Economic Alternatives for Sub-Saharan Africa: MDG-Based Policy Implications

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Economic Alternatives Economic Alternatives for Sub-Saharan Africa:for Sub-Saharan Africa:MDG-Based Policy ImplicationsMDG-Based Policy Implications

Terry McKinleyTerry McKinleyInternational Poverty Centre, BrasiliaInternational Poverty Centre, Brasilia

MDG-Based National Development Planning MDG-Based National Development Planning Training Workshop, Dar es Salaam, TanzaniaTraining Workshop, Dar es Salaam, Tanzania

27 February – 3 March 200627 February – 3 March 2006

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Does Africa Suffer from Does Africa Suffer from a ‘Poverty Trap’?a ‘Poverty Trap’?

Gross domestic savings are low: 17% of GDP in Gross domestic savings are low: 17% of GDP in 20032003

Net National Savings are lower: 6% of GDPNet National Savings are lower: 6% of GDP

The Implication: ODA is necessary to scale up The Implication: ODA is necessary to scale up public investmentpublic investment

What will be the impact of a ‘Big Push’ in ODA What will be the impact of a ‘Big Push’ in ODA on National Savings?on National Savings?

How can domestic resources be:How can domestic resources be:

1) raised and 2) directed to investment? 1) raised and 2) directed to investment?

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Gross and Net National SavingsGross and Net National Savings(% of GNI, 2003)(% of GNI, 2003)Low-Low-

Income Income CountriesCountries

East Asia East Asia & Pacific& Pacific

South South AsiaAsia

Sub-Sub-Saharan Saharan AfricaAfrica

Gross Gross National National SavingsSavings 23.123.1 41.841.8 24.924.9 16.916.9

Net Net National National SavingsSavings 14.214.2 32.632.6 15.915.9 6.36.3

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Did Domestic Savings Contribute Did Domestic Savings Contribute

to Growth in ‘Success Cases’?to Growth in ‘Success Cases’?14 African countries are on track to halve 14 African countries are on track to halve extreme income poverty by 2015 extreme income poverty by 2015 (1.5% per (1.5% per capita yearly growth, 1990-2003)capita yearly growth, 1990-2003)

Their investment is relatively high Their investment is relatively high (20% of GDP)(20% of GDP)

But little correlation exists between their But little correlation exists between their Growth and Domestic SavingsGrowth and Domestic Savings

ODA (& FDI) have financed investmentODA (& FDI) have financed investment

Over time Domestic Savings has not improved Over time Domestic Savings has not improved

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CountryCountry

Gross Domestic Gross Domestic Savings Savings

% of GDP, 1990% of GDP, 1990

Gross Domestic Gross Domestic Savings Savings

% of GDP, 2003% of GDP, 2003

BeninBenin 22 55

GhanaGhana 55 1111

TanzaniaTanzania 11 10 10

UgandaUganda 11 77

Burkina FasoBurkina Faso 55 44

EthiopiaEthiopia 77 11

GuineaGuinea 1818 77

MauritaniaMauritania 55 33

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Growth-Oriented Policies for AfricaGrowth-Oriented Policies for Africa

Need for a ‘Post-Stabilization’,Need for a ‘Post-Stabilization’,MDG-Oriented Policy AgendaMDG-Oriented Policy AgendaMove From Stabilization to Capital Move From Stabilization to Capital AccumulationAccumulation::

1.1. Improve Public FinanceImprove Public Finance2.2. Focus on Public InvestmentFocus on Public Investment3.3. Avoid ‘Inflation-Targeting’ Avoid ‘Inflation-Targeting’ 4.4. Gear Financial Policies to InvestmentGear Financial Policies to Investment5.5. Spend and Absorb ODASpend and Absorb ODA

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Improve Public FinanceImprove Public Finance

The Revenue Base of most developing The Revenue Base of most developing countries is too small, not too bigcountries is too small, not too bigRevenue needs to reach 20-25% of GDPRevenue needs to reach 20-25% of GDPMany African states command less than 15%Many African states command less than 15%A priority is to boost revenue to this minimum A priority is to boost revenue to this minimum thresholdthresholdSo avoid Potential Revenue Losses:So avoid Potential Revenue Losses:

