government interventions through taxation, price setting, and public trading monopolies. Recently, many of these interventions have been reversed. However, such liberalizations have not been fully credible, and so the effect of controls has proved persistent. … Both a hostile environment, particularly high risks, and inadequate social capital, particularly dysfunctional government, have lowered the returns on investment. The low returns on investment have caused capital flight on a massive scale. Thus, in practice, government and market failures may turn out to be more interwoven than what appears to be the case at first sight. As William Baumol (1990) has pointed out in a celebrated article, entrepreneurs may be productive, unproductive (rent-seeking) or even destructive from the point of view of society, depending on the relative payoffs of the three different types of activities, and these payoffs are determined, among other things, by the rules of the game set up by the government. A concrete example of this was provided by one of the referees of the present volume: Borrowers will have an incentive to default when they know that they do not have the entrepreneurial skills to set up and run a business to earn profits greater than what they can gain by simply decamping with the money. The incentive rises when the legal system is weak and influenced by politicians. This is not corruption, but a rational response of the economic agents.

Introduction 21 It is unfortunately not the only example. On the contrary, many more studies are required on the interplay between rule-setting governments and economic agents responding to the rules. It is the very interplay that tends to make for the disastrous outcomes in many African countries.

References Baumol, William J. (1990), ‘Entrepreneurship: Productive, Unproductive, and Destructive’, Journal of Political Economy, 98. Blomström, Magnus and Lundahl, Mats (1993), ‘Introduction’, in Magnus Blomström and Mats Lundahl (eds), Economic Crisis in Africa: Perspectives on Policy Responses. London and New York: Routledge. Collier, Paul and Gunning, Jan Willem (1999a), ‘Why Has Africa Grown Slowly?’, Journal of Economic Perspectives, 13. Collier, Paul and Gunning, Jan Willem (1999b), ‘Explaining African Economic Performance’, Journal of Economic Literature, 37. Freeman, Richard B. and Lindauer, David L. (1999), ‘Why Not Africa?’, NBER Working Paper 6942. Cambridge, MA: National Bureau of Economic Research. Ndulu, Benno J. and O’Connell, Stephen A. (1999), ‘Governance and Growth in SubSaharan Africa’, Journal of Economic Perspectives, 13. Sender, John (1999), ‘Africa’s Economic Performance: Limitations of the Current Consensus’, Journal of Economic Perspectives, 13. World Bank (1998), Assessing Aid: What Works, What Doesn’t and Why. Oxford: Oxford University Press.

Part I

The war-stricken economies

2

Angola A history of oil, war and economic policy Renato Aguilar and Åsa Stenman

1 Introduction Modern independent Angola has a short but turbulent and chaotic economic history. To the dramatic consequences of almost permanent civil war and international military intervention, one should add the effect of disastrous economic policy. A main reason for this situation is Angola’s exceedingly rich endowment of natural resources. In fact, Angola is moving rapidly to a position as the main African oil exporter. The diamond industry is expected to reach a similar position shortly after a reasonable degree of security can be obtained. Angola’s modern history is filled with violence and shattered dreams. After independence most observers had high expectations about the future of Angola. The country is rich in natural resources and was expected to generate a positive development in quite a short time. For various reasons, the development since independence has taken another path. War has been the rule rather than the exception and three peace accords have failed to change that. The economy survives due to the incomes from a steadily expanding oil sector. However, the standard of living has deteriorated significantly for common people during the mid and late 1990s. Many observers have singled out the civil war surge after the 1992 election as a crucial event, both because of its unprecedented degree of destructiveness and because it started an accelerated deterioration of the public sector. Consequently, economic and political power is extremely centralized in the hands of a narrow group and there is a serious lack of transparency in public affairs. The lack of effective protection for human rights and democratic institutions has a serious and negative impact for the development of the civil society. The resurgence of full-scale civil war in December 1998, after the final capsizing of the Lusaka agreement, has again resulted in about 1.5 million displaced persons. Following previous experiences, this will result in increased urbanization and cause poverty in the main urban areas. It is not possible to expect the return of displaced persons to the rural areas, when the country faces one of the worst personal mine problems in the world and the government is unable to provide even minimal security. The outline of the chapter is as follows. After this introduction follows a section analyzing the main features of the macroeconomic development during the period.

26

From crisis to growth in Africa?

Section 3 discusses the economic policy pursued by the Angolan government and Section 4 analyzes future growth and development perspectives. Finally, Section 5 presents some concluding comments.

2 Macroeconomic development In this section we discuss the development of Angola’s main macroeconomic variables, mainly growth performance, inflation, exchange rate, fiscal accounts, the balance of the external accounts and, finally, the external debt problem. Economic growth Angola’s national accounts are based on a quite fragile database and all GDP figures published since 1992 are only provisional estimates. The estimations are roughly based on available budget information,1 and production data on crude oil, natural gas and diamonds. A long period of overvalued domestic currency and multiple exchange rates increases the difficulties in estimating many critical macroeconomic variables. The national accounts clearly reveal a highly skewed production structure. Angola’s economy exhibits a very high degree of concentration to the oil sector, a process called petrolarization by many analysts. This situation does not seem to improve, but rather to stabilize or even worsen. This is most obvious when we consider that oil production represents about half of the GDP but, for example in the case of other commercial services and other important sectors, a large share of these activities are also closely related to the oil sector. The two largest sectors after oil are commercial services (which, as we noted earlier, is heavily oil-related) and agriculture. However, there are many reasons to suspect that the level of agricultural production is overestimated. Table 2.1 shows that GDP, which had grown steadily during the late 1980s, dropped markedly in the aftermath of the 1992 election. This drop in GDP is a direct consequence of the surge of war that occurred then, and has been estimated to be of a magnitude of 25 per cent in 1993. From 1994 to 1996 the annual average

Table 2.1 GDP growth 1993–8 Year

Rate (%)

1993 1994 1995 1996 1997 1998

924.8 3.5 10.7 12.2 3.3 95.1

Source: Aguilar (1998).

Angola 27 growth was approximately 10 per cent. This growth is almost entirely, directly or indirectly, generated by the oil sector. In fact, non-oil economic activities could have shrunk during this period. Thus, Angola has developed an extremely dual economy, where the oil sector is an income-generating enclave but with very few spillover effects to other productive sectors of the economy. Recent estimates show that during 1997 the economy grew by 5 or 6 per cent and, as usual, it was the oil sector that generated most of this growth. The domestic economy grew very slowly. It is even possible that it contracted that year. In other words, the oil sector continues to grow while the domestic economy faces the depressive effects of fiscal and monetary policy and, lately also the effects of the resumed civil war. Inflation In 1991 important and largely delayed economic reforms were implemented. Wages were monetized and most prices were deregulated. This helped to adjust the system of relative prices, which had become extremely distorted. This liberalization attempt was followed by a severe inflationary surge. Inflation still continues to be a main issue for Angola’s economic policy. However, some price controls have been kept, and with the introduction of the Nova Vida program in June 1996 price controls once again became a favored policy instrument. Thus, Angola has suffered from high inflation, with several surges of hyperinflation during most of the 1990s. The two most important factors explaining Angola’s inflation are, probably, the lack of coherence and stability in economic policy and the inflationary financing of the large budget deficit. Table 2.2 presents the evolution of Angola’s inflation during the last few years. The seasonal pattern that can be observed in this table is closely related to the cycle that has characterized Angola’s economic policy during the last years. This cycle may be characterized by two seasons, one season at mid-year with lower levels of inflation and one season by the end of the year with higher levels. This is a consequence of the traditional practice of adopting an economic policy program by the end of the first quarter, and abandoning it during the third quarter of the year. An econometric study about Angola’s inflation, Aguilar (1995), suggests that apart from the obvious effects of money expansion, inflation seems to be strongly influenced by inertia and expectations. Studies from other countries show that this is common in high inflation economies and that this factor becomes increasingly important when the country faces a hyperinflationary event. The study by Aguilar also showed that the parallel exchange rate seems to be significant for the determination of prices, but the official exchange rate seems to have no effect on inflation. Thus, the government cannot find an argument in inflation for not devaluing the kwanza. In August 1996 the monthly inflation rate had been brought down to a one-digit level. The government used administrative price controls together with two main policy instruments to achieve this result. First, the budget was strictly controlled in the cash sense. Many payments implying money expansion were simply delayed,

28

From crisis to growth in Africa?

Table 2.2 Inflation rates 1995 Monthly January February March April May June July August September October November December Yearly CV

38.6 32.4 28.9 16.8 14.2 16.5 22.3 43.3 52.7 30.4 82.0 66.4 2,671.9 121.7

1996 12-month 1085.3 1302.2 1479.0 1477.2 1510.1 1654.2 1738.0 2041.0 2549.4 2591.9 3596.1 3783.4 — —

Monthly 36.0 22.5 34.9 51.9 84.1 61.8 38.1 9.4 5.0 2.1 0.7 5.5 4,143.5 65.8

1997

12-month

Monthly

12-month

3710.5 3425.2 3589.0 4697.8 7636.0 10644.8 12030.5 9165.0 6272.9 4889.4 2659.8 1649.5

7.9 2.2 93.5 3.2 0.9 0.5 1.3 6.5 6.0 7.4 6.1 12.9

1287.4 1057.5 728.0 462.7 208.5 91.7 40.7 36.9 38.2 45.4 53.3 64.0

— —

111.2 14.9

— —

Source: Aguilar (1998).

thus creating a huge domestic debt, which had clear depressive effects on the domestic non-oil sector. Second, the domestic currency was appreciated. Evolution of the exchange rate The price of foreign exchange is a central problem in Angola’s economic policy. Multiple exchange rates, a heavily overvalued domestic currency, rationed access and highly administrative methods for the allocation of scarce foreign exchange characterize foreign exchange markets. These factors encourage rent-seeking activities, speculation and corruption, which, in their turn, contribute to further inflationary pressures. In spite of many recommendations and failed attempts to reduce the gap between the official and the parallel exchange rates to a level under 5 per cent, this target has been achieved only for short periods, and is normally quite larger. As can be seen in Table 2.3, the exchange rate gap almost closed in June 1995, and once again in September 1996. This was the result of a consistent policy to achieve a more sustainable situation at the foreign exchange market. The kwanza was devalued from 6,024 to 31,378 kwanzas per dollar on 2 March 1995, and the fixing sessions at the Central Bank worked reasonably well. We can see how the exchange rates gap rapidly increased after the economic policy program was, once again, abandoned. During 1996 and 1997 the government continued with a passive exchange rate policy which resulted in an appreciation of the kwanza in real terms. This appreciation is estimated to be 13 per cent from December 1996 to December 1997, and 103 per cent since June 1995. The large overvaluation of the kwanza is clearly perceptible in

Angola 29 Table 2.3 Real exchange rates; Readjusted kwanzas per dollar; January 1994 prices 1995 Official January February March April May June July August September October November December Yearlya

44.87 36.14 29.56 28.75 63.26 71.00 60.52 56.28 50.15 52.43 29.41 17.31 100.2

1996

Parallel Gap 132.45 106.95 80.47 74.58 73.21 73.17 78.12 102.08 99.96 95.23 71.23 64.45

195.2 195.9 172.2 159.5 15.7 3.1 29.1 81.4 99.3 81.6 142.2 272.3

222.5

122.1

1997

Official Parallel Gap 12.73 13.64 50.12 40.55 34.15 46.62 43.55 39.79 37.88 37.11 36.86 34.94 109.3

72.45 78.56 72.16 66.52 86.41 70.86 52.81 40.50 38.44 41.12 41.82 41.61 140.3

469.2 476.1 44.0 64.0 153.0 52.0 21.2 1.8 1.5 10.8 13.5 19.1

Official 32.40 31.70 32.85 31.83 31.54 34.70 40.81 38.33 36.15 33.65 31.70 32.79

28.3 97.0

Parallel Gap 42.52 37.33 33.10 33.93 37.59 39.46 45.36 50.81 47.92 43.75 38.04 37.71 116.1

31.3 17.8 0.8 6.6 19.2 13.7 11.2 32.6 32.6 30.0 20.0 15.0 19.7

a At average 1994 prices. Source: Aguilar (1998).

the market and affects the competitiveness of domestic production, effectively hindering the development of non-oil exports and fostering imports. The main reason argued by the government for the appreciation of the local currency is the use of this variable as an instrument for reducing inflation. Certainly, there is a clear relationship between the level of prices and the nominal exchange rate in the parallel market in Angola. However, the use of the official exchange as an instrument to fight inflation rate is illusory. As mentioned earlier, empirical studies show that there is an exceedingly weak relationship between the official exchange rate and the level of prices, or even none at all. It is the parallel rate that determines the level of prices.

Public finances There are many problems in collecting reliable data on public revenues and expenditures in Angola. First, the records are weak and incomplete. Second, fiscal accounts cover only the central government, provincial governments and a number of municipalities. Public enterprises are not included, nor are several autonomous funds because they simply lack proper accounting. Third, many times the communication between the Ministry of Finance and the Central Bank fails. There is in fact a complicated and non-transparent relationship between the Central Bank, the Ministry of Finance and the SONANGOL, the public oil company. This relationship has been a major contentious issue with the international financial institutions and the donors. One important consequence of the problems mentioned above is the existence of large flows of public funds outside the budget, and in a quite non-transparent way.

30

From crisis to growth in Africa?

Estimations in 1996 showed that these flows could be of a magnitude comparable to the published budget. Summing up the arguments above, there are three main factors explaining why it is difficult to make a complete evaluation of the budget outcome: 1

2

3

There are revenue flows, mostly foreign exchange, that are not accounted for by the Treasury. These revenues are used to pay for non-accounted expenditures by public entities. Debt contracts are signed by public entities outside the normal procedures of the Treasury, mostly by the SONANGOL or through the commercial activities of the Central Bank. Incomplete accounting of the short-term external debt makes it difficult to get a complete picture of the total debt and the extent of the accumulation of arrears.

By comparing the programmed and executed budgets for 1997, we can observe that they differ not only in terms of the levels, as expected, but the structure is also significantly different. That is, the priorities originally set up by the budget are not respected during the execution. Most often, ambitious targets proposed in the budget are exceedingly difficult to achieve. For example, the budget proposed in 1997 that about 20 per cent of expenditures would go to investments, but only 1.6 per cent could be applied to this purpose. Lack of basic information and this dynamic execution of the budget hinder us to present a reasonable sectorial distribution of expenditures. For example, the execution figures include a large item called Government Program. Little is known about these expenditures. We know that a large amount of diffuse subsidies and current expenditures are included here. We also suspect that some investment expenditures have been recorded here. Anyway, this large item makes it almost impossible to estimate a reasonable sectorial distribution until these expenditures are properly classified. Table 2.4 presents an assortment of selected fiscal indicators. Angola has a surprising fiscal situation with a primary surplus (without interest payments) of 6.5 per cent of the GDP on a program basis, and 13.6 per cent of the GDP on an execution basis. However, the country has a global deficit equal to 12.7 per cent of GDP on a program basis and a staggering 18.7 per cent of GDP on an execution basis. These results imply that the main problem of Angola is of fiscal nature. Moreover, the main problem is not the lack of financial resources but the inadequacy of financial management. This problem originated in economically inefficient and excessively large projects, many, but not all of them, related to war, an inadequate management of the external debt, and the lack of a coherent and well-coordinated strategy for the management of this debt. External balance Export revenues depend almost exclusively on oil. Oil will, probably, continue to be the main source of revenues for all the foreseeable future. However, diamonds could

Angola 31 Table 2.4 Selected fiscal indicators 1997

Nominal GDP (billion kzr) Nominal GDP (million dollars) Percentage of GDP Global deficit Cash deficit Primary deficit Current account deficit Total revenues Oil revenues Taxes Non-oil taxes Total expenditures Investments Investments/total expenditures

1998

Program

Review

Executed

Program

1,779,096

1,779,096

1,779,096

2,854,651

7,774

7,774

7,774

7,908

99.7 99.7 6.5 5.9 29.3 23.8 19.5 4.1 39.0 5.5

912.7 99.7 6.5 2.8 29.3 23.8 19.5 4.1 42.0 5.5

918.7 916.6 13.6 11.9 33.0 0.0 20.2 0.0 51.6 0.8

98.9 98.9 16.5 15.0 39.6 28.4 24.0 0.0 48.5 9.8

14.1

13.1

1.6

20.2

Source: Aguilar (1998).

become a strong second export item in the near future. The South African company de Beers estimated total sales of Angolan diamonds in 1998 to be worth about 600 million dollars, with the ENDIAMA (the Angolan public enterprise) accounting for 120 million, UNITA for 320 million and other sources for 160 million. See EIU Country Report, 2nd quarter, 1996. Angola continues to have a positive trade account, due to high oil export earnings, but the country also has a large deficit in their service account (the two major components are transportation and travel and payments to oil-sector-related consultants and service companies); this erodes the positive trade balance. Combining this with a negative capital account (mostly debt repayments) makes Angola end up with a balance of payments deficit of around 1 billion US dollars. This deficit is almost completely financed by the accumulation of arrears, which constantly worsens Angola’s position towards international creditors. External debt Angola’s medium- and long-term external debt is now reasonably well documented. The most important problem with this debt is not its size but its exceedingly short profile. Information on the short-term debt is incomplete and partial. It is difficult to collect data on this debt because many government agencies incur in debt outside the control of the Central Bank or the Treasury. The cost of this short-term debt is exceedingly high and backed by oil. However, it is obvious that Angola has continued to accumulate arrears as a means of financing its deficit, and the country is now,

32

From crisis to growth in Africa?

in principle, excluded from the regular international financial market. In general, the only loans available are very expensive short-term credits with oil warranties in the marginal financial markets. These oil warranties heavily decrease the amount of available foreign exchange, thus restricting the room for economic policy in the future. Considering Angola’s export earnings, the external debt should not be a major problem, but the profile of the debt is such that it becomes a serious burden and an obstacle to the attempts to decrease the balance of payment deficit. Today, most of the debt (a rough estimate is 80–85 per cent) is arrears.

3 Economic policy In this section we will analyze some of the most important features of economic policy in Angola focusing on the different policy programs presented by the government in the mid and late 1990s. Main policy events As mentioned in Section 2, an economic policy cycle has developed in Angola. This cycle is characterized by the introduction of a policy program in the first quarter of the year followed by a short period of implementation. Subsequently, the program is abandoned during the third quarter of the year, which usually leads to a serious economic crisis and high inflation by the end of the year. After the economic reforms actually began in September 1990, economic policy has been non-systematic and based in vague documents stating only a few ideological or philosophical ideas. In 1994 a group of economists and civil servants were able to produce the first systematic policy program ever in Angola. This document later became known as PES94 (Programa Económico e Social ). The economy responded adequately to the program but following Angolan practice it was abandoned in the third quarter of that year. The program introduced in April 1995, PES95/96, was mostly a re-edition of PES94 and introduced only a few new elements. The design and introduction of the program are closely related to the solution of a political crisis, including the substitution of the Minister of Finance and the Governor of the Central Bank, and a marked shift of functions from the Ministry of Planning towards the Ministry of Finance. This crisis considerably delayed the implementation of economic policy during 1995. Moreover, the reasonable level of coordination that had been achieved among the technical staff in the Central Bank, the Ministry of Finance and the Ministry of Planning was lost. In fact, the technical staff that in the past was able to prepare economic policy programs and negotiate with the IMF was mostly disbanded or abandoned the public service or the country, or became totally unmotivated. Thus, the country seems to have suffered important losses in its capability for economic management. Possibly the main policy event of the period was the launching of a Staff Monitored Program, based on the PES95/96, and its subsequent suspension by the

Angola 33 IMF by the end of 1995. We discuss this program in the next subsection. As is traditional in Angola, we could observe some policy activity in the second and third quarters of 1995. This pattern begins with a period of discussions and preparation on an economic policy program during the first quarter. The program is usually launched in April. After a period of vacillations and delays, some of the policies are implemented, usually in the form of large shocks on the economy, and with poor coordination. During the third quarter, there are a number of political interventions and policy reversals originating at the highest levels within the government, and the program is abandoned. Thus the country lacks a program in the fourth quarter and the year ends in a deep economic crisis including the highest monthly inflation rate observed during the year. We want to stress the idea that the system of generalized price subsidies is a central feature of the economic crisis affecting Angola. First, these subsidies are clearly regressive and have a negative social effect. Through the associate inflationary mechanisms they are capturing resources from the most exposed sectors of the population and channeling them to the most well-to-do sectors. Second, these subsidies cause a serious distortion in the allocation of resources, affecting negatively the overall efficiency of the economy. Finally, they impose an unbearable burden on the budget. At the beginning of 1995 it was clear that Angola’s currency system had become increasingly cumbersome and inefficient because of inflation. The cost of reposition of bank notes was already significant; transaction costs, in an economy dominated by cash operations, were too large; and several liquidity crises occurred because of bank notes scarcity. Thus, the government changed the currency, novo kwanza, for the kwanza reajustado in 1 July 1995. The exchange rate was 1,000 to 1, eliminating three zeroes. No liquid balances were confiscated as in the previous changeover. However, the exchange rate was too low and the currency system is again showing symptoms of obsolescence due to extremely high inflation. During 1998 the schedule for fixing sessions at the Central Bank has become quite irregular and only small amounts of foreign exchange have been allocated by this mechanism. Foreign exchange allocated to the free market has been practically null during the last few months. The Central Bank has started deciding the exchange rate, and the shares of each bank. During the last fixing sessions, the bank even decided which clients within the commercial banks would be allocated foreign currency. Thus, the fixing mechanism has become, in practice, a mechanism for the administrative allocation of foreign exchange. The introduction of foreign exchange auctions was formally approved in April 1998. However, they were continuously postponed, and it is highly unlikely that the new government would take up this idea. The relationship with the IMF The signature of a peace agreement at Lusaka on 20 November 1994 had a positive and rather optimistic response from the international financial institutions and among some donors. However, domestic economic agents had a less enthusiastic response in view of the previous experiences with the Bicesse Agreement, and the difficulties and continuous delays in the Lusaka Agreement.

34

From crisis to growth in Africa?

The situation seemed to become more stable with the introduction of a new policy program: PES95/96. This new program was basically a re-edition of PES94 and its implementation was delayed. The first significant measures were taken only in June 1995. In spite of these contradictory and fuzzy signals from the government, the IMF adopted a rather optimistic attitude and, in July 1995, issued a set of targets and proposed a number of policy measures broadly based on the PES95/96. These targets and policy measures could be interpreted as a kind of shadow program or prior actions that could lead to an ESAF, possibly in 1996. It is difficult to understand the optimism of the IMF that led to the start of the Staff Monitored Program. There were not as many elements as in the similar situation of 1994. On the contrary, it was increasingly clear that the situation was worse, with the reformists rapidly losing positions within the government, and the orthodox opinion assuming more aggressive positions. Even though some support for the program could be found among the ministries of the economic area, it was clear that the government had no political will to proceed with the necessary reforms and policy measures. Three issues may be sorted out as crucial for the impact of the IMF Staff Monitored Program: the exchange rate policy, the government subsidies, and the lack of transparency in the transactions between the Central Bank, the Treasury and the SONANGOL. The gap between the parallel and the official exchange rates should, according to the program, be kept within 15 per cent. The subsidies of gasoline should be cut so that the price per liter would correspond to 25–30 US cents by December 1995. The gain from decreased subsidies on gasoline and diesel fuel would then allow them to maintain subsidies on cooking gas and kerosene that are crucial products for lowincome households. The lack of transparency in the transactions between the Central Bank, the Treasury and the SONANGOL would be tackled by the introduction of a special oil account (conta petróleo) before September 1995. These targets were complemented by a policy package containing measures in the fields of fiscal policy, monetary policy, balance of payments, social sectors and economic information. A technical mission from the IMF visited Luanda in November and December 1995 in order to evaluate the implementation of the Staff Monitored Program. They concluded that Angola continued to suffer from high inflation caused by a huge fiscal deficit that had been automatically financed by the Central Bank through money emission and credit expansion. All this led to the collapse of confidence in the kwanza and an increasing dollarization of the economy. Furthermore, the mission expressed its preoccupation that several important preconditions for implementing the stabilization measures were not met. There was no political consensus about the importance of stabilizing the economy, and the policy implementation capacity had decreased below the necessary level to accompany the policy measures. The IMF mission also complained about the lack of quantitative information and the state of the public finances. None of the important targets set out in the program from July had been fulfilled. Several indicators had instead deteriorated; two examples of this were the exchange rate gap and the credit expansion, not to mention the resulting inflation rates. The Staff Monitored Program was suspended until the government could show a better performance.

Angola 35 The Nova Vida crisis The President, in a speech held on 3 June 1996, dismissed the whole government. The speech by the President, announcing the dismissal of the government on June 3, together with the nature of the changes actually made in the government clearly stressed that the target was a change in the orientation of economic policy. This crisis was expected and was clearly necessary to break the paralysis observed in the government during the last few months. A clear aim could be to restore confidence in the government’s handling capacity. However, the President clearly exceeded this target when he, in his speech, included a number of ideas that amounted to the core of a new economic policy program. In this sense the crisis might be interpreted as a victory of the most conservative sectors within the government and the Party over the reformist sector, mostly represented by the technical staff. Thus, it is quite clear that the problem is not technical but political. What was needed was a profound discussion and effort aimed at solving two main problems. One is the building up of a broader consensus within the government about the policy consequences of the country’s basic decision in order to move towards a marketoriented economy. The other problem was the creation of proper mechanisms for designing and implementing economic policy. Executive decisions should be clearly separated from policy and political decisions. Trade with foreign exchange acquired at the open market (operações com recursos próprios), and often by foreign traders generically denominated Lebanese, was seen as the main cause of inflation. This is surprising because this foreign exchange open market, with the trading of some tourism money, some remittances of emigrated workers and, especially, money coming from diamond smuggling, was significantly expanding Angola’s import capacity. On the other hand, the free Lebanese traders added a small measure of competitiveness to the extremely oligopolistic market. Thus, it is easy to see that the effect of these operations is rather deflationary than inflationary, contradicting the government’s assumption.

The worsening policy environment The environment for policy design and implementation has been worsening rapidly. An important element of this development is an increasing and dangerous degree of centralization within the government. More and more decisions, even on quite irrelevant details, have moved to the Council of Ministers and the Presidency. Thus, the ministries and general directorates are becoming more and more irrelevant. At this moment they are just passive bureaucratic institutions, without real power and capacity to define and implement policy. The National Assembly lacks the experience and capacity to counteract these centripetal forces. Hyperinflation and the lack of a consistent wage policy are destroying the state. Many critical public servants are leaving the state or have decreased their productivity and engagement. The repeated political interference and abandonment of the programs have also taken its toll within the technical staff. Many public servants within the technical staff became dismayed when they observed that their work was

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From crisis to growth in Africa?

useless and wasted because of unjustified political interference. Moreover, hyperinflation makes public expenditure erratic and inconsistent. In fact, the state has serious difficulties in keeping the expenditure levels in real terms. In this sense the Angolan state is shrinking and losing control of its leading role over society. Economic policy and peace Besides the external emergency assistance, there is a need to do something drastic in poverty alleviation, and the reconstruction of the educational and health care systems. Thus, the consolidation of the Lusaka Agreement and peace in Angola depends on the solution of a number of rather difficult problems, demanding a radical resource reallocation and the availability of additional resources, both domestic and external. There are, then, clear implications for economic policy in the needs and conditions imposed by the peace process. On the other hand, what can be achieved in this process depends, to a large extent, on the successful implementation of proper economic policy and the creation of a relatively stable macroeconomic environment. Thus, after the war it is necessary to win the peace. There is a close relationship between economic policy and the peace process. It is clear that peace liberates important resources previously wasted in the military effort, and that new opportunities are open for economic policy. On the other hand, there are a number of negative effects in the confusing situation faced by economic policy in Angola today. For example, the negative distributive effects implicit in a foreign exchange policy, with administrative allocation of resources, multiple exchange rates and overvalued domestic currency, reinforce the enormous damage made to the social sectors by war. The same effects make the task of reallocating resources to proceed with the peace process impossible. Similar effects may be caused by high inflation. When discussing the recuperation of the agriculture we want to stress a number of basic ideas that are critical. First, it is necessary to realize that it is possible to recuperate the agriculture, both in the short term as rapid food and employment response, and in the medium and long term as a source of export revenues. In fact, there is an enormous potential in Angola’s agriculture. This is easily understood considering the statistics of the colonial period, when Angola was an important coffee exporter. It is easy to see that Angola’s agriculture could easily generate an important positive trade balance. However, economic policy in Angola has traditionally had a strong pro-industry and anti-agriculture bias. The enormous overvaluation of the domestic currency was at least as important as war for the destruction of Angola’s agriculture. Second, there are several obvious factors determining the recovery of the agricultural sector. For example, mines are a serious hinder for the development of agriculture. Destroyed transport infrastructure is another important obstacle. Finally, Angola’s agricultural system cannot be restored without regaining a minimal level of economic stability. Agricultural systems, with exceedingly long productive cycles, are often the most exposed sectors to the destructive effects of inflation. The present macroeconomic environment, characterized by hyper-inflation, an

Angola 37 overvalued domestic currency, and the absence of a working financial system, is a very serious obstacle to the development of agriculture. The solution of these problems will require enormous amounts of external financial resources. An effective access to these resources can only be achieved through economic stabilization. Thus, the macroeconomic environment is a crucial obstacle in the consolidation of peace. Though the present situation is exceedingly serious and requires a high prioritization of emergency assistance, we must realize that there is a clear risk of marginalization of large sectors of the population. Moreover, it is also clear that the sources for emergency funds will be open only during a short period and then they will dry out. Thus, it is important to emphasize the need to include programs aimed at more permanent solutions. For example, it is important to emphasize poverty alleviation through employment creation, or emphasize the reconstruction or creation of selfsustained systems in health and education. Once again the main obstacle, besides the war, to reaching these targets is the macroeconomic environment.

4 Policy considerations and options for the future This section is devoted to different views regarding Angola’s economic policy at present and the options open for the future. We try to bring forward a few strategic comments from the international community’s point of view as well as from Angola’s point of view.

The leadership of economic policy In Angola, there is often a shift in the leadership of economic policy between the Ministry of Planning, the Central Bank and the Ministry of Finance, when the ministers or the policy program are altered. This is one of the symptoms showing the very weak institutionality of the public administration. Another important factor for the implementation of policy programs is the relationship between key ministries, the government and the Presidency, the main center for decisions in Angola. There is still a severe lack of technical staff able to implement and control the orientations of economic policy. The statistical basis is still weak and little progress has been made in this area. Moreover, the government has failed to benefit from several important capacity building projects in course, such as PREGE, PMFI, etc. Furthermore, it has failed to signal a clear interest in these projects, which have already proved to be able to contribute to the solution of Angola’s problems. In spite of the obvious difficulties with the Nova Vida program, the government is still reluctant with regard to the issue of economic reforms, prioritizing administrative controls. Very little has been done to help the economy in its way to a market-oriented economy with a large and dynamic private sector. The government is too focused on the monetary policy, delaying measures focused on the structural causes of the fiscal deficit, especially in the case of the external debt and the Public Investment Program.

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From crisis to growth in Africa?

Additional external shock During 1997 and 1998 Angola faced a severe external shock in addition to the serious problems mentioned above: exhaustion of policy instruments, institutional weaknesses and political difficulties in the implementation of policies. The external shock originates in the deep fall of the international price of oil, from about 18 dollars per barrel to about 12 dollars. As oil exports is the main financial source of both the public sector and the balance of payments, this constitutes a very severe financial crisis. The projections made by the Central Bank, based on a price of 15 dollars per barrel, include financing needs of about 1.4 billion dollars, over and above 500 million dollars of arrears accumulation. At the price of 12 dollars per barrel, these financing needs would easily approach 2 billion dollars. The strategy adopted, attempting a bilateral rescheduling of the external debt, is simply too slow. On the other hand, a financed program with the international financial institutions is still far off, even if negotiations would start at once. Thus, the country is obliged to continue borrowing abroad and to implement deep cuts in the budget. Angola is not in a good position to borrow abroad or to significantly reduce public expenditures. Its position and record in international financial markets is not good. Thus, the country can borrow only to a limited extent and at exceedingly high interest rates. The marginal rate of interest must be exceedingly high.

Options for the future It is increasingly clear that the period in which the government could contain inflation mainly, and almost exclusively, through the use of monetary instruments was coming to an end in 1998 when these instruments were close to being exhausted. The levels reached by the domestic public debt and the repeated delays in the payments of wages prevent the continuation of a strict cash control of public expenditures. The loss of international reserves and the increasing level of imports will surely force an active exchange rate policy. In addition, an external shock caused by low international prices of oil caused a crisis in the balance of payments. Although the government had already signaled its willingness to start a crawling peg with small weekly devaluations during February 1998, this devaluation process had not yet started by mid-March the same year. Most possibly, this policy was faced with strong opposition within the government, which blocked the efforts of the powerful Ministry of Planning and the Central Bank. Thus, we are afraid that these devaluations will be further delayed and replaced in the future by a massive one, which will destabilize the financial system again. It is highly dubious that Angola has the capacity and the necessary discipline to implement a crawling peg. On the one hand, there are endless discussions of each devaluation in the Council of Ministers. On the other hand, the foreign exchange market is quite small, with a reduced number of large operators with close links to the government. Thus, a programmed crawling becomes a tablita system, where the agents can easily discount the effect of the devaluations, even in the medium term, creating further inflationary expectations.

Angola 39 A major strategic issue faced by Angola regards the external debt. The government is giving ambiguous signals in this field. Recent visits to Portugal and Spain, the two main creditors, suggest that the government is trying to reach a broad rescheduling on a case-by-case basis, and outside the Paris Club. This strategy would avoid an arrangement with the international financial institutions, which are considered by many government members as politically too costly and undesirable. On the other hand, the government still wishes to keep an open door towards the international financial institutions, but they are obviously giving priority to a solution without the international financial institutions. This strategy is unlikely to succeed. There are several reasons for this. In fact, the levels of the debt and the levels of exports make the rescheduling on case-by-case basis plausible prima facie. We should also note that a direct partial rescheduling is more expensive and less advantageous than the Paris Club rescheduling. The rescheduling of the Russian debt is a good example. Successful rescheduling on a case-by-case basis requires negotiations and a debt management with a level of sophistication that Angola simply lacks. Finally, the leverage and clout that Angola has in the international financial system is limited. Angola’s main argument is an increasing potential for output growth in the oil industry. Thus, the most probable outcome is a rather limited success, possibly based in new mortgages on oil. Thus, the relationship with the international financial institutions seems still to be a crucial strategic issue. An important element in a possible arrangement with the international financial institutions, beyond the implicit financial relief, is that it will bring the necessary coherence and discipline to economic policy. However, the government is still afraid that such a program will have a very high political price.

5 Conclusions Summing up, we draw two main conclusions. First, the central problem of Angola’s economy is not economic but political. The country has the resources and the minimum technical staff to change the situation radically in a short period. What is needed is political consensus and political will within the government. Second, the economic situation is dangerously bad. The education and health systems are destroyed, even in zones not affected by war. The state is seriously degraded. Hyperinflation, erroneous foreign exchange policies and a biased subsidy system have created an enormous distortion in the distribution of income. Poverty levels and the degree of social dissolution observed today in Luanda make us issue a warning for a possible social explosion. In many senses Angola is an example of how damaging an exceedingly large endowment of natural resources could be. Most of Angola’s problems originate in oil and diamond and the struggle to control them. Twenty-five years after independence Angola produces almost only oil, diamonds and a few services closely linked to oil. Thus, the control of oil that the government has, gives it an enormous power to control the whole society. The control that UNITA had at a time over diamonds gave them the power to challenge the government during a long period of time.

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In some sense Angola has developed almost a pure rent society. In this system, an isolated sector, oil, produces enormous rents that are distributed among the population. In the case of Angola the redistributive process occurs through state subsidies and multiple exchange rates. Unfortunately, this distributive process is non-transparent and highly skewed in favor of the richer part of the population.

Note 1 This is a rather unreliable source of information in the case of Angola.

References Aguilar, Renato (1995), Consultoría sobre Política de Preços, Final Report, Ministry of Planning and Economic Coordination, PREGE, Luanda, May 1995. Aguilar, Renato (1998), Angola, More Oil and Financial Problems, Department of Economics, Gothenburg University, Sida, Country Economic Report, 1998: 5. Aguilar, Renato and Stenman, Åsa (1993), Angola 1993, Back to Square One?, Department of Economics, Gothenburg University, SIDA, The Planning Secretariat, 41/93. Aguilar, Renato and Stenman, Åsa (1994), Angola, Trying to Break Through the Wall, Department of Economics, Gothenburg University, SIDA, The Planning Secretariat, 54/94. Aguilar, Renato and Stenman, Åsa (1995), Angola 1995, Let’s Try Again, Department of Economics, Gothenburg University, Sida, Macroeconomic Studies, 1995: 63. Aguilar, Renato and Stenman, Åsa (1996), Angola 1996, Hyper-Inflation, Confusion, and Political Crisis, Department of Economics, Gothenburg University, Sida, Macroeconomic Report, 1996: 11. da Rocha, Alves (1996) Economia e Sociedade em Angola, Algumas Reflexões Pontuais, Luanda, June 1996. Government of Angola (1997a), Programa de Política Económica e Social do Governo para 1997, Luanda, April 1997. Government of Angola (1997b), Programa de Estabilização e Recuperação Económica de Médio Prazo. 1998–2000, Luanda, November 1997. Government of Angola (1997c), Orçamento Geral do Estado. 1997, Luanda, June 1997. Government of Angola (1997d), Orçamento Geral do Estado. 1998, Luanda, December 1997. International Monetary Fund (1997), Angola – Recent Economic Developments, Washington, DC: International Monetary Fund. INE (1996), Perfil da Pobreza em Angola, Luanda: INE. INE (1997a), Indicadores do Comércio Externo. 1992–1995, Luanda: INE. INE (1997b), Indíce de Preços no Consumidor, Cidade de Luanda. Dezembro 1997. Luanda: INE. Ministério do Planeamiento, República de Angola, Estudos sobre a Economía Angolana, Boletim Trimestral No. 3–4. United Nations Development Program (1997), Human Development Report, Angola 1997, Luanda, 1997.

3

Guinea-Bissau A rocky road to reform and stability Renato Aguilar and Åsa Stenman

1 Introduction At the end of the second millennium, the young nation of Guinea-Bissau is on an inflexion point of its economic history. The country recently went through a severe political and military crisis, causing extensive material damage, reorienting public expenses, interrupting investments, and generally affecting economic activity negatively. Crises like this force us to rethink the problems and options faced by the country. Reconstruction will take place in a different political and institutional framework. Thus, it is necessary to discuss the institutional framework and reexamine the main lines of development followed until now. On the other hand, a new situation opens new spaces to the design and implementation of economic and development policy. The discussion of the main problems and options faced by Guinea-Bissau today is the main aim of this chapter. We make just a few reflections about the recent events in Guinea-Bissau and the possibilities open for the economy and international aid to this country. The main limitation of this document derives from the scarcity of data and information about what is really happening in Guinea. The recent political and military crisis meant a serious interruption in the normal flow of economic data and information. Previously, and given the country’s precarious degree of development, the availability of data was quite limited. In that sense the crisis was simply a worsening of an already bad situation. This document was elaborated with the information collected outside the country, and with a few observations and pieces of data that some kind friends in Bissau succeeded in sending us. When we wrote this, the hardest aspect of the crisis seemed to have already been solved. However, there are important political processes that are still unfolding in Guinea-Bissau. In this sense the outcome of the recent election is exceedingly important. The stability and ability of the new government to survive under President Kumba Yalá is still an open issue. Section 2 involves a discussion of the economy before the crisis. The good performance shown in the previous period will, surely, be very important to ensure adequate flows of international financing and provide a starting point for future development. We continue with a short discussion of the consequences for the economy of the recent political and military crisis. Guinea-Bissau is an exceedingly poor, small, and

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underdeveloped society. These characteristics are crucial for the consideration of the problems and options that the country faces. These are the main topics of section 4. Finally we discuss some of the possible options that are open for the country.

2 The economic situation before the crisis When the political and military crisis that ousted President Vieira erupted, GuineaBissau’s economy was going through one of its best periods since independence, and probably within recorded economic history. With this we do not mean that GuineaBissau’s main problems were solved, but that the country had been capable of developing a set of feasible and relatively efficient economic policies that could move it towards a more permanent solution. Besides a reasonable and probably sustainable rate of growth, several other positive indicators could be mentioned. Table 3.1 shows growth rates during the short period covered by available National Accounts. The sustainability of growth was still fragile and critically dependent on both internal and external factors. Internally, the impending approval of the Land Law, which would formalize property rights in the countryside, was important for continued agricultural expansion. Another signal that allowed us to forecast future growth was a sustained building boom, a common phenomenon in the earlier stage of growth in similar countries. On the other hand, Guinea-Bissau was still highly dependent on external financing, with donors whose behavior was often erratic and unpredictable. There were also clear signals that suggested an increased interest by foreign investors. There was an important effort to improve fiscal discipline. A sharp increase in public revenues was the main consequence of this effort. On the other hand, there was a significant improvement in the control of public expenditures and the generalization of formal budgetary procedures. Especially important was the sharp reduction observed in undocumented expenditures, a chronic problem in Guinea-Bissau’s public sector. Table 3.2 shows the success of the effort in improving public revenues. Thus, fiscal revenues exceeded the targets of the program agreed with the international financial institutions, reaching 15.5 per cent of GDP. The primary budget balance1 also exceeded the targets with a healthy 6.3 per cent of GDP, even despite expenditures that slightly exceeded the program. It is easy to see the effects of this effort. The government could improve real wages in the public sector and pay them in a timely fashion during the last few months of 1997. However, the total wage bill Table 3.1 GDP growth rates 1991 1992 1993 1994 1995 1996 1997

5.0 1.6 1.2 3.2 3.8 5.1 5.4

Source: Aguilar (1998).

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Table 3.2 Quarterly fiscal revenues, 1997

Tax revenue Non-tax revenue Total

I

II

III

IV

Total

10.5 13.6 11.9

15.2 6.1 11.0

26.1 11.7 19.3

48.2 68.6 57.8

100.0 100.0 100.0

Source: Aguilar (1998).

was below the programmed limit because of further advances in the cleaning2 of the public servants roll. For the first time the government was able to finance a number of small projects with its own resources. A long-term work at the Ministry of Planning succeeded in trimming the Program of Public Investments to a more reasonable size and content. A number of projects deemed beyond the country’s management capacity or with unclear financing were dropped. Thus, public investments got an enhanced efficiency level. As investments in Guinea-Bissau are mostly public investments, this meant an overall enhancement of investment efficiency. After a short but serious crisis, cashew exports resumed and were growing at a steady and promising rate. Revenues derived from the fishing sector also increased, both because of fishing licenses and some own export of fish. Thus exports were on a quite promising path and a much needed narrowing of the trade deficit appeared possible. At the outbreak of the war, Guinea-Bissau was witnessing a construction boom. Many small private building projects could be observed in Bissau as well as in other cities. This sector showed one of the highest sectorial growth rates, improving its share of GDP. This feature, a booming construction sector, is typically a feature of a successful structural adjustment. However, not only the construction sector was growing. There were signs of increased economic activity in a broad array of sectors. The cashew industry was growing in terms of the volume of exported raw cashew, because a number of very small and simple processing units had started operations at Bissau. These plants were quite small and simple, but significantly important for Guinea-Bissau’s economy. It is interesting to note that the equipment used in these small plants was partially produced locally. A much needed public service reform was under way. This reform succeeded in introducing a new registration and enumeration of public servants, and also new wage payment routines making phony employment more difficult. This reform was successful enough to open a financial space to improve wages of the public servants. A number of critical infrastructure projects were completed or close to starting. These projects were located mainly in the transport sector, clearly one of the most serious weaknesses of Guinea-Bissau’s infrastructure. Especially important was the new net of roads and the bridge connecting Bissau with Bula and Cacheu, and further north to Senegal and Gambia. Possibly the most important achievement was eligibility to the HIPC (Highly Indebted Poor Countries) initiative. In the framework of this initiative, the international financial institutions offer considerable multilateral debt relief to a group of highly indebted poor countries. These countries must qualify for these benefits by

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showing a good performance in a policy program. In fact, the country was very close to being selected for the HIPC initiative. Given the structure of GuineaBissau’s external debt, this would mean a write-off of a sizeable part of it. Inclusion in the HIPC initiative opens the first real possibility of solving the balance of payments problem in the foreseeable future. Previous performance suggests clearly that the country could have been successful in complying with the conditionality associated with the HIPC. See, for example, Aguilar (1998).

3 The damage of war We have seen only a few reports quantifying the extent of damage caused by war in Guinea-Bissau. However, war, and in particular civil war, has often damaging effects on the infrastructure, the economy and society. In this case there were a number of violent confrontations, fortunately mostly limited in time and affecting mainly urban areas. Thus, war caused between 2,000 and 6,000 victims. The country now has about 11,000 land mines, most of them around Bissau. Capital loss can be estimated to be about 90 million dollars in the private sector, and about 30 million dollars in the public service. A lot of urban infrastructure was destroyed during the military operations, mostly in Bissau, possibly about 5,000 houses. However, Guinea-Bissau’s exceedingly low level of infrastructure development made this destruction less important. Possibly the delay of several important infrastructure projects was more damaging than direct destruction of infrastructure. GDP dropped by 28 per cent during 1998. The interruption of international trade caused by war was very serious. Exports decreased from 49 million dollars in 1997 to 27 million in 1998. This could have caused long-term effects on the net of market contacts recently developed. Thus, we should not only consider the direct loss of export revenues but also possible difficulties in reestablishing lost contacts. Guinean traders, previously excluded by tightly knitted international Indian traders, only recently explored these markets for cashew. These contacts could have been negatively affected by the conflict. The public service was affected by war. Guinea-Bissau depends on a thin layer of qualified public servants to reach a minimal level of efficiency in the operation of the state. A few of them were on the wrong side when the conflict ended. Others took the often-delayed decision to emigrate. Public service routines were interrupted. Thus, the general efficiency of the public service was severely deteriorated by war. Discipline and controls were relaxed, critical cadres were lost, and routines were interrupted with loss of data and control. The ambiguous position of the military, now with a paramount influence on public affairs not clearly spelled out in the constitution, could have quite negative effects for public expenditures.

4 The present situation One of the main problems of the present situation is a duality of power. On the one hand, there was an effort to follow, as much as possible, constitutional procedures

Guinea-Bissau

45

aimed at gaining international legitimacy. This process produced the interim Presidency of Malam Bacai Sanhá and his government and, later on, a general election and the Presidency and government of Kumba Yalá. However, the hard fact that Asumane Mané is a successful military leader that recently won a major armed domestic confrontation subsists. In these conditions it is difficult to think about fiscal discipline and a coordinate development effort. There is some degree of uncertainty about the constitutional position of Brigadier Mané. Approbation of the constitutional figure of co-President for Brigadier Mané formally solved the problem for a while. However, there still is a duality of power that could introduce further difficulties in the task of leading the country into sustained development. After victory, there were no clear signals from the military if the movement led by Brigadier Mané would be translated into a civil project for the country to be submitted to the people at the elections. The political parties were in disarray and suffering from internal strife. However, the election took place along older political divisions, mostly unresolved by the previous one or by the political and military crisis. Economic and social policy was never an issue during the conflict. This recent civil war can be considered as a conflict between two very powerful men that went out of control. The main reason for the dimension of the conflict was an increasing feeling of exclusion and social injustice in the population. Guinea-Bissau’s public sector has problems. Some cadres left the public service and even left the country. Data were lost, and routines and controls were interrupted. Computers containing important information disappeared during the confusion. Thus, the already low level of efficiency of the public service has become even lower. Public finances face serious problems. There have been difficulties to pay wages in time. It is surprising and very commendable that the Ministry of Finance succeeded in paying salaries at all. However, we have no information about the cost of this success in terms of public debt. The routines and sources of fiscal revenues are only partially restored. We have no information about military expenditures, past, present or planned, and how these would be controlled. Most of the Public Investment Program is suspended and a reallocation of public-owned infrastructure, mostly housing, has taken place. The need to restore basic service put a heavy burden on public finances. Unfortunately, in situations like this it is easier for the state to keep a certain level of expenditures than a corresponding level of revenues. The periodical surges of violence during the crisis were quite damaging for the public revenues. Ironically, the high degree of dependence of public finances on international aid and fishing licenses, both sources that are relatively immune to the crisis, could prove beneficial in this situation. However, the Ministry of Finance made a commendable work during the crisis and its aftermath. A new budget for 1999 was produced, much in line with the 1998 budget, including a few changes necessary to accommodate new situations, like the figure of the co-President, for example. This budget was not formally approved until mid-September. In the meantime the Ministry decided to execute the 1999 budget proposal, even if the constitution said that they should execute the

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1998 budget. The execution was less than 60 per cent during the first half of 1999, and the situation of revenues even worse. On the other hand, it is important to note that the Ministry had important initiatives to enhance public revenues and to centralize its re-collection. This is a clear move in the right direction and some important results could be expected after political stability is achieved and confidence restored. It should be noted that there is a significant degree of continuity in fiscal policy. This is not at all surprising when we observe that both the interim and the new government have stated very clearly their commitment to previous economic policy, with only minor changes. This emphasizes the idea that the crisis had mainly political roots and aimed to solve a power dispute. Possibly the most positive feature of today’s situation in Guinea-Bissau is monetary stability, a consequence of the country’s recent incorporation in the West African Monetary Union (WAMU) (Aguilar 1998). Thus, when the country renounced monetary policy by participating in WAMU, it also became protected against the negative effects on monetary stability that crises like this usually have. The recovery has been faster and stronger than expected, with GDP growing at 8.7 per cent and a record crop and export of cashew. The most important issue today is to recover the previous levels of activity in the cashew industry and exports. This depends critically on reaching political stability and restarting the financial system. This should be a major aim for the government. The recovery of cashew crop does not seem difficult because of the characteristics of this crop, very suitable for tropical underdeveloped countries like Guinea-Bissau. Thus, the outcome of the year 2000 crop will be critical for the country. Restarting fishing activities based on the national fleet, the periodical visits by the Spanish fleet, and resuming activities of cold installations in Cacheu and Bissau also depends critically on political stability. Improving and consolidating the Ministry of Finances must be the main target within the effort to revitalize the public sector. Practices in fiscal discipline previously introduced should be retaken, and new initiatives aimed at centralizing public revenues should be consolidated. It is especially important to recuperate financial records. To have adequate accounts will prove very important in the negotiation of future programs, both with the international financial institutions and with the donors. An important issue within the reorganization of public finances will be the reduction and control of military expenditures. A good relationship with the international financial institutions is critical for a country like Guinea-Bissau. These institutions are not only important sources of international financing, but they can open important flows of financing from the donors and from Guinea-Bissau’s creditors. The development of a good relationship with these institutions depends critically on agreeing on some kind of program and keeping it on track. The country still has a good chance of benefiting from the HIPC initiative, possibly in 2000 or 2001. The answer of the international institutions was fast and the country has already had emergency financial support from the IMF and a reconstruction loan from the World Bank. The country was expected to reach the decision point in the HIPC initiative during the second half of 2000.

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47

However, an important condition for creating these policy programs is to restate the medium- and long-term goals. Before the crisis some important landmarks were reached in this effort, for example the Agricultural Policy Chart. It is important that the government states, very clearly, if the medium- and long-term goals proposed before the crisis are still going to be the basic orientation of economic policy.

5 Guinea-Bissau’s problems and options Guinea-Bissau seems to be moving towards a new period of relative political and military stability. Thus, it seems appropriate to discuss the options and problems that the country faces. We organized this discussion along three main lines. First, we discuss the present conditions for economic policy and for solving the main problems that the country faces. Second, we discuss the present situation from a longterm perspective in order to get an adequate framework for short-term policy. Finally, we discuss the problems and options that should be taken in the short term. Conditions for economic policy Ending the crisis meant, possibly, solving a few political problems and, certainly, solving some ethical ones. However, the basic conditions for starting a sustainable development path and solving the country’s main economic and social problems, are the same than before the crisis, or somewhat worse. Guinea-Bissau is still a small country absent from the world markets, lacking a significant endowment of natural resources, quite underdeveloped, and with a primitive infrastructure, exceedingly low income levels and, especially, with health and education indicators among the worst in the world (Aguilar and Stenman 1997). These factors certainly did not change positively with the war. Most probably, they were negatively affected. However, there are some positive elements in this picture. Guinea-Bissau can get some advantages from its small size and deep poverty when dealing with donors and international financial institutions. The country’s financial needs are simply quite small as compared to the budget of the donors and the international financial institutions. This is possibly one of the reasons explaining the high degree of dependency on international aid observed today. On the other hand, being a small country allows decisions to be taken within a reduced group of persons that can be coordinated and consulted directly and easily. The small size also allows richer contacts between local communities and between individuals and authorities. These personal contacts could be important for solving conflicts. Finally, small countries usually have simpler infrastructure problems. Quite often, small projects, which are easy to finance, are quite important for the economy and the society. However, the small size also has some negative aspects. Often the international political clout and capacity to negotiate is directly related to size. However, given Guinea-Bissau’s past it could be possible to get diplomatic support, with donors using their influence and political clout in negotiations with other donors and the international financial institutions.

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From crisis to growth in Africa?

Another problem affecting very small countries is the high cost of the basic institutions of the state. For example, in Guinea-Bissau, the Presidency, the Parliament and diplomatic representations together take a rather large share of public expenditures. The new situation with the military worsens this further. Poverty and the exceedingly low levels of education and health indicators are still an enormous barrier for development and social improvement. The scarcity of qualified staff seriously limits the variety and extension of projects that can be developed, both in the public and the private sector. The poor sanitary conditions seriously affect the efficiency of economic activities. A widespread problem is illness and absent personel, mostly because of malaria. Health condition also affects the composition of the population, which is very young, implying an exceedingly high index of dependency on the working force. Infrastructure development is a clear hinder for development. Electricity supply is limited, unreliable and exceedingly expensive. This is also true for telecommunications. The timing of the privatizations in this field can be questioned (Aguilar and Stenman 1997). These privatizations took place before an adequate regulatory framework was in place. Road and transport infrastructure grew a lot during the last few years. However, there are still dramatic problems in this sector. The country’s physical integration is still waiting for a number of critical bridges and connections. The crisis erupted precisely when the country was succeeding in significant achievements in the development of the port, airport and road infrastructure. Long-term development Guinea-Bissau’s main long-term problem is still the same: to reach a minimal educational level for the population. This is the most important problem that the country faces, and should be the starting point of any development strategy. It is necessary to set clear, dated and quantified targets in this field. These targets should be a major issue in the relationship with the donors. The second long-term problem is health. This field also requires an effort focused on a few quantified targets, with the support and collaboration of the international community. Possibly, the effort should focus on the control of problems that directly affect economic activities, such as malaria. There are clear overlapping areas between the efforts to be made in education and health. The third basic long-term problem is infrastructure development. It is important to ensure a reasonable degree of geographical integration. Such integration would not only improve the efficiency of the economy, but the provision of public services could benefit of a larger scale. It is important to ensure the supply of energy and telecommunications to most of the country, in a reliable way and at reasonable prices. A critical point in the field of energy and telecommunications seems to be the development of a minimal regulatory framework. The fourth basic problem is the development of an investment system. This is critical for an underdeveloped economy, with a rudimentary monetary system, and a practically inexistent capital market. It is necessary to develop mechanisms that capture funds from the donors and the international financial institutions, and

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channel them towards small and medium-sized projects within the private sector. The public sector must develop its own capacity to identify and evaluate projects. Finally, agricultural development is crucial for the country’s future. It is necessary to stabilize the issue of land ownership. The government should plan for a future without export taxes on cashew. It is necessary to develop mechanisms that protect Guinean agriculture from the frequent international rice dumping. It is especially important to improve agricultural technology and the use of land and water. Short-term problems and options Guinea-Bissau’s short-term problems are mostly located in the public finances. It is necessary to reorganize them, to recuperate and improve expenditure controls and routines, and to extend and improve taxation. The aftermath of a crisis, such as that Guinea-Bissau recently went through, usually opens a short period where the political costs of radical and deep reforms seem reasonable. A central target in the short term should be to benefit from the HIPC initiative. This initiative would imply a strong reduction of the burden of the external debt. This reduction is important enough to allow Guinea-Bissau to have, for the first time since independence, a manageable balance of payments and, consequently, to be able to plan its economic development. The critical element to be included in the HIPC initiative is to go successfully through a program agreed with the international financial institutions. We have discussed before the importance of the relationship with the international financial institutions. Another important element of this relationship is to avoid arrears in the multilateral debt. Guinea-Bissau has already received financial aid to pay arrears, and will need further financial assistance in the future to honor the service of the multilateral debt. This should be an important target for the donors’ financial assistance. Guinea-Bissau has recently solved the problem of arrears with the World Bank, partly with Swedish and other donors’ money and partly with money from the fishing licenses. The debt service until the end of 1999 with the World Bank and the IMF has been estimated to 3 million dollars. There were still pending arrears with the African Development Bank of about 3.5 million dollars and perhaps one additional million in debt service until the end of 1999. These arrears could block important sources of international financing. Finally, an important issue open in the short term is to advance in the liberalization of the economy and international trade. For a small country, like GuineaBissau, without industry and without a significant endowment of natural resources, trade openness and liberalization is interesting, because there are few interests to protect. Thus, development could be based on the development of the services and industrial sector closely related to agriculture and to the country’s long-term comparative advantages: land availability and cheap labor.

6 Conclusions Before the recent civil war, Guinea-Bissau was a small and very poor country. However, and in spite of its difficulties, the country had a good track record in its

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From crisis to growth in Africa?

efforts to adjust the economy and seemed to be moving in the right direction. Most observers expected a long period with monetary stability, high growth and a controlable balance of payment deficit. The country was clearly on its way to benefit from the HIPC initiative, thus alleviating the problem of the external debt. After the war, Guinea-Bissau has had a fast and strong recovery and is again performing well, with open and strong support of the international financial institutions and, hopefully, of the donors. We should not forget that the war was damaging and a lot was lost. The country still has to work hard to recuperate the losses caused by the war. Nothing basic changed in the economy. Economic policy is a clear continuation of the programs implemented before the war. Economic policy was not an issue during the conflict. Perhaps the only positive result of the war is a deeper understanding of the need for a working democratic process to ensure political stability. There is a broader consensus now about the urgency in the fight against poverty and that equity is a necessary component of growth and development. Three main lessons can be drawn from the case of Guinea-Bissau. One of them is that a very poor country, with an exceedingly limited endowment of natural resources and physical and human capital, can organize, design and implement a minimal, working economic policy. Poverty is not an excuse for not having a proper economic policy. Second, to achieve much needed political stability seems to be harder than achieving economic stability. Finally, Guinea-Bissau reminds us that poverty alleviation should be a necessary component of every policy program. Growth and development without equity is especially dangerous for these poor and small countries.

Notes 1 Current account balance less interest payments. 2 The public servants roll included many inexistent people whose wages were cashed by corrupted individuals.

References Aguilar, Renato (1998), Guinea-Bissau 1997, Going into High Gear, Department of Economics, Gothenburg University, Sida, 1998: 6. Aguilar, Renato and Stenman, Åsa (1993), Guinea-Bissau 1993, Facing New Temptations and Challenges, Department of Economics, Gothenburg University, SIDA, The Planning Secretariat, 43/93. Aguilar, Renato and Stenman, Åsa (1994), Guinea-Bissau 1994, On the Eve of Tomorrow, Department of Economics, Gothenburg University, SIDA, The Planning Secretariat, 56/94. Aguilar, Renato and Stenman, Åsa (1996), Guinea-Bissau 1995, Missing the Beat, Department of Economics, Gothenburg University, Sida, 1996: 5. Aguilar, Renato and Stenman, Åsa (1997), Guinea-Bissau 1996, Looking for New Development Paths, Department of Economics, Gothenburg University, Sida, 1997: 2. BCEAO (1997), Rapport Trimestriel, Setembre 1997. Bissau: Banque Central des Etats de l’Afrique de l’Ouest.

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EIU Country Report (1996), Guinea-Bissau, several quarterly reports. EIU Country Report (1997), Guinea-Bissau, several quarterly reports. Ministério de Economía e Finanças (1998), Evolução Económica e Financeira em 1997 e Perspectivas para 1998, Bissau, Janeiro 1998. Ministério de Economía e Finanças (1998), Desempenho Orçamental, Fiscal e Reforma Estrutural 1997, Bissau, Janeiro 1998. República da Guiné-Bissau (1997), Projecto de Lei do Orçamento Geral do Estado 1998. Documentos I, II e II, Bissau, Outubro 1997.

4

Ethiopian reforms Government legitimacy, economic growth and development Göte Hansson

1 Introduction Ethiopia is one of the poorest countries in the world. Up to mid-1991 the country was engaged in a civil war with various liberation groups challenging and fighting the dictatorship of President Mengistu Haile Mariam. Besides mainland Ethiopian liberation movements, there was the Eritrean liberation movement, struggling for Eritrean political independence and sovereignty. In May 1991 all this ended, President Mengistu was defeated and a new government took power in Ethiopia, which from then on no longer incorporates Eritrea, even though the formal declaration of Eritrean independence had to wait until May 1993. From 1992 and onwards the post-Mengistu governments have introduced a number of political and economic system reforms. The Ethiopian economic actors have responded positively to the system changes, and up to 1997 the economic performance was largely improved. However, on 6 May 1998 a border conflict with Eritrea arose and led to a rapidly deteriorating economic situation. There are a large number of factors that, aside from military conflicts, affect the potentials for a positive economic and political development. In less developed countries that undergo drastic changes in the political and economic systems, the legitimacy of the ruling government is crucial for successful reform implementation. Legitimacy, which refers both to the domestic and the international political arena, is an important factor for political credibility and stability, and thus for predictability of future government policy, which is of great importance for potential investors. To analyse the legitimacy of the Ethiopian government and its implications for growth and development is an important objective of this study. The plan of the present study is to give a brief orientation of the concept of government legitimacy, the norms that are of interest for the analysis of legitimacy in Ethiopia and how these various norms have developed during the 1990s and how this relates to the potential for economic growth and development.

2

Government legitimacy and economic development

Government Legitimacy Legitimacy is a concept that refers to both the domestic and the international relations of the government in question (for a discussion of the concept and theory

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of legitimacy, see e.g. Steiner (1996: 20–40) and references therein). Obviously domestic legitimacy is of crucial interest for the domestic political actors, both the government and the opposition. In democracies the domestic legitimacy is provided by the population, e.g. through democratic elections. By achieving legitimacy, a political actor gets access to power, for instance by getting the constitutional right to form the government. A government has domestic legitimacy, defined by Robert A. Dahl (1984: 53), ‘if the people to whom its orders are directed believe that the structure, procedures, acts, decisions, policies, officials or leaders of government possess the quality of “rightness”, propriety, or moral goodness’. International legitimacy, also, is of crucial interest for the political actors in the country under consideration. In this case the benefit of legitimacy takes the form of international recognition. For developing countries the legitimacy or recognition provided by the international donor society is of major interest. Thus, the World Bank and the IMF in particular, and also major bilateral donors, are of importance since they can all deliver material rewards for the legitimised actor. International legitimacy is also an important factor for attracting foreign investments. Domestic and international legitimacy are not independent of each other. International legitimacy and the material resources it can provide for an actor positively affect the respective actor’s potential to achieve increased domestic legitimacy. Strong domestic legitimacy, in turn, is one important condition for achieving international legitimacy, even though it is not a necessary or a sufficient one. In the case of Ethiopia the legitimacy of the EPRDF-dominated governments, that have been in power since the overthrow of the Mengistu government in mid1991, has been questioned and is a topic of debate among Ethiopians residing in Ethiopia as well as among the Ethiopians in the diaspora. In the international community the legitimacy of the post-Mengistu governments has been of less interest, even though the opposition has partly succeeded in questioning the legitimacy of the government, in particular by pointing to the government’s problems in achieving rapid progress in implementing its declared human rights policies and institutions, as laid down by the constitution. During the past two years (May 1998–December 2000), the international legitimacy of the EPRDF government was also affected by the border war with Eritrea (see below).

Norms of legitimacy: the case of Ethiopia During the 1990s Ethiopia has been subject to numerous political and economic reforms (see e.g. Hansson 1995). The motive behind these reforms is the overriding objective: to transform Ethiopia from a country with a long-standing civil war into a peaceful country opting for democracy, decentralised governance, market economy, economic growth and improved standards of living. Thus, in the case of Ethiopia in the 1990s the following norms of legitimacy can be identified: A B C

Peace Democracy and respect for human rights Market economy and good economic performance

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From crisis to growth in Africa?

D E

Social improvements Regionalisation and decentralisation of power to the regions.

These norms are quite broad and thus not possible to measure directly, so, for analytical reasons, for each one of the five norms we define sub-norms that can more easily be evaluated and measured. The first norm, Peace, can be divided into the following two sub-norms: a1 Internal peace a2 Peace with neighbouring countries. These two sub-norms do not always affect the legitimacy of the ruling government in the same way. Achievement of internal peace affects both the domestic and the international legitimacy of the government positively, while peace with neighbouring countries is not always seen as something uniquely positive by the domestic population. The international community, on the other hand, usually sees the achievement of peace with neighbouring countries as something that strengthens the legitimacy of the ruling government, even though one must make a reservation depending on whether the country under analysis can be seen as the offender or the defender in the actual conflict. In the case of the second norm, Democracy and respect for human rights, three central sub-norms are: b1 An appropriate electoral system b2 Free and democratic elections b3 Guarantees for human rights. The electoral system is crucial for the working of democracy (see e.g. Hansson (1995: 149–54) and references therein). The choice of system should pay due attention to the characteristics of the country in question and the design of the system should be composed in a way that makes the electorate feel comfortable that the resulting elections represent the preferences of various sections of the population. The two other sub-norms are quite clear-cut and need no further comments before we go into a concrete case study. The Market economy and good economic performance norm can be broken down into the following nine sub-norms: c1 c2 c3 c4 c5 c6 c7 c8 c9

Liberalised markets A dominating role for the private sector An appropriate market-based exchange rate Low inflation Low unemployment Fiscal balance Balance in the current account Economic growth Decreasing role for foreign aid.

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The superiority of markets in allocating scarce resources has become almost universally recognised. Thus, from the beginning of the 1980s the world has experienced frequent system reforms away from economic systems that used to be governed by socialist and administrative principles in a highly centralised way over to more market-oriented systems. The various economic sub-norms are also quite undebatable. In the above list the ideal status of the individual sub-norms is given by the wording of the respective sub-norm. In relation to sub-norm c9 (decreasing role for foreign aid) the criterion for success lies in the potential for achieving sustainable development and growth. In relation to the fourth norm, Social improvements, we choose to focus on the following sub-norms: d1 d2 d3 d4

Access to safe water Access to sanitation Access to health services School enrolment.

It is obvious that the higher the figures for these respective sub-norms, the higher the legitimacy, ceteris paribus. Finally, in relation to Regionalisation the following sub-norms can be defined: e1 Freely and fairly elected regional parliaments e2 Right to self-determination e3 Providing equal development opportunities for the regions. It should be noted that the relative importance of the various norms and sub-norms may change over time, depending on the actual situation and development in the country. Furthermore, it should be noted that it is not possible to construct a unanimous one-dimensional index of legitimacy. Therefore, in order to protect or to increase its legitimacy, preferably a government should demonstrate progress in relation to all of these sub-norms. As a rule, however, there are some sub-norms that are not satisfied or, which is an even worse situation for the government’s legitimacy, the situation deteriorates in terms of some of the sub-norms. When the development does not show improvements in relation to all sub-norms, there is clearly a case for the opposition to criticise the government. In fact, this type of opposition activities are not only natural but even positive activities in the work of improving the situation in democracies. If the government is not successful in meeting such opposition with positive and convincing information or propaganda about the development as regards the respective norms, the government will lose legitimacy, ceteris paribus. Thereby, the uncertainty about the policies will grow, and thus the future of the economic conditions in general and the profitability of investments in the country will be negatively affected. If the loss of legitimacy mainly concerns the status of the government among domestic political and economic actors, the domestic political stability will be threatened and so will the economic development. If the government’s legitimacy is weakened in the international community, the inflow of aid and foreign investments

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will be hampered also. Such a development will reduce the prospects for economic growth and development.

3

The present state of government legitimacy in Ethiopia

What has been the actual development in Ethiopia during the 1990s as concerns the various norms of government legitimacy described above? For a case study of the legitimacy, it is necessary to set target values for the various norms. In the case of the economic norms this is quite easy compared to the case of the norms that relate to peace, democracy and decentralisation (regionalisation) of power. Table 4.1 presents target values for good or adequate satisfaction in relation to the norms where we think such a value can be applied. For the economic norms, as a rule we have used the same norms of performance as the World Bank study on Adjustment in Africa (World Bank 1994). The table also contains brief indications of the Ethiopian situation in 1997, that is before the outbreak of the border war with Eritrea. The effects of this war on government legitimacy are briefly studied in relation to the analysis of the Ethiopian government’s satisfaction of each one of the various norms of legitimacy. Satisfaction of the peace norms In relation to the Peace norms there have been and still are some problems, even though the border conflicts with Somalia and Sudan cannot be claimed to have been solely negative from the perspective of the Ethiopian government’s international legitimacy, as these conflicts by non-fundamentalist Muslims can be seen as a defence against the spread of Islamic fundamentalism in Africa. Regarding the border conflict with Eritrea, the effect on the international legitimacy can also be debated. The border war between Ethiopia and Eritrea that broke out in May 1998, and formally lasted up to December 2000 should be seen in the light of the fact that ever since the peace agreement in 1991 there have been some disputable areas along 1,000 km of the Eritrean–Ethiopian border. One reason why these issues were left unsolved for seven years was that the areas had little economic value. From January 1992, Ethiopia had a free trade agreement with the Eritrean provisional government. Furthermore, up to the introduction of the Eritrean nakfa in November 1997, the two countries used the Ethiopian birr as their common currency. Due to the free trade agreement and the de facto currency union, the border had little economic importance in the daily life of the two countries. When the latter was ended by the introduction of the Eritrean national currency, the border suddenly became a real trade barrier with clear economic consequences in terms of increased transaction costs in Eritrean–Ethiopian trade relations. Even though, for centuries, there have been severe tensions between the Ethiopians and the Eritreans, in terms of, for instance, the attitude to the issue of ethnicity in nation building, it is reasonable to expect that the introduction of the Eritrean national currency largely contributed to the outbreak of the border conflict in May 1998 (see also the chapter on Eritrea in the present volume). Rwanda and the US developed a peace plan which later on was adopted by the Organisation of African Unity (OAU). This plan demanded Eritrea to withdraw

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Table 4.1 Norms of legitimacy and the Ethiopian situation in 1997 Norm A. Peace a1. Internal peace a2. Peace with neighbouring countries

Score/ideal values

Ethiopian situationa

Harmonious internal relations No ongoing wars

Clashes reported in various regions, terrorist attacks (9) Border conflicts with Sudan and Somalia (9)

B. Democracy and respect for human rights b1. An appropriate Mirror the electorate electoral system b2. Free elections Anonymous and free voting b3. Human rights Respect of the UN declaration C. Market economy and good economic performance c1. Liberalised markets Low number of price controls c2. A dominating role for Private investments the private sector increases c3. An appropriate marketLow parallel market based exchange rate premium less than 10% c4. Low inflation Inflation lower than 10% c5. Low unemployment Low rate of unemployment c6. Fiscal balance :3.5% of GDP c7. Current account Small deficit c8. Economic growth Real per capita growth c9. Low need for foreign aid Falling aid/GDP ratio D. Social improvements d1. Access to safe water d2. Access to sanitation d3. Access to health services d4. School enrolment (combined 1st, 2nd and 3rd gross enrolment) E. Regionalisation e1. Freely and fairly elected regional parliaments e2. Right to self-determination e3. Providing equal development opportunities for the regions

Improvements Improvements Improvements Improvements

Majority system (9) No clear picture (?) Human rights institutions in the constitution (;) but problems of implementation (9) Very few price controls remain (;) Still low but rapidly growing (;) Less than 10% (;) Less than 10% (;) Less than 20% — 91.5 (incl. grants), 95.2 (excl. grants) 93.6 (incl. grants), 97.1 (excl. grants) Positive (;) 3–4% (1993/4–1996/7) 25% (1990/95) 19% (1990/95) 46% (1985–95) 16% (1993)

Regional elections have taken place (;) No clear picture about the fairness (?) Constitution (;) Frequent rumours about unequal treatment (9) Distribution of government subsidies (;) Distribution of investments (9)

a ;,9 indicate satisfaction and non-satisfaction of ideal values, respectively.

from the areas that had been under Ethiopian administration prior to the outbreak of the war and then let an international committee solve the issues at stake. This proposal was accepted by Ethiopia but turned down by Eritrea. After some eight months of lull, on 6 February 1999 the war intensified. After some severe losses in the Badime area, on 27 February the Eritrean government suddenly accepted the

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From crisis to growth in Africa?

peace plan. However, the Ethiopian government demanded a complete withdrawal not only from Badime but also from the other border areas under conflict, i.e. Zalambessa, Aiga, Bada-Burie, Alitena and Egala. The Ethiopian government classified the Eritrean acceptance of the OAU peace proposal as nothing more than a tactical move to get time for reorganisation of their military forces and to prepare for new military activities. The Eritrean government naturally denied this. The 18 June a ceasefire agreement was concluded. However, the peace plan was not implemented until the signing of the formal peace agreement on 12 December 2000. All in all it seems reasonable to assume that the governments in both countries have lost international legitimacy due to the two and a half years of war.

