Race to the Next Income Frontier
Chapter

Chapter 2. Can Plan Sénégal Émergent Growth Rates Be Achieved—and If So, How?

Author(s):
Ali Mansoor, Salifou Issoufou, and Daouda Sembene
Published Date:
April 2018
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Author(s)
Ali Mansoor and Salifou Issoufou

Introduction

The Plan Sénégal Émergent calls for Senegal to be an emerging market economy by 2035 and aims to make the country a logistics and industrial hub for the region. This vision is shared by an increasing number of low-income countries and is inspired by the success of a growing cohort of economies, including several in Africa. It is also being pushed, as a result of democracy, by the aspirations of the people, who are increasingly frustrated at being left behind.

The goal is for Senegal, after 60 years of independence, finally to move forward economically and in so doing reduce poverty and create jobs and economic opportunity for its entire population. Senegal has been punching above its weight in international affairs as a key ally of the West and as a purveyor of good principles and values—humanism, tolerance, and cultural sophistication—and more recently as a beacon of democracy. However, the position of high regard in which it is now held by many may suffer if Senegal continues to fall behind economically, especially in relation to other African economies.

The Plan Sénégal Émergent is a reaction to these various requirements and aims to make Senegal a key player in the region through better infrastructure, greater human development, and better governance. The plan aims to develop key sectors, such as agriculture, agribusiness, mining, and tourism. To achieve these goals, Senegal would need to accelerate its per capita growth rate from its average of about 0.5 percent over the last 30 years to a rate in the range of 4 to 5 percent.1 Success is within grasp, but it will require that the Senegalese elite make strategic decisions to move away from rent seeking and rent sharing to the creation of new wealth based on globally competitive activity.

This chapter warns that an attempt to achieve the Plan Sénégal Émergent objectives based mainly on expanded public investment is unlikely to succeed, because sustaining high growth also requires continued private investment, including foreign direct investment. From a purely rent-seeking point of view, however, achieving the Plan Sénégal Émergent objectives by expanding public investment may be the most attractive option.2 This reality—that investment booms in themselves do not unlock sustainable growth—is indicated not only by Senegal’s own experience but by consistent international experience, as presented in this chapter. Success requires making reforms, breaking with the past to open economic space for new globally competitive wealth creation. In turn, supporting such new economic activity will require a combination of efficient investment in public infrastructure, investment in human capital, and structural reforms.

The structure of the chapter is as follows. The first section reviews the international experience in attaining and sustaining high growth for extended periods. Concrete proposals in this regard are presented in the remaining sections. These proposals are centered on the view that a new approach to special economic zones along the lines that China and Mauritius have followed may offer a way to open space for new wealth creation without having to tackle head-on the problems of rent seeking in the rest of the economy. A new special economic zone policy would rapidly put in place the institutional and regulatory framework required to unlock private investment, including foreign direct investment, and would open economic space to small and medium-sized enterprises for high, sustained, and inclusive growth. The chapter concludes with a proposal for contingency planning to avoid the derailing of Plan Sénégal Émergent targets when risks manifest themselves.

Is the Special Economic Zone Really a Solution?

It is clear that in a first-best world, the reforms that hold back inclusive growth would be adopted to apply across the whole economy. However, as the necessary policies are unlikely to be adopted, the novelty of this work is to suggest the creation of a special economic zone as a more politically feasible option. In turn, this raises the question whether this will actually work, a highly relevant question because special zones or regimes, whether they concern physical spaces or policy regimes, have a history that is largely one of failures.

The first point to note is that while there have been many failures, there have also been successes, as documented by Farole and Akinci (2011). In some cases, the successes have been so spectacular that their special-regime aspect may have been overlooked, as in the cases of China, Dubai, Ireland, Korea, Mauritius, and Singapore. As The Economist pointed out in April 2015:

First, offering nothing but fiscal incentives may help get a zone off the ground, but it does not make for a lasting project. The most successful zones are entwined with the domestic economy: South Korea, for example, has been good at fostering links with local suppliers. Zones need to be connected to global markets. Improving infrastructure for this purpose has a bigger impact on the success of zones than tax breaks do. This often requires public spending to upgrade roads, railways and ports to handle the extra freight. Lack of such investment has been the downfall of many an SEZ [special economic zone] in Africa. Lots of the continent’s new zones will fail for lack of a reliable power supply or because they are too far from a port.3

Each of the six countries noted earlier had a different set of initial conditions that are likely not replicable in today’s Senegal. However, what these countries showed is that focusing on exporting and being globally competitive allows policies and institutions to evolve in ways that can produce results in very varied circumstances. In this context, it may be worth contrasting the reasons for success in China and Mauritius.