1.1. VAT compensates for only 30% of lost tariff revenue VAT compensates for only 30% of lost tariff revenue after trade liberalization in poor countriesafter trade liberalization in poor countries

2.2. Do not greatly reduce top rates on corporate and Do not greatly reduce top rates on corporate and personal income (this is ineffective) personal income (this is ineffective)

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Maintain vertical equity in tax Maintain vertical equity in tax systems where possiblesystems where possible

1.1. Property taxes, such as on urban real estateProperty taxes, such as on urban real estate2.2. Excise taxes on luxury itemsExcise taxes on luxury items3.3. Maintain moderately high rates on corporate Maintain moderately high rates on corporate

profits (except for small enterprises)profits (except for small enterprises)4.4. Direct and Indirect taxes will grow as the Direct and Indirect taxes will grow as the

formal sector grows formal sector grows -- Build and maintain a buoyant system-- Build and maintain a buoyant system

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Expanding ‘Fiscal Space’Expanding ‘Fiscal Space’

Governments should be able to run Governments should be able to run moderate ‘fiscal deficits’ (3% of GDP)moderate ‘fiscal deficits’ (3% of GDP)

Monetization of deficits: under-funded Monetization of deficits: under-funded states need revenue from an inflation taxstates need revenue from an inflation tax

AfricaAfrica: primary deficits 1.6% of GDP but : primary deficits 1.6% of GDP but overall deficits 5% of GDPoverall deficits 5% of GDP

The large external debt remains the initial The large external debt remains the initial problem for expanding ‘fiscal space’problem for expanding ‘fiscal space’

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Fiscal Deficits in AfricaFiscal Deficits in Africa(% of GDP)(% of GDP)

Primary DeficitPrimary Deficit

1979-19891979-1989

Primary DeficitPrimary Deficit

1990-20021990-2002

-3.58-3.58 -1.63-1.63

Overall DeficitOverall Deficit

1979-19891979-1989

Overall DeficitOverall Deficit

1990-20021990-2002

-6.45-6.45 -4.99-4.99

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How to Add Revenue of 5-6% of GDP:How to Add Revenue of 5-6% of GDP:1.1. About 2% of GDP from relieving debt About 2% of GDP from relieving debt

serviceservice2.2. About 2% of GDP from restoring, at the About 2% of GDP from restoring, at the

minimum, 1990 levels of ODAminimum, 1990 levels of ODA3.3. 2-3% of GDP from additional domestic 2-3% of GDP from additional domestic

revenuerevenue(adding revenue of 2% of GDP is common (adding revenue of 2% of GDP is common over the medium term and easier below 15%)over the medium term and easier below 15%)

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Focus on Public InvestmentFocus on Public Investment

The Central Role of Public InvestmentThe Central Role of Public Investment1.1. Stimulate Aggregate DemandStimulate Aggregate Demand2.2. Expand Productive CapacityExpand Productive Capacity3.3. Focus Resources on the PoorFocus Resources on the Poor

Public Investment has been in long-term Public Investment has been in long-term decline in many countries—e.g., Africadecline in many countries—e.g., AfricaBy raising private-sector productivity, By raising private-sector productivity, public investment can ‘crowd-in’ private public investment can ‘crowd-in’ private investmentinvestment

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The Decline of Public InvestmentThe Decline of Public Investment

RegionRegion 1970s1970s 1980s1980s 1990s1990s

East AsiaEast Asia 3.43.4 3.93.9 4.14.1

Latin AmericaLatin America 4.04.0 2.72.7 2.82.8

Middle EastMiddle East 11.711.7 9.29.2 6.86.8

South AsiaSouth Asia 2.42.4 2.52.5 2.62.6

Sub-Saharan Sub-Saharan AfricaAfrica

4.74.7 3.63.6 3.33.3

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Focus on Public InvestmentFocus on Public Investment

The state has to ensure adequate economic and The state has to ensure adequate economic and social infrastructure:social infrastructure:This is part of accelerating capital accumulationThis is part of accelerating capital accumulation

Fiscal retrenchment has led to depletion of Fiscal retrenchment has led to depletion of public capital stockpublic capital stockIn low-income countries, the ratio of public In low-income countries, the ratio of public investment to GDP should be higher than in rich investment to GDP should be higher than in rich countriescountriesPublic investment is one of the most Public investment is one of the most concreteconcrete ways to stimulate ‘private-sector’ developmentways to stimulate ‘private-sector’ development