Satisfaction of the democratisation and human rights norms Turning to the Democratisation and human rights norms, Ethiopia’s choice of a majority electoral system can be questioned. With such a system there is an obvious risk of manipulation of the geographical division of voting districts and there are few incentives for creating a consensus democracy. Furthermore, with such an electoral system minority interests have difficulties to become represented in the National Assembly and thus to influence the national policy. This constitutes a risk to unity and peace in the country which in turn will threaten stability and continuity in the State leadership, at least in a medium- and long-term perspective (see e.g. Hansson (1995: 151–4) and references therein). Even though significant changes in human rights legislation and institutions have been introduced, for instance in the new constitution, in many cases these changes have only been implemented to a minor extent. For instance, this is the case with the two new human rights institutions, the Ombudsman and the Human Rights Commission, that so far exist just on paper. The government’s intentions and implementation problems are illustrated in the following quotation from the US Department of State’s 1996 Human Rights Report on Ethiopia: The Government took a number of steps to improve its human rights practices, but serious problems remain. Security forces sometimes beat or mistreated detainees, and arbitrarily arrested and detained citizens. Prolonged pretrial detention is a problem. The judiciary lacks sufficient staff and funds, and consequently most citizens are denied the full protections provided for in the Constitution. … (US Department of State 1996: 1) Finally, the border conflict with Eritrea affected the human rights situation both directly and indirectly. In particular, the treatment of Eritreans in Ethiopia (and Ethiopians in Eritrea) has been claimed to have been in conflict with basic principles of human rights (see e.g. Amnesty International 1999).

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Satisfaction of the economic norms The removal of the Mengistu government in May 1991 introduced a new period in the economic life of Ethiopia. The economic system has been subject to far-reaching reforms: both commodity and factor markets have been liberalised, the administration of the public enterprises has been reformed and private actors have been stimulated to start business. Furthermore, trade and exchange rate policies have been liberalised and through foreign exchange auctions the exchange rate has become more in line with its true market value (see e.g. Hansson 1995: chapter 7; IMF 1999a: 21f.). From Table 4.2 we note that since the change in power in 1991 up to 1997, the Ethiopian economic actors have responded positively to the reforms. The economic growth has been quite good, not only compared with what it used to be during the Mengistu period, but also by sub-Saharan standards. Investments also showed a steady annual increase. Between the fiscal years 1994/5 and 1995/6, licensed imports of capital goods increased by 78 per cent. Around half of these imports were vehicles, which increased by 23 per cent. This means that also outside the transport sector there was a rapid increase in capital investments during the latter year. The budget deficit has also been kept reasonably low considering the needs for and work on restructuring and rehabilitating infrastructure and the social sectors. The same is true for the current account deficit, and the international reserves have increased from little more than one month in 1990/1 to around four months of import coverage in 1997. Even though the Ethiopian government has made statements about economic system changes and has also introduced new laws and policies to substantiate these changes, much of the implementation and fine-tuning of the far-reaching reforms remains. Up to 1997 the government was quite consistent in its economic policy implementation, there was a close and non-conflicting relationship between the objectives of the system changes and the various changes and policies that were actually introduced, even though some critics thought that the government was moving too slowly. After a relatively slow start, from 1996 the process of privatisation advanced at a relatively high speed with a number of small-scale enterprises being privatised. According to the World Bank (1996: 6), when the Ethiopian Privatization Agency was established in 1994, ‘an initial batch of 197 state-owned enterprises (SOEs) were targetted for divesture’. By mid-1996, 127 of these state-owned enterprises had been privatised (ibid.) and by the end of 1998 the number had increased to 177 (IMF 1999a: table 14). A new investment code towards a more open and liberalised system has also been introduced (Federal Negarit Gazeta 1996). The new code invites foreign investors to joint investments with Ethiopian investors, for instance in large-scale engineering and metallurgical industries. Furthermore, according to this new investment code there is no longer any requirement for foreign investors to make a pre-payment for their coming investments. However, the minimum amount for foreign investments is still 500,000 US dollars, even though lower amounts apply to joint investments

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From crisis to growth in Africa?

Table 4.2 Selected economic indicators 1990/1 Annual percentage changes GDP (constant 96.7 factor costs) Inflation (CPI) 20.9 Nominal effective — exchange rate Real effective — exchange rate Government budget (% of GDP) Expenditure 24.9 Revenues (excl. 13.6 grants) Deficit (on a cash basis) Incl. grants 8.5 Excl. grants 10.9 External financing (net) 2.4 Grants 2.4 External affairs (% of GDP) Trade in goods and non-factor services Exports 5.5 Imports 12.5 Current account (excl. 9.7 official transf.) Terms of trade (annual change) 95.0 External debt (incl. out34.2 standing fund credit, excl. rouble debt, % of GDP) Debt service ratio 62.3 (% of exports of goods and non-factor services) on a commitment basis Gross official reserves (in months of imports)

1.1

1992/3

1993/4

1994/5

1995/6

1996/7 estimates

12.0

1.6

6.2

10.6

5.2

10.1 953.1

1.2 910.7

13.4 97.9

0.9 3.7

96.4 0.2

955.0

914.8

1.7

98.2

1.2

19.6 12.0

25.2 13.9

24.8 17.4

27.0 18.4

24.3 19.0

5.9 7.6 2.7 1.7

7.7 11.1 6.0 3.5

3.9 7.3 3.7 3.3

5.6 8.5 3.7 2.9

1.5 5.2 1.8 3.6

8.3 16.9 96.8

10.0 19.8 94.1

13.6 22.1 99.9

13.1 27.5 97.5

15.8 26.4

921.2 61.7

10.0 71.6

33.8 80.3

922.1 71.6

19.1 64.4

77.4

51.6

35.1

36.5

42.7

2.6

5.6

5.8

6.6

4.2

Sources: IMF (1994a, Appendix: table I), IMF (1994b, Appendix III: table 1), IMF (1996, table 1), IMF (1998: 4, tables 1, 11, 21, 24 and 25), IMF (1999a, tables 2, 11, 12, 23 and 26) and IMF (1999b, table 2).

(300,000 dollars) and for investment in services (100,000 dollars) (Federal Negarit Gazeta 1996: 179). Even though government officials stress that small business should be reserved for indigenous businessmen, this type of infant industry protection risks sending negative signals not only to potential foreign investors but also to domestic businessmen who

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get protection through this policy. Thereby there is a risk that efficiency in smallscale business is hampered. If the infant industry argument is to be credible and the policy is not to be seen as pure protection of domestic business, the government should announce a date when all minimum requirements on foreign investments will be removed. Such an announcement would also tell the Ethiopian businessmen that before long they will face competition, not just from imports of similar goods but also from foreign producers producing in Ethiopia. To summarise, there has been a series of positive reforms in the economic system since the replacement of the Mengistu government in 1991. Most of these reforms are in line with the recommendations presented at an international seminar on External Assistance and Policies for Growth in Africa (Liuksila 1995). The macroeconomic environment for sustainable growth has been improved and the market forces and the private sector have been encouraged to play a more vital role in the economy. In conclusion, from Tables 4.1 and 4.2 it is obvious that the Ethiopian government was quite successful in satisfying most of the components incorporated in the Economic norms up to 1997. This was also the major view held by the international financial institutions and the donor community. However, the border war with Eritrea that broke out in May 1998 led to a deterioration of the economic performance and situation in Ethiopia. Due to the war, the defence spending that had decreased to around 2 per cent of GDP in the fiscal year 1997 increased again to 4.5 per cent in the fiscal year 1998 (IMF 1999a: 17). It should be noted that information about the economic performance during the period 1997–8 is scarce and uncertain. Table 4.3, based on the most recent available information from the World Bank in March 2000, however, describes some indications about the development by presenting estimates for 1998. The lag of the effects of the war and the mere fact that there was no signing of a full peace agreement until 12 December 2000 make it reasonable to expect that the situation continued to deteriorate during the year 2000.

Table 4.3 Some indicators of economic performance in 1997–8a

Real GDP growth (%) GNP per capita growth (%) Inflation, GDP deflator (%) Fiscal balance (incl. grants, % of GDP) Export growth (real) (%) Current account before capital grants (% of GDP) Debt service ratio (ex post) (%)

1997

1998

5.9 0 3.2 91.5 51.0 97.1

91.0 99.1 9.7 93.9 99.4 98.0

9.5

10.8

a 1998 numbers are estimates. Source: World Bank: Africa Regional Database, ‘Macroeconomic Profile for Ethiopia’ and ‘Sectoral Profile for Ethiopia’, most recent version on http://wbln0018.worldbank.org/afr/aftbreif.nsf

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From Table 4.3 we conclude that the economic norms of legitimacy for which we have some, even though very preliminary, data have deteriorated. The negative growth rate together with the increased needs for military equipment to serve the war led to a deterioration in the fiscal and current accounts. The lower production, including production for exports, increased the ex post debt service ratio from 9.5 to 10.8 per cent of the total export value. The long-term costs can be expected to be quite high for economic growth and development. The reason is that the war created mistrust and thus increased uncertainty and insecurity in the area. The positive development that has taken place during the 1990s, in particular as regards the economic situation, but also as regards politics, has now been disrupted. It is reasonable to assume that this will mean several years of lost confidence in the region and thus slow if any positive economic development at all. The past two and a half years of military development means that the Eritrean and Ethiopian parts of the Horn of Africa, where there was a clear case for regional economic integration, have now turned into a situation of regional economic disintegration. The costs of this turn can be expected to be high due to the increased transaction costs in the commercial relations between the two countries and thus reduced possibilities to utilise their respective comparative advantages. To this should be added that both governments have deported, or in other ways made citizens from the other country emigrate back even though they have been living and working a long time in the country. Thereby the mistrust among the two nationals has grown quite strong at all levels of the two societies. This will be a difficult barrier to surpass when the war now is over. Thereby it will also be difficult to reestablish friendly and harmonious relations that can lead to a return to the path of prosperous economic development that characterised the period from May 1991 to May 1998. Satisfaction of the social improvements norms Lack of historical data makes it difficult to make a clear-cut judgement about the satisfaction of the Social improvements norms. The social situation in Ethiopia is still quite poor, also in a sub-Saharan perspective. Furthermore, from an analysis of the national budgets for the past couple of years it can be concluded that even though the social sectors have received growing amounts, their share of the total recurrent budget has decreased from 26.8 per cent in 1993/94 to 25.7 per cent in 1995/6 (Ministry of Finance 1996, 1997a). For 1996/7 the budget showed a further reduction to 24.5 per cent. The picture looks a bit more positive if we turn to the social sectors’ share of the capital budget. From 1993/4 to 1995/6 this share has increased from 16.8 per cent to 21.0 per cent, which was also the budgeted share for 1996/7. Even though the budget allocation tells us something about the government’s priorities, it is more interesting to analyse the development of the current and capital expenditures. Here we note that during the post-Mengistu period, the social sectors have experienced growing shares of the total government expenditures. The social sectors’ share of current expenditures has increased from 17.5 per cent in 1990/1 to a preliminary estimated share of 25.5 per cent in 1995/6. The corresponding figures

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for the social sectors’ share of total capital expenditures show a positive development also, from 8.2 per cent in 1990/1 to a preliminary estimate of 20.2 per cent in 1995/6. In relation to the social improvements norms it can be concluded that the Ethiopian situation is still quite problematic, and that the government’s priorities as shown in the budget allocations are not uniquely positive. Furthermore, the war with Eritrea demanded resources that reduced the possibilities to improve the social situation. Instead, the war can be expected to have led to a deterioration of the already poor social situation. Satisfaction of the regionalisation and decentralisation norms In terms of the regionalisation and decentralisation norms, the government has made progress. For instance, the new constitution is quite clear on these sub-norms, and regional elections have been arranged and regionally elected governments have been established. One issue that is closely related to the legitimacy of the Ethiopian government as a government for the whole of Ethiopia is the regional aspects of development. The critics of the EPRDF government argue that Tigray has been given unmotivated favourable treatment compared to other regions of Ethiopia (see e.g. Assefa Negash 1996). One of the important instruments in second-generation reforms is the restructuring of the central–local government relationships. In post-Mengistu Ethiopia this restructuring in the form of decentralisation of power to the regional level has had a central place in the reform process. Immediately after the replacement of the Mengistu government in 1991, the new government declared that the country should be divided into ethnically based regions and that these regions should be given quite far-reaching autonomy. The Constitution of the Federal Democratic Republic of Ethiopia (1994: 23) states that Ethiopia shall be a federal state and that the various states in the Federal Democratic Republic ‘shall be delimited on basis of the settlement patterns, identity, language and consent of the people concerned’ (ibid.). The constitution defines that the Federal Democratic Republic of Ethiopia shall consist of the regional states and autonomous administrative regional units that are listed in Table 4.4. This table also presents the regional distribution of the population in Ethiopia in 1994. From Table 4.4 we note that, in addition to the administrative regional units of Addis Ababa and Dire Dawa, it is only Harari state that has a high rate of urbanisation, measured as the urban share of the total population. For all other regional states the rate of urbanisation is less than 17 per cent. The rights of the regions were first described in the second article of the Transitional Charter where e.g. each nation, nationality and people were guaranteed the right to ‘Administer its own affairs within its own defined territory and effectively participate in the central government on the basis of freedom, and fair and proper representation’ (Negarit Gazeta No. 1, 22 July 1991: 2).

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From crisis to growth in Africa? Table 4.4 The regional and urban–rural distribution of the Ethiopian population in 1994 Millions Per cent (urban within parentheses) 1. Tigray 2. Afar 3. Amhara 4. Oromiya 5. Somale 6. Benshangul/Gumaz 7. Southern Nations, Nationalities and Peoples 8. Gambella Peoples 9. Harari People

3.14 (0.47) 1.11 (0.09) 13.83 (1.27) 18.73 (1.97) 2.5 (9) 0.46 (0.04) 10.38 (0.70)

5.9 (15.0) 2.1 (8.1) 26.2 (9.2) 35.4 (10.5) 4.7 (9) 0.9 (8.7) 19.6 (6.7)

0.18 (0.03) 0.13 (0.08)

0.3 (16.7) 0.2 (61.5)

Total, regions 1–9

50.46

Other autonomous administrative regional units Addis Ababa 2.1 Dire Dawa 0.3 Total

52.86

95.3 4.0 0.6 99.9

Source: Central Statistical Authority: The 1994 Population and Housing Census of Ethiopia.

The various regions are quite different in terms of their respective production possibilities and thus living standards and also in terms of ethnic heterogeneity. Even though the regional division is based on nationality and ethnicity, the ethnicbased division of Ethiopia resulted in a situation where most regions consist of more than four, and in some cases even more than ten, nationalities (Baxter 1994: 166). Only three regions (Afar, Oromo and Somale) consist of just one nationality (ibid.). Thus, not only on the federal state level but also within many individual regions there is a difficult but very important challenge for the respective government to achieve ethnic accommodation. There are several problems and thus challenges related to the regionalisation programme in Ethiopia. First, there are large differences between the regions in terms of, for instance, agricultural production, social services and infrastructure. The Transitional Government therefore announced that it would pursue a redistribution strategy with the objective of reducing regional differences and creating greater equality among regions. In order to achieve this, in January 1992 the government declared that regional parliaments should be elected and that power should be given to these regional parliaments on an extensive set of issues within their region with exception for matters such as defence, foreign affairs and economic policy including the printing of money (Negarit Gazeta No. 2, 14 January 1992: 10). However, it was also stated that the regional transitional governments ‘are, in every respect entities subordinate to the Central Transitional Government’ (ibid.: 8).

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In January 1994 the government published a document, The System of Regional Administration in Ethiopia, where its regionalisation and decentralisation strategy was described. In this document it was noted that there should be an ‘equitable distribution of social and basic services among regions, zones and woredas (districts)’ (TGE, January 1994: 10). During the 1990s the regions’ budgetary share of the total budget has increased (Ministry of Finance 1997d: tables 2 and 3). The regions’ share of recurrent budget allocations has increased from 39.1 per cent in 1993/4 to 43.7 per cent in 1997/8. For budgetary capital allocations the increase has been from 37.3 per cent in 1993/4 to 43.3 per cent in 1997/8. Table 4.5 shows that, with a few exceptions, the rate of implementation of the central treasury budget in the regions has been relatively high, in most cases over 90 per cent. This means that also in reality the resources that have been actually used in the regions have increased. It should be noted that it has not been possible to obtain information about the regional distribution of the federal budget that is kept on the central level. Therefore, the following analysis is limited to the implications of the budget allocations that are decentralised to the regional administrations. Turning to the distribution of the regional budget among the various regions, Tables 4.5 and 4.6 show that Oromiya has been the regional state that has received the greatest recurrent as well as capital budgetary allocations, followed by the Amhara region, the Southern Nations, Nationalities and Peoples’ region and Addis Ababa. Together these four regions received 60 per cent of the recurrent budgetary allocations to the regions for 1997/8, 62 per cent of the corresponding total regional capital budgetary allocations and 66 per cent of the central treasury regional capital budget allocations. On a per capita basis it should be noted that there has been a marked bias towards Addis Ababa both as regards the allocation of the regional recurrent budget and the allocation of the regional capital budget. In both cases this bias was mainly paid for by the Amhara region, the Oromiya region and the Southern Nations, Nationalities and Peoples’ region. In addition to Addis Ababa, the regional capital budget during the period 1994/5–1997/8 was also biased, but to a much lesser extent, towards Tigray, Afar, the Somale region, Benshangul and Gambella, that is poorly developed regions with totally just around 8 million inhabitants. In the public debate and in the criticism of the EPRDF policy, it is frequently claimed that the Tigray region is largely favoured by the central government in various ways. However, from the information in Tables 4.5 and 4.6 it is not possible to draw such a conclusion as regards the distribution of the national regional budget even though there is a slight positive bias towards Tigray, as regards the distribution of both the regional recurrent and the regional capital budget. Table 4.6 shows that during the period 1994/5–1997/8 the Federal Government’s allocation of the regional capital budget increased the regional relative capital–labour abundance in Addis Ababa, and to a lesser extent in Dire Dawa, Harari, Afar, Somale, Benshangul, Tigray and Gambella regions, whereas it decreased the relative capital–labour abundance in the populous Amhara, Oromiya,

100.0

Total

Source: Ministry of Finance (1997b).

Central

39.1 (91.52) 60.9

Total Regions

Addis Ababa

Dire Dawa

Harari

100.0

38.5 (105.03) 61.5

0.6 (97.86) 0.5 (99.32) 0.5 (85.91) 3.4 (122.79)

0.6 (78.96) 0.5 (73.76) 0.5 (80.90) 3.7 (96.31)

Southern Nations, Nationalities and Peoples Gambella

Benshangul

Somale

Oromiya

Amhara

Afar

2.7 (108.57) 1.0 (59.96) 8.3 (106.94) 12.5 (107.5) 1.5 (55.26) 0.9 (85.83) 6.5 (110.18)

2.8 (89.75) 1.0 (96.05) 8.2 (95.21) 12.8 (94.94) 1.5 (55.21) 0.9 (68.82) 6.6 (97.17

Tigray

1994/5

1993/4

Region

100.0

40.2 (102.11) 59.8

0.7 (103.52) 0.5 (106.50) 0.5 (86.52) 3.8 (97.37)

2.8 (103.18) 0.8 (86.15) 9.5 (96.12) 12.7 (110.21) 1.1 (77.65) 0.8 (81.94) 7.0 (106.13)

1995/6

100.0

41.5 (98.17) 58.5

0.8 (82.94) 0.5 (98.68) 0.4 (93.32) 4.7 (94.57)

3.1 (97.59) 1.0 (90.15) 9.3 (95.87) 13.3 (100.78) 0.9 (93.49) 0.7 (97.91) 6.9 (102.65)

1996/7

100.0

56.3

43.7

5.0

0.5

0.7

0.9

7.2

1.0

1.2

14.0

8.9

1.2

3.2

1997/8

99.9

11.4

1.1

1.5

2.1

16.5

2.3

2.7

32.0

20.3

2.8

7.2

Per cent of total regional recurrent budget 1997 (1)

100.0

4.0

0.5

0.2

0.3

19.6

0.9

4.8

35.5

26.2

2.1

5.9

Per cent of total population (2)

90.1

7.4

0.6

1.3

1.8

93.1

1.4

92.1

93.5

95.9

0.7

1.3

Bias (1)9(2)

Table 4.5 Distribution of recurrent budget among regions 1993/4–1997/8 (%) and the regional distribution of the Ethiopian population 1994 (rate of implementation within parentheses)

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Table 4.6 Distribution of the total national regional capital budget (%) Region

1994/5

1995/6

11.3 5.5 18.3 22.9 5.4 3.7 16.3

9.9 5.7 17.2 22.3 6.2 3.4 15.4

10.6 4.9 17.9 23.3 6.3 3.7 15.7

3.5 0.9 0.7 11.6

2.9 0.8 0.6 15.7

2.5 0.7 0.7 13.5

Total 100.1 Of which: Central treasury 65.8 External 8.3 assistance External loans 25.9

100.1

99.8

70.7 7.0

74.2 11.4

78.9 11.4

22.3

14.4

9.7

Tigray Afar Amhara Oromiya Somale Benshangul Southern Nations, Nationalities and Peoples Gambella Harari Dire Dawa Addis Ababa

1996/7

1997/8

Per cent of total regional capital budget 1994/5– 1997/8 (1)

Per cent of total population (2)

Bias (1)9(2)

7.0 7.7 15.5 17.8 12.7 4.8 13.2

9.5 6.0 17.1 21.4 8.0 4.0 15.0

5.9 2.1 26.2 35.4 4.7 0.9 19.6

3.6 3.9 99.1 914.0 3.3 3.1 94.6

3.3 1.8 0.9 15.3

3.0 1.1 0.7 14.2

0.3 0.2 0.6 4.0

2.7 0.9 0.1 10.2

100.0 100.0

99.9

0.1

Source: Ministry of Finance (1997c).

and Southern Nations, Nationalities and Peoples’ regions. The total number of inhabitants in these latter regions amounts to about 43 million. Thus, it can be concluded that the Federal Government’s design of the regional capital budget contributes to further concentration of modernisation, commercialisation and industrialisation to Addis Ababa and makes it more difficult for most of rural Ethiopia to diversify and develop away from traditional peasant agriculture over to a more diversified economic structure. The reason is that the capital–labour abundance will continue to be low in these parts of Ethiopia, even though some of the poorest and economically least developed regions (Tigray, Afar, Benshangul, Gambella and Somale) have experienced increased relative capital–labour abundance as a consequence of the regional capital budget allocation. Budgetary resources are not enough for a positive economic growth and development. Availability of educated people is another crucial precondition. The institutional development and thus economic growth and development are highly dependent on

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From crisis to growth in Africa?

the availability of competent middle management in the public sector. In the regionalisation and decentralisation policy of Ethiopia, this is particularly true and it is a very demanding task to recruit and educate staff for a successful implementation of the new decentralised policy. The availability of qualified staff is also a crucial factor for private entrepreneurs in their choice of investment site. The level of education is very low in Ethiopia, both on the national and the regional level. From Table 4.7 it can be concluded that the availability of skilled or even low-skilled labour will continue to be scarce in Ethiopia for the foreseeable future. It should also be noted that there is a marked bias towards Addis Ababa in enrolment rates, both as regards primary and secondary school. The enrolment rates in the other regions are very low; in six regions the primary school enrolment rate was below 50 per cent in 1995/6, leaving half of the children without any formal education. From the table it should also be noted that, with the exception of Addis Ababa and Harari, less than a third of all seven-year-old children begin the first grade of primary school at this age. In most regions the net intake rate in 1995/6 was below 20 per cent and in some cases (Tigray, Afar and Somale) the net intake was even below 10 per cent. This does not mean, however, that the rest of the children never enter the school system, but, as shown by the statistics on the ‘apparent intake’, those children who really go to school do so at an older age. In terms of secondary education, in 1995/6 all regions but Addis Ababa, Dire Dawa and Harari had enrolment rates below 10 per cent. From the point of view of both democratisation and decentralisation of power, the low enrolment rates in the Ethiopian school system are a severe problem that Table 4.7 Regional gross enrolment rates in 1995/6 (%) 1–6

1–8

9–12

Net intake grade 1

Apparent intake grade 1

Tigray Afar (1987 data) Amhara Oromiya Somale (1987 data) Benshangul Southern Nations Gambella Harari Dire Dawa Addis Ababa

54.7 9.1 25.9 30.0 14.3 52.2 44.9 61.0 58.1 45.5 85.5

45.0 8.4 22.3 26.0 11.6 42.8 38.4 50.4 54.9 41.6 82.9

5.2 1.5 5.9 6.6 0.5 3.8 6.5 7.0 33.6 19.9 43.4

7.4 3.8 15.0 10.9 6.3 18.1 15.7 24.7 33.0 18.8 35.4

73.1 9.7 58.0 67.8 22.3 113.7 100.8 123.7 103.7 57.3 97.9

National level

34.6

30.1

8.1

13.2

70.7

Notes: 1–6 and 1–8 both represent the primary school grades where the latter is the new system. ‘Net intake grade 1’ shows the ratio between the entrants of seven-year-old children to grade 1 and the population of seven years old, whereas ‘Apparent intake grade 1’ shows the ratio between the total number of students entering grade 1 and the population of seven-year-old children in the respective region or at the national level. Source: Ministry of Education (1997: 5, 6, 8, 9).

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deserves attention and increased resources so that literacy and the availability of labour with at least some elementary education can increase. Given the present situation the prospects for rural modernisation and development are bleak, even though the resources that have been allocated to education have increased during the 1990s. The EPRDF government has tried to reduce the problem of the weak educational basis of the regional administrations by providing education for executive managers and officers at the regional level. For instance, there is a training programme that initially was intended to comprise around 6,200 trainees (Alemseged 1996). Special attention has been devoted to the situation in what the government has classified as the five less developed regional states: Afar, Somale, Harari, Gambella and Benshangul/Gumaz. The content of Table 4.7 is problematic also from a perspective of rural economic development. It reveals that the distribution of schooling is heavily biased towards the urban areas. Thereby, the availability of even elementary skilled labour in the rural areas is scarce, and will continue to be so for the foreseeable future. Thus, the picture and tendencies from Tables 4.5 and 4.6 of poor prospects for economic diversification and development in rural areas are strengthened. These tendencies are further strengthened by the poor status of infrastructure in general and in particular the road network outside urban areas. In total there are only around 18,000 km of all types of roads in Ethiopia. Most of the roads are found in the central, eastern and northern highlands (Ofcansky and Berry 1993: 193f.). To conclude, even though the ongoing five-year development programme by the Ethiopian government is presented as a ‘five year rural centered development programme’ (Ministry of Economic Development and Cooperation 1996), the government’s regional budgetary allocations and the present situation of education tend to counteract a successful regionally balanced economic development. The urban–rural gap in capital–labour and the skilled–unskilled labour ratios tend to be even more marked in the future if the present regional budget and education policies continue and are not counteracted by foreign assistance and private sector activities. However, given the current infrastructural situation the latter is quite unrealistic from a general rural perspective. Infrastructure, availability of skilled labour and a competent regional administration are crucial factors for private investments. Furthermore, infrastructure, education and efficiency in public administration are normally the responsibility of the government. There is no reason why the private sector in Ethiopia and potential foreign investors should have another view on these issues. Therefore, even though the Ethiopian post-Mengistu governments have decentralised important functions and powers to the regions and also increased the budget allocations to the regions, on a per capita basis the distributions of both budgetary resources and primary and secondary education are highly biased towards the urban areas and against the poor rural areas. Thus, the policy is not completely consistent with the government’s declaration of adopting a rural-based economic development strategy. Therefore, the outcome of an evaluation of the regionalisation and decentralisation norms is mixed. Keeping in mind the biases mentioned above, it seems still fair to give an overall relatively positive evaluation of the institutional and budgetary reforms as regards the regionalisation and decentralisation norms.

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Concluding remarks

This study has analysed the role of government legitimacy in the process of economic growth and development in Ethiopia. In the type of society that the Ethiopian government has declared as the objective of its various reform programmes, the support of the domestic population is of great importance for the government’s stability and thus for the conditions for doing business in the country. To this it should be added that Ethiopia is a country that needs foreign assistance and foreign investments in order to speed up both physical and human capital formation and thus economic development. For aid flows to come without conflicting with the Ethiopian ownership of her own development, the international legitimacy of the government is of crucial importance. The same is true for the possibilities of Ethiopia to attract foreign investments. We have shown that, notwithstanding the demanding post-Mengistu reconstruction and rehabilitation work, Ethiopia has succeeded in avoiding becoming increasingly aid-dependent, measured as the aid–GDP ratio. This has been avoided through the introduction of quite far-reaching economic system reforms and the economic growth that these reforms have given rise to. In the interest of Ethiopian ownership of aid, and thus of her development process also, it is of crucial importance that the government’s legitimacy is not reduced but strengthened. By analyzing various norms of legitimacy that can be assumed to be of major importance in the case of Ethiopia, it has been concluded that the government has made quite impressive progress in terms of the economic norms, and also in relation to the decentralisation and regionalisation norms even though the policy so far seems to have been largely biased towards the urban regions. In Ethiopia there is a growing political awareness and the opposition has become relatively efficient in criticising the government policy. During the past decade the author of this study has witnessed increased activities from the opposition both in publications like books and newspapers in Addis Ababa and internationally. The opposition has also intensified its propaganda in speeches and lobbying to foreign politicians, representatives and organisations. This open opposition should be seen as a positive sign as regards the exercise of human rights in Ethiopia. Non-violent activities by the opposition should be seen as natural and positive for development in democratic societies. In the case of Ethiopia the opposition in its propaganda and press debate has largely ignored the progress in the economy. Instead it has focused mainly on issues related to democratisation and human rights. If the opposition succeeds in delegitimising the EPRDF government, there is a risk that aid flows will cease and that foreign investments will not be allocated to Ethiopia, and the prospects for sustainable growth and economic development risk being hampered also. Therefore, parallel to the ongoing work on improvements in these fields, in order to counteract the delegitimisation that this criticism risks giving rise to, the government can stimulate and take active part in public debates about the various reform programmes and development strategies and also about the implementation problems related to these programmes and strategies. After a period characterised by quite a positive economic development, and a large increased government legitimacy, Ethiopia in 1998 faced severe political and economic problems through the military conflict with Eritrea that started on 6 May

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the same year. In addition to direct human suffering, this war led to reduced activities outside the military sector, reduced productive investments and thus reduced economic growth, and a reduction in exports. The increased military expenditure also meant less resources available for social sector development. In terms of government legitimacy, the border conflict with Ethiopia can be expected to have led to a break in the positive development of the international legitimacy that was achieved during the period 1991–7. The negative effects on the economic situation that the war with Eritrea has given rise to can also be expected to have reduced the domestic legitimacy of the Ethiopian government. Even though the war came to a final end by the signing of the peace agreement in December 2000, the long-run cost in terms of lack of confidence for a lasting peace will hamper the economic prospects for growth and development in Ethiopia for many years to come. Therefore, it will be a heavy task for the government to take Ethiopia back on the 1991–7 track of positive economic development. To this should be added that the loss of international legitimacy along with the war risks leading to a discontinuation of the international community’s development cooperation with Ethiopia. The World Bank, for instance, has declared that there will be problems to obtain loans for new projects as long as the war continues (EIU, 4th quarter, 1999: 23). In the present social and economic situation a stop of the inflow of foreign resources would be quite negative and make a return to economic development and prosperity even more difficult.

References Alemseged, Bitew (1996), Progress Report on Regional-Zonal and Woreda Executive Members Training Development and Workplan to the Programme, August 1996. Addis Ababa: Prime Minister’s Office. Amnesty International – Report – AFR 25/02/99, 29 January 1999, Ethiopia/Eritrea: Amnesty International Witnesses Cruelty of Mass Deportations, available on http://www.amnesty.org/ailib/aipub/1999/AFR/12500299.htm Assefa, Negash (1996), The Pillage of Ethiopia. Los Angeles: Adey Publishing Company. Central Statistical Authority, The 1994 Population and Housing Census of Ethiopia. Addis Ababa: Central Statistical Authority. Baxter, P .T. W. (1994), ‘The Creation & Constitution of Oromo Nationality’, in K. Fukui and J. Markakis (eds), Ethnicity & Conflict in the Horn of Africa. London and Athens: James Currey and Ohio University Press. Dahl, R. A. (1984), Modern Political Analysis. Englewood Cliffs, NJ: Prentice-Hall Inc. EIU (1999), Country Report Ethiopia, Eritrea, Somalia, Djibouti (3rd and 4th quarter). London: The Economist Intelligence Unit. Federal Negarit Gazeta (1996), Investment Proclamation, Proclamation No. 37/1996. Addis Ababa: The Federal Democratic Republic of Ethiopia. Hansson, G. (1995), The Ethiopian Economy 1974–94: Ethiopia Tikdem and After. London and New York: Routledge. IMF (1994a), Ethiopia: Recent Economic Developments, August 29. Washington, DC: IMF. IMF (1994b), Request for the Third Annual Arrangement under the Structural Adjustment Facility, 18 October 1994. Washington, DC: IMF, African and Policy Development and Review Departments.

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IMF (1996), Ethiopia Enhanced Structural Adjustment Facility, Medium-Term Economic and Financial Policy Framework Paper 1996/97–1998/99. IMF (1998), Ethiopia: Statistical Appendix, January 1998, IMF Staff Country Report No. 98/6. Washington, DC: IMF. IMF (1999a), Ethiopia: Recent Economic Developments, September 1999, IMF Staff Country Report No. 99/98. Washington, DC: IMF. IMF (1999b), IMF Concludes Article IV Consultation with Ethiopia, Public Information Notice (PIN) No. 99/77, 16 August 1999. Washington, DC: IMF (available on http://www.imf.org/external/np/sec/pn/1999/PN9977.htm). Liuksila, C. (ed.) (1995), External Assistance and Policies for Growth in Africa. Washington: IMF and the Ministry of Finance of Japan. Ministry of Economic Development and Cooperation (1996), FDRE’s Five Year Programme on Development, Peace and Democracy, abridged unofficial translation. Addis Ababa: Ministry of Economic Development and Cooperation. Ministry of Education (1997), Education Statistics, Annual Abstract 1988 E.C. 1995/96, Education Management Information Systems. Addis Ababa: Ministry of Education. Ministry of Finance (1996), 1989 E.C. Fiscal Year Budget Proclamation No. 39/1996. Addis Ababa: Ministry of Finance. Ministry of Finance (1997a), 1990 F.Y. Budget Proclamation. Addis Ababa: Ministry of Finance. Ministry of Finance (1997b), Brief Outline on the Ethiopian Budgetary Laws and Highlights on the 1990 F.Y. Recurrent Budget, August 1997. Addis Ababa: Budget Department, Ministry of Finance. Ministry of Finance (1997c), Ethiopia: Current and Capital Budgetary Expenditure Level of Regional States, 2 September 1997. Addis Ababa: Planning and Research Department, Ministry of Finance. Ministry of Finance (1997d), Ethiopia: Current and Capital Budgetary Allocation for FYs 1993/94–1997/98 and Outturn for FYs 1993/94–1996/97, 2, September 1997, Addis Ababa: Planning and Research Department, Ministry of Finance. Negarit Gazeta No. 1, 22 July 1991. Addis Ababa: The Transitional Government of Ethiopia. Negarit Gazeta No. 2, 14 January 1992. Addis Ababa: The Transitional Government of Ethiopia. Ofcansky, T. P. and Berry, L. (1993), Ethiopia: A Country Study. Washington, DC: Federal Research Division of the Library Congress. Steiner, K. (1996), Strategies for International Legitimacy: A Comparative Study of Elite Behavior in Ethnic Conflicts. Lund: Lund University Press. TGE (1994), The System of Regional Administration in Ethiopia. Addis Ababa: Transitional Government of Ethiopia. The Constitution of the Federal Democratic Republic of Ethiopia (unofficial English translation from the Amharic Original), 8 December 1994, Addis Ababa. US Department of State, 1996 Human Rights Report on Ethiopia. Washington, DC: US Department of State. World Bank (1994), Adjustment in Africa – Reforms, Results, and the Road Ahead. New York: Oxford University Press. World Bank (1996), Ethiopia: An Economic Overview, Prepared for the Consultative Group Meeting of 10–12 December 1996. Addis Ababa: The World Bank. World Bank, Africa Regional Database, ‘Macroeconomic Profile for Ethiopia’ and ‘Sectoral Profile for Ethiopia’, most recent version on http://wbln0018.worldbank.org/afr/aftbreif.nsf

5

Eritrean reforms A struggle for sustained independence and economic growth Göte Hansson

1 Introduction Eritrea is located at the coast of the Red Sea in what is often named the Horn of Africa. The country comprises around 3.5 million people who live on the 12.4 million hectares of land under Eritrean rule. Of this land, at present around 25 per cent is classified as arable but only around 12 per cent of the arable land is actually cultivated. According to the World Bank’s and the UNDP’s classifications, Eritrea is one of the poorest countries. To a large extent this is due to the political unrest and the economic political mismanagement that have characterised the environment of the Eritreans during the thirty years under Ethiopian rule. Eritrea’s history as an entity goes back to 1890 when the Italians drew up the borders of a colony in the Horn of Africa and named it Eritrea. Since then Eritrea has been a colony under Italy (1890–1941) and Great Britain (1941–52). In 1952 the United Nations decided that Eritrea should be a self-determining region within Ethiopia. In 1962 this situation was changed and Eritrea became an integrated region in Ethiopia without any rights of self-determination. It is interesting to note that freedom is very deeply rooted in Eritrean history. According to Pateman (1990: 29): In ancient times, Eritrea was called Medri Geez, the land of the free, Medri Bahari, the land of the sea and Mareb Mellash, the land beyond the river. Throughout her history Eritrea and her people have struggled for independence. After thirty years of liberation struggle against the Ethiopian rulers, in May 1991 Eritrea achieved de facto, though not formal, political independence when the Mengistu government in Ethiopia was defeated by the Eritrean Peoples Liberation Front (EPLF) and their Ethiopian opposition colleagues in the Ethiopian Peoples Revolutionary Democratic Front (EPRDF). After a referendum among Eritreans, on 24 May 1993 Eritrea declared itself as an independent and sovereign state and made herself worthy of her ancient name Medri Geez, the land of the free. The country that in 1991 achieved de facto, and in 1993 formal, independence was a severely ravaged country that had to be thoroughly rebuilt. To quote the first

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paragraph of the Eritrean government’s Macro-Policy document: Eritrea is rising from the ashes of war and destruction, conflict and conflagration, colonial rule and oppression, and has entered a new era of peace and prosperity, of development and democracy. A bright vista which draws on the hard won independence, prevailing peace and stability, strong national unity, accelerating process of democratization, and harmonious and cooperative external relations is opening up. A concerted effort is underway to transform the war ravaged backward economy into a modern one characterized by self-sustaining growth. (GSE 1994: 1) It is obvious that the task of raising Eritrea from the ashes is not only a great challenge for the Eritrean government and the Eritrean people but it is also very difficult and demanding. The present study analyses the policy measures decided by the government to achieve its objectives to take the country to a self-sustaining growth and thus defend and strengthen its achieved independence. The plan of the study is first to give a brief analysis of the political situation and challenges. Then, we turn to an analysis of the economic situation and the reforms of the economic system that have been announced and in some cases have begun to be implemented. The consequences of the military conflict with Ethiopia that began in 6 May 1998 are analysed also. Thereafter we ask how the world community can contribute to the development process in Eritrea. What is the Eritrean government’s attitude to their richer partners in their development strategy and how does this attitude fit into the overall objectives of raising Eritrea from the ashes and creating self-sustainable economic growth? Finally, the major conclusions from the study are summarised.

2

Political situation

Introduction After more than 100 years under foreign rule, in May 1991 Eritrea achieved de facto political independence when the Mengistu government was defeated by the EPLF and their Ethiopian opposition colleagues in the EPRDF. In July the same year, the new Ethiopian leaders called for a National Conference on Peace and Democracy. At this conference it was decided that the Eritrean people should be given the right to decide the future political status of their country. In April 1993 the Provisional Government in Eritrea organised a referendum among Eritreans about the future status of the country. An overwhelming majority of the electorate participated (98.5 per cent) and voted for formal independence (99.8 per cent of the votes). On 24 May 1993, Eritrea declared itself an independent and sovereign nation state. The world community at large declared its recognition of the new state in the Horn of Africa and long-term foreign assistance for economic development could thereby be offered to Eritrea. On 28 May 1993 Eritrea became a member of the United Nations, in July 1994 it became a member of the IBRD and IDA, and in October 1995 membership of IFC was obtained.

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The struggle for continued political independence and autonomy Today Eritrea is governed by a government, headed by President Issaias Afwerki, and a National Assembly consisting of 150 members – 75 from the Central Council of the Peoples Front for Democracy and Justice (PFDJ, formerly EPLF) and 75 nonPFDJ members, including representatives from the Eritrean diaspora. A pluralist national election for President and the National Assembly was scheduled for 1997 and then postponed to 1998. On 6 May 1998 a violent border conflict with Ethiopia arose and made the government postpone the elections once more. The work on a new constitution was the most important political activity for the new government in creating the future political system in Eritrea. On 16 April 1994 the government established The Constitutional Commission of Eritrea. The task of this commission was ‘to draft a constitution on the basis of “a wide-ranging and allembracing national debate and education through public seminars and lectures series on constitutional principles and practices” ’ (CCE, October 1995: 1). Furthermore it was stated that: The mission of the Commission shall be to … draft a constitution on the basis of which a democratic order would be established, and which, as the basic law, shall be the ultimate point of reference of all the laws of the country, and the final arbiter of all basic issues in dispute. (CCE, August 1995: 3) The Commission consisted of fifty members in a policy-making council, ten members form an Executive Committee. It is worth noting that the Commission members were recruited from various parts of Eritrean society representing various ethnic groups, rural and urban people; also Eritreans in the diaspora were found in the Commission. Of the fifty members of the Constitutional Commission, 21 were women. Under the Executive Committee the work in the Commission was organised in four ad hoc Committees (one committee on governmental institutions and human rights, one economic committee, one on social and cultural affairs, and one on governance and related issues) and one Standing Committee of the Commission on civic education and public debate. In addition to these committees the Constitutional Commission had access to one advisory board of international experts and one advisory board with Eritrean experts on customary law. In line with their instruction, the Constitutional Commission arranged a great number of seminars both within Eritrea and abroad where Eritreans are living (CCE, October 1995: 8). Four hundred people were trained to provide education in civic issues. It has been estimated that up to October 1995 more than half a million people, of whom about 40 per cent were women, participated in meetings where information about the ongoing constitutional work was presented. In the constitutional proposal for public debate, the objective to protect the recently achieved independence is based on the following fact: We Eritreans are engaged in creating our own government for the first time in our history. … If we can create a strong government that is free from corruption

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In line with the overall objective to create a democracy for independent Eritrea, it was stressed that the constitution: has to be based on the history, political circumstance and experience, social structure and culture, level of development and in general on the specific conditions of the Eritrean society; and its contents have to serve the basic aims of nation building, equitable development and stability, the building of democracy, the protection of human rights and the assurance of popular participation. (ibid.: 6) Furthermore, it was stressed that the Eritrean political system ‘ought to be based on the principles of nationalism [national unity and development], secularism [separation of religion from government] and democracy [ensure equal participation of all members of Eritrean society without any exception]’ (ibid.: 7f.). In particular the objective to build a nation characterised by unity in diversity was strongly emphasised. Therefore, the formation of political parties along ethnic or religious lines is prohibited. This can be seen as a means to avoid ethnic and religious political problems and strifes of the kind that are quite common in the African continent. The National Assembly shall be a one-house assembly that shall be elected every fifth year. This assembly elects the President of Eritrea for five years with a possibility to be reelected one time but no more. It also elects its own Chairman. The Ministers of the President’s cabinet can be recruited from both within and outside the National Assembly (CCE, August 1995: 22f.). Even though Eritrea is to have a unitary government, the objective of decentralising powers to regional and local levels is stressed as is the importance of local governments in facilitating the popular participation in politics (CCE, August 1995: 27). However, the lack of administrative capacity makes it necessary to ‘realize that decentralization is something that naturally develops alongside regional (or local) economic and cultural development, and is not created, or even accelerated, by policy decisions alone’ (CCE, August 1995: 28). Therefore, the more precise details of decentralisation and the future administrative structure and division of power between the central government and administrative democratic bodies at lower levels were left outside the constitution and should be decided by the legislative body that should be one of the important cornerstones in the intended democratic political system that is opted for in Eritrea (ibid.). However, in the summary report from the seminar with international experts on constitutional issues it was stated that: The Eritrean State can succeed only if (a) it shares political power through decentralization, (b) mobilizes at the grassroots level, and (c) promotes the

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welfare of the majority which in the Eritrean context means the rural areas, and translates essentially into food security. (CCE, January 1995: 23) The form of the electoral system was left outside the work of the Constitutional Commission. For democracy to work on the basis of a wide participation among people all over the country and groups of society, the choice of or design of the electoral system is crucial. Sartori has classified this choice as ‘the most specific manipulative instrument of politics’ (here quoted from Lijphart (1991: 73); for an analysis of electoral systems, see also e.g. Linz (1990), Horowitz (1990) and Hydén (1993)). In a proportional electoral system the minorities tend to be better protected or represented than in a plurality/majority system. This is due to the fact that in the former system, the districts’ representation in the parliament will be proportional to the actual votes in the respective districts, whereas in a plurality (majority) system the candidate or party obtaining most (majority of the) votes in the district will take all seats for the district in the parliament. Thus, in a country aiming at democracy of the people we should expect a preference for a proportional electoral system. Furthermore, in comparison with a plurality/majority system, a proportional electoral system leaves less room for manipulation with the division of the country into voting districts. On the other hand, in a country where there is a high preference for strong governments, we should expect a preference for a plurality/majority system. In such a system, there is a relatively stronger tendency for a one- or two-party system and a government with an absolute majority in the parliament. With a plurality/majority system there is greater potential to carry through difficult policy programmes, for example various types of economic or structural adjustment programmes, ceteris paribus. This is an important aspect, in particular in countries that face deep economic crisis and where far-reaching structural reforms are needed. In the case of Eritrea, with her quite demanding economic and political reform programmes, there is need for a strong government. Thus, there seems to be an obvious case for choosing a plurality/majority electoral system. Majority rule is central in democratic decision making. It is important, however, to note that in the doctrine of liberal democracy, decision making is preceded by discussion and a search for compromises so that the opinion of the minorities can be taken into explicit consideration. Due to the lack of democratic tradition, and thus of well-organised parties and well-functioning information channels in Eritrea, together with the low level of education and literacy, it will take considerable time to build a basis for democratic elections of the type we are used to in the Western world. Coalitions between various parties in the electoral processes will be difficult to establish on a national level. It should be noted also that at present there are great differences in the resources available for political work, where naturally the ruling party, PFDJ, can be expected to have a better position than other organisations in the country. One can therefore expect that, for quite a long time, PFDJ will obtain a clear majority of the votes and a majority of the seats in the National Assembly. Therefore, in the short- and

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medium-term perspective we should not expect that the electoral system per se will be a critical factor for the governance of the country and the possibility to implement economic reforms. This has also been suggested by President Issaias Afeworki in an interview where he, on the democratic rights attempted at in the constitution and the issue of existing or emerging opposition to the ruling PFDJ, stated that: If you’re looking in terms of five or 10 years, you will be disappointed. Given our circumstances, the Front will continue to be dominant for several years to come. (Financial Times, 18 January 1996: 13) From a long-term perspective, stability and continuity, and thus predictability and credibility, are crucial prerequisites for a successful introduction and implementation of substantial, and thus time-consuming, economic systemic changes of the kind now under way in Eritrea. These important factors are in turn dependent on the situation of minority groups. In the Eritrean context it is interesting to note that there are two dominating ethnic groups: ethnic Tigrays (50 per cent of the population) and Tigre and Kunama (40 per cent). However, given the new regional division there does not seem to be such a heavy ethnic concentration in various regions as is the case in Ethiopia. As mentioned above, the government has chosen to prohibit political parties that are based on ethnicity and religion. In the Constitutional Commission’s proposals for public debate, it was clearly spelled out that: building democracy has to follow the path of nation-building in which sub-nationalism and its concomitant religious, tribal and sectarian tendencies are not given any chance to grow, but rather, unity and stability are maintained. What we need is a participatory democracy that is based on, and reinforces, national consensus, one that serves the purpose of developing a stable political system as opposed to one that institutionalised exclusion. (CCE, August 1995: 15) Therefore, compared to the situation in neighbouring Ethiopia with her multiethnic character, in Eritrea there does not seem to be the same risk for minority neglect and concomitant political strives and instability. Concluding remarks After independence the creation of a democratic and unitary Eritrea in diversity was given high priority through the work on a new constitution. By arranging a great number of seminars within and outside Eritrea, the Constitutional Commission tried to give all Eritreans a possibility to raise their voice and affect the constitution. The new constitution was eventually approved by the National Assembly in May 1997. One severe problem in Eritrea has been and still is the lack of administrative capacity and lack of skilled persons both for the central administration of the country and for the administration at lower levels of government. Thus, the process of

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democratisation will be a gradual process. One example of this is that many issues that are crucial for the future development of democracy in Eritrea, like the choice of the electoral system and the ratification of international human rights conventions, have been postponed. This is an interesting attitude towards development in Eritrea. The Constitutional Commission expressed the Eritrean strategy of gradualism in the following way: In listing social, economic and cultural rights, caution is necessary. Rights which cannot be implemented should not be listed. If rights listed in the constitution cannot be implemented, for example, due to resource limitations, which in fact is a violation, it devalues the constitution and gives the impression that it can be violated. … We think it is essential to mention rights, which cannot be accomplished in our current conditions, as goals. (CCE, August 1995: 26f.)

3 Economic situation The Ethiopian heritage: An economic system in distress When Eritrea achieved de facto independence in 1991, it was a country in ‘ashes’ not only due to thirty years of devastating war but also due to the economic system and policy that President Mengistu had introduced in Ethiopia since the mid-1970s. In terms of economic system dimensions, i.e. the dimensions that describe the institutional (i.e. the legal and political) framework that determines how the scarce resources of an economy are used, the Eritrean economy could be described by means of Figure 5.1, which is based on Lindbeck’s (1973) definition of the main dimensions of economic systems. In short, from economic theory we expect that the further to the left an economy falls along the scales of the six dimensions in Figure 5.1, the more flexible and able to adjust to external and internal shocks it tends to be. Furthermore, there is a tendency for economic agents and organisations to be more committed and efficient in their performance when the economic system falls to the left rather than to the right in Figure 5.1. 1. 2. 3. 4. 5. 6.

Decentralisation Markets Private ownership Incentives Competition Internationalisation

< < < < < <

> > > > > >

Centralisation Administrative processes Collective ownership Orders Non-competition Autarky

Figure 5.1 Economic system dimensions.

In terms of the dimensions in Figure 5.1, Eritrea by the end of the 1980s could be classified as having the following features (for an analysis of the background and the processes leading up to this situation, see e.g. Hansson (1995: chapter 3) and

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references therein):









Highly centralised resource allocation governed from the central government in Addis Ababa, Ethiopia. Administrative processes that dominated the allocation of resources of production, and where non-market prices on inputs and outputs were the rule. Furthermore, orders, not prices, dominated as the basis for industrial production and investments. Thus, the economy was close to a command economy. As a consequence parallel markets for consumer goods and some inputs flourished. Widespread State ownership in non-agriculture. In agriculture the Ethiopian State owned the land but private (individual) farmers dominated the use of it. Lack of incentives for individuals and companies, insecure land tenure for peasants, and an emphasis on State farms and producer co-operatives in agriculture. Lack of competition. Heavy trade and exchange rate controls with an overvalued exchange rate and a growing illegal trade both in goods and foreign exchange. (Hansson 1995: 38)

President Mengistu, placed under heavy pressure from domestic economic realities, and also from international donor organisations and even from old partners like Michael Gorbachev in the Soviet Union, introduced relatively far-reaching reforms in March 1990. In particular the reforms affected the conditions in the agricultural sector, where the former emphasis on producer co-operatives was now dismantled, the farmers got lifetime rights to use their land, and the agricultural marketing system was liberalised (see e.g. Hansson 1995: 92 f.). Notwithstanding the March 1990 reforms the economic problems continued, and the civil war with various Ethiopian and Eritrean liberation movements escalated and occupied more and more resources. This, together with the uncertainty created by the war, slowed down the actual implementation of the reform package. Therefore, when the Provisional Government of Eritrea came to de facto power in 1991, it faced an economy with severe system deficiencies. As noted above, the Eritrean economy was a highly centralised economy governed from Addis Ababa. By independence therefore, the central functions had to be taken over by the Provisional Government in Eritrea since there was no administrative capacity either in the public sector or in the small private sector to immediately introduce a more decentralised economic system. It should be noted that, as a rule, the higher the degree of centralisation, the more the information needed at the central level for efficient decision making and the higher the costs related to implementation and control. Furthermore, the more decentralised the decision making, the more responsible and committed the individuals or organisations concerned. Thus, there was an important potential for improving the efficiency in the Eritrean economy by introducing a more decentralised economic system. The same reasoning applies to the second dimension, markets ↔ administrative processes as means in the allocation of resources. When markets are used, the income distribution, the prices, consumer preferences and the production possibilities together determine the allocation through the interaction of individual economic actors, while

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in a system governed by administrative processes, other, information-intensive, and thereby also more costly, processes have to be used to decide and coordinate the resource allocation. Therefore, in this respect also, the Eritrean economy could gain in efficiency if it increases the role of markets in the allocation of resources. Another crucial dimension of an economic system concerns the issue of ownership. As a rule, it is assumed that private ownership requires much less control for efficient long-run utilisation of capital and land than is the case when capital or land are publicly owned or are owned collectively by individuals in various types of cooperatives. In the case of Eritrea, the issue of privatisation of enterprises and the rights to establish new private enterprises is of crucial importance for the future of the Eritrean economy. Closely related to the previous dimension is the fourth dimension, incentives ↔ orders. This dimension deals with the issue of how to make economic actors act efficiently. It is well known that incentives tend to give the individual a feeling of being freer to act than is the case with orders. This, in turn, tends to increase the involvement, responsibility and efficiency of individuals in their economic activities. In the former Ethiopian, and thus the Eritrean system, there was not much room for incentives. Instead, the centralised, administrative allocation of resources and, in the nonagricultural sectors, the state ownership implied that the individuals had to comply largely with orders that tended to alienate them from their activities. Therefore, by introducing a system with fewer orders and more incentives, the economic actors’ commitment to and responsibility in their respective economic activities could give rise to important positive effects on the performance of the Eritrean economy. The same conclusion relates to changes in the system that gives competition more weight in the economy. Lack of competition tends to lead to higher costs and, over time, to lower quality in production. Thus, by increasing the degree of competition, the more efficient the individual actors tend to become, and thereby the performance of the economy will also improve. One important way to increase competition is to open up the economy to international trade and investments. By liberalising the international economic relations, the degree of competition in Eritrea could increase significantly, and the inflow of foreign capital, raw material and foreign technology could be made available for the country. A brief description of the 1974–98 economic system changes Immediately after the de facto independence in 1991, there was a conference about the economic policy challenges and options held at the University of Asmara (Gebre Hiwet Tesfagioris 1993) with academic researchers, civil servants and politicians. This conference reached a consensus about the objective to develop the Eritrean economy to a mixed economy, to stimulate industries that could augment the output from the dominant agricultural sector, develop regional co-operation with neighbouring countries, and to incorporate environmental and ecological aspects in industrialisation and other economic development decisions (Gebre Hiwet Tesfagioris 1993: ix f.). Quite soon after the de facto independence, a Recovery and Rehabilitation Programme for Eritrea (RRPE) was designed and began to be implemented. The priority issues

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identified in the RRPE related to agricultural and industrial inputs, rehabilitation of the infrastructure, launching labour-intensive projects, and the strengthening of central economic agencies (UNDP 1993: 5f.). The main economic system changes included in the RRPE were e.g. the following:






encourage the development of a market economy denationalisation of enterprises that were nationalised by the former Ethiopian government encourage private sector activities reform the land tenure system liberalise trade and exchange regimes.

Already from the fall of the Mengistu government in Ethiopia, the Eritrean provisional government and the Ethiopian transitional government worked on, and in January 1992 also signed, agreements about transit trade. Furthermore, they agreed that Assab should be a free port for Ethiopia. Eritrea and Ethiopia also signed a free trade pact that among other things should stimulate cooperation between enterprises in the two countries (UNDP 1993: 3). Up to November 1997, Eritrea and Ethiopia also had a de facto currency union where the Ethiopian birr was the common currency unit. In November 1994 the Eritrean government published a Macro-Policy document where the economic strategy was more carefully presented. In this document it was stated that: The overriding national development objective is the creation of a modern, technologically advanced and internationally competitive economy within the next two decades. (GSE 1994: 10) In the same policy document the government declared that its development efforts aim at:










Improved agricultural production through the development of irrigated agriculture, and by enhancing the productivity of peasants, pastoralists and agropastoralists. Developed capital and knowledge-intensive and export-oriented industries and services. An upgraded and technologically improved informal sector. A developed tourism sector and high-grade conference and convention facilities. A competitive international financial centre. A developed and systematic public health care system. Broad-based education incorporating widespread dissemination of skills and languages and extensive human capital formation. (GSE 1994: 10)

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The government noted that in order to facilitate these objectives it must also pay due attention to the social sectors. Therefore, in the list of objectives we also find:






An efficient social welfare and safety net system. An upgraded and safe-guarded environment that is free from pollution. A decentralised and democratic political system. An internally peaceful and stable nation at peace and in harmony with its neighbours. A free and sovereign state where human rights are respected. (GSE 1994: 11)

In 1998 the government released a document about the national economic policy for 1998–2000, where it stressed its ambitions to continue the process of reconstruction and reforms and where it also identified some of the major obstacles to growth and development. In particular, the lack of human resources, physical infrastructure and low institutional capacity were emphasised (GSE 1998: 9f.). Then what changes have actually been introduced in the transformation of the Eritrean economy away from socialism and centralism to a more market-oriented mixed economy where the private sector plays a dominating role? The government started to change the economic system and economic policy by reforming the labour-, the investment- and the commercial-codes. Furthermore, the tax system was revised and, through the establishment of an efficient licence office, the establishment of small business was simplified (EIU 1995, 4th quarter 1995: 29). In a first privatisation move all (some 700) small-scale enterprises were privatised already by the end of 1993. With regard to larger enterprises, in December 1995 the government established a national agency for the supervision and privatisation of public enterprises (Gazette of Eritrean Laws, No. 12, 1995). The government announced its intention to privatise most of the state-owned enterprises and in 1997 it was decided that all 39 state-owned manufacturing enterprises should be privatised. However, as noted in other countries (e.g. Ethiopia), the process of privatisation of state-owned enterprises is not easy (see e.g. Hansson 1995: 124ff.) and up to May 1998 only 11 enterprises had been privatised (IMF 1998: 24). As a step towards improved efficiency in the state-owned enterprises before privatisation, it was decided that these enterprises shall be governed by autonomous boards and should operate on commercial conditions. Furthermore, trade was liberalised in order to increase competition and efficiency and also to stimulate exports from Eritrea. Another important field of economic policy that is closely related to trade, and that is crucial for making trade work as an engine of growth, is the exchange rate policy. During the entire period of Ethiopian rule, the currency was in a completely fix relation to the US dollar and this relationship was not supported or motivated by the actual trade patterns (see e.g. Hansson 1995: 35). Furthermore, the Ethiopian birr, partly as a consequence of this relationship and the development of the international value of the US dollar, was heavily overvalued. Thus, the export potentials were restricted not only by the internal organisation of the Eritrean economic system but also by the exchange rate policy.

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On 30 September 1992 the Ethiopian birr was devalued from its 2.07 birr per US dollar (an exchange rate that has lasted since the early 1970s) to 5.00 birr per US dollar. Furthermore, in May 1993 the Ethiopian government introduced a foreign exchange auctioning system (see Hansson (1995: 114f.) and references therein) which adjusted the exchange rate further towards a level more in line with the ‘true’ market value of the birr. From independence and up to November 1997 Eritrea continued to use the Ethiopian birr as her currency. Thereby, Eritrea had problems to carry out a sovereign monetary policy, in particular to design an active interest rate policy. Even though this problem was recognised by the Eritrean authorities and international financial institutions, it is interesting to note that the then close links between the Eritrean and Ethiopian governments and their central banks, according to the Bank of Eritrea, made it possible to solve arising problems before they became severe. One example was that Eritrea within the currency area with Ethiopia was allowed to and also did work with a preferential exchange rate for private business instead of the official Ethiopian exchange rate. However, notwithstanding this, the Eritrean government introduced its own currency, the nakfa, in November 1997. The Eritrean authorities have also liberalised its foreign exchange administration with the objective to make Eritrea ‘a centre of finance and trade’. As a consequence of this objective, the Bank of Eritrea released ‘A Guide to Investors’ on 17 January 1996. In this document it clearly states the intentions to ‘phasing out all types of exchange controls’ (Bank of Eritrea, 17 January 1996). Among the measures taken, the following should be given special attention: 1 Foreign exchange holding need not be declared when coming into or going out of Eritrea. 2 Exporters may retain up to 100 per cent of proceeds of their goods. 3 Except those internationally prohibited items, no negative list is maintained for the import of goods. 4 Restrictions with regard to the transfers of profits, dividends, patent rights and capital, etc. now belong to the past. 5 Producing enterprises are not protected. There is no limitation on import goods on account of type, quantity or value. Conditions of sales or purchases, including prices, are left to be market determined. 6 At their discretion, enterprises and individuals are free to maintain foreign currency account. 7 Investors are accorded a preferential rate of exchange for their foreign exchange components of their investments. 8 All convertible hard currencies are acceptable in Eritrea. 9 Foreign employees may remit up to 40 per cent of their net earnings each month. 10 The travel allowance for business trips is USD 200 per person per day for up to thirty days. This limit may be exceeded in exceptional circumstances. 11 Medical expenses of up to USD 10,000 for treatment abroad. This may be exceeded in exceptional circumstances. 12 Exports may be made under letters of credit, on advance or consignment basis.

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Thus, we note that the Eritrean exchange rate policy has been significantly liberalised. As the changes are quite recent, and due to the military conflict with Ethiopia that broke out in May 1998 it is not possible to make a proper evaluation of the effects of the new policy. However, from economic theory we should expect the changes to give rise to positive effects on the inflow of foreign investments and on the export performance. In conclusion, during the years of de facto and formal independence, the Eritrean government announced an impressive number of important system changes and also started to implement a great number of them. In terms of the six economic system dimensions that were presented in Figure 5.1, these reforms have moved or can be expected to move the Eritrean economic system towards a more decentralised, market-oriented and internationally open economic system. Thereby we can also expect the economy to become more efficient and flexible. If successfully implemented, these system changes will enhance economic growth and development. Economic performance 1992–7 The reforms of the Eritrean economy, through decentralisation of power, greater reliance on markets, incentives and competition, and by liberalising trade and exchange rate policies as well as the possibilities for foreign investors to start business in Eritrea, have paved the way for economic growth and development. Furthermore, there are no important consistency problems with the reforms introduced so far. From Table 5.1 we learn that the role of agriculture has decreased whereas the respective roles of industry and services have increased. This development is what could be expected from the new development strategy, but due to the short time since the system changes were introduced, it is too early to make a proper evaluation of their actual effects. Therefore, Table 5.1 should just be seen as indications of the structural development in Eritrea after independence. As can be concluded from Table 5.2, the Eritrean economy grew quite rapidly in 1994, that is directly after independence and the drought in 1993, but that growth during 1995 was more moderate due to another drought. Data for 1996 and the preliminary data for 1997 show quite a high growth rate of 7 and 8 per cent, respectively, implying a positive development in per capita income. Furthermore, we note that inflation rates have been kept at a reasonable level. This is interesting, since there have been deregulation and liberalisation of the price controls. In 1996 controls remained only for bread, flour, petroleum products and pharmaceuticals (IMF 1996: 2). Table 5.1 Structure of the Eritrean economy in 1993–7 (% of GDP at factor cost)

Agriculture Industry Distribution services Other services Source: IMF (1998: 49).

1993

1994

1995

1996

1997

12.7 20.7 43.6 23.0

16.1 19.1 41.9 22.9

11.2 22.7 39.3 26.8

9.8 27.4 40.1 22.7

9.3 29.5 38.6 22.5

0.5 —

3.9

Sources: IMF (1996 tables 1–5) and IMF (1998: tables 11, 14, 19, 26, 27 and 33).

a Preliminary figures for 1997.

— —

911.9

Balance of payments (% of GNP, excl. official grants) Current account

External debt (% of GNP) Debt service (% of exports of goods and and services)

921.5 95.2

910.3 92.7

Fiscal balance (cash, excl. grants) Fiscal balance (cash, incl. grants)

5.6

28.7 16.7 12.0 16.3 35.5 14.6

20.4 12.4 8.0 7.6 26.8 3.8

Fiscal conditions (% of GNP) Total revenue (excl. grants) Tax revenue Non-tax revenue Grants Current expenditure Capital expenditure and net lending

—

8.0 9.0–12.5

8.0 9.0–12.5

International reserves in months of imports

6.2

4.7

92.5 62.2 9.6

1993

Exchange rate (birr per US dollar, as annual average of auction and preferential rate) Interest rates on savings (%), Dec. Interest rates on loans (%), Dec.

— 140.0 8.8

1992

Economic performance in 1992–7a

Real GDP growth (%) Broad money growth (%) Inflation, CPI (%)

Table 5.2

4.8 —

5.1

2.7

923.9 99.7

21.6 14.9 6.7 14.2 35.2 10.3

6.0 7.0–9.0

6.6

9.8 50.1 6.8

1994

5.7 —

4.6

97.7

929.2 918.7

28.4 15.4 13.0 10.6 45.8 11.8

6.0–8.0 7.0–12.0

6.7

2.9 23.5 11.0

1995

6.2 0.2

4.1

917.2

926.3 916.4

26.7 16.2 10.6 9.9 36.7 16.3

6.0 7.5–12.0

6.8

6.8 15.2 3.4

1996

9.1 0.6

4.9

94.4

910.4 95.5

32.9 16.1 16.9 4.9 24.2 19.1

6.0 8.5–12.0

7.1

7.9 26.9 10.6

1997

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The relatively low inflation may describe a situation where, due to lack of efficient price control administration and supervision for example, the prices in the actual markets in Eritrea were already market-based when the deregulation of prices was introduced. This was the case in Ethiopia during the first years of deregulation and devaluation (see e.g. Hansson 1995: chapters 7 and 8) and there is no reason why the same should not apply to Eritrea. Even though the annual growth of the money stock up to 1997 was still high due to the reconstruction work and private sector expansion, the Eritrean government seems to have taken a relatively firm control over the money supply and reduced the growth rates considerably, from 50–60 per cent in 1993 and 1994 down to 15 per cent in 1996 and 27 per cent in 1997. Turning to the fiscal conditions, it is obvious that there are some problems that have to be given due consideration. During 1993–6 the fiscal deficits before grants were high, 22–29 per cent of GNP, but by the completion of the major reconstruction work and improved tax collections and increased economic activities the deficit decreased to slightly above 10 per cent in 1997. Fiscal deficits are a natural consequence in a country that finds itself in a rehabilitation and reconstruction phase and where the response in the form of increased economic activities has not fully resulted in increased revenues. On the expenditure side there have been heavy increases in the allocations to the health and education sectors and also in the costs related to war victims and demobilisation and resettlement. On the revenue side it is important and encouraging, from the point of view of economic efficiency, that there has been a substantial increase in dividends from state-owned enterprises and from port fees and charges. Finally, regarding the development of Eritrea’s external economic relations, the data for 1995–7 show a deteriorating development in the current account. However, because of the rehabilitation and reconstruction policy and the increased investments that are needed in order to improve economic performance and create a basis for sustainable development, this deterioration should not automatically be seen as alarming. It should be noted that Eritrea at independence did not have any foreign debt, the debt of former Ethiopia (including Eritrea) was inherited completely by the ‘new’ Ethiopia (excluding Eritrea). During the past few years, however, Eritrea has started to borrow on her own and in 1997 the estimated stock of external debt amounted to 9.1 per cent of GNP. In 1997 the debt service ratio was estimated to less than 1 per cent of Eritrea’s total exports of goods and services. Compared to most other countries in sub-Saharan Africa this is a low figure, but considering that in 1993 Eritrea was free from external debt, the development of her debt situation should be kept under strict control. From peace to war: Development consequences of the border war with Ethiopia Ever since the peace agreement in 1991 up to 6 May 1998, the relations between the Eritrean and the Ethiopian governments were quite friendly and harmonious even though there were some disagreements on e.g. issues related to the Ethiopian use of the port of Assab.

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In November 1997 the Eritrean government introduced the nakfa as the national currency. One reason behind this introduction was that the Eritrean government could thereby get better control over the money supply in the country and thereby also improve the macroeconomic control. Another factor was probably the national identity symbol that a national currency represents. Finally, quite an important factor was probably the wish to come on an equal footing with Ethiopia before creating a future economic union, inclusive of a common currency, with that country. That an economic union was the ultimate aim of the economic relations between the two countries was underlined in interviews made by the author in both countries in 1996 and 1997. However, when the nakfa was introduced, the Ethiopian and the Eritrean governments could not agree upon the role of the nakfa in their economic relations. The Eritrean government demanded that the nakfa be used on par with the Ethiopian birr in the trade between the two countries. This was not accepted by the Ethiopian government, who saw the nakfa as any other foreign currency that is not subject to valuation and trade in the international currency markets. Thus, the Ethiopian government demanded hard currency in the trade with Eritrea (except for trade below the value of 2000 birr in the border areas). According to Gilkes and Plaut (1999: 14), this Ethiopian decision: came as a shock and a rebuff to the Eritreans. They clearly believed both that the dual currency regime would benefit Eritrea’s economy and that the Ethiopians would acquiesce to this arrangement. These conflicting views rapidly developed into severe tensions between the two countries, tensions that largely contributed to the outbreak of the border war in May 1998. It should be noted that ever since the peace agreement in 1991 there were some disputed areas along 1,000 km of the Eritrean–Ethiopian border (see e.g. Gilkes and Plaut 1999: 17f.). One reason why these issues were left unsolved for seven years was that the actual land areas had little economic value. Furthermore, the border per se had little economic importance in the daily life of the two countries as long as they had a free trade agreement and a de facto currency union. The positive economic effects of the free trade area and the currency union outweighed the political problems with the unclear border delineation and other different views on ideology and domestic politics, like the view on ethnicity (see e.g. Gilkes and Plaut 1999: 7ff.; Pateman 1990: 125f.). However, when in November 1997 the de facto currency union was ended by the introduction of the nakfa, the problems in the economic relations between the two countries increased and in reality the free trade area was also lost. Due to the problems with the use of two currencies, the border became a real trade barrier with clear economic consequences in terms of increased transaction costs in the Eritrean–Ethiopian trade relations. The net gains from the integration decreased and thus became less important. Factors like differences in ideology and old rivalries between Tigray and the Eritrean highlands thus became relatively more important. Furthermore, the existing, but so far less important, differences in opinion about the exact border delineation could not be held back any longer.

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To the picture we should also add some tensions in relation to the Assab port administration and the payment of fees for the Ethiopian use of the port. The growing costs charged in dollars made the Ethiopian Minister of Transport negotiate an agreement with Djibouti to which Ethiopian trade was transferred away from Assab. The military conflict that arose in May 1998 made Rwanda and the US develop a peace plan that later on was adopted by the Organisation of African Unity (OAU) (for a description of this peace proposal, see e.g. Gilkes and Plaut 1999: 65f.). The peace plan demanded Eritrea to withdraw from the areas that had been under Ethiopian rule up to the war broke out and then let an international committee solve the issues at stake. This proposal was accepted by Ethiopia but turned down by Eritrea. After some eight months of lull, on 6 February 1999 the war intensified. After some severe losses in the Badime area, on 27 February the Eritrean government suddenly accepted the peace plan. However, the Ethiopian government demanded a complete withdrawal not only from Badime but also from the other border areas under conflict, i.e. Zalambessa, Aiga, Bada-Burie, Alitena and Egala. In March there were new military fights at the Tsorena–Zalambessa border. In June the conflict expanded by involving Somalia. In July both Eritrea and Ethiopia agreed to the OAU peace plan. However, Ethiopia raised some issues for further clarifications before they were willing to implement the peace plan. Parallel to the military war, a war of words developed as part of the propaganda in trying to affect both the domestic and the international legitimacy of the two respective countries. Thus, the two governments tried to convince their people and the international community that the other country was obstructing the peace plan whereas they themselves were longing for and working for a peaceful solution to the border conflict (for views of the respective countries, see e.g. Gilkes and Plaut 1999: chapter 5). So the Ethiopian government in the debate classified the Eritrean acceptance of the OAU peace proposal as nothing more than a tactical move to buy time for reorganisation of their military forces and to prepare them for new military activities. The Ethiopian government also faced increased problems with the Oromo Liberation Front and Al-ittihad members who were claimed to be armed by Eritrea. From the government paper Addis Zemen (August 12/99) the Press Digest (August 19/99) reports: The Eritrean government has opened a new war front in eastern Ethiopia and deployed mercenaries and traitors of the OLF and Al-ittihad with a view to redressing the humiliating defeat it suffered in the northern and north-eastern fronts during the last 14 months. … The Eritrean government has been training and arming the terrorist groups in Eritrea, the Ministry [of Defence] said, adding certain officials of the Asmara regime along with the leaderships of OLF, Al-ittihad and Tokichuma, have also been co-ordinating and giving direct military orders to the terrorists. The Asmara regime is perpetrating these acts at a time when it is professing that it has accepted the OAU Implementation Modalities, it said adding this proves its belligerence and anti peace stand.