China is in many ways a unique case in its combination of political economy, discipline, and work ethic. Mauritius, by contrast, enjoyed fortunate timing, coincidentally deciding to open up just as investors in clothing manufacture were keen to leave Hong Kong SAR and local businessmen with large financial surpluses from selling sugar at preferential prices to the European Union were keen to attract foreign partners, for whom the special economic zone was mainly a flag signifying that the country was open for business.

The key point is that in a world of global networks, there is at least some foreign direct investment for which the binding constraint on locating in a country is the quality of the logistics, the institutions, and the enabling policy. Senegal has been unable to attract foreign investors because of resistance to policy and institutional change on the part of rent seekers, who have mobilized to keep the economic status quo—an issue discussed elsewhere in this book (see Chapters 13 and 17).

Indeed, as pointed out by Farole and Akinci (2011, 1), “despite many zones having failed to meet their objectives . . . many others are contributing significantly to growth in foreign direct investment (FDI), exports, and employment, as well as playing a catalytic role in integration into global trade and structural transformation, including industrialization and upgrading.” They also note that, in addition, the survey results show clearly that the investment climate inside the zone—specifically, infrastructure and trade facilitation—is linked to program outcomes.

Therefore, the governance arrangement for building and operating a special economic zone is clearly the critical issue. Success will largely rest on the willingness of Senegalese authorities and public opinion to allow outsiders from, among other places, China, France, Mauritius, and the United States to play key roles in governing the zone and its logistical links to the rest of the world. It may well be that the resistance of those who enjoy the status quo in Senegal today would be so strong that it would not be possible to carve out such a space for small and medium-sized enterprises and foreign direct investment where a liberal economic regime would prevail. If so, there may be no politically feasible strategies that would allow Senegal to rapidly move up the world income ladder.

It is the belief of all the authors of this book, however, that this is not the case. Indeed, the political economy argument is that a deal could be negotiated wherein rentiers preserve their gains by agreeing to the creation of a space for new activity by small and medium-sized enterprises and foreign direct investment based on liberal economic rules. By not pressing for reform to roll back existing rents,4 it may be possible for the rentiers of Senegal to accept a carve out, much as has been the experience of the successful countries listed earlier.

International Experience with Growth and Debt

Recent experience, particularly since 1987, suggests that high per capita growth has been achieved by a number of countries (see Annex 2.1).5 However, countries that have embarked on important investment programs have had mixed fortunes.6 Those that complemented investment in human capital and infrastructure with ambitious structural reforms have unlocked foreign direct investment and private sector activity that propelled them forward. Those that just ramped up public spending without accompanying reforms merely accrued debt; many such countries, including Senegal, still remain low-income countries.

The analysis compares two sets of countries.7 The first set consists of 24 of the fastest-growing low-income, middle-income, and sub-Saharan African countries. The second set consists of 40 high-debt countries and was derived by applying criteria on growth in debt position as well as the evolution of debt-to-GDP ratios between 1990 and 2013.8 During this period, the fastest-growing countries averaged higher than 4.5 percent growth in GDP per capita, leading to income levels that by 2015 were approximately four times their initial level. In contrast, the high-debt countries accumulated debt during the period and grew at a rate of only 1.75 percent, a rate that would allow them to double their living standards only every 40 years.

The successful countries sustained growth by relying on foreign-direct-investment-driven exports and on an expansion of private investment both as a share of GDP and as share of total investment. In contrast, those that accumulated debt did not seem to do so (Figure 2.1). Over this period, on average, exports increased by almost 4 percentage points of GDP in the high-growth countries. High-debt countries, which include Senegal, instead saw a dip in exports of 0.5 percent of GDP. The changes in foreign direct investment, as a percentage of GDP, followed a similar pattern: foreign direct investment increased by more than 4 percent of GDP in the high-growth countries between 1990 and 2013. In contrast, the high-debt countries saw virtually no increase in foreign direct investment.9Hausmann, Pritchett, and Rodrik (2005) find that in the high-growth countries, the growth acceleration driven by economic reforms tended to be sustained.10

Figure 2.1.Change over High-Growth Episodes in Exports, Foreign Direct Investment, and Private Investment, High-Growth and High-Debt Countries versus Senegal

(Percent of GDP)

Source: World Bank, World Development Indicators.