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Avoid Inflation TargetingAvoid Inflation Targeting

Moderate Rates of Inflation (5-15%) are Moderate Rates of Inflation (5-15%) are compatible with growthcompatible with growthTargeting 3-5% can dampen growth Targeting 3-5% can dampen growth (through high real rates of interest)(through high real rates of interest)In Africa, part of inflation is cost-push In Africa, part of inflation is cost-push (Food, ToT shocks, rising oil prices)(Food, ToT shocks, rising oil prices)Role Reversal needed: Monetary policy Role Reversal needed: Monetary policy should be subordinate to fiscal policyshould be subordinate to fiscal policyGear the interest rate to long-term growthGear the interest rate to long-term growth

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The real interest rate should equal the The real interest rate should equal the sustainable growth rate of GDP per capitasustainable growth rate of GDP per capita(No more than 3%?)(No more than 3%?)

Average inflation in Africa was under 12% Average inflation in Africa was under 12% in 2000-2003 and under 8% in 2004in 2000-2003 and under 8% in 2004Cost-push factors can keep inflation higher Cost-push factors can keep inflation higher than 5%than 5%Raising interest rates to keep inflation low Raising interest rates to keep inflation low cannot address demand shocks cannot address demand shocks (oil prices)(oil prices)

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CPI Inflation Rates (% per year)CPI Inflation Rates (% per year)

1990-941990-94 1995-991995-99 2000-032000-03

AfricaAfrica 39.8%39.8% 20.6%20.6% 11.8%11.8%

Developing Developing CountriesCountries

53.2%53.2% 13.1%13.1% 5.7%5.7%

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High real rates of interest (e.g., 10%) are High real rates of interest (e.g., 10%) are grossly misalignedgrossly misalignedGear monetary policy, as well, to real Gear monetary policy, as well, to real variables: variables: growth, employment, income povertygrowth, employment, income poverty

Poor households suffer from under-Poor households suffer from under-employment and lack of income as well as employment and lack of income as well as high priceshigh pricesWhy do we focus only on inflation as the Why do we focus only on inflation as the primary problem?primary problem?

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Exchange Rate and Capital Exchange Rate and Capital Management PoliciesManagement Policies

Policy instruments are needed to balance Policy instruments are needed to balance both the current and capital accountsboth the current and capital accounts

Since the exchange rate is not wholly Since the exchange rate is not wholly ‘market-determined’, use a managed float‘market-determined’, use a managed float

Combine a managed float with regulation Combine a managed float with regulation of the capital account of the capital account (e.g., capital outflows)(e.g., capital outflows)

Otherwise there can be no independent Otherwise there can be no independent monetary policymonetary policy

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Link Macro-policies to GrowthLink Macro-policies to Growth

Four policy instruments: fiscal, monetary, Four policy instruments: fiscal, monetary, exchange-rate and capital-account policiesexchange-rate and capital-account policiesFiscal policies (mostly public investment) Fiscal policies (mostly public investment) should focus on growth should focus on growth Previously, macro-policies were focused Previously, macro-policies were focused on stabilization: none were focused on on stabilization: none were focused on growthgrowthFinancial policies should focus on private Financial policies should focus on private investmentinvestment

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Gear Financial Policies Gear Financial Policies to Investmentto Investment

Financial liberalization has been neither Financial liberalization has been neither pro-growth nor pro-poorpro-growth nor pro-poorBanks provide short-term, high-cost credit: Banks provide short-term, high-cost credit: working capital, T-Bills, consumer durables, tradeworking capital, T-Bills, consumer durables, trade

High and Rising Interest-Rate Spreads High and Rising Interest-Rate Spreads (from 8 to 12 ppts) have dampened (from 8 to 12 ppts) have dampened savings and investmentsavings and investmentBanks hold large amounts of excess Banks hold large amounts of excess reserves (idle national savings)reserves (idle national savings)

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Banks Short-Circuit Capital Accumulation Banks Short-Circuit Capital Accumulation (Even the accumulation of public revenue)(Even the accumulation of public revenue)

Why is this the case? What can be done to Why is this the case? What can be done to improve their functioning?improve their functioning?