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The Eritrean government naturally denied this. Instead, the Ethiopian refusal to implement the peace plan was heavily criticised by the Eritrean government. One example of this is found in the statement delivered to the UN General Assembly by Ambassador Haile Menkerios in response to a statement made by the Ethiopian Foreign Minister at the 54th session of the UN General Assembly: When Ethiopia refuses to accept [the OAU peace package], it is not rejection to Eritrea’s stand for peace alone but an affront to the international community that presented the package for peace. It is the credibility of the OAU, the UN and the international community, the credibility of the instruments of collective security that is at stake. Ethiopia must be made answerable to the collective will of the international community. (Eritrea Profile, 9 October 1999: 5) The pride of the two countries’ citizens and the high value given to self-identity symbols made this war of words relatively easy to carry out by the respective governments. Thus, notwithstanding the ceasefire, in early June 2000 long-standing peace seemed quite far away. To this should be added that the longer the war continued, the more difficult it became to find a peaceful solution where both countries could claim and demonstrate that they have preserved national identity of which national borders are of great importance. In the case of Eritrea, the emphasis given to the objective of independence and national sovereignty ever since the breakaway from Ethiopia made it very difficult for the government to sign a peace agreement with Ethiopia that could be interpreted as a defeat or loss of territory without losing much of its domestic legitimacy. Here it is worth remembering the EPLF slogan ‘Never Kneel Down’, which can still be said to be a valid slogan in Eritrea. In the same way the Ethiopian government would make severe losses in domestic legitimacy if it came out a loser in the conflict with Eritrea. Ever since the peace agreement in 1991, the government has been criticised for the agreement with the Eritrean leadership on Eritrean independence. To give up territories that have been under Ethiopian administration up to May 1998 would increase this criticism and thus reduce the domestic legitimacy of the Ethiopian government. The war has cost both countries enormous resources and particularly human suffering in terms of causalities (quite uncertain estimates referred to by The Economist Intelligence Unit, EIU (3rd quarter, 1999: 21), point at some 50,000 causalities) and split families. It should be noted that information about the economic development during the period after 1997 is scarce and uncertain. Table 5.3, based on the most recent available information from the World Bank in March 2000, describes some indications about the development by presenting estimates for 1998. The lag of the effects of the war and the mere fact that there was no formal peace agreement until 12 December 2000 make it reasonable to expect that the situation continued to deteriorate during 1999 and 2000. An indication of this is the information in The Economist Intelligence Unit (4th quarter, 1999: 22) quoting Philadelphia Inquirer (7 September) saying that the military spending in 1999 amounted to about

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44 per cent of Eritrea’s GNP. Even though this figure is quite uncertain, it is obvious that the prospects for investment activities and thus economic growth were negatively affected as long as the war continued. From Table 5.3 we conclude that the economic variables for which we have some, even though very preliminary, data have deteriorated. The reduction in growth rate together with the increased needs for military equipment led to a deterioration in the fiscal and current accounts. The lower production, including production for exports, has increased the ex post debt service ratio from 0.1 to 0.3. Therefore, it seems to be no exaggeration to state that Eritrea, due to the war with Ethiopia, was a bleeding country not only in terms of human suffering but also in terms of economic resources. In addition to this, one should be aware that the long-term costs will be quite high due to mistrust and thus increased insecurity in the area. The positive developments that have taken place in both countries during the 1990s, both as regards politics and economics, have now been disrupted and it is reasonable to assume that this will mean years of lost confidence in the region and thus slow if any positive economic development at all. This means that the Eritrean and Ethiopian parts of the Horn of Africa, where there was a clear case for regional economic integration during the period 1991 up to the introduction of the nakfa in November 1997, have now turned into a situation of regional economic disintegration. The costs of this turn can be expected to be high due to the increased transaction costs in the commercial relations between the two countries and thus reduced possibilities to utilise their respective comparative advantages. The risks for such a negative development have been enlarged by the fact that both governments have deported or in other ways made citizens from the other country emigrate back even though they have lived and worked for long in the country. Thereby the mistrust among the two nationals has grown quite strong at all levels of the two societies. This will be a difficult barrier to surpass when the war is now over and the governments should start trying to reestablish friendly and harmonious relations that can lead to a return to the path of prosperous economic development that characterised the two countries during the period 1991 to mid-1998. Table 5.3 Some indicators of economic performance in 1997 and 1998a

Real GDP growth (%) GNP per capita growth (US$) (%) Inflation, consumer prices (%) Fiscal balance (incl. grants, % of GDP) Export growth, incl. non-factor services (real) (%) Current account before capital grants (% of GDP) Debt service ratio (ex post) (%)

1997

1998

7.9 15.0 4.6 97.0 4.7 93.2 0.1

3.0 913.0 7.0 932.4 933.4 933.3 0.3

a 1998 numbers are estimates. Source: World Bank, Africa Regional Database, ‘Macroeconomic Profile for Eritrea’ and ‘Sectoral Profile for Eritrea’, most recent version on http://wbln0018.worldbank.org/afr/aftbreif.nsf; and World Bank, Country Status Report for Eritrea Prepared for the December 1999 SPA Meeting.

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From crisis to growth in Africa?

4 The role of foreign cooperation in the struggle for sustained independence The Eritrean development strategy strongly emphasises that to achieve the objectives of development, there is a strong need for human capital formation, development of the infrastructure, environmental restoration and protection, and promotion of the private sector (GSE 1994: 12; GSE 1998). An interesting issue is how external sources can contribute in this development. Eritrea has not become critically dependent on foreign assistance since the amount made available to the country in this form is quite low, less than 10 per cent of GNP since 1994 and even below 5 per cent in 1997. The fact that Eritrea has not run into a high degree of aid dependency makes the government quite strict in their attitude towards donors. Thus, the Eritrean government does not want to talk about donor–recipient relations but prefer the term partners in development. Furthermore, the Eritrean government sees the cooperation with foreign partners as a temporary means to pave the way for self-sufficiency and independence where trade and not aid should be the centrepiece in the future. In the field of food, for instance, the objective to reach self-sufficiency has been stated – not necessarily through domestic food production but through developing the export sectors in a way that makes it possible to cover the cost for imports of food by export revenues. The same is true for e.g. investment goods where Eritrea has a comparative disadvantage. It is important to note that the government is strict on its condition that foreign assistance should fit into the Eritrean development strategy and that the projects should be owned by Eritrea. Furthermore, development cooperation projects should not be run for but together with Eritrea. Another interesting and quite unique dimension of project and development ownership is that the government is reluctant to accept foreign expatriates running the projects. Even though it may, and in most cases also will, take a longer time to carry out the projects with no or just a few foreign expatriates, the government seems to be convinced that this is the best policy for sustained independence. Looking at experience from many other less developed, and still heavily aid dependent, countries with a more traditional attitude towards foreign expatriates, this attitude and strategy seems worth testing. Then what can aid contribute to make the Eritrean development strategy successful? Looking at various sectors of the economy, lack of competent staff at more or less all levels seems to be the most serious bottleneck for development in Eritrea. This is so in the government sector, where there is just a thin top of highly qualified staff and where the degree of competence decreases rapidly down the organisation pyramid. It is easily understood if one considers the low educational level in the country, where the adult literacy rate is around 20 per cent, for females 10 per cent (World Bank, February 1996: 31). Thus, in the macro-policy document the government declares that its objective is to make up to seven years of primary education available to all (GSE 1994: 39). This is not only a crucial objective and measure in the Eritrean development strategy but it is also quite demanding, considering the current poor status of literacy and the enrolment rates in basic education. For primary school education the enrolment rates are just 47.4 per cent, and for junior secondary

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school and the secondary school the enrolment rates are 22.4 and 13.7 per cent, respectively. Thus, there is a long way to go before Eritrea has a welleducated population that can take on highly qualified tasks in the private or public sector. The fact that this is one of the issues that is given high priority in the government’s development strategy makes it one of the major candidates for foreign assistance. Even though the Eritrean government is reluctant to accept foreign expatriates, it should be open for aid in the form of temporary use of foreign expatriates who can assist in administration and in-house training of domestic staff, thereby assisting Eritrea to avoid poor technicians in policy making. Foreign assistance in basic education is also important in the process of democratisation. Information and public debate cannot work efficiently in a country with an illiteracy rate of 80 per cent of the adult population. Another field where foreign cooperation and assistance is urgently needed is the health sector. The government has started an ambitious programme of building new health institutions and rehabilitating existing ones all over the country and of upgrading medical staff who received their basic education at the front during the liberation war. Between 1992 and 1996, 70 health stations and 40 health centres were built. As a complement to the direct government activities in the operation of the health sector, the government has also invited the private sector to invest in and run operations in this sector. According to the Ministry of Health, in 1996 three private hospitals were planned or under construction. A field that is closely related to the health situation in the country is access to water and sanitation. The lack of, or scarce availability of, water is a problem at the individual consumer level and also at the farm level, where irrigation could be a means to give rise to great increases in productivity and thus pave the way for a diversified and high-yield or high-value agricultural and horticultural production. Thus, apart from the rehabilitation and reconstruction projects, there are no difficulties in identifying sectors and activities where the Eritrean government could be assisted in its struggle for improvements without running into conflict with her condition that aid should not lead to dependency but contribute to sustainable independence.

5 Concluding remarks From the achieved independence in mid-1991, Eritrea has introduced and also started to implement far-reaching reforms of both the political and the economic system. A new constitution has been introduced after a quite broadly based dialogue within the Eritrean society and also within the Eritrean diaspora. The economic reforms have been consistent with the objective of raising the war-ravaged country from the ashes and creating a market-led and private-sector-dominated economy, and have also resulted in positive economic development and performance. The attitude towards foreign assistance has been quite reserved and has stressed the Eritrean ownership and responsibility in project design and operation. However, the growth and development of the new Eritrean state are severely threatened by the two and a half years of military border conflict with Ethiopia, even though it is

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highly unlikely that the system changes introduced will be reversed. The threat lies not only in the direct war costs but also – and more serious in a long-run perspective – in the loss of confidence in a stable economic environment that can attract investors.

References Bank of Eritrea (1996), Eritrea – Profile of Foreign Exchange Administration: A Guide to Investors, January 17. Asmara: Bank of Eritrea. CCE (January 1995), International Symposium on the Making of the Eritrean Constitution. Asmara: Constitutional Commission of Eritrea. CCE (August 1995), Constitutional Proposals for Public Debate. Asmara: Constitutional Commission of Eritrea. CCE (October 1995), Information on Strategy, Plans and Activities. Asmara: Constitutional Commission of Eritrea. EIU (1995, 1999), Country Report Ethiopia, Eritrea, Somalia and Djibouti. London: The Economist Intelligence Unit. Eritrea Profile (October 1999), Asmara: Eritrea Profile. Financial Times (18 January 1996), pp. 12ff. Gazette of Eritrean Laws (1995 and 1996), various issues. Asmara: The Government of Eritrea. Gebre Hiwet Tesfagioris (ed.) (1993), Emergent Eritrea: Challenges of Economic Development. Trenton, NJ: The Red Sea Press. Gilkes, P. and Plaut, M. (1999), The War in the Horn – The Conflict between Eritrea and Ethiopia. London: The Royal Institute of International Affairs. GSE (1994), Macro-Policy. Asmara: Government of the State of Eritrea. GSE (1998), National Economic Policy Framework and Program for 1998–2000, April 1998. Asmara: Government of the State of Eritrea. Hansson, G. (1995), The Ethiopian Economy 1974–94: Ethiopia Tikdem and After. London and New York: Routledge. Horowitz, D. L. (1990), ‘Comparing Democratic Systems’, Journal of Democracy, 1: 73–9. Hydén, G. (1993), ‘Electoral Systems and Political Reform’, in Inter-Africa Group, Constitutionalism: Reflections and Recommendations. Addis Ababa: Inter-Africa Group. IMF (1996), Eritrea – Staff Report for the 1996 Article IV Consultation. Washington, DC: IMF. IMF (1998), Eritrea: Selected Issues, IMF Staff Country Report No. 98/91. Washington, DC: IMF. Lijphart, A. (1991), ‘Constitutional Choices for New Democracies’, Journal of Democracy, 2: 72–84. Lindbeck, A. (1973), ‘Ekonomiska system – ett mångdimensionellt fenomen’, Ekonomisk Debatt, 1: 3–18. Linz, J. J. (1990), ‘The Perils of Presidentialism’, Journal of Democracy, 1: 51–69. Pateman, R. (1990), Eritrea – Even the Stones are Burning. Trenton, NJ: The Red Sea Press. Press Digest (19 August 1999). Addis Ababa: Phoenix Universal. UNDP (1993), Project of the State of Eritrea, New York: UNDP. World Bank (1996), Eritrea Poverty Assessment, Report No. 15595-ER. Washington: The World Bank. World Bank, Africa Regional Database, ‘Macroeconomic Profile for Eritrea’ and ‘Sectoral Profile for Eritrea’, most recent version on http://wbln0018.worldbank.org/afr/aftbreif.nsf; and World Bank, Country Status Report for Eritrea Prepared for the December 1999 SPA Meeting.

Part II

The reform strugglers

6

Kenya’s growth prospects The basic constraints Jörgen Levin and Njuguna S. Ndung’u

This chapter addresses structural and policy impediments to Kenya’s growth. We look at the nature of the exchange rate, monetary and trade policies pursued and at the institutional structure constraints in both the financial and labour markets.

1 Structural Adjustment Programmes in Kenya Slow pace of reform 1980–91 In 1980 Kenya became one of the first African countries to adopt Structural Adjustment Programmes (SAPs). This followed prolonged economic decline, triggered by the two oil shocks of the 1970s. The economic policies contained in the Sessional Paper No. 4 of 1980 were largely in line with the recommendations of the World Bank and the IMF, and served as the basis on which Kenya’s first Structural Adjustment Loan (SAL) was agreed and signed in March 1980. A second standby agreement was signed in October 1980. These developments marked the beginning of SAPs in Kenya. The first phase, 1980–4, was, however, characterised by noncompliance on the part of Kenya due to timing and design shortcomings, as well as limited commitment (Swamy 1994). The failure to meet the conditionalities, registered with the first standby agreement, continued in subsequent years and became a persistent source of friction between the government and the multilateral donor institutions. Poor implementation of recommended policy measures resulted in delays in the disbursement of funds from the World Bank for the period July 1982 to January 1984. Thus in the early 1980s the programme had no major impact on the economy. In the period 1985–91, official commitment to reforms increased, as witnessed by the publication of the Sessional Paper No. 1 of 1986, on ‘Economic Management for Renewed Growth’. Its objectives were to achieve rapid and sustained economic growth, create employment, improve access to basic services and reduce the rural–urban imbalance. In addition to structural adjustment programmes, the country also undertook some stabilisation programmes aimed at reducing inflation and improving budgetary and balance of payments deficits. A general lack of success in implementing reforms led the World Bank to change strategy. Emphasis was now put on sectoral adjustment programmes. Thus a quick

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disbursing sectoral adjustment credit (ASAL-1), whose main goal was to restructure the National Cereals and Produce Board (NCPB), as well as a number of other parastatals were approved in June 1986, in order to reduce their dependence on the budget (Swamy 1994). In February 1988 a new standby agreement with the IMF and a three-year Structural Adjustment Facility, together with credits from the International Development Association (IDA) and other donors, was signed. The programme was aimed at the restoration of fiscal and monetary discipline that had been eroded in the previous few years, especially during the mini-coffee boom of 1986. However, already in May 1989, the standby agreement was replaced by a three-year Enhanced Structural Adjustment Facility (ESAF). The performance targets attached to the latter included positive per capita growth, the lowering of inflation, reduction of the current account deficit and the building up of the country’s net official international reserves. Yet again, the programme was poorly implemented, with three out of four quantitative performance criteria not satisfied. Net domestic assets of the domestic banking sector had expanded, thanks to government borrowing from the banking system, while net official international reserves had fallen. The poor results were blamed on lack of government commitment, both in terms of implementation, especially with respect to removing controls on industrial and agricultural sectors, and domestic trade. Policy implementation under pressure, 1992–5 Donor frustration with the slow pace of implementation, and in some instances policy reversals, reached a climax in November 1991 when quick-disbursing aid was suspended. The reasons given for this by the donors were rising levels of corruption, failure to correct macroeconomic imbalances, slow reforms in the civil service and privatisation of public enterprises, lack of accountability of public enterprises, failure to establish a supportive environment for the growth of the private sector and a slow pace of political reforms. These, in essence, were the conditions that needed to be satisfied before aid could be resumed. At the beginning of 1992, a ‘shadow’ programme was negotiated with the IMF under which the government was required to reduce the budget deficit to 2 per cent of GDP in 1992/3 in order to stabilise the macroeconomic environment. In September 1992, the World Bank decided to postpone the disbursement of the second tranche, again due to poor implementation of several of the conditions attached to sectoral programmes (Swamy 1994). When controls on the movement of grain between districts were re-imposed, after two months of their suspension, the second tranche of the ASAL was then cancelled. Although monetary, financial and external sectors were the main areas of concern by the donors in 1992, there were no significant improvements there by the beginning of 1993. The government then quickly implemented some critical reforms, especially related to the exchange rate and foreign exchange controls. The shilling was floated, while foreign exchange retention accounts as well as retention accounts for traditional exports and service sectors were introduced or reintroduced. The

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inter-bank market was expanded while there was some liberalisation of coffee and tea marketing systems. It is important to note that although the years 1992–5 generally witnessed much more dramatic implementation of the recommended reforms than in previous periods, considerable tension remained between donors and the Kenya government. For instance, in March 1993 some elements in the government threatened to reverse the reforms that had been introduced. Retention accounts for foreign exchange were abolished, followed by a directive requiring the remittance of all export proceeds to the Central Bank at the official rate. The floating of the currency was stopped and the market for Foreign Exchange Bearer Certificates (Forex-Cs) collapsed.1 However, already by November 1993, Kenya had applied for a one-year arrangement under ESAF, for a total of SDR 45.23 million, but with the following IMF conditions: effective control of the fiscal deficit, limits on government borrowing from the Central Bank, appropriate targets on the net international reserves, and limits on new non-concessional external loans contracted or guaranteed by the government. The second disbursement was to be released only after the government had fully decontrolled pricing and marketing of maize and petroleum products, increased the proportion of foreign exchange retained by exporters to 100 per cent of export earnings, and relaxed restrictions on payments and transfer for current international transactions. By the end of 1995, the country had implemented major political and economic reforms agreed upon with the multilateral and bilateral donors, including removal of virtually all price and foreign exchange controls, liberalisation of domestic marketing trade, export and import liberalisation, rationalisation and reduction of government expenditures, financial sector reforms, privatisation, and labour market reforms. The government hoped to receive new credits after the Consultative Group meeting expected in early 1996. The IMF hinted strongly, however, that this would not be possible due to unresolved differences, especially over massive corruption and scandals involving public resources. IMF officials were quoted in the local press as saying that new aid was unlikely to be committed by the IMF and other donors unless the ‘Goldenberg Scandal’ in which the government had lost KSh 13 billion in fraudulent deals was resolved. Financial accountability, especially limiting unplanned and non-priority projects, good governance and human rights were emerging as important conditionalities. The ESAF was suspended by the IMF in August 1997.

2 Economic performance Let us now highlight some of the macroeconomic changes, notably shifts in relative prices that characterised the period 1980–97. The political and economic trade-offs inherent in structural adjustment are sometimes portrayed with the help of the dependent-economy model (Bevan et al. 1990), where the goods are divided into tradables and non-tradables. Since adjustment shifts relative prices, it is also bound

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to bring about real changes in production patterns, and ultimately in the welfare of the households engaged in the two sectors. In an economy like Kenya where the import-substitution regime was pursued for decades, however, the tradable sector tends to split into exportables (in Kenya mainly coffee and tea) which compete with the rest of the world and importables (the bulk of the manufacturing sector) which operate behind high tariff walls. The analysis is done with the help of two relative prices: the export to import price ratio (Px/Pm) and the non-tradable to import price ratio (Pn/Pm). When controlled economies are opened up, the Px/Pm ratio rises as import tariffs and related taxes are lowered. This then draws resources from the importable sector towards exports. However, the ultimate outcome is adjustment in internal demand. To ensure that resources actually flow to exportables, the rise in the Pn/Pm ratio, which can also be regarded as a proxy for the domestic cost structure, should not be large. Otherwise, resources would flow into non-tradables (or services) and the export expansion would not be realised. In Figure 6.1 we have plotted the Px/Pm and Pn/Pm ratios on the vertical and horizontal axes, respectively, for the period 1980–97. The points have been joined to indicate clearly the regime shifts over the period. Ideally, we would expect that fiscal and monetary policies would ensure that Pn remains relatively constant to enable a real depreciation to take place. On the other hand, we would want the implied export promotion drive to lead to a rise in the Px/Pm ratio in order to ensure that resources flow towards exportables. Thus from the point of view of trade liberalisation, only upward movements in the Px/Pm–Pn/Pm space would be desirable, while downward or leftward movements would indicate relative price changes that would favour importables and non-tradables. The liberalisation effort would have failed. Figure 6.1 shows two distinct ‘policy clusters’, separated by slow and rapid implementation periods described above. The government took discretionary steps towards reform, which were then negated by policy reversal or external shocks. Taken as a whole, therefore, little liberalisation was effected during 1980–92. The increase in the Px/Pm ratio in the early 1980s was more a result of the brief commodity price booms. At the beginning of the 1990s the policy regime clearly turned against exporters, that is coffee farmers and tea producers. However, the aid embargo as well as the associated responses by the government led to a dramatic improvement in the Px/Pm ratio. Still the diagonal movement in the relative-price space between 1992 and 1993 indicates that rising domestic costs could not be entirely reined in. Movements between 1995 and 1997 show that exporters were once again losing the edge to the non-tradable sector as a result of rising inflation. Further we review some specific economic events as well as discuss the liberalisation and stabilisation process in the 1990s. This is because of the significant steps undertaken in the liberalisation process during the decade and the significant weaknesses that have emerged. Although economic recovery and increased investment response have been the key policy guidelines, the results have been disappointing. Economic growth has been low while per capita incomes have fallen or remained stagnant (Table 6.1).

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2.00

1.75

1.50 1993

Px /P m

1995

1994 1997 1.25

1.00

1996

1984 1987–88 1986 1989 1985 1981 1983 1980 1982

0.75 0.75

1.00

1992 1990 1991

1.25

1.50

1.75

2.00

Pn /Pm

Figure 6.1 Changes in relative prices, 1980–97. Px: the GDP deflator for agriculture used as a proxy for prices of exportables; Pm: the GDP deflator for manufacturing used as a proxy for prices of import substitutes; Pn: the GDP deflator for building and construction, wholesale and retail trade, transport, storage and communication, hotels and restaurants used as a proxy for prices of non-tradables. Sources: Republic of Kenya, Economic Survey (various issues).

Exchange rate and monetary policy In 1990, the government introduced a dual exchange rate regime with an official exchange rate and the other determined in the market for Foreign Exchange Bearer Certificates (Forex-Cs). By 1993, the dual exchange rate system was operating with an inter-bank rate and an official exchange rate, which merged in October 1993 when the shilling was floated. All import and foreign exchange controls were abolished. Thus in terms of implementation, the exchange rate policy can be regarded as the most successful component of structural adjustment in Kenya in the 1990s. In 1993, when the currency was floated, the initial effect was a stiff depreciation, a result of the fact that macroeconomic stability had not been restored. This instability, which stemmed from excessive expansion of money supply, rapid increase in inflation, severe shortage of foreign exchange and lack of fiscal control,

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Table 6.1 Sectoral and overall growth rates, 1990–8

Agriculture Manufacturing Building and construction Trade, restaurants and hotels Transport, storage and communication Finance, real estate and business services Other Government services GDP GDP/capita (1982 Kenya shillings)

1990

1991

1992

1993

1994

1995

1996

1997

1998

3.5 5.2 3.5

90.7 3.9 90.2

93.3 1.0 92.3

93.3 1.8 93.4

3.1 1.9 1.9

4.8 3.9 2.7

4.5 3.6 2.8

1.2 1.9 2.3

1.6 1.3 1.4

2.3

1.3

1.5

0.1

6.1

8.6

8.0

4.0

2.5

3.6

3.7

1.7

0.8

3.0

4.2

4.0

2.0

1.3

6.4

6.1

6.9

7.2

6.1

6.9

7.1

5.3

3.2

6.2 4.4 4.2 190.6

4.1 3.6 2.1 176.0

2.7 2.4 0.5 171.6

1.1 2.1 0.2 167.0

1.4 1.5 3.0 167.2

6.4 1.8 4.8 170.4

6.2 1.6 4.6 173.6

3.5 1.1 2.4 173.1

2.6 0.8 1.8 172.2

Sources: Republic of Kenya, Economic Survey (various issues).

Private capital flows (Kenya shillings million)

Capital account (Kenya shillings million) 15,000 10,000

15,000 10,000 5,000

5,000 0

0 –5,000

–5,000

–10,000

–10,000

–15,000

1990

–15,000 1991

1992

1993

1994

1995

1990 1991

Changes in reserves (Kenya shillings million) 20,000 15,000 10,000 5,000 0 –5,000 –10,000 –15,000 1990

1992

1993

199 4 1995 1996

Real exchange rate (log of KSh/USD) 3.1

2.1 1990

1991

1992

1993

1994

1995

1991

1992

1993

1994

1995

1996 Interest rate spread (percentage units)

25 20 15 10 5 0 1990

1991

1992

1993

1994

1995

1996

Figure 6.2 Indicators of the foreign exchange market. Sources: Central Bank of Kenya (various issues).

caused a widening gap in the interest rate differential between Kenya and the rest of the world. Holders of foreign exchange profited by bringing funds back, converting them to shillings and then buying treasury bills, thus enjoying a high return. In the process, foreign exchange reserves rose, partly as a result of sluggish demand; this led to an appreciation of the real exchange rate and a drastic fall of the interest rates differential (Figure 6.2).

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Kenya’s experience with a unified floating exchange rate highlights several issues. First, after the adoption of a floating exchange rate, it was expected that the shilling price of exportables would rise, stimulating production and boosting the incomes of exporters. However, as already noted, there was towards the end of 1995 a rapid increase in capital inflows. These led to a real exchange rate appreciation, which negatively affected exporters. Moreover, there is also no evidence that private capital inflows were invested in irreversible fixed assets. Financial sector, Domestic debt and interest rate As in most African countries, financial sector liberalisation has been an important aspect of structural adjustment, intended to create appropriate incentives for the private sector. Altogether, the programme was aimed at spurring economic growth through increased savings, improved efficiency and reduced costs of intermediation, higher level and improved quality of investment, and improved efficiency of capital stock. However, the Central Bank did not have the political weight necessary for the job, which meant that some key institutional reforms could not be implemented. Official meddling in the credit allocation process was rampant, while Central Bank supervision of banks was weak. Many financial institutions also lacked the qualified staff and sufficient capital necessary to operate efficiently. While it had been assumed that potentially high-yielding investment in Kenya had not been undertaken because of credit constraints, this turned out not to be the case. Demand for high-quality credit was not as high as expected. Financial institutions then had two bad choices: either lend to the government at negative real interest or lend to private enterprises highly likely to default. Thus the financial reform was not sustainable, since the preconditions were not in place. However, financial reforms continued after the economy stabilised in 1994. Measures implemented included additional liberalisation of the capital account with offshore borrowing by residents allowed since May 1994. Remaining restrictions on inward portfolio investment were lifted in January 1995, with foreign investors allowed to participate directly on the stock exchange. Further, non-bank financial institutions (NBFI) were required to convert to banks by January 1996, thus simplifying the regulatory environment. Figure 6.3 shows some of the financial indicators for the period 1972–97. Despite liberalisation, the real discount rate was negative during 1990–3. The major reasons for this were the government’s failure to allow and encourage a secondary market for its long-term bonds, together with pervasive controls on foreign exchange transactions. The spread between the lending and deposit rates had also been widening, indicating that liberalisation had not succeeded. While there is a combination of factors preventing the rate of interest from adjusting, the most important relates to the general lack of fiscal adjustment. Given the trend growth of the treasury discount rate, it is unlikely that other interest rates will come down since it is the benchmark of all interest rates. Another factor that has prevented lending rates from coming down is the oligopolistic structure of Kenya’s banking sector, which is dominated by a few large banks

104 30

From crisis to growth in Africa? Real deposit rate (%)

30

20

20

10

10

0

0

–10

–10

–20

1973 1976 1979 1982 1985 1988 1991 1994 1997

–20

Real treasury bills rate (%) 30

30

20

20

10

10

0

0

–10

– 10

Real lending rate (%)

1973 1976 1979 1982 1985 1988 1991 1994 1997 Real interest spread (percentage units)

– 20 – 20 1973 1976 1979 1982 1985 1988 1991 1994 1997 1973 1976 1979 1982 1985 1988 1991 1994 1997

Figure 6.3 Financial indicators. Sources: Central Bank of Kenya (various issues).

with a tradition of collusion rather than of competition. The financial sector has experienced excess liquidity in the last years and economic logic would require a lower rate of interest to attract borrowers. This has not happened. It has partly also been the price paid for a stable and secure financial system. During the first phase of financial reform, a number of small banks were established with a view to increasing competition in the banking sector. However, some of these were merely ‘political banks’, that is owned by groups close to political leaders and thus subject to high levels of non-performing assets. They inevitably collapsed and had to be bailed out by the government. Under the current strategy, the government plans to introduce additional measures to reform the financial sector, targeted at reducing rent-seeking activities. For example, following recent legislation the National Social Security Fund (NSSF) will become a pension fund, competing with others. Moreover, NSSF has been instructed to invest its revenue in government securities only, except for deposits limited to 15 per cent of its total assets in sound and stable financial institutions. Other measures include increase of financial instruments traded in the Nairobi Stock Exchange (NSE) as well as improvements of central banks’ technical capacity to intervene in domestic money and foreign exchange markets. Thus, compared to the early 1990s, the institutional environment in the financial sector is much improved today. However, for it to be sustainable, it is important that the reform programme also succeed in other areas such as improved effectiveness in monetary policy and most important of all fiscal adjustment. Thus, further deepening of reforms is not the only answer to revived growth in Kenya; there is also need for eradicating corruption and establishment of a legal system that ensures enforcement of contracts and property rights, to restore credibility. Trade liberalisation and economic growth Before the first oil shock, the Kenyan economy was even more open than some fastgrowing economies in East Asia. This was Kenya’s era of high growth. However,

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after the oil shocks the import control regime tightened and there was a steady downward trend in the openness to trade. This also affected foreign direct investments (FDI) negatively. The intensified implementation of economic reforms in the 1990s reversed what has been a downward trend in Kenya’s trade–GDP ratio. But, with respect to FDI there has been little response despite the economic reforms. The FDI/GDP ratio is still extremely low. There is even evidence of disinvestment; the reasons cited are cumbersome establishment procedures and corruption. With the deepening of economic reforms, the import tariff structure began to change. Government controls, including rationing of imports, were dismantled, nontariff measures were replaced by tariff-based protection, the tariff structure was harmonised and tariff dispersion was lowered. However, although tariff rates have come down, effective rates of protection (ERP) have not been reduced by as much. The positive outcomes of the reform process have been the removal of the foreign exchange constraints as well as the simplification of import procedures. Notably, it is easier to purchase foreign machinery and equipment. Since capital goods embody ideas, which have important intangible effects on economic growth, access to them is very important (De Long and Summers 1993). However, during liberalisation, many Kenyan industries collapsed, especially textiles.2 A combination of factors, not necessarily reduced protection, led to the dramatic decline in the textile sector. Levin (1998) argues that although static efficiency gains from lowering tariffs were relatively small, most sectors tended to gain while important incentives were created for producers of tradable goods. However, Kenya made attempts to lower tariffs and to restructure the economy, while at the same time government expenditures were above target. Substantial aid inflows helped to sustain government revenue. But aid inflows had costs, in terms of delays of the reallocation of resources to tradable sectors. Thus, the ultimate goal of increasing incentives for the export sector was delayed. In addition, a survey from 1994 showed that economic infrastructure in Kenya has been declining (Departments of Economics, 1994). Most of the firms had to provide their own power or water. Public provision of business support services was poor. Corruption was common among public institutions providing utilities. Moreover, a majority of the firms suffered from escalating utility prices and poor services, which affected the competitiveness of their products.

Labour market reforms In terms of growth prospects, the labour market is another important mediating institution. The market’s flexibility determines the pace at which certain policy goals can be achieved; for instance how quickly resources can be moved across sectors, by shifting relative earnings, and how labour market changes impact on the well-being of the households and their individual members. The government has made several attempts to liberalise the labour market but failed. For example, cumbersome restrictions on layoffs still exist and there are indications that a considerable number

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of firms would hire more workers if these restrictions were removed (Departments of Economics, 1994). Another obstacle is minimum wages set by the government. A rigid wage structure could, particularly during trade liberalisation, be counterproductive.3 On average, real wages in both private and public sectors are lower than in the 1970s.4 Although real consumption wages have been falling through most of the years, employer costs have not been reduced. In response to this, activities within the informal sector increased tremendously. As there is a large and significant difference between formal and informal sector wages, an increasing number of individuals were forced to live below the poverty line. Income distribution and poverty Shared growth has been an important abstract in a number of Kenyan policy documents, but in reality the principle has never been implemented, much less realised. Between 1982 and 1992, inequality actually increased in all rural provinces (Mukui 1993) and almost half of the population was classified as poor in the early 1990s (Demery and Squire 1996). The government has indicated that a sustainable growthoriented strategy is necessary, and has developed a comprehensive list of projects supposed to benefit the poor. However, Khasiani and Ndung’u (1996) argued that lack of proper assessment implied failure to determine targets as well as time frames for achievement of results. Further, the location of projects was influenced by factors other than benefit to the poor and there was little effort to identify the poor.5 In Kenya it has been common to blame specific policies included in the adjustment programme for the decline in household incomes. Levin (1998) analyses the extent to which individual policies, alone or in combination, have affected household welfare. On its own, reduced tariff protection only increases household incomes by small amounts. Notably, the poorest groups see little change. However, supporting tariff reform with aid, to cushion the revenue loss, has a small positive impact on poverty. Households in the urban areas and most rural households located in the food-producing region see their head-count ratio falling, but those located in the coffee and tea region are negatively affected by the aid inflows. When tariff reform is combined with a reduction in government expenditures, real income improves and poverty falls among rural households, while most urban households experience falling incomes. Since urban groups are politically vocal, combining aid and expenditure reduction improves the sustainability of the programme in the sense that the situation for the urban households improves. But if the objective of the programme is to improve the situation for the rural poor, there needs to be a balance between aid and reduction of expenditures. Expansionary policies, with or without aid, could derail the goals of the structural adjustment programme. Besides the negative effects on the budget, incentives for exporters are eroded. Still, in the short term there is a positive overall impact on poverty. But as with incomes, those who benefit most are urban households, and those located in the coffee–tea region are worse off.

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Drawing on support from the endogenous growth literature, Pio (1994) argues that highly skewed income distribution and poverty may substantially inhibit the broad-based accumulation of human capital and hence growth. Other studies in the same tradition, such as Person and Tabellini (1994), have also found a strong negative relation between initial income inequality and future growth for both developed and developing countries. Thus lack of specific policies to deal with distributional aspects might be an obstacle to the achievement of higher growth rates in the future. Thus, an active policy of redistribution would be required to not only ensure that poverty is reduced but also to ensure that the overall strategy will be sustainable. Supplementary measures, such as targeting specific groups or regions, have to be undertaken to ensure that also the poorest of the poor benefit.

3 Summarising the lessons The outcome of the economic reform process has been disappointing in Kenya. Policy uncertainties, competition from imports, the poor state of infrastructure and high domestic interest rates are some of the factors explaining Kenya’s recent poor performance. In order to achieve sustained and increased growth rates, the government needs to restore credibility and demonstrate a strong commitment to the reform process. Thus, policy makers have an important role to play in creating an environment that fosters profitable opportunities. The conclusions we make from our discussion above are as follows:








Liberalisation of the foreign exchange market, financial reforms and a move towards indirect instruments of monetary policy have been implemented in Kenya. The authorities have targeted a competitive exchange rate and low inflation while at the same time defending the nominal rate, but with inadequate instruments to do so effectively. Liberalisation has thus been shown in the analysis to lead to a series of conflicts and dilemmas. The end results have included high interest rates that jeopardise economic recovery. Thus, the short-run consequences of the liberalisation process have sacrificed long-term growth. The authorities seem to have lost sight of the long-term goals of the economy in their pursuit of conflicting intermediate goals and targets. The results thus show weaknesses in the management of the liberalisation process. These are at two levels. First, there seems to be serious lack of capacity to manage the liberalisation process. The policies formulated by the Bretton Woods Institutions seem to be adopted with little regard to the prevailing economic conditions or institutional capacities. Second, there are inherent structural weaknesses in the economy and this has limited the transmission mechanisms of the economy. Finally, political economy issues, such as corruption and political interference, have induced more uncertainty in the economy. This has spilled over into the erosion of the enforcement of contracts with disastrous implications for the economy.

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Notes 1 Foreign Exchange Bearer Certificates (Forex-Cs) were purchased at the official exchange rate from the Central Bank of Kenya, on a ‘no questions asked basis’. The certificates, which bore an interest rate, were then marketed as any other paper asset. 2 Results of a 1994 survey show that almost 60 per cent of companies interviewed in the textile sector indicated that competition from imports had worsened, and about 40 per cent rated this as the major problem. In other sectors such as wood, food and metal, the severity of the problem was rated much lower. An indication that the informal sector is relatively insulated from competition from abroad is that 80 per cent of the companies indicated that there was no change related to increased competition from imports (Departments of Economics, Götebory University and University of Nairobi, 1994). 3 For an analytical survey of labour market distortions and structural adjustment in developing countries, see Edwards and Edwards (1994). 4 Similarly, in Ghana real wages have fallen substantially over the last two decades (Teal 1995). 5 A review of the literature analysing adjustment and poverty can be found in Levin (1998).

References Bevan, D., Collier, P. and Gunning, J. W. with Bigsten, A. and Horsnell, P. (1990), Controlled Open Economies – A Neoclassical Approach to Structuralism. Oxford: Clarendon Press. Central Bank of Kenya (various issues), Annual Report, Nairobi. De Long, J. B. and Summers, L. H. (1993), ‘How Strongly Do Developing Economies Benefit from Equipment Investment’, Journal of Monetary Economics, 32(3): 395–415. Demery, L. and Squire, L. (1996), ‘Macroeconomic Adjustment and Poverty in Africa: An Emerging Picture’, World Bank Research Observer. Departments of Economics, Göteborg University and University of Nairobi (1994), Regional Programme on Enterprise Development: Second Report on the Kenyan Survey. Edwards, A. C. and Edwards, S. (1994), ‘Labour Market Distortions and Structural Adjustment in Developing Countries’, in Horton et al. (eds), Labor Markets in an Era of Adjustment. Washington, DC: The World Bank, EDI Development Studies. Khasiani, S. A. and Ndung’u, N. S. (1996), ‘Economic Reforms and Poverty in Kenya: A Survey of Issues’, commissioned by the Republic of Kenya, Ministry of Finance and the Embassy of Sweden, Nairobi. Levin, J. (1998), ‘Structural Adjustment and Poverty – The Case of Kenya’, Ph.D. Thesis, Department of Economics, Göteborg University. Levin, J. (1999), ‘Economic Reform with Labour Market Rigidities – The Kenyan Experience’, Country Economic Report, SIDA, Stockholm. Levin, J. (2000), ‘Adjustment to External Shocks: Kenya 1986–95’, African Development Review, 12(1): 78–88. Mukui, J. T. (1994), ‘Kenya Poverty Profiles, 1982–92’, prepared for the Kenya Ministry of Planning and National Development, Nairobi. Person, T. and Tabellini, G. (1994), ‘Is Inequality Harmful for Growth?’, American Economic Review, 84(3): 600–21. Pio, A. (1994), ‘New Growth Theory and Old Development Problems: How Recent Developments in Endogenous Growth Theory Apply to Developing Countries’, Development Policy Review, 12(3): 277–300.

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Republic of Kenya (various issues), Economic Survey 1996, Central Bureau of Statistics, Office of the Vice-President and Ministry of Planning and National Development. Swamy, G. (1994), ‘Kenya: Structural Adjustment in the 1980s’, World Bank Policy Research Working Paper 1238. Teal, F. (1995), ‘Real Wages and the Demand for Labour in Ghana’s Manufacturing Sector’, Working Paper Series 95-7, Centre for the Study of African Economies, University of Oxford.

7

Cape Verde Reform policy and growth in a small remote island economy Yves Bourdet

1 Introduction Since 1991 Cape Verde has been engaged in an ambitious programme of political and economic reforms named Mudança. The economic programme began to be implemented after the victory of the right-wing political party, the MPD (Movimento para a Democracia), in the first multi-party elections in early 1991.1 The ambition of the new government was to put an end to one and a half decades of socialist rule and to favour the development of an economy open to international trade and based on a large and dynamic private sector. The purpose of the reform programme was also to boost economic growth, so as to increase the living standards of the Capverdean population, to reduce poverty and to curb the severe macroeconomic imbalances. The eight years that have passed since the start of reform policy permit a more definite evaluation of reform policy in Cape Verde. The main purpose of this chapter is therefore to evaluate the design and economic outcome of the reform programme. The reform policy faces domestic constraints, many of them of structural, institutional and political character, which put limits on the reformability and growth of the Capverdean economy. A secondary purpose of this chapter is to highlight these constraints. The paper is structured in the following way. Section 2 surveys briefly the Capverdean reform policy and its economic logic. Sections 3–6 provide an economic assessment of reform policy and highlight the bottlenecks that prevent the Capverdean economy from embarking on a more ambitious and harmonious growth path. Emphasis is put on fiscal policy, competitiveness and foreign trade, economic growth and the labour market. Section 7, finally, draws some policy conclusions.

2 The design and logic of Mudança The main objective of reform policy in Cape Verde is the creation of an exportoriented economy based on a dynamic private sector. The reform programme is comprehensive, including a large number of measures of both systemic and macroeconomic character. Both kinds of measures are necessary to secure the transition, from the kind of socialist economic system in force in Cape Verde prior to 1991,

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to a market-oriented economy open to international trade. The reform process began in 1991 and is still going on. This means that the various components of the reform programme have not been introduced simultaneously, and that a clear sequencing appears with trade liberalisation and part of the tax reform being implemented at the start of the reform programme, and microeconomic measures of more systemic character as well as concern for macroeconomic stabilisation being concentrated to the last few years. The measures encompassed in the reform package can be summarised under three main headings: (1) redefinition of the role of the state in the economy (including macroeconomic policy), (2) microeconomic and institutional aspects, and (3) import liberalisation and export promotion. Note that all these components are related and overlap to some extent. Redefining the role of the state One of the main purposes of reform policy is to redefine the role of the state in the economy as well as the boundary between the private and public sectors. In other words, the purpose of reform policy is to limit the role of the state in the economy by giving markets a predominant role in the allocation of resources and the distribution of income. This redefinition of the role of the state has important implications for public policy. In general, public policy has three economic functions. The first is to secure some form of adjustment in the allocation of resources. (In most cases this consists only of bringing about minor changes in the allocation made by the market.) The second function is to affect the distribution of income and wealth in the direction regarded as the politically desired distribution. The third function concerns macroeconomic stabilisation and aims at achieving a high level of capacity utilisation and macroeconomic balance, particularly price stability. The redefinition of the role of the state in Cape Verde implies a shift from a planning paradigm to a market paradigm and hence a decrease of its resource allocation and income distribution functions, as well as an increase of its macroeconomic stabilisation function. The change in public policy concerns both the revenue and the expenditure side of the budget. A comprehensive tax reform has been implemented. Its objective is to improve the efficiency and effectiveness of the tax system and, hence, broaden the tax base and secure budget revenues. In a first stage, in 1991, measures were taken to simplify the tax structure, modernise the tax administration, extend the coverage of the income tax, increase the rate of some other taxes and improve the collection of duties on imports. In 1996, the second stage of the tax reform began to be implemented with a unification of the income tax and the tax on business profits. The unified income tax replaced the tax on salaries and self-employment income, the tax on business profits and the complementary tax (on rental income, capital gains, retirement pensions, etc.). On the expenditure side, the reform programme includes a reduction in the number of civil servants through an early retirement scheme and a voluntary departure programme. The early retirement scheme was implemented in the mid-1990s while the voluntary departure programme only began to be implemented in 1998.

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The fiscal reform has been accompanied by a reform of the banking system so as to give public policy the tools necessary for the conduct of stabilisation policy. Fiscal and monetary policies have been separated through the setting up of a two-tier banking system. Thus, in 1993, the former monobank was divided into a central bank (Banco de Cabo Verde) and a state-owned commercial bank (Banco Comercial do Atlântico). The transformation of the post office savings bank into a state-owned commercial bank, the CECV (Caixa Económica de Cabo Verde), and the opening up of the banking sector to foreign banks also contributed to the restructuring of the banking sector. As yet, however, only one Portuguese bank has opened a branch in Cape Verde (Banco Totta e Açores). The new central bank is in charge of the supervision of the operations of the commercial banks and the implementation of monetary and exchange rate policy. Since 1982, Cape Verde has opted for a nominal exchange rate peg that serves as an anchor to help build anti-inflationary credibility and control for inflation. Until July 1998, the escudo was pegged to a basket including the nine currencies of the most important sources of imports and emigrants’ remittances. Since July 1998, the Capverdean escudo has been pegged only to the Portuguese escudo through an exchange rate arrangement between Cape Verde and Portugal. Microeconomic and institutional aspects A second component of the reform programme concerns all the measures of more systemic and institutional character whose purpose is to improve the structure of incentives and encourage private investments and long-term growth. All these measures aim at increasing competition in product and factor markets so as to improve the allocation of resources in the Capverdean economy. A first measure has been the liberalisation of most prices. Price controls have been removed for all goods except rice, maize, wheat flour and cooking oil. The price controls on these goods are to be gradually removed. In addition, the government intends to privatise the two enterprises in charge of food aid procurement, EMPA (Empresa Pública de Abastecimento) and MOAVE (Moagem de Cabo Verde). In order to increase competition, it is also planned to allow private firms to participate in the procurement of food aid in the context of food aid assistance. A second measure concerns the agricultural sector. In order to improve incentives in the agricultural sector, the government introduced legislative measures to secure property rights. In 1993 the government reversed the agrarian reform law of 1981 that, among other things, organised the redistribution of land.2 In the early 1980s, this land reform had raised considerable opposition to the collectivisation attempts in Cape Verde. Another factor contributed to the low degree of implementation of the 1981 agrarian reform. In Cape Verde, a non-negligible part of the land is owned by emigrants responsible for the stream of remittances that play a decisive role in the population’s well-being.3 To avoid jeopardising this important source of funds, the socialist government more or less interrupted the collectivisation process. A third measure concerns public enterprises. In 1990, the public sector comprised thirty-two companies, which came under the control of the state in the aftermath of

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independence in 1975. Two-thirds of these enterprises were wholly owned by the state, while the remaining one-third were mixed-ownership enterprises. The state enterprise sector was relatively important since it accounted for 42 per cent of the value added in the manufacturing sector, 40–45 per cent of the value added in fishing and tourism, and 61 per cent of the value added in transport and telecommunications. The privatisation (or liquidation) of state-owned enterprises began in 1994 and was intensified during the 1995–8 period.4 By 1997 some thirty-two enterprises had been privatised and six liquidated.5 The government aims to complete the privatisation programme within a couple of years. Difficulties in overcoming the resistance of the trade unions and the management of certain enterprises, and the limited availability of fresh capital, explain the rather slow path of privatisation in Cape Verde. A fourth measure concerns the labour market. The Labour Code was revised in 1993 to introduce more flexibility in the labour market and to facilitate labour reallocation across sectors. The revision concerns mainly the simplification of rules for hiring and dismissal. A new revision of the labour legislation is under way, with further simplification of dismissal procedures. A fifth measure concerns the promotion of foreign direct investments. In 1993, a new law on foreign investment was enacted, granting foreign companies protection against expropriation and nationalisation. The new law gives foreign companies considerable tax benefits, the authorisation to have accounts in foreign currencies and the right to transfer out of the country all the profits derived from their activity in Cape Verde. The application procedure was also simplified with the foreign investment automatically approved in case of no response from the government within a period of thirty days.6 The last kind of measure is of a more institutional nature and concerns the legal framework that makes markets work smoothly and efficiently. This is necessary for the measures of more microeconomic character to have their full positive effects on private sector development and economic growth. The legislative process is under way. In 1999, a new Code on Commercial Enterprises replaced the old Commercial Code. Further, the government plans to modify the Civil Construction Legislation and the Registry and Notary Legislation.7 Import liberalisation and export promotion A third main component of reform policy is a rather liberal trade policy with a significant reduction and simplification of import duties, as well as the removal of most import quotas. In August 1991, the import tariff structure was simplified from seventy-nine rates, ranging from 5 to 100 per cent, to eleven rates, ranging from 5 to 50 per cent. The majority of the tariffs were set within the 10–20 per cent range. In 1992 and 1993 quantitative restrictions were removed for most commodities except for basic food items (like corn, rice, sugar, milk and edible oils) and some import products competing with domestic production (like fish, tomatoes, bananas, salt, beer and soft drinks). In mid-1996, however, following the rapid diminution in foreign exchange reserves, import controls were re-imposed on twenty-six products

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that accounted for some 15–20 per cent of the value of imports. The restrictive change in trade policy was only temporary and in November 1997 these trade restrictions were again lifted. The government is committed to abolishing all import quotas beginning in 1999 and to replacing them with tariffs, consistent with the rules of the WTO. In addition, the government plans a further simplification of the tariff structure and a lowering of the overall tariff level to comply with requirements for membership in the Economic Community of West African States (ECOWAS). Export promotion is the second aspect of the opening up of the Capverdean economy and its integration into the world economy. Two specific measures (and laws) were introduced in 1993. First, exporting firms benefit from a tax reduction on profits. The reduction, which decreases over time, amounts to the percentage of the production that is exported during the first five years of export activity, to be gradually reduced and finally removed within a period of ten years. Second, export processing zones (EPZs) have been created for enterprises whose production is entirely destined for export. As yet there exist only two EPZs in Mindelo and Praia. Enterprises in EPZs are exempted from taxes on profits (and dividends) during the first ten years of their activities and benefit from a maximum tax rate of 15 per cent thereafter. In addition, these enterprises are exonerated of indirect taxes and exempted from customs duties on raw materials and intermediate products used in production. These legislative changes have been accompanied by the strengthening of an agency in charge of the promotion of exports and foreign investments, the PROMEX (Centro de Promoção Turística do Investimento e das Exportações).

3 Expansive fiscal policy and unsustainable public deficit A critical aspect of the reform policy concerns the role of the state, which will be examined in this chapter. The first part will examine budgetary developments, with emphasis on changes in the volume and structure of expenditure and revenue since the start of the reform process. How these changes have affected the budget deficit will be analysed in the second part, as will be the way in which the deficit has been financed. In a third and final part, we will examine the macroeconomic consequences of the deficit in terms of inflation and crowding out of private investments. The budgetary development in Cape Verde since 1990 is portrayed in Table 7.1. A first clear finding is the increased role of the state in the economy. This is somewhat surprising because one of the main purposes of the new policy is to limit the role of the state in the economy. Government expenditure has jumped from some 25 per cent of GDP in 1990 to more than 60 per cent in 1994–5, before decreasing somewhat thereafter. Capital expenditure and interest on public debt show the most rapid increase (see Table 7.1). Wages and salaries (in per cent of GDP) have increased as well but to a much lower extent. The increase in capital expenditure concerns principally the tertiary sector whose share of public investment expenditure went up from 48 per cent in 1991–2 to 59 per cent during the 1993–6 period. Transport and communications, education, and energy, water and sewage are the main beneficiaries of this increase. The share of public investments devoted to the primary and the secondary sectors has decreased

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115

Table 7.1 Budgetary situation (in % of GDP), 1990–7 Total

1990 1991 1992 1993 1994 1995 1996 1997

22.3 28.6 39.8 42.5 45.7 45.4 40.8 38.0

Revenue

Total

Tax revenue

Non-tax revenue

External grants

11.0 13.6 15.6 17.9 19.7 19.9 21.6 19.6

4.3 4.0 5.0 5.8 5.3 6.2 4.6 4.4

7.1 10.9 19.3 16.8 18.0 17.4 14.6 13.0

25.7 37.5 48.6 52.7 62.2 60.5 57.0 53.0

Expenditure Capital expenditure

Wages and salaries

Interest on public debt

9.9 17.9 28.9 31.0 37.9 31.7 29.5 28.0

7.6 9.4 9.7 12.0 11.9 12.2 12.2 11.5

1.3 1.3 1.2 1.3 1.2 3.7 4.2 4.2

Sources: Capverdean authorities and IMF estimates for 1997.

and amounted to 24 and 17 per cent in 1993–6 to be compared with 32 and 20 per cent in 1991–2, respectively.8 Note, however, that the share of construction (in the secondary sector) almost doubled during the same period, from 4.5 to more than 9 per cent of total public investments. Also, budgetary revenue has increased. The increase concerns external revenue (grants) as well as tax revenue. External grants have increased more than internal revenue, reflecting the support of the international community for the new policy. As a result of the tax reform, the tax base has broadened and tax revenue now accounts for some 20 per cent of GDP, to be compared with 11 per cent in 1991. Non-tax revenue has remained within the range of 4–6 per cent of GDP over the period examined. The tax reform has altered the structure of tax revenue somewhat. Taxes on international trade (mostly import duties), taxes on income and profits, and stamp and municipal taxes accounted for 56, 36 and 8 per cent of total tax revenue in 1996–7 while they accounted for 62, 28 and 10 per cent in 1990–1.9 The tax reform in Cape Verde has permitted the country to attain a level of tax revenue (in per cent of GDP) which by and large corresponds to that found in countries with similar income levels. In that sense, it can be regarded as successful. But taxes on international trade still account for a significantly larger share of total tax revenue than in countries at a corresponding level of development. This might slow down the reform process by putting some restrictions on the government’s attempts to further liberalise trade policy. Unsustainable budget deficit In spite of the tax reform, fiscal revenues have fallen short of expenditures, resulting in a budget deficit. The more rapid increase in expenditure than in revenue has resulted in large and growing public sector deficits. The budget deficit jumped from 3.4 per cent of GDP in 1990 to 15–16 per cent of GDP in the 1994–7 period (see Table 7.2). It was in 1994 that the sharpest increase took place, as a result of a huge

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From crisis to growth in Africa? Table 7.2 Fiscal deficit (in % of GDP), 1990–7 Fiscal deficit

1990 1991 1992 1993 1994 1995 1996 1997

3.4 8.9 8.7 10.2 16.5 15.1 16.1 15.0

Primary deficit 2.1 7.6 7.5 8.9 15.3 11.4 11.9 10.8

Foreign financing 1.5 0.9 3.9 4.9 5.8 3.5 4.8 4.0

Domestic financing Banking system

Other

1.1 4.3 4.4 3.4 7.5 6.1 2.8 7.0

0.7 3.8 0.4 1.9 3.2 5.5 8.6 4.0

Note: Primary deficit:Fiscal deficit9Interest on public debt. Sources: Capverdean authorities and IMF estimates for 1997.

increase in public investments in transport and communications, construction and education.10 The way in which the budget deficit has been financed has changed over time. Table 7.2 shows that foreign financing accounts for a minor share, even if it has increased substantially in absolute terms. Because of its nature, grants and concessional borrowing, foreign financing of the budget deficit is not a problem in Cape Verde.11 The most significant increase concerns domestic financing that covered some 70 per cent of the budget deficit and amounted to some 11 per cent of GDP (on average) between 1994 and 1997. Two sources of domestic financing exist: (1) the banking system; and (2) the other, that is mainly the privatisation receipts. Table 7.2 shows that financing through the banking system has been significantly larger, except for the year 1996 when the proceeds from privatisation financed most of the deficit. The rapid increase in the public sector deficit has been accompanied by a tremendous increase in the public debt. The increase in the public debt reflects the fact that the government is borrowing not only to cover the current budget deficit but also to pay interest on the existing debt (see Table 7.1, last column). An implication of this is that even when the primary budget is balanced, that is when budget revenues cover current and capital expenditures, the public debt feeds on itself and increases. The rather explosive increase in the domestic debt in Cape Verde is illustrated in Figure 7.1, which shows that the domestic public debt jumped from some 4 per cent of GDP in 1991 to more than 45 per cent in 1996–7. The most rapid increase took place in 1994. Since 1994 total domestic debt has more or less stabilised at around 45 per cent of GDP. A decisive factor behind this stabilisation is the use of the proceeds from privatisation to finance part of the budget deficit. The stabilisation of the public debt concerns principally the long-term debt. Thus, the changes in structure of the domestic public debt are mainly caused by medium-term and eventually short-term debts, which have increased drastically since 1994 (see Figure 7.1). This explosion in medium-term and, more particularly,

Cape Verde

117 60

20,000 50

Total public debt (left scale)

16,000

40

Short-term debt 12,000 Public debt in % of GDP (right scale)

30 Medium-term debt

8,000

20

4,000

10

Long-term debt 0

1991

1993

1995

1997

0

Figure 7.1 Domestic public debt (in millions of escudos and in % of GDP), 1991–7. Sources: Ministry of Economic Coordination and IMF estimates.

short-term debt significantly increases the country’s degree of macroeconomic vulnerability and instability. The central bank, Banco de Cabo Verde, held most of the long-term debt that accounted for one-third of the total public debt in 1996. The long-term debt was contracted at zero or below-market fixed interest rates. (The long-term debt consists mostly of loans to public enterprises taken over by the central bank following their privatisation.) The two commercial banks, Banco Commercial do Atlântico and Caixa Económica de Cabo Verde, held an additional half of the public debt and the other financial institutions held the remaining public debt. The debt held by the commercial banks and other financial institutions is mainly of medium- and shortterm character and carries an average interest rate of about 8.5 per cent. The rapid increase in the domestic public debt has made debt stabilisation a dominant concern of fiscal policy in Cape Verde. This is even more the case now that the proceeds of privatisation diminish concomitantly with the number of the remaining public enterprises. In order to put an end to the explosion of the public debt, the government aims at suppressing the budget deficit within the next few years. The expenditure contraction will be concentrated on capital expenditures that have increased most since the start of the reform process. This focus should be facilitated by the fact that, from a political point of view, it is easier to reduce public investments than to cut current expenditures (wages and salaries). According to the Capverdean government, from 1998, development expenditures will only include those projects that are totally financed by external aid and those for which donors require counterpart funds. In addition, the budgetary procedure will be streamlined and the control function of the Ministry of Economic Coordination over all spending strengthened to avoid overruns in the capital budget.12 In the absence of inflation, the growth rate of GDP should exceed the real interest rate for a balanced primary budget to reduce the debt–GDP ratio. This is the

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From crisis to growth in Africa?

situation the Capverdean government is expecting for the future with an average growth of GDP of some 5 per cent and real interest rate on the public debt lower than that. (Real interest rate was about 4–5 per cent during the past three years.) On the other hand, if the real interest rate exceeds the growth rate of GDP, a budget surplus will be required for the debt process not to be explosive. A factor that is likely to facilitate the task of the government and to improve the fiscal situation in Cape Verde is the creation of a Trust Fund in 1998. Proceeds from the privatisation of state-owned enterprises (US$ 80 million) and funding from multilateral and bilateral donors (US$ 100 million mostly in forms of grants) finance the Trust Fund.13 Its revenue will be used to reduce gradually the burden of the domestic public debt.14 A period of ten years is required to pay off the entire domestic public debt. The Fund is managed by the Portuguese Central Bank and placed abroad, so as to prevent an increase in the liquidity of the banking system and inflationary pressures. Macroeconomic impact A somewhat different solution to the public debt problem can be achieved via money creation and inflation. The deficit can also be financed by the creation of additional money, and stabilisation of the debt–GDP ratio can be achieved even with a primary deficit if enough money is created. In Cape Verde, this solution is excluded because the government has tied its hands and adopted a nominal exchange rate peg precisely in order to prevent and control inflation. Thus a monetary financing of the deficit will mainly result in a depletion of the exchange rate reserves, which is actually what happens in Cape Verde from time to time. Figure 7.2 investigates the possible impact of the fiscal deficit on inflation. The relation was rather weak during the first years of reform policy partly because trade liberalisation had a downward effect on the development of consumer prices. Between 1991 and 1994, inflation averaged 5.2 per cent in Cape Verde.15 Since 1994 there seems to have been a clear relation between the financing of the budget deficit through the banking system and changes in prices, albeit with a lag in 1994–5. The prices of food items have increased most over the past three years, probably as a result of the persistent drought that has hit the country since 1994. Another likely impact of large public deficits works through the financial system. An increase of domestic public borrowing to finance fiscal deficits and debt service can exert an upward effect on real interest rates and contribute to a further deterioration of the fiscal situation. Large public borrowing can also have so-called crowding-out effects. The increase in the real interest rates can reduce investments in the private sector and slow down the rate of economic growth. It can also be the case that large public deficits reduce the amount of credits allocated to the private sector even in the absence of an upward effect on interest rates, and hence have a negative effect on private output. Note, however, that the impact of increased public borrowing on private investments is less clear if it reflects increased public investments and if public and private investments are complementary (Agénor and Montiel 1996: 83–4). To some extent, this reasoning can apply to the situation in Cape Verde, because the increase in public expenditures since 1991 largely reflects investments in

Cape Verde

119

10 9 Consumer price index (% growth rate)

8 7 6 5 4 3

Banking system financing of the fiscal deficit (in % of GDP)

2 1 0

1991

1993

1995

1997

Figure 7.2 Banking system financing of the fiscal deficit and inflation, 1991–7. Sources: Table 7.2 and Bank of Cape Verde.

infrastructure (in sectors like transport and communications, education and energy) and because such investments raise the productivity of capital and thus enhance private investments. Hence there might be an offsetting effect. In the case of Cape Verde, the evidence of an upward effect of large public deficits on real interest rates is not conclusive, however.16 During most of the reform period, no association has existed between the developments of fiscal deficits and real interest rates. Between the 1992–4 and 1995–7 periods, real interest rates decreased from some 7.2 per cent to some 4.7 per cent, while the fiscal deficit jumped from 11.8 to 15.4 per cent of GDP and the part of the fiscal deficit financed domestically through the banking system increased from 5.1 to 5.3 per cent of GDP. The lack of association results from the regulations of the Banco de Cabo Verde, which have prevented the adjustment of the nominal interest rates to market levels. The policy of the central bank could not prevent, however, a direct crowding-out effect that results from the fact that large public deficits financed via the banking system reduce automatically the volume of credits available for the private sector.

4 Competitiveness and foreign trade adjustment A main component of the reform programme concerns the integration of the Capverdean economy into the world economy. Trade liberalisation and export promotion measures are expected to favour this integration and the specialisation of the economy along the lines of the country’s comparative advantages. The main sources of comparative advantages for Cape Verde are a relatively well-educated labour force, relatively low unit labour costs, a proximity to the West-European markets, in particular when compared with the other sub-Saharan countries, the relative political stability of the country, and the various tax incentives.

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From crisis to growth in Africa?

Both import liberalisation and export promotion measures have contributed to the opening up of the Capverdean economy. The degree of openness of the economy, as measured by the trade–GDP ratio, has increased from some 38 per cent of GDP in 1990 to some 59 per cent on average between 1994 and 1997. Figure 7.3 shows that the impact of reform policy on imports and exports varies significantly over time, with a clear J-curve profile for the export–import ratio. Until 1994 reform policy resulted in a much larger increase in imports than in exports. It is the introduction of import liberalisation measures at the start of the reform process that explains the sharp increase in imports. On the other hand, the depreciation of the Capverdean escudo in 1993–4, both in nominal and real terms, seems to have had only limited effects on this development. Presumably, the increase in the domestic prices of imports due to the depreciation of the escudo was outweighed by the decrease in import prices following the adoption of lower tariff rates and the removal of quantitative restrictions. Export promotion measures seem to have contributed to the rapid increase in exports after 1994. The export–import ratio almost doubled between 1994 and 1997 (see Figure 7.3). The depreciation of the escudo in terms of the US dollar after 1995 was much larger in nominal than in real terms, the inflation differential between Cape Verde and the United States being lower than the nominal depreciation of the Capverdean currency. In 1997, the high inflation rate in Cape Verde (some 8.9 per cent) resulted in a real appreciation of the escudo in terms of WestEuropean currencies, but this appreciation was masked by the rise in the value of

6.5

140

6 130 5.5 5

Nominal exchange rate (right scale)

Real exchange rate (right scale)

120

4.5 110 4 100

3.5 3 Exports / imports (%) (left scale)

2.5

90

80

2 1990

1992

1994

1997

Figure 7.3 Exchange rates (1990:100) and real trade situation, 1990–7. Notes: The nominal exchange rate is the price of a US dollar in escudos, the Capverdean domestic currency. An increase in the exchange rate signifies depreciation of the escudo, and vice versa. The real exchange rate is obtained by multiplying the nominal exchange rate by the US consumer price index and dividing it by the Capverdean consumer price index (the real exchange rate uses as a base the 1990 nominal exchange rate). Sources: Computed from Bank of Cape Verde and IMF statistics.

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121

the US dollar (see Figure 7.3). All in all the real exchange rate was roughly the same in 1997 as in 1994. This suggests that the rapid increase of exports in terms of imports after 1994 can hardly be ascribed to movements in the exchange rate. The increase in the export–import ratio in part reflects an export boom that should be ascribed to other kinds of measures, like the creation of free exporting zones and tax incentives. But this increase is also the result of the imposition of temporary quantitative restrictions on imports in 1996 and 1997 and the consequent decrease in imports. An analysis of the composition of foreign trade gives much support to this contention. Table 7.3 shows that the structure of exports has changed markedly since the early 1990s. From being an exporter of primary products, Cape Verde has become an exporter of labour-intensive manufactured products. Agriculture and fishery accounted for some 80 per cent of total exports in 1990–1, but only for about 25 per cent in 1996–7. The main primary products exported in the early 1990s were bananas and fish and seafood products. On the other hand, exports of footwear and clothing were almost absent in the early 1990s but accounted for 75 per cent of total exports in 1996–7. To a large extent, these changes can be ascribed to the free exporting zones. The changes on the import side are less dramatic, even if the import of machine and electrical equipment has increased significantly to satisfy the investment needs of the newly established industrial enterprises. The export processing zones (EPZs) have a direct effect on exports, the exports from the EPZ being part of the country’s total exports. But it is often suggested that Table 7.3 Composition of imports and exports, 1990–7

Exports (in % of GDP) Composition in % Agricultural products Fish and seafood products Footwear and parts Clothing Other Imports (in % of GDP) Composition in % Food products Mineral, chemical, metal products, plastics and rubber Machine and electrical equipment Transportation material Other

1990

1991

1992

1993

1994

1995

1996

1997

1.4

1.3

1.2

1.2

1.5

2.1

3.1

3.2

37 51 — — 12

40 36 — — 24

31 68 — — 1

12 63 — — 25

8 46 44 — 2

5 24 63 6 2

4 22 54 19 1

4 23 60 12 1

36.5

45.9

50.3

46.5

60.2

60.2

55.0

50.7

28 27

28 30

42 20

36 23

31 21

34 26

32 29

36 25

10

16

13

11

16

18

17

20

20 15

11 15

8 17

13 17

20 12

9 13

8 14

5 14

Notes: Exports are f.o.b. and imports c.i.f. The figures for 1997 are based on the first six months. Export figures only concern export of goods. Goods produced in ports by carriers (fuel) are not included. Sources: Bank of Cape Verde and National Statistical Institute.

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From crisis to growth in Africa?

EPZs also have an indirect effect on enterprises that operate outside the EPZ. This effect is called a catalyst effect and refers to a situation where firms located within the EPZ affect firms outside the zone through various spillovers: demonstration effects, export know-how, on-the-job accumulation of human capital and labour mobility, and access to improved technology (Johansson 1994: 395–7; Johansson and Nilsson 1997). The catalyst effect is, however, of more medium- and long-term character and is still to come in Cape Verde. Also, the small industrial base in the country suggests that this effect may be limited. Another effect of EPZ works through trade policy. The success of EPZ in promoting exports may induce the host country to continue with trade liberalisation reforms and speed up the country’s integration into the world’s economy (Johansson and Nilsson 1997: 2118). EPZs actually provide both the arguments for and the resources needed to expand and accelerate trade liberalisation. The ongoing discussion in Cape Verde about the expansion of the free zones to the whole economy is an illustration of this second effect. To what extent further trade liberalisation will succeed in expanding exports from Cape Verde depends, however, upon liberalisation efforts in other developing countries, in particular in the other subSaharan countries.

5

Growth performance

A main purpose of reform policy in Cape Verde is to increase growth so as to improve the living standards of the population. This is also the best way to secure legitimacy for the right-wing government. Several of the measures implemented since 1991 have been designed with the explicit goal of promoting economic growth. The policy of deregulation, the privatisation of some state-owned enterprises, the more liberal trade policy, the development of infrastructure, etc., are all expected to boost growth in Cape Verde. Figure 7.4 shows that GDP growth has been rather constant since the start of the reform policy in 1991 (on average some 3.3 per cent over the 1991–7 period). As compared to sub-Saharan countries the rate of GDP growth in Cape Verde was higher between 1991 and 1994 but lower thereafter. This is even more significant when compared to ‘recent strong performers’ in sub-Saharan Africa whose growth performance has been significantly better than that of Cape Verde after 1995 (see Figure 7.4). The mediocre growth performance of CFA countries, resulting from the misalignment of the CFA franc prior to the devaluation in 1994, explains to a large extent the poor performance of sub-Saharan countries prior to 1995.17 A main factor behind the relatively poor growth performance of the Capeverdean economy can be found in the sector distribution of growth. Actually, the aggregate growth figures hide large differences between and within the economic sectors. The poorest results have been achieved by the primary sector, and more particularly agriculture, which accounts for some 90 per cent of the primary sector output. The primary sector experienced a negative growth over the 1991–7 period (see Table 7.4). Sugarcane, bananas, potatoes, maize, manioc and vegetables account for the overwhelming share of agricultural production in Cape Verde. Persistent drought is the

Cape Verde

123

140

Sub-Saharan Africa –Recent strong performers

130

120 Cape Verde 110 Sub-Saharan Africa 100

90 1989

1990

1991

1992

1993

1994

1995

1996

1997

Figure 7.4 Real GDP growth, 1989–97 (1989:100). Recent strong exporters: Angola, Benin, Côte d’Ivoire, Equatorial Guinea, Ethiopia, Guinea-Bissau, Lesotho, Mauritius and Uganda. Source: IMF Statistics.

Table 7.4 Gross domestic product by sector, 1991–7 (% change) 1991

1992

1993

1994

1995 1996

1997 Average 1991–7

Share of GDP 1990

GDP 1.4 3.3 4.2 3.8 Primary 97.1 98.0 90.4 915.3 Secondary 2.9 3.8 3.7 7.3 Tertiary 2.7 5.2 5.1 5.7

4.7 9.4 4.6 4.1

3.0 91.8 3.3 3.5

3.0 2.8 3.5 2.9

3.3 92.9 4.2 4.2

1997

100 100 13.7 8.7 20.3 21.4 66.0 69.9

Source: IMF estimates and projections for 1997.

main factor behind the sector’s poor results. A contributory factor may also be the low administered prices of some agricultural products, which do not encourage crop production. Low food prices are made possible by international food aid, which covers some 70–90 per cent of domestic consumption in Cape Verde.18 The growth performance of the primary sector contrasts with that of the secondary and tertiary sectors, which have experienced an average growth rate of 4.2 per cent over the same period. Sector growth differentials have greatly modified the structure of the Capverdean economy, making it less dependent on the primary sector and more dependent on the tertiary sector. In 1997, the primary, secondary and tertiary sectors accounted for 8.7, 21.4 and 69.9 per cent of GDP, respectively, while they accounted for 13.7, 20.3 and 60 per cent of GDP prior to the start of the reform process in 1990. Even within each sector there are large disparities between the various sub-sectors. Within the secondary sector, the best results have been achieved by the industry and

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From crisis to growth in Africa?

energy sectors with an average growth rate of 5.4 per cent over the 1991–7 period. Part of the growth of the industry sector can be ascribed to the rise of the EPZs in Mindelo and Praia (see above). Industry and energy accounted for about one-third of the secondary sector’s output. During the same period, construction, which accounted for the remaining two-thirds, returned a growth rate of 3.5 per cent. Increased public investments in energy and construction since 1991 is the main factor behind the relatively high growth rates of these two sub-sectors. A more diversified picture emerges for the tertiary sector. Its aggregate rate of growth is equal to that of the secondary sector but the differences between the various sub-sectors are more pronounced than in the secondary sector. Commerce, public service and hotels have achieved the poorest results. The negative growth rate of hotels is somewhat surprising because of the active policy of tourism promotion in Cape Verde. The best results were achieved by transport and communications and other services with an average growth rate of some 7.6 and 8.8 per cent, respectively, over the 1991–7 period. A large part of the increase in the growth rate of the tertiary sector as a whole can be ascribed to these two sub-sectors which together accounted for some 36 per cent of the tertiary sector in 1996. The expansion of the public investment programme explains the rapid growth in transport and communications. It is actually the expansion of the port infrastructure (in Praia, São Vicente and Porto Novo) and the investments in the Telecommunication Company that account for the rapid growth of transport and communications.

