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External shocks and policy responses in sub-Saharan Africa, 1973–78: More open and outward-oriented economies fared better

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1984
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Under stress, market-oriented economies fared better than others

Bela Balassa

The author’s earlier investigations of the adjustment policies applied by developing countries pursuing different development strategies in response to the external shocks of 1973–78 showed that outward-oriented countries were better able to overcome the effects of these shocks through domestic adjustment. This was achieved even though these countries with their greater reliance on international trade suffered greater external shocks than countries pursuing an inward-oriented development strategy. After a temporary decline following the shock, economic growth accelerated in the first group of countries, while declining in the second. These differences in growth rates reflected the lower incremental capital-output ratios in outward-oriented countries—implying less additional capital was required to increase output—as well as their higher domestic savings ratios as a greater proportion of their national income was saved. These economies also relied less than their inward-looking counterparts on foreign borrowing. The conclusions applied equally well to the newly industrializing as to the less developed countries studied. The analysis also showed that reliance on export promotion in response to external shocks, associated with the application of an outward-oriented development strategy, was highly correlated with the rate of economic growth.

This article is based on a longer study published by the Bank as Report DRD 41. Copies are available from the Bank Research Documentation Center, Room 18–203,1818 H St. NW, Washington, DC 20433, USA.

Are these conclusions relevant for sub-Saharan Africa? There, it is argued, economic incentives have limited effects, especially in countries at lower levels of development. In attempting to provide an answer, this article summarizes the findings of a study that examined the relevance of the choice of development strategy for coping with external shocks in the oil importing low- and middle-income countries of sub-Saharan Africa between 1973 and 1978. The low-income countries covered were Benin, Botswana, Ethiopia, Madagascar, Malawi, Mali, Niger, Tanzania, Upper Volta, and Zaïre; middle-income countries included Cameroon, Ghana, Ivory Coast, Kenya, Mauritius, Senegal, Sudan, Togo, and Zambia.

Magnitude of the shocks

These countries were grouped according to two types of classification: the first distinguished between interventionist and market-oriented countries, while the second utilized the threefold classification of etatist, intermediate, and private market economies. The first classification separated those countries that tended to be inward-oriented and interventionist in product, capital, labor, and foreign exchange markets from those that placed greater reliance on the price mechanism and market forces and were more outward-oriented in their trade strategies. (The former comprised Benin, Ethiopia, Ghana, Madagascar, Mali, Senegal, Sudan, Tanzania, Zaïre, and Zambia; the latter included Botswana, Cameroon, Ivory Coast, Kenya, Malawi, Mauritius, Niger, Togo, and Upper Volta.) This distinction seems robust; most observers would agree on the classification of different countries, and shifting marginal cases from one group to another changes the empirical results little. Nevertheless, an alternative classification was made in order to provide a finer distinction among countries in terms of their economic policies, with Kenya, Malawi, Niger, Senegal, Sudan, Togo, and Upper Volta being classified in the intermediate group.

The external shocks experienced by the countries in question included changes in their terms of trade and a slowdown of foreign demand for their exports. The effects of these shocks on the balance of payments were estimated by postulating a situation that would have existed in the absence of external shocks. In turn, the policy responses to these shocks included additional net external financing, export promotion, import substitution, and lowering the rate of economic growth.

The balance of payments effects of policy responses were also estimated by postulating a situation that would have occurred in the absence of external shocks. Additional net external financing was derived as the difference between the actual trade balance and the trade balance that would have been obtained if trends in imports and exports in 1963–73 continued; the effects of export promotion were calculated as increases in exports associated with increases in the countries’ export shares in 1971–73; import substitution was defined as savings in imports resulting from a fall in the income elasticity of import demand (the rate of growth of imports divided by that of GNP) in the country concerned; and the effects on imports of changes in GNP growth rates compared with the 1963–73 period were calculated by assuming unchanged income elasticity of import demand in the particular country (Table 1). (The original study contains details regarding estimation methods.)