Two Strategic OptionsTwo Strategic Options: :

1) Provide incentives to private banks to lend for 1) Provide incentives to private banks to lend for productive investment and social purposesproductive investment and social purposes

2) strengthen public banks to serve these objectives2) strengthen public banks to serve these objectives

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Various Policy Options:Various Policy Options:Develop longer-term public debt instruments: Develop longer-term public debt instruments: relieve short-term pressure of domestic debtrelieve short-term pressure of domestic debt

Experiment with deposit insurance programmes: Experiment with deposit insurance programmes: the need to boost savingsthe need to boost savings

Use differential reserve requirements: direct Use differential reserve requirements: direct credit to certain sectors (those with employment credit to certain sectors (those with employment intensity or high employment multipliers)intensity or high employment multipliers)

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Provide partial loan guarantee schemesProvide partial loan guarantee schemesExample: Recent recommendations from a Example: Recent recommendations from a UNDP draft Report on an “Employment Targeted UNDP draft Report on an “Employment Targeted Economic Program” for South AfricaEconomic Program” for South Africa

Proposal provides guarantees for 25% of Proposal provides guarantees for 25% of productive investment in the countryproductive investment in the country

Guarantees cover 75% of loans and assume a Guarantees cover 75% of loans and assume a 15% default rate15% default rate

Projected Cost: 1-2% of national budgetProjected Cost: 1-2% of national budget

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Publicly Owned or Controlled Banks:Publicly Owned or Controlled Banks:

What have been their strengths and What have been their strengths and weaknesses?weaknesses?

Strengthen Agricultural Banks and SME Strengthen Agricultural Banks and SME Banks: for Banks: for pro-poorpro-poor growth growth

Strengthen Development Banks where Strengthen Development Banks where feasible: satisfy the urgent, unfulfilled need feasible: satisfy the urgent, unfulfilled need for long-term loansfor long-term loans

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Spending and Absorbing ODASpending and Absorbing ODA

Key QuestionKey Question: will an upsurge of ODA : will an upsurge of ODA weaken international competitiveness?weaken international competitiveness?

ODA should enable the government to ODA should enable the government to spend more (run a larger deficit)spend more (run a larger deficit)

ODA should finance a larger trade gap ODA should finance a larger trade gap (more imports, less exports)(more imports, less exports)

Some appreciation of the exchange rate is Some appreciation of the exchange rate is likely to accompany this processlikely to accompany this process

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Bottlenecks in Domestic Policymaking:Bottlenecks in Domestic Policymaking:1.1. Governments are unwilling to spend ODAGovernments are unwilling to spend ODA2.2. Central Banks are unwilling to sell forexCentral Banks are unwilling to sell forexWhat Are the Reasons?What Are the Reasons?1.1. Governments fear higher inflation and Governments fear higher inflation and

crowding out of private investmentcrowding out of private investment2.2. Central Banks, fearing financial instability, Central Banks, fearing financial instability,

would rather sterilize (sell bonds), driving up would rather sterilize (sell bonds), driving up real rates of interestreal rates of interest

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Governments should use ODA to finance Governments should use ODA to finance increased public investmentincreased public investmentGovernments should use ODA to finance Governments should use ODA to finance imports of technology and capital goodsimports of technology and capital goodsThe private sector should be encouraged The private sector should be encouraged to do the sameto do the sameThere need be There need be nono trade-off between trade-off between current human well-being and long-term current human well-being and long-term growthgrowth

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The Tragedy of HIV/AIDSThe Tragedy of HIV/AIDS

ODA is available, in some cases, but ODA is available, in some cases, but cannot be disbursedcannot be disbursedThe ReasonThe Reason: Restrictive Macroeconomic : Restrictive Macroeconomic Policies are a roadblock Policies are a roadblock (e.g., budget ceilings)(e.g., budget ceilings)

Will such ODA destabilize the economy?Will such ODA destabilize the economy?Contradiction: This Human Development Crisis Contradiction: This Human Development Crisis has to be addressed quicklyhas to be addressed quicklyAnswer:Answer: Directly import if possible, spend aid Directly import if possible, spend aid (effectively) and carefully manage the sale of (effectively) and carefully manage the sale of foreign exchangeforeign exchange

Economic Alternatives for Sub-Saharan Africa: MDG-Based Policy Implications

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public investmentwhat

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