6

Dismal labour market

The labour market plays an important role in determining the success of reform policy and in mediating the impact of reform policy on the standards of living of the population. The labour market has three main functions during the reform process: (1) to allocate workers between sectors, (2) to match worker skills to job requirements, and (3) to provide incentives for human capital accumulation in education and on-the-job training (through its impact on relative wages), and hence to further long-term growth.19 The reform of the labour market legislation is expected to improve the flexibility of the labour market to enable it to perform these three functions. In combination with the other components of the reform programme, the reform of the labour market is expected to increase employment and reduce the chronically high level of unemployment in Cape Verde. Unemployment has always been a serious problem in Cape Verde, which explains the recurrent surges of emigration. In 1990, the Ministry of Labour estimated the urban unemployment rate to be about 25 per cent of the labour force. In Praia, the largest urban centre, the rate of unemployment was estimated to be 22 per cent in the same year. Some four years later the rate of unemployment in Praia had reached 33 per cent. A similar development could be noticed in the second main urban centre, São Vicente. Only the two main islands were covered by the employment statistics of 1994. Urban unemployment decreased somewhat thereafter and in mid1998 the urban unemployment rate amounted to some 26 per cent, 23 per cent in Santiago and 28 per cent in São Vicente (Ministério das Finanças 1998: 10). Note,

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125

however, that the accuracy of these statistics has been questioned since they only imperfectly captured the rapid increase in self-employment and employment in the informal sector after 1991 (IMF 1996: 4–5). In addition they are only concerned with urban areas. Anyway, the 1996 Labour Force Survey, which covers both urban and rural areas, confirms the depressed situation in the labour market in Cape Verde (see Table 7.5). First it indicates that some 38 per cent of the labour force is unemployed.20 Unemployment differs markedly between the islands. This should contribute to significant island-to-island migration and different rates of emigration from Cape Verde between the islands. The worst situation is found in São Vicente where no less than 44 per cent of the labour force is unemployed.21 Unemployment is also very high in Fogo, Maio and Santiago, the latter clearly the largest island in Cape Verde. Unemployment is lowest in the small islands of Sal, Boa Vista and Brava. Even within the relatively large islands there exist large disparities between the regions, suggesting that the labour market is regionally segmented. There is a clear gender dimension in unemployment manifested in much higher unemployment rates for women. The (total) rate of female unemployment in Cape Verde is some eighteen percentage points higher than the male rate (Table 7.5). Not only the level and the gender composition, but also the structure of unemployment varies markedly between the islands. An illustration of this is the distribution of unemployment in terms of short-term (unemployed less than one month) and long-term unemployment (unemployed twelve months or more). The low share of short-term unemployment and high share of long-term unemployment in total unemployment suggest that unemployment in Cape Verde is more of a structural Table 7.5 Unemployment and level of education, 1996 Unemployment rate

Total Boa Vista Brava Fogo Maio Sal Santiago Santo Antão São Nicolau São Vicente

Unemployment

Total Males Females

Population Primary education (in 1,000s) Long-term Short-term Less than More than

37.9 26.6 29.8 40.8 40.0 19.9 38.2 31.9

29.8 23.6 21.8 32.9 30.9 9.5 29.8 25.4

47.8 32.4 48.6 51.7 48.6 35.0 47.2 43.7

50.9 44.9 21.6 56.1 23.2 49.1 46.8 61.6

5.4 17.2 0 3.5 14.3 12.3 5.5 5.8

391.0 3.6 5.7 33.5 4.8 8.7 211.4 49.6

27.2 20.5 27.5 29.5 28.8 12.2 25.5 37.1

12.2 6.5 8.5 8.3 4.2 21.3 13.9 5.7

34.3 44.2

28.6 37.1

44.0 53.3

58.3 56.7

3.7 4.6

13.2 60.7

36.3 24.6

6.1 14.9

Notes: Unemployment comprises people without work, available to work and looking for work. Long-term unemployment (twelve months or more) in % of total unemployment. Short-term unemployment (less than one month) in % of total unemployment. Primary education refers to the % of the population with less than, respectively more than, primary education. Source: Inquérito às Forças de Trabalho (1996).

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than a frictional character. The high share of long-term unemployment is worrying, because it reflects low labour market flexibility with low flows in and out of unemployment and long periods of unemployment. In 1996 long-term unemployment accounted for some 51 per cent of total unemployment. Another feature of unemployment is its age structure. Some 58 per cent of the unemployed are between 14 and 24 years old, some 37 per cent between 25 and 44, the rest being 45 or older (Inquérito às Forças de Trabalho 1996: 50). Youth is strongly over-represented among the unemployed since the 14–24 age group only represents 44 per cent of the 14–64 population. The severity of youth unemployment is also reflected in very high unemployment rates. According to the Labour Force Survey, in 1996 the unemployment rates for males and females (14–24 age group) were 51 and 69 per cent, respectively. This clearly indicates the existence of serious problems in the transition from school to work. Another characteristic of unemployment in Cape Verde concerns the educational background of the unemployed. The 1996 Labour Force Survey shows that unemployed workers with low educational attainment form the overwhelming majority of the unemployed. Some 91 per cent of the unemployed had less than or only primary education and thus only 9 per cent had more than primary education (Inquérito às Forças de Trabalho 1996: 52). Table 7.5 shows that there exists a certain relation between the level of education and the long-term unemployment outcome across the islands. Islands with low levels of educational attainment, as measured by the proportion of the population with less than primary education (Santo Antão, São Nicolau and Fogo), are also those with high shares of long-term unemployment. There are, however, several exceptions, like Brava and Maio, which suggest that labour demand and the structure of the island economy also matter. There is a clear bias in the sector distribution of unemployment relative to the sector distribution of employment. Construction and public works, and public administration accounted for 31 and 18 per cent, respectively, of the total number of unemployed.22 The remaining 51 per cent of the unemployed were divided between the service sector (public administration and education excluded) (13 per cent), the primary sector (11.5 per cent), commerce, restaurants and hotels (8.5 per cent), transport and communications (7 per cent), manufacturing (6.5 per cent), and education (3 per cent). The distribution of unemployment between the primary, secondary and tertiary sectors does not reflect the distribution of employment. While the primary, secondary and tertiary sectors account for 12, 38 and 50 per cent of total unemployment, they account for 16, 18 and 66 per cent of employment (Inquérito às Forças de Trabalho 1996: 18). Part of the discrepancy can be ascribed to the difficulties in defining and measuring unemployment in the agricultural sector. But it is also the case that some sectors, like construction and public administration, are overrepresented among the unemployed. This last finding is somewhat surprising in view of the increase in public expenditures in the sectors concerned. It could be that the Labour Force Survey was conducted in 1996, that is during the period of contraction of capital expenditures in order to improve the budgetary situation (see Table 7.1). The high level of unemployment in Cape Verde has contributed to containing the development of wages in the private sector. This explains why private sector

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wages did not increase to the same extent as public sector wages after 1991 (IMF 1996: 5). Private wages increased in line with inflation while public wages increased in real terms during the same period. A result of this development is that the average salary in public administration is some 20–30 per cent higher than in the private sector. The increase in public sector salaries has concerned mainly high-level managers and skilled workers, resulting in widening wage differentials in the public sector and a rapid increase in government current expenditures.

7 In search of internal balance and growth The results of reform policy are somewhat mixed. The policy can be considered successful in the sense that it has introduced a certain number of systemic measures that are steps in the right direction. The liberalisation of most prices, improved incentives for private investments, in particular foreign direct investments, the privatisation of some public enterprises, the liberalisation of foreign trade and export promotion measures are examples of measures to promote long-term economic growth and improved standards of living. The results in terms of macroeconomic balances, private investments and current growth are, however, short of expectations. Three main macroeconomic problems remain. A first problem concerns fiscal policy. A main objective of reform policy has been to reduce the scope of state intervention in the economy. In spite of this, public expenditures as a share of GDP have increased from some 26 per cent in 1990 to some 58 per cent on average between 1994 and 1997! There is a clear political dimension in the growth of public expenditure in the sense that the most rapid increase took place in 1994 and 1995, prior to the second legislative and presidential elections in December 1995 and February 1996. To bring back public expenditures to a level compatible with the level of tax and non-tax revenues, foreign assistance should therefore be a first priority. As shown above it is mainly capital and development expenditures that have increased since the start of reform policy. A contraction of such expenditures is necessary to restore internal balance, but at the same time it risks endangering the growth-oriented policy.23 It also risks hurting those with low incomes, as well as rural areas that are most dependent upon capital expenditures. Labour-intensive public work projects (Frentes de Alta Intensidade de Mão de Obra – FAIMOs), aimed at developing infrastructure and protecting the environment, have contributed to the increase in public spending since 1991 (IMF 1996: 24). An average of 17,000 people a year have been employed by these projects, which are to a large extent financed by the proceeds from food-aid sales (PNUD 1997: 37). The FAIMO projects play a critical role in the poverty alleviation strategy of the government and cuts in them will affect the situation of the poor negatively. A second related problem concerns the choice of exchange rate regime. Between 1982 and June 1998, the domestic currency was pegged to a currency basket including the nine currencies of the most important sources of imports and emigrants’ remittances. Since July 1998, the Capverdean (c.v.) escudo has been pegged exclusively to the Portuguese escudo and from 1999 to the euro. The change of exchange rate regime only marginally affects the parity of the c.v. escudo because of

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the large weight of the Portuguese escudo and other European currencies in the currency basket. The new exchange rate arrangement secures the convertibility of the c.v. escudo.24 It is managed jointly by the governments of Cape Verde and Portugal, and strictly limits the room for manoeuvre of economic policy in Cape Verde.25 First, monetary policy has to be subordinated to the requirements of the peg and can no longer be used to finance fiscal deficits (through inflation and seignorage). Second, fiscal policy also needs to be consistent with the peg since the sale of bonds to finance fiscal deficits can increase the rate of interest and strain the peg through capital inflows. A main consideration for the government to enter such an exchange rate arrangement has been to improve the credibility of economic policy and thus achieve, among other things, an increase of foreign direct investments and emigrant remittances. To be successful, the macroeconomic policy in Cape Verde needs to bring down the inflation rate to the level of that of Portugal in a first stage and to that of the countries of the European Monetary Union (EMU) from 1999 and onwards.26 Otherwise, potential gains in the form of increased credibility will be rapidly offset by an appreciation of the real exchange rate, a misalignment of the c.v. escudo and a loss of competitiveness. A third problem concerns growth. The rate of growth of GDP has been rather modest in Cape Verde, some 3.3 per cent on average over the 1991–7 period. A higher growth rate is required in order to increase employment, wages and the standard of living of the population. It is also necessary in order to reduce the widespread poverty. Both the tightening of fiscal policy and the adoption of a stricter pegged exchange rate arrangement are likely to reduce public investments and hence to slow down the rate of economic growth in Cape Verde. Accelerating and deepening the reform process are therefore necessary to counteract these forces and to increase the volume of private investments necessary to achieve a more dynamic and more sustained growth. The acceleration can concern the growth-promoting measures that were introduced during the later stage of reform policy (the mid-1990s). Note that many of these measures take time to materialise, which explains why their effects on growth have been delayed. But new measures can also be introduced to deepen the reform process. One can be the accelerated privatisation of the two state-owned commercial banks. Such a measure will increase competition in the financial system and improve financial intermediation and resource allocation.27 It would also help to reduce the domestic public debt through the Trust Fund and thus relax the straitjacket on fiscal policy somewhat. It will make it possible to avoid too severe cuts in capital expenditures and lessen the macroeconomic obstacles to higher growth. However, there remain obstacles of more structural character that prevent Cape Verde from embarking on a more rapid growth path, obstacles that the country shares with other small remote island economies (poor location and high transaction costs, small domestic markets, poorly developed physical infrastructure and inadequate stock of human capital).28 Overcoming these obstacles is a long-run process and much more difficult to achieve.

Notes An earlier version of this paper benefited from constructive comments by Magnus Alvesson, Inácio Felino Rosa de Carvalho, Carl-Erhard Lindahl, Mats Lundahl, Inga

Cape Verde

1

2 3

4

5 6 7 8 9 10 11 12 13 14 15 16 17 18

129

Persson, Åsa Stenman, Bo Westman and seminar participants in Stockholm. Thanks are also due to Luís Dupret and to all the officials in Cape Verde who devoted time to informing me about the economic and political situation. The MPD secured some 70 per cent of the seats in both the 1991 and 1995 legislative elections. The PAICV (Partido Africano para a Independência de Cabo Verde), the party that exercised the monopoly of power between 1975 and early 1991, remains the main opposition party with 30 per cent of the seats. The candidate supported by the MPD (António Mascarenhas Monteiro) won both the 1991 and 1996 presidential elections. On the land reform in Cape Verde, see e.g. Lesourd (1995, chapter 8). Remittances amounted to some 20 per cent of GDP in the mid-1990s. The major country sources of these remittances are the United States, the Netherlands, Portugal and France. For an analysis of the determinants of emigrants’ remittances to Cape Verde, see IMF (1996: 84–97). For an analysis of the structure and evolution of emigration, see Andrade (1998). The majority of privatised enterprises (some 65 per cent) belong to the industry and service sectors, including tourism. The most common privatisation form has been the competitive sale of shares (about half of the total), followed by the direct sale of shares and management/employee buyouts (each some 20 per cent). The largest privatisation concerns the partial privatisation of the Telecommunication Company, Cape Verde Telecom. The number of enterprises privatised or liquidated was higher than the number of stateowned enterprises at the start of the reform process, because some of them were fragmented into separate enterprises to facilitate their privatisation. The new legislation contributed to a large increase in foreign direct investments in the mid-1990s. For a survey of legislative changes in Cape Verde, see Bogdan (2000). In absolute terms, public investments increased in all three sectors. Between the 1991–2 and 1993–6 periods, the real increase in public investments in the primary, secondary and tertiary sectors attained 3, 16 and 61 per cent, respectively. In absolute terms, the three sorts of tax revenue increased. Between the 1990–1 and 1996–7 periods, the real increases in taxes on international trade, on income and profits, and stamp and municipal taxes reached 60, 142 and 36 per cent, respectively. Public investments in transport and communications, construction and education increased by 73, 60 and 34 per cent in real terms between 1993 and 1994. In 1993–7, grants and concessional borrowing accounted for 75 and 25 per cent of foreign financing. For a description of the budget management reforms, see Republic of Cape Verde (1997: V–VII). Foreign assistance to Cape Verde is not limited to the financing of the Trust Fund. It amounts to some 20 per cent of GDP. On foreign assistance to Cape Verde, see PNUD (1997, 1998). Only 90 per cent of revenues will be used to service the debt. Five per cent will be put aside to cover emergency expenditures and 5 per cent to remunerate the central bank for its management services. During the same period, inflation attained 37 per cent on average in sub-Saharan Africa (Fisher et al. 1998: 22). This is supported by the experience of other developing countries with poorly developed financial systems. See e.g. Agénor and Montiel (1996: 138–9). For a recent analysis of growth in sub-Saharan Africa, see Fischer et al. (1998) and Calamitsis et al. (1999). The bad performance of the agricultural sector has clear implications for the extent and depth of poverty in Cape Verde. Most of the poor live in rural areas (68 per cent according to the World Bank poverty study (1994)), and the bad performance of the agricultural sector aggravates their situation and fosters rural to urban migration.

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19 For an analysis of the role of the labour market during adjustment, see Horton et al. (1994: 14–57). 20 In the Labour Force Survey, unemployment comprises people without work, available to work and looking for work. This extended definition explains part of the difference noticed with the unemployment figures of the Ministry of Finance. 21 As yet the impact on unemployment in São Vicente of the EPZ of Mindelo can be considered limited. This applies to all foreign direct investments in Cape Verde as well. According to the Banco de Cabo Verde, about 1,500 jobs have been created by foreign direct investments (Banco de Cabo Verde 1997: 27). 22 The Labour Force Survey provides information on the sub-sectors in which the unemployed worked prior to unemployment (Inquérito às Forças de Trabalho 1996: 55). 23 For an illustration of the negative impact of cuts in government investment on economic growth in sub-Saharan Africa, see e.g. Ghura and Hadjimichael (1996). 24 The convertibility of the Capverdean escudo is secured through a line of credit made available by the government of Portugal. Mutual consent is required for drawings from the line of credit. 25 The agreement between Cape Verde and Portugal contains the obligation for the government of Cape Verde to adopt the Maastricht criteria, that is a government deficit below 3 per cent of GDP, a debt–GDP ratio below 60 per cent or declining at a satisfactory rate, a long-term interest rate at most 2 per cent above those of the three best performing countries in terms of inflation, and an inflation rate at most 1.5 per cent above that of the three best performing countries. There is, however, no mention of fines imposed on Cape Verde in case of, for example, a budget deficit exceeding 3 per cent of GDP. This suggests that the obligation should rather be regarded as a strong recommendation. 26 Cape Verde, like the African countries of the Franc Zone, will in practice become an associate member of EMU in 1999. All these countries will endorse stricter rules for fiscal policy that can contribute to securing the transition from fiscal precariousness to fiscal sustainability. For a discussion of the implications of EMU for fiscal policy in Africa, see Collier (1992). 27 Note, however, that it is important to maintain prudential regulation and supervision of the financial sector as long as there remain large public deficits and weak institutions (characterised by ineffective law enforcement and inefficient bureaucracy) (McKinnon 1991: 6–7; Demirgüç-Kunt and Detragiache 1998). 28 On the structural problems faced by small island economies, see Crusol et al. (1988).

References Andrade, J. (1998), ‘Les migrations capverdiennes’, in Découverte des îles du Cap-Vert, AHN Praia – Sépia Paris, pp. 63–94. Agénor, P.-R. and Montiel, P. J. (1996), Development Macroeconomics. Princeton: Princeton University Press. Banco de Cabo Verde (1997), Boletim de Estatísticas, 3o trimestre de 1997, Dezembro de 1997. Bogdan, M. (2000), ‘The Law of the Republic of Cape Verde after 25 Years of Independence’, Journal of African Law, 44: 86–95. Calamitsis, E., Basu, A. and Ghura, D. (1999), ‘Adjustment and Growth in Sub-Saharan Africa’, IMF Working Paper, WP/99/51. Collier, P. (1992), ‘European Monetary Union and “1992”: Opportunities for Africa’, The World Economy, 15(5): 633–43. Crusol, J., Hein, P. and Vellas, F. (eds) (1998), L’enjeu des petites économies insulaires. Paris: Economica.

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Demirgüç-Kunt, A. and Detragiache, E. (1998), ‘Financial Liberalization and Financial Fragility’, IMF Working Paper, WP/98/83. Fischer, S., Hernández-Catá, E. and Khan, M. (1998), ‘Africa: Is This the Turning Point?’, Paper on Policy Analysis and Assessment of the International Monetary Fund, PPAA/98/6. Ghura, D. and Hadjimichael, M. T. (1996), ‘Growth in Sub-Saharan Africa’, IMF Staff Papers, 43(3): 605–34. Horton, S. Kanbur, R. and Mazumdar, D. (1994), ‘Labor Markets in an Era of Adjustment: An Overview’, in S. Horton, R. Kanbur and D. Mazumdar (eds), Labor Markets in an Era of Adjustment, Vol. 1. Washington, DC: Economic Development Institute of the World Bank. Instituto do Emprego e Formaçào Profissional (1996), Inquérito às Forças de Trabalho, mimeo, Praia. International Monetary Fund (1995), ‘Cape Verde – Background Issues and Statistical Update’, IMF Staff Country Report No. 95/9, Washington, DC. International Monetary Fund (1996), ‘Cape Verde – Recent Economic Development’, IMF Staff Country Report No. 96/103, Washington, DC. International Monetary Fund (1998), ‘Cape Verde – Statistical Tables’, IMF Staff Country Report No. 98/31, Washington, DC. Johansson, H. (1994), ‘The Economics of Export Processing Zones Revisited’, Development Policy Review, 12(4): 387–402. Johansson, H. and Nilsson, L. (1997), ‘Export Processing Zones as Catalysts’, World Development, 25(12): 2115–28. Lesourd, M. (1995), État et société aux îles du Cap-Vert. Paris: Éditions Karthala. McKinnon, R. I. (1991), The Order of Economic Liberalization, Financial Control in the Transition to a Market Economy. Baltimore and London: The Johns Hopkins University Press. Ministério das Finanças (1998), Conjuntura No. 2/98, República de Cabo Verde. Ministry of Economic Coordination (1997), Cape Verde’s Dynamic Insertion in the World Economic System, Republic of Cape Verde. PNUD (1997), Coopération au développement – Cap Vert, Rapport 1996, Praia. PNUD (1998), Coopération au développement – Cap Vert, Rapport 1997, Praia. Republic of Cape Verde (1997), Economic Reforms Program, Round Table Conference with the Development Partners, Praia. World Bank (1994), ‘La pauvreté au Cap-Vert – Evaluation sommaire du problème et stratégie en vue de son allégement’, Rapport No. 13126, Washington, DC.

8

Explaining Zambia’s elusive growth Credibility gap, external shocks or reluctant donors? Steve Kayizzi-Mugerwa

In the past decade, Zambian authorities have tried to combine the country’s return to multiparty democracy with liberal economic reforms but with somewhat contradictory results. Uniquely, the transfer of power in 1991 from the United National Independence Party (UNIP), in government for close to thirty years, to the newly formed Movement for Multiparty Democracy (MMD) was without major setbacks or violence. On assuming power, the MMD embarked on ‘tough policies’ including removal of controls on prices and the exchange rate, public sector retrenchment, reform of financial institutions and privatisation. Trade reform led to the reduction of tariff rates from 100 per cent down to 40 per cent. From the outset, the MMD blamed Zambia’s earlier poor economic performance on UNIP’s pursuit of ‘failed socialist policies’, arguing that to generate high and sustainable growth required firm and credible reforms. Lauding the combination of economic reforms and multiparty politics as the dawn of democratic governance in the region, donors increased aid flows. However, in spite of the government’s market ‘radicalism’, the growth response in Zambia has for much of the 1990s been poor both in absolute terms and in comparison to its neighbours. Thus while Zambia registered a negative average growth rate of 90.4 per cent during 1991–7, implying a per capita income growth decline of 93 per cent (Table 8.1), its immediate neighbours, Mozambique, Zimbabwe, Tanzania, Malawi and Botswana, had average growth rates ranging from 2.1 to 4.2 per cent, while more distant Kenya registered 2.0 per cent (the sub-Saharan African average was 1.9 per cent). Although Zambia’s poor performance is sometimes blamed on external shocks, movements in its terms of trade were not any more adverse than those of its neighbours (Table 8.2). In the 1990s, the growth in export unit values for Zambia at 2.2 per cent was better than the 92.4 per cent for Zimbabwe, 0.2 per cent for Malawi, 95.6 per cent for Mozambique or the subSaharan African average of 0.2 per cent. In trying to explain the paucity of growth in Zambia in the past decade, ‘bad luck’ is therefore simply not sufficient. It is clear in retrospect that while the government’s wide-ranging economic policies needed to be buttressed by equally ambitious political reforms, there were, reminiscent of the Kaunda era, too few human and financial resources to ensure success. Thus although the government had quickly embarked on the Zambian equivalent of ‘big bang’, projecting a policy

Zambia’s elusive growth 133 Table 8.1 Average growth of real GDP for selected African countries (%), 1975–97 Period

Zambia

Zimbabwe

Malawi

Botswana

1975–84 1985–9 1990–7

0.2 2.3 90.4

3.0 4.2 2.1

3.2 1.9 3.5

11.4 10.3 4.7

Mozambique — 6.0 4.2

Kenya

SSAa

4.7 5.9 2.1

2.2 2.6 1.9

a Sub-Saharan Africa excluding South Africa. Source: World Bank (1998).

Table 8.2 Average growth in export unit values for selected African countries (%), 1975–97 Period

Zambia

Zimbabwe

Malawi

Botswana

Mozambique

Kenya

SSAa

1975–84 1985–9 1990–7

2.4 9.3 2.2

0.3 3.9 92.4

3.8 1.4 0.2

— 11.3 2.0

— 4.8 95.6

5.5 91.8 2.0

6.1 5.7 0.2

a Sub-Saharan Africa excluding South Africa. Source: World Bank (1998).

profile as different from that of UNIP as possible, the fundamentals had changed little. The loss of donor support during the second half of the 1990s and an adverse political climate made it even more difficult for the new government to establish a reputation for effectiveness. Zambia in the 1990s thus provides an interesting variation on the timeinconsistency problems faced by the ‘new’ African governments. After decades of mismanagement, the economies inherited in the 1980s and 1990s were often in a poor position to generate the resources necessary to meet the electoral promises of the new rulers. Thus a record of success has been difficult to establish. This chapter looks at the issue of policy credibility in Zambia during a period of political and economic transition. We try to isolate the factors, both domestic and external, that explain the government’s choice of policies, focusing on the reasons that explain the failure to commit.

1 Reforms and credibility: An overview of the issues The analysis in this chapter draws on the policy credibility and reputation literature in order to highlight a number of issues in Zambia’s transition from a one-party state, with a fairly controlled economy, to a multiparty one striving to transform itself into a market economy. In a bid to establish reputation, the MMD came to power with a programme, which tried to incorporate as many credibility-enhancing measures as possible. For example, the central bank was to be fully independent,

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fiscal discipline was to be rigorously enforced, while controls on food prices, and the exchange rate, were entirely eliminated. Furthermore, the retrenchment of public sector employees and privatisation would curtail the role of the public sector in the economy, enhancing private initiative and raising efficiency. Moreover, decentralisation would help devolve power to the regions and involve the public more directly in the formulation of policies, which affect them. The point of departure in the policy credibility analysis is that since policy makers operate under a variety of competing agendas, time-inconsistency problems are bound to arise in the course of policy formulation and implementation (Apergis et al. 1997). For example, while policy makers would like to promise low inflation as this would appeal to wage earning voters, they also like to promise more jobs, another important political consideration. The latter implies that policy makers would not be averse to surprising the public with higher inflation, in order to decrease real wages and raise employment (Barro and Gordon 1983; Blackburn and Christensson 1989; Buffie 1998). This shifting policy stance is characterised as having an ‘inflation bias’ (Edwards 1998). However, given that the public understands the incentives of the policy makers, the earlier promise of low inflation would not be believed. Thus policy makers cannot benefit from reneging on earlier announcements. In practical terms, this means that expected and realised inflation will be higher than if the promises of the policy makers were binding. Policy incredibility thus results in sub-optimal social outcomes. The issue of addressing the credibility problem then revolves around designing mechanisms for enhancing the reputation of policy makers by making them adhere to their promises. Two mechanisms are envisaged: one is based on institutional inducements devised to prevent policy makers from benefiting from the effects of unexpected policy shifts. For example, in the case of the central banker and monetary policy, it has been suggested that remuneration and even length of tenure should be tied to the inflation fighting capabilities of the incumbent. An important institutional variant, favoured in advanced countries, and now copied in developing ones, is to put in place the legal framework that gives the central bank full independence over monetary policy (see Hesselmark (1998) for the Zambian case). The second one is based on the social value of a reputation for honesty. A reputation for not reneging on promises generates its own incentives for compliance, the risk of losing credibility being the disciplining device. The literature suggests that the reputation of policy makers can be enhanced if the government appoints overseers who have a greater distaste for economic instability than society at large. Such individuals would, for example, refrain from all attempts at engineering unexpected inflation for fiscal or employment purposes. In terms of policy credibility, the situation of Zambia at the end of the 1980s and beginning of the 1990s could be compared to that of countries of Eastern Europe, at the beginning of their economic and political transition (Roland 1995). Policy makers were all too aware of the inadequacy of their policies and yet, owing to lack of credibility, all efforts at refining them had failed. Decades of failed reform attempts made it impossible for the incumbent regime to convince the public that the new policies would be maintained. To reestablish credibility, it was necessary to

Zambia’s elusive growth 135 start from ‘scratch’, that is with policies and policy makers who were not tainted by past failures. Seen in this way, a change of government in Zambia was inevitable if credible reform was to be embarked on. However, while UNIP was clearly defeated at the polls for its past failures, the MMD had won power on the strength of its promises, not necessarily backed up by a reputation, and the general desire for change. In retrospect the democratic and market-friendly stance that the MMD adopted was partly an effort to ‘mimic’ the actions of serious policy makers (such as those favoured by the IMF) in an effort to gain credibility with the public and the donors. In pre-election attempts to bolster public confidence in its manifesto, for example, the MMD had floated the idea of reducing the powers of the presidency, for instance in the appointment of highranking civil servants. This was an attempt to ensure the evolution of a more professional public service. Human rights were to be upheld as well as the freedom of the press, with the MMD promising to sell off the two government-owned papers when it took power. There was thus all indication that the autocratic ways of the government under UNIP were to be abandoned. However, this pluralistic approach fell through following the MMD’s landslide victory. By virtually wiping out the opposition (the party won 125 seats of a total of 150), the MMD had eliminated both the Parliament and multiparty politics as ‘agents of restraint’. In the absence of credible threats to its power, the government’s willingness to commit to its electoral promises became doubtful. In his discussion of the credibility problem of African governments, Collier (1993, 1995) has highlighted the need for an external agent of restraint, that is an institutional framework to ensure policy discipline that is outside the control of the governments and thus is immune to swings in domestic politics. This could be a regional currency board or a trade arrangement, such as the creation of a preferential trade area, with an advanced economic region such as the European Union. In terms of regional agents of restraint for Zambia, there are two possible ones. The Southern African Development Community is a potentially powerful grouping that includes South Africa. However, this body has not yet evolved an effective framework for macroeconomic policy coordination for its members. Another important grouping is the Common Market for Eastern and Southern Africa (COMESA), with a membership of twenty-two countries and a secretariat in Lusaka. However, although a fully fledged common market is planned for the year 2000, this is a less homogeneous body than SADC. Notably, South Africa has not considered it worthwhile to join COMESA, which has even forced some founder members to abandon it. However, in light of the newly signed trade agreement between South Africa and the European Union, some of the reputation gained by the former might rub off on the sub-region and thus on Zambia as well. Donors, as a group, have also played a sort of restraining role. This was possible not only because they provided the bulk of the funds but also because the government saw their return as a vote of confidence in its policies. However, since donor responses were not entirely independent of domestic events, donor behaviour suffered from the same type of time-inconsistency problems as the government. Huge aid inflows were promised at the beginning of the 1990s, but much less actually

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materialised since donors were constrained by their own budgets as well as their constituencies’ concerns for governance and human rights issues in Zambia. The rest of this chapter analyses the tension between the government’s wish to establish credibility with the public and the limits set by the inherited policy and institutional constraints, including paucity of financial resources as well as the public scepticism engendered by decades of broken promises.

2 The transition from a controlled economy The most important legacy of the copper industry in Zambia is that it boosted the state machinery’s capacity for patronage and control (see Ndulo 1999). Mineral rents were in the first instance expended on the creation of a huge parastatal sector, which would with time encompass the breadth of the economy, and for the subsidisation of urban producers and consumers. State ownership of the mines provides an early example of the credibility problem. It was thought, for example, that with the nationalisation of the mining companies, miners would become less militant in their wage demands, preventing wage escalation in the rest of the economy and ensuring higher profitability in the mines. The copper surpluses would then be used in the diversification drive. However, the combination of a sharp copper price reversal in the 1970s with an increasingly militant workforce on the Copperbelt, making the restructuring of the mining companies impossible, was to turn state ownership into a serious economic and ultimately political liability. Another important consideration in the transition from a controlled economy has been the changing nature of the country’s relationship with the donors. Aid to Zambia in the 1960s and 1970s, as indeed that to Tanzania, especially from the Scandinavian countries, was mostly given in appreciation of the egalitarian principles on which the Zambian government seemed to base its policies. Subsequently, Zambia’s important role as a Frontline State in the fight against South Africa’s apartheid policy helped increase total aid flows, even as donor disaffection with the ineffectiveness of the policies pursued since independence, especially the partiality for controls, was mounting. However, donors were to become altogether more critical of the government towards the end of the 1980s. Notably, had bilateral donors not thrown in their lot with the multilateral agencies to demand economic and political reforms – as they did in Tanzania – Kaunda could very well have muddled through at least a couple of more years in power. However, UNIP’s last attempt at policy autonomy, dubbed ‘growth from own resources’, had elicited little donor support and was abandoned. Since Kaunda was forced to return to policies he had earlier rejected as ‘ineffective’, and the cause of Zambia’s decline, he was to suffer a serious credibility problem up to the election. The elections of October 1991 led to a landslide victory for the MMD. The regime shift seemed complete when the MMD received 80 per cent of the votes in the local government elections held in November 1991. The MMD saw its victory as a mandate to embark on ‘broad reforms’ and a New Economic Recovery Programme (NERP) was launched. It is somewhat ironical that a programme of similar name was presented by Kaunda’s government in 1987 as an alternative to

Zambia’s elusive growth 137 the structural adjustment programmes of the IMF and World Bank (KayizziMugerwa 1990). Thus by the end of 1992 the government had made considerable progress on its pledge to transform economic policy in Zambia. Interest rates were freed and exchange rates were liberalised with the introduction of foreign exchange bureaux. Furthermore, a negative list replaced licensing in the Open General Licence (OGL) system, leading to a degree of trade liberalisation. The bank sector was itself liberalised, leading to an unprecedented increase in the number of banks in Lusaka. Subsequently, the Bank of Zambia was declared an independent manager of monetary policy, with powers of supervision over all financial institutions. Price controls on maize as well as fertiliser subsidies were terminated. Notably, while earlier price adjustment on maize had caused serious riots on the Copperbelt and in Lusaka, the changes had been effected without serious incident. Partly thanks to substantial aid inflows, the MMD’s reform package was implemented rapidly. For example, besides increasing their balance of payments support, donors rescheduled about $2.5 billion of Zambian debt, with some of it cancelled altogether. To enhance effectiveness in service provision and in the regulation of the private sector, a number of organisations were created, again with donor support, including the Zambian Revenue Authority (ZRA), the Zambian Investment Centre (ZIC) as well as the Communications Authority of Zambia (CAZ). These new organisations enjoyed considerable autonomy with their employees receiving enhanced wages. The goal was to minimise the lethargy and other ‘agency’ problems related to parastatal sector activities.

3 Policy and outcomes in the multiparty era Politics, security concerns and the donor community On taking power, the MMD was rent by internal squabbles over most issues, notably the ‘shock therapy’ that the leadership was intent on applying.1 In May 1993, a government reshuffle involving fourteen ministers, with four dismissed outright, was announced. Furthermore, a total of nine MPs resigned from the MMD, while another five were sacked from the party. The following years would witness more resignations and sackings, as the leadership sought to evolve a style that suited its market-friendly policies, while at the same time trying to project a high moral profile.2 But since the bulk of the resignations as well as those sacked belonged to the more radical faction of the MMD, the reshuffles helped bring some coherence to the government’s reform effort. Indeed the IMF referred to the 1994 budget as ‘bold’, removing Zambia from its list of delinquent debtors. Although in policy terms the MMD’s first three years in power were relatively well focused, from the mid-1990s onwards corruption and abuse of power were frequently cited by opposition parties, domestic civil rights groups and donors as posing serious threats to democracy and economic reform. It was argued that on the assumption of power the human rights and governance issues that the MMD had so well articulated in its election manifesto, and that had generated unprecedented

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enthusiasm in the donor community, had been relegated from the top of the policy agenda. Thus, although donors wished so much to find an African model (The Economist, February 1993), the MMD failed to accompany one of Africa’s fastest economic liberalisations with rapid political reform. This performance gap, referred to euphemistically by donors as ‘governance issues’, led to an increasingly chaotic political environment, which began to have serious effects: policy uncertainty, declining credibility, and unprecedented escalation in violence. In 1996, the government introduced its ‘exclusive’ constitution directed mainly at Kaunda, barring him from standing for elections because he had ‘non-Zambian parentage’. A year later, lowranking military officers attempted to take over the government. Although the effort soon crumbled, it proved to be both a security and political embarrassment to the government. With the declaration of a State of Emergency in late 1997, much of the social capital that the government had accumulated with the public and the donors had begun to dissipate. Notably, the private sector was now less certain than before whether the policies implemented in the early 1990s were going to be maintained.3 Private investors thus became less willing to take ‘long-term’ positions in kwacha. Many withdrew their money, while there was a clear bias towards shortterm and speculative investment activity, notably drug trafficking. The unwillingness to hold kwacha-based assets was also reflected in negative returns on treasury bills and a sharp depreciation of the Zambian currency. Donors reacted to these ‘policy reversals’ by withdrawing quick-disbursing aid in 1996 and subsequently generally taking a ‘wait and see’ stance with regard to new projects. In retrospect, donor disappointment was partly a result of too high expectations of what the MMD could accomplish in such a short time and with so few resources. First, while Zambia’s serious structural constraints had become even more exposed by the liberalisation of the economy, the capacity to find real cures had not improved by much. Second, though important in establishing political legitimacy, the return to multiparty democracy was only a first step in the long process of creating an enabling environment for development and, as the coup attempt showed, not the definitive cure for the accumulated structural and policy distortions of the past.4 Third, the policy of privatisation that underpinned the MMD’s reform programme was in practice characterised by a considerable amount of political interference. Like in other African countries, this weakened the budding democratic structures much more than the spread of asset ownership enhanced pluralism. However, in spite of the political difficulties and the relatively poor economic performance during the 1990s, the ruling party (MMD) remains, if its showing at the national polls and the by-elections are indicators, the most popular party in Zambia. It would seem that the public has been able to differentiate between the credibility of policies and that of the policy makers (see Drazen and Masson (1994) for the theory). Indeed the government has sometimes blamed the poor outcomes on ‘donor intransigence’. A compelling explanation for the continued domestic support is that, in spite of the economic problems, policy makers have been able to avoid widespread civil strife, currently the bane of the countries of the Great Lakes Region. It is also possible to argue that the Zambian population was so tired of the

Zambia’s elusive growth 139 authoritarianism of the past that it was willing to withstand economic difficulties so long as they promised a future with less government controls and more democracy. Privatisation as signalling In the early 1990s, the Zambian government embarked on one of the fastest rates of privatisation in Africa, which won it much praise in the donor community. While in other African countries privatisation was invariably undertaken as part of the conditionality attached to economic reforms, Zambia was one of the few countries where a party with an election manifesto, that included privatisation was elected. In 1992, six months after assuming power, the MMD introduced the Privatisation Act, which provided a framework for the privatisation of the large parastatal sector. As a signalling device, privatisation was initially used very effectively. Though it had been feared that with a former union leader as President the government would be reluctant to go against the wishes of the workers, it was stated pointedly that there would be ‘no scared cows’. That the government was able to stand up to the miners and other domestic groups on the issue of privatisation enhanced its reputation in the eyes of investors. A plan was soon unveiled for the privatisation of 280 parastatals, including the Zambia Consolidated Copper Mines, one of the biggest companies in sub-Saharan Africa. The exercise attracted a number of foreign buyers, many from South Africa. In a review of the country’s privatisation process, Campbell White and Bhatia (1998) cite a number of reasons for Zambia’s initial success. First, the government, with help from donors, invested resources in careful programme design and preparation. Second, appropriate legislation was put in place and the ZPA was able to undertake its work free of political interference. Third, the process was transparent, with steps taken to inform the public about the programme and to encourage Zambian participation. Fourth, decisive steps were taken to deal with the weak capital market, notably by instituting a Privatisation Trust Fund to provide funds for prospective local buyers. These attributes indicate that in the early 1990s, Zambia had been able to quickly reach ‘best practice’ in the process of privatisation, while at the same time garnering donor support. The question was whether the government would be able to sustain its privatisation programme as more politically sensitive companies fell due for divestment. Two features related to privatisation in Zambia dictated that this would not be the case. The first relates to the politics of privatisation. Though lauded for its transparency in the initial years, Zambian privatisation was soon stifled by political interference. The Zambian Privatisation Agency regularly publishes the names of all bidders for the businesses on sale with a view to enhancing transparency. While many of the bigger companies were sold to foreign individuals and groups, a number of smaller and medium-sized ones went to ranking politicians, implying that the process was far from neutral, with potential for high-level interference. Politicians were in a position, at least indirectly, to set the bid price, have access to a loan from the Privatisation Trust Fund and ensure that their bid was successful.5 This fits well with the positive theory of privatisation, which suggests that since bureaucrats and

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politicians benefit from state control, they only undertake divestments when they can be sufficiently compensated for their loss of rents (Laffont and Meleu 1997). In Zambia, politicians literally fought over the smaller assets. The related scandals increased the scepticism of the public and the donors. The second feature relates to privatisation as part of donor conditionality. When the government was privatising enthusiastically in the early 1990s, there seemed to be no problem between its goals and those of the donor community. However, following the 1996 elections and the attempted coup, the relationship became extremely strained. The difficulties can be illustrated by the proposed sale of the Zambia Consolidated Copper Mines (ZCCM). Although the government had assured the donor community that the sale of this company would be rapid, the size of the assets as well as the political symbolism of its ownership overwhelmed the first attempts. Because of its size, the government was advised to break it up and sell it as separate entities, while in deference to its symbolism, the government hoped to sell it for billions of dollars. In the Copperbelt, the ZCCM was more than a company. It was a state within a state, with its own schools, hospitals and farms. The houses belonging to executives were themselves worth millions of dollars. While the government was negotiating with the first set of bidders, the Asian crisis led to a sharp decline in copper prices. The potential buyers either lost interest or wanted to renegotiate. One such group, the ‘Kafue consortium’, comprising American, Canadian and South African companies, as well as the Commonwealth Development Corporation, bid for the largest section of ZCCM including Nkana and Nchanga mines. Its bid, though considered attractive by analysts tied as it were with commitments to invest $1 billion in equipment and infrastructure, was rejected as ‘peanuts’ by the government. ZCCM continued to lose money, close to $2 million per day by late 1998, and asset stripping became rife. The failure to divest ZCCM coupled with the prolongation of the State of Emergency and charges of corruption convinced donors that their aid embargo needed to be tightened. At this time, the government seemed to be preoccupied with the political fallout from the attempted coup and the donor concerns regarding the human rights of those arrested, including Kaunda. The pace at which privatisation decisions were taken had clearly retrogressed. Still, it is curious that donors had gone in so heavily in support of the sale of ZCCM, neglecting the government’s genuine fear at the time that a poor sale would lead to much domestic criticism, especially in light of the much changed political environment, thus eroding its authority. It is thus probable that by coming out so strongly in favour of the privatisation of ZCCM, the country’s largest conglomerate, donors inadvertently strengthened the hand of the potential buyers. Realising that the sale of ZCCM was now more than just a market proposition and had become a precondition for continued donor assistance to Zambia, they were now intent on pushing for a lower price. In a recent review, Kayizzi-Mugerwa (1999) has argued that in pursuit of an economic strategy based on the creation of reputations for efficiency and unencumbered entrepreneurial activities, privatisation becomes an important signal. As such, it is even more important for regimes which had earlier emphasised nationalisation,

Zambia’s elusive growth 141 such as Zambia and Tanzania, or those which had expelled non-African minorities and expropriated their properties such as Uganda, than for those, such as Kenya and Zimbabwe, which had pursued more capitalist-oriented policies. The record shows that in the 1990s the first set of countries has come further in the privatisation process than the second one. Macroeconomic policies and growth In this section we look at some of the macroeconomic outcomes. Table 8.3 shows that with respect to stabilisation and growth, the barrage of policy initiatives in the early 1990s was fairly ineffective. The budget deficit increased from 2.4 to over 13 per cent of GDP in 1993. As most of it was funded via the Bank of Zambia, money supply grew by over 120 per cent in 1993 alone. Inflation, at around 190 per cent in 1992–3, was higher than any noted earlier. Owing to poor growth, Zambian per capita incomes fell by close to 20 per cent between 1992 and 1998. For two consecutive years, 1994 and 1995, for example, per capita incomes fell by close to 17 per cent. Thus, it would take another five years of relatively high growth just to recoup the losses made in the first half of the 1990s. But since growth in Zambia has been difficult to sustain over long periods, it will take much longer to recover the income losses of the 1990s (see also Department of Economics). The 1999 Budget has projected a medium-term growth rate of 4.5 per cent, which is hardly enough to help recoup the decline of the past decade. In 1993, the government introduced a cash budget in a bid to control runaway ministerial expenditures. The goal was to ensure that the government would not incur a primary deficit, that is that the revenue collected would be able to meet the current expenditure needs, excluding debt payments. The government also sought to roll over internal debt by introducing a treasury bill action in January 1993 (see Mwenda 1999). However, while the cash budget helped keep expenditure within limits, it also caused much rigidity in the system, for example, leading to nonpayment of teachers’ and nurses’ salaries. Still, it was probably the only means of containing the deficit. By 1997, there was a small budget surplus. Ministries have, however, found other ways of financing their extra-budgetary activities, by for Table 8.3 Changes in macroeconomic aggregates 1990–8 (%)

Per capita growth Budget deficit/GDP Inflation Money (M2) Investment/ GDP

1990

1991

1992

93.5

94.8

95.8

97.7

97.5

105.0 45.8 16.6

95.0 98.1 12.0

1993

1994

1995

1996

1997

1998

3.1

96.4

911

3.5

0.5

95.0

92.4

913.3

95.5

99.1

0.8

0.7

—

191.0 70.0 12.6

189 122 11.5

52 46 9.8

35 40 10

25 19 15.4

31 — 17

43 32 11

Sources: Central Statistical Office (various issues) and Ministry of Finance, Lusaka.

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From crisis to growth in Africa?

example accumulating debts and arrears to domestic suppliers. Also even when the budget is said to be ‘fully funded’, the impacts of short-term revenue shortfalls, due to lower aid flows, are not always factored in. Past experience indicates that given revenue constraints, there will be a tendency to preserve the more politically sensitive expenditure, for example funds for maize imports or military expenditure, and to default on the ‘soft’ social sector outlays. In the recent budgets the government has set aside contingent funds for such eventualities. However, the policy which had most social resonance and led to the first signs of disaffection with the MMD was the removal of controls on maize prices. In the first year of the price liberalisation, maize price increased fivefold. The sharp price increase was also the result of one of the most serious droughts in memory, which affected the whole of Southern Africa. Maize consumption was reduced in many families, which of course stabilised foods markets but with a serious impact on poverty. Ironically, Zambia’s poor economic performance and the high level of debt and debt arrears increased the role of donors in the running of the economy. For example, donor support and pressure was crucial in the establishment of a Rights Accumulation Programme with the IMF in the early 1990s, which took care of the arrears and enabled the country to draw once again on the Fund’s concessionary windows. Similarly, donors provided money to retire IBRD loans to Zambia, in order to enable the country access to the more concessionary IDA loans. Furthermore, donors provided crucial balance of payments support which helped fund the Ordinary General Licence programme, a crucial feature in the earlier efforts at trade liberalisation. By the mid-1990s the reforms had begun to have some positive impact (Mwenda 1999), with a noticeable reduction in excess demand pressure in the economy. Inflation fell from close to 200 per cent in 1992 to 52 per cent in 1994 (Table 8.3), declining further down to 25 per cent by 1997. However, 1998 saw a moderate increase in inflation to 30.6 per cent, as the budget projection of 15 per cent failed to materialise. In the 1999 Budget presentation, the Finance Minister projected 15 per cent inflation for the year. Though Zambia once had Africa’s highest investment ratios, close to 25 per cent in the late 1960s and early 1970s with the bulk of it financed by the government, they fell to below 10 per cent in the early 1990s (Table 8.3). Given the general credibility problem facing policy makers in the 1990s, private investment failed to increase rapidly, although it was higher than in the days of controls. The 1999 Budget has estimated that total investment will increase to an average of 20 per cent of GDP over the medium term, a 3 per cent increase from 1998. Often one likes to think of investment as deferred consumption; however, given the very low incomes of the Zambian population a substantial amount of this investment will have to come from outside. With the improvement of relations with donors, following the lifting of the emergence in 1998, the release of Kaunda, and the resolution of some of the problems related to the privatisation of the ZCCM, private inflows were expected in the form of new investment and repatriation of funds. Still, for long-term investment to take place, the government needs to undertake confidence-building

Zambia’s elusive growth 143 measures. Refusal by donors to release balance of payments support of US$ 235 million in mid-1998 even after a good Consultative Group meeting in Paris, following the lifting of the State of Emergency, showed that donors had become more reluctant to resume cooperation without more concrete signs of policy change. Overview of sector responses Zambian agriculture has for decades been seen as the real alternative to copper and the government has embarked on numerous initiatives to get ‘agriculture going’. Though the commercial farming sector has been boosted by the immigration of Afrikaner farmers, peasant farmers still comprise the majority. Still, the years of reform have seen the emergence of medium-scale producers who are trying to diversify into non-traditional agricultural products, notably flowers. These groups have simple but subtle demands. What they often do not have is adequate market access for inputs and output. Experience shows that since governments are rarely in a position to meet the needs of peasants via subsidies or extension services, they should focus their efforts on improving market access. Commercial farmers have easier access to markets for inputs and produce; peasants are poorly connected to the main roads. Zambia’s mining sector has been in steady decline for much of the 1990s, while the troubled privatisation process made the sector’s prospects for recovery quite uncertain. However, it is still a crucial sector in the economy. Besides the generation of foreign exchange and provision of employment, it also demands a whole range of inputs and services from the rest of the economy. By the end of 1999, Zambia was, after protracted negotiations, on the verge of completing the privatisation of the ZCCM. It is somewhat ironical that when the deal with Anglo-American is finally sealed, the bulk of the mines would have returned to their original owners. Thus, the minority voices that had opposed their nationalisation, some thirty years ago, would have triumphed. It was argued then that the biggest value of the mines to Zambia was employment and the taxes paid to the government. However, the government had opted for outright control. Still, even in private ownership the mines will continue to have a powerful influence on the economy. Zambian manufacturing now comprises a substantial portion of the economy. It had a growth rate of 3 per cent in 1998, a substantial decline from the 7 per cent registered in 1997. However, manufacturers emerging from the control regime feel that government has opened up too quickly to imports. A frequently given example is that of imported used clothes, which make it difficult for the textile industry to operate profitably. In 1998, the Dunlop Tyre Corporation withdrew from the country, blaming its move among others on ‘lack of protection’ while many other foreign firms threatened to do so. In the 1999 Budget, duty on selected manufacturing inputs was reduced in order to ‘level the playing field’. However, it is in the nature of business to extract as many concessions as possible from the government. But if the goal, as stated in the 1999 Budget, is to increase manufactured exports, it will be difficult to achieve it under increased protection. The government thus needs to find less distracting ways of supporting manufacturing, say by reducing the cost of

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From crisis to growth in Africa?

utilities or even lowering taxes on petrol to reduce transport and production costs in the landlocked country. Public sector reforms have fallen victim to the ‘on and off ’ relationship between Zambia and the donor community, since much of the reform strategy was based on the availability of donor money to compensate those retrenched. With relations with the World Bank and the IMF better, the government hopes to be able to continue with its public sector reforms, including improvement of incentives and conditions of service. However, it is ironical that while ministries in the capital city might have an excess of employees, the provincial and district offices are poorly manned, making their capacity for intervention at the local level very low. Thus the many interventions planned by the government in poverty reduction and social service provision are bound to fail for lack of staff to implement them at the local level. The performance of Zambia’s financial sector tends to reflect that of the rest of the economy. Although the bank sector is not as frail as it was in the early 1990s, following the liberalisation of the financial sector, many financial institutions are still burdened by non-performing assets. In recent years, it has seen a number of innovations, including the introduction of the Lusaka stock exchange (Luse). The 1999 Budget statement emphasises that the Bank of Zambia will reduce its reliance on cash and liquidity reserve requirements as instruments of credit control, a strategy it has tried in the past with little success. The government’s incessant need of money made it difficult to maintain central bank independence. In a recent contribution, Mwenda (1999) has argued that to succeed, market-based monetary policies must be accompanied by well-designed measures to address the problems related to slow learning and system inefficiencies. The planned amendments to the Banking and Financial Institutions Act of 1994 are a move in that direction. The government sees poverty eradication as its long-term goal. To realise it will demand high growth and investment rates that are well above 20 per cent of GDP. While some of this investment will be from the public sector, a big part of it will have to come from the private sector, domestic and foreign. Moreover, to have a meaningful impact on rural incomes, agriculture will need to grow faster in the medium term than the 5 per cent projected in the 1999 Budget. This will demand higher public outlays on the improvement of infrastructure, irrigation systems and produce marketing. In mining, privatisation is expected to boost output in the long run. In the short term, however, a considerable amount of new investment and rehabilitation of structures will be needed.

4

Conclusion

In the 1990s, there has been a persistent divergence between the Zambian government’s optimistic policy statements on economic reform and governance issues and the actual performance. This has strained relations with donors, putting at risk a key source of financial support. Investor behaviour has also been closely patterned on that of donors, since their collaboration with the government lends the reform process credibility. Still, although factors not entirely in the hands of the government, such as rain and copper prices, have been important determinants of performance,

Zambia’s elusive growth 145 relations with donors are not beyond government influence. It is in the policy makers’ self-interest to limit the level of confrontation with donors. On the other hand, donors need to reconsider the practicality of conditioning their cooperation on how well the government synchronises its economic and democratic reforms. Experience has shown that in early stages of development the latter hardly move in the same direction. It is, however, ironical that the domestic constituency has been less critical of government behaviour than the donors. In this regard national security might have taken precedence over economic well-being. In the past year, civil wars have engulfed Zambia’s neighbours, threatening a catastrophe of continental proportions. This situation is bound to unsettle the country’s social stability, which has been an important ingredient in the difficult period of adjustment. Already, the war in Angola is having repercussions in Zambia. Regional agencies of restraint are thus necessary for the country’s growth as well as security.

Notes 1 Some prominent members like Mbikusita-Lewanika, a minister in the post-election lineup, even advocated a socialist approach to economic management. He was one of the first ones to depart. 2 The President soon declared Zambia a ‘Christian nation’, which while having no legal implications, stood in sharp contrast with the increasing accusations of corruption and drug dealing that were levelled at key members of the government. 3 The exclusive constitution, the impact of the attempted coup d’etat in 1997 on the political climate, and the regulatory difficulties emanating from the rapid reforms have all contributed to the policy uncertainty. In the past few years, however, the Zambian President’s negotiation of a return to peace in the Democratic Republic of the Congo has enhanced his prestige as well as that of the country. 4 Taking the long-term view, The Economist, 7 July 1990, had predicted that it would take at least a generation to revive the Zambian economy. 5 A reviewer has argued that in the absence of entrepreneurs or entrepreneurial skills, that is when ability to make profits is poor, borrowers will have incentive to default when the risk of getting caught is low, due for example to a weak legal system (see also Taslim 1995).

References Apergis, N., Papanastasiou, J. and Velentzas, K. (1997), ‘The Credibility of Policy Announcements: Greek Evidence’, Applied Economics, 29(6): 699–705. Barro, R. J. and Gordon, D. B. (1983), ‘Rules, Discretion and Reputation in a Model of Monetary Policy’, Journal of Monetary Economics, 12: 101–21. Blackburn, K. and Christensson, M. (1989), ‘Monetary Policy and Policy Credibility’, Journal of Economic Literature, XXII(1): 1–45. Buffie, E. F. (1998), ‘Public Sector Layoffs, Credibility and the Dynamics of Inflation in a Simple Macromodel’, Journal of Development Economics, 56(1): 115–40. Campbell White, O. and Bhatia, A. (1998), Privatization in Africa, Washington, DC: World Bank. Collier, P. (1993), ‘Higgledy-Piggledy Liberalization’, World Economy, 16(4): 503–11. Collier, P. (1995), ‘The Marginalisation of Africa’, International Labour Review, 134: 4–5.

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Department of Economics, University of Zambia (1998), ‘1998 Budget Analysis’, Lusaka. Drazen, A. and Masson, P. R. (1994), ‘Credibility of Policies versus Credibility of Policymakers’, Quarterly Journal of Economics, 109(3): 735–74. Edwards, S. (1998), ‘Two Crises: Inflationary Inertia and Credibility’, Economic Journal, 108: 680–702. Hesselmark, O. (1998), ‘The Fall and Rise of the Bank of Zambia’, Central Banking (Spring), VII(4): 34–41. Kayizzi-Mugerwa, S. (1990), ‘Growth from Own Resources: Zambia’s Fourth National Development Plan in Perspective’, Development Policy Review, 8(1): 59–76. Kayizzi-Mugerwa, S. (1998), ‘Zambia and the Aid Embargo: Two Essays on the Politics and Economics of Aid-Constrained Reform’, mimeo, Department of Economics, University of Gothenburg. Kayizzi-Mugerwa, S. (1999), ‘Privatisation and Market Development’, in S. KayizziMugerwa (ed.), The African Economy, Policy, Institutions and the Future. London and New York: Routledge Studies in Development Economics. Laffont, J. J. and Meleu, M. (1997), ‘A Positive Theory of Privatization for Sub-Saharan Africa’, mimeo, Université des Sciences Sociales, Toulouse and Université d’Abidjan. Mwenda, A. (1999), ‘Monetary Policy Effectiveness in Zambia’, in S. Kayizzi-Mugerwa (ed.), The African Economy, Policy, Institutions and the Future. London and New York: Routledge Studies in Development Economics. Ndulo, M. (1999), ‘Transforming Economic and Political Structures for Growth: The Zambian Experience’, in S. Kayizzi-Mugerwa (ed.), The African Economy, Policy, Institutions and the Future. London and New York: Routledge Studies in Development Economics. Republic of Zambia (1997), Selected Socio-economic Indicators, Central Statistical Office, Lusaka. Republic of Zambia (1998), Macroeconomic Indicators, Directorate of Macro-economic Policy Analysis, Ministry of Finance and Economic Development, Lusaka. Republic of Zambia (1998), Budget Speech, Presented by the Minister of Finance and National Commission for Development Planning, The Hon. G. G. Chigaga, SC, MCC, MP, Lusaka. Republic of Zambia (1999), Budget Speech, Presented by the Minister of Finance and Economic Development, The Hon. Edith Z. Nawakwi, MP, Lusaka. Republic of Zambia (1999), Estimates of Revenue and Expenditure (including Capital Constitutional and Statutory Expenditure) for the year 1st January, 1999 to 31st December, 1999, Ministry of Finance and Economic Development, Lusaka. Roland, G. (1995), ‘Political Economy Issues of Ownership Transformation in Eastern Europe’, in M. Aoki and H. K. Kim (eds), Corporate Governance in Transitional Economies: Insider Control and the Role of Banks, pp. 31–57. Washington, DC: World Bank. Taslim, M. A. (1995), ‘Entrepreneurship, Default and the Problem of Development Finance’, Canadian Journal of Economics, 28: 4. The Economist (February 1993), ‘The Miseries of Modeldom. Zambia’, Vol. 326, No. 7799: 44. The Post, various issues, Lusaka. The Times of Zambia, various issues. World Bank (1998), Social Indicators. Washington, DC: World Bank. Zambia Barclays (1998), Quarterly Economic Review, 3rd quarter, Lusaka.

9

From stagnation to growth in Tanzania Breaking the vicious circle of high aid and bad governance? Anders Danielson and Gun Eriksson Skoog

1 Introduction Market-oriented economic reforms have been going on in Tanzania since the early 1980s, and with financial support from the international financial institutions since 1986. As a result, Tanzania has been transformed from an economy with severe imbalances and profound structural weaknesses to one with single-digit inflation, budget balance, shrinking public involvement in economic life and an expanding export sector. Growth of income – while still low – has returned to positive levels on a per capita basis. However, the road to improvement has not been easily traveled. Momentum has often been slow and backtracks legion. Reforms have been sluggishly implemented, if at all, and it is easy to get the impression that reforms have been carried out only insofar as they have been accompanied by prospects of soft finance from abroad. From this viewpoint, reforms have certainly paid off. The growing realization in the late 1970s by donors of the unsustainability of the prevailing development strategy in Tanzania led to a sharp reduction in the levels of foreign aid. On a per capita basis, net official development assistance (ODA) fell by 20 per cent from 1981 to 1983 and another 20 per cent by 1985. After reforms were endorsed by the International Monetary Fund and the World Bank in 1986, bilaterals followed: on a per capita basis, net ODA more than doubled – from US$ 22 to US$ 46 – between 1985 and 1990. Even though the 1990s have seen a consistent reduction in the levels of foreign aid (but this is worldwide, and thus not necessarily linked to Tanzania’s performance), ODA still accounted for something like 15 per cent of GDP and over four-fifths of gross investments in 1997 (Bigsten and Danielson 1999: chapter I.1). The relation between reform outcomes and foreign aid in Tanzania – as evidenced by the relation between per capita growth and per capita aid (Danielson and Mjema, 1999) – is not unambiguous. In particular, does aid induce reforms or do reforms induce aid? While part of aid – program aid – clearly is designed to influence policy making, recent studies suggest that aid is not effective in persuading countries to change economic policies. Furthermore, there is an emerging consensus that foreign aid works best in countries already under way with reforms (Burnside and Dollar 1997; World Bank 1998), thus suggesting that donors should refrain

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from attempting to bribe governments into reforms and instead focus on aid as reward for measures already taken. In this chapter we address an issue which has not received much attention in recent studies of aid effectiveness: the extent to which high levels of aid affect the rather simple and unambiguous relations envisaged in aid theory (see White (1998) and Lensink and White (1999) for a thorough discussion) or in aid effectiveness studies (aptly summarized by Tsikata 1998). In particular, we seek to understand the extent to which long-term relations between donor and recipient introduce a component of permanency in aid flows, the extent to which such permanent flows affect the workings of the state apparatus, and how this in turn affects the prospects of implementing viable reforms which are capable of generating sustained growth in the economy. It should be clear at the outset that we do not attempt an exhaustive treatment of these wide-ranging and somewhat awkward issues. Our purpose is simply to point at some weak features of Tanzanian reforms (or remaining legacies from the socialist past) and to examine the extent to which these are related to or even may have been caused by a large and sustained inflow of foreign aid. The remainder of the chapter is divided into four sections. In Section 2 we briefly survey reform accomplishments arguing that while Tanzania has come a long way in terms of macroeconomic balances, structural and institutional reforms are still absent or ineffective. One possible reason for this is the inability of the state to push through politically difficult reforms – a characteristic of most structural reforms. Section 3 discusses several aspects of the ‘soft’ character of the Tanzanian state, and relates the persistence of softness partly to the socialist legacy, partly to the role of informal rules and relationships within the so-called economy of affection. In Section 4 the relationship between the soft state and aid dependence is discussed with particular focus on (i) the emergence of a self-reinforcing circle between high levels of aid and a soft state, and (ii) the role played in this by the very organization of foreign aid flows. Section 5 offers a few concluding remarks.

2 Is the ugly duckling growing up? The title of this section is motivated by the fact that relations between the Bretton Woods institutions and the government of Tanzania were very uneasy from the commencement of reforms in 1986 until the culmination in November 1994 when program aid was suspended following the revelation of major corruption. The election of President Mkapa in 1995 (in the first multiparty elections ever) seemed to change all that. Here was a president who had spent most of his career abroad and who was unstained by the accusations of corruption, mismanagement and incompetence attached to earlier administrations. Mkapa was pictured as a fresh wind, the first of a new breed of Tanzanian politicians that would finally heed the advice of the international financial institutions and reform the economy thoroughly – not because they had no choice, but because they realized that such actions would be for the benefit of the country and, ultimately, for themselves. Consequently, the reform ratings of Tanzania have changed drastically in the last few years. From being the ugly duckling that implemented reforms reluctantly and

From stagnation to growth in Tanzania 149 only when pressed, the country is now being lauded by the entire donor community for meeting ESAF benchmarks, for rapid and consistent implementation, and for showing a willingness to reform and a thorough understanding of the need for a drastic change of economic policies. Now Tanzania is no longer looked at as the ugly duckling. Now, she has transformed into a beautiful swan, a keen reformer, who actively and enthusiastically participates in reform negotiations, suggesting even more drastic measures than donor organizations do. It is argued in this chapter that the story told above is not really true. Tanzania has indeed achieved tremendous things in her reforms, and not just during Mkapa. While one could possibly argue that pre-Mkapa reforms were never put into context, that issues of corruption and governance were addressed without enthusiasm, and that the government’s commitment to reforms was constantly questioned, one cannot escape the fact that much was accomplished between 1986 and 1995, particularly in terms of paving the way for the current reforms. So the prospects for further reform seem brighter as the current government looks committed, as issues of governance and corruption are openly discussed (if not addressed), and serious attempts are now being made at integrating the different reform elements into a consistent whole. However, although Mkapa’s accomplishments are laudable and cover a lot of ground, the most difficult, and politically most costly, reforms still remain to be implemented (Danielson and Mjema 2000). We do not attempt here to identify accomplishments and future challenges in Tanzania’s reforms (cf. Danielson and Mjema 1999: chapter 2; 2000: chapter 3), but focus instead on aspects of stability and structural adjustment. The main argument is that while the macroeconomic picture shows much improvement in recent years, the situation is still economically fragile: surprisingly little has come out in terms of structural change, so the extent to which Tanzania is actually on the way towards self-sustained growth remains very much an open question (cf. Bigsten and Danielson 1999). Economic indicators Growth of income remains stubbornly at slightly above 1 per cent per annum in per capita terms. Most analysts forecast small increases in the coming years. Heavy and unexpected rains in 1997/8 revised the forecasted growth downwards by a full percentage point. Since per capita growth is so low and official incomes are so small, current rates of growth imply that Tanzania will achieve a per capita income to the equivalent of one dollar a day in the year 2045. Consequently, although growth picked up in the last years of the 1990s, substantial poverty reduction should not be expected for some time to come. Inflation follows a consistent downward trend with the rate of non-food inflation being in single digits from December 1997 and onwards, indicating that the Central Bank’s focus on the rate of inflation (rather than the exchange rate) is successful. Note, however, that the real Treasury Bill rate (i.e. nominal T-Bill rate minus rate of non-food inflation) was negative between March 1996 and June 1997 and showed an upward trend only after December 1997. Note also that the data in Table 9.1 imply that the real exchange rate displays an appreciating trend.

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Table 9.1 Economic indicators, selected years

GDPb GDP per capitab Inflation Exchange rate (TZS/US$) Fiscal surplusc C/A positionc Treasury bill (%) Maize (’000 tons) Paddy (’000 tons) Cassava (’000 tons) Monetizatione a b c d e

1991

1993

1994

1995

1996

1997

1998a

5.7 2.5 28.8 219.5

3.9 0.9 25.2 407.8

3.5 0.6 33.1 512.4

2.6 90.3 29.8 581.3

4.1 1.2 21.1 582.2

3.9 1 16.1 618.3

4.0 1.1 12.1 670

90.3 920 n.a. 2,331 624 1,566 73.7

96 925.2 42.5 2,432 600 1,790 73.4

2.1 922.9 37.9 1,812 614 1,802 71.6

92.7 90.8 1.3 1.1 922 913.8 910.7 912.9 44.6 18.6 10.3 10.7d 2,567 2,663 2,376 722 734 535 1,492 1,498 1,611 72.1 71.0

Projections. Monetary GDP. Annual percentage change. In % of GDP. C/A position before grants. May. Monetary GDP in % of monetary plus non-monetary GDP.

Sources: PER (1998), TET (1996), BOT (1998) and Danielson and Mjema (2000).

The subsistence sector still accounts for over one-quarter of total production and there is no clear trend as regards monetization. To this should be added clandestine and illegal activities, the amount of which has been estimated at something between 20 and 60 per cent of GDP (Sarris and van der Brink 1993). The fiscal position has improved, particularly since the introduction of the cashbudget in 1996. The current account continues to improve, despite falling levels of official transfers. This is explained more by falling imports than by increasing exports (a tendency that was amplified after the adverse weather conditions in 1997/8). Heavy fluctuations in the output of major food crops indicate that a major determinant still is the weather, and thus that the ability to affect food output by demand policies is limited. Savings-investment identity One of the more worrying trends in the macro data is the falling levels of private investment, down by almost ten percentage points of GDP since the early 1990s. As shown in the savings-investment identity, this trend has been accompanied by increasing private savings, a declining fiscal gap, and falling ‘foreign savings’, i.e. an improvement in the current account. (see Table 9.2) One important task is to explain the falling investments. At least two preliminary hypotheses, linked to current macro policies, may be distinguished. First, it is possible that investments are falling because of, inter alia, changed expectations and falling levels of project aid. In that case, the improving current account – which is lauded as being a major success of the government’s policies – may be explained by

From stagnation to growth in Tanzania 151 Table 9.2 Savings-investment identity (% of GDP)

Investment o/w private Financing Private savings Fiscal surplus ‘Foreign savings’

1994

1995

1996

1997

1998 a

27.7 24

24.6 20.5

21.7 17.5

17.9 13.3

19.5 15.8

21.7 17.2

8.5 96 25.2

90.4 2.1 22.9

2.4 92.7 22

4.9 90.8 13.8

7.5 1.3 10.7

7.7 1.1 12.9

1991

1992

1993

29.6 26.6

28.9 27.1

9.9 90.3 20

2.9 1.1 24.9

a Projections. Source: Danielson (1999b).

falling levels of capital goods import. While an improving current account is important in Tanzania, it is difficult to see how falling levels of investment are compatible with long-run sustainability of current policies. Further, the volume of project aid is shrinking partly because of decisions in donor countries and partly because the cash-budget system does not allow for sufficient generation of the counterpart funds necessary to implement projects. Danielson (1999b) provides some evidence in favor of this hypothesis as do the World Bank and Bank of Tanzania staff in informal discussions. Second, if current-account improvement is the leading factor, the explanation of falling investments should be inadequate domestic savings. Seen in this light, the consequences of falling levels of aid merit further investigation, as it runs counter to the hypothesis that foreign aid substitutes for government savings. One possible explanation of this could be that Tanzania is dependent on foreign assistance to collect revenue, and that falling project aid adversely affects incomes of the educated middle-class and, therefore, that private savings fall with foreign aid levels. However, national accounts data are currently being revised and are not available in sufficient volume (or detail) to facilitate the testing of this hypothesis. Balance of payments Levels of imports have been falling since the mid-1990s. This problem is even more serious than the data suggest, since private imports of consumer goods surged following import and foreign exchange liberalization in the early 1990s (cf. Tarimo 1996) (see Table 9.3). The external imbalance suggests an import compression of the type experienced in the late 1970s mainly because most imports are financed – directly or indirectly – by foreign aid, because clearance of debt arrears has assumed priority in Tanzanian authority agendas, and because the Bank of Tanzania – as an instrument in the quest for monetary stability – strives to keep the nominal exchange rate stable against the dollar. A light in an otherwise quite dark situation is the increase in foreign direct investments which have doubled in a few years’ time. It is important to remember, however,

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Table 9.3 Balance of payments, selected years (US$ mn, current prices) 1991

1993

1994

1995

1996

1997

1998a

Current account Exports GNFS Imports GNFS Transfers (net)

9458 528 1,569 583

9622 611 2,017 785

9758 848 2,242 636

9399 941 1,818 478

9371 1,017 1,871 482

9292 1,084 1,921 546

9283 1,177 2,014 554

Capital account Private FDI Long-term loans (net) Other (incl. arrears)

522 10 61 451

499 62 9183 620

865 63 9151 953

444 67 951 428

381 70 32 279

356 75 206 37

344 80 193 71

Reserves (;inc) memo: Coffee exp. (mn tons) Coffee, unit priceb Cotton exp. (mn tons) Cotton, unit priceb Export growthc (%) Import growth (%)

64

9123

107

45

10

64

61

52.46 100 38.67 100 2.6 90.4

58.59 111.4 61.15 78.3 19.8 1.5

37.00 211.8 60.00 106.9 910.2 23.2

47.97 201.9 70.86 103.5 5.8 921.2

64.0 146.2 89.67 93.7 17.7 5.3

16.4 141.6 25.7 84.6 8.0 3.9

18.4 122.2 13.2 91.8 12.3 3.6

a Projection. b Index, 1991:100. c Primary exports. Sources: PER (1997), TET (1996) and BOT (1998).

that this increase is from a very small base, and that only a small fraction of the estimated mineral resources (which is the sector to which most foreign direct investment is directed) is being assessed for possible (foreign-financed) exploitation. In conclusion, then, one possible hypothesis that needs to be investigated is that import liberalization has decreased the room for imports of non-competitive goods by (a) the rapid increase in consumer-goods imports following liberalization; (b) the wiping out of domestic industries that otherwise could have contributed to export growth (particularly textiles, but also other commodities); and (c) through ‘import strangulation’ following the surge in local-currency prices of imports after devaluations. At the same time, donor funds have fallen and an increasing share of export revenues are being used for clearance of past arrears and honoring current debt obligations. This interpretation of the data – which puts the issues of external debt and sequencing and pace of import liberalization in the limelight – is also consistent with the falling levels of private investment noted in Table 9.2. Government operations Soft budget constraints, widespread corruption, incompetence and lethargy on the part of tax collectors in the past contributed to a large and growing fiscal deficit. This is viewed as the most important determinant of Tanzania’s relatively high inflation during the first half of the 1990s. Steps to rectify the situation include the creation of

From stagnation to growth in Tanzania 153 Table 9.4 Government operations, % of GDP, selected years

Total revenue Tax revenue Non-tax revenue Total expenditure Recurrent Debt service Wages Other Development budget

1990/1 1992/93 1994/5 1995/6

1996/7

1997/8 a

1998/9b

14.2 12.6 1.6 16.2 14.5 5.4 3.3 5.8 1.8

15.6 14.1 1.5 21.0 17.5 5.3 5.1 7.1 3.5

16.3 14.6 1.7 21.0 17.8 6.3 5.2 6.3 3.2

17.0 15.2 1.8 20.3 18.1 6.4 5.3 6.4 2.2

12.9 11.6 1.3 27.1 22 6.2 4.6 11.2 5.1

14.5 13.1 1.4 19.1 16.9 3.9 4.8 8.2 2.2

15.0 12.8 2.2 16.1 14.5 5.5 5.1 3.9 1.7

a Budget estimates. b Projected. Source: PER (1998) and GOT (1998).

the Tanzania Revenue Authority (TRA) and the introduction of a cash-budget system, both in 1996. Major problems on the revenue side include a large unofficial – and therefore non-taxed – sector, possibly remaining corruption on the part of TRA officials, widespread tax evasion, and conflicting interpretations of the relevant legislation between the Customs and the TRA1 (see Table 9.4). The difficulties of getting expenditures under control are rendered worse by a deceleration in the pace of privatization of loss-making parastatals, slow implementation of new pay scales for the civil service and delays in the rationalization of ministries and agencies. While the introduction of the cash-budget has succeeded in achieving the short-term objective (fiscal balance), it remains to be seen whether longer-term objectives can also be achieved (in particular the changing of the government’s priorities) or if the potential problem (associated with slower implementation of development projects, a mounting domestic debt and deterioration of infrastructure) will dominate. In the latter case, it is difficult to see how Tanzania’s recent growth spur can be maintained in the future. From the point of view of the budget as well as the balance of payment, the size of the external debt stands out as one of the major problems. It is difficult to envisage sustainable fiscal and external developments without radical measures for bringing the debt down (cf. OXFAM 1998). Even if Tanzania becomes eligible for multilateral debt relief under the Highly Indebted Poor Countries (HIPC) debt initiative,2 it is doubtful whether HIPC relief will be sufficient to create an environment conducive to growth and poverty alleviation.3 ‘Aid dependence’ It is an irony that the Arusha Declaration, with its emphasis on self-reliance, was found so attractive by donors that Tanzania ended up in a situation that several writers characterize as ‘dependence’. While aid flows to Tanzania, after 1970, have

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From crisis to growth in Africa?

gone through three distinct phases – an increase throughout the 1970s, a steep decline between 1980 and 1985, and a new boom up to 1992 (Adam et al., 1994) – it was only in the second aid boom that program aid and associated policy conditions were prominent; flows during the first aid boom were largely tied to specific projects and on the recipient’s terms. The term ‘aid dependence’, although in frequent use, does not describe the Tanzanian situation particularly well. Proper use of the word ‘dependence’ suggests that the recipient would do worse in the absence of aid – that aid assists in achieving stated objectives – but, for Tanzania, there are several reasons to doubt that this is the case (cf. Adam et al. (1994) for an analysis of aid to Tanzania, and Lensink and White (1999) for a conceptual analysis). In any case, all indicators suggest that levels of aid in Tanzania are high and have been so for at least a quarter of a century (see Table 9.5). The nature of aid relations has changed profoundly since the early 1970s. As noted, during the first aid-boom foreign aid was largely given to support the development vision of the Arusha Declaration, a product of Tanzanians for Tanzania. The steep decline in aid during the first half of the 1980s was characterized as a ‘war of attrition’ (Adam et al. 1994), as a rift between donor and recipient objectives emerged. The second aid-boom, which coincided with the first formal agreement between Tanzania and, the IMF and World Bank, moved bargaining power even further towards donors, this time using program aid as the primary vehicle for enforcing policy change. It is worth noting, however, that the bulk of aid to Tanzania still is, and has always been, project aid: it was a bit over 80 per cent in the late 1980s and the share has increased consistently since then (van Donge and White 1999: table 2.2). This circumstance raises several questions, some of which will be discussed in what follows. What is the relation between the large and sustained inflows of project aid and the rapid and sustained increase in recurrent public expenditures? Has project aid helped preserve (and expand) an obsolete and outmoded bureaucracy? How are the

Table 9.5 Indicators of ‘aid dependence’ in Tanzania; official development assistance as percentage of variables except as indicated

1990 1991 1992 1993 1994 1995 1996

GDP

Gross Investment

Imports

Aid per capita a

29.3 24.9 28.7 21.9 23.8 18.3 15.6

122.9 86.7 102.1 80.4 92.5 81.2 84.8

67.2 61.4 64.6 43.4 40.4 37.8 38.4

46.1 41.1 49.6 34.1 33.6 29.7 29.3

a Current US$. Source: Bigsten and Danielson (1999: table 1.8).