Table 1External shocks and policy responses In sub-Saharan Africa, 1973-78
External

shocks

(As a percent

of GNP, 1974–78)
Additional

net external

financing
Change in

export

market

shares
Import

substitution
Import

effects

of lower

GNP growth

rates
Debt-

service

ratio

(In percent)
(As a percent of the balance of payments

effects of external shocks, 1974–78)
19731978
Interventionist
Middle income4.9129–3720–1311.320.2
Low income5.737–49654710.527.7
Average5.384–43421610.924.2
Market oriented
Middle income1.6374640–2214.412.7
Low income7.9403829–810.610.7
Average2.6394235–1514.012.5
Threefold classification scheme
Etatist3.7111–7164–49.010.9
Intermediate7.764–18243017.528.5
Private market–0.8–24034557–2627.913.4
Source: World Bank Data Base.
Source: World Bank Data Base.

The estimation procedure is subject to certain qualifications: the policies applied in the period of external shocks may represent a continuation of past policies rather than a response to these shocks; structural changes may limit the validity of the assumption that past relationships would have continued in the absence of external shocks and policy responses to them; and finally, rather than being the result of conscious decisions, measured import substitution may reflect the effects of foreign exchange shortages, brought about by the deterioration of the terms of trade or export shortfalls in countries with limited capacity to obtain funds abroad. These considerations do not invalidate the method applied, however; the policies followed can be judged according to their relative success in coping with external shocks. The study covered a sufficiently short time span to limit the likelihood of structural changes occurring, and by and large the countries that encountered difficulties in obtaining funds abroad got into this predicament as a result of the misuse of funds borrowed earlier. At any rate, there is no reason to assume that such changes would have introduced a bias in the results.

Adjustment policies

There are some clear-cut differences in the adjustment policies adopted by different groups of oil importing sub-Saharan countries. Interventionist countries experienced considerable losses in export market shares that were not fully offset by import substitution (Table 1). In turn, the favorable effects of export promotion and import substitution reinforced each other in market-oriented countries, offsetting over three fourths of the adverse balance of payments effects of external shocks. These countries were also able to limit their reliance on additional net external financing, while the inflow of foreign capital increased to a considerable extent in interventionist countries, even though their import requirements were reduced through lower rates of growth of GNP.

These conclusions are reinforced if use is made of the threefold classification scheme. Etatist countries not only suffered large losses in export market shares, losses which added significantly to the adverse balance of payments effects of external shocks, but the effects of these losses were also only partially offset by import substitution. With minimal reductions in imports associated with deflationary policies, additional net external financing needed by the etatist group exceeded the adverse balance of payments effects of external shocks in these countries. Nevertheless, increases in debt servicing were mitigated by the large share of grants in external financing.

Export promotion and import substitution both raise output levels in the short run by increasing the utilization of existing resources but may have different implications for long-term economic growth. In the interventionist countries of sub-Saharan Africa, import substitution occurred behind high protection that involved a cost to the national economy. Meanwhile, export promotion in market-oriented countries was associated with reducing the bias of the incentive system against exports, thereby contributing to resource allocation according to comparative advantage, the exploitation of economies of scale, increased capacity utilization, and technological change in response to the stimulus of competition in world markets.

The differences in the growth performance of market-oriented and interventionist countries shown in Table 2 may be attributed to differences in incremental capital-output ratios and in domestic and foreign savings ratios. The higher growth rates of the market-oriented countries were associated with lower incremental capital-output ratios, representing efficiency in the use of incremental resources, and substantially higher domestic savings ratios, reflecting the success of mobilization efforts.

Table 2Savings ratios, Incremental capital-output ratios, and growth rates In sub-Saharan Africa, 1963–79
1963–731973–761976–791973–79
Interventionist countries
Domestic savings ratio16.812.48.710.1
Foreign savings ratio0.86.66.16.3
Incremental capital-output ratio7.317.38.37.8
Rate of growth of GNP3.12.01.81.9
Growth rate of per capita GNP0.7–0.7–0.8–0.8
Market-oriented countries
Domestic savings ratio16.319.222.921.5
Foreign savings ratio2.63.95.95.1
Incremental capital-output ratio3.94.04.74.4
Rate of growth of GNP5.25.56.86.2
Growth rate of per capita GNP2.42.53.83.2
Source: World Bank Data Base.
Source: World Bank Data Base.

Differences in incremental capital-output and domestic savings ratios are largely explained by the policies followed. Protectionist policies, aggravated by export taxes, price controls, and the commercial margins of parastatal trading companies, discriminated against exports and against agriculture in interventionist countries. At the same time, on the whole, the extent of discrimination increased during 1973–78.