From stagnation to growth in Tanzania 155 relations between donor and recipient affected by a switch from cooperation and mutual trust to conflict and externally formulated policy conditions? How are donor–recipient relations affected by projects that make it difficult and costly for donors to withdraw?

3 The softness of the Tanzanian state Years of reform, changing the formal economic and political rules, do not seem to have improved the workings of the state sector in any fundamental way. Bad governance and ‘softness’ remain severe problems, while a precondition for sustainable growth in Tanzania appears, at least, to be a fairly efficient, responsible and impartial state. The present section discusses the ‘soft’ character of the Tanzanian state and some possible explanations of why it has remained so in spite of formal reform. By a soft state is often meant a state that is not independent of pressures from the influence of interest groups. We shall use a broader definition of softness, adding aspects such as the prevalence of a soft budget constraint, lack of responsibility, transparency and accountability, replacement of the rule of law by discretion and bargaining, and of formal by informal rules. Many of the soft traits are interrelated, and all apply in the Tanzanian case. The former socialist state was characterized by softness. It was closely integrated with the single party, which had supreme power over all state organs, including the judicial system. The state-cum-party incorporated a large parastatal sector and a huge bureaucracy. Decision making was centralized with frequent political intervention in the activities of lower-level organs, whose autonomy was weak. Appointments were not based on competence and professional skills, but on political, kinship or other social ties with the leadership. Hence loyalty and kickbacks were important for success. Regulation and bureaucratic coordination vested vast discretionary powers with the bureaucracy, but detailed formal rules for resource allocation were missing. Hence bargaining was common. The division and demarcation of responsibilities between different organs were poorly defined and often overlapping. The formal system was complemented by informal institutions, some culturally determined and others that emerged during its formation. One behavioral rule that developed within the public sector was the soft budget constraint. It implied that parastatal financing gaps were externally accommodated by different state organs, such as the banks, the Treasury and the tax administration. Applying the soft budget constraint became a method for dealing with recurrent parastatal financial problems. Thus the rule guided and facilitated the behavior of the bureaucrats and offered ‘solutions’ to systemic problems. It kept the parastatal sector intact, provided certain flexibility to a rigid system and mitigated the problems of information and incentive (Eriksson Skoog 1998: 188–204). However, the socialist state was riddled by inefficiencies, corruption and other problems that were worsened by the soft budget constraint. When the performance of the system collapsed into an economic crisis, and the leadership finally turned to reform, the intention was partly to improve the functioning of the state. However, the socialist heritage would prove to be strong.

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From crisis to growth in Africa?

The soft budget constraint Despite comprehensive reform of the socialist system of which it was an integral part and certain efforts to come to grips with the problem, the soft budget constraint continued to apply when parastatals were in financial trouble. This fact is revealed by the survival of chronic loss-makers. Parastatal accounts audited during 1980/1–1991/2 show that the largest loss-makers survived for more than a decade after the late 1970s, in spite of the fact that almost half of them made huge losses for eight years or more (Eriksson Skoog 1998: chapters 4–5).4 Parastatal losses were tremendous, costly and growing. Deregulation and devaluation dramatically altered relative prices and market conditions, which exposed many parastatals to cost increases and competition. They failed to adapt to the new circumstances and their losses escalated. Audited losses of commercial parastatals, excluding marketing boards, grew from 3 per cent of official GDP in 1984 to 17 per cent in 1989, or from 12 to 53 per cent of public expenditure. The worsening parastatal financial problems suggest that the soft budget constraint was applied to an increasing extent during the second half of the 1980s. Soft finance was provided in a number of different ways: as direct budgetary subsidies, discretionary tax exemptions, soft bank credit despite previous payment default and poor prospects for recovery, soft import support e.g. in terms of nonenforced cash-cover payments, soft administrative cost-plus and residual pricing, devaluation as a means of dealing with the losses of the exporting agricultural marketing boards and, finally, as soft bridging-finance loans from and non-enforced long-term foreign loans, channeled by the Treasury. Eventually, the leadership and bureaucracy tried to enforce a hard budget constraint, but they also applied the soft one albeit to a lesser extent and more selectively. This was partly a compelling circumstance of reform, which reduced the amounts of finance available for discretionary allocation when the donors withdrew large amounts of soft import support. Perhaps the strongest indication of this was the transfer of non-performing bank assets – debts owed by parastatals and cooperatives – to the Loans and Advances Realization Trust (LART) in 1993. Hence, in the early 1990s, the total amounts of soft parastatal finance appear to have declined. In spite of these changes and government claims to have imposed a hard budget constraint (United Republic of Tanzania 1996: 7), there are strong indications that the soft budget constraint survived after 1992 as well. First of all, the implications of the transfer of parastatal debts to LART are not unambiguous. Just as government assumption of bad parastatal debts in the past, this transfer relieved the stateowned banks of part of their non-performing assets, which were replaced by Treasury bonds. Thus the banks were partly recapitalized, which may be seen as a renewed application of the soft budget constraint. Such a perception of the baddebt relief by the NBC is suggested by its continued accumulation of bad debts. In mid-1993, non-performing assets accounted for 49 per cent, and two years later for two-thirds, of its portfolio. The situation worsened in 1996, and the bank accumulated losses. While some of the bad loans were old ones that had not been taken over by LART, the NBC continued to lend to non-performing clients as in the past

From stagnation to growth in Tanzania 157 (Ahlquist and Wissinger 1996: table 5.6; Bigsten and Danielson 1999: 100; International Monetary Fund 1996: 7). The soft budget constraint persisted by adapting to the changing circumstances. Its application shifted arena and form. For instance, when the amounts of finance that could be transferred to parastatals declined, passive application of the soft budget constraint, by not transferring resources from parastatals, was increasingly used. Parastatal managers refrained from servicing their payment obligations, and bureaucrats refrained from enforcing payment. As a result, parastatal debts accumulated. By mid-1992, the total debt of commercial parastatals was estimated to be 1,000 billion TZS, more or less equivalent to the official GDP. Net debt was estimated to be 790 billion TZS (Haggerty 1992: 6–7). The NBC’s continued accumulation of bad debts indicates a passive application of the soft budget constraint. The government also failed to recover the outstanding cash-cover debt for old commodity import support. Counterpart-fund arrears owed by parastatals were 70 billion TZS in 1994 (World Bank 1995: 9), and are still partly unsettled. Soft taxation also appears to have persisted, to judge from the difficulties in collecting taxes, large tax exemptions and remaining ministerial powers to grant discretionary exemptions. In 1994 a corruption scandal within the tax administration, involving political leaders, exploded, but by 1997 the opportunity for parastatals and others to negotiate tax exemptions had not yet been eliminated (United Republic of Tanzania 1997). Tax officials continued to abuse exemptions, use fake revenue stamps, deliberately under-assess imported goods, apply faulty exchange rates and so forth (Bigsten and Danielson 1999: 85). Another form of passive application of the soft budget constraint that may have developed was cross-lending between firms. In 1992 inter-parastatal debt was estimated to be 165 billion TZS (Haggerty 1992: 6). Parastatals under the Board of Internal Trade, for instance, allowed ‘sister’ companies to accumulate arrears because of loyalty between the companies. Within the National Transport Corporation such credit, which used to be granted because of political pressure, was now increasingly used as a means of keeping customers (personal communication, 1991). Hence the soft budget constraint did not only assume new expressions, but appears to have been put to new uses and applied between new actors. Parastatal reform itself may have implied continued application of the soft budget constraint, allowing for a prolonged restructuring of many parastatals rather than outright liquidation. Given donor pressure for change and withdrawal of soft import support, the government may have perceived parastatal reform unavoidable in order to protect the levels of other forms of aid. By sacrificing some parastatals – selectively imposing a hard budget constraint – the remainder of the sector was kept alive, at least for a while. Rehabilitation and financial restructuring was often necessary, regardless of whether the parastatals were to be kept public or sold. Given the past experience of the soft budget constraint, financial restructuring ran the risk of being perceived as a renewed application of the rule.5 Such expectations were fueled by government statements that parastatals would be granted ‘transitional budgetary subsidies’ during the period of restructuring (United Republic of Tanzania 1991: 7.) Data suggest that budgetary transfer payments to

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parastatals rose sharply in 1992/3, from 7 billion TSh in the two previous years to 20 billion, but thereafter declined gradually to an estimated 3 billion TSh in 1995/6 (International Monetary Fund 1996: 52). Although parastatal reform eventually became comprehensive, many parastatals survived in the meantime and many continued to make losses. In 1995, forty-one parastatals were reported to have made losses to a total of 24 billion TZS, equivalent to around 4 per cent of official GDP (World Bank 1995: 10). Thus the soft budget constraint may at least partly have continued to apply to parastatals waiting for privatization, as well as to already partprivatized or otherwise reformed ones. It may even have applied to private firms. Just as parastatal managers began to apply the soft budget constraint in interaction with other parastatals, bureaucrats may have applied it to new counterparts. The rule had a number of beneficial consequences for those who applied it. Bureaucrats could – and did – grant soft finance in exchange for rents. Such waste, abuse and misappropriation of all kinds of public resources is a well-known circumstance in Tanzania (see e.g. Kiondo 1989). Reform reduced the amount of resources that could be extracted from or granted to parastatals, and, when the private sector and its activities grew, options and thus incentives were created for bureaucrats to seek rents from the ‘new’ actors. These incentives were reinforced over time: real incomes and scarcity rents declined, parastatal reform threatened to shrink the parastatal sector and civil-service reform, launched in 1992, threatened mass retrenchment.6 Being used to successfully applying the soft budget constraint to parastatals in financial trouble, bureaucrats may have repeated this behavior when confronted with private firms. This is suggested by their exchange of tax exemptions for bribes, non-enforcement of cash-cover payments, renewed import support despite previous payment default and granting of bank credit to non-performing clients in the private sector. Through repetition, the informal institution may thus have spread to the interaction between bureaucrats and private firms. Other soft traits A related indication of the remaining softness of the state is the informal social relationships between the bureaucracy and private business. During reform, close bonds developed between members of the leadership and wealthy businessmen. Kiondo (1989: 317–18) refers to the ‘nouveau riche’ class, and the consequent wealth accumulation of political leaders was criticized by Nyerere as early as in 1987. The closeness of these bonds was reconfirmed by the commission of corruption in 1997 (United Republic of Tanzania 1997). Corrupt practices had already spread during socialism, due partly to extensive regulation and poor performance of the formal system. However, contrary to what may have been expected, the prevalence of the phenomenon appears to have grown during reform. In 1998 investors ranked Tanzania as one of the most corrupt countries in the world (Bigsten and Danielson 1999: 23). And just as in the past, the recent campaign against corruption appears to have led to little action. There have been few dismissals or court cases – instead people tend to be transferred to alternative

From stagnation to growth in Tanzania 159 activities – and none of the big fish have been caught, particularly not among state and political leaders (Bigsten and Danielson 1999: 123–5). The soft budget constraint, private extraction of public property and corruption are strong indications that the Tanzanian state is far from independent from the influence of pressure groups. Vested interests within private business and the public sector itself continue to use the state for their private purposes. Remaining discretionary powers have facilitated the survival of these practices, as formal institutional change has only been partly effective. Reform is partial, selective and evolves gradually. Hence, many old rules granting formal discretionary powers to the bureaucracy to control trade, set prices, allocate resources and approve of various licenses persisted for quite some time. Besides, deregulation measures were not legalized for a long period, and liberalization initially consisted in officially sanctioned non-enforcement of prevailing laws rather than changes of these (Kiondo 1989: 377). Legal provisions eventually followed, but discretion often continued to effectively apply anyway. In many parastatals, operational decisions still had to be sanctioned by various superior organs, while the division of authorities and responsibilities within the bureaucracy remained unclear (Tanzania Association of Parastatal Organisations 1989). Bargaining also remained important, e.g. within the relatively market-oriented open-general-license system that replaced the old commodity import support (van den Andel 1992: 96). Hence, the rules that apply to decision making, resource allocation and other activities within the state are largely informal, such as discretion, bargaining, rent seeking and corruption. In 1998 investors found bureaucratic red tape to be more extensive and the protection of their interests by the judicial system to be weaker in Tanzania than in other countries. Mechanisms for contract enforcement, for instance, remain weak (Bigsten and Danielson 1999: 121, 124; PWC 1999). The rule of law does still not apply, only selectively and irregularly. The lack of a uniform hierarchy of authorities, well-specified responsibilities and performance criteria, effective control mechanisms, information, transparency and accountability continues to characterize the state sector. These weaknesses have been recognized since the early 1980s, but after fifteen years of market-oriented reform, little improvement has been accomplished. Hence a Public Sector Reform Programme addressing them was launched in 1998 (Bigsten and Danielson 1999: 125–6). But why does the state remain soft in spite of reform? One explanation is most probably to be found in the character of institutional change. Let us suggest an additional explanation, related to the informal relationships of the so-called economy of affection. The economy of affection The softness of the Tanzanian state is not unique. Rather, the inefficiency, poor governance and private abuse of the sub-Saharan African state are widely discussed, not least within political science (see e.g. Havnevik 1996; Chabal and Daloz 1999). Softness is not only traceable to formal institutions, ideology and organizational

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structures. Culturally and historically determined – ‘traditional’ – values, informal rules and relationships also characterize these societies and hence influence the functioning of their state sectors. Hydén (1980, 1985) discusses what he calls the economy of affection, which prevails in African societies that are based on small-scale peasant agriculture. It is characterized by informal social networks and the interaction that takes place within these, between actors who are tied to each other on the basis of kinship, friendship or residence, etc. Many African households would be unable to survive or fulfil their obligations towards their members without access to the support mechanisms offered by the economy of affection. Individuals are obliged to assist group members, which restricts their ability and willingness to support concerns of a more general character. They identify themselves primarily with the particular social group to which they belong, rather than with society as a nation, and tend to maintain a local-patriotic perspective, as expressed for instance in nepotism. As noted by Platteau (1991), a generalized morality is often lacking in traditional societies. Obligations to behave morally only apply within a person’s own group and not towards outsiders. Hence behavior that favors the own group may be considered moral even if it takes place at the expense of others or society at large. The economy of affection permeates the entire society, and has severe implications for the functioning of the state, which is choked by a myriad of informal social networks, and for its softness. The extraction and abuse of public resources for the purpose of benefiting one’s own group is an obligation of state officials – people expect their local leaders to make use of their official positions. In Tanzania, the practice of distributing ‘patronage through the allocation of lower level positions to relatives, friends and others from their home areas’ is referred to as the ‘godfather’ syndrome (Hanak 1985: 54). Chabal and Daloz (1999: 1–16) stress the importance of these informal rules and relationships. They argue that the (formal) sub-Saharan African state is an empty shell. ‘It is vacuous because the exercise of central political power has not been emancipated from the overriding dominance of localized and personalized political contests.’ The state is non-independent, ‘in that it has not become structurally differentiated from society’. Instead, it is particularistic and patrimonial. There is no effective functional distinction between the public and private spheres. The holders of power command the resources that they administer and distribute political office on the basis of patronage rather than professionalism. Politicians and bureaucrats are not primarily servants of the state, but their ‘political obligations are, first and foremost, to their kith and kin, their clients’, communities and regions. The African political elites gain legitimacy from their ability to nourish their clientele, which makes the exploitation of government resources necessary. Resource waste, lack of transparency, weak accountability and other soft characteristics of the state result. What matters for the operation of the state is thus largely the informal. Informal power, relationships, rules and values are often disguised behind the formal economic and political institutions, undetected and representing a logic not often understood by Western observers. This may account not only for much of the softness of the

From stagnation to growth in Tanzania 161 Tanzanian state, but also for why years of comprehensive formal reform only seem to have had an impact at a superficial level. Chabal and Daloz (1999: 14) further argue that the very weakness and inefficiency of the state has been profitable to the African political elites. The development of political machines and the consolidation of clientilistic networks within the formal political apparatus has been immensely advantageous. It has allowed them to respond to the demands for protection, assistance and aid made by the members of their constituency communities in exchange for the recognition of the political prominence and social status which, as patrons, they crave. These circumstances weaken the incentives of Tanzanian leaders and bureaucrats to reduce the softness of the state, despite official statements to the contrary. Making the state more efficient, transparent and accountable would reduce their opportunity to satisfy the clientilistic demands upon which their positions depend. Even if the new Tanzanian government’s serious ambition is to change the existing order, it will probably be constrained by the obligations of the economy of affection, just as previous leaders have been. The economy of affection raises the question ‘as to whether corruption should merely be seen as a “selfish” additional source of income or more accurately understood as part of a complex network of redistribution driven by particularistic social pressures’ (Chabal and Daloz 1999: 98). It also adds an explanation for why market-oriented reform has not led to a reduction of corruption in Tanzania and campaigns against it have been mainly rhetorical. When the availability of public resources declined, the need of leaders and bureaucrats to acquire the patrimonial means to defend their positions forced them to seek alternative ways, like turning to increased personal exchange with the private business sector (cf. Havnevik 1996; Chabal and Daloz 1999: 105). Given the economy of affection, a successful shift to market economy, with an impartial and efficient state and healthy competition between private firms engaged in impersonal exchange taking the lead towards a process of sustainable growth, may prove more difficult to achieve than we wish to believe.

4 The soft state and aid dependence: A vicious circle The importance of traditional informal rules and networks does not imply that African societies are stagnant. While the remaining softness of the state is partly a socialist heritage and a consequence of the economy of affection, an additional explanation is related to long-term relationships between the state and foreign donors and to the permanency in aid flows. This section argues that state softness and aid dependence are interrelated and tend to reinforce one another in a vicious circle. Hence the Tanzanian government and foreign donors are locked in a relationship that is difficult to break, and which may prevent self-sustained growth from taking off.

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Aid dependence creates a soft state Aid dependence developed when Tanzania implemented its socialist development strategy in the 1970s. The large and permanent aid flows, and the long-term relationships with the donors that resulted, contributed to the softness of the Tanzanian state in several ways. The socialist model was based on state ownership, and hence a central measure was to expand the role of parastatals, which soon ventured into most economic sectors. The number of parastatals grew from 85 in 1970 to 380 in 1979 (Eriksson Skoog 1998: 81). Much of this expansion was made possible by foreign aid, which also financed large parts of other government investments, such as in social infrastructure. This implies, first of all, that foreign aid contributed to the establishment of a huge state bureaucracy, within not only the parastatal sector, but also the public administration, as a vast organizational structure was set up to control the parastatals. Considering the large amounts of foreign aid, tremendous powers were vested in those who controlled the resources, whether used for official purposes or diverted for private and informal network use; namely, the state bureaucracy. Second, foreign aid not only enabled but also fueled expansion of the state sector, and the circumstances under which it was granted influenced the direction and character of, for instance, parastatal and industrial investments. The practice of planning and deciding on investments in Tanzania was based on the proposer’s ability to raise non-government financing for the project, since government finance was scarce (Williams 1979: 43). Hence parastatals and projects were established when and where there was finance. Regional trucking companies, for instance, were formed for the very purpose of utilizing the available aid funds (Hanak 1985: 78). Third, the abundance of foreign aid also implied that the scrutiny and viability of investment projects were neglected or at least suffered. The Swedish International Development Authority (SIDA), for instance, had problems spending all its funds, which resulted in large unspent amounts that were carried over from one year to another. These difficulties gave rise to an unofficial disbursement goal, which had implications for the quality and character of Swedish aid. ‘In order to spend more money, capital intensive technology choices have been made, and costly projects and “hardware” (buildings, equipment) have been prioritized at the expense of “software” (transfer of knowledge). Efforts to spread a more cost-conscious way of thinking have been stalled.’ (Elgström 1992: 42–3) The choice of technology was often ‘a fallout from the chosen source of finance and related project inputs’ (Williams 1979: 43), and hence large-scale and capital-intensive. Most of the priority industries under state ownership became, contrary to the intention, highly import-dependent (Skarstein and Wangwe 1986: 20–75). Besides, donors often tied their aid to procurement in the donor country, even to specific suppliers, which ought to have raised project costs as competitive procedures were bypassed. Finally, foreign aid contributed to many of the values, behavioral rules and incentives within the state sector, whose soft traits were reinforced. The large aid flows, their permanency and the donors’ disbursement goal also worsened the state’s already poor administrative capacity. The resulting inefficiency, disorder and lack of

From stagnation to growth in Tanzania 163 transparency within the state facilitated corrupt practices and private extraction of aid funds, while the magnitude of aid offered a huge financial potential for abuse and appropriation. The circumstance that aid was provided in a context where the economy of affection prevailed suggests that this potential was utilized extensively. An additional form of softness In response to the crisis, the donors shifted part of their aid from project finance to import support in the 1980s. Import support was initially seen as an emergency relief measure that would eliminate temporary bottlenecks. Eventually, together with import liberalization, it did ease the severe supply constraints. The local counterpart funds paid for import support were granted to the government, and financed a growing share of the budget deficit during the second half of the 1980s and early 1990s (Bhaduri et al. 1993: 96–103). This method of financing may in fact have contributed to increasing the size of the deficit. Import support at least partly relieved the government from making rapid and drastic expenditure cuts and from mobilizing other revenues, and thus provided a ‘soft option’. The permanence of aid and its tendency to compensate for financing gaps suggests that when the state failed to finance imports and public expenditure, the donors stepped in to ‘solve’ the problem by providing aid and taking responsibility – which is another expression of aid dependence. Just as when the soft budget constraint applied within the parastatal sector, such behavior ought to have created expectations of future donor assistance in case of recurrent financial trouble. Aid dependence may thus have given rise to an additional form of softness of the Tanzanian state: softness in its relationship with the donors. We know that the donors applied the soft budget constraint in their allocation of import support and non-enforcement of counterpart-fund payments to parastatals and their own projects (Eriksson Skoog 1998: chapters 4–5). A similar informal behavioral rule also may have applied in the interaction between the donors and the government. The soft state creates aid dependence Once the Tanzanian state had become soft, this circumstance tended to perpetuate the country’s dependence on foreign aid. First of all, the tremendous state bureaucracy, that foreign aid contributed to establishing, had an interest in maintaining its position. The bureaucrats’ formal and informal positions largely depended on foreign aid. Not least the leaders needed further aid to ‘distribute’ to their clients in order to legitimize their positions. Hence, dependence is not only a constraint, but also a resource (Chabal and Daloz 1999: 111). This dependence forced the leaders to adapt to donor demands to escalate reform, in order to secure access to foreign aid. Since reform – e.g. reduction of the parastatal sector and the civil service – threatened the discretionary powers of leaders and bureaucrats and the positions of some of them, their main option was to delay its implementation and weaken its effects. Chabal and Daloz (1999: 122–3) argue

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that African rulers have also succeeded in using structural adjustment politically and in preventing it from undermining the patrimonial foundations of the state. As Tanzania, for instance, seemingly followed the reform agenda (at least prior to 1995), the donors were reluctant to stop aid, in spite of their recognition of the slow implementation, inefficiency, corruption and other soft traits of the state. The donors have a stake in the success of reform, as well as of any aid activity in which they are engaged (Danielson and Mjema 1999). The soft budget constraint creates expectations of external assistance and weakens incentives for the recipients to take action to solve their financial problems on their own. It creates passivity and may, together with the other soft traits, therefore have contributed to the leadership’s lack of ownership of reform in general, and of the performance of the state and its numerous development projects in particular. Passivity and lack of ownership, in turn, have forced the donors to step in, assume responsibility, solve problems, formulate policy – and thus take the lead in the reform process – and provide finance. Thus softness tends to perpetuate aid dependence – and lack of ownership reinforces itself. Consequently, when the government fails to sustain its (donor-funded) development projects, the donors continue to provide recurrent financing – e.g. in terms of local-cost compensation (LCC) for salary payments – in what appears to be efforts to rescue their own investments. Danielson and Mjema (1999) argue that when the government imposed the cash budget in 1996, and its expenditures for operation and maintenance of the capital stock suffered, LCC from the donors may have increased. Thus LCC may have become a new means for donors to provide soft finance to ‘their’ Tanzanian state projects. SIDA/Sida has found it tremendously difficult to phase out of projects (Elgström 1992), largely because the projects were not financially sustainable (Catterson and Lindahl 1998). This difficulty can partly be traced to donors’ contradictory motives – problems inherent to much foreign aid. While donors have a long-run interest in the success of reform, they have a short-run interest in the successful operation of their project (Danielson and Mjema 1999). Besides, as noted by Mosley et al. (1991: 73), while the extent of reform is a contested terrain between the parties, the government and the donors have a common interest in spending the donors’ budgeted amount. The major short-term function of the donors is to grant or lend aid; hence the disbursement goal. LCC implies that when the government makes certain efforts to enforce a hard budget constraint on itself, its ministries and projects by introducing the cash budget, donor behavior may erode the intended incentive effects. Instead of supporting attempts to break old expectations and attitudes in order to improve financial discipline within the public sector, the donors may perpetuate the soft budget constraint and launch another round of the vicious circle. Since the government expects the donors to step in to rescue ‘their’ own projects, it can ‘afford’ to impose a ‘hard’ cash budget and extract the associated goodwill. Thus donor behavior may prevent formal reform from becoming effective, slowing the process of change, while perpetuating both the softness of the state and Tanzania’s dependence on foreign aid. Let us elaborate on the role of donor practices below.

From stagnation to growth in Tanzania 165 Additional contributing factors Bilateral aid is channeled through the state apparatus; ideally, it is integrated in the normal budget. However, donors are anxious to get results and monitor progress on projects that they have funded themselves. Consequently, as the efficiency of the recipient’s bureaucracy has deteriorated, donors have turned to independent projects and control systems of their own in order to ensure that the money is disbursed and used in a reasonably efficient way. While this may increase disbursement rates and possibly efficiency of individual projects, it is likely to further decrease local ownership.7 It is likely that low local ownership of projects is a key reason for the bad performance of aid projects. There are several reasons for this. First, donors draw up their own country strategies without much local consultation, either with the government of Tanzania or other donors. Donor objectives, as reflected in the country strategy, are then not necessarily consistent with the recipient’s development strategy as reflected in the budget or (as in Tanzania) the Forward Budget and Rolling Plan. Second, donors often have disbursement targets, which may be explicit or implicit. Some donors deny the existence of disbursement targets, but acknowledge the existence of commitment targets (such as Sweden’s 0.7 per cent of GNP target). Having a commitment target, however, necessarily implies a disbursement target; why would a donor strive to commit resources that it does not plan to disburse? Given the low efficiency in the recipient’s bureaucracy, and the relatively strained budget of the recipient, disbursement targets have two implications. First, donors often try to speed up the process by hiring local consultants, often from the relevant Ministry, to implement and run the project. This diverts attention from the daily chores and separates the project from the strategy followed by the Ministry (Danielson and Mjema 1999). Second, when projects cannot be integrated in the normal budget because of lack of funds for recurrent-cost financing, donors are likely to accept such financing.8 This creates a situation in which project sustainability is dependent on donor finance. When recipients are strapped for cash to finance the running of projects, donors are trapped between the Scylla of slow disbursement and the Charybdis of project unsustainability. In addition, donors may try to force their way through: ‘It is also likely that agency staff will be under pressure to ensure that they spend their budgets, even if it requires a degree of bulldozing to achieve this result, and they may well see it as in their own career interests to secure a high level of aid giving or lending.’ (Helleiner et al. 1995: 15). Third, the building up of parallel systems is symptomatic of a weak state in the recipient country. Such systems tend to reinforce the weakness of the state in that resources are diverted from government control, which implies that the government’s development plans become less relevant. An additional, and related, problem that has been particularly acute in Tanzania is donors’ use of alternative entry points for aid – directly to the relevant Ministry or via NGOs. This adds to the tendency of eroding power in the Treasury. Finally, donor behavior has added to weakening the state through the lack of coordination between donors. In program aid, coordination is better – most donors accept the reform conditions imposed by the international financial institutions as

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prerequisites for release of funds.9 However, given the large number of projects, and the heavy administrative costs associated with this, it is understandable that donors resort to local-cost compensation, alternative entry points and the creation of parallel structures. These, however, are short-term solutions that may worsen the problem in the longer run.

5

Concluding remarks

The rationale for giving foreign aid may be altruistic or egoistic, but its objective is almost always to increase incomes in the recipient country. Whether it works as intended or not may be disputed, but it should be clear from the analysis above that sustained flows of aid may weaken the state and thus render self-sustained growth more difficult to achieve in the long run. Foreign aid, in other words, may help solve acute problems only at the expense of a long-term erosion of local governance capacity. The key to the problem, we suggest in this chapter, is not aid per se, but its organization. Problems are traced both to the recipient’s willing acceptance of aid for which it has no absorption capacity and to the donors’ surprising eagerness to disburse, even though previous experience has suggested limited impact. To alleviate the problems, donors have turned to increasing control of details and the creation of parallel structures. While these measures may have had a positive impact on growth and poverty alleviation, their longer-run consequence is still an open question: as far as Tanzania is concerned, we simply do not know the net benefits of thirty years of aid.

Notes 1 In particular, the two organizations differ in their definitions of ‘capital goods’, which has a bearing on legal tax exemption. For details, see PWC (1999) and Danielson and Mjema (2000: chapter 3). 2 Information at the time of revision (May 2000) suggests that Tanzania will reach the completion point of the HIPC program during 2001. 3 The major reason for this is that Tanzania is currently enjoying a net inflow of resources. If multilateral debt relief leads to a cessation of program aid, the net inflow will be reversed. 4 The discussion on the soft budget constraint below, incl. figures without reference, is based on this source. 5 Cf. Haggerty (1992: 14). 6 According to Sarris and van den Brink (1993: 180), real incomes of rich urban households declined during the 1980s. Cf. Adam et al. (1994: 142–3) on incentives for increased corruption. 7 This does not imply that donors always put local ownership as a top priority, or even understand the term properly. A survey of donor attitudes in Dar es Salaam noted that ‘some usages seem decidedly eccentric, as with the statement from one aid agency that ‘we have pressured the GOT to accept ownership of …’’. Another stated, “we want them to take ownership. Of course, they must do what we want. If not, they should get their money elsewhere.” ’ (Helleiner et al. 1995: 10). 8 The DAC’s Guidelines for Efficient Aid used to contain a paragraph recommending that donors do not engage in recurrent-cost financing. The African crisis of the early 1980s implied that adherence to this principle led to very slow disbursement of project financing

From stagnation to growth in Tanzania 167 and so the principle was abandoned (it does not appear in the 1992 edition of the Principles). Some donors, including Sweden, have never taken that principle seriously anyway (Danielson 1999a). 9 At least nominally, even though bilateral donors as well as the World Bank have often released funds even though conditions have not been met; cf. van Donge and White (1999).

References Adam, C., Bigsten, A., Collier, P., Julin, E. and O’Connel, S. (1994), Evaluation of Swedish Development Co-operation with Tanzania, Ds 1994: 113. Stockholm: Ministry for Foreign Affairs. Ahlquist, M. and Wissinger, J. (1996), Financial Liberalization in Tanzania: Reforms, Results and the Road Ahead, Minor Field Study No. 1996: 2. Uppsala: Department of Economics and Department of Statistics, Uppsala University. Bhaduri, A., Rutayisire, L. and Skarstein, R. (1993), Evaluation of Macroeconomic Impacts of Import Support to Tanzania, Report No. 4/93. Trondheim: Centre for Environment and Development (SMU), University of Trondheim. Bigsten, A. and Danielson, A. (1999), Is Tanzania an Emerging Economy?, Paris: OECD. BOT (1998), Economic Bulletin, Vol. XXVIII: 1. Dar es Salaam: Bank of Tanzania. Burnside, C. and Dollar, D. (1997), Aid, Policies and Growth, PRWP #1777. Washington, DC: World Bank. Catterson, Julie and Lindahl, Claes (1998), The Sustainability Enigma, EDGI Report 1999: 1. Stockholm: Ministry for Foreign Affairs. Chabal, Partick and Daloz, Jean-Pascal (1999), Africa Works: Disorder as Political Instrument. Oxford and Bloomington: The International African Institute in association with James Currey and Indiana University Press. Danielson, A. (1999a), ‘Policy Coherence Towards Developing Countries: The Case of Sweden’, in J. Forster and O. Stokke (eds), Policy Coherence Towards Developing Countries. London: Frank Cass. Danielson, A. (1999b), ‘Why are Donors So Enthusiastic about Current Economic Performance?’, Tanzania Economic Trends, Vol. 10, pp 14–26. Danielson, A. and Mjema, G. (1999), Tanzania 1998: Cost-Sharing in Development Projects: Principles, Practice and Problems, Country Economic Report 1999: 2. Stockholm: Swedish International Development Cooperation Agency. Danielson, Anders and Mjema, Godwin (2000), Tanzania 1999: Obstacles to Private Sector Growth. Stockholm: Swedish International Development Cooperation Agency. Elgström, O. (1992), Foreign Aid Negotiations: The Swedish–Tanzanian Aid Dialogue. Aldershot: Avebury. Eriksson Skoog, G. (1998), ‘The Soft Budget Constraint: The Emergence, Persistence and Logic of an Institution: The Case of Tanzania 1967–1992’, Ph.D. Thesis, The Economic Research Institute, Stockholm School of Economics, Stockholm. GOT (1998), Budget Speech for 1998/99. Dar es Salaam: Government Printer. Haggerty, O’. (1992), ‘Public Enterprise Sector Debt in Tanzania’, London: Coopers & Lybrand for the Parastatal Sector Reform Commission, Dar es Salaam, mimeo. Hanak, E. (1985), The Politics of Agricultural Policy in Tanzania. Washington, DC: World Bank, mimeo. Havnevik, Kjell (1996), Project 2015: Tanzania with Outlooks to Kenya and Uganda. Stockholm: Swedish International Development Cooperation Agency. Helleiner, G., Killick, T., Lipumba, N., Ndulu, B. and Svendsen, K.-E. (1995), Report of the Group of Independent Advisers on Development Cooperation Issues between Tanzania and its Aid Donors. Copenhagen: Royal Danish Ministry of Foreign Affairs, mimeo.

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Hydén, G. (1980), Beyond Ujamaa in Tanzania: Underdevelopment and an Uncaptured Peasantry. Berkeley: University of California Press. Hydén, G. (1985), Utveckling utan genvägar: Ett perspektiv på krisen och biståndet i Afrika. Stockholm: Wahlström & Widstrand. First published in English in 1983 as No Shortcuts to Progress. London: Heinemann. International Monetary Fund (1996), Tanzania – Selected Issues and Statistical Appendix, SM/96/267. Washington, DC: IMF. Kiondo, A. S. Z. (1989), The Politics of Economic Reforms in Tanzania: 1977–1988’, Ph.D. Thesis, University of Toronto, Toronto. Lensink, R. and White, H. (1999), Aid Dependence, EGDI Report 1999: 2. Stockholm: Ministry for Foreign Affairs. Mosley, P., Harrigan, J. and Toye, J. (1991), Aid and Power: The World Bank and Policy-Based Lending, Vol. 1: Analysis and Policy Proposals. London: Routledge. OXFAM (1998), ‘Debt Relief for Tanzania’, OXFAM Position Paper, April. PER (1997), Public Expenditure Review, 1997. Washington: World Bank. PER (1998), Public Expenditure Review, 1998. Washington: World Bank. Platteau, J.-P. (1991), The Free Market is Not Readily Transferable: Reflections on the Links between Market, Social Relations, and Moral Norms, Cahiers de la Faculté des Sciences Economiques et Sociales, Serie Recherche No. 117, 1991/8. Namur: Facultés Universitaires Notre-Dame de la Paix. PWC (1999), Tanzania: Investment Guide. Dar es Salaam: PriceWaterhouseCoopers. Sarris, A. and van der Brink, R. (1993), Economic Policy and Household Welfare during Crisis and Adjustment in Tanzania. New York: New York University Press. Skarstein, R. and Wangwe, S. (1986), Industrial Development in Tanzania: Some Critical Issues. Uppsala: Scandinavian Institute of African Studies. Tanzania Association of Parastatal Organisations (1989), ‘Problems of Parastatals and Proposals for Structural Reforms’, Main Report, Submitted to Ali Hassan Mwinyi, President of the United Republic of Tanzania, Dar es Salaam. Tarimo, B. (1996), ‘External Trade Liberalization: The Tanzanian Experience’, Tanzanian Economic Trends, Vol. 9, pp 56–72. TET (1996), ‘Statistical Appendix’, Tanzanian Economic Trends, Vol. 9, pp 92–114. Tsikata, T. (1998), Aid Effectiveness: A Survey of the Recent Empirical Literature, PPAA 98/1. Washington, DC: International Monetary Fund. United Republic of Tanzania (1991), Parastatal Sector Reform (A Policy Statement), Ref. No. TYC/P/10/22. Dar es Salaam: Ministry of Finance and Economic Affairs. United Republic of Tanzania (1996), ‘Parastatal Reform and Privatisation’, Paper prepared for the Consultative Group Meeting of July in Paris, Dar es Salaam, June. United Republic of Tanzania (1997), Executive Summary on Commission Report: State of Corruption in the Country, Dar es Salaam: Presidential Commission on Corruption. van den Andel, W. A. (1992), ‘Evaluation of the Netherlands Programme Assistance to Tanzania in the 1980s’, Andel Consultants, Report prepared for the Ministry of Foreign Affairs, The Netherlands. van Donge, J. K. and White H. (1999), Counting the Donors’ Blessings: Programme Aid to Tanzania, Sida Evaluation Report 99/17: 5. Stockholm: Swedish International Development Cooperation Agency. White, H. (1998), Aid and Macroeconomic Performance, London: Macmillan. Williams, D. (1979), ‘National Planning and the Choice of Technology: The Case of Textiles in Tanzania’, in K. Kim, R. Mabele and M. Schulteis (eds), Papers on the Political Economy of Tanzania’, London: Heinemann Educational Books. World Bank (1995), Tanzania: The Challenge of Reforms: Growth, Incomes and Welfare, Report No. 14982-TA, Vol. 1: Main Report. Washington, DC: World Bank. World Bank (1998), Assessing Aid, Washington, DC: World Bank.

10 The Post-Washington Consensus in Mozambique Hans Falck

This paper analyses the extent to which different types of reforms have been implemented in Mozambique, and puts them in the perspective of the macroeconomic development during the 1990s. As a basis for organisation of the analysis, we have used the 1998 WIDER Annual Lecture by Joseph Stiglitz (1998). In his lecture, Stiglitz analyses and criticises the so-called Washington Consensus reforms, and instead suggests a Post-Washington Consensus, i.e. a new set of instruments and goals for economic reform. In the first section of this paper, Stiglitz’ arguments for and against the Washington Consensus and the Post-Washington Consensus are presented respectively. In the following section we examine to what extent the Washington Consensus and the Post-Washington Consensus reforms have been implemented in Mozambique. Next, the macroeconomic development of Mozambique is presented, and an analysis is made of the extent to which it results from the different reforms. Finally, conclusions are presented.

1 The Washington Consensus versus the Post-Washington Consensus To solve the financial crises that shook several developing countries at the end of the 1980s, the International Monetary Fund (IMF), the World Bank, and US economic officials formulated a standardised reform programme. The agreement behind this reform programme has become known as the Washington Consensus (see Table 10.1), and has since been applied to a number of developing countries with economic problems. Since the Washington Consensus considers macroeconomic stability a prerequisite for economic growth, it aims at correcting imbalances such as large budget deficits, high and recurring inflation, and external imbalances. The concentration on relatively few variables has been the strength of the Washington Consensus, since this has made it widely applicable. However, its standardised form has also been a source of criticism. It has been claimed that by using the same (or similar) methods, institutional particularities of the different countries have been neglected. Also from other standpoints the Washington Consensus reform programme has been controversial. The result of the reform programme has been debated, however, less because of doubts that it can achieve its targeted goal, but more because of its alleged side effects. The critics of the Washington Consensus programme

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From crisis to growth in Africa? Table 10.1 Washington Consensus: goal and instruments Goal:

Economic growth

Instruments:

Macroeconomic stabilisation Liberalised trade Privatisation

Source: Stiglitz (1998).

claim that in particular the social sectors of the economy have suffered. There has also been doubt as to whether the tight policy recommended by the Washington Consensus can really foster economic growth and development. In the 1998 WIDER Annual Lecture, Joseph Stiglitz joined the critics of the Washington Consensus (Stiglitz 1998). According to Stiglitz, the Washington Consensus is based on an oversimplified assumption that privatisation, liberalisation and macroeconomic stability are sufficient to achieve good economic performance. Macroeconomic stability implies control of inflation and balanced budget and external accounts. Stiglitz argues that the Washington Consensus reforms were appropriate for solving the problems of the Latin American countries in the 1980s. These countries suffered from high, persistent inflation and external imbalances, which gave rise to large capital outflows. The imbalances could be explained by large budget deficits, which were caused by subsidies to inefficient state-owned companies and financed through money creation. However, according to Stiglitz the means and goals of the Washington Consensus are less well adapted to the present development problems, which differ from those in the 1980s. Unlike the 1980s, the problems facing developing countries today can be traced to underlying problems in the operation of markets and financial sectors. Further, Stiglitz argues that the examples of the Asian countries show that, in spite of the recent turmoil, other ways to achieve economic development are possible than the cures recommended by the Washington Consensus. According to Stiglitz, both the IMF and the World Bank have focused too narrowly on the goals and instruments of the Washington Consensus. The Washington Consensus ‘contained important elements but in many ways does not go far enough in promoting issues like financial sector reform and competition policy’ (Stiglitz 1998: 22). Furthermore, ‘[m]aking markets work requires more than just low inflation, it requires sound financial regulation, competition policy, and policies to facilitate the transfer of technology, and transparency, to name some fundamental issues neglected by the Washington Consensus’ (Stiglitz 1998: 1). In light of the experience of the Asian countries and the changed economic conditions, Stiglitz calls for a new economic consensus, a Post-Washington Consensus. However, the Post-Washington Consensus as put forward by Stiglitz is not a completely new programme. Rather, even though Stiglitz argues that the Washington Consensus was ‘sometimes … misguided’ (Stiglitz 1998: 1) and ‘hardly

Post-Washington Consensus in Mozambique 171 Table 10.2 Post-Washington Consensus: broadened sets of goals and instruments Goals:

Increases in living standards (health, education) Sustainable development (preserving natural resources, healthy environment) Equitable development Democratic development

Instruments:

Financial regulation Competition policy Investment in human capital Transfer of technology

Source: Stiglitz (1998).

complete’, the Post-Washington Consensus implies an extension reversion and addition to the Washington Consensus. The Post-Washington Consensus implies both broadened sets of instruments and goals (Table 10.2). In addition to economic growth, Stiglitz would like to see further goals such as increased living standards, sustainable development, and equitable and democratic development. In order for privatisation and liberalisation to yield sustainable results, they must be accompanied by economic instruments that create competitive markets and functioning financial systems. For example, privatisation without competitive markets may simply result in the substitution of private monopolies for public ones, which increases neither growth nor welfare. Human capital and research and development are two other factors essential for economic growth and development. Since investment in research and development takes a long time to materialise and implies high costs, Stiglitz considers transfer of technology a good alternative for developing countries. Both in the promotion of human capital and transfer of technology, government has an important role to play. Most economists probably agree with Stiglitz that the existence of competitive markets and a functioning financial system are essential for an economy. A potentially controversial issue, however, is how these instruments are created. There is a difference between those who argue that the economy, left to itself, creates competitive markets and a functioning financial system, and the opposing view that it is the responsibility of the state to create those instruments. This difference in view originates in the ideological debate about the role of the state, i.e. whether the state is considered a substitute or a complement to the market. Stiglitz favours the latter view and adds that the ‘heart of the current problem in most cases is not that government has done too much, but that it has done too little’ (Stiglitz 1998: 2). Consequently, Stiglitz attributes an important role to the state in facilitating the working of the market.

2 Reforms in Mozambique In 1987 the Government of Mozambique launched the Economic Rehabilitation Program (PRE), supported by the IMF, with the purpose of reducing the large

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imbalances and increasing the overall efficiency of the economy. The ERP reforms included devaluation of the metical, tighter fiscal and monetary policy, and deregulation of prices. In 1990 a further programme of economic reforms for the period 1990–2 was introduced with the purpose of increasing the role of the private sector, promoting foreign investment, and improving access to imports and industrial inputs. Examples of other plans and programmes initiated by the government are a three-year plan for cuts in expenditure in 1992, a national reconstruction plan in the aftermath of the war in 1993, and new structural adjustment programmes for the periods 1994–5 and 1996–8 (Cravinho 1998: 719). In this section the reforms implemented as a result of PRE and the subsequent structural adjustment programmes are analysed and categorised first in terms of the Washington Consensus and then in terms of the Post-Washington Consensus. Washington Consensus instruments The Washington Consensus focuses on a number of easily identifiable reforms and instruments judged to be essential for good economic performance. These reforms are based on the belief that the private sector is better able than the public sector to promote economic growth (Stiglitz 1998: 1). Thus, underlying the implementation of the Washington Consensus instruments and reforms is the objective to improve the operating conditions of the private sector. Privatisation Privatisation of state-owned companies in the transition economies is a pillar stone of the Washington Consensus. The principal argument for privatisation is based on the Fundamental Theorems of Welfare Economics, which state that private property is a precondition of an efficient market economy. A more straightforward argument for privatisation is that state-owned companies in transition economies are used to operating under soft budget constraints, and under conditions where political considerations, contacts and personal loyalties are more important than profitability as criteria for receiving credits. In such a system, the state is prepared to bail out lossmaking companies in the case of poor production results. Consequently, incentives for efficient production are lacking. There is also a macroeconomic aspect of soft budget constraints since they add to the budget deficit. Privatisation consequently both decreases the budget deficit, and thereby also inflation and interest rates, and increases the incentives for more efficient production, since the privatised companies can no longer turn to the state for loans. Stiglitz agrees with the Washington Consensus that privatisation is important. The state should focus on what it does best and not get involved in all sorts of economic activities. However, Stiglitz stresses that privatisation is neither a substitute for competitive markets nor a sufficient means of creating such markets. Instead, as we will return to below, the Post-Washington Consensus stresses regulation and competition policy in order to achieve competitive markets. Stiglitz also points out that there are alternatives to straightforward privatisation, e.g. implementing market

Post-Washington Consensus in Mozambique 173 mechanisms in public companies such as corporatisation and performance-based organisations (Stiglitz 1998: 18). PRIVATISATION IN MOZAMBIQUE

Mozambique, together with Zambia, is considered to have carried through the most ambitious and successful privatisation programme in Africa (Financial Times 1997). The coordinating unit for the restructuring of medium and large companies has been the Technical Unit for Enterprise Restructuring (UTRE) within the Ministry of Planning and Finance. The privatisation process from its outset has embraced around 900 enterprises, establishments and financial holdings, out of a total of more than 1,200, since 1989. Until the end of 1997, almost 75 per cent of these companies were either sold or liquidated, 17 per cent turned into joint ventures, and 8 per cent leased to the private sector. More than 50 per cent of the companies were in industry and commerce, 19 per cent in agriculture and fishing, and 16 per cent in construction (IMF 1998: 8). Mozambican enterprises have purchased more than 90 per cent of the companies privatised. The part of the privatisation programme carried through by UTRE is scheduled to end in 1998, while the privatisation of smaller companies is planned to be completed in 1999. The single measure in the privatisation process with the largest impact is probably the privatisation of the state-owned banks (see the section on financial reforms). In the pipeline for privatisation at present are the management of companies that were earlier considered ‘strategic’, such as the railways, port terminals and port services of the three corridors that connect Mozambique’s neighbours to the sea. Concessioning of these companies has been delayed, but contracts are expected to be agreed upon later this year (Canadian High Commission Mozambique 1998b). Mozambique Air Lines (LAM) and Telecommunications of Mozambique (TDM) are other larger companies undergoing privatisation. Privatisation of LAM has been delayed, while a strategic partner is planned to be selected for TDM next year (UTRE 1998: 10). The results of privatisation have been mixed. While privatisation has succeeded in increasing output and productivity and has been able to attract both domestic and foreign investment, it has had only a marginal effect on state revenues. For example in 1994, the year with the largest net receipts from privatisation, these receipts constituted only 1.4 per cent of government revenues and 0.2 per cent of GDP (IMF 1998: 86). Liberalisation The argument for trade liberalisation is based on the assumption that a country through specialisation and trade can reap the benefits from economies of scale and comparative advantages and thereby increase its welfare. Even though this positive view of the benefits of trade is shared by most economists, there are also alternative views, as for example the dependency school which claims that trade results in dependence and underdevelopment. During the Cold War, in many developing

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countries the alternative approaches legitimated an import substitution policy that protected domestic industries through quotas and high tariffs. The lack of competition resulted in most cases in inefficient production, especially since many of the domestic companies were state-owned and operated under soft budget constraints. The import substitution policy also affects production negatively in other ways: the low competitiveness of the export industries implies that insufficient foreign exchange is generated to buy intermediate goods. As a result, many companies in the countries pursuing an import substitution policy operate at a low capacity utilisation level. For example, one of the most important reasons for the Latin American economic crisis in the 1980s was the damaging effect of the substitution policy on economic growth. Therefore the Washington Consensus emphasises trade liberalisation as an instrument to achieve increased output for countries which have pursued an import substitution policy. The Post-Washington Consensus stance on liberalisation is similar to its view on privatisation. Liberalisation is important; however, on its own it does not result in increased welfare and competitive markets – this requires a competition policy and an overhaul of the regulatory system (Stiglitz 1998: 15). Liberalisation that simply implies the shifting of rent from the government to a monopoly importer does not contribute to increased welfare. Thus, it is not sufficient to liberalise if competitive markets are not created at the same time. LIBERALISATION IN MOZAMBIQUE

Extensive trade liberalisation and reforms of the import tariff structure have been one important part of PRE. In 1991 the number of tariff rates decreased from thirty-four to five, with the rates ranging from 5 to 35 per cent. It was followed in 1993 by a 25 per cent tariff ceiling on all products, and a 5 per cent reduction in tariffs on inputs (IMF 1996: 30). The government simplified the trade regime and lowered nominal tariffs in November 1996. After the implementation of a new tariff structure, the average nominal tariff structure was 10.8 per cent, which implied a fall of 7.9 per cent (World Bank 1997a). By April 1999 the maximum import tariff rate will be reduced from 35 per cent to 30 per cent. The reform programme has also addressed the problem of the extensive exemptions from trade taxes. Tax exemptions fell from 44 to 23 per cent between 1996 and 1997. However, the problem remains in spite of the abrogation of several decrees providing for exemptions from custom duties. Examples of imports exempted from tariffs are capital goods for investment and imports financed by foreign aid. Another category of exemptions is those authorised by the Ministry of Finance. As part of the customs reform programme, the management of customs was concessioned to the Crown Agency in 1996, resulting in increased customs revenues during 1997. However, the full year target was not achieved, which can be explained by delays in the implementation of customs reforms (LME 1998: 4). These reforms, aimed at improving customs effectiveness and revenue collection, include measures such as recruiting new customs personnel, improving the technical

Post-Washington Consensus in Mozambique 175 capacity, and the establishment of a full reconciliation system of taxes due (World Bank 1997b: 19). In line with the Policy Framework Paper 1997–9 (PFP), trade policy aims at continuing the rationalisation of import tariffs through:




revision of import tariffs and limiting of tax exemptions correction of misclassification in the tariff code reduction of dispersion in import duties.

Post-Washington Consensus instruments Privatisation and liberalisation constitute the core of the Washington Consensus reform concept. Even though Stiglitz does not view privatisation and liberalisation as unimportant, he claims that these reforms are not sufficient to achieve economic growth, and require modification. Indeed, if the Washington Consensus instruments are carried too far they can even act as obstacles to the establishment of competitive markets and an efficient financial system. Competitive markets The Fundamental Theorems of Welfare state that a second condition for an efficient market economy is, besides private property, the existence of competitive markets. However, while the Washington Consensus emphasises privatisation and thereby the private property conditions, it does not place the same importance on the creation of competitive markets. These, the Washington Consensus assumes, will emerge more or less automatically as a side effect of the reform process. Stiglitz, on the other hand, stresses that liberalisation or privatisation of the economy are not the same as the creation of competitive markets. Instead, he emphasises that explicit measures to create competitive markets are essential parts of a reform programme. Furthermore, contrary to the Washington Consensus, Stiglitz argues that government has a key role in providing the necessary regulation for the creation and protection of competitive markets. Business and trade in Mozambique are regulated by the Commercial Code of 1898, which is to a large extent obsolete. A timetable for the revision of the Code was to be submitted to the Council of Ministers in June 1997, but was delayed. In March 1998 Parliament passed a temporary commercial code pending the new Commercial Code (Canadian High Commission Mozambique 1998b). In 1997 the government’s action plan for the removal of administrative barriers to investment and enterprise entry was adopted. The PFP (World Bank 1997a) lists the following strategies and measures that are or will be taken in order to improve the business and investment climate:


On the basis of the World Bank red tape analysis (World Bank 1996), company registration procedure will be simplified. For this purpose an inter-ministerial working group has been set up under the leadership of the Minister of Industry, Commerce and Tourism (MICTUR) (LME 1998: 5).

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From crisis to growth in Africa? The government has taken measures to simplify the procedure of obtaining commercial and trading licences. The deregulation serves the purpose of stimulating rural trading and agricultural marketing activities (LME 1998: 5). From having been an investment approval agency, the functions of the Investment Promotion Office (CPI) are now exclusively investment promotion.

Financial reforms Research has shown that macroeconomic development not only depends on traditional countercyclical monetary and fiscal policy, but also on the existence of a working microeconomic foundation. Thus, one instrument for stabilising output and employment is a functioning financial system. According to Stiglitz (1998: 11), ‘clearly building robust financial systems is a crucial part of promoting macroeconomic stability’. Stiglitz claims that the occurrence of such a system may be more important than low inflation and budget deficits in achieving macroeconomic stability, since ‘major economic downturns in developed countries resulted from financial panics’ (Stiglitz 1998: 10). Besides contributing to macroeconomic stability, financial markets serve a number of other purposes important for the efficient working of an economy. Financial markets collect capital from economic agents with a surplus and allocate it to investments with the highest return. Through providing information, reducing risk and increasing liquidity, financial markets make the economy run more smoothly (Stiglitz 1998: 11). As in the case of securing the existence of competitive markets, the PostWashington Consensus attributes a role to government in the creation and upholding of financial markets. Since market failures are especially severe in the financial sector, it is important that the government creates ‘a sound legal framework combined with regulation and oversight’ (Stiglitz 1998: 11). According to Stiglitz (1998: 12), regulation serves four purposes: maintaining safety and soundness, promoting competition, protecting consumers, and ensuring that underserved groups have some access to capital. FINANCIAL REFORMS IN MOZAMBIQUE

The substantial devaluations of the metical at the end of the 1980s were the first steps towards a reform of the financial sector in Mozambique. Further reforms followed soon after, including the liberalisation of interest rates and the unification of the exchange rate (IMF 1998: 8). One of the most important changes in the financial sector has been the transformation of the Bank of Mozambique from simply a tool of the government for subsidising loss-making state-owned enterprises into a modern central bank. The privatisation of the banks has been particularly important for the modernisation of the Bank of Mozambique. Through its focus on monetary control, the purpose of the Bank of Mozambique is to contribute to lower inflation, increased growth, and balances in the external accounts, i.e. the same goals as the Washington Consensus.

Post-Washington Consensus in Mozambique 177 To improve monetary control, the Bank of Mozambique is increasing bank supervision, reforming financial legislation, and monitoring the credit operations of the commercial banks (IMF 1997: 48). Money growth is primarily controlled by the use of direct monetary instruments such as credit ceilings of net domestic assets. At present, the Bank of Mozambique uses quarterly ceilings on an indicative basis, and plans also to make the semi-annual ceilings indicative. The bank gradually expects, however, to be able to abandon direct monetary instruments for indirect instruments, such as free market operations and compulsory reserves. As well as the introduction of indirect instruments, the government’s financial plan for 1998–2000 suggests a number of changes that will deepen and widen the capital, money and foreign exchange markets, e.g. improvements in the payment system and measures for developing a sound banking system. In this process the creation of two inter-bank markets, one for money and one for foreign exchange, are important steps. In the money market, created in October 1997, government papers such as Treasury and Central Bank bills are traded. The intention was that the inter-bank foreign exchange market should be used both for the disbursements of foreign aid and for the trade in free funds. However, the foreign exchange market consists almost exclusively of donor funds, since the thin market makes the commercial banks reluctant to use it for their scarce free funds. The market for donor funds is not operating properly either due to complicated and time-consuming procedures (for a presentation of the allocation mechanism of foreign exchange, see Disch et al. 1998: 15). In addition, not all imports are eligible for donor funds; for example, soft drink and beer companies are excluded. Since foreign exchange from donor funds is cheap, the banks earlier bought more from these funds than their immediate need in order to supply important customers. However, since March 1998 proof of finality in the form of documentation is necessary. In 1992 the banking system was dominated by two state-owned banks, Banco Commercial de Moçambique (BCM) and Banco Popular de Desenvolvimento (BPD), which together controlled 90 per cent of the market. In the process of reforming the financial sector, the government began to analyse the possibilities of privatising these banks, with the result that BCM was privatised in 1996. The privatisation was successful with an immediate cut in net domestic assets (Table 10A.3). In 1997 the bank reform continued with the selling off of the BPD. The privatisation implied improvements in the efficiency of the banks both in terms of information system and operation. At the privatisation of BCM, as with other privatisations, the government retained 20 per cent of the shares with the intention of selling them to the employees. Alongside banks, other financial institutions such as venture capital funds and leasing enterprises are developing (Disch et al. 1998: 20). A stock exchange, Bolsa de Valores, is planned to open later this year. Initially, the shares of only a limited number of companies will be listed on the exchange, but the intention is to expand trading to include shares of the privatised companies (Disch et al. 1998; Swedish Development Advisers 1998). In Mozambique the micro credit institutes have been criticised for not being sufficiently professional; for example, credit losses have been

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From crisis to growth in Africa?

incurred due to inadequate following up of the financial performance of borrowers. Alongside the formal institutions, traditional lenders constitute an important source of capital. Even though when privatised 90 per cent of all enterprises were sold to domestic investors (UTRE 1998: 6), the share of domestic capital invested in Mozambique is low. It could be argued from a purely economic point of view that it is irrelevant who invests as long as someone is investing. Psychologically, however, it can be important. The low level of domestic investment has given rise to concern and a number of possible explanations have been put forward. High interest rates and large collateral requirements have resulted in only a small number of local investors being able to afford bank credit. Other explanations of the low volume of credit are insufficient knowledge and practices in accounting and business management, high costs of registering loans and deficiencies in the judiciary system (IMF 1998). Although shortcomings in the financial system to a large extent explain the low number of local investors, this does not provide the entire explanation. Other possible causes are:






The lack of a capitalistic class in Mozambique. For historical reasons a domestic entrepreneurial class has not developed in Mozambique. This has been described as a hangover from the socialist era, with many people still embracing the socialist way of economic thinking. Arbitrary rules and a high level of corruption in the civil service deter potential investors. Structural factors such as the lack of infrastructure, means of communication, markets and information.

It is however important to point out that the solution to the problem with too few private Mozambican investments is not that the public sector attempts to play the role of an entrepreneur. Instead it is of utmost importance that a Mozambican entrepreneurial class develops. Probably one of the best ways to achieve this goal is to facilitate for foreign investors and entrepreneurs, which through serving as example and through providing on-the-job education can contribute to an increase in the number in local entrepreneurs. Government regulations In contrast to the Washington Consensus, which more or less explicitly assumed that economic reforms in combination with a minimum of government interference would result in economic growth, the Post-Washington Consensus attributes an important role to the government in the development process. The role of the government in creating competitive markets through regulation has already been analysed. We now turn to the role of the government as a protector of private property. Privatisation does not imply the end of government involvement since it must also guarantee property rights in order to attract buyers. Potential investors must be assured that they can keep the results of their investments.

Post-Washington Consensus in Mozambique 179 Similarly, to promote trade, laws and regulations covering all aspects of business life must be put in place. Developing countries, and in particular countries with limited experience of market economy conditions, often lack these laws and regulations, and thereby also the security they provide. It is also important that regulations are formulated to facilitate both the entering and operation of new companies in the market. Furthermore, registration procedures must be neither too complicated nor the fees too high. These questions are also related to the issue of creating competitive markets, since a requirement of competition is that a sufficient number of companies enter the market. Besides creating appropriate laws and regulations, Stiglitz (1998: 23) sees other missions for government, examples of which are industrial policy, social protection and welfare. It is also the task of government to correct market failures resulting from imperfect information and incomplete markets. Finally, although Stiglitz attributes an important role to government, he also emphasises that the government should not get involved in all kinds of activities, but instead focus on what it can do best. There should be a division of tasks between government and the private sector. Government should provide services and an institutional framework that facilitates private sector activities, i.e. government and the private sector should be considered complementary rather than substitutes. In Mozambique unclear and obsolete rules and regulations provide opportunities for state officials to gain additional ‘incomes’. Corruption is widespread not only among civil service officials but also within the police. The parliamentary Legal Affairs Commission goes so far as to state that ‘the cancer of corruption was spreading in these same institutions which are entrusted with upholding the law’. In spite of this acknowledgement last year, the Assembly of the Republic has rejected an independent anti-corruption authority (Canadian High Commission Mozambique 1998a). The World Bank red tape analysis (World Bank 1996) acknowledged the problem in the Mozambican civil service, and on the basis of its conclusions measures have been taken to restructure the civil service. A new labour law in progress will replace the 1985 law. However, controversial issues in the new law about holiday payments, strike rights, overtime and the right to employ foreign workers have caused debate within the ruling Frelimo party (Canadian High Commission Mozambique 1998b). There are plans to increase the skills of employees in the state sector through education and on-the-job training. In addition, a new system for promotion in the civil service is planned for 1999. The government’s civil service reform strategy includes a wage reform which will bring about a decompression of wages. The decompression procedure, taking place in two stages during 1998 and 1999, will bring the ratio of highest to lowest salaries from 1 to 9 before the reform to 1 to 20 in the year after. The intention of this reform is both to attract and keep skilled personnel and to provide incentives for education (Canadian High Commission Mozambique 1998b). Human capital Research has shown the importance of human capital in achieving sustainable growth. However, since education is a public good the market tends to underprovide

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it. Therefore, one of the most important purposes of government is to provide appropriate conditions for the generation of human capital, i.e. to create and supply schools and other educational institutions. The education and health systems reflect the fact that Mozambique is one of the poorest nations in the world, with a life expectancy at birth of 46 years (UNDP 1997). In 1994–5, of the total population only 28 per cent had access to safe water and 23 per cent to sanitation. The illiteracy rate for adults was 60 per cent in 1994 (UNDP 1997). There is a lack of school buildings, teachers and educational materials, suggesting that many children do not get the education they are entitled to. In 1993 primary and secondary school enrolment was 51 per cent and 6 per cent, respectively, for girls, and 69 and 9 per cent for boys. The corresponding figures for the whole of sub-Saharan Africa were 65 and 22 per cent for girls, and 78 and 27 per cent for boys (World Bank 1997b). Similarly, the supply of doctors, nurses, and medical centres and equipment is far from adequate. Both the government and the donor community have shown commitment at Consultative Group meetings to improve the situation. In the Economic and Social Programme (PES) for 1998 the government announced that expenditure on the social sector, including education and health, will increase. Absolute expenditure on education and health increased considerably during the reform period 1987–97. The reason was the strong growth of the economy, which explains 74 per cent of the total increase in expenditure (IMF 1998: 59). However, spending on education in relation to GDP has been static. Average expenditure on education in relation to overall expenditure is only marginally higher for the period 1993–7 than for the entire reform period 1987–97, although from 1995 an increase is observable. Similarly, expenditure on health both in relation to GDP and overall expenditure has also been static throughout the reform period (see Table 10.3). Although investment in human capital is made in Mozambique, it is insufficient for the immense needs of the country. It would be desirable to increase expenditure in this sector in order to generate the human capital required for the future growth of the country. However, as with all expenditure, there is an alternative cost to spending on education and health. It is not obvious that limited resources are best spent on education. There might be other investments that give a higher return and better satisfy the immediate needs of the country. Transfer of technology As with human capital, research and development is an important instrument for achieving high growth. However, the costs of investing in research and development are high, and investments take a long time to materialise. Rather than expensive investment in research and development, a better method for developing countries is to acquire new technology through technology transfer from developed countries. The sources through which developing countries can obtain technology are primarily foreign aid in the form of technical assistance, and direct investment. Since most of Mozambican agricultural and non-agricultural production is low tech, there is obvious potential for technology transfer. Until now foreign aid has

Post-Washington Consensus in Mozambique 181 Table 10.3 Expenditure on education and health, 1991–7

In per cent of GDP Current expenditure on education Current expenditure on health Total expenditure on education Total expenditure on health

1991

1992

1993

3.2

3.3

2.7

1.5

1.8

3.7 1.7

1995

1996

1997

2.2

2.7

2.8

3.3

2.9

2.7

1.4

1.1

1.3

1.2

1.6

1.3

1.3

4.0

3.1

2.9

3.1

3.1

3.6

3.4

3.2

2.1

1.6

1.4

1.5

1.5

1.8

1.6a

1.6

12.0

9.6

16.2

17.4

17.5

13.4

14.5

6.5

4.8

7.6

7.8

8.3

6.3

7.0

6.1

7.9

9.0

9.0

7.7

In per cent of current expenditure Current expenditure 14.2 13.7 on education Current expenditure 6.9 7.5 on health

In per cent of total expenditure and net lending Total expenditure 7.9 8.4 7.4 on education Total expenditure 3.7 4.3 3.8 on health

1994

3.0

3.9

4.3

4.4

Average 1987–97

a

3.8

Average 1993–7

7.9 3.9

a 1989–97. Sources: Ministry of Planning and Finance and IMF.

been the primary source; however, foreign investment in Mozambique is increasing. In particular, high expectations are bound up to the spin-off effects of the so-called mega projects. As yet, only the US$ 1.2 billion aluminium smelter, Mozal, is launched. From Mozal the Mozambican state will receive only 1 per cent of the expected US$ 400 million annual turnover in royalties and the employees are granted a 50 per cent tax exemption; however, it is hoped that the project will generate the equivalent of 10 per cent in linkage effects. These linkage effects consist of employment opportunities for 800–900 workers in activities related to Mozal. So far US$ 6 million has been spent in developing the linkage activities. The construction of Mozal will employ 5,000 people, which will contribute US$ 1 million to the local economy per day. Other projects in the pipeline that may involve technology transfer include Maputo steel and Pande gas, the reduction of iron ore from South Africa, new investment at Cahora Bassa, and the rehabilitation of the Moatize coal mine (Sida 1998). Reforms in Mozambique: Summary This presentation shows that the Washington Consensus reforms of privatisation and liberalisation have to a large extent been implemented in Mozambique. The

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From crisis to growth in Africa?

banks and a majority of other state-owned enterprises have been privatised, and the trade structure has been liberalised. Turning to the Post-Washington Consensus reforms, there seems to exist an awareness of the importance of these more microoriented market economy and social sector reforms. However, the pace of implementation has been slow, with most reforms still at the planning stage, awaiting implementation, or progressing slowly, e.g. the delay in the revision of the Commercial Code, and the insufficient expansion of the education and health systems. The exception is the financial reforms, which have progressed rapidly. However, due to the impact of the bank privatisation, these reforms can also be considered part of the Washington Consensus concept. The focus on privatisation and liberalisation by the Bretton Woods institutions in particular, and also by the government and donors, explains much of the slower pace in implementing the Post-Washington Consensus reforms in Mozambique. One explanation for the one-sided concentration in Mozambique on Washington Consensus reforms is their focus on macroeconomic variables, which made them appropriate for solving the severe macroeconomic imbalances of the country. The reforms of the Post-Washington Consensus have been viewed as a secondgeneration type, i.e. reforms implemented after privatisation and liberalisation with the objective of consolidating the achievements attained.

3 Macroeconomic development in Mozambique Macroeconomic stability provides the confidence and predictability necessary for investment and economic growth. To maintain macroeconomic stability, the Washington Consensus emphasises the control of inflation, the budget deficit and the current account deficit. These three variables are directly linked to the development of interest rates and exchange rates, which are variables essential for investment decisions. By keeping inflation, budget and current account deficits low, it is possible also to maintain interest rates at low levels attractive to investors. In addition, these measures should help to stabilise the exchange rate and thereby decrease the risk of devaluation. Stiglitz claims that the Washington Consensus mixes goals and instruments. The emphasis on inflation and the budget and current account deficits implies less concern for economic growth and employment, which are the true goals of economic policy. Furthermore, as shown above, according to the Post-Washington Consensus, inflation and the budget and current account deficits are not the only or even the most important determinants of economic growth. Other variables such as the existence of competitive markets and a functioning financial system are at least as important. In this section, the development of the Washington Consensus target variables and other macroeconomic indicators during the Mozambican reform period are analysed. We compare how these variables have developed in comparison with their values in 1986, the year before the Economic Rehabilitation Program (PRE) was launched.

Post-Washington Consensus in Mozambique 183 When analysing Mozambican economic variables there are problems with the quality of the data and the low number of observations. As a result, it is important to treat any conclusions with caution. This problem was addressed in 1996 when a Master Plan of Statistics was approved and an independent National Statistics Institute (INE) was set up. In support of the INE a Statistical Strengthening Program (SSP) was approved. On the basis of the Household Budget Survey from 1996, an analysis has been carried out with the results presented in the Poverty Assessment (1998). However, at the time of writing this report the figures from the survey were not available. In the analysis we have used existing data series based on statistics from the Mozambican government, the Bank of Mozambique and the IMF. Monetary policy Up to the privatisation of the first state-owned bank in 1996, the BCM, Mozambican monetary policy was expansive. The privatisation of BCM in 1996 resulted in improved monetary control and thereby better possibilities for the Bank of Mozambique to implement a tighter monetary policy. The increase in broad money (M2) fell from 38 per cent in 1995 to 20.3 per cent in 1996. In spite of the tightening of the monetary policy, net foreign assets were allowed to increase and instead the adjustment was accommodated through a decrease in net domestic assets. Primarily it was credit to the government (which met its debt repayment requirements to the Bank of Mozambique) that was curtailed, while increases in credit to the private sector remained at a high level. Thus in 1997, in response to increased money demand and an increase in the money multiplier, the Central Bank allowed broad money (M2) to increase by 25.4 per cent and credit to the private sector by 47.6 per cent. Liberalisation of interest rates has been an important part of the financial sector reforms (IMF 1998: 8) and has suggested the creation of a direct link between monetary policy and interest rates. In spite of the sharp fall in inflation, interest rates have remained. This combination of high nominal interest rates and low inflation has resulted in high real interest rates. Not surprisingly, there are differing explanations for this. While the commercial banks claim that monetary policy is too tight, there is a widespread view among investors that bank competition is insufficient. However, the decrease in interest rates during 1997 from over 40 per cent to the current level indicates that the high real interest rates at present are a passing phenomenon that may disappear when the market feels confident that the low inflation rate will pursue. The fact that the gap between the nominal exchange rate and inflation has narrowed since the end of 1997 also supports this view. Price development Perhaps the most remarkable result of the reform programme has been the curbing of inflation. The inflation rate fell from 41.0 per cent in 1986 to 5.8 per cent in 1997. However, the road to low inflation has not been straightforward. The reform programme initially resulted in higher inflation – as late as 1995 the rate was 57 per cent. During the first years after the launch of the reform programme, the rise

184

From crisis to growth in Africa?

in the rate of inflation can be explained by the inflationary effects of the large devaluations of the metical and the deregulation of prices, and thereafter by the expansive monetary policy (IMF 1998: 8). However, the restructuring of the financial system, including the privatisation of the state-owned banks and companies, resulted in 1996 in a tightening of monetary policy which led to a sharp fall in inflation to 16.6 per cent (IMF 1998: 8). And, in spite of pessimistic forecasts predicting a rise in inflation due to the El Niño effects, inflation is still coming down. Thus, the twelve-month inflation rate measured from April 1997 to April 1998 was 1.5 per cent, with the inflation rate from the beginning of 1998 to May 0.5 per cent (Bank of Mozambique). As well as a stricter monetary policy, the low rate of inflation can be explained by factors such as an exchange rate that has stabilised against the dollar and several good harvests.

Exchange rate development Before the reform programme, the metical was heavily overvalued with a parallel market rate forty times the official rate (IMF 1998: 34). As a result of a large number of devaluations, unification of the official, market and parallel exchange rates was achieved in 1992. The metical continued to depreciate against the dollar also after the exchange rate became market determined in 1993 (IMF 1998: 34). However, this depreciation slowed, and since the third quarter of 1995 there has only been a minor loss against the dollar, while the metical has appreciated against some of the currencies of its most important trading partners, for example South Africa. The combination of low inflation and one of the strongest currencies in Southern Africa has led to an appreciation of the real exchange rate. Figure 10.1 shows a real exchange rate appreciation of the metical during the last two years. This appreciation should be a matter of concern since it implies a loss in competitiveness with Mozambique’s trading partners and thereby also an obstacle to improving the current account. The overall low competitiveness of the Mozambican economy was confirmed by the African Competitiveness Report in which Mozambique was ranked eighteenth of twenty-three African countries (Canadian High Commission Mozambique 1998b).

Fiscal development The budget deficit is the Washington Consensus target variable that has shown least improvement since the launch of the reform programme. In 1986 the fiscal deficit before grants was close to one-quarter of GDP (IMF 1998: 8). Total Mozambican budget expenditure is still considerably larger than revenues which, in 1997, left Mozambique with a budget deficit before grants amounting to MT 4514 billion or one-fifth of GDP. Grants received are the most important source for financing the budget deficit (Figure 10.2). In 1997 almost two-thirds came in the form of project aid while the rest was primarily made up by countervalue funds from the balance of payments support. To finance the deficit after grants the government relies on

Post-Washington Consensus in Mozambique 185 110 100 90 80 70 60 50 1990 1991 1992 1993 1994 1995 1996 1997

Figure 10.1 Real effective exchange rate, 1990–7 (1990:100). Sources: Bank of Mozambique and IMF. 30

25

20

15

10

5

0 1990

1991

1992

1993

Overall deficit before grants Grants received

1994

1995

1996

1997

Overall deficit after grants

Figure 10.2 Overall deficits and grants received in % of GDP, 1990–7. Sources: Mozambican authorities and IMF estimates.

external borrowing. During the last five years external borrowing has covered between 20 and 30 per cent of the deficit. Since 1994 external borrowing has been large enough not only to cover the budget deficit but also to make net repayments to the banking system.

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From crisis to growth in Africa?

Even though the budget deficit remains large, there have been significant structural improvements both on the expenditure and the revenue side. Privatisation has resulted in that subsidies to state-owned companies have decreased considerably, thereby making more resources available for the social sectors. In 1998 only 0.5 per cent of the total state budget was allocated to state-owned companies. On the revenue side, there have been significant improvements in the collection of taxes, for example through the privatisation of the customs services. The improvements in tax collection together with economic growth explain the increase in revenues by an average of 48 per cent during the last five years. By comparison, the current expenditure during the same period increased by less than 43 per cent. In 1997, however, current expenditures increased at a higher rate than revenues. One reason behind the increased expenditure is the requirement from donors that Mozambique should contribute to the current expenditures of aid projects (see Table 10.4). Total expenditure is more or less equally divided between current and capital expenditures; the latter, however, increased at a somewhat higher rate during the last five years. The current balance has shown a small surplus during the last three years (Figure 10.3). A problem when analysing the current budget is that a number of current expenditures are registered in the capital budget, which suggests that current expenditures appear smaller than they really are. Donors contribute to the problem by not letting all aid pass through the budget. The new budget law would suggest an improvement since it implies a breakdown of revenues and expenditures into sub-categories. As a result, transparency increases and thereby the opportunities for rent seeking decrease. The goal is that the state should be able to balance its overall budget. One measure taken to achieve this is the planned introduction of a value-added tax (VAT) system. It can be expected that the implementation of VAT will be a challenging task, considering the large informal sector in Mozambique. Another way to increase revenues is to decrease tax exemptions. Large tax exemptions are a problem both with trade taxes and in investment in the mega projects. Table 10.4 Government finances, 1993–7 (annual percentage changes)

Total revenue Tax revenue Non-tax revenue Total expenditure and net lending Current expenditure Capital expenditure Grants received External borrowing (net)

1997

Average 1995–7

Average 1993–7

31.8 32.6 22.7 34.3

44.7 45.1 40.6 30.5

47.8 49.8 33.2 44.9

37.9 31.3 40.8 35.7

29.7 31.5 21.0 36.0

42.6 49.4 32.4 78.9

Sources: Mozambican authorities and IMF estimates.

Post-Washington Consensus in Mozambique 187 50 45 40 35 30 25 20 15 10 1990

1991

1992

1993

1994

Total expenditure and net lending Current expenditure

1995

1996

1997

Total revenue

Figure 10.3 Budget revenue and expenditure, 1990–7. Sources: Mozambican authorities and IMF estimates.

External balance After a growth in exports of almost 30 per cent in 1996, the 3.7 per cent growth rate in 1997 was disappointing. This low rate of export growth is primarily explained by the poor development of cashew exports (IMF 1998: 9). In addition, the value of cotton exports decreased in 1997 due both to a fall in prices and a decrease in the export volume. As in previous years, revenues from the prawn fishing industry were the most important source of export income in 1997. However, the sizeable catches – a consequence of generously granted fishing concessions last year – are expected to result in a decrease in prawn stocks and therefore also a fall in future export incomes. The export of electricity from the Cahora Bassa dam is expected to generate large export earnings and substitute fishing as the most important source of export income. However, the restart of Cahora Bassa was delayed several times, and it was not until the end of 1997 that exports to Zimbabwe commenced. Exports to South Africa have not begun, however, due to ongoing negotiations between the Portuguese majority owner of the dam and the South African electricity producer Escom over the price of power (Canadian High Commission Mozambique 1998a,b). Another promising source of income, not yet fully exploited, are the revenues from extended transit trade. However, these export incomes have yet to materialise. At present, the Mozambican trade balance is heavily in deficit as a result of imports three times the

188

From crisis to growth in Africa?

900 800 700 600 500 400 300 200 100 0 1990

1991

1992

1993

Imports (c.i.f.)

1994

1995

1996

1997

Exports (f.o.b.)

Figure 10.4 Exports and imports, 1990–7 (US$ million). Sources: Bank of Mozambique and IMF estimates.

value of exports in 1997. Nevertheless, there has been an improvement in the trade balance over the last five years, explained mainly by increased exports, and also by a modest decrease in imports (Figure 10.4). One reason behind the lower imports is increased import competition since privatisation and more efficient customs handling (IMF 1998: 9). However, even though border controls have improved, it can be suspected that much of the actual imports are not registered and accounted for due to smuggling and exemptions. The service balance is also negative, with the result that there is a current account deficit that in 1997 constituted 120 per cent of exports of goods and non-factor services. Still, this is a considerable improvement in comparison with 1986 when the current account deficit was more than three times the size of exports of goods and non-factor services (IMF 1998: 8). Between 1993 and 1997 the current account deficit decreased by a quarter. The current account deficit is sizeable also after grants have been included (in 1997 the current account deficit was 50 per cent of exports of goods and non-factor services). The major sources for financing the current account deficit have been foreign borrowing and debt relief. Economic growth The annual average real GDP growth in the period 1987–97 was 6.8 per cent. During the last five-year period economic performance has been mixed. After low

Post-Washington Consensus in Mozambique 189 Table 10.5 Gross output, 1993–7 (real rates of change)

Agriculture and livestock Industry and fishing Construction Transport and communications Services Gross output

1993

1994

1995

1996

1997

Average 1993–7

21.3

4.8

6.8

9.1

5.9

9.6

96.7 7 16.7

96.0 7.4 3.8

16.3 7.0 13.2

11.6 8.0 7.6

9.1 7.0 11.3

4.9 7.3 10.5

22.3 14.3

5.4 6.6

94.1 2.1

7.4 8.7

8.4 8.0

7.9 8.0

Sources: Ministry of Planning and Finance and IMF.

GDP growth at the beginning of the 1990s due to war and drought, in 1993 rains and the end of the war led to an 18.8 per cent increase. GDP growth rates were lower in 1994 and 1995 due to the overall poor performance of the economy. The economy recovered, however, and real GDP growth in 1997 was 7.9 per cent, and is expected to grow by around 10 per cent in 1998. New figures from INE indicate that the growth rate was as high as 12–13 per cent during 1997. In spite of differing rates of growth in individual years, the sector structure has remained largely unchanged during the period. Services and agriculture are the largest sectors, contributing 33 and 26 per cent respectively to gross output. Within the services sector, production services and government services are the most important, with each contributing around one-third of the total production value. The most important sector in terms of employment is agriculture, which employs 80–90 per cent of the working population (Cravinho 1998: 720). During the fiveyear period 1993–7 the transport and communications sector grew the fastest. The growth rate in agriculture was also high, though more unevenly distributed over the period (see Table 10.5).

Concluding remarks From the examination of the macroeconomic development, we conclude that most of the Washington Consensus target variables have had a positive development in Mozambique. Growth has increased, inflation has decreased, and budget and external balances have improved since the reform programme began in 1987. Furthermore, fresh statistics indicate that the economic growth rate has been even higher than previously thought. Table 10.6 summarises the development of the most important economic indicators. The obvious question that arises is whether these improvements are due to the reforms or to other factors such as the end of the war or climatic conditions. Obviously, without an end to the war it would be difficult to imagine any far-reaching economic improvements. Similarly, Mozambique’s economic development depends to a large degree on climatic effects on agriculture.1 New severe droughts or floods

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From crisis to growth in Africa?

Table 10.6

Macroeconomic indicators, 1990–7 (%)

Annual change CPI Real GDP growth rate Budget deficita /GDP Export growth Investment /GDP

1990

1991

47.1

35.2

1.0

1992

1993

1994

1995

1996

1997

Average Average 1990–7 1993–7

54.5

43.6

70.2

57.0

16.2

5.8

41.2

38.6

4.9

90.8

18.8

4.5

1.4

6.2

7.9

5.5

7.8

29.2

24.9

26.3

22.2

29.7

20.8

17.0

20.1

23.8

22.0

20.6 45.8

28.5 45.7

914.2 48.8

95.4 54.4

24.4 51.0

6.3 51.2

29.8 48.2

3.7 45.2

11.7 48.8

11.8 50.0

a Before grants. Sources: Mozambican authorities, IMF estimates, and Europe Publications Limited 1998.

are one of the greatest threats to future development. In Mozambique sustainable economic development is possible only if the basic requirements of favourable weather conditions and political stability are satisfied. However, it is difficult to imagine that the fulfilment of these conditions would have been sufficient to foster the last years’ economic progress given Mozambique’s structural imbalances and large inefficient public sector. To overcome these problems the Washington Consensus reforms have been necessary. The importance of the reforms is shown by the fact that it was not until the privatisation of BCM and the accompanying financial reforms that Mozambique saw significant economic improvements. The lowering of inflation and the improvement in the budget balances would not have been possible without the privatisation of banks and loss-making state-owned enterprises. Other important reform measures were the devaluations of the metical and trade liberalisation, which both explain the decrease in the current account deficit. Ultimately, the positive effects of these reforms and measures explain the increased efficiency of investments and the increase in GDP growth.

Post-Washington Consensus in Mozambique 191

Appendix Table 10A.1 Government finances, 1993–7 (in billions of meticals) 1993 Total revenue Total expenditure and net lending Current expenditure Current balance Capital expenditure Net lending Overall balance before grants Overall balance after grants External borrowing (net) Domestic financing

1994

1995

1,093 2,305

1,526 407

2,413 5,157

116 974 1,097 40 91,212 9280 204 76

1,978 9452 2,119 0 92,571 9714 788 974

2,188 225 2,863 106 92,744 9654 816 9162

1996 3,479 6,773

1997 4,584 9,098

3,077 4,244 402 340 3,669 4,817 27 37 93,294 94,514 91,003 91,288 1,377 1,869 9374 9581

Source: IMF (1998).

Table 10A.2 Balance of payments, 1993–7 (in millions of US dollars)

Trade balance Exports (f.o.b.) Imports (c.i.f.) Services (net) Current account (excluding grants) Unrequited official transfers Current account (including grants) Capital account Short-term capital and errors and omissions (net) Overall balance Financing Net foreign assets Net change in arrears (increase;) Financing gap Debt relief Source: IMF (1998).

1993

1994

1995

1996

1997

9697.9 131.8 9829.7 9126.6 9824.5

9717 164 9881 9147.3 9864.3

9552.7 174.3 9727 9124.1 9676.8

9556.5 226.1 9782.6 985.3 9641.7

9540.6 234.4 9775 974.3 9614.9

503.3

564.6

339.2

282.9

354.6

9321.2

9299.7

9337.6

9358.8

9260.3

99.7 11.3

63.8 23.2

238.6 57.7

163.3 18.8

9436.2 436.2 46 177.8

9298 298 952.4 147.3

9250.6 250.6 959.6 189.4

212.2 212.2

203.2 203.2

120.9 120.9

9107 98

962.5 978.2 62.5 78.2 9159.3 9136.6 964.5 93,932.7 286.3 286.3

4,147.5 4,147.5

192

From crisis to growth in Africa? Table 10A.3 Monetary survey, flows, 1993–7 (in billions of meticals)

Net foreign assets Net domestic assets Credit to the government (net) Credit to the economy Adjusted M2 flow Change in M2 stock

1993

1994

1995

1996

975 786 79 197 711 889

289 728 974 616 1,017 1,162

485 731 9137 825 1,217 1,739

2,102 91,105 9433 1,103 997 1,038

1997 1,701 9187 9605 1,697 1,515 1,511

Source: IMF (1998).

Notes I would like to thank Göte Hansson, Malin Krook, Maude Svensson and seminar participants in Maputo, at Sida in Stockholm and at the conference ‘From Crisis to Growth in Africa?’ arranged by the Stockholm School of Economics for valuable comments and suggestions. Further, I would like to express my gratitude to officials of the Mozambican Government and staff at different embassies and organisations in Maputo for providing valuable and useful information. 1 The large rains in the beginning of 2000 acted as a reminder of this fact. Even though the immediate costs of these rains in the form of human suffering have been huge, it is still too early to estimate fully their consequences for the pace of reforms. Undoubtedly they can be expected to delay the implementation of some reforms; however, it is probable that their long-term effects will be smaller than initially feared.

References Canadian High Commission Mozambique (1998a), Mozambique: Political and Economic Overview Fourth Quarter 1997, Maputo. Canadian High Commission Mozambique (1998b), Mozambique: Political and Economic Overview First Quarter 1998, Maputo. Cravinho, J. G. (1998), ‘Mozambique – Economy’, in Africa South of the Sahara 1998, Europa Publications Limited. Disch, A., Engström, L., Kappel, R. and Laursen, J. (1998), Aide-Memoire, Joint Review of Balance-of-Payments Support, Copenhagen. Falck, H. (1997), Aid and Economic Performance – The Case of Tanzania. Lund: Lund Economic Studies. Financial Times (1997), ‘Survey Mozambique’, 25 June 1997. Government of Mozambique, Edvardo Mondlane University, and the International Food Policy Research Institute (IFPRI) (1998), Understanding Poverty and Well-Being in Mozambique; The First National Assessment (1996–97), Maputo. International Monetary Fund (1996), Republic of Mozambique – Recent Economic Developments. Washington, DC: IMF. International Monetary Fund (1997), Republic of Mozambique – Request for the Second Annual Arrangement under the Enhanced Structural Adjustment Facility. Washington, DC: IMF. International Monetary Fund (1998), Republic of Mozambique – Selected Issues. Washington, DC: IMF.

Post-Washington Consensus in Mozambique 193 LME – Like Minded Economists Group Maputo (1997), Mozambique: Political and Economic Overview Quarter Three 1997, Maputo. LME – Like Minded Economists Group Maputo (1998), Mozambique: Political and Economic Overview Quarter Four 1997, Maputo. Republic of Mozambique (1997), The Challenges Ahead (April). Sachs, J. (1996), Meeting with Donors, 16 January 1996, Maputo. Sida (1997), Half-Yearly Report Mozambique October 1996–March 1997, Maputo: Embassy of Sweden. Sida (1998), Half-Yearly Report Mozambique April 1997–October 1997. Maputo: Embassy of Sweden. Stiglitz, J. (1998), More Instruments and Broader Goals: Moving Toward the Post-Washington Consensus, The 1998 WIDER Annual Lecture, Helsinki. Swedish Development Advisers (1998), A Stock Market for Mozambique – Where is it Heading and What can Sida Do to help?, Gothenburg. UNDP (1997), Human Development Report 1997. Oxford: Oxford University Press. UTRE (1998), Privatisation in Mozambique – 1998 – Consolidating the Gains, No. 05/March, Maputo. World Bank (1996), Mozambique – Administrative Barriers to Investment: The Red Tape Analysis. Washington: World Bank. World Bank (1997a), Mozambique: Policy Framework Paper. Washington: World Bank. World Bank (1997b), World Development Report 1997 – The State in a Changing World. Oxford: Oxford University Press.

11 Investment, productivity growth and structural adjustment in Zimbabwe Dick Durevall

1 Introduction Zimbabwe’s Economic Structural Adjustment Programme (ESAP) was launched in the beginning of 1991. Since then economic policy has changed considerably as the old import-substitution regime, which emphasised development through government interventions and controls, has been replaced by a market-oriented development strategy. The primary objective of ESAP was to improve living conditions through rapid and sustainable economic growth. To achieve this, the economy was to become more competitive and productive, which was expected to occur as liberalisation led to a recovery of investments and more efficient resource allocation (Government of Zimbabwe (GoZ) 1992). The impact of structural adjustment so far can at best be described as mixed, and it is clear that the Zimbabwean economy has not yet embarked on a sustainable, high-growth process. The purpose of this chapter is to evaluate the impact of liberalisation on economic growth in Zimbabwe. To do this we analyse the development of two important determinants of economic growth: capital formation and productivity. An understanding of their roles in the growth process is essential when discussing the future development of Zimbabwe. Thus, we first review the evolution and composition of capital formation during the 1990s, and evaluate the importance of different forces driving investments. Then the development of labour, land and total factor productivity in various sectors is analysed. Labour supply changes, which also might influence economic growth, are not dealt with here since they are likely to have been of minor importance during ESAP. Nevertheless, the rapid spread of HIV and AIDS is having an impact, and during the next decade this will certainly reduce the supply of both skilled and unskilled workers significantly. The following section briefly discusses the implementation of ESAP and some of the outcomes. In Section 3, capital formation and its determinants are reviewed in some detail for the period 1985–97. Section 4 focuses on productivity, both at a national level and in manufacturing and agriculture. The chapter is concluded with a discussion about the conditions needed for creating sustainable growth during the next decade.

Structural adjustment in Zimbabwe 195

2 ESAP: A brief overview Although the 1980s began on an optimistic note with an economic boom following independence, it turned out to be a disappointing decade. As a consequence, the Zimbabwean government decided to initiate an economic reform programme designed to reorient the economy away from socialist transformation, which had been the stated goal, towards market-driven development. The overall objectives of the programme were outlined in the government document ‘A Framework for Economic Reform, 1991–95’ (GoZ 1992). These were trade liberalisation, deregulation of domestic markets, public sector reform, implementation of a social dimension programme, and macroeconomic stabilisation. Trade liberalisation, the centrepiece of the reform programme, consisted of dismantling government control over allocations of foreign exchange and import licenses, and a tariff reform. It was to be carried out gradually over five years by sequentially putting import goods on an Open General Import License (OGIL) list: such goods could be imported in any quantity without import permits. However, in 1993 the programme was altered and the Export Retention Scheme (ERS) was introduced as the main policy instrument. It allowed exporters to retain part of their export earnings in the form of import certificates and sell these at a market determined price. The final step was taken in January 1994, when OGIL, ERS and what remained of the system of discretionary allocation of foreign currency were abolished, unifying the official and parallel exchange rates. This regime lasted until 1998 when the Zimbabwe dollar came under severe pressure. As a result there was a policy reversal at the end of 1998; the exchange rate was fixed by moral suasion, import tariffs were raised, and some measures were taken to limit capital flows. The creation of a foreign exchange market implied that restrictions on domestic demand for imports disappeared, exposing local companies to foreign competition. For many producers competition was made worse by slow progress in tariff reform, and the fact that ad hoc changes had made import tariffs for several final products lower than for intermediate inputs used in the production of these goods. It was not until 1997 that a new tariff system, that remedied these deficiencies, was put in place. The deregulation of the domestic markets included removal of widespread price controls in the goods market, reduction of government’s involvement in wage setting and introduction of new labour regulations making it cheaper and easier to retrench employees, and liberalisation of the financial markets. Substantial progress was made in all these areas. Practically all price controls were abolished, although some prices continued to be set by state-owned monopolies (e.g. petroleum), and there was a reintroduction of price controls on some basic food products at the end of 1998. The labour market has also undergone profound changes since 1991; wages are in general determined by collective bargaining, and retrenchment no longer requires ministerial approval. And in the financial markets most administrative controls have been removed. The majority of interest rates were deregulated already in 1991, and lately new companies have entered the financial market, increasing competition considerably.

196

From crisis to growth in Africa?

Public sector reform was one of the components of ESAP that did not advance according to plan. It was focused on ten large public enterprises that together had a deficit that averaged 4 per cent of GDP during the last four years of the 1980s. Although steps were taken to improve efficiency and reduce losses, by permitting private sector competition, granting managerial autonomy and allowing cost-based pricing, it was not until after 1995 that government subsidies to public enterprises became negligible and serious progress was made toward privatisation. However, during 1998 a setback was recorded when some public enterprises started making losses again as a result of the political and economic turmoil (see ‘Good governance, external shocks and uncertainty’ in Section 3). The social dimensions programme was intended to protect poor and vulnerable groups likely to be affected by the implementation of ESAP. To achieve this, a Social Development Fund was set up to pay education and health fees for the poor, retrain retrenched workers, and stimulate the establishment of small enterprises. It also financed collection of data on households for ascertaining changes in the welfare status of vulnerable groups. It is generally agreed that the Social Development Fund has not been as effective as expected. The results of the macroeconomic stabilisation part of the programme are summarised in Table 11.1. It reports the projections made in ‘A Framework for Economic Reform, 1991–95’ for several key macroeconomic indicators and the actual outcomes. The principal goals of macroeconomic stabilisation were to cut the budget deficit from 10 per cent of GDP to 5 per cent, reduce inflation from 16 per cent to 10 per cent, and maintain a sustainable external sector. The budget deficit, in per cent of GDP, initially declined to 8.5 per cent. But drought and low tax revenues resulted in an increased deficit in 1992/3, and at the end of ESAP it had gone up to 11.2 per cent of GDP. However, these figures are based on the old National Accounts, which underestimated GDP.1 When the deficits are related to the revised GDP measures published in 1997, they are lower; in 1995/6, for example, it is 8.6 per cent instead of 11.2 per cent. Nevertheless, during the latter half of the 1990s the budget target was missed every year resulting in deficits of around 10 per cent of GDP. Also inflation turned out to be much higher than planned. It rose rapidly during the first years of reform, and the yearly change in the GDP deflator was 28 per cent in 1992, twice as high as the target, while consumer prices peaked at close to 50 per cent. Tight monetary policy in 1993 and recovery in the agricultural sector then reduced inflation to about 20 per cent where it stayed until the end of 1996, that is, well above target. Inflation started to rise again during 1998, hitting 70 per cent in late 1999. In contrast, the performance of the external sector was quite satisfactory. Exports did not grow as quickly as planned but were 40 per cent higher in 1996 than in 1990, when measured in US dollars, and the trade account was in surplus during all years except in 1992, the year of the worst drought of the century. On the other hand, the current account deficit was larger than projected for most years, though it declined to a relatively low level in 1996. Nonetheless, in spite of these deficits the external debt service as a share of exports of goods and services was clearly lower in 1996 than in 1990 (20.5 per cent and 17.5 per cent, respectively).

Structural adjustment in Zimbabwe 197 Table 11.1 Macroeconomic indicators: actual and projected values Key indicator GDP growth rate (% ) GDP growth rate (% ) Budget def./ GDPa (%) Budget def./ GDPb (%) Budget def./ GDP (%) Inflation (GDP deflator) Inflation (GDP deflator) Exports (in US$ m) Exports (in US$ m) Imports (in US$ m) Imports (in US$ m) Trade balance (in US$ m) Trade balance (in US$ m) Current account (in US$ m) Current account (in US$ m) External debt service (as % of exports) Terms of trade (1990:100) Terms of trade (1990:100)

1990

1991

1992

1993

1994

1995

1996 7.3

Actual

7.0

5.5

99.0

1.3

6.8

0.1

Projected

4.2

4.3

4.4

4.6

4.8

5.0

Actual

7.4

6.4

6.7

9.6

6.4

12.3

8.6

Actual

10.2

9.8

8.5

11.5

7.6

12.5

11.2

9.4

8.2

7.2

6.5

5.6

5.1

Actual

14.7

30.6

27.6

22.0

24.4

18.0

19.8

Projected

16.0

16.0

14.0

12.0

10.0

10.0

—

Actual Projected Actual Projected Actual

1,753 1,688 1,512 1,333 241

1,783 1,825 1,700 1,606 85

1,530 1,892 1,781 1,746 9251

1,610 2,159 1,512 1,860 98

1,947 2363 1788 1986 169

2,217 2,593 2,128 2,115 89

2,499 — 2,213 — 286

Projected

355

218

236

299

378

478

9258

9547

9842

9311

9318

9369

Projected 9177

9348

9373

9358

9269

9269

21.5

27.8

28.7

24.2

19.5

17.5

95.7

92.1

89.4

94.8

98.4

99.0

99.0

99.0

99.0

—

Projected

Actual

Actual

20.5

Actual

100

Projected

100

110 91.5

—

—

— 9130 —

a Budget as a share of GDP calculated using the GDP from the revised National Accounts. The fiscal year ends in the year indicated. b Budget as a share of GDP calculated using the old GDP. The fiscal year ends in the year indicated. Notes: The projected series are from ‘Zimbabwe: A Framework for Economic Reform, 1991–95’. The sources for the other variables are Central Statistical Office (1998a,b), and various IMF and World Bank documents.

Table 11.1 also shows that economic growth was disappointing; the average projected value for the period 1991–5 was 4.6 per cent per year, while the outcome, based on the revised National Accounts, for 1991–6 was 2 per cent per year. Hence, the response of the Zimbabwean economy to ESAP does not seem to have been as good as expected. Negative external shocks, such as the drought in 1991/2 and declines in terms of trade (see Table 11.1), certainly contributed to this outcome – particularly during the first part of ESAP. During the period 1994–6 the performance was better, and the prospects for the rest of the decade seemed good. However, during the latter half of 1997 and 1998, a combination of policy-induced and external shocks resulted in a collapse of the Zimbabwe dollar and a drop of

198

From crisis to growth in Africa?

GDP growth to 3.7 per cent in 1997, 2.5 per cent in 1998 and 0.0 per cent in 1999 (see ‘Good governance, external shocks and uncertainty’ in Section 3).

3

Capital formation, 1985–97

Given the foregoing scenario, an interesting question is why the targeted growth rate was not achieved. This question can be answered in many different ways, one being that the target was too optimistic given the conditionality of the IMF (see Botchwey et al. 1998). Another way of looking at the issue is to use a traditional production function, which shows that growth in production is due to changes in inputs and in productivity. This is the approach used in the following sections, focusing on the proximate determinants of economic growth, changes in the capital stock and productivity growth, and the forces driving them. The growth and decline of investments Investments in physical capital are usually considered an important driving force behind economic growth. Historically they seem to be particularly important in Zimbabwe. According to Nziramasanga (1998), who estimated a production function for GDP, practically all growth prior to ESAP was due to capital accumulation. It is thus not surprising that one of the main concerns of the government during the 1980s was the fall in the propensity of the private sector to invest; it dropped from 11 per cent of GDP before independence to 8 per cent during 1985–7 (Jenkins 1998). In the following paragraphs we first review the growth of investments since 1985 using data from the revised National Accounts. Then we look at various determinants of investments. Table 11.2 shows gross fixed capital formation (GFCF) in real terms for five different assets. To increase the readability, the series were turned into indexes with the value set to 100 in 1990. Shortly before and during the first year of the reforms, the level of investments rose substantially. That is, total GFCF grew from 74 in 1989 to 123 in 1991. It then continued to be well above the levels of the 1980s until 1997, when there was a sharp drop that made investments return back to the 1990 level. When looking at the composition of the capital formation, the increase in ‘other equipment, plant and machinery’ is striking. It rose from an average of 86 during 1985–9 to 160 for 1990–5. By 1997 investments in equipment had declined to 134, but it was still well above the average for the 1980s. This increase is particularly noteworthy since international studies have shown that machinery is the most important component of capital formation for economic growth (DeLong and Summers 1991). Another asset that also shows a spectacular performance is transport equipment; in this case the rapid growth occurred during 1989–91, then there was a continuous decline back towards the levels of the 1980s. Hence, there is evidence of an investment boom in conjunction with the introduction of ESAP, which lasted up to about 1997. In this regard Zimbabwe differs from many other developing countries that saw declining investments after introducing structural adjustment programmes. To strengthen the support for this conclusion,

64 66 43 113 43 77

84 41 120 28 67

1986

60

1985

Source: Central Statistical Office (1998b).

Total gross fixed capital formation Residential buildings Non-residential buildings Civil engineering works Transport equipment Other equipment, plant and machinery

Type of assets

83 53 103 44 78

68

1987

111 57 944 55 147

75

1988

111 63 71 112 59

74

1989

100 100 100 100 100

100

1990

Table 11.2 Real gross fixed capital formation in different assets (1990:100)

110 92 129 142 147

123

1991

92 85 112 115 147

113

1992

82 95 115 102 169

121

1993

126 86 91 96 191

123

1994

99 79 117 95 202

126

1995

121 86 185 73 138

115

1996

100 71 146 55 134

99

1997

200

From crisis to growth in Africa?

data on investment – output ratios for total gross investments and investments in ‘asset equipment plants and machinery’ are shown in Figure 11.1. During the latter half of the 1980s, the ratio for total investments was hovering slightly above 15 per cent, a low level indeed. In the 1990s it first rose to 20 per cent, then to about 24 per cent, where it stayed until 1996 when it dropped, ending up at 18 per cent in 1997. Investments in ‘other equipment, plant and machinery’, which on average make up more than one-third of total investments, show a similar pattern with the exception of a spike in 1988. So far we have not distinguished between private and public sector investments. Making such a distinction is of interest because their respective developments are likely to differ, and private investments are believed to play a much larger role in the development process than public investments (Jenkins 1998). Figure 11.2 shows that the public sector’s share of total investments in general was well above 20 per cent

30.0 25.0 20.0

Total gross fixed capital formation Other equipment, plant and machinery

15.0 10.0 5.0 0.0 1985

1987

1989 1991 1993 1995

1997

Figure 11.1 Gross fixed capital formation as a share of GDP. Source: Central Statistical Office (1998b).

35

Total gross fixed capital formation ratio public–private sector

30 25 20 15 10 5 0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Figure 11.2 The share of public investment in total investments (in nominal values). Source: Central Statistical Office (1998b).

Structural adjustment in Zimbabwe 201 during the period 1985–90. Then its share declined, and for the ESAP period it was about five percentage points lower than in the 1980s, mainly as a result of increases in private investments. However, in 1996 the ratio dropped to 8 per cent due to a sharp contraction in public investments; total GFCF as a share of GDP declined by 4.5 percentage points out of which the public sector was responsible for as many as three percentage points. In 1997 the share of the public sector rose from 8 per cent to 12 per cent, but this was due to a reduction in private investments. It is also of interest to look at capital formation in different sectors since this gives an indication of the structural change generated by liberalisation during the 1990s. Data for capital formation at the sectoral level is only available up to 1995, however, so we do not know which sectors are responsible for the decline during 1996–7. Table 11.3 reports capital formation as a share of output for thirteen different sectors. The most notable changes are the strong and persistent response in mining, manufacturing, and distribution, hotels and restaurants, and the rapid initial increase and subsequent contraction in investments in agriculture, transport and construction. It is also notable that the sectors dominated by the public sector, such as education, health, public administration, and electricity and water, and those that are mainly producers of non-tradable goods, real estate, and finance and insurance, all have negligible increases in their investment–output ratios. These changes indicate that there probably was a structural change towards production of tradable goods relative to non-tradable goods. However, the decline in capital formation in the agricultural sector after 1992, in which Zimbabwe should have a comparative Table 11.3 GFCF as a share of GDP for different sectors Industry Agriculture, hunting, fishing and forestry Mining and quarrying Manufacturing Electricity and water Construction Finance and insurance Real estate Distribution, hotels and restaurants Transport and communication Public administration Education Health

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 7

11

13

12

13

15

21

23

13

14

15

8

12

22

33

20

20

26

36

28

35

71

10 127

14 88

16 40

18 47

24 26

23 31

38 28

30 36

34 47

35 55

37 91

35 20

32 17

46 16

55 7

54 5

84 36

78 20

68 25

51 39

41 29

32 23

72 4

55 7

52 5

68 6

67 6

59 6

63 7

49 11

42 14

62 17

47 13

29

21

26

26

17

38

44

40

44

25

22

8

10

10

12

8

6

9

8

8

8

11

3 10

5 11

3 7

1 7

1 7

1 3

1 9

1 6

1 7

3 19

3 7

Source: Central Statistical Office (1998b).

202

From crisis to growth in Africa?

advantage, runs counter to what one would expect. A possible explanation is the return on the political agenda of the half-dormant programme for land reform. To summarise, there was a drastic increase in capital formation following ESAP. A significant part of this increase went into equipment and machinery, and this should have spurred growth. Also, there appears to have taken place a sectoral change in capital formation in line with what is expected during structural adjustment, that is, from non-tradable to tradable sectors. Moreover, at the end of the period analysed, there was a significant decline in investments. In 1996 this was due to a drop in public sector capital formation, while in 1997 the reduction in private sector investments accounted for most of the decline. The determinants of investments Explaining what determines private sector investments is known to be a difficult task, particularly in developing economies. This is partly because the decision to invest to a large extent is forward-looking, and partly because there is a lack of good data. Nevertheless, empirical studies have identified some factors that seem to influence investments in developing economies (see Agénor and Montiel 1996: chapter 3). The most important one appears to be aggregate demand, which in almost all studies plays a principal role. Moreover, relative factor prices, credit availability, foreign exchange availability, foreign debt service, public sector investments and several indicators of macroeconomic uncertainty have also been found to drive investments. However, these findings refer to developing countries in general. There are a few recent studies analysing the determinants of private sector investments in subSaharan countries, including Zimbabwe. Bigsten et al. (1998, 1999), using a panel collected during the 1990s for manufacturing firms, find that profitability plays a major role in investment decisions. From this it follows that aggregate demand, capital costs and macroeconomic instability are also likely to affect investments. Another finding is that expectations about a future devaluation appear to increase investments in exporting firms. The explanation given is that devaluations improve export sales. The results of the studies by Bigsten et al. are relevant for economies that are in the process of, or have undergone, structural adjustment. In Zimbabwe, before the introduction of ESAP there was strict import rationing and shortages of foreign exchange, and this was generally believed to be the main constraint on private capital formation. The expectation was that trade liberalisation, coupled with large inflows of foreign aid, would have a strong impact on investments. However, a recent study into the behaviour of aggregate private investments in Zimbabwe for the period 1969–89 by Jenkins (1998) casts some doubt on the importance of rationing. She found that the main determinants were gross profits and external debt-to-GDP ratio, while there was some influence from net capital inflows. Foreign exchange rationing and the relative cost of capital only affect investments in the short run. Since several studies on African economies find profits to be the most important determinant of investments, we have graphed the development of real private sector profits together with real private GFCF for the period 1985–97. Both series are

Structural adjustment in Zimbabwe 203 turned into indexes with the values in 1985 set to 100. As Figure 11.3 shows, overall both series follow a similar pattern. However, there is almost a doubling in capital formation between 1989 and 1991, while profits only grew by about 20 per cent. This change coincides with the introduction of ESAP. The high level of capital formation relative to profits then continues until 1997, when it returns back to the pre-ESAP situation. Capital inflows are also likely to have influenced capital formation in Zimbabwe during ESAP, as well as in the 1980s. Agreements with the World Bank and IMF to carry out a structural adjustment programme attracted a lot of foreign aid, while liberalisation of financial markets, and partial deregulation of the capital account, generated substantial capital inflows during some years. There are several ways in which these might have affected investment decisions. First, the foreign exchange constraint could be relaxed with less depreciation of the real exchange rate than what would have been the case without inflows. This affected the real price of imported investment goods. Second, the supply of credit improved, facilitating the access to investment finance for many firms. Third, aggregate demand increased, making the prospects of selling products better. Fourth, inflows of foreign capital, whether in the form of aid or private capital, are likely to signal that the structural adjustment programme is on track. This in turn enhances the credibility of the programme and stimulates investments. Finally, it should be noted that capital inflows also include direct investments. However, in Zimbabwe they have been small and can be ignored in this context. In Table 11.4 we report a measure of net foreign aid and private capital inflows to Zimbabwe over the period 1985–96. In the latter half of the 1980s it was on average about US$ 200 million. As ESAP was launched foreign aid started to flow in, raising the value to close to US$ 500 million in 1991 and to over US$ 800 million in 1992. Since the high value in 1992 partly was due to inflows related to the drought, there was a drop to approximately US$ 400 million in 1993. In 1995 the IMF declared Zimbabwe to be off-track because the fiscal deficit had risen from 250 200 150

Private profits index GFCF index

100 50 0 1985 1987 1989 1991 1993 1995 1987 1986 1988 1990 1992 1994 1996

Figure 11.3 Indexes of private sector profits and private gross capital formation. Source: Central Statistical Office (1998b).

204

From crisis to growth in Africa?

Table 11.4 Investment indicators, 1985–97 Variable

1985–90

1991

1992

1993

1994

1995

1996

1997

Aid and private inflows (US$ m) External debt-toGDP ratio (%) Real lending rate (%) Capital/labour relative price Capital/output relative pricea

231.0

496.4

835.6

398.8

506.0

647.0

416.0

359.5

38.7

40

60.1

65.5

65.8

70.8

58.6

55.7

5.0

5.4

19.9

17.7

15.9

15.6

17.2

100

106.7

128.7

136.5

141.0

128.9

147.2

146.7

100

90.5

81.9

82.3

81.7

74.8

97.0

103.4

1.0

a The average is for 1988–90. Notes: The external debt-to-GDP ratio is debt divided by GDP in current US dollars. The relative prices for capital goods were calculated with the implicit deflator for gross capital formation, wage costs per employee and the producer price index. The base year is the average of the period 1985–90. The real lending rate was calculated as the difference between the maximum lending rate of the commercial banks minus inflation. The interest rate series was taken from Quarterly Economic Review of the Reserve Bank of Zimbabwe. The source of the first three variables is the database World Development Indicators (1999) of the World Bank. The rest of the variables are from the Central Statistical Office (1998a).

6.0 per cent to 10.9 per cent of GDP. The result was a contraction from approximately US$ 650 million in 1995 to 360 in 1997. Hence, overall the pattern of net capital inflows is quite similar to that for capital formation. Two other variables found to influence investments are external debt-to-GDP ratio and foreign debt service, reported in Table 11.4 and Table 11.1, respectively. They both rose during the first part of the 1990s and then started declining. Since their influence on investments is supposed to be negative – a higher debt ratio signals higher future taxation, and higher debt service crowds out investment – they do not appear to have played an important role in determining capital formation during the structural adjustment programme. There were also policy changes included in ESAP that are likely to have influenced the willingness to invest. Real interest rates rose sharply following deregulation of the financial markets, that is from an average of about 1 per cent during the latter half of the 1980s, to close to 20% in 1993 (see Table 11.4). Although the availability of credit might have improved at the same time, the high interest rates did cause problems for investors. An indication of this is the large number of newspaper articles that have appeared since the beginning of the 1990s where businessmen raise their concern about the high interest rates. Nonetheless, our data do not show any clear relation between real interest rates and the level of investments. Since most investments in Zimbabwe contain a large import component, it is also likely that exchange rate devaluations affected investments negatively through its effect on imported investment goods. Table 11.4 reports prices of capital goods relative to wages and producer prices. During the first years of ESAP the price of capital increased much faster than wages, and by 1993 the relative price had risen

Structural adjustment in Zimbabwe 205 by about 40 per cent. One would have expected this to lead to a rapid substitution of labour for capital, but the opposite seems to have taken place, at least in the formal sector (see Durevall et al. 1999). A factor contributing to the increase in capital formation might have been the decrease in the price of investment goods relative to producer prices; it declined by 25 per cent between 1990 and 1995, and then returned to its preESAP level. The pattern of this ratio corresponds quite well to that for investments. As this review has shown, several factors appear to be closely related to the investment boom in the first half of the 1990s and the decline starting in 1996. Profitability and the relative price between capital goods and output explain some of these changes in investments. Moreover, foreign transfers also seem to have contributed significantly, probably by affecting the price of foreign exchange and signalling credibility in the reform programme. Good governance, external shocks and uncertainty As described above, ESAP was in general implemented as planned, and in some respects even faster than expected. However, there were repeated failures to meet the targets for the budget deficit. This, together with a combination of policy mistakes and external shocks during the late 1990s, created uncertainty about the stability of the Zimbabwean economy and the sustainability of the reform programme. These factors are bound to have affected investment decisions through their influence on the variables discussed in the previous sub-section, although it is not easy to quantify their importance. Below follows a brief account on the developments that led to the current crisis. It highlights the fact that good governance in general, and adequate policy responses to external shocks are essential for the maintenance of a high level of investments. Although the IMF declared Zimbabwe off-track at the end of 1995 and several donors withheld disbursements of foreign aid, the economy grew by 7.3 per cent in 1996 and the prospects for the future looked good. The losses of the public enterprises had been reduced significantly and budget deficit as a ratio to GDP was declining. The improvement in fiscal policies and the budget presented for 1997/8 persuaded the World Bank that the economy was on the right track again, and it decided to release the second tranche of the second structural adjustment credit in mid-1997. However, just before the agreement was to be signed President Mugabe announced that more than Z$ 4 billion had been promised to war veterans in compensation and pensions. This unexpected and unplanned increase in public expenditures made it impossible for the World Bank to release the money. In conjunction with the failure to reach an agreement with the World Bank, three other important events took place. First, during late 1996 and early 1997 there were adverse developments in export volumes and prices, and a rapid increase in imports. This led to a large trade deficit and a downward pressure on the exchange rate. By defending the value of the currency, the authorities reduced foreign reserves sharply. Second, in an attempt to boost its popularity after the agreement over compensation to the war veterans, the government announced that close to 1,500, out of 4,000, mainly white-owned commercial farms would be nationalised during 1998.

206

From crisis to growth in Africa?

This announcement was done without clarifying how the nationalisation would be financed or to what extent farmers would receive compensation for their property. Third, because of El Niño, fears were created of a serious drought in 1998, which would raise food prices and reduce export income. All this contributed to a severe currency crisis in November 1997 when the Zimbabwe dollar plummeted. To curb the crisis, the Reserve Bank ordered all companies to liquidate their foreign currency accounts, and the discount rate was increased by five percentage points to 28.5 per cent. Shortly after the government announced tax increases to finance the war veterans’ compensation. But the party conference held a few days later unanimously rejected this measure, and a wave of strikes hit the country. Over the following year the crisis deepened as basic food prices rose rapidly, and yet another currency crisis took place reducing the value of the Zimbabwe dollar by 50 per cent against the US dollar. On top of all this Zimbabwe entered the war in the Democratic Republic of Congo. One of the measures taken by the government to calm down public opinion was to reintroduce price controls on some basic commodities. Moreover, the exchange rate was fixed by government decree in an attempt to reduce inflation. Since little progress was made in reducing the budget deficit, the domestic debt continued rising rapidly and domestic inflation soared. At the end of 1999 foreign exchange shortages started to appear, as the real exchange rate appreciated and the level of resource transfers from abroad remained low. Furthermore, because of declining popularity the government had to participate in tripartite negotiations with the labour unions and the business community. In these negotiations, labour and business were in general united in arguing that government bore the full responsibility for the economic problems. However, the negotiations failed, and the labour movement formed a new party that has the potential to play an important role in Zimbabwean politics in the future.

4

Productivity growth

During the 1980s productivity growth was in general low in Zimbabwe, and capital formation was the main factor driving economic growth (Nziramasanga 1998). Hence, one of the intermediate goals of ESAP was to generate rapid increases in productivity. With resources fully employed, that is, full capacity utilisation and no unemployment, the importance of increased productivity is easy to explain. On the other hand, in situations with underutilisation of resources, such as unemployment, one may argue that increasing productivity is not that important. However, this argument overlooks the fact that behind productivity growth are the dynamic forces of the economy. For instance, in sectors for tradable goods high and increasing productivity is necessary for the domestic firms to be able to compete internationally. The alternative is low salaries and/or firm closures and unemployment. Moreover, several studies have found that differences in productivity growth explain why some countries are rich and others are poor (Prescott 1997). There is thus no doubt that high productivity growth, at least in some sectors, is a necessary requirement for high economic growth in Zimbabwe over the next ten to twenty years.

Structural adjustment in Zimbabwe 207 There are many possible causes for changes in productivity; in the short run productivity can increase as a result of higher capacity utilisation, which might be due to higher domestic and international demand, or access to rationed inputs. More fundamental sources of increased productivity are the use of new techniques, investments in physical and human capital, and a more efficient allocation of resources in relation to relative factor prices. All these factors are likely to have been at work during the implementation of ESAP. The most appropriate measure of productivity for analysing the development of productivity during ESAP is total factor productivity (TFP), defined as the ratio between output and an index of all inputs. However, the relevant data to calculate total factor productivity is only available for the manufacturing sector, so we also look at labour productivity, defined as output per employee, and land productivity, defined as yield per hectare planted. To get a general picture of the development of productivity since 1985, Table 11.5 reports indices of labour productivity for eleven sectors using National Accounts data. Although these measures should not be taken too seriously because of measurement problems and limited coverage of the informal sector, they do suggest that only a few sectors have experienced improvements in labour productivity during the 1990s in spite of the investment boom. This could be explained by a rapid increase in employment and falling capital–labour ratios. However, the increase in labour demand during the 1990s appears to have been negligible; employment only rose by 9.6 per cent between 1990 and 1997. This is an indication that capital–labour ratios increased in most sectors.2 Manufacturing There exists data for the manufacturing sector that is somewhat more reliable than the National Accounts because information on output and employment is collected at the same time (the Census of Industrial Production). Moreover, data on investments exists from the mid-1960s, making it possible to calculate meaningful measures of capital stocks. In Bjurek and Durevall (2000), these data were used to calculate total factor productivity indexes for thirty-one different manufacturing sub-sectors over the period 1980–95. In general, the growth rates in TFP varied greatly both over time and across sections. Nevertheless, the overall impression was that TFP growth was lower during the period of ESAP than during the period 1986–90, as was implied by the data on capital formation and labour productivity reviewed above. However, during the last two years of the sample, 1994–5, most sub-sectors experienced higher productivity growth than during 1986–90. Table 11.6 summarises information on the development of the components of TFP, capital–labour ratio, output–labour ratio, output and employment by means of correlation coefficients for the thirty-one sub-sectors over the period 1990–5. In the second column the correlations for capital–labour ratios are reported. The vast majority are positive and well above 0.5, indicating that capital–labour/ratios increased. The third column contains the output–labour ratios. These are positive in all but two sub-sectors, so labour productivity in manufacturing appears to have grown during ESAP. The two final columns give an indication of the sources of the

110 99

102

106

101

100 98

100 100

100

100

100

100 100

Source: Central Statistical Office (1998b).

92 93 99 110

100 100 100 100

Agriculture, etc. Mining Manufacturing Electricity and water Construction Financial Services and real estate Distribution, hotels and restaurants Transport and communication Public administration Education Health

1986

1985

Industry

100 104

102

102

97

124 104

91 95 100 136

1987

100 109

101

107

101

129 109

90 94 100 132

1988

100 107

100

105

98

103 115

91 101 101 150

1989

100 93

101

109

110

95 120

100 110 106 147

1990

Table 11.5 Index of labour productivity, 1985:100 in constant 1990 dollars

100 94

101

107

112

90 120

97 110 105 135

1991

100 99

100

125

106

85 119

75 109 100 144

1992

100 109

100

126

110

82 123

89 120 97 132

1993

100 133

100

130

108

87 120

93 113 100 133

1994

100 125

101

163

118

79 129

85 106 95 118

1995

100 115

101

162

125

82 127

99 103 101 89

1996

90 110

101

171

127

92 101

99 99 99 87

1997

Structural adjustment in Zimbabwe 209 changes in the capital–output ratios and labour productivity. The overall picture is that manufacturing output has increased, while there has been a fall or no change in employment. We can thus conclude that in contrast to what is indicated by the National Accounts, labour productivity seems to have increased in manufacturing, most likely because of substitution from labour to capital. Agriculture In this sub-section we analyse how productivity has evolved for some of the main crops in the communal (smallholder) and commercial areas, and review some of the Table 11.6 Correlation coefficients for capital–labour ratio, output–labour ratio, output and labour over the period 1990–5 Capital–labour Meat 0.95 Grain mills 0.71 Bakery products 0.54 Confectionery 0.97 Miscellaneous foods 0.78 Alcoholic beverages 90.54 Soft drinks 0.73 Tobacco products 0.60 Cotton textiles 0.93 Knitted products 0.78 Other textile products 0.88 Wearing apparel 0.90 Footwear 0.64 Wooden products 0.96 Furniture 0.42 Paper products 0.66 Printing 0.85 Fertiliser 90.90 Paints 0.96 Soaps, pharmaceuticals 0.97 Miscellaneous chemicals 0.65 Basic chemicals 90.39 Rubber products 0.64 Plastic products 0.54 Structural clay products 0.15 Non-metallic 0.91 mineral products Basic metals 0.95 Metal products, machinery 0.82 Electrical machinery 0.56 Motor vehicles 0.90 Other vehicles 0.81

Output–labour

Output

Labour

0.77 0.46 0.27 0.78 0.70 90.56 0.64 0.78 0.60 0.61 0.57 0.31 0.18 0.76 0.73 0.81 0.71 0.74 0.21 0.62 0.54 0.15 0.74 0.23 0.57 0.80

0.49 0.42 0.26 0.62 0.44 90.05 0.48 0.76 90.08 0.56 0.41 90.13 0.21 0.79 0.78 0.74 0.60 0.73 0.01 0.38 0.59 0.26 0.80 0.14 0.56 0.85

90.98 90.15 0.09 90.95 90.77 0.82 90.46 90.60 90.86 90.36 0.02 90.96 0.05 0.90 0.89 90.42 90.65 90.26 90.71 90.96 0.49 0.36 90.01 90.16 0.31 0.42

0.26 0.61 0.61 0.57 90.37

90.19 0.45 0.54 0.23 90.86

90.85 90.69 90.32 90.81 90.74

Note: The source of the data is the Census of Industrial Production data file provided by the Central Statistical Office. The capital stock was calculated with the perpetual inventory method, starting in 1968. Details can be found in Bjurek and Durevall (2000).

210

From crisis to growth in Africa?

results obtained in recent studies. The emphasis is on yield per hectare, which is of interest because land is a scarce resource in Zimbabwe. In any case, paucity of timeseries data on the use of inputs in the production of specific crops makes it difficult to calculate other measures of productivity. Table 11.7 reports estimates of land productivity for some of the principal crops produced in the communal sector (maize and cotton) and the commercial sector (maize, cotton and tobacco). Since agricultural output fluctuates a great deal, data from as far back as 1970 are reported. The overall impression is that land productivity was about the same in the 1990s as before liberalisation. Apart from this, there are two interesting features of the data. First, tobacco is the only crop that exhibits a positive trend in productivity. The trend is visible already in the 1970s and it is not related to ESAP. It is notable, however, that tobacco was one of the few crops that were freely traded before implementation of agricultural reforms. Second, there was a substantial increase in maize yields in the communal sector during the latter half of the 1980s, known as the Zimbabwean Miracle, but it is not clear from the data if the high level of productivity was sustained into the 1990s. To some extent this is due to the variability in rainfall; the sharp drops in productivity in 1991/2 and 1994/5 were due to serious droughts. Since variation in rainfall has a large impact on the size of harvests, regression analysis is required to detect if market reforms coincided with changes in productivity. Chipika and Chisvo (1999), Durevall et al. (1998) and Durevall and Mabugu (2000) undertook such an analysis for a number of crops in both the communal and commercial sectors. In the regressions, yield per hectare was used as the dependent variable and rainfall and several control variables, such as availability of credit, the number of depots and collection points, and relative producer prices, were entered as explanatory variables. The results did not provide any evidence of changes in productivity growth during the 1990s. Nevertheless, there were some

Table 11.7 Yield in kg per hectare for various crops in the communal and commercial sectors Crop Sector

Maize Commercial

Maize Communal

Cotton Commercial

Cotton Communal

Virginia tobacco Commercial

70/1–74/5 75/6–79/80 80/1–84/5 85/6–89/90 90/1 91/2 92/3 93/4 94/5 95/6 96/7 97/8

4,349 3,936 3,789 4,080 3,237 1,607 4,436 4,364 2,333 4,498 4,700 4,140

612 654 787 1,140 1,101 158 1,090 1,124 330 1,268 980 688

1,569 1,667 1,879 1,805 1,595 768 1,687 1,760 1,078 1,827 1,756 1,921

782 749 668 756 700 195 676 612 312 724 740 764

1,372 1,684 2,016 2,108 2,542 2,512 2,640 2,510 2,664 2,480 4,929 —

Source: Statistical Bulletin 1998, Ministry of Lands and Agriculture.

Structural adjustment in Zimbabwe 211 indications of a decline in yield per hectare for some crops in the communal areas, such as maize. The regression results also provided some information on the determinants of land productivity. Although they varied somewhat for different crops and for the communal and commercial sectors, rainfall turned out to be the most important variable. In the communal areas, the number of depots and collection points managed by the Marketing Board, the use of inputs, agricultural extension services and relative prices also influenced the yields of many of the crops. These can to some extent explain the lack of growth in productivity; both the number of collection points and public expenditures on agricultural extension services were reduced rapidly during the end of the 1980s and the first half of the 1990s. Moreover, many input prices rose when price controls were removed and markets were liberalised, reducing the use of, among others, purchased improved seed, fertilisers and herbicides.

5 Concluding remarks: Issues of the twenty-first century In this chapter, we set out to evaluate the impact of economic liberalisation on economic growth in Zimbabwe. It is clear that the shift in development strategy from import substitution to a market-oriented approach has not put the Zimbabwean economy on a path of rapid and sustainable economic growth. In this sense structural adjustment has not succeeded. It has however fundamentally changed the functioning of the economy and hopefully laid the foundation for a future take-off. The challenge for the next decade is to reduce poverty and raise standards of living markedly by achieving much faster growth than during the 1990s. This can only occur if the investment-to-GDP ratio is increased to well over 20 per cent again and productivity growth is boosted. A relevant question in this regard is why growth in output and productivity was so low when there was an investment boom during the period 1990–5. Part of the answer is that Zimbabwe experienced two very severe droughts during this period. However, there are also other explanations. Mehlum (1998) and Ratsø and Torvik (1998) use computable equilibrium models to show that trade liberalisation led to a short-run contraction in consumer demand. To some extent this was balanced by the increase in investment demand, but its main impact was on imports. Since demand for domestic goods was low, the rise in investments resulted in a reduction in capacity utilisation. To this story one can add that when the short-run impact of trade liberalisation was petering out, say around 1996, the economy was hit by a number of policy-induced and external shocks that affected it negatively. Another explanation, which complements the previous one, is that exposure to foreign competition might have forced the local producers to replace a significant part of their capital stock. The reason is that after liberalisation modern machinery was needed to make goods of sufficiently high quality; the quality of many of the products made in the pre-ESAP period was probably so low that they would be hard to sell at any price. Thus, instead of increasing output measured in number of goods per input, the high rate of investments made it possible for firms to produce better goods. Since this improvement in quality probably was not reflected in higher

212

From crisis to growth in Africa?

prices due to foreign competition, the data used do not reveal significant increases in productivity. Yet another explanation is that a number of bad investments were made. This could have been due to a rapidly changing business environment during structural adjustment, in combination with the noise generated by macroeconomic instability such as high and variable inflation and unexpected devaluations. There is for instance some anecdotal evidence on firms investing in imported second-hand machinery and equipment, without understanding how tough foreign competition would be. Nevertheless, finding strong evidence in favour of this explanation is difficult. In any case, it is apparent that the government needs to be much better at policy making to raise the level of investments and achieve higher growth; it has to avoid creating negative shocks, and make sure that the effects of the external shocks are minimised. There is some hope that the next ten years will be better in this sense, in spite of the fact that at the time of writing there is economic and political turmoil due to presidential elections, scheduled for 2001. The reason is that the recent crisis has highlighted the increased interaction between politics and the economy; liberalisation has created a situation where government policies are evaluated by the market in a way that makes costs and benefits much more visible to the public than in the old regime. Before, an event like the announcement of the badly planned land redistribution would not have led to any visible reaction at the macro level, at least in the short run. However, in a liberalised environment where international trade is free and there are markets for foreign exchange and agricultural commodities, the response is immediate. This was amply illustrated by the rapid rise in prices of basic commodities during 1998 when government policies generated expectations about a sharp reduction in future supply of agricultural products. So far the government has reacted by trying to reverse or hinder some of the market outcomes, but it has only led to further deterioration of the economy. As a result there has been a sharp drop in the popularity of the government. Hence, free markets can impose discipline on politicians and hopefully over time this will make them deliberate their actions more carefully. Although good governance and reliance on market forces might go a long way, they are not likely to be sufficient for pulling Zimbabwe out of poverty. Like many other African countries, it is a small landlocked country with a limited potential for expansion in agricultural production.3 This means that increased agricultural production might provide poverty alleviation in the short to medium term, but it cannot be a long-run solution for economic development. The emphasis of policy should therefore be on industrialisation and increasing total factor productivity growth, and active policies are needed to achieve this. The design of an industrial policy that promotes production and productivity growth in an environment of competition should therefore be high on the agenda (for details, see Lall 1992). A serious impediment to the development of the industrial sector in Zimbabwe is the smallness of its domestic market and those of most of its neighbours, and the distances to the big markets in Europe, the American continent and East Asia. To compete on the world market in those circumstances is bound to be hard. Hence, the establishment of a truly free trade area within the African continent seems to be required for generating the necessary dynamics of industrialisation. The agreement

Structural adjustment in Zimbabwe 213 within the Common Market for Eastern and Southern Africa (COMESA), including twenty-one member states and 385 million people, is a promising step in the right direction.

Notes 1 In 1996 there was a major revision of the National Accounts for the period 1985–96. 2 Employment appears to have responded much stronger in the informal sector than in the formal sector. A recent survey found that employment in manufacturing, commercial and services activities rose by 22 per cent between 1991 and 1998 (Development Alternatives 1998). 3 See Bloom and Sachs (1998) on the fundamental problems with productivity in African agriculture.

References Agénor, P. R. and Montiel, P. (1996), Development Macroeconomics. Princeton, New Jersey: Princeton University Press. Bigsten, A., Collier, P., Dercon, S., Fafchamps, M., Gauthier, B., Gunning, J. W., Oduro, A., Oostendorp, R., Pattillo, C., Söderbom, M., Teal, F. and Zeufack, A. (1998), ‘Expectations in a Dynamic Investment Model: Survey Evidence from Kenya and Zimbabwe’, memo, Department of Economics, Göteborg University. Bigsten, A., Collier, P. Dercon, S., Fafchamps, M., Gauthier, B., Gunning, J. W., Isaksson A., Oduro, A., Oostendorp, R., Pattillo, C., Söderbom, M., Sylvain, M., Teal, F. and Zeufack, A. (1999), ‘Investment in Africa’s Manufacturing Sector: A Four Country Panel Data Analysis’, Oxford Bulletin of Economics and Statistics, 61(4): 489–512. Bjurek, H. and Durevall, D. (1998), ‘Does Market Liberalisation Increase Total Factor Productivity: Evidence from the Manufacturing Sector in Zimbabwe’, Journal of Southern African Studies, Vol. 26, No. 3, Sept. 2000. Bloom, D. and Sachs, J. (1998), ‘Geography, Demography, and Economic Growth in Africa’, Brookings Papers on Economic Activity, No. 2. Botchewi, K., Collier, P., Gunning, J. W. and Hamada K. (1998), Report of the Group of Independent Persons Appointed to Conduct an Evaluation of Certain Aspects of the Enhanced Structural Adjustment Facility. Washington: IMF. Central Statistical Office (1997), ‘Agriculture and Livestock Survey in Communal Lands 1994/95’, Harare. Central Statistical Office (1998a), ‘Quarterly Digest of Statistics’, March, Harare. Central Statistical Office (1998b), ‘National Accounts 1997’, Harare. Chipika, S. and Chisvo, M. (1999), ‘Economic Reforms and Smallholder Communal Agricultural Development in Zimbabwe’, Draft, Intermediate Technology, Harare. DeLong, B. and Summers, L. (1991), ‘Equipment Investment and Economic Growth’, Quarterly Journal of Economics, 106(2): 445–502. Development Alternatives (1998), Zimbabwe: A Third Nationwide Survey of Micro and Small Enterprises. Harare: USAID. Durevall, D. and Mabugu, R. (2000), ‘Maize Markets in Zimbabwe’, Country Economic Report, Sida, Stockholm, No. 2000: 10. Durevall, D., Bjurek H. and Godana, T. (1998), ‘Structural Adjustment and Productivity: A Study of the Manufacturing and Agricultural Sectors in Zimbabwe’, Country Economic Report 1998: 1, Sida, Stockholm.

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Durevall, D., Ncube, M. and Bjurek, H. (1999), ‘Employment, Labour Market Reform and Trade Liberalisation: Zimbabwe 1990–1997’, Country Economic Report 1999: 6, Sida, Stockholm. Government of Zimbabwe (GoZ) (1992), A Framework for Economic Reform, 1991–1995, Harare. Jenkins, C. (1998), ‘Determinants of Private Investments in Zimbabwe’, Journal of African Economies, 7(1): 34–61. Lall, S. (1992), ‘Technological Capabilities and Industrialization’, World Development, 20(2). Mehlum, H. (1998), ‘Zimbabwe: Investment, Credibility and the Dynamics Following Trade Liberalization’, Paper presented at Zimbabwe: Macroeconomic Policy, Management and Performance since Independence, Harare, 1998. Nziramasanga, M. (1998), ‘Distributive Policies and Economic Growth’, Paper presented at Zimbabwe: Macroeconomic Policy, Management and Performance since Independence, Harare, 1998. Prescott, E. C. (1997), ‘Needed: A Theory of Total Factor Productivity’, Research Department Staff Report 242, Federal Reserve Bank of Minneapolis. Torvik, R. and Ratsø, J. (1998), ‘Trade Liberalization and Investment Response in Zimbabwe’, Paper presented at Zimbabwe: Macroeconomic Policy, Management and Performance since Independence, Harare, 1998.

Part III

The growth seekers

12 Has Uganda taken off? Arne Bigsten

1 Introduction The 1960s was a decade of growing per capita incomes in Africa, but from the first half of the 1970s per capita incomes started to decline. The import-substitution policies that were pursued could no longer sustain growth. After a period of vacillation, African governments were forced to change their policies. From the early 1980s most countries in Africa have, more or less systematically, pursued structural adjustment programmes, with the aim of creating viable market economies. The growth results during the adjustment period have been mixed, but in some countries we have even seen extended periods of rapidly rising per capita incomes. Uganda is one of those successful countries, and the question I ask in this paper is whether Uganda has turned the corner. Has the economy taken off on the path of self-sustained economic growth?

2 Theory and cross-country evidence on growth The accumulation of physical and human capital, efficiency in resource allocation, and acquisition and application of modern technology are the basic determinants of growth in any economy. The policy question is how the environment should be organised in order for it to be able to facilitate the accumulation of production factors, their efficient allocation, as well as the introduction of more efficient technologies. There is now widespread consensus that economic policies at the micro level should aim to develop and sustain efficient markets, while macro policy must be geared towards guaranteeing macroeconomic stability. It is also clear that a supportive environment of efficient institutions is crucial for the functioning of the economy. Hall and Jones (1999) analyse the determinants of per capita income levels in a cross-country setting. Their starting point is that growth is determined in an accounting sense by the accumulation of human and physical capital and productivity growth, but that there are more fundamental determinants underlying these variables. They thus suggest that one should distinguish the proximate causes of growth such as capital accumulation and productivity improvements from social infrastructure, which is ‘the institutions and government policies that determine the economic environment within which individuals accumulate skills, and firms accumulate capital and produce output’ (Hall and Jones 1999: 84).

218

From crisis to growth in Africa?

According to their hypothesis, growth will be high in an environment that supports productive activities and encourages capital accumulation, skill acquisition and technology transfer. In such an infrastructure prices will also tend to be right, so that individuals are able to capture the social returns to their actions as private economic agents. In a good environment there would also be secure property rights. Control of income diversion has two benefits. Producers are allowed to reap the full rewards of their production and they do not need to invest resources in avoiding diversion. The government should therefore try to prevent private diversion and refrain from diverting incomes itself. Hall and Jones note that social infrastructure may be an endogenous variable and therefore they use instrumental variables in their empirical analysis to control for this. The instruments they use are geographic and linguistic variables that measure the extent to which western Europe has influenced the countries in their sample, which was the first region that created an environment for sustainable growth. As proxies for social infrastructure, Hall and Jones use an index of government antidiversion policies plus an index of the extent to which a country is open to international trade. Openness gives scope for specialisation but it also facilitates the adoption of new ideas and technologies. Even controlling for endogeneity (and measurement error), they find that social infrastructure explains most of the crosscountry differences in per capita incomes. ‘Differences in physical capital and educational attainment explain only a modest amount of the difference in output per worker across countries.’ (Hall and Jones 1999: 92). Countries with a good social infrastructure have high capital intensities, high human capital per worker and high productivity. These differences, interpreted through an aggregate production function, are able to account for the variation in output per worker. The view of Hall and Jones is that variables such as size of the government, rate of inflation and share of high-tech goods in international trade are best thought of as outcomes rather than determinants. The success in investment and productivity growth is driven by social infrastructure as reflected in institutions and government policies. Another paper in the same vein is due to Rodrik (1998), who attempts to reinterpret the import-substitution experience of the Third World. His point is that the decline of many ISI countries from about 1975 was not due to the policy as such, but to their inability to adjust and manage the domestic social conflicts that were triggered by the turbulence of the world economy during the 1970s. The declining countries experienced a debt crisis because their monetary and fiscal policies were incompatible with a sustained external balance. The deeper question then is why some countries managed to adjust their policy successfully, while others failed. Rodrik constructs a heuristic index, which increases with measures of latent social conflict and declines with the quality of the institutions of conflict management. The former is proxied by inequality, ethnic and linguistic fragmentation and social distrust, while the latter is proxied by measures of democracy, quality of government institutions and public spending on social insurance. It turns out that his index of conflict explains the drop in growth after 1975 well, and that there is little additional explanatory power from government consumption level, openness to trade or the debt–export ratio. His point is thus that it was the countries with internal social divisions and weak social institutions of conflict management that experienced growth collapse. Divided

Has Uganda taken off ?

219

societies with weak institutions are ineffective in dealing with negative external shocks and thus to sustain growth. His policy conclusion is that development requires deeper reforms of political institutions, bureaucracies, judiciaries and social safety nets. The results of the cross-country analyses of Hall and Jones as well as Rodrik are consistent with other work that has been done focusing on African economic growth. Recent cross-country work on growth in Africa suggests that the poor economic growth to a large extent can be blamed on economic policy failures and the weak institutional environment, although several studies also point to ‘hard to change’ determinants such as ethnic fragmentation and geographical factors (Easterly and Levine 1996; Sachs and Warner 1997; Collier and Gunning 1999). Policy reform is crucial and understanding the nature of the domestic politics and institutions is a key to successful economic reform. The question raised in this paper is whether Uganda has taken off? How can we tell? From the brief discussion above, we may conclude that there are a range of factors required for sustainable growth. We may also conclude that they are highly correlated with each other and that some are in a sense more ‘basic’ than others. Both Hall and Jones, and Rodrik point out that it is the quality of the basic infrastructure or the institutional setup that determines outcomes also with regard to economic policy. Although this certainly seems to be true, it is hard to find generally accepted measures of these factors. I therefore pursue a compromise strategy here by trying to cover both the major policy outcomes and the quality of the institutional setup. This approach should provide a broader and thus more reliable picture of the state of the Ugandan economy. I will use the criteria for takeoff as set out in Bigsten and KayizziMugerwa (1999b). There we said that a country has taken off if it has entered into a process of sustainable per capita income growth. The criteria set out to check this were as follows: First, an emerging economy would be expected to have a sufficiently efficient macroeconomic framework accompanied by an appreciable level of international competitiveness. Second, it should be a market economy with reasonably efficient and competitive domestic markets. Third, the level of human resource development as well as that of the quality of infrastructure and institutions would be consistent with the needs of an economy set for rapid expansion. Fourth, an emerging economy is expected to become gradually less dependent on aid, relying more on domestic savings and foreign private inflows for investment. Its debt burden also ceases to claim more than a modest share of total resources. Finally, a properly functioning economy is largely the result of an adequate level of governance and political accommodation. These factors are largely determining the outcomes on the indicators listed under the other points. On the basis of this set of criteria, I will discuss whether Uganda has ‘taken off ’ on the path of self-sustaining economic growth. Doing so, I draw heavily on Bigsten and Kayizzi-Mugerwa (1999b).

3 Uganda’s growth record In its four decades of independence Uganda has seen political upheavals and dramatic shifts in policy. The immediate post-independence period was characterised by import-substitution and extensive government interventions and nationalisation. When Idi Amin took power in 1971, the country entered a period of atrocities and

220

From crisis to growth in Africa?

confused economic policies at the same time as the country was exposed to a series of external shocks. The Obote II regime of the early 1980s (the first Obote government was toppled by Amin in 1971) aimed to establish more market-based policies in an attempt to woo foreign investors back and to accelerate growth. However, the regime was not able to establish a viable political base, and the country again plunged into civil war. As a result of this, Yoweri Museveni assumed power in 1986 and his National Resistance Movement (NRM) has remained in power since then. After a year of policy wavering, Museveni’s government embarked on an Economic Recovery Programme in May 1987. It did so from a position of extreme economic weakness. After a decade of civil disturbances and war, the infrastructure was badly damaged, and the social services, education and health especially, had been seriously disrupted, and were close to non-existent in the countryside. Per capita incomes were some 40 per cent lower than what they had been in 1971, and there was an extreme dearth of resources. The emphasis of the reform programme has changed somewhat over time, but the overall goals have remained unchanged: to stabilise the economy, to bring about growth and maintain a sustainable external balance. Among the measures instituted are public sector reforms, market and price reforms, and exchange rate reforms and trade liberalisation. The reform process and its immediate impacts are analysed in detail in Bigsten and Kayizzi-Mugerwa (1999a), so here I just present some basic data (Table 12.1). During the first few years of the reform process there were several setbacks, and in 1992 there were severe fiscal disruptions. However, this sparked a phase of more sustained reform efforts and since then Uganda has managed to combine high levels of economic growth with low levels of inflation. The first growth acceleration may partly be ascribed to the recovery of production capacities as peace returned, policies became more predictable and aid increased, but increased levels of investment have also driven the subsequent growth. In current dollars, Uganda’s per capita aid receipts reached 40 US$ in 1990 and remained high throughout the decade. As a share of gross domestic product (GDP), aid flows were close to or over 15 per cent for most of the period. Investments have been around 17 per cent of GDP even during the last few years of rapid growth, which is fairly low, even by sub-Saharan African comparison. Private investment has edged upwards from 9.9 per cent in 1993/4 to 11.5 per cent in 1996/7, which suggests that the private sector is responding reasonably well to the changes in incentives and the improved stability in the economy. It is noteworthy, though, that the overwhelming share of investment, 13.5 per cent of GDP in 1996/7, is in construction, while only 3.8 per cent was in machinery and vehicles. This concentration is worrying, since the choice of investing in housing rather than machinery may be an indication that investors are still uncertain about the longterm stability of the business environment.