Interventionist countries also failed to devalue their currencies pari passu with inflation during the period under consideration. As a result, their real exchange rates appreciated to a considerable extent, discriminating against both exports and import substitution. The extent of appreciation in real terms was especially pronounced, exceeding one fourth, in Mali, Sudan, and Zaïre. The licensing of private investments and the implementation of high-cost, capital-intensive public projects further reduced the efficiency of resource allocation in interventionist—and, in particular, etatist—countries.

By contrast, greater openness and price flexibility, more realistic exchange rates, and a freer choice of private investments, as well as a smaller number (and a more judicious selection) of public projects, favorably affected the efficiency of resource allocation in market-oriented countries.

Domestic savings ratios are influenced by public as well as by private decisions. By and large, the government budget deficit was greater in interventionist than in market-oriented countries, reducing public savings. In those interventionist countries for which data are available, the ratio of the government budget deficit to GDP ranged from 18 percent in Zaïre to 1 percent in Senegal between 1974 and 1978. The highest deficit in a market-oriented country was 6 percent of GDP in Malawi.

Private savings are also affected by interest rate policy. While, on average, real interest rates were negative in all the countries under consideration, they were most negative in two interventionist countries, Zaïre (– 24 percent) and Ghana (– 22 percent) and the least so in two market-oriented countries, Malawi (– 3 percent) and Upper Volta (– 2 percent).

The inflow of foreign savings depends on the availability of funds at concessional terms as well as on the creditworthiness of the country concerned for lending on commercial terms. As noted above, interventionist countries borrowed relatively more abroad than market-oriented countries; they also received a larger proportion of foreign funds at concessional terms. At the same time, two etatist countries, Zaïre and Tanzania, encountered limitations in borrowing at commercial terms owing to a decline in their creditworthiness.

Economic performance

To identify the changes that occurred in conjunction with adjustment policies, comparisons were made between 1963–73 and 1973–79 (Table 2). In interventionist countries growth rates fell as did domestic savings ratios, while incremental capital-output ratios and reliance on foreign capital increased—the extent of deterioration in economic performance being greatest in low-income countries. By contrast, GNP growth rates rose between the two periods in market-oriented countries, with the greatest improvement in low-income countries. In low-income countries, increases in domestic and foreign savings ratios, as well as a decline in incremental capital-output ratios, contributed to this result; in middle-income countries, increases in domestic and foreign saving ratios were only partially offset by a rise in incremental capital-output ratios. Market-oriented countries simultaneously increased their reliance on foreign capital to a much lesser extent than interventionist countries, thus avoiding increases in debt-service ratios that more than doubled between 1973 and 1978 in etatist countries.

These findings are confirmed in the threefold classification scheme. Average rates of economic growth fell in etatist countries that experienced a near-quintupling of incremental capital-output ratios as well as a substantial decline in domestic savings ratios that was only partially offset by increased capital inflow. At the same time, average GNP growth rates increased in the countries of the intermediate group, which experienced a decline in incremental capital-output and domestic savings ratios that was more than offset by the increased inflow of foreign capital. Finally, private market economies increased their average rates of economic growth, as increases in domestic savings ratios more than offset a rise in incremental capital-output ratios and a decline in foreign savings ratios.

Confirmation of other results

The results obtained for oil importing sub-Saharan African countries applying different development strategies conform to the author’s earlier findings that outward-oriented countries generally perform better than inward-oriented countries. The conclusion applies to exports, domestic savings, the efficiency of resource use, and the rate of economic growth, although market-oriented countries were helped by the lower external shocks they experienced.

At the same time, in comparing market-oriented sub-Saharan African countries with outward-oriented developing countries and interventionist sub-Saharan African countries with inward-oriented developing countries, it is apparent that incremental capital-output ratios are higher and domestic savings ratios are lower in sub-Saharan Africa, leading to lower GNP growth rates. These conclusions apply even if the comparisons are limited to countries at similar income levels; thus, middle-income countries in sub-Saharan Africa tend to have lower growth rates than less developed countries with similar per capita GNP in other regions. The observed differences may be explained by the fact that public interventions are more prevalent in sub-Saharan Africa than elsewhere in the developing world.

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