4 Does Uganda meet the takeoff criteria? During the last decade Uganda has thus managed to maintain an impressive annual growth rate of 3.3 per cent in per capita terms. So far, the growth acceleration has been achieved mainly via improvements in the policy environment and by the

7.1 65

11

1

8 78

10.0

1,974.4

126

164 118

95

145

23

40 16.0

6.7 62

12

0

9 72

28.0

1,940.4

100

225 167

116

42

23

30 15.6

1988

50 16.4

36 16.8

32

42

913 33

58

27 40

194

2,668.7

5.5

178

73 93

163

2,253.5

13.0

7 47

1

92 7 60

14

5.5 69

1990

11

6.4 67

1989

37 17.2

30

551

64

32 64

211

2,877.1

1.0

8 47

1

15

5.2 70

1991

33 17.6

32

91

23

60 16

232

3,032.0

2.0

7 35

1

15

4.5 71

1992

20 1810

12

22 18.6

6

—

91

96 —

16 37

405

—

5.0

11 50

6

14

10.1 78

1994

1 38

294

3,055.5

4.0

8 42

2

16

6.3 73

1993

19 19.2

3

—

913

— 15

513

11

7

17

8.4 82

1995

84 19.8

—

5.1 84

1996

—

5.2 86

1997

Sources: Bigsten and Kayizzi-Mugerwa (1999a) and Statistical Abstract (1998: 27) for GDP 1996–7.

a Derived from annual wage bill for selected manufacturing industries. b Since the claims of the banking system on government are becoming increasingly negative, it is not meaningful to compute percentage changes 1993–1996.

GDP growth (%) GDP per capita index (1960:100) Fixed capital formation/ GDP (%) Gross domestic savings / GDP (%) Export/GDP (%) Terms of trade (1960:100) Net foreign direct investment (US$ m) Total external debt (US$ m) Real manufacturing wages (1987:100)a Inflation (GDP deflator) Money supply (M1) (growth %) Domestic credit (growth %) Credit to government (growth %)b Interest, bank savings rate Interest, lending rate Population (million)

1987

Table 12.1 Indicators of economic performance, 1987–97 (index and %)

222

From crisis to growth in Africa?

(partial) restoration of peace, making it possible to rehabilitate facilities and increase capacity utilisation. In the longer term, however, growth also requires investment and technological progress. In the past few years, private investment has increased somewhat, much of it from domestic investors, but there has also been a substantial inflow of foreign investment. The current war in the Congo might slow down this expansion, though. Investors perceive the risks to be substantial and are therefore cautious. So how does Uganda do on the five sets of criteria, which were identified as crucial for sustainable growth?

Macroeconomic aspects Macroeconomic stability Sound fiscal and monetary policies are prerequisites for successful development, and the stabilisation efforts in Uganda have, in this respect, after some initial setbacks until about 1992/3, been successful. The Ministry of Finance is keeping tight controls on spending and is committed to the preservation of stability. It collaborates closely with the Bank of Uganda, which in recent years has helped to sustain a fairly responsible monetary policy. Inflation is under control. There is a concern, though, that much of the persistence of the stabilisation efforts is due to the commitment of a small circle of individuals in the Ministry of Finance and Economic Planning, which has been able to maintain control due to the consistent support of President Yoweri Museveni. Under a different leader this group and its policies might not have been accepted, and during the first period after the National Resistance Movement had gained power, there was a fierce struggle within the movement about the appropriate course. When the movement came out of the bush its economic policy vision was highly interventionist, and one of the first measures was actually an appreciation of the currency ‘to restore its value’. The learning curve was rather steep, though. Sufficient revenue collection is a basic requirement for self-sustaining growth. If not achieved, the government will have to continue relying on foreign aid to finance its expenditures. If part of the aid inflow is used to help reduce the tax burden on the private sector and thus facilitate its expansion, ensuring a larger tax base in the future, then aid dependency need not be a threat. The Uganda Revenue Authority has not been able to build on its initial success, though, and revenue collection has stagnated at around 11–12 per cent of GDP. The problem now is not so much the lack of statutes and regulations, but their proper implementation in order to remove the institutional inefficiencies and administrative problems currently affecting revenue collection. The efficiency and impartiality of tax collection must be enhanced, and the tax base should be extended, but it is possible that the actual rates of taxation even could be lowered for some strategic types of incomes. There are often no proper accounts in firms, creating scope for discretion and corruption. Still, the private sector firms need to be given some leeway to grow stronger before they can carry much taxation. The introduction of a cash budget system has helped to discipline the ministries and it has supported the drive towards macroeconomic stabilisation. However, a negative consequence of the system is increased volatility of expenditures.

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223

Eventually it should be possible to abandon the cash budget straitjacket. It is imperative, though, that the measure of control over the aggregate budget achieved so far is not given up. Further down the line, however, budget procedures and transparency must be further strengthened, particularly with respect to the current emphasis on decentralisation. Much of the money that is allocated centrally never reaches the intended beneficiaries. To come to grips with this problem, one has to develop administrative systems and responsible behaviour. This is going to be very difficult as well as costly. The level of remuneration of state employees is one important variable in this context. International competitiveness One important indicator of whether Uganda has taken off is whether it has become internationally competitive in areas outside traditional commodity exports. There have been some breakthroughs, particularly in horticulture. However, there is hardly any manufacturing firm that has managed or even tried to penetrate foreign markets and so far there are few indications that they are going to be successful in doing so. Improvement of Uganda’s external competitiveness has been a very slow process. If it is the case, as suggested by Wood (1994), that Africa does not have its comparative advantages in labour intensive manufacturing production, but rather that they are in production that uses intensively the abundant natural resources, then one would expect improvements in land intensive exports. However, this does not seem to be happening on a large scale, even if there are small steps in the right direction with regard to e.g. flower exports. Cross-country results on African manufacturing exports reported in Bigsten et al. (1998) suggest that there are important productivity effects of manufacturing export. To be able to achieve rapid growth, it thus seems essential to make a breakthrough also into manufacturing export markets. The process of the liberalisation of the trade regime is under way. There has been a shift towards tariffs from quantitative restrictions on imports, and those have been harmonised and lowered. Tariff revenues are, however, still an important revenue source for the government, which means that the pace of reform here will to some extent depend on the progress made with respect to tax revenue collection in the form of, for example, income taxes and value-added tax (VAT). The preservation of a realistic exchange rate plus a continuation of the trade reform measures are necessary, but not sufficient, ingredients in a policy aimed at becoming competitive in the world market outside traditional areas.

Microeconomic aspects Competitive domestic markets There is less government interference in domestic markets, and, for example, the role of marketing parastatals has been dramatically diminished. One of the major gains for coffee producers was the end of the marketing monopoly of the Coffee Marketing Board. In many other areas competition is still weak, however. In the utilities, for example, the regulatory framework is still to become operative.

224

From crisis to growth in Africa?

A stable financial system There has been some progress in efforts to create a more diversified and reliable financial system, but the sector is still fragile and prone to abuse. Weak domestically controlled banks are a major problem. A whole range of measures are required to strengthen the control of the financial system, which is misused by private agents as well as bureaucrats in the public sector. The financial markets are very poorly developed, and the system needs to be reformed to make it possible for the Bank of Uganda to effectively pursue monetary policy via indirect monetary control. Still, the development of a stock market, etc. is a lower priority than the cleaning up of the banking system. Human resources and infrastructure Human capital for competitive production Human capital development is crucial if growth is to be sustained. In the area of education there has been some progress with the policy of ‘Universal’ Primary Education (free education for at least four children per family). However, technical skills are scarce, with white-collar employment still the driving goal of education. Likewise, health care delivery reaches only a small portion of the population. Uganda has poor health indicators, even by African comparison. The poor delivery of social services in Uganda is a consequence of the virtual collapse of the public sector under Amin and in the subsequent turmoil. Though there have been some improvements in the 1990s, most of the work remains to be done. An effective physical infrastructure Uganda has focused on the development of the transportation network. The major trunk roads in the south are relatively good, while roads in northern Uganda remain poor. Energy and telecommunications are still major bottlenecks for large-scale producers. Self-reliance Reduced aid dependence The achievement of self-sustaining growth also requires that the country increasingly can grow from its own resources, that is a reduction of aid dependence. This will help it to reduce the negative bureaucratic impact of aid inflows, when donors become the most important constituency for the government. In the case of Uganda the aid inflows have remained unchanged in nominal terms in the last few years, but as the economy has grown quite rapidly there has also been a reduction in the extent of aid dependency as measured by the aid/GDP ratio. One problem related to aid is that the mechanisms used to deliver it make administrators and politicians beholden to foreign constituencies rather than to their own. This leads to loss of accountability to the domestic political process. Furthermore, the proliferation of externally initiated projects ties up recurrent costs, and sometimes represents a large waste of time and managerial capabilities. Authority, control and accountability need to be returned to the recipient country government. One way of doing this is to reduce direct flows to the recipient country

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in the form of project and programme loans, and instead use aid resources to reduce their debt burden. This will involve less direct interference in the affairs of the recipient country, at the same time, as aid indirectly would have a beneficial effect. This, in essence, is the spirit of the Highly Indebted Poor Countries (HIPC) programme. Alternatively, since non-governmental organisations (NGOs) operate more independently of the government, aid through this channel does not affect the recipient government activities to the same extent, and one could choose to channel more aid via them. This form of aid would not impose conditionally on the government and leave it to work out its own policies. Nor do NGOs withdraw as quickly from the country when disagreements about policies pursued arise. It is thus a less volatile and risky type of inflow from the recipient country’s point of view. NGOs cannot substitute for an efficient public sector, but they may have a contribution to make in efforts to reach the more disadvantaged segments of the population. Controlled level of foreign debt The debt reduction under the HIPC initiative has relieved the pressure on the budget. Donors still provide approximately the same amounts as before, but the part that earlier went to debt servicing can now be used for domestic expenditures instead. So there is a double benefit for the country. As the first country to qualify for the HIPC programme, Uganda has a better chance to manage its foreign debt. The latter is not as threatening as it was a while ago, although the actual level of indebtedness is still high. To support the creation of a functioning domestic credit market, it is important to sort out the arrears on domestic debt. Domestic saving and foreign private investment as the major sources of investment finance A large share of investment is still financed by official foreign resources, but the domestic share has been increasing, while foreign private capital is flowing in as well. Governance and politics The previous sections have dealt with important outcomes in terms of implemented economic policy and economic outcomes of the policy. We noted, however, in the discussion in Section 2 that efficient and sustainable changes in these areas depend on more basic institutional features of the economy. Four such aspects are discussed in this section. Unbiased institutions Growth requires a set of functioning public institutions, such as courts. The rule of law is essential for the development of a market economy. There have been some improvements and some innovations in this area in Uganda, but the process is still slow and inefficient. It has been difficult to bring cases to foreclosure. The independence of the private sector is increasing, but there is still undue interference from agents in the public sector. Borrowing from banks without sufficient ‘cover’ is an example. The emphasis is now on the development of the private sector within a market economy. Much needs to be done before private investors can feel that there is an

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enabling environment where investments are secure. For the time being investors are reluctant to invest long-term. The maintenance of macroeconomic stability is essential, but the focus now needs to be on the development of a fair system of taxation and a judicial system that can deal effectively with commercial disputes. Privatisation has gone a long way and should be continued up until the targets set are reached. It is important, however, that transparency is improved and that a fair bidding for the properties on sale is undertaken. The Parliament has on some occasions forced the government to reverse decisions found to be favouring certain vested interests. Good governance Growth requires good governance. The Ugandan public sector has been streamlined and there have been significant improvements in its effectiveness in the 1990s. There is still much rent seeking and corruption, with negative consequences for the economy that need to be addressed. The decentralisation efforts undertaken in Uganda are interesting and will in the longer term probably make it easier to achieve improvements outside the core regions of the south. However, local capacities are low and funds are inefficiently used at the district level. A broad-based development pattern Rodrik emphasised very strongly in the study quoted above that the provision of social insurance is important for economic reforms to be feasible. If the country cannot deal with the distributional conflicts that invariably follow from market reforms, the conflicts may become so severe that the reforms get off-track. The direct government interventions to this end have been rather limited in Uganda, but the reforms have still generated rather widespread improvements. In terms of poverty reduction there certainly has been progress, but in some regions, particularly those ravaged by guerrilla activity, the situation is desperate. This is a problem that cannot be solved by economic policy measures in a narrow sense. Still, to eliminate the basis for guerrilla opposition there is certainly a need for economic improvements in these regions. However, the challenge is that while there is a clear need for social improvements, the instability there makes it hard to achieve. The benefits of Uganda’s recent growth have been enjoyed mainly by urban dwellers, while subsistence farmers have benefited less (Appleton 1998). The reintegration of these into the market economy will be essential for improving conditions in the countryside. In the short term the most effective way of increasing rural standards may be via improved provision of social services. However, while the introduction of Universal Primary Education has improved access to education services, private costs are still substantial enough to keep children of the poorest households out of school. Increased funding for education should be one of the top priorities of the government. Primary health care is another area which is very short of funds. In both these areas, clients are forced to bribe their way through the system, and again there is a need to have a two-pronged strategy with administrative reforms and better salaries for employees. Political maturity The main constraints on Uganda future growth are probably to be found in the political sphere. This is an area where outside interventions generally

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cannot achieve much. Political maturity will have to emerge over time through the building of trust and mutual respect. For this to be possible the country needs both internal and external peace, and this has not quite been achieved as yet. If there is too much corruption or political interference in economic activities, if the war in the Congo gets out of hand or if guerrillas now fighting the government step up their activities, growth may well come to a halt. This in turn will lead to more economic pressure and threaten policy reversal.

5 Conclusion Uganda is one of the countries in Africa which by now has a fairly satisfactory policy environment, and it has been growing rapidly over the last decade. However, its investment rate remains fairly low, so the high growth is to a large extent the dividend to policy reform. Unless the investment rate can be raised, the present growth rate will not be sustainable in the longer term. Since domestic income levels are still low, this will require external inflows of private and/or public investment resources. However, at present investors perceive risks to be high and many take a wait-and-see attitude. Recent studies have shown that aid can function as a catalyst for private investment (Burnside and Dollar 1997) in a reformed policy environment, but there is also need for measures that either reduce risks or insure investors against risks if private investors are to come in on a large scale. Visible support from donors to countries that are on the right track would constitute a powerful signal for investors. On balance then, is Uganda on the path of self-sustaining economic growth? On the basis of the criteria laid down, the answer is no. The country has done well in the last decade, and has taken significant steps towards the creation of a market economy, but the growth momentum is still fragile. Aid dependency remains high, and it is not certain that positive per capita income growth can continue without aid. There has not been any breakthrough in exports that can substitute for aid inflows. The level of human capital development is low, and not enough to sustain a growth process based on exports of manufacturing goods. The political and institutional structures are weak and are an encumbrance to the effective functioning of the economy. The inability of the government to collect sufficient tax revenue is a severe constraint on the government’s ability to take full control of the process of policy formulation as well as the scope for interventions. The fragility of the financial system and its abuse is another constraint on enterprise development, and it may also undermine efforts at macroeconomic stabilisation. There is still a lot of straddling by politicians or top-level bureaucrats, making it difficult for the government to guarantee a level playing field in the private sector. Politically the current situation is very problematic due to the Ugandan intervention in the Congo conflict. This may have far-reaching consequences. It has certainly undermined the credibility of President Museveni, which has been a very important asset during the last decade. It is thus too early to say that Uganda has ‘taken off ’. It is on the right track in its economic reform efforts, but as yet they have not come far enough to provide a solid basis for future growth. The political maturity and stability that would guarantee the

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maintenance of an appropriate economic environment and the credibility of government is still not there. The internal conflicts, that were assumed to fade away with increased prosperity, have not done so. They have rather become more severe in the last few years. Political instability has also increased in the last few years due to the foreign policy of Museveni. It is therefore too early to say that there is a solid institutional or social base for growth in Uganda. Still, Uganda is one of the African countries that has come furthest on the way to takeoff. And if one compares the achievements with the starting point in 1986, the achievements of the Museveni government are certainly impressive.

References Appleton, S. (1998), ‘Changes in Poverty in Uganda, 1992–1996’, CSAE, Oxford University, mimeo. Bigsten, A. and Kayizzi-Mugerwa, S. (1999a), Crisis, Adjustment and Growth in Uganda. A Study of Adaptation in an African Economy. London: Macmillan. Bigsten, A. and Kayizzi-Mugerwa, S. (1999b), Is Uganda an Emerging Economy? Paris: OECD. Bigsten, A. et al. (1998), ‘Are There Efficiency Gains from Exporting in African Manufacturing?’, Paper presented at an OECD/IMF conference in Johannesburg, November. Burnside, C. and Dollar, D. (1997), Aid, Policy and Growth, Policy Research Working Paper No. 1777. Washington, DC: World Bank. Collier, P. and Gunning, J. W. (1999), ‘Explaining African Economic Performance’, Journal of Economic Literature, 37(1): 64–111. Easterly, W. and Levine, R. (1996), Africa’s Growth Tragedy: A Retrospective 1960–89, Policy Research Working Paper No. 1503. Washington, DC: World Bank. Hall, R. E. and Jones, C. I. (1999), ‘Why Do Some Countries Produce So Much More Output Per Worker than Others’, Quarterly Journal of Economics, 114(1): 83–116. Rodrik, D. (1998), ‘Globalisation, Social Conflict and Economic Growth’, The World Economy, 21(2): 143–58. Sachs, J. D. and Warner, A. M. (1997), ‘Sources of Slow Growth in African Economies’, Journal of African Economies, 6(3): 335–76. Uganda (various years), Background to the Budget. Kampala: Ministry of Planning and Economic Development. Uganda (1998), Statistical Abstract 1998. Kampala: Ministry of Planning and Economic Development. Wood, A. (1994), North–South Trade, Employment and Inequality: Changing Fortunes in a Skill-Driven World. Oxford: Clarendon Press.

13 Can South Africa break the deadlock? Mats Lundahl

The 1980s were a difficult decade for the South African economy, which was suffering the double impact of international sanctions and past policy mistakes. A turning point came in 1993, when indicators began to point upwards again. The subsequent performance, however, has not been one of sustained development. During the past three years growth has again been sluggish. The expansion of GDP has not been fast enough to match the growth of the population, i.e. real per capita income is falling, and during the second half of 1998 GDP took a downward turn as well – to pick up gradually during 1999, but not enough to match population growth. This does not bode well for the future. The African National Congress (ANC) secured its triumph at the elections in 1994 on a platform emphasizing justice and redistribution in favor of the underprivileged majority, but redistribution is hardly feasible in a non-growing economy. Unless the wheels can be made to turn faster, the entire Reconstruction and Development Programme will be in jeopardy. So far, the population at large has showed admirable patience, but the confidence in the ANC may easily be eroded, and social unrest may begin to spread, if the economy fails to perform well enough to permit an improvement in the living standards of the masses. The present chapter attempts to answer the question of whether South Africa will manage to break out of the present deadlock. We begin with a review of the historical growth record of the country. Thereafter, we examine the connection between growth and redistribution. Section 3 deals with some necessary conditions for growth in the South African context, related to good governance. Then, we examine the role of the state and economic policy in the growth process. Section 5 focuses on one of the key growth problems: that of finding suitable export products. Next, the relation between growth and stabilization is dissected, in order to find out whether the two are complementary or there is a trade-off between them. In Section 7 the focus is on labor market issues. Growth is not just a question of expanding output, but employment has a very high priority in the South African context. The following two sections examine some pertinent issues of the future: on the one hand the political situation, and on the other hand some economic question marks. Finally, some concluding remarks are offered.

1 From high to low growth The modern economic history of South Africa begins with the discovery of diamonds and gold during the last third of the nineteenth century (Hobart Houghton 1971).

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These discoveries immediately created a boom in the economy. All of a sudden South Africa was converted from an agrarian economy to a mineral one. Gold in particular became the staple that was to drive economic events for a number of decades. At the end of World War I South Africa had become the world’s leading gold producer, and all the way up to World War II mining would remain the most important component of GDP. South Africa had a unique product to sell in the international markets. The country also managed to attract the capital and labor needed for the successful exploitation of it. Whereas diamond mining had expanded largely on the basis of reinvested profits until concentration of the industry began to set in, gold mining almost from the very outset required large doses of foreign capital. Between 1887 and 1932, 120 of the 200 million pounds that were invested in gold mining came from abroad (Frankel 1938: 813). Labor came both from inside and outside the country. The extraordinary expansion of gold exports (Hobart Houghton 1971: 18), based on ore bodies with a low mineral content located at deep levels, required large quantities of cheap labor to be profitable. To achieve this, the Africans were deprived of their land and had to compete with large numbers of immigrants from neighboring territories. In addition, with government aid various attempts were made to monopsonize recruitment of African workers both in South Africa and abroad. While the latter failed, due to competition from Rhodesia, on the eve of World War I, the former succeeded (Lundahl and Ndlela 1980). The combined result of these measures was amazing: a freeze of unskilled real wages in the gold mines between 1911 and 1971 (Lipton 1985: 388). As it were, the South African economy surged ahead in a fashion reminiscent of the growth model connected with the name of Arthur Lewis (1954). Between 1919 and 1955, according to Simon Kuznets (1961: 5), net capital formation amounted to almost 18 per cent of the net national product – certainly one of the highest figures in the world, if not the highest. During this period, gold would soon be complemented by manufactures. Mining activities created linkages to a budding domestic industrial sector, which from the mid-1920s received tariff protection, and later on aid from quantitative import restrictions as well. Between minerals and manufactures, as the leading sectors of the South African economy, an average growth rate of the national income of 5–6 per cent per annum was obtained from the beginning of the 1920s to the end of the 1960s (Hobart Houghton 1973: 43). In the 1970s this formidable growth machine began to stall. After World War II the manufacturing sector had overtaken mining as the most important component of GDP. Both sectors, however, were in trouble. Wage increases could no longer be avoided in mining and in manufacturing import substitution had by and large run its course. The oil shocks from 1974 onwards complicated economic life, and the international community was beginning to react to South Africa’s racial policies. In 1977, the zero growth level had been reached and the first half of the 1980s was dominated by negative growth rates (Republic of South Africa 1994a: 21.8). At this point, not only did wages increase and the domestic market for manufactured consumer goods stagnate, but apartheid was beginning to take its economic toll. In the fashion predicted by Lewis (1954), skilled and semi-skilled workers were

Can South Africa break the deadlock? 231 getting scarce – a result of apartheid educational policies – and the inflow of capital from abroad (South Africa was traditionally a net capital importer) was drying up. At the beginning of the 1980s foreign lending increased. This was to culminate in an acute crisis as American banks began to call in their loans in 1985, largely for ideological, namely apartheid, reasons. The South African economy took a downward plunge. The growth rate of GDP during the latter half of the 1980s was not high enough to match population growth, with the result that GDP per capita fell (Republic of South Africa 1994b: 21), and 1990–2 saw a decline of GDP (South African Reserve Bank 1995a: 42). The turning point came in May 1993, and between 1994 and 1996, the growth rate of GDP fluctuated around 3 per cent per annum, but fell to 1.7 per cent in 1997, and during the second half of 1998 a contraction set in (Republic of South Africa 1999a: 42). Thus, the recovery has been both weak and declining. Per capita income has improved only marginally since 1993.

2 Why growth? Growth is absolutely essential in the South African context, both directly and indirectly. By definition the road to higher per capita income goes via sustained growth. This, however, does not insure that everybody shares the fruits. For this, an active redistribution policy is usually necessary, at least under the circumstances prevailing in South Africa, where the heritage of the apartheid years still makes itself strongly felt. The need for redistribution is to be seen everywhere. It does not matter very much which indicator or which survey one chooses. With minor variations they all tend to convey the same information. When South Africa emerged from apartheid, it was a country characterized by extreme interracial inequalities in terms of incomes and living standards, producing Gini coefficients that are the highest in the world (Lachman and Bercuson 1992; Whiteford et al. 1995). In 1993, the Southern Africa Labour and Development Research Unit (SALDRU) undertook the most comprehensive socioeconomic survey yet in South Africa. The SALDRU findings convey a good picture of the situation that the Government of National Unity had to face when it took over in 1994 (Pillay 1996). Beginning with income inequalities, the average white household per capita income was 7.4 times that of Africans, 4.4 times that of coloreds and 2.4 times that of Asians. Average household per capita expenditure was 5.4 times as high among whites as among Africans (3.7 times the figure for coloreds and 2.2 times as high as that for Asians), with considerable variations among provinces and consistently lower figures for female-headed African households and African households located in rural areas. Educational standards are unequal as well, in spite of a rapid expansion of African education since the mid-1970s. Adult Africans have little formal schooling, but even teenagers who had spent more time in school were found not to be significantly more literate than their parents. Quality had not kept pace with quantity during the expansion, least of all in rural districts. The survey also showed considerable differences in housing standards, with 15 per cent of all Africans living in shacks, usually under crowded conditions. Few

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more had access to inside pipe-water, the majority having to walk some (often large) distance to get to any water at all. The majority (43 per cent) of all African households had to make do with pit latrines and 16 per cent had no toilet facilities at all, while virtually all white and Asian households had flush toilets. Far fewer African households (37 per cent) than the average (54 per cent) had access to electricity and hence had to resort to wood for cooking and heating and candles for lighting. In rural districts, access to land was very limited among Africans, 26 per cent (usually communally held) against 41 per cent for whites, and farms were far smaller, 0.6 hectares per farmer against 222 hectares for each white farmer. It is not necessary to go any further. (Employment figures will be dealt with below.) Other indicators simply confirm the above figures. Around 1994 (and today as well) poverty was strongly concentrated to Africans, women and children, households with female heads, rural areas and provinces with many former bantustans. This was the challenge that the first post-apartheid government had to face. The ANC went into the 1994 parliamentary elections equipped with a basic needs program to reduce poverty: the Reconstruction and Development Programme (RDP). This program contained ambitious measures in all the areas discussed here, as well as in the areas of health care and social security. This is not the place to go into a detailed enumeration of the details of the RDP (see ANC 1994). Rather, the purpose is to point out that the program stands no chance to be carried out other than in the context of a growing economy. A number of investigations were carried out around the time of the parliamentary elections to find out what scope there was for undertaking a redistribution via the government budget. The results were almost unanimous. The budgetary situation, in terms of actual and potential revenue, scope for expenditure switching and borrowing capacity, was such as to preclude other than very marginal measures on any sustained basis. In the international perspective South Africa is not a low-tax country, and the expenditure that the dismantling of the apartheid system freed for redistributive purposes amounted to no more than 2–3 per cent of GDP (Lundahl and Moritz 1994). It was completely clear that economic growth was the key to redistribution (and, as we will see below, employment as well).

3

Good governance

Growth does not take place automatically, as the South African example eloquently demonstrates. A number of necessary, but not sufficient, conditions have to be fulfilled before the wheels can be made to move. Good governance is one such condition. While state action per se is not likely to result directly in higher growth, it can certainly support growth-creating forces elsewhere in the economy. In the South African context, five issues stand out in this respect: maintenance of law and order, macroeconomic stabilization, strengthening of the market economy, structural adjustment and improved efficiency in the labor market. The last two will be dealt with below. Under the present heading we will concentrate on the former three. The first is the high crime rate. Johannesburg easily beats the worst cities of the United States when it comes to violent crime, and South Africa is reputedly the

Can South Africa break the deadlock? 233 country with the highest incidence of murder of any country not at war. Burglary and car hijacking are rampant. The worst situation is that of the African townships, where in addition bands of tsotsis (gangsters) and self-appointed vigilante groups – both frequently with good police connections – contribute to the general atmosphere of violence. South Africa also attracts foreign criminals, not only because of the opportunities for crime it offers inside its borders, but also because the country constitutes a good base for operations elsewhere. The estimated criminal turnover in the country is in the order of over 40 billion rand per year (Ellis 1999: 49–51, 65). Crime poses a tremendous problem for ordinary business activities. Reforms are under way in South Africa to guarantee a sound legal system, but so far a firm policy to deal with crime has been lacking. This is serious, for crime scares away investors, particularly foreign investors who have a choice between going into South Africa and other countries. Clearly, something needs to be done about that if the prevailing investor mood of wait and see is to change. Some observers (Ellis 1999: 68) argue that the reduction of the incidence of crime should be the first priority: … probably the most pressing question for South Africa is to ascertain whether it is possible for criminal activity to be successfully contained in such a way as to permit the functioning of a conventional political and economic sector, with all that that implies with regard to the rule of law and the security of the individuals. A second prerequisite for growth is a sound macroeconomic policy that avoids major imbalances. Here, more has been achieved. Much of the debate on fiscal policy in South Africa has revolved around the budget deficit, which threatened to get out of hand in the early 1990s. The government has, however, adopted a strategy of gradual reduction, from 7.9 per cent of GDP in 1992/3 (Republic of South Africa 1996b: 17) to 3 per cent in 2000/1 (Republic of South Africa 1999a: Table 3.1), in order to reduce the rate of inflation and ease the pressure on the balance of payments. By and large the downward path has been followed, with a registered deficit of 4.5 for 1997/8 and an estimated one of 3.3 per cent for 1998/9 (Republic of South Africa 1999b). This has been complemented by a conservative monetary policy, to stabilize the currency and combat inflation, until recently underwritten by a conservative, monetarist head of the Reserve Bank. The autonomy of the Reserve Bank is guaranteed by the constitution, and although some circles may fear that an ANC victory of two-thirds in the 1999 elections will be used to bring the bank under political control, and inaugurate a policy of ‘easy money’, this is hardly a likely course of action, given the commitment of the government to a ‘consistent monetary policy to prevent the resurgence of inflation’ (Republic of South Africa 1996a: 2). The exchange rate as well is a key variable in the stabilization context. The marginal propensity to import is high in South Africa and an overvalued currency provides further incentives. The balance of payments hence easily comes under pressure. The current account has shown a deficit for five consecutive years (1993–8) (Republic of South Africa 1999a: 38). In the past, South Africa has protected its manufacturing sector with both tariffs and quantitative import restrictions, but now, that the country has signed the Marrakesh Agreement, joining the WTO, quantitative restrictions have been abolished and tariff levels have been unified

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and their level brought down. Unless exports can be made to increase, this adds to the balance of payments problem, which in turn makes the exchange rate doubly important. At the end of 1995 the rand was slightly overvalued but this situation has changed. The trend for the real exchange rate was basically a downward one from 1996 to 2000, however, with upward fluctuations in 1997 and 1999 (South African Reserve Bank 2000: 33, S-145). Altogether, from this point of view, the exchange rate does not appear to be a problem. Rather, the key to improving the balance of payments situation is to be found in the export situation. We will come back to this below. From another point of view, exchange rate management appears more difficult. The objective of the South African exchange rate policy is ‘to keep the real exchange rate of the rand at a competitive level’ (Republic of South Africa 1996a: 10). To this end, exchange controls are being phased out to let market forces have a more decisive influence, but if a stabilization at the level which makes exports competitive is to be achieved, anti-inflation measures must be taken into account (Nomvete et al. 1997: 22–3). Fiscal and monetary policy must be coordinated with exchange rate policy. (Labor market policy also has a role to play, to prevent cost push effects.) Here, fiscal policy will have to bear the main burden, since interest rates have been high in recent years and may have to come down in order to stimulate investment and growth. This in turn means expenditure cuts because revenues are difficult to increase, in a situation where it is imperative to increase social spending to meet the objectives of the RDP. The South African economy has in the past been characterized by an unusually high degree of government intervention, both through regulations and in the form of direct state participation in production (see Lipton and Simkins (1993: 1–4) for a list). Beginning in 1928, a series of public corporations were created that were to guarantee the production of strategically important goods and services, a task that became even more important as the National Party took over government in 1948 and South Africa became increasingly isolated by the international community. The results can hardly be termed satisfactory (Moll 1993: 71). However, in line with its commitment to underwrite a market economy in South Africa, the government has embarked on a course of ‘restructuring of state assets’, i.e. privatization. Thus, signals are being sent to the business community that government dirigisme is a thing of the past and that South Africa is entering the new millennium as a market economy. What the effect of privatization will be, however, depends on how the market works. The degree of concentration is high in the South African economy, with six conglomerates dominating ownership and oligopolistic practices in many branches (Joffe et al. 1993; Gerson 1993; Fine and Rustomjee 1996: chapter 5). Collusion reduces efficiency and makes it difficult for outsiders to enter. The government is aware of this and has appointed a commission on competition policy. In addition the policy of persistent tariff reduction is putting competitive pressure on sectors that enjoyed protection that created scope for monopolistic pricing before.

4 Which signals matter? Maintenance of law and order and macroeconomic stability is necessary both to help growth get going and to ensure that the economy is not derailed from the

Can South Africa break the deadlock? 235 growth track once the process is under way. It is, however, not sufficient. Producers need incentives that make them believe in the future to the extent that they find it worthwhile to invest and employ workers, laying the foundations for a positive spiral of rising incomes, rising demand, etc., which in turn feeds back on investment, production and employment. The road chosen by the South African government in its Growth, Employment and Redistribution (GEAR) strategy (Republic of South Africa 1996a,b) is that of signaling that a number of policy measures are taken that will ensure a favorable, confidence-inspiring, climate for investors. In other words, it is assumed that a sound policy environment will do the trick. Above, we put macroeconomic stability, privatization and measures to favor competition in the category of necessary, but not sufficient, conditions for growth. As it seems, this is not a view which is shared by the South African government. Could it then be that there are factors in the stabilization policy which simultaneously serve to trigger private investment? It does not appear likely that mere stabilization will be sufficient. (Improvements in terms of law and order probably have a much stronger direct impact.) Causation does not necessarily run from stabilization to investment to growth. It could easily be the case that a Catch-22-like mechanism is at work. Investment leads to growth, but investors may not be ready to risk their money before they are convinced that incomes and markets are growing. Possibly, a successful reduction of the budget deficit will make it possible to lower interest rates, both because it eases inflationary pressure and because it reduces the borrowing needs of the public sector. Still, in the absence of a strong belief that the future will be bright, investment may be interest-inelastic. The recent reduction of the growth rate provides a counter-signal to prospective investors. Possibly, the failure to invest is the result of a coordination failure (Rodrik 1995) or a free rider problem. Each investor is waiting for the other to do something, and since nobody is willing to take the first step, nothing happens. If investors could be persuaded to act in concert the process would take off and some kind of balanced growth path would ensue. Even this may require previous growth, however. If those who are to be coordinated believe that the future is gloomy, coordination has no role to play. Quite probably, and this seems to be recognized by the government, the trigger of the upward spiral must be sought abroad, in the international markets. The doctrine of balanced growth saw the light of day in the 1940s (Rosenstein-Rodan 1943) and 1950s (Nurkse 1953) because trade possibilities were perceived as limited. In South Africa we rather have the opposite case. Since it is difficult to start the balanced growth process, the stimulus may have to come from abroad. Inwardlooking economic policies today are a thing of the past in South Africa, as witnessed by the country’s decision to join the WTO. Then, however, it becomes imperative to find where South Africa’s comparative advantage lies. To this we turn next.

5 In search of comparative advantage Finding the comparative advantage in the case of South Africa is no easy matter. The economy has been subject to serious distortions in both commodity and factor

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markets over a long period of time. Tariff protection and quantitative import restrictions have been coupled with racial discrimination in the labor market and controls of capital movements, to mention the most obvious factors. On the eve of the post-apartheid era, in 1993, minerals dominated South Africa’s exports, with gold accounting for over 28 per cent of the total value and other sectors of the extractive industry for another 24 per cent. The pattern that was established in the late nineteenth century was still present, modified, however, by a 35 per cent contribution by manufactured goods (South African Department of Finance Mission in Europe 1994: 6). Thereafter, gold has not fared particularly well. What once was a staple capable of pulling the economy ahead at a brisk pace had by the 1990s become a product facing severe problems. In 1981, South Africa accounted for two-thirds of the world output of the precious metal. Twelve years later, the share had fallen to less than one-fourth (Nattrass 1995: 858). South Africa had been hard squeezed by output increases by the major competitors: United States, Canada and Australia. Worse yet, the industry is struggling with domestic problems. The South African ore is of comparatively low quality and the mining of it has proceeded to levels that are so deep and difficult to work that costs tend to increase over time. This makes gold mining very vulnerable to price changes in the world market. Each price reduction tends to close some operations – those with no Ricardian rents – and recent increases in labor productivity have in the main been too low to compensate for that. It is completely clear that South Africa today has left the literally golden export age behind (Nattrass 1995: 866): … it is worth bearing in mind that gold mining in South Africa today is not likely ever again to play the central economic role it did in the past. The economy is going to have to generate additional export capacity in order to obtain the necessary foreign exchange and to absorb unemployment. This is a tough challenge. Instead, South Africa is looking towards the manufacturing sector for new export products that can propel the economy and increase the rate of growth to the target levels spelled out in the RDP and in the GEAR strategy: around 6 per cent by 2000. It is, however, not obvious where to start the search. Manufacturing has been a sheltered sector since the 1920s, one which many observers feel would be threatened by the introduction of a more outward-looking trade policy (e.g. Bell 1993), and has hence not had much opportunity to reveal where its strength lies. A priori, there are two types of industries or products that could have a comparative advantage in South Africa. The first category consists of labor-intensive goods and the second of resource-intensive commodities. A study from 1979, however, indicated that, somewhat surprisingly, it was capital-intensive manufactures that had performed best in the world market (Ariovich 1979). This could be explained in different ways, one of which is that the comparative advantage is actually to be found in resource-intensive production but that processing requires capital. Other studies point toward labor-intensive branches (Levy 1992). Still, labor-intensive

Can South Africa break the deadlock? 237 products may not be a self-evident candidate for exports, given the present combination of a largely ‘insider’ trade union movement pushing for higher wages and low labor productivity in the aftermath of apartheid education. This then points directly towards the resource-intensive end of the spectrum. As Ben Fine and Zavareh Rustomjee (1996) have forcefully argued, the ‘mineralsenergy complex’ has constituted the core of manufacturing activities in South Africa. So, presumably, this is where the search for comparative advantage should begin – not at the labor-intensive end of things where South Africa would have to compete with the ‘second-generation tigers’ of South-East Asia. This is confirmed by the most recent investigation, by Hildegunn Nordås (1996), where medium-wage, lowtechnology, resource-intensive industries are identified as being competitive with countries like the United States (the leading country in terms of productivity). The immediate future of South Africa thus is to be sought in branches like non-ferrous metals, iron and steel, and paper and printing. To what extent it will be possible to boost growth through a future expansion in this direction is, however, difficult to say. The branches identified by Nordås have the virtue of being among the least protected before the reversal of the trade policy, and they will definitely be favored in the short run, by further trade liberalization. Whether they will be successful in the longer run is a different matter. They are dependent either on cheap raw materials and energy or on economies of scale. However, they have the disadvantage that they are relatively capital-intensive. This is a double disadvantage. In the first place their development builds on investment, and investment is precisely what should be stimulated by trade, i.e. the industries supposed to generate growth and investment are themselves dependent on investment. Second, they require human capital – an exceedingly scarce factor in South Africa, where apartheid educational policies inflicted a damage that will presumably continue to be felt for a full generation. The conclusions are clear. We should not expect exports to pull the South African economy up in any bootstrap fashion. The ability of trade to do the trick rests either on factors that trade is supposed to stimulate or on preconditions that it will take a long time to produce.

6 Growth versus stabilization If we look at the performance of GEAR so far, the growth rates obtained have been far below the average that was programmed for 1996–2000: 4.2 per cent (Republic of South Africa 1996b: 13). Likewise, non-agricultural employment, that was supposed to increase at 2.9 per cent per annum, has not only failed to expand at the planned rate but has actually fallen since 1994 (Republic of South Africa 1999a: 50). The failure to make the economy grow has in turn led to serious problems of nondelivery of vital components of the Reconstruction and Development Programme, notably housing, health and education (Michie and Padayachee 1998: 630–1). GEAR has been far more successful in terms of stabilization, with an estimated 1999/2000 budget deficit of 2.4 per cent of GDP (South African Reserve Bank 2000: 59) to be compared with a projected 3.0 per cent for both 1999 and 2000 (Republic of South

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Africa 1996a: 7), and, in terms of inflation, in January 2000 a figure of 2.6 per cent had been reached (South African Reserve Bank 2000: 22). These findings immediately raise the question of whether there is a trade-off between growth and stabilization or the two could be made to go hand in hand as the GEAR strategy assumes. Unfortunately, there are strong indications that the former may be the case (Lundahl 1997, 1998, 1999; Michie and Padayachee 1998; Weeks 1999). As it seems, the rapid reduction of the budget deficit has compressed aggregate demand and reduced the growth rate, i.e. private investment has not responded in the fashion hoped for when GEAR was put together. Interest rates have not come down so we do not know whether government borrowing has crowded out private investment or not. Also, low inflation and low growth tend to go together in South Africa. Measures that reduce inflation also hold back growth (Weeks 1999). It can also be argued that GEAR contains strong built-in policy brakes on growth (Lundahl 1999: 226–8). The reduction of the budget deficit affects growth negatively not only because it reduces aggregate demand but also because in a situation where it is difficult to increase taxes the reduction has to be achieved via expenditure cuts. From the growth point of view it is preferable that these cuts hurt growthgenerating budget items as little as possible, but in practice cuts are likely to take place across the board, without much consideration for efficiency and growth. Slow growth creates its own problems, because this makes tax revenues fall short of the projected volume and hence puts even stronger pressure on the expenditure side. The contractive effect becomes even stronger. Nor is increased growth likely to be without problems from the stabilization point of view. As mentioned above, the marginal propensity to import is high in South Africa, which means that growth will almost ‘automatically’ create a current account problem on the balance of payments. Since the increase in imports does not consist exclusively of inputs used by the exporting and import-competing sectors, but also of consumer goods and inputs used by sectors producing non-traded goods, action may be required to reduce the deficit and prevent the rand from depreciating. In the past this has usually meant a tighter monetary policy, to reduce the extent to which inflation is imported. A tighter monetary policy may also be triggered by the appearance of bottlenecks in the skilled labor market which lead to wage increases. To the extent that wages for unskilled workers are indexed to skilled wages, a ‘contamination’ effect will come into play and the wage-price spiral will be set off, with a consequent tightening of the monetary screw following suit. Presumably this constraint has a tendency to kick in at lower growth levels than before both since South Africa is beginning to experience white brain drain and since manufacturing techniques have a tendency to become more capital and skill intensive over time.

7

The troublesome labor market

Employment is a problem that requires special attention. It is hardly any exaggeration to state that the performance of the South African economy in terms of creation of new jobs is dismal. The employment target stated in GEAR is that of

Can South Africa break the deadlock? 239 400,000 new jobs per annum by 2000 (Republic of South Africa 1996a: 1), but when the program was begun, in 1996, with a growth rate of GDP of around 3 per cent, the annual addition to formal employment was rather in the order of 100,000 jobs – a figure which furthermore included some 20,000 jobs that were the direct result of public expenditure programs of various kinds (ibid.: 3). Today, as we have already pointed out, formal employment is contracting. The employment problem is of course not new in South Africa. Much of it can be traced to the apartheid policies of the past which served to segment the labor market and erect artificial barriers to formal employment of Africans, in particular in skilled and semi-skilled positions. This problem was compounded towards the end of the apartheid period, as a result of the recession in the South African economy. Between 1989 and 1993 some 420,000 jobs were lost, and at the end of 1994 another 41,000 jobs could be added to that figure (South African Reserve Bank 1995b: 15). When the economy began to grow again, employment did not keep pace with GDP, and today South Africa is back in a position resembling the one prevailing at the beginning of the 1990s. Unemployment rates are a tricky issue in the South African context, and it should come as no surprise that figures are in dispute. The 1993 SALDRU survey and the Household Survey by the Central Statistical Service carried out in 1994 reported unemployment rates of 30.1 per cent and 32.6 per cent, respectively (Project for Statistics on Living Standards and Development 1994; Republic of South Africa 1995), and 38.4 per cent and 41.1 per cent, respectively, for Africans (Standing et al. 1996: 116). These figures have, however, come in for criticism from an ILO team (ibid.: chapter 4), because they build on a definition which makes international comparisons difficult and because the surveys were plagued by technical deficiencies. According to the ILO team, the best (international) definition is the ‘strict’ one that requires a person to actively look for work during the four weeks preceding the interview. If this is used, much lower figures result, 12.8 per cent in the SALDRU case and 20.3 per cent for the Household Survey (Nattrass and Seekings 1996: 7). These figures, however, exclude the ‘discouraged’ workers – those who do not bother to look for work but who would gladly accept, given the opportunity, and who are very much part of the employment problem in South Africa. Regardless of which figures we choose to use – even 20 per cent, the level deemed to be reasonable by the ILO team, is a respectable figure – it is obvious that special measures are called for if unemployment is to be reduced in South Africa. Just growth will not do the trick, as demonstrated by the experience of the mid-1990s. In the early 1990s many observers were advocating a kick-start approach to growth that should also solve the employment problem (cf. Lundahl and Moritz 1994: 193–7). The idea was to redistribute income and wealth in favor of poorer groups that would then spend on labor-intensive commodities to a much larger extent than the average, generating a good spiral of income, demand, production and employment. However, this sequence does not necessarily materialize. Poor people spend on other than labor-intensive commodities as well, and there may simply not be enough excess capacity in the relevant manufacturing sectors to make rapid expansion possible.

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Hence, the kick-start idea has been pushed into the background in the debate. Instead, attention has focused on the flexibility of the labor market, in terms of wages and labor conditions. The employer side has stressed the necessity to avoid such measures as collective bargaining, minimum wage legislation, etc. that render wage levels downwardly inflexible, especially at the low-wage end of the spectrum. Otherwise, it is felt, the labor market will not clear and unemployment will rise (notably South African Foundation 1996). As could be expected, this argument has not been accepted by the trade union movement, which instead has advocated a Keynesian-oriented economic policy which aims at expanding effective demand (Social Equity and Job Creation 1996). The government, in turn, by and large has accepted the business view of the labor market. The GEAR document speaks about ‘regulated flexibility in managing the labour market … in a manner that allows for flexible collective bargaining structures, variable application of employment standards and voice regulation’ (Republic of South Africa 1996a: 17). In order to soothe the trade unions, a presidential commission on the labor market (Restructuring the South African Labour Market 1996) has suggested a tripartite accord, whereby the unions should show restraint in wage matters, employers should agree to invest and hold back price increases, and the government should on the one hand provide physical infrastructure and on the other hand increase social spending in order to ensure that basic needs are being met. It is, however, highly doubtful whether this solution will work. The main problem lies with the employer representation in such negotiations, who in a market economy hardly can promise to fix prices and increase investments in a way that will be respected by the individual companies, and as long as this cannot be guaranteed the worker side has no incentives to make concessions either. Besides, the South African labor market displays clear insider–outsider characteristics (Lindbeck and Snower 1988). The trade unions represent those already employed, who are mainly interested in keeping wages up, and care less about those who have been unable to enter the formal labor market. The entire process then turns into a nonstarter. An attempt has been made to institutionalize discussions and negotiations between the business community and the trade union movement (together with the government) in a somewhat corporatist forum: the National Economic, Development and Labour Council (NEDLAC) (Lundahl and Petersson 1996). To what extent this has been successful is, however, hard to say, and the work of the presidential labor market commission has by and large disappeared from the debate after less than three years. It is finally difficult to know how much there is to be gained from wage reductions in terms of employment. The employment elasticity figure reported by the labor market commission, 0.7 (Restructuring the South African Labour Market 1996: 51–2), has been severely questioned by the authors of the ILO report who argue that the need for special measures is small since wages in practice are not as rigid as commonly assumed, and least of all in the large informal labor market (Standing et al. 1996: chapter 6).

Can South Africa break the deadlock? 241

8 The political factor The search for economic solutions in South Africa is to a large extent inspired by the success that the country has experienced in the process of finding solutions to its pressing political problems, above all the transition from the old apartheid regime to the post-apartheid Government of National Unity. The key phrase in that context has been ‘consensus building’. In the period that elapsed between the unbanning of the ANC in 1990 and the free and democratic elections in 1994, confidence was gradually built from an initial position where the two main protagonists, the National Party and the ANC, had mistrusted each other deeply. At the outset both parties had a strong tendency to look at the negotiation process as a zero-sum game, where any one side could only make a gain at the expense of the other (Sisk 1995). The next handful of years witnessed a slow and uneasy path take shape under constant threats from those groups in South African society that under no circumstances wanted an agreement where both sides had to make concessions. Still, this process survived both such events as the murder of Communist Party General Secretary Chris Hani and a commando attack on the building where some of the negotiations were held and repeated clashes between ANC and Inkatha supporters in the African townships. In the end an interim constitution could be drawn up (to be followed by a full-fledged new one) and the date for the elections could be fixed. The Government of National Unity that followed the 1994 elections did not survive the entire period until the next elections. In April 1996, the National Party left the coalition and went into opposition, in good time before the 1999 elections. In the latter the ANC swept the field. It, however, by a narrow margin failed to pass the critical two-thirds line that would have made it possible, for example, to dictate changes in the constitution. What will happen in South African politics in the longer run is difficult to say. The small opposition parties constitute no threat whatsoever to the ANC in the foreseeable future. Rather, the threat comes from inside the ANC itself. The difference of opinion with COSATU (Congress of South African Trade Unions) over labor market policy is already a sign of a split that could easily widen. So far, during Nelson Mandela’s presidency, it has been possible to avoid it. The memories of the past are still vivid. The modern ANC coalition has been held together very much by the desire to break with the past and achieve the transition to a post-apartheid society that would be politically dominated by the ANC itself. The internal division was thus postponed. This can probably not continue now that Thabo Mbeki has taken over as president after Mandela. Mbeki must deliver the fruits of redistribution to an extent that is deemed acceptable by the COSATU and Communist Party partners in the ANC alliance (Max Sisulu, quoted by Hadland and Rantao 1999: 138): Under Thabo, the economy – improving the livelihoods of the people – and the leadership of South Africa, will be the key defining needs. He will be

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From crisis to growth in Africa? judged by completely different yardsticks from Mandela. Mandela was all about reconciliation and democracy. Thabo will be about the economy, how we’ll thrive in an economic situation that’s not favourable. Thabo has to take the country into the next millennium. We will need to be competitive and education will be vital.

It is, however, difficult to see how this could take place. As we have seen in the foregoing, no immediate solutions are in sight. The most probable course of events is one of muddling through at a growth rate that is not likely to be any higher than the one that has prevailed since 1994. Possibly it will be lower. In the aftermath of the Asian crisis, the international economy may in the worst case grow considerably slower than before and South Africa has not yet found the manufactured exports that could serve as an engine of growth. The substitution of Mbeki for Mandela will not imply any drastic change of economic policy. Mbeki, who is an economist by training, has endorsed the GEAR program wholeheartedly and has made it clear that he is in favor of free market principles. Employment – the most important economic objective – cannot be obtained at the expense of fiscal stability, since this is perceived by Mbeki as jeopardizing the future. This has brought criticism not only from COSATU, but also from the Communists, who have accused him of dumping the redistributioncentered RDP in favor of the stabilization-oriented GEAR (Hadland and Rantao 1999: 137–42). Thus, whether the ANC survives as a broad coalition until the next elections remains to be seen. It could very well split into two different factions, one – the one going into opposition – urging for a more active redistribution along largely populist lines (cf. the fanciful scenario presented in Venter 1997).

9 Issues of the twenty-first century It should be clear from the foregoing that the most important economic issues of the early twenty-first century will very closely resemble those of the 1990s. The redistribution problem remains unsolved, redistribution is completely conditional on growth and it is not possible to find any easy shortcuts to growth. The most likely scenario for the period until the next elections, in 2004, is that of a growth rate of GDP which in the best case is high enough to allow for a growth of GDP per capita in the order of 1 per cent per annum. In the worst case the per capita growth rate will be negative. (The medium-term forecast made by the Bureau for Economic Research at the University of Stellenbosch (1998) for 1998–2003 predicts an average real growth of GDP of 2.2 per cent, given that stability returns to the world economy and growth picks up towards the end of 2000.) This, in turn, means that unemployment will increase. It is calculated that if the new entrants are to be absorbed into the labor market and the number of currently unemployed is to be decreased, growth rates of GDP in the order of 7–8 per cent will be needed (Michie and Padayachee 1998: 629), but this in the light of the recent experience seems completely unlikely. Most probably, the time perspective will change. The opening of the economy to international competition means that the import-substitution-based industrialization

Can South Africa break the deadlock? 243 strategy has been scrapped. Some critics (notably Trevor Bell 1997) argue that trade liberalization has been far too fast and too deep-going. Nevertheless it has come to stay. Thus, as the government has recognized, if there is to be growth the impulses will quite probably have to come from the export sector, but this, as we have seen, will require investment in both human and physical capital, both of which are going to require time. The educational system in South Africa is today under tremendous strain to make up for what the apartheid years destroyed, but this is easier said than done. It will require both funds and time. Investment as well is likely to be slow to emerge, for reasons that we have already discussed. This calls for a lengthening of the time perspective. Delivery on the Reconstruction and Development Programme will be slower than planned. In 1996 it was discovered that the implementation of the RDP at the planned rate rested on completely unrealistic assumptions. This led to the construction of GEAR. The next step may have to be a downward revision of the targets for GEAR or the design of a new macroeconomic strategy which is less ambitious, but that would, in turn, constitute a signal to potential investors that the South African government no longer believes that the economy will grow at the rate envisaged when the two previous programs were constructed and put into practice. It is thus very difficult to be optimistic with respect to the immediate future of the South African economy. The year 1994 saw a great deal of enthusiasm, but this post-election enthusiasm was mainly politically, not economically, fueled, and in the economic field it simply led to the proposal of unrealistic solutions. If the current stabilization program produces only stabilization but no growth, the mood that will prevail ten years and two elections later may be very different. Hostility, impatience and pessimism may have taken the place of reconciliation, patience and optimism with respect to the future.

10

Conclusions

The South African economy has described a parabola-like trajectory during the past 125 years. The mineral discoveries of the late nineteenth century converted it from a pastoral and agrarian low-growth society into a mineral-based high-growth one. With time, manufacturing was added to mining, and during the post World War II period the growth impulses have to an increasing extent come from manufacturing rather than mining. The era of high growth, however, came to an end in the 1970s and was followed by a difficult period of stagnation and retrogression. When the apartheid system was scrapped and the Reconstruction and Development Programme was presented, in 1994, it looked as if the South African economy were heading for better times. Unfortunately, this was not the case. Growth was high enough to outstrip the population growth between 1994 and 1996. Thereafter the trend has been a downward one, and during 1999 GDP grew with a mere 1.2 per cent – less than the population (Republic of South Africa 2000: 4). This poses large problems with respect to the future, since growth is absolutely necessary if the long overdue redistribution of income and social service in favor of the majority is to be carried out. The growth strategy of the South African government, however, presents serious defects. The basic assumption behind the Growth, Employment and Redistribution

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document is that stabilization and growth can be achieved by the same means: fiscal and monetary austerity in combination with an opening of the economy to international competition. So far, it appears that the program has been successful only in terms of stabilization but not in terms of growth. It could even be the case that there is a trade-off between the two goals. At any rate, it has not proved possible to increase growth rates drastically in the short run. It is difficult to find a potential comparative advantage that does not require either heavy investment or substantial education. Growth tends to become a long-run proposition and in the meantime employment is suffering badly. The management of the transition from apartheid to democracy has been surprisingly smooth in South Africa. So many things could have gone wrong, but they haven’t, and the substitution of Mbeki for Mandela represents political continuity. As time goes by, however, economic issues tend to become more important than political ones. There is a limit to how long the formerly underprivileged majority of Africans are prepared to wait for patent results in the form of jobs, education, housing and incomes, but present economic trends hardly allow the delivery to be sped up. On the contrary, they are likely to tax the patience of the masses even more than during the 1990s. The failure to achieve growth will sooner or later be translated into a failure to redistribute as well, and this is bound to have social effects – in a country with a recent history of extreme tensions and divisions. As the twenty-first century is dawning, South Africa is facing an economic challenge which the country is not equipped to meet, either in terms of resources or in terms of policies.

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Can South Africa break the deadlock? 247 Standing, Guy, Sender, John and Weeks, John (1996), Restructuring the Labour Market: The South African Challenge. Geneva: International Labour Office. Venter, Lester (1997), When Mandela Goes: The Coming of South Africa’s Second Revolution. London: Doubleday. Weeks, John (1999), ‘Stuck in Low GEAR? Macroeconomic Policy in South Africa, 1996–98’, Cambridge Journal of Economics, 23: 795–811. Whiteford, Andrew, Posel, Dori and Kelatwang, Teresa (1995), A Profile of Poverty, Inequality and Human Development. Pretoria: Human Sciences Research Council.

14 Foreign dependency and high-speed growth in Lesotho Lennart Petersson

1 Introduction At independence in 1966 Lesotho was one of the world’s poorest and least developed countries. Apart from abundant water and eroding soil, there were few exploitable resources. Industries were virtually non-existent. Most of the population lived in rural areas, engaged in subsistence agriculture. The conditions for agricultural production were, however, unfavourable with shortages of cultivable land, ongoing soil erosion because of overgrazing and deforesting, an inefficient land utilisation and fragmentation arising from the land tenure system. These poor economic conditions had created a heavy economic dependence on South Africa, especially for employment, and on the United Kingdom for the major share of government spending (World Bank 1974: 27). Commerce was largely in the hands of South African traders. Consequently, there was considerable scepticism about the economic viability of the new sovereign state of Lesotho. In the first development plan 1970–5, it was brought out clearly that ‘for Lesotho, economic development is not an end in itself – in overcoming poverty, malnutrition, ignorance and unemployment – but it is also necessary if she is to survive as a nation’ (Kingdom of Lesotho 1970: 23). From this first plan onwards, economic development and the need to lessen the dependence on South Africa have consistently been stressed as central and mutually interdependent national aims. In order to achieve these aims, the critical objectives of development planning have been economic growth and the creation of domestic employment, assumed to reduce the country’s foreign dependency and lead to poverty alleviation. Despite the aim of reduced external dependency, Lesotho has maintained a policy of integration with the South African economy, but has increased the benefits through renegotiations of the agreements. The present agreements comprise the country’s membership in the Common Monetary Area (CMA) and the Southern African Customs Union (SACU), a labour agreement, which sets out the conditions of labour migration between Lesotho and South Africa, and the Treaty on the Lesotho Highlands Water Project (LHWP). In the long-term perspective, the most important link with South Africa is the export of labour from Lesotho. These extensive links to the South African economy obviously mean that changes in policy and

High-speed growth in Lesotho

249

development of the surrounding country have a major impact on economic development in Lesotho. This chapter will focus on the issue of economic development and foreign dependency in Lesotho, and on whether the country’s rapid growth since 1970 has been driven by external or internal factors and is sustainable. The next section reviews the growth patterns of Lesotho’s economy, compared to South Africa and sub-Saharan Africa. Two periods of high-speed growth in Lesotho’s development are revealed, driven by different growth regimes. These periods are analysed in two subsequent sections. Then, the relation between foreign dependency and growth is examined. Finally, the long-term impacts of the different growth regimes are discussed.

2

Growth patterns

The indices of growth rates of Lesotho compared to South Africa and sub-Saharan Africa, excluding Nigeria and South Africa, are presented in Figure 14.1. The overall growth of GDP in sub-Saharan Africa 1970–97 averaged 2.8 per cent annually with a decelerating growth rate. Thus, in the 1980s, the growth rate slowed down to an average of about 2.3 with a further decline to 1.3 per cent in the early 1990s. This means that, since the mid-1970s, the aggregate economic performance had fallen below that of other developing countries, and since 1980, per capita GDP had declined at almost 1 per cent per annum (Collier and Gunning 1999: 3; World Bank 1989: 16–17). Until recently it had largely been accepted that the main causes of slow growth were external, including an adverse external ‘destiny’ factor: a high proportion of Africa’s population live in landlocked states (Collier and Gunning 1999: 6). Since the 1980s, the slow growth has also been attributed to poor domestic policy, which has created an unstable macroeconomic environment and an expensive and poor public service delivery. As a result, in collaboration with the World Bank and IMF, a large 600 500 400 Lesotho 300 sub-Saharan Africa

200

South Africa 100 0 70

72

74

76

78

80

82

84

86

88

90

92

94

96

Figure 14.1 Real GDP growth of Lesotho, South Africa and sub-Saharan Africa, excluding Nigeria and South Africa, 1970–97 (1970:100). Sources: BOS (1999: 1–2), World Bank (1992a: 22–3) and World Bank (1998: 17).

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From crisis to growth in Africa?

number of African countries have drawn up adjustment programmes. It is emphasised that there exists a close link between investment and growth in developing countries, and that private investments in particular have an important role in a process of sustainable growth (Ghura and Hadjimichael 1996; Fisher et al. 1998). Compared to other developing countries, the ratio of investments to GDP has been low in subSaharan Africa, and the region has not been very successful in increasing private (domestic and foreign) investments (Fisher et al. 1998: 4–5, 22). Moreover, in real terms Africa’s investment rate is less because of higher costs (World Bank 1989: 25). The growth performance has, however, varied greatly from country to country, and a few countries stand out in contrast against the picture of general decline. The four countries with the highest average growth rates since 1970 are located in Southern Africa, namely Mauritius (5.6 per cent) and three SACU member countries: Botswana (8.2 per cent), Lesotho (6.3 per cent) and Swaziland (4.9 per cent). In South Africa, which dominates SACU, a relatively high average annual growth of about 4 per cent in the 1970s has declined to 1.3 per cent since 1980. For Lesotho, various estimates indicate little or no growth of production during the first few years after gaining political independence. The World Bank estimates a declining production in real terms between 1966 and 1970 (World Bank 1974: 16–17). Thereafter, GDP grew at an average annual rate of 6.3 per cent to 1997. However, the impressive growth performance, compared to sub-Saharan Africa and South Africa, is concentrated to two periods. Between 1972 and 1978 GDP increased on average by about 12 per cent annually. After 1978, economic growth slowed down until 1987 with a growth rate of 2.2 per cent, which is slightly below the average for sub-Saharan Africa. This was then followed by a decade of rapid growth of 6.4 per cent per annum. In Lesotho, with the exception of a decline in four years (1974, 1978, 1983 and 1993), real gross investments have increased continuously each year since 1970. In both periods of high-speed growth, as shown in Figure 14.2, gross domestic investment showed a high growth rate, while the average annual growth stayed at 4.7 per cent from 1978 to 1987. The ratio of fixed investments to GDP increased from 17 per cent in 1970 to fluctuate around 35 per cent between 1978 and 1987. Thereafter, the ratio of capital formation to GDP peaked at 65 per cent in 1992 followed by a decline to 55 per cent in 1997 (BOS 1999: 2–3, 18–19; World Bank 1992a: 372). Thus, for two decades, the investment ratio significantly exceeded the average of about 15–20 per cent for sub-Saharan Africa (Fisher et al. 1988: 22; World Bank 1989: 26). The two periods of impressive growth were driven by different regimes. The main characteristic of the 1970s was the dramatic increase in labour income from abroad, producing a consumption boom with positive linkage effects for the domestic economy, as well as creating imports. In the public sector, increasing government revenue and external grants were used to increase government consumption, but in particular to increase capital expenditures. Total investments became increasingly dominated by the public sector (BOS 1983: 140; World Bank 1992a: 372). In the face of worsening economic conditions after 1988, Lesotho implemented structural adjustment programmes, the broad objectives of which were to restore

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4,500 4,000 3,500

Private consumption

3,000 2,500 2,000 1,500 Gross domestic investment

1,000 500 0 70

72

74

76

78

80

82

84

86

88

90

92

94

96

Figure 14.2 Private consumption and gross domestic investment in Lesotho, 1970–97 (1995 prices). Sources: World Bank (1992a: 372) (1970–80) and BOS (1999) (1980–97).

and maintain a high economic growth within the context of strengthened fiscal and external balances. The main explanation for the high growth rate during the decade after 1987 was a long-term private investment boom with an average growth rate of capital formation around 10 per cent per annum. The growth rate of private and public consumption has been around 4 per cent per annum. Investments and economic development are dominated by the activities of one single project, the LHWP. The project consists of a large component that will export water to South Africa and a smaller one that will generate electricity for Lesotho and export. Since its start in 1988, investments related to the LHWP have increased enormously. In the 1990s, about half of all investments were related to the project (IMF 1999: 17). Also other, domestic and foreign private, but in particular public, investments have increased significantly. Most of the investments have been in infrastructure.

3 Demand-driven growth Ever since the end of the nineteenth century, low and declining productivity in agriculture and inadequate opportunities for employment in the industrial and service sectors have made wage employment in the South African mining sector of critical importance to the livelihood of a large section of Lesotho’s population. In the 1970s, rising mine wages meant that the migrants in the South African mines were well paid compared to income earnings in agriculture or the wages of unskilled employees in the domestic economy. From 1972 to 1978, increased remittances from migrant workers in the South African mines resulted in a demand-driven growth in Lesotho, and increased foreign aid and customs union revenue resulted in increased public expenditures.

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Foreign dependency In the 1970s, various political and economic pressures induced the mining industry to initiate a policy of internalisation, which led to the composition of the workforce shifting towards domestic labour. For almost a decade, following the abolition of the fixed price of gold in the early 1970s, wages in the mining industry were allowed to rise for the first time in such a way that they could compete with wages in the manufacturing industry and thus attract black South Africans. Real mine wages, which had been at a virtually constant level since 1911, trebled in the 1970s, the major increase occurring between 1971 and 1975 (Crush et al. 1991: 198–202; Knight and Lenta 1980: 172). In spite of a reduction of about 100,000 foreign workers in the South African mines, the number of Basotho mine migrants increased, however, from 101,515 in 1972 to 115,044 in 1978 (BOS 1983: 66; Crush et al. 1991: 235). For Lesotho, the increases of migrants and their wages meant an impressive growth of labour incomes from abroad, which in 1978 accounted for almost half of GNP. Net factor income from abroad, entirely dominated by labour income, increased by around 18 per cent per annum (World Bank 1992a: 372). A second main stimulus behind Lesotho’s growth was foreign aid, which increased significantly in the 1970s. From about the mid-1970s, the Prime Minister, Leabua Jonathan, exploited growing hostility towards South Africa in order to increase Western economic support. Foreign aid increased in particular after the Soweto uprising in 1976, and when Lesotho refused to recognise the ‘independence’ of Transkei in the same year (New African Yearbook 1987–88 (1988): 175). These events, and the aim of reducing the country’s dependence on South Africa, became a widespread argument for justifying a higher level of aid per capita compared to the average for sub-Saharan Africa. A third factor was rapidly rising customs union receipts. In terms of the 1969 SACU agreement, the main determinants of the revenue accruing to Lesotho were the country’s import and excisable production, the average duty collection in the customs union area and a compensating factor (Lundahl and Petersson 1991: chapter 10). Furthermore, after 1976/7, Lesotho’s total customs union revenue became constrained by a 17 per cent lower boundary and a 23 per cent upper boundary of the country’s import and excisable production. The rapid growth of the domestic economy and migrant remittances meant rapidly increasing imports. In real terms, the growth of imports for the period 1972–8 was in the order of 15 per cent, on average, per annum. As a result, in real terms, customs union revenue quadrupled (Lundahl and Petersson 1991: 223). As a proportion of GNP, the revenue doubled to approximately 15 per cent in 1978/9. Finally, towards the end of the 1970s, diamond production on an industrial scale was begun at the Lets’eng-la-Terain. The project was a joint venture between the De Beers company and the government (IMF 1983: 17–18). The latter’s share was 25 per cent, but was to rise when the initial investment by De Beers was recovered. The mine began full operation in early 1977 but was closed down in the course of 1982.

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Growth For the private sector, the increase in migration and real mine wages drastically altered relative incentives, in particular in the rural economy. Most of the population lived in rural areas, and were dependent on the combined income possibilities from migration to South Africa and agriculture for their livelihood. In the early 1970s, production in agriculture was a major source of income for approximately 85 per cent of the population, and almost 70 per cent of the population of Lesotho were owners of livestock (Kingdom of Lesotho 1970: 9–10). Migrant remittances contributed approximately 40 per cent to their household income. This proportion increased to about 70 per cent in 1976–8, while incomes from crop production and livestock declined to about 20 per cent, the remaining 10 per cent being incomes from off-farm activities within Lesotho (Eckert and Wykstra 1980: 13; World Bank 1974: 42). Eckert and Wykstra (1980) estimate that mine wages in maize equivalents trebled from 1972 to 1976. After a few years of permanent higher mine wages, the planted area dropped substantially after 1974 (Eckert and Wykstra 1980: 16–17; World Bank 1998). A trend of declining area of land fallow, due to the population pressure on land, had been reversed (World Bank 1974: 39). This change was accompanied by a sudden and sustained increase in crop yields (Low 1986: 130–2). The main explanation is that, having reduced cultivated acreage by almost 40 per cent between 1974 and 1978, farmers concentrated their input and cropping to good land, letting marginal fields return to grass. The increasing mine wages also generated a fundamental shift in livestock trade. After the mid-1970s, Lesotho’s historic role as a net exporter of livestock changed into a large net importer of cattle, reinforced by a similar pattern in sheep (BOS 1983: 125, 136). Altogether, with a large yearly variation in crop production, due to vagaries of rainfall, agricultural production had an increasing trend from 1972 to 1978. For the period 1973–8, it is estimated that more than 70 per cent of mine migrant earnings were remitted to Lesotho as cash or goods brought home from South Africa (ILO/JASPA 1979: 50). The increased purchasing power generated positive linkage effects for the domestic economy, and created imports which are crucial determinants of customs revenue. Available data allow only crude estimates to be made of the magnitude of the multiplier effects of the spending of migrants earnings within Lesotho. According to James Cobbe, each loti a migrant spent in Lesotho gave rise to an additional 0.25–0.85 maloti of value added within the country with 0.50 a reasonable point estimate (Cobbe 1986: 38). The earnings spent in Lesotho generated value added mainly in transport, retail trade, construction, catering, services and products related to agriculture and the informal sector of the economy (ibid.: 37). Accordingly, much of the increase of migrant incomes generated growth in the secondary and service sectors. In the secondary sector, the construction boom included the building of living quarters for returning migrants. The immediate post-independence development policy may also have supported the manufacturing production of consumer goods. Until 1978, the strategy focused on the promotion

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of small-scale indigenous industries for import substitution and handicraft production for export. The small-scale industries were favoured because it was felt they would offer a practical solution to the small size of the domestic market and permit the decentralisation of industry (Ministry of Planning 1994: chapter 6). In absolute terms, the result was modest and the growth rate of manufacturing (8 per cent) was slightly below the average for GDP (11 per cent at factor cost). However, the policy of import substitution met with some success. In spite of the demand-driven growth and the integration of the country’s commodity and factor markets with South Africa’s, the average propensity to import was more or less the same in 1972/3 and 1977/8. The budgetary situation improved substantially between 1972 and 1978, due to increased customs union revenue and development aid. In real terms, customs union revenue growth was in the order of 26 per cent, on average, per annum, and gross ODA in US$ grew by 22 per cent each year (Lundahl and Petersson 1991: 223; Bardill and Cobbe 1985: 66). Government consumption grew slightly faster than private consumption. The increasing revenue created a significant net government saving in a few years (Kingdom of Lesotho 1975: 27; World Bank 1983: 8, 10, 53). This surplus and development aid was used for public investments, largely in infrastructure, and, after the mid-1970s, public investments dominated gross capital formation. The growth rate of investments for 1972–8 was around 24 per cent per annum.

4 Foreign investment and infrastructure-driven growth After the late 1970s and in particular the mid-1980s, Lesotho’s economic and financial situation deteriorated. Economic activity slowed down, the current account weakened considerably, the overall budget deficit grew substantially and the public sector firms’ performance was very low. The financial imbalances of the economy can be attributed to the sluggish growth of migrant remittances and customs union revenue in combination with an expansive fiscal and monetary policy. In recognition of the worsening economic conditions, the government of Lesotho, in collaboration with the IMF and the World Bank, implemented a three-year structural adjustment programme in 1988, followed by successive three-year programmes. The broad objectives of the programmes were to restore and maintain a reasonable economic growth, expand employment opportunities and improve living standards within the context of strengthened fiscal and external balances. Foreign dependency For a decade, Lesotho’s relation with South Africa had deteriorated seriously, which culminated in an economic blockade of Lesotho in January 1986. This resulted in a military coup, which brought General Lekhanya to power as the head of a military council (Lundahl and Petersson 1991: 51). In the same year, on 24 October 1986, the government of Lesotho and South Africa signed an agreement to undertake a large joint inter-country water project. This event marks the starting point for a

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new policy in Lesotho based on cooperation with its large neighbour (Tsikoane 1991: 118). For South Africa the LHWP is a single-purpose project to procure a constant and reliable water supply for the industrial and commercial sectors of the country in the Gauteng province (Pretoria-Witwatersrand-Vereeiniging (PWV) area), which were experiencing a growing demand for water (Moeti 1996; Senaoana 1992). Under the agreement, the dams and reservoir infrastructures are located in Lesotho and water will be transferred to South Africa by a system of tunnels via a hydroelectric plant. In comparison to transferring water from the Orange River against gravity to the PWV area, this was a cost-efficient alternative (Moeti 1996: 73). The net benefit of reduced costs in comparison to a ‘Least Cost Orange Vaal Transfer Scheme’ within South Africa is shared between the two countries (LHWP Treaty, undated: Article 12). According to the LHWP Treaty, South Africa will be responsible for all the costs of all the components of the project concerned with the transfer of water, as well as the implementation, operation and maintenance of this part of the project (LHWP Treaty, undated: 51). For Lesotho, the LHWP is a multipurpose project, and seen as an opportunity to exploit its huge water resources, which ‘unlike mineral resources are of an inexhaustible nature’ (Kingdom of Lesotho 1970: 27). In addition to royalty income paid by South Africa in return for water exports, Lesotho will benefit from hydroelectric generation for consumption, substituting imported power from South Africa, provision of water for irrigation purposes and accompanying improvements in infrastructure. The funding of the engineering and preliminary construction phase of the project, implemented in the late 1980s, and the hydropower component, was the responsibility of the Lesotho government (World Bank 1993: 21–2). The entire project is anticipated to take thirty years to complete, and will take place in four phases. The cost of the water transfer and hydropower components over the period 1988–97 (phase IA) has been estimated at approximately US$ 2.3 billion and US$ 0.24 billion, respectively, at 1990 prices (World Bank 1992b: 2). In particular the LHWP, but also the introduction of structural adjustment programmes, resulted in an enormous inflow of long-term capital and foreign aid in order to finance investments. The financial inflows related to the water transfer component of the LHWP, provided by South Africa, are classified as private foreign investment. The LHWP has, as seen in Table 14.1, resulted in an enormous and steady increase in capital inflow. The growth rate of long-term capital, net, was on average 34 per cent, per annum, between 1987 and 1997. Since 1990, threequarters of the inflow has been financing of the water transfer component. The total capital inflow related to the project from 1988 to 1997 was 6,164 million maloti. This can be compared to GDP in 1997 of around 4,715 million maloti. A second factor behind Lesotho’s growth was an increase in the flow of external assistance, including increases in both grants and loans on favourable terms. The main proportion of long-term official net inflow is related to the engineering and preliminary phase of the LHWP, and the hydropower component of the project. In particular during the first three-year structural adjustment programmes, external aid (included in unrequited transfers in Table 14.1) increased significantly.

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From crisis to growth in Africa? Table 14.1 Long-term capital, net, and unrequited transfers, 1987–98 Long-term capital, net

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Unrequited transfers, net

Total

Financing– LHWP

Private

Official, net

82.1 163.2 306.4 340.0 578.0 748.2 1,001.1 1,087.9 1,175.5 1,533.4 1,514.5 1,765.0

-0.4 39.4 186.2 183.4 461.0 580.7 781.0 817.9 913.6 1,107.4 1,093.8 1,303.1

11.5 39.5 33.7 43.1 18.3 42.4 57.1 149.2 82.9 114.6 141.8 144.8

71.0 84.3 86.5 113.4 98.8 125.0 163.1 120.7 179.0 311.4 276.9 317.1

160.0 265.7 314.4 408.3 414.8 606.2 646.8 762.6 878.9 958.2 1,086.9 912.5

Source: CBL (1999: 83).

A third source of growth was increased foreign direct investments. Since 1978, comprehensive programmes of promotion and incentives had been designed and implemented to attract foreign investments, while less effort was paid to the stimulation of Basotho enterprise. These incentives seem to have been a key factor in the decision of foreign investors to invest in Lesotho. This new policy was further strengthened in the structural adjustment programmes aimed at a friendly investment climate and competitive labour market conditions in order to encourage domestic and foreign investments in manufacturing activity. Since 1988, a number of improvements have taken place in the promotion of export-oriented foreign investments. External factors were, however, vital for the success. In the late 1980s, sanctions against South Africa were intensified. It was also a period of growing quota problems for Far East manufacturers exporting to USA and Europe. The combination of these trends created opportunities for the promotion of foreign investments in Lesotho, particularly in sectors such as clothing and footwear. Since 1987, as shown in Table 14.1, private foreign investments have increased significantly. A fourth stimulus to growth was rapidly increasing customs revenue, which is partly recorded as unrequited transfers to Lesotho (the so-called SACU non-duty receipts). From 1987 to 1993, the ratio of customs union revenue to GNP doubled to about 20 per cent, and stagnated at this level (CBL 1997b: 72; 1999: 69; BOS 1999: 1–2). The good performance of this source of revenue largely reflects the extraordinary growth of imports for the LHWP. The only figures that suggest a lessening of dependence are labour incomes from abroad. After the 1980s, a crisis gradually developed in the gold mining industry, due to a variety of factors. Only a few new mines were opened, and the working conditions and grades of ores produced declined as the existing mines expanded. A more active and increasingly unionised black labour force in the mines continued to press for

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higher wages. This resulted in real wage increases of around 50 per cent, the main increase occurring after a large-scale strike in the mines in 1987 (Crush et al. 1991: 197–202; CBL 1992: 86). With declining productivity, the industry lost its formerly high international competitiveness, based on low wages in its very labour-intensive production of gold. After having peaked in 1990, the number of Basotho mine migrants declined by around 25 per cent until 1997, which means a reduction of about 30,000 in the migrants employed (CBL 1995: 87; 1999: 85). As a result, factor income from abroad has declined in real terms by about 10 per cent in the period 1990–7. Structural adjustment and growth In the short term, structural adjustment was meant to achieve economic stabilisation, assumed to be a necessary condition for growth. The emphasis was on budget planning, monitoring and control to be followed by civil service reforms and structural measures aimed at sustainable internal and external balances. The public sector’s role was to be mainly supportive, concentrated on the development of infrastructure and the provision of market-oriented incentives (IMF 1988: 11–13). In order to make domestic resources available to the private sector while maintaining a high level of capital expenditure, the growth of government consumption was to be held back by a tight fiscal policy. The long-term strategy to ensure balance-ofpayment viability and to avoid external debt service problems were strict limits on external non-concession borrowing contracted or guaranteed by government and public agencies. However, Lesotho’s problem also had its roots in the structure of the domestic economy, such as lack of incentives, deficient basic infrastructure and low productive capacity. Accordingly, structural or supply-side policies had to accompany stabilisation policy to increase output. This included measures to improve the efficiency of resource allocation in general and the public sector in particular, and to reduce state participation in the economy. A more productive and flexible economic structure was supposed to be created by systemic reforms largely through measures commonly termed ‘market liberalisation’ and the implementation of institutional reforms. However, Lesotho’s market integration with South Africa means that the major prices are heavily influenced or determined by those of South Africa, such as prices of commodities, credit, labour and foreign exchange. The major structural measures were directed towards agriculture, industry, and public sector reforms including commercialisation and liquidation of loss-making parastatals and improvement of the performance of public utility firms. From 1987 to 1997, the overall growth performance of Lesotho’s economy was impressive with an average annual growth rate of GDP (to factor costs) of 6.4 per cent (BOS 1999: 9–10). Because of declining factor income from abroad in real terms, the average annual growth rate of GNP was a more modest 3.7 per cent. Two periods are distinguished in Table 14.2. From 1987 to 1992 the growth rate of gross domestic investments was around 20 per cent per annum, largely attributed to increasing investment activities related to the LHWP. Then followed a period of maintained high level of investments in the range of 55–60 per cent of GDP. The growth rate of final

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From crisis to growth in Africa? Table 14.2 Growth performance, 1987–97 and 1998 1987–92 GDP (factor costs) Primary sector Secondary sector Manufacturing Electricity and water Building and construction Tertiary sector Public sector Private sector GDP (market prices) Factor income from abroad, net GNP Gross capital formation Final consumption expenditures

1992–7

1987–97

1998

6.7 1.4 13.6 7.2 18.5 18.1

6.0 3.9 7.0 9.1 32.3 1.2

6.4 2.6 10.2 8.1 25.2 9.3

95.5 90.7 911.8 0.4 929.4 912.0

4.7 2.6 6.0 6.9 92.1

6.0 5.5 6.4 5.9 0.0

5.2 4.1 6.2 6.4 91.2

0.0 7.6 96.4 95.5 915.6

3.4 19.5 2.5

4.0 1.2 6.0

3.7 10.0 4.2

98.3 911.3 92.2

Source: BOS (1999: 9–10, 19–20).

consumption expenditures was only 2.5 per cent per annum from 1987 to 1992, but increased to an average of 6 per cent annually from 1992 to 1997. Since 1987, industry has been the driving force of growth in the economy, largely derived from the rapid increase of investments. In the public sector, capital expenditure has been dominated by investments arising from the implementation of the LHWP, which includes substantial investments in the sector of electricity and water. The main increase in gross capital formation has, however, been foreign investments. These have been related to the water transfer component of the LHWP and investments in the manufacturing sector, creating a growth demand for houses, offices and residential accommodation. As a result, the share of building and construction in total GDP increased from 13.3 per cent in 1987 to a peak of 22.7 per cent in 1992. However, there exist a number of bottlenecks in Lesotho’s economy such as bureaucratic inefficiency, a restricted land act and out-of-date property legislation, shortage of finance for residential development, serviced land and skilled labour. This reduced the opportunities for the country to make the most of the opportunity created by the investment boom. For example, the entire LHWP is estimated to have employed less than 5,000 Basotho 1995–8 (ILO 1997: 17). Since 1992, the share of production in the building and construction sector has almost stagnated at around one-fifth of GDP (BOS 1999: 7–8). In 1987, 64 per cent of value added in manufacturing and approximately 18 per cent of exports were food and beverages (CBL 1993: 11–12; BOS 1999: 7). The food industry, producing largely for the domestic market, is dominated by public-owned enterprises, while the private sector consists mainly of small-scale enterprises producing for local markets. The financial performance of the major parastatals has

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generally been poor, requiring massive subsidies or government-guaranteed loans. Since 1987, the growth rate has been around 4 per cent per annum, and the sectors’ share of total manufacturing production has declined to less than 50 per cent (BOS 1999: 8). The share of food and beverages in total exports has declined to around 4 per cent (CBL 1999: 8). The favourable development of the manufacturing sector with an average annual growth rate of around 8 per cent was based on an export-led growth in foreignowned enterprises. The strengthening of investment incentives to attract foreign investors, together with low wages compared to those of South Africa, was successful. The promotion of investments has been focused on medium- and large-scale enterprises, producing labour-intensive commodities for export to South Africa and overseas markets. In the process, strong emphasis has been placed on clothing, textile and footwear production, the investment coming largely from South Africa and Southeast Asia. Since 1987, the growth rate of non-food manufacturing products has been approximately 13 per cent per annum. The private service sector has by and large had the same growth rate as the entire economy with a high growth rate for wholesale and retail trade, transport and real estate and business services (BOS 1999: 9–10). The growth rate of the public service sector was significantly below the average growth rate of GDP during the first four years of structural adjustment. However, after 1993, with the transfer of power from the previous military regime to a newly elected civilian government, the policy of restrained expenditures became weaker, and the public service sector grew at the same rate as GDP. In agriculture, the policy objectives were to increase production through product diversification into more land-intensive crops, increases in traditional cereal crop yields and encouragement of intensive rearing of improved livestock (IMF 1988: 14–17; Kingdom of Lesotho 1997: 13–15; World Bank 1995: 50–63). Programmes to support these efforts included development of markets, improvements of distribution as well as provision of better extension services, and subsidies for fertilisers and hybrid seeds. A number of factors contributed to the failure of most programmes (Ministry of Planning 1994: 147–50). There were cuts in expenditures and staff under the tight fiscal policy under structural adjustment, and skilled labour resigned from government posts to take up better paid jobs in the LHWP or at the national university. As a result policy making and the implementation of projects became ‘donor driven’, due to the low capacity of the Ministry of Agriculture in terms of finances, personnel and other support services. Consequently, the programmes became dependent on foreign assistance and financial support, which resulted in non-sustainability because the government or the local communities were expected to contribute and eventually be responsible for service of the projects. As an example, in the livestock sub-sector, the programme of proper management of ranges to protect the deteriorating land-base, progress was slow and most of the fund was retained by the donor (USAID) (ibid.: 148). Despite these problems, there has been a trend towards improved yields in crop production, and minor diversification of the sector by increased production of highvalue vegetables and fruit growing. In the late 1980s and in 1993/4 and 1995/6,

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favourable weather conditions encouraged most of the farmers to plant their fields, and the total area harvested and crop yields increased significantly (CBL 1997a: 7). This suggests that the performance of the sector is largely determined by weather conditions rather than policy implementation of structural measures. The growth rate for 1987–97 was 2.6 per cent per annum.

5 Growth and foreign dependency Growth resulted in substantial changes in the sector composition of domestic production. Two main trends, presented in Figure 14.3, were the decline of agriculture in the late 1970s followed by stagnation of production, and the increase of secondary industries in real terms (1995 prices). Industry was dominated by the sectors of ‘manufacturing’ and ‘building and construction’, except for a short period from 1978 to 1982 of large-scale diamond production. After 1970, both sectors showed a long-term trend of rapid growth of around 12 per cent per annum. As a result, from 1970 to 1997 the share of industry in GDP increased from around 8 per cent to roughly 42 per cent (BOS 1999: 8; World Bank 1992a: 372). In the late 1990s with the completion of the water transfer component of the LHWP, production in the sub-sector of electricity and water also increased significantly. The growth rate of the service sector slightly exceeded the average growth rate of GDP. The agricultural sector predominates among the currently employed population, providing part-time employment and survival for large population segments. Its main elements are a livestock system under common property management, and crop production suffering from adverse climatic conditions and characterised by low-input, risk-avert management (Bojö 1991: chapter 3). The main goals of agricultural policy have been to improve self-sufficiency, emphasised during the period of political

1,600 1,400 Secondary industries 1,200 1,000 400

Agriculture

300 200 Manufacturing 100 0 70

72

74

76

78

80

82

84

86

88

90

92

94

96 98

Figure 14.3 Growth performance in agriculture and secondary industries, 1970–98 (1995 prices). Sources: World Bank (1992a: 372–3) and BOS (1999: 9–10).

High-speed growth in Lesotho

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confrontation with South Africa (1976–86), and to encourage the adoption of more intensive techniques (Ministry of Planning 1994: 131–47). Despite high priority, a strategy of improved performance of subsistence farming has failed. In addition to weak management or incapacity to implement projects, development of the sector is influenced by the integration of labour and commodity markets in the region. Crop production is characterised by high risks and low returns in absolute terms, and the relative return to cultivation has declined significantly with rapidly rising wages in the South African mines (Sechaba Consultants 1995: 105). As a result, offfarm incomes have played an increasing role for subsistence living and can be regarded as an alternative strategy adopted by farmers. The number of livestock has increased substantially since the beginning of the 1970s, due to rising migrant incomes. This sector is, however, signified by overstocking, low marketing, low reproduction, range degradation and environmental destruction and erosion (Bojö, 1991: 101–3). Thus, although there may be a net profit for the individual family, there is a net loss to the wider community, due to overstocking. In the gradual development, increased dependency on migrant remittances was accompanied by increased land degradation and a substantial decline in production in the early 1980s, followed by a trend of low increase of production. In manufacturing, the immediate post-independence period was associated with the promotion of small-scale import substitution strategies and handicraft manufacturing for export. It was also a period during which the public sector enterprise sector was promoted intensively (Ministry of Planning 1994: chapter 6). In spite of a high growth rate, due to its expansion from a very small base, in absolute terms the growth of employment and production was very small. After 1978, policies changed towards promotion of the private sector, while the public sector adopted the role of creating an enabling investment environment. In the period after 1988, following the implementation of structural adjustment programmes, existing policies were consolidated. The ultimate result of the policy, introduced in 1978, was the attraction of foreign investments, creating an export-led growth. In addition to a programme of incentives and restrained wages, investment promotion was made easier in the late 1980s by trade and investment sanctions imposed against South Africa and the United States quotas against the Far Eastern textile and clothing exports. These external factors resulted in relocation of production to Lesotho, largely in the sectors of textiles, clothing, footwear and other leather products. As a result, production and exports of manufactured goods enjoyed a dramatic increase following the change of strategy in 1978. Until recently, an increasing share of these non-traditional export products went to overseas markets. From 1987 to 1997, as shown in Table 14.3, the share of employment in entirely foreign-owned companies increased from 63.7 per cent to 91 per cent, and the number of employees more than doubled. Most of this shift was due to increased investments from overseas countries, while the share of employment in companies with South African ownership remained at about a third of total employment. Construction activity, including residential and non-residential building and public works, increased rapidly in two periods, from the mid-1970s to the early 1980s and after 1987. In both periods, the main stimulus of growth was external

262

From crisis to growth in Africa? Table 14.3 Foreign ownership and employment in manufacturing companies operating in Lesotho, 1987 and 1997 1987 Employment Lesotho-owned Lesotho/foreign-owned, of which Lesotho/RSA Other Foreign-owned, of which RSA or RSA/other countries Other Total

% of total

1997 Employment

% of total

1,801 1,369

20.6 15.7

902 913

4.5 4.5

983 386 5,558 2,784

11.3 4.4 63.7 31.9

806 107 18,457 6,432

4.0 0.5 91.0 31.7

2,774 8,728

31.8 100.0

12,025 20,272

59.3 100.0

Sources: LNDC (1987, 1998).

and connected to an inflow of external resources. In the mid-1970s, public investments became largely determined by the political development in the region. This culminated in the closing of the border with part of South Africa (Transkei) in 1976 (Bardill and Cobbe 1985: 67, 172, 182). As a result, the government, with the support of foreign aid, decided to rapidly build up the country’s infrastructure, including alternative routes of supply to the affected area (World Bank 1983: 8). In the private sector, the rapidly rising migrant remittances generated a boom in shopping centres and other commercial construction as well as improvements in living quarters of the mine migrants (ibid.). In the 1980s, activity in the sector stagnated at a high level with the implementation of major government projects, such as the airport and government office complex, largely financed by foreign aid and external loans, and residential construction financed by workers’ remittances (Lundahl and Petersson 1991: 290–3). After 1987, the boom in construction was largely due to the LHWP. The large water transfer component of the project is entirely financed by South Africa, which has resulted in a dramatic increase in long-term capital inflow. However, the Lesotho government has also made large investments related to the project, financed by increased revenue, largely increased customs union revenue due to a sharp increase in imports related to the LHWP, external borrowing and foreign aid. The World Bank was active in creating a market for the LHWP, and also in the preparation and implementation of Lesotho’s first structural adjustment programme. Consequently, it participated in the financing as a direct lender and supported with technical assistance, generating the necessary degree of confidence in international financial circles and among donor countries. These sources included the World Bank, UNDP, the EC, South Africa and a number of donor countries (IMF 1988: 7).

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263

Long-term impact

Until military rule in 1986, the Lesotho government consistently emphasised the need to lessen the economic dependence on South Africa. However, because policy actions of reduced integration with the South African economy were expected to have substantial short-term costs, the government and the donor community were reluctant in practice to introduce measures of reduced dependency. We have found that external sources have been a main stimulus to the economy during periods of growth. The question is whether the long-term impact has been favourable in creating a sustainable growth of production and incomes. In the 1970s, increased opportunities for well-paid wage employment in South Africa reduced the incentives to farm, and in the early 1980s crop production fell significantly. It is doubtful if this development can be reversed. The reduced opportunities for mine migration in the 1990s, which is likely to continue, may increase the desire of landed rural households to cultivate, but at the same time their ability to make agricultural investment will be limited by the lack of non-rural incomes. A severe problem is soil erosion, where the combination of rising migrant wages and a livestock system under common property management created overstocking and range degradation. Property rights reforms are needed, but various governments have failed in the past to implement, or directly opposed, such measures because they may have affected social relations and the power structure in rural areas. Thus, in subsistence agriculture, the external dependence on migrant remittances has contributed to the poor performance with a long-term negative impact. Furthermore, the offer in the mid-1990s of permanent residency status to Basotho workers is expected to adversely affect migrant workers’ remittances and in particular rural development in the future as well (ILO/SAMAT 1998: 12). Consequently, the long-term impact of the temporary migration system may, in post-apartheid southern Africa, be permanent migration of miners and their families to South Africa. The miners have few options for making a living, other than trying to be re-engaged (Sechaba Consultants 1997: 6). The belief that there will always be employment in the South African mines for boys even when they are uneducated, has tended to discourage many young males from pursuing education, and their formal education standards are low compared to other population segments. In the public sector, the performance has deteriorated. Although a wide range of structural reforms have been introduced, the overall progress has been slow and the performance in implementing agreed reforms has been declining. The programmes are largely designed by foreign advisors, and the main problem is that implementation also rests heavily on technical assistance, which seems increasingly to be a substitute rather than a complement to local capacity. This means that substantial efforts in the past have not paid off (Petersson 1995: 1–8). From 1993 onwards, the deterioration in the form of low implementation capacity can be related to difficulties in the transition to a democratic political system and the weak political authority of the government to pursue the programme. Since independence in 1966, Lesotho’s public investment programmes have relied heavily on external support, in which investments in infrastructure with road

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construction have been an important component. Lesotho relies on road and air transport for passengers and freight, and since independence the country’s road network has greatly improved. Most of the roads run in the western part of the country, where most urban areas and industries are located, and which contains the fastest growing urban areas due to internal migration. In addition, the LHWP has spurred the development of a northern road network. This has facilitated easier access to and from remote areas, and created opportunities of industrial and tourist developments in a new district of the country. If maintenance of these investments is ensured, they may play an important role in the future, because a reliable and well-maintained road network is critical to the commercial and rural development. In the 1990s, a major part of investments has been related to the LHWP. The ‘electricity and water’ sector, as a proportion of GDP, increased from 0.6 per cent in 1987 to 7.5 per cent in 1997. A large increase in 1987 was due to the completion of the Katse Dam, where production and royalties from South Africa in the water transfer project are related to the actual amount of water in this dam (Kingdom of Lesotho 1998: 18). The LHWP will bring long-term economic benefit to Lesotho, through the sale of water and generation of electricity for both domestic consumption and export to southern Africa. The successful completion of the first phase appears to have ensured a continuation, and infrastructure on the next phase was reported to have started in 1999 (Kingdom of Lesotho 1999: 19). The project is scheduled to be completed in 2020, which means that it will have a long-term impact on the economy. For manufacturing, with a long-term steady growth of production and exports, the outlook is uncertain due to a number of mutually reinforcing factors. Manufactured exports will be facing stronger competition in the future, due to the reintegration of South Africa into the world economy and, in particular, to regional trade liberalisation if this comes into effect. Concerning labour and medium capitalintensive projects, many other countries, South Africa included, offer a better package of financial incentives than Lesotho. Furthermore, the low quality of utilities in Lesotho, especially of water, electricity, telecommunications, property rentals and rates, must be improved and the high costs of these services kept under control. Utility and other related costs are relatively high in Lesotho as compared with South Africa and various other countries in the region (Reilly 1998). Thus in order to attract foreign investors, Lesotho will have to find its competitive advantage in the quality of its workforce, which is regarded as highly literate and easy to train, and in good industrial relations. It can be questioned, however, whether the development strategy in Lesotho, based on foreign investments and cheap and productive labour, is sustainable. In the 1990s, workers have resorted to industrial actions in a number of cases (Southall 1994). Since the late 1980s, industrial development has also been threatened by the political instability in Lesotho. A stable economy and the maintenance and assurance of security and political stability are of critical importance. These are factors that only a few years ago were assumed to give Lesotho an important advantage over South Africa in the promotion of foreign investments. Industrial development in Lesotho appears to have been the reverse of what was expected, and to have been clouded by political instability and labour unrest. After the general elections on 23 May 1998, an increase in political

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instability led to an open crisis, culminating in an intervention by SADC military forces on 22 September (African Business 1998: 33; EIU 1999: 47, 60). In the security vacuum that followed the invasion, massive looting took place and government buildings, South African businesses and anything else associated with South Africa were torched by the mob. As a direct result, a large number of foreigners left the country. The overall negative impact on the economy in 1998 is seen in Table 14.2, which shows a fall in GDP of 5.5 per cent. This and other political crises in the 1990s and the uncertainty they have created will undermine the progress Lesotho has been making towards attracting investments since the late 1970s. It will take a long time to create harmony between South Africans and the people of Lesotho and to restore business confidence there. There has also been a mistrust of South African policy in the post-apartheid era with its roots in the asymmetry in industrial development between South Africa and the rest of the region (see McGowan and Ahwireng-Obeng 1998). However, for Lesotho the integration approach to development may be the only viable alternative. Growth has in the past been linked to increased cooperation, while periods of political confrontation with South Africa have been periods of low growth and economic crises. Given the population size and income levels, market potential is limited, hence the dependence on external markets for exports and imports. Trade has been concentrated on a single trading partner, South Africa, which took an increasing share of Lesotho’s exports in the 1990s (CBL 1999: 16). The absence of a local entrepreneurial class with adequate skills and financial resources makes industrial development dependent on foreign investors. In the public sector and in development planning, the country is dependent on technical assistance. The main drawback of this strategy is the problem of instability, resulting from the sensitivity of expatriates to economic and political uncertainties in Lesotho and the region, and from the donor community, which may focus attention on new areas such as South Africa. Lesotho’s dilemma of dependence on external factors for development has not changed since political independence in 1966.

References African Business (1998), No. 237, November 1998. Bardill, John E. and Cobbe, James H. (1985), Lesotho. Dilemmas of Dependence in Southern Africa. London: Westview Press. Bojö, Jan (1991), The Economics of Land Degradation. Theory and Applications to Lesotho. Stockholm: Stockholm School of Economics. BOS (Lesotho Bureau of Statistics) (1983), Annual Statistical Bulletin 1982, Maseru. BOS (Lesotho Bureau of Statistics) (1997), Statistical Reports, No. 11: 1997, National Accounts 1980–96, Maseru. BOS (Lesotho Bureau of Statistics) (1999), Statistical Reports, No. 6: 1999, National Accounts 1980–98, Maseru. CBL (Central Bank of Lesotho) (1992), Quarterly Review, December 1992, Vol. 11, No. 4, Maseru. CBL (Central Bank of Lesotho) (1993), Annual Report for 1992, Maseru. CBL (Central Bank of Lesotho) (1995), Quarterly Review, March 1995, Vol. 14, No. 1, Maseru.

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CBL (Central Bank of Lesotho) (1997a), Annual Report for 1996, Maseru. CBL (Central Bank of Lesotho) (1997b), Quarterly Review, December 1997, Vol. 16, No. 4, Maseru. CBL (Central Bank of Lesotho) (1999), Annual Report for 1998, Maseru. Cobbe, J. H. (1986), ‘Consequences for Lesotho of Changing South African Labour Demand’, African Affairs, 85: 23–49. Collier, Paul and Gunning, Jan Willem (1999), ‘Why Has Africa Grown Slowly’, Journal of Economic Perspectives, 13(3): 3–22. Crush, Jonathan, Jeeves, Alan and Yudelman, David (1991), South Africa’s Labour Empire. A History of Black Migrancy to the Gold Mines, Boulder, CO: Westview Press. Eckert, Jerry and Wykstra, Ron (1980), ‘South African Mine Wages in the Seventies and Their Effects on Lesotho’s Economy’, Research Report No. 7, Lesotho Agricultural Sector Analysis Project, Ministry of Agriculture, Maseru. EIU (The Economist Intelligence Unit) (1999), EIU Country Profile 1999–2000, Lesotho. Fisher, Stanley, Hernández-Catá, Ernesto and Khan, Mohsin S. (1998), ‘Africa: Is This the Turning Point?’, IMF Paper on Policy Analysis and Assessment, PPAA/98/6, Washington, DC. Ghura, Dhaneshwar and Hadjimichael, Michael T. (1996), ‘Growth in Sub-Saharan Africa’, IMF Staff Papers, 43(3): 605–634. ILO (International Labour Office) (1997), Demand for Labour and the Potential for Increased Labour Absorption in the Formal and Informal Sectors. Maseru: ILO/UNDP. ILO/JASPA (International Labour Office/Jobs and Skills Programme for Africa) (1979), Options for a Dependent Economy. Development, Employment and Equity Problems in Lesotho. Addis Ababa: ILO. ILO/SAMAT (International Labour Organization/Southern Africa Multidisciplinary Advisory Team) (1998), Labour Migration to South Africa in the 1990s, ILO/SAMAT Policy Paper No. 4. Harare: ILO/SAMAT. IMF (1983), ‘Lesotho – Recent Economic Developments’, mimeo, Washington, DC. IMF (1988), ‘Lesotho Policy Framework Paper, 1988/89–1990/91’, mimeo, 11 April 1988, Washington, DC. IMF (1999), ‘Observations of the March 1999 Article IV Consultation Mission to Lesotho’, mimeo, Washington, DC. Johnston, Deborah Zerena (1997), ‘Migration and Poverty in Lesotho: A Case Study of Female Farm Labourers’, Ph.D. Thesis, University of London. Kingdom of Lesotho (1970), Lesotho First Five-Year Development Plan 1970/71–1974/75, Maseru. Kingdom of Lesotho (1975), Second Five-Year Development Plan 1975/76–1979/80. Volume One, Maseru. Kingdom of Lesotho (1997), Sixth National Development Plan 1996/97–1998/99, Ministry of Economic Planning, Maseru. Kingdom of Lesotho (1998), Budget Speech – 1998/99, Ministry of Finance and Development Planning, Maseru. Kingdom of Lesotho (1999), Budget Speech – 1999/2000, Ministry of Finance and Development Planning, Maseru. Knight, John B. and Lenta, G. (1980), ‘Has Capitalism Underdeveloped the Labour Reserves of South Africa?’, Oxford Bulletin of Economics and Statistics, 42: 157–201. LHWP Treaty (undated), Treaty on the Lesotho Highlands Water Project between the Government of the Kingdom of Lesotho and the Government of the Republic of South Africa. LNDC (Lesotho National Development Corporation) (1987), Investment Guides to Lesotho (September 1987 edition), Maseru.

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LNDC (Lesotho National Development Corporation) (1998), ‘Some of LNDC Assisted Companies: Key Parameters’, mimeo (updated version 29 January 1998), Maseru. Low, Allan (1986), Agricultural Development in Southern Africa. Farm Household-Economics & the Food Crisis, London: James Currry. Lundahl, Mats and Petersson, Lennart (1991), The Dependent Economy. Lesotho and the Southern African Customs Union, Boulder, CO: Westview Press. McGowan, Patrick J. and Ahwireng-Obeng, Fred (1998), ‘Partner or Hegemon? South Africa in Africa’ (Part One and Part Two), Journal of Contemporary African Studies, 16 (1 and 2). Ministry of Planning (1994), Lesotho Strategic Economic Options Report, Ministry of Planning, Economic and Manpower Development, mimeo, Maseru. Moeti, Lehlohonolo David (1996), ‘An Assessment of the Irrigation Potential of the Lesotho Highlands Water Project in the Lower Senqu Valley’, unpublished Ph.D. Thesis, University of Stellenbosch. New African Yearbook 1987–88 (1988), 7th edition, New York, NY. Petersson, Lennart (1995), Lesotho’s Strategic Economic Options: Towards Closer Integration, Stockholm: Sida. Reilly, Eugene (1998), ‘Comparison of Investment Incentives’, mimeo. Maseru: LNDC. Sechaba Consultants (1995), Lesotho’s Long Journey. Hard Choices at the Crossroads, Maseru. Sechaba Consultants (1997), Riding the Tiger: Lesotho Miners and Permanent Residence in South Africa, Migration Policy Series No. 2, Maseru. Senaoana, Moeketsi Pius (1992), ‘The Economic and Social Cost Benefit Analysis of a Multipurpose Water Project. A Case Study of the Lesotho Highlands Water Project’, unpublished Ph.D. Thesis, Department of Economics, Faculty of Commerce and Social Science, University of Birmingham. Southall, Roger (1994), ‘The Labour Market and the Trade Unions at the South African Periphery: Lesotho and Transkei’, African Affairs, 93 (373). Tsikoane, Tumelo (1991), ‘Towards a Redefined Role of the Lesotho Highlands Water Project in the Post-Apartheid Southern Africa’, in Santho, Sehoai and Sejanamane, Mafa (eds), Southern Africa after Apartheid, Harare: SAPES Trust. World Bank (1974), The Economy of Lesotho, Report No. 331a-LSO, Washington, DC. World Bank (1983), Economic Memorandum on Lesotho, Report No. 4415-LSO, Washington, DC. World Bank (1989), Sub-Saharan Africa. From Crisis to Sustainable Growth, Washington, DC. World Bank (1992a), World Tables 1992, Washington, DC. World Bank (1992b), ‘Lesotho: Policy Framework Paper, 1992/93 to 1994/95’, SecM92678, 22 May 1992, mimeo, Washington, DC. World Bank (1993), ‘Report and Recommendation of the President of the International Development Association to the Executive Directors on a Proposed Credit to the Kingdom of Lesotho for the Lesotho Highlands Water Engineering Project’, 18 November 1986, mimeo, Washington, DC. World Bank (1995), Lesotho Poverty Assessment, Report No. 13171-LSO, Washington DC. World Bank (1998), World Development Indicators 1998 on CD-ROM, Washington, DC.

Epilogue: development cooperation with Africa in the twenty-first century Iftekhar Hossain and Mario Carlos Zejan

1 Introduction Foreign aid has been provided to developing countries for over forty years. As a result of the persistence of poverty and the emergence of a new set of global problems, many official aid donors have begun to rethink the aid relationship and their role as donors in the changing environment after the end of the cold war. The contemporary agenda for aid, however, is being shaped on the basis of important experiences accumulated in the last decades. We discuss here the present efforts to improve the efficiency of aid in fighting poverty, with Africa in focus. In the 1960s and 1970s, cooperation with Africa was based on the traditional concept of foreign aid. The lack of savings and investment capital was regarded as the perhaps major obstacle for growth. The basic argument was that domestic savings were insufficient to achieve high rates of growth and should be complemented by financial transfers from abroad, aid being one of them. That would allow developing economies to achieve sufficiently high growth rates to guarantee essential consumption and investment needs. Reduction of poverty was also given a high priority, but mostly within this framework. This paradigm of aid has been severely undermined by the developments in recent decades. Growth has failed to respond to large inflows of aid. In sub-Saharan Africa, with the world’s highest aid inflows per capita, growth faltered and regional GDP contracted during the 1980s to where it had been in the early 1960s. At the same time, other forms of capital inflows and expertise played an important role in the development of many Latin American and Asian countries. Besides the fact that aid had failed to stimulate growth, international donors have also come to recognise that aid transfers may lead to permanent dependency, crowding out domestic initiatives in mobilising resources. Hence, experience has proven the inadequacy of earlier development strategies in Africa. In the lost decade of the 1980s, real income declined persistently, in a fashion unprecedented in recent history. The factors behind this decline are many. The stagnation of foreign trade, the increased debt burden and an overall failure of the closed-door development strategy, all bear their share. External factors, such as a fall in commodity prices, the energy shock, slumps in the global business cycle and aid fatigue, have also contributed. The deteriorating economy has worsened the already

Development cooperation with Africa 269 severe state of poverty on the continent, especially in sub-Saharan Africa. Many African economies have been brought to the verge of collapse, with a high and unsustainable debt burden, stagnant growth and deteriorating human development indicators. The situation has been perceived by many as a major crisis and has led to new thinking on development patterns. At the same time, changes have occurred in the global economy. Increased globalisation and the success of the East Asian economies have brought many of the old paradigms of development, including those related to foreign aid policies, into question. The success of the East Asian economies in recent decades, which has led to substantial poverty reduction, has established a positive correlation between economic prosperity on the one hand, and outward oriented economic policies, investment in human capital and sound macroeconomic fundamentals on the other hand. The environment for international cooperation has also undergone important changes. The process of globalisation is leading to profound transformations in the structures and patterns of production, income and consumption. The dismantling of barriers to trade and investment has led to reallocations of production at a global level to exploit economies of scale, as well as differentials in wages, material and infrastructure costs, and productivity. These processes have made it possible for many countries to benefit from the technological revolution, with a rapid growth of new technologies and industries. However, some countries, regions and population groups have been seen as less attractive in terms of competitiveness, markets and profit potential. As a consequence, some developing countries and national regions have become economically marginalised, with rising unemployment, falling income levels and increasing migration as a result. Many African countries are suffering from this marginalisation. Presently, Africa is going through a transition. During the last decade, significant economic and political changes have occurred on the continent, bringing forth a promise for new leadership. Economic reforms, deregulation and trade liberalisation have been initiated. Some African countries are already benefiting from an economic recovery, while democratisation is gaining momentum. In this era of transition, support from the global donor community is crucially important.

2 Development assistance The end of the cold war has brought the very idea of the official development assistance (ODA) under pressure. Foreign aid was once motivated on the grounds of politics, security and solidarity with the poor in developing nations. With the disappearance of these motives and with aid fatigue gaining momentum in the West, new criticisms have emerged. Government to government aid has come under scrutiny as the public sector in general has come to be looked upon with suspicion, especially when the private capital flows at the aggregate level have outstripped official aid (see Jayaraman and Kanbur 1999). Poor and corrupt public services and the emergence of civil societies have added fuel to this scepticism. The mood in the analytical literature has changed as well. In the 1980s, the major assessments of aid were mainly positive (Cassen 1987; Riddell 1987). By the

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end of the 1990s, evaluations tended to suggest that aid has positive effects only in specific circumstances. For instance, an important World Bank study analysing the effects of aid (World Bank 1998) concludes that aid can only increase growth and reduce poverty in an environment of good policies. For the moment, the prospects for ODA seem bleak. Net ODA disbursements relative to donor-country GDP fell from an average of 0.35 per cent in the two decades up to the early 1990s to a record low of 0.25 per cent in 1996. The outcome has been even bleaker for the least developed countries (LDCs), the overwhelming majority of which are located in sub-Saharan Africa. Although remaining steady in nominal terms during the first half of the 1990s (at about $15–16 billion), in real terms the decline in ODA for LDCs has been significant. In 1995 the decline was particularly steep, even in nominal terms (a fall from $16.6 to $12.2 billion). Actual disbursement declined as well. The GNP share of ODA directed to LDCs from the DAC countries fell to 0.05 per cent during 1996, as compared to 0.09 per cent at the beginning of the decade (UNCTAD 1998). There are several reasons for this development. One is that with increased globalisation, private capital flows are expected to play a greater role in financing development. However, the African countries have derived only limited benefits from the increase in private capital flows. Official development cooperation still remains the main channel for financial support to economic reform programmes and development plans. The falling trend in ODA might be reversed if the present debate in developed countries about the need for renewed support to Africa leads to concrete measures. The World Bank, several United Nations bodies, the European Union, the Organisation for Economic Co-operation and Development (OECD) and several developed countries have recently taken different initiatives to fight world poverty. Developed countries in the Development Assistance Committee of the OECD signed the document ‘Shaping the 21st Century’ in 1996, which established six major international development targets to be achieved by the year 2015. These are:









a reduction by one-half in the proportion of people living in extreme poverty; universal primary education in all countries; demonstrated progress toward gender equality and the empowerment of women by eliminating gender disparity in primary and secondary education; a reduction by two-thirds in the mortality rates for infants and children under age 5 and a reduction by three-fourths in maternal mortality; access through the primary health care system to reproductive health services for all individuals of appropriate ages as soon as possible and no later than the year 2015; the current implementation of national strategies for sustainable development in all countries by 2005, so as to ensure that current trends in the loss of environmental resources are effectively reversed at both global and national levels by 2015.

While expressed in terms of their global impact, these goals must be pursued country by country through individual approaches, which reflect local conditions and locally owned development strategies.

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3 Capital flows Since the late 1980s, the flows of private capital to the developing countries have undergone a radical change and have increased dramatically. The role of foreign private investment in the development process has been manifold. Foreign investments have contributed to the acceleration of growth by complementing domestic savings. More importantly, spillover effects, particularly from foreign direct investment (FDI), have been significant, contributing to the dissemination of technical knowhow, management skills and entrepreneurial knowledge to national firms (Blomström et al. 2000). These processes have arguably been particularly important in several East Asian economies. However, private capital flows have concentrated to only a limited group of countries (less than a dozen), with barely a trickle to sub-Saharan Africa. According to OECD statistics, the net flow of private capital flows to all less developed countries (LDCs), including both FDI and portfolio equity investment, amounted to $0.9 billion during 1996. The UNCTAD figure, which is based on balance-ofpayments statistics, shows a slightly higher level, about $2 billion. The point, however, is that the flow has almost entirely bypassed the LDCs that are located in Africa. There are many reasons why FDI flows have failed to move towards Africa. FDI is attracted by factors such as political stability, good governance, macroeconomic reform, free trade, open foreign exchange systems and large market size. Africa has performed relatively poorly on most of these points (Cross-Border Initiative 1999).

4 Growth performance and poverty record People in Africa are among the poorest in the world in terms of both income and overall living conditions. About 45 per cent of the population in sub-Saharan Africa live below the national poverty lines and the depth of poverty is more severe than anywhere else in the world. Between 1970 and 1992, average per capita GDP in sub-Saharan Africa increased by only $73 in purchasing power parity terms (compared to $420 in South Asia), although the starting point in 1970 was similar (World Bank 1996). Low life expectancy, high child mortality, lack of access to water, sanitation and medical care, and widespread disease have all added to poverty. Female life expectancy in sub-Saharan Africa is only 54 years compared to 63 years in South Asia, and the decline in the under-five mortality rate, from 193 in 1980 to 147 in 1996, is the slowest in the world. While Demery and Walton (1997) estimate that consumption in sub-Saharan Africa should grow by 1.9 per cent per year in order to achieve some reduction in the proportion of people living in poverty by 2015, the actual growth for the period 1991–5 has been negative with 91.3 per cent. The reasons for this extremely low standard of living, once again, are numerous. Slow economic performance alone is a major factor. High population growth, migration, and depletion of the environmental and natural resource base all contribute to a deteriorating quality of life. Economic growth in Africa has been disappointing compared to the average performance rate for low-income countries. Africa has lagged behind during the

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1980s and the gap has even widened during the 1990s, despite some encouraging trends in recent years. Only a few countries have been able to sustain positive real per capita GDP growth in the past decades. The following table of trends in economic indicators (1965–96; percentages) illustrates the disappointing growth performance of Africa in the past two and a half decades. (Source: Mlambo and Oshikoya (1999)). 1965–73 GDP growth Per capita growth Export growth Fiscal deficit/GDP Inflation Current account deficit/GDP

5.7 3.0 8.2 — 5.8 6.7

1974–9

1980–5

1986–90

3.5 0.7 2.6 5.4 13.8 14.4

2.1 90.8 1.0 5.9 15.8 —

2.8 90.1 6.2 6.7 16.3 3.7

1991–5 1.7 91.2 1.1 5.9 30.7 2.5

There have been numerous attempts to trace the factors behind the weak aggregate growth performance in Africa.1 A recent study (Collier and Gunning 1997) lists some of the important determinants: high risks, high transport costs and trade barriers, poor infrastructure, low levels of education, limited financial markets and high regulation (categorised into four groups: openness, social capital, risk and public services). The authors conclude that: … the lack of openness to trade and the low level of social capital have had large, damaging effects on the growth rate. The effects of high policy volatility and poor public services on growth may also be highly damaging but are less well established. Geography has probably also played a part in reducing growth, through high transport costs, poor soils, disease, climatic risk, and export concentration in commodities, although only a few of these effects have been quantified. (Collier and Gunning 1999)

5 Structural adjustment During the last decade many African countries began drawing lessons from the past and embarked upon a path of economic reform and openness. The Structural Adjustment Programmes (SAP) proposed by the World Bank and the International Monetary Fund (IMF) supported these efforts. The main thrust of these programmes has been on fiscal discipline, openness to trade and on an overall market orientation along with enhanced private ownership and institutional reforms. The experience of the structural adjustment programmes has been mixed: ranging from success to failure, depending on the specific country context, adequacy of the policy design and, not the least, the appropriateness of the sequencing of reforms (see White and Leavy 1999).

Development cooperation with Africa 273 While the programmes have performed relatively well in terms of stabilisation, bringing budgets into balance and reducing inflationary pressures, their effects on growth and poverty reduction have been ambiguous. The merits of bringing inflation down to a very low level, a major concern of the programmes, have now come under increasing criticism (Stiglitz 1998a). In some successful cases, the programmes have tended to increase income across the board, but in other instances the effects on growth have been limited. By increasing income relatively more for higher income groups they have, in some cases, contributed to increased inequality, while the burden of adjustment has been shared unproportionately by the least advantaged sections of the population, including women, children and the poor. Africa is one of the poorest regions in the world. Doubts have been cast on the speed with which renewed growth may reduce poverty. Recent studies conclude that the impact of economic growth on poverty reduction in Africa is lower than in other regions of the world. An explanatory factor may be the high extent of income inequality on the continent (McCulloch and Baluch 1999; Baluch and Grant 1999). This underscores, once again, the old truth that growth and economic prosperity may well be necessary conditions for reducing poverty but they are not always sufficient. A participatory method of poverty reduction has been developed with an emphasis on processes rather than outcomes on poverty record. This necessitates grass root participation and an all-round engagement of the civil societies. During the last decade, substantial financing has been transferred to Africa. The idea has been to put into place donor-tailored reform packages, in return for aid. The packages have often been harsh and unrealistic, and the recipients in many cases have failed to carry them through (see Collier 1997). That has sometimes appeared as a loss of credibility for these countries, and business activities in the private sectors had also suffered. The response to the failure of the conditionality has taken two different shapes. One pleads for a selectivity approach, favouring countries with good policy environments and rewarding the successful ones. This approach will set examples and increase the efficiency of aid in terms of being a catalyst for higher GNP (Collier 1997). The other approach emphasises a policy dialogue. A genuine dialogue, not confined only to formal forums, may influence policies and bring about improvements. This approach attempts to combine two concerns: the pursuit for efficiency in the use of aid, and the importance of not isolating nations that fare less successfully (see White and Leavy 1999; White 1999).

6 The efficiency of aid Against the backdrop of a changing international environment and increasing globalisation, the debate on African development and aid has gained new momentum. It is fair to suggest that the thrust of the multilateral donor agencies is now on the efficacy of institutional capacity in utilising aid. The World Bank report ‘Assessing Aid’ has forcefully stressed this point. The report defines criteria for good policies, and regression analysis shows that countries scoring high on these criteria are also

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countries that have performed well in propelling growth and development and reducing poverty. The report also investigates the links between poverty reduction and foreign aid, and finds that it is again the same set of countries that have been most successful. More elaborate schemes, based on an ex post ‘performance-based’ allocation of aid, have been proposed recently (Eccles and Gwin 1999). Different aid modalities are considered to be suitable for countries showing different degrees of commitment to reform: policy dialogue, development-oriented relief and reconstruction, capacity development assistance, poverty-related project financing and humanitarian assistance. It is important to note that the criteria on performance emphasise not only macroeconomic management but also poverty reduction and good governance. The difficulties with these approaches lie in the trade-offs in picking countries that badly need support but have a weak performance record and countries that are efficient and doing relatively well. Moreover, from a historical point of view, it is extremely difficult to agree upon a set of criteria that is universally acknowledged to be ‘good’.

7 Donors in a changing environment The role of aid agencies is also under a process of change. Less emphasis is now put on the direct implementation of development projects. Financing is complemented with the task of being a facilitator, emphasising the transfer of knowledge and institution building, and providing guarantees for commercial operations and investments. The targets for success are today formulated more in terms of achievements. Together with a requirement for increased efficiency in government agencies, more emphasis is also given to the participation of civil society in decisions. A tendency towards decentralisation of aid management to district and municipal bodies can also be seen. Not only the economic but also the political agendas for donors have changed. Decolonisation and the struggle for majority rights were initially more important for the direction of aid flows than the institutions and the exercise of governance. In the 1970s, the emphasis was on development programmes benefiting the masses and on empowerment of the state rather than on democracy. Today, the role of governments in development cooperation is perceived as increasingly related to governance and shaping the policy environment, rather than direct involvement in production activities. The agenda for policy dialogue has been broadened to comprise issues of governance, democracy and human rights. A lack of good governance or serious and systematic violations of human rights and brutal reversals from democratisation would lead to reduced aid flows. Democracy and respect for human rights are now seen as essential preconditions for access to aid flows. Another major shift in the international development community is the recognition of the importance of sound institutions – economic, political and social. In view of past experience, it has become increasingly evident that good governance plays a vital role in the development process. An important aspect of democratisation is the participation of civil society. Aid donors are seeking new ways to work with civil society, as a means of broadening

Development cooperation with Africa 275 their partnership to actors outside the narrow confines of central government ministries. The increasing weight given to the objectives of democracy, human rights and support for emerging civil societies will place emphasis on the qualitative rather than the quantitative aspects of social change. The lessons from the last decades have led to the recognition that successful development cooperation requires a broad exchange of views between donor and recipient, and shared responsibilities in a partnership relation. This notion involves two parties collaborating to attain jointly formulated aims. The parties must agree on premises and conditions. The basis of shared values that are manifested primarily in respect for human rights is crucial to the development of the partnership. If the conditions are not fulfilled by one or the other party, modifying or discontinuing the cooperation must be feasible (GC 1998). The notion of partnership puts dialogue on development issues and domestic ownership of policies in the foreground. The new stance is represented by a shift from traditional projects to the support of sector wide programmes in key development areas like education and health. The sector programme is seen as a joint programme of work with a process-oriented approach, geared to jointly agreed goals and policies. The partners work together in the definition of a strategy and in negotiation concerning resource allocation. The broad sector approach is intended to reduce aid fragmentation and to improve coordination, strengthen national institutional capacity, enhance the effectiveness of public sector expenditure and promote institutional reform. Expected benefits are the strengthening of democratic practices through improved transparency in the national budget and the promotion of participatory practices in decision making. Partners are expected to strive to reach a point where resources, external and domestic, can be pooled in non-earmarked budget support to the sector.

8 Conclusions A global phenomenon of great importance to Africa is the growing gap between rich and poor, within as well as between countries and continents. The most rapid increase in the proportion of poor people is taking place in sub-Saharan Africa. The overall orientation of the development cooperation with Africa should give eradication of poverty a high priority. Massive investments in human capital, health and education will definitely contribute to the improvement of living standards and also create a solid foundation for an economic takeoff. At the same time, efforts should be taken to improve the economic environment, enhancing national institutional capacity, public sector efficiency and physical infrastructure. Reforms at the administrative and governmental levels are preconditions for good governance. The financial sector should be deepened and restructured in order to create an investment-friendly environment. Once it is recognised that the record of foreign aid in the region has been less than satisfactory, it is necessary to draw some conclusions for the future direction of foreign aid. One such direction is suggested in the literature of selectivity and efficiency: to choose the star performers, set up examples and let others follow. A more sober direction to go would be to create a relationship based on mutual trust and understanding.

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A genuine dialogue embedded in an honest concept of partnership may be the key to successful development cooperation with Africa in the twenty-first century.

Note 1 See Easterly and Levine (1997), Sachs and Warner (1997) and Gallup and Sachs (1998); also see White and Leavy (1999) for a review. Two major factors that retard growth in Africa are the debt burden and the flight of capital. The debt initiative for the heavily indebted poor countries (HIPCs) is designed to tackle the debt problem.

References Baluch, Bob and Grant, U. (1999), ‘Poverty, Inequality and Growth in sub-Saharan Africa’, SPA Status Report for Sub-Saharan Africa, mimeo. Blomström, Magnus, Kokko, A. and Zejan, M. (2000), Foreign Direct Investment: Firm and Host Country Strategies, London: Macmillan. Cassen, Robert (1987), Does Aid Work? Oxford: Oxford University Press. Collier, Paul (1997), ‘The Failure of Conditionality’, in C. Gwin and J. Nelson (eds), Perspectives on Aid and Development, Washington, DC: Overseas Development Council. Collier, Paul and Gunning J. W. (1999), ‘Explaining African Economic Performance’, Journal of Economic Literature, 37: 64–111. Cross-Border Initiative (1999), Road Map for Investment Facilitation, Prepared by the co-sponsors in consultation with the TWGs of the CBI participating countries, draft. Demery, L. and Walton, M. (1997), ‘Are Poverty and Social Targets for the 21st Century Attainable?’, Paper prepared for the DAC-Development Centre Seminar, mimeo. Easterly, W. and Levine, R. (1997), ‘Africa’s Growth Tragedy: Policies and Ethnic Divisions’, Quarterly Journal of Economics, November. Eccles, Stephen and Gwin, C. (1999), Supporting Effective Aid: A Framework for Future Concessional Funding of Multilateral Development Banks, Washington, DC: Overseas Development Council. Edgren, Gus (1997), ‘Structural Adjustment of the Foreign Aid Industry – Current Trends and Future Scenarios’, in Development Cooperation in the 21st Century, Stockholm: Sida. Gallup, J. L. and Sachs, J. D. (1998), ‘Geography and Economic Development’, Harvard Institute of International Development, mimeo. GC (1998), Africa on the Move. Revitalising Swedish Policy towards Africa for the 21st Century, Government Communication SKR 1997/8: 122, Regeringskansliet. Jayaraman, R. and Kanbur, R. (1999), ‘Public Goods and the Case for Foreign Aid’, in K. Inge, I. Grunberg and M. Stern (eds), Global Public Goods, International Cooperation in the 21st Century. UNDP, Oxford University Press. McCulloch, Neil and Baluch, B. (1999), ‘Poverty, Inequality and Growth in Zambia’, SPA Status Report for sub-Saharan Africa, mimeo. Mlambo, Kupukile and Oshikoya, T. W. (1999), ‘Investment, Macroeconomic Policies and Growth’, in S. Kayizzi-Mugerwa (ed.), The African Economy . Policy, Institutions and the Future, Routledge. Riddell, Roger C. (1987), Foreign Aid Reconsidered. Baltimore, MD: Johns Hopkins University Press. Sachs, Jeffrey D. and Warner, A. M. (1997), ‘Sources of Slow Growth in African Economies’, Journal of African Economies, 6: 335–376.

Development cooperation with Africa 277 Stiglitz, Joseph (1998a), More Instruments and Broader Goals: Moving Toward the PostWashington Consensus, WIDER Annual Lecture, Helsinki. Stiglitz, Joseph (1998b), Towards a New Paradigm for Development: Strategies, Policies and Processes, Raul Prebisch Lecture, UNCTAD, Geneva. UNCTAD (1998), The Least Development Countries 1998 Report, United Nations. White, Howard (1999), Swedish Programme Aid, An Evaluation. Stockholm: Sida. White, Howard, and Leavy, J. (1999), The Impact of Adjustment Policies, A Literature Review, mimeo. Stockholm: Sida. World Bank (1996), Taking Action to Reduce Poverty in Sub-Saharan Africa, Washington, DC. World Bank (1997), Private Capital Flows to Developing Countries, the Road to Financial Integration, Washington, DC. World Bank (1998), Assessing Aid, Washington, DC. World Bank (1999a), World Development Indicators 1998, Washington, DC. World Bank (1999b), Global Economic Prospects and the Developing Countries, Washington, DC.

Index

‘A Frame for Economic Reform’ 195–6 ‘A Guide to Investors’ 84 Addis Ababa 7, 63, 65 Afar 64–5, 67 African Competitiveness Report 184 African National Congress (ANC) 16, 229, 232, 241 Afwerki, Issaias (President) 75, 78 ‘agents of restraint’ 135 agrarian reform (law) 14, 112 Agricultural Policy Chart 47 agriculture 6, 26, 49, 112, 122, 209–10, 259 Aguilar, R. 27 aid 18–19, 136, 148, 268, 273; boom 154; dependence 3, 153–4, 162, 224; fatigue 4, 18, 269 aid/GDP ratio 15, 70, 224 Aiga 89 Alitena 89 Al-ittihad 89 Amhara 65 Amin, Idi 219, 224 Angola 2, 4, 25–40, 145 apartheid 230–1, 237, 239 appreciation of currency 120, 184 Arusha Declaration 153 Asmara regime 89 Assab (port) 82, 87, 89 ‘Assessing Aid’ 273 autonomy 75–8, 136 Bada-Burie 89 Banco Commercial de Moçambique (BCM) 177, 183 Banco Commercial do Atlântico 117 Banco de Cabo Verde 117 Banco Nacional de Angola (BNA) 34, 38 Banco Popular de Desenvolvimento (BPD) 177

Bank of Mozambique 13, 176, 183 Bank of Tanzania 151 Bank of Uganda 222, 224 Bank of Zambia 137, 141, 143 banks 103, 137, 176, 224 Basotho 17, 263 Baumol, W. J. 20 Benshangul 65, 67 Bhatia, A. 139 Bicesse Agreement 33 Bigsten, A. 202 birr 82–3 Blomström, M. 2 Board of Internal Trade 157 Bolsa de Valores 177 borrowing (external) 185 Botswana 132, 250 Bretton Woods institutions 107, 148, 182 broad money 183 budget 45, 65, 114–15, 141; deficit 11, 98, 115–18, 184, 196 Cahora Bassa dam 187 Caixa Económica de Cabo Verde 117 Campbell, W. O. 139 Cape Verde 9, 110–28 Cape Verde Telecom 129 capital 230; expenditure 114, 258; flows 270–1; formation 198–206; inflows 203 capital–labour ratio(s) 65, 67, 207 cash budgets 11, 141, 150, 153, 222 cashew nuts 6, 43, 46, 187 catalyst effect 122 Central Council of the Peoples Front for Democracy and Justice (PFDJ) 75 Central Statistical Service 239 centralization 35, 80

Index Centro de Promoção Turística do Investimento e das Exportações (PROMEX) 114 Chabal, P. 160–1 civil war 4–8, 25, 52, 80, 145, 220 coalitions 77 Cobbe, J. 253 coffee 36, 98, 100, 223 Coffee Marketing Board 223 cold war 18, 173, 268 Collier, P. 2, 20, 135, 272 collusion 104 Commercial Code 175 commercial services 26 committees 75 Common Market for Eastern and Southern Africa (COMESA) 135, 213 Common Monetary Area (CMA) 248 Commonwealth Development Corporation 140 Communications Authority of Zambia (CAZ) 137 Communism 4, 18, 241 competition 15, 80–1, 104, 171, 175, 211, 223 Congress of South African Trade Unions (COSATU) 241 ‘consensus building’ 241 constitution 8, 63, 75, 78, 241 Constitutional Commission of Eritrea 75, 78 construction 17, 43, 124, 253, 261 consumer price index 120 ‘contamination’ effect 238 cooperatives 81 copper 136 Copperbelt 136–7, 140 corruption 3, 8, 98, 137, 158, 161, 179 credibility 10, 78, 133–6 crime 16, 232 cross-country analyses 217–19, 223 crowding-out effects 118–19 currency: crisis 206; floating 99, 101; union 56, 82, 88 current account 150, 233; deficit 188, 196 customs union revenue 17, 252, 254, 256 Dahl, R. A. 53 Daloz, J.-P. 160–1 de Beers 31 debt 157; burden 276; domestic 103–4, 116–18, 206; external 31, 39, 87, 153; long-term 117

279

debt–GDP ratio 117–18, 130 decentralization 56, 63–9, 76, 80, 134 defence/military spending 61, 71, 90 democracy 8, 54, 58, 76, 79, 274 dependence 92 dependent-economy model 99 deportation 91 depreciation of currency 101, 120, 184 deregulation 85, 156, 184, 195 devaluation 38, 156, 184, 202 diamonds 30, 35, 39, 229, 252 Dire Dawa 63 disinvestment 105 Djibouti 89 dollar 195, 206 dollarization 34 domestic financing 116 domestic legitimacy 53, 71, 90 domestic markets 223 domestic saving 225, 268, 271 ‘donor intransigence’ 138 donor–recipient relations 92, 148, 275 donors 11, 19, 92, 98, 135, 140, 143, 164–6, 274–5 droughts 85, 118, 122, 189, 196, 210 drug trafficking 138 dual exchange rate 101 Dunlop Tire Corporation 143 early retirement scheme 111 Eckert, J. 253 Economic and Social Programme 180 Economic Community of West African States (ECOWAS) 114 Economic Recovery Programme 220 Economic Rehabilitation Program 171, 182 economy of affection 159–61 education 15, 48, 68–9, 92, 126, 180, 224, 231 effective rates of protection (ERP) 105 Egala 89 El Niño effects 184, 206 elections 54, 136, 241, 264 electoral system 54, 79 electricity 48, 187, 258, 264 embargo 11, 100 emigration 91, 124–5, 129 employment 207, 213, 238–40, 242, 261 Empresa Pública de Abastecimento (EMPA) 112 ENDIAMA 31 energy 48, 124, 224

280

Index

enhanced structural adjustment facility (ESAF) 98–9 enrolment rates 68, 92, 180 entrepreneurship 19–20 environmental restoration/protection 92, 127 Eritrea 2, 7–8, 73–93 Eritrean Peoples Liberation Front (EPLF) 73 Economic Structural Adjustment Programme (ESAP) 195–7 escudo 112, 120, 127 Ethiopia 2, 6–7, 52–71 Ethiopian Peoples Revolutionary Democratic Front (EPRDF) 73; government 53, 69 Ethiopian Privatization Agency 59 ethnicity 64, 78, 88 European Monetary Union (EMU) 128, 130 European Union 270 exchange rate 3, 28–9, 233; controls 80, 98; floating 103; nominal 120; official; 27, 101, 108; parallel 27; real 29, 102, 120 export processing zones (EPZs) 114, 121, 124 export promotion (measures) 10, 114, 119 Export Retention Scheme (ERS) 195 exports 6, 10, 121, 187, 196 external shocks 14, 38, 132, 197, 205–6 financial institutions 103, 117, 177 financial markets 176, 224 financial reforms 176–8 financial system 171, 176, 224 Fine, B. 237 fiscal deficits 87, 152 fiscal indicators 30 fiscal policy 127 fish/fishing 43, 46, 113 floods 13, 189 food 92, 258 foreign aid 4, 15, 70, 92–3, 162, 252, 268 foreign banks 112 foreign companies 113 foreign debt 87, 225 foreign dependency 252, 254–7, 260–2 foreign direct investment (FDI) 17, 105, 113, 151, 256, 271 foreign exchange 28, 33; auctions 59, 84 Foreign Exchange Bearer Certificates (Forex-Cs) 101, 108 foreign financing 116

foreign investment 18, 59, 70, 178, 220, 222, 225, 233, 254–60, 271 free trade 56, 88 Frentes de Alta Intensidade de Mão de Obra (FAIMOs) 127 Fundamental Theorems of Welfare Economics 172, 175 Gambella 65, 67 GDP: Angola 26–7, 30; Cape Verde 10, 114, 122; Eritrea 85; Ethiopia 6; Guinea-Bissau 42; Lesotho 17, 249, 257; Mozambique 12; South Africa 229, 231, 249; Tanzania 11, 150; Uganda 15, 220; Zambia 10; Zimbabwe 198 geographical integration 48 Gilkes, P. 88 globalization 269 ‘godfather’ syndrome 160 gold 16, 229, 236 ‘Goldenberg Scandal’ 99 Gorbachev, Michael 80 governance 8, 19, 99, 138, 205–6, 226, 232–4, 274 government 75, 93, 104, 135, 139, 152, 171, 178–9, 252 government expenditure 9, 29–30, 36, 45, 48, 87, 180 government failures 20 government legitimacy 52, 71 Government of National Unity 16, 241 government revenues 9, 29–30, 42, 45, 87, 222 gradualism 79 growth 122–4, 229–32, 237–8, 249–62, 272; economic growth 26–7, 100, 104, 149, 188, 197, 217–19, 271 Growth, Employment and Redistribution (GEAR) strategy 235, 237–8, 240 Guinea-Bissau 2, 5–6, 41–50 Gunning, J.W. 2, 20, 272 Hall, R.E. 217–19 Hani, Chris 241 Harari 63 hard budget constraint 156 health 15, 48, 93, 180, 224, 270 Heavily/Highly Indebted Poor Countries (HIPC) programme 6, 15, 43, 153, 225 heuristic index 218 Horn of Africa 62, 73 horticulture 223 hotels 124

Index Household Budget Survey 183 Household Survey 239 human capital 92, 171, 179–80, 224, 237 human rights 54, 58, 79, 99, 135, 274 Human Rights Commission 58 Hydén, G. 160 hyperinflation 35 import(s) 10, 121, 152, 187; duties 113; quotas 114, 174; substitution policy 174, 194, 217–18; support 163 ‘import strangulation’ 152 incentives 80–1, 253 income: distribution 106–7, 273; tax 111, 223 industry 123, 212, 258 infant industry protection 60 inflation 11, 16, 27–8, 85, 87, 118, 134, 149, 183, 196 informal sector 108 infrastructure 15, 43, 48, 69, 92, 127, 224, 254–60, 263 Inkatha 241 interest rates 103, 183, 234 International Development Association (IDA) 98 international financial institutions 39, 46, 49 International Labour Office (ILO) 239 International Monetary Fund (IMF) 5, 15, 33–4, 98–9, 169 investment(s) 14, 81, 142, 198–205, 212, 220, 237, 250; code 59 Investment Promotion Office 176 investors 11, 158, 178, 220, 227, 235 irrigation 93 Jenkins, C. 202 Johannesburg 232 Jonathan, Leabua (Prime Minister) 252 Jones, C.I. 217–19 Kafue consortium 140 Kaunda, Kenneth (President) 10, 132, 136, 138 Kenya 2, 8–9, 97–107, 132 kick-start approach 239 Kiondo, A.S.Z. 158 Kuznets, S. 230 kwacha 138 kwanza 28, 33–4 Labour Code 113 Labour Force Survey 125, 130

281

labour market 104, 105, 113, 124–7, 230, 238–40; productivity 207 Land Law 42 land: productivity 207, 210; reform 3, 112; tenure 80 law and order 234 Lebanese traders 35 Legal Affairs Commission 179 Lekhanya, Justin (General) 254 Lesotho 3, 17–18, 248–65 Lesotho Highlands Water Project (LHWP) 3, 248, 251; agreement/treaty 17, 255 Levin, J. 105–6 Lewis, A. 230 liberalization of: exchange rate policy 84; 103–4; foreign trade 9, 173–4, 195, 223; labour market 9, 106; price controls 85, 112, 142; trade 83, 104, 105 liberation movements 52 life expectancy 1, 180, 271 Lindauer, D.L. 3 Lindbeck, A. 79 livestock 260 Loans and Advances Realization Trust (LART) 156 local-cost compensation (LCC) 164 loti 253 Luanda 34 Lundahl, M. 2 Lusaka 135, 137 Lusaka Agreement 25, 33, 36 Lusaka stock exchange (Luse) 143 Maastricht criteria 130 maize 142, 210, 253 Malawi 132 Mandela, Nelson 241 Mané, Asumane 45 manufacturing sector 100, 113, 143, 207–9, 230, 236, 243, 258 Mareb Mellash 73 market(s) failures 20; liberalization 257 Marrakesh Agreement 233 Master Plan of Statistics 183 Mauritius 250 Mbeki, Thabo (President) 16, 241 Medri Bahari 73 Medri Geez 73 Mehlum, H. 211 Mengistu government 6, 53, 73, 79–80 Mengistu Haile Mariam (President) 52 metical 172, 176, 184 migration 17, 125, 129, 252–3 Mindelo 114, 124

282

Index

mine wages 17, 251, 253 mines 36, 136, 143, 230, 243, 251, 256, 263 mixed-ownership enterprises 113 Mkapa, Benjamin (President) 148 Moagem de Cabo Verde (MOAVE) 112 monetary policy 101, 183, 222, 238 mortality rate 1, 270 Movement for Multiparty Democracy (MMD) 132–3, 135, 137–8 Movimento para a Democracia (MPD) 110, 129 Mozal 181 Mozambique 3, 12–13, 132, 171–89 Mozambique Air Lines 173 Mudança 110–14 Mugabe, Robert (President) 3, 14, 205 multiparty state 133 Museveni, Yoweri (President) 220, 222, 227 nafka 56, 84, 88 Nairobi Stock Exchange (NSE) 104 national accounts 26, 196, 198, 207 National Assembly 75–6, 78 National Cereals and Produce Board (NCPB) 98 National Conference on Peace and Democracy 74 National Economic Development and Labour Council (NEDLAC) 240 National Party 241 National Resistance Movement (NRM) 220, 222 National Social Security Fund (NSSF) 104 National Transport Corporation 157 nationalization 136, 140, 206 nationalism 76 natural resources 4, 39 Nchanga mines 140 Ndulu, B. 2 New Economic Recovery Programme (NERP) 136 Nkana mines 140 non-tradables 99 Nordås, H. 237 norms of legitimacy 53–5 Nova Vida program 37; crisis 27, 35 Nyerere, Julius (President) 158 Nziramasanga, M. 198 Obote, Milton (President) regime 220 O’Connell, S. 2 official development assistance (ODA) 147, 254, 269

oil 4, 26–7, 30; price 38–9; shocks 97, 105, 230; warranties 32 Open General Import License (OGIL) 195 Open General Licence (OGL) 137 Orange River 255 Organisation for Economic Co-operation and Development (OECD) 270 Organisation of African Unity (OAU) 56, 89 Oromiya 65 Oromo 64 Oromo Liberation Front (OLF) 89 Partido Africano para a Independência de Cabo Verde (PAICV) 129 Pateman, R. 73 peace 36–7, 54, 56, 87–92 Programa Económico e Social (PES94 ) 32, 34 PES95/96 34 Pio, A. 107 Platteau, J.-P. 160 Plaut, M. 88 policy 32–9, 137–44, 233, 253; dialogue 273–4; implementation 98–9; makers 107, 134–5, 138, 145 Policy Framework Paper (PFP) 175 political independence 75–8 Portugal 39 Portuguese Central Bank 118 Post-Washington Consensus 13, 170–1, 175 poverty 106–7, 129, 232, 271; eradication 19, 143, 211, 226, 270, 273 Praia 114, 124 Pretoria–Witwatersrand–Vereeiniging (PWV) area 255 price controls 85, 112, 137, 195, 206 primary sector 122, 258 private investments 69, 118, 142, 150, 200, 250 private ownership 81, 178 private property 178 private sector 92, 138, 143, 179, 225, 253, 261 Privatisation Act 139 Privatisation Trust Fund 139 privatization 10, 83, 113, 139–40, 172–3, 234 producer co-operatives 80 programme aid 154 Program of Public Investments 43, 45 project aid 154, 184 proportional electoral system 77

Index public investments 43, 114, 118, 200 public sector 112, 143, 196, 201, 225, 257–8, 261 Public Sector Reform Programme 159 public service 44–5, 135 public work projects 127 rand 234 Ratsø, J. 211 real interest rate 118, 204 real wages 42, 106, 230, 253 Reconstruction and Development Programme (RDP) 232, 237, 243 Recovery and Rehabilitation Programme for Eriteria (RRPE) 81 Red Sea 73 redistribution 16, 107, 231, 242 regionalization 56, 63–9 remittances 17, 129, 253, 262 Rights Accumulation Programme 142 roads 69, 224, 264 Rodrik, D. 218–9 Rustomjee, Z. 237 Rwanda 56, 89 Sanhá Malam Bacai (President) 45 sanitation 180 São Vicente 124 secondary sector 123, 253, 258 ‘second-generation tigers’ 237 self-reliance 224–5 Sender, J. 1 ‘Shaping the 21st Century’ 270 shilling 98 short-term unemployment 125 Sisulu, Max 241 skilled labour 68–9, 78 small-scale industries 254, 258, 261 Social Development Fund 196 social developments 56, 62, 196, 218, 226 socialism 155, 158 soft budget constraint 13, 152, 156–8 soil erosion 263 Somale 64–5, 67 Somalia 56, 89 SONANGOL 34 South Africa 3, 16, 229–44, 248 Southern Africa Labour and Development Research Unit (SALDRU) 231, 239 Southern African Customs Union (SACU) 17, 248, 252 Southern African Development Community (SADC) 135, 265

283

Soweto uprising 252 Spain 39 stabilization macroeconomic 78, 97, 101, 111, 170, 176, 182, 196, 222, 234, 237 Staff Monitored Program 32, 34 state; role of 9, 111–12, 171 state farms 80 State of Emergency 138 state ownership 80–1, 162 state softness 3, 11, 155–66 state-owned banks 173 state-owned enterprises (SOEs) 59, 113 Statistical Strengthening Program (SSP) 183 Stiglitz, J. 13, 170, 175 structural adjustment 257–60, 272–3; facility 98; Kenya 97–9; loan 97; programmes 2, 19, 217, 250, 254, 272 subsidies 33–4 Sudan 56 Swaziland 250 Swedish International Development Authortiy (SIDA) 162, 164 tablita system 38 Tanzania 3, 11–12, 132, 136, 147–66 Tanzania Revenue Authority (TRA) 153 tariffs 15, 100, 105, 114, 174, 223 taxes 83, 100, 111, 115, 157, 222 tea 100 Technical Unit for Enterprise Restructuring 173 technology transfer 171, 180 telecommunications 48, 113, 124, 224 Telecommunications of Mozambique 173 tertiary sector 124, 258 textile sector 108 Tigray 63, 65, 67 Tigre and Kunama 78 time inconsistency (problems) 10, 134 tobacco 3, 210 Tokichuma 89 Torvik, R. 211 total factor productivity (TFP) 207; policy 212 tourism 113, 124 trade 35, 80, 82, 173, 237, 265 Transitional Charter 63 Transkei 252, 262 transport 113, 124; equipment 198; infrastructure 36, 43, 48, 224 Treasury bills 102, 177; rate 149 Trust Fund 118

284

Index

tsotsis (gangsters) 233 two-tier banking system 112 Uganda 3, 15, 217–27 Uganda Revenue Authority 222 unemployment 10, 124–7, 239 Union Monétaire Économique Ouest-Africaine (UMEOA) 6 UNITA 31, 39 United National Independence Party (UNIP) 132, 135 urbanization 63 urban–rural gap 69 value-added tax (VAT) 186, 223 Vieira (President) 42 violence 138, 265 voluntary departure programme 111 wages 27, 45, 106, 126, 204, 230, 252 war 4–8, 44, 57, 61, 71, 87–92 Washington Consensus 13, 19, 169

water 93, 180, 255, 258, 264 West African Monetary Union (WAMU) 46 Wood, A. 223 World Bank 15, 71, 97, 169, 205, 250, 262, 270 World Trade Organization (WTO) 114, 233 Wykstra, R. 253 Yalá, Kumba (President) 41, 45 Zalambessa 89 Zambia 3, 10–11, 132–44 Zambia Consolidated Copper Mines (ZCCM) 11, 139 Zambian Investment Centre (ZIC) 137 Zambian Privatisation Agency 139 Zambian Revenue Authority (ZRA) 137 Zimbabwe 3, 13–14, 132, 194–212 Zimbabwe’s Economic Structural Adjustment Programme (ESAP) 194