Note: For a list and definition of the 24 high-growth countries and the 40 high-debt countries used in this analysis, see Annex 2.1.

Senegal’s own growth rate declined during the episode of debt accumulation, consistent with the typical experience of high-debt countries as a whole. This is partly explained by the failure of public spending to crowd-in private investment. In fact, the high-debt countries registered a decrease in private investment (as a percentage of GDP). In contrast, the sustained growth in high-growth countries seems to be underpinned by crowding-in private investment, which rose in percentage of GDP.

BOX 2.1Unlocking Growth with Public Investment

The regressions in Table 2.1.1 consider cross-country empirical evidence regarding the factors that have contributed to growth. The dependent variable is growth in GDP per capita. All three regressions include fixed effects to address any country-specific potential causes of growth not captured by the other variables. Across all three regression specifications, we see that public investment has no significant differential effect from the total level of investment in the economy. Additional regressions, not shown in the table, find that private and public investment have a similar magnitude and significance for growth.

TABLE 2.1.1Growth Regressions: Public Investment Complementarities
(1)(2)(3)
GDP per Capita (thousands of dollars at purchasing power parity)−0.078−0.05−0.041
Inflation (percent)−0.001−0.001−0.001
Trade (percent of GDP)0.046**0.04***0.035**
Government (percent of GDP)−0.212***−0.21**−0.209***
Investment (percent of GDP)0.113***0.068*0.09**
Public Investment (percent of GDP)0.0650.042−0.022
Public Investment × Private Investment0.002***
Public Investment × Trade0.001***
Constant−0.90.2920.507
Number of Observations3,2053,2053,205
Source: Authors’ calculations.*p < .10; **p < .05; ***p < .01.

Instead, this analysis focuses on the interaction between public investment and other potential causes of growth. Considering the second and third columns of the table, the regressions show that there are strong complementarities between public investment and increasing levels of private investment and trade. This suggests that the effect of public investment on growth is amplified when accompanied by more trade and private investment. Sustained growth therefore can be achieved when countries complement public investment with structural reforms that encourage an increase in private investment and trade.

To provide a sense of what these coefficients mean for Senegal, increasing public investment by 5 percent of GDP, if accompanied by an increase in private investment by 5 percent of GDP, would lead to an increase in the GDP per capita growth rate of nearly 1 percent. This same increase in GDP per capita growth could also be achieved by making the same increase in public investment accompanied by increasing trade by 15 percent of GDP. If Senegal were to achieve the same level of private investment as the high-growth comparator countries (19.4 percent of GDP), as compared with Senegal’s current rate of 16.7 percent of GDP, while still increasing public investment by 5 percent of GDP, this would lead to an estimated 0.75 percent increase in the growth rate of GDP per capita.

Senegal could achieve even greater growth by reaching the same level of trade as the high-growth comparators—86.1 percent of GDP as compared with Senegal’s current 64.9 percent of GDP—such that the 5 percent increase in public investment complemented by the increase in trade would lead to an estimated increase of 1.2 percent in GDP per capita growth. Public investment in infrastructure such as roads and ports, which facilitate trade and encourage private investment to reach levels seen in the high-growth countries, could increase the growth rate of GDP per capita by nearly 2 percent. This would render emerging market status attainable for Senegal.

Hausmann, Pritchett, and Rodrik (2005) also confirm that episodes of sustained growth and growth acceleration usually coincide with a sharp uptick in private investment and trade. However, macroeconomic volatility and external shocks are negatively associated with the duration of growth episodes, while increasing sophistication in export products tends to prolong growth.11

The data presented in Box 2.1 support these findings. Senegal could increase its GDP per capita growth rate by up to 2 percentage points by promoting trade and private investment to complement the public investment in human capital and infrastructure supporting these activities. If it were to do so, it would be taking a highly significant step in achieving the growth rates envisaged by the Plan Sénégal Émergent to achieve emerging market status within 20 years.

In addition, Beck, Demirgüç-Kunt, and Levine (2005, 224) find that “a prosperous small and medium-sized enterprise sector is a characteristic of flourishing economies.”12 In the high-growth countries, the small and medium-sized enterprise sector accounted for over 64 percent of total employment on average over the period 1990–2000. In Senegal, by contrast, this sector contributed approximately 56 percent of all jobs (Beck, Demirgüç-Kunt, and Levine 2005).

This analysis is encouraging: it highlights the fact that, with the right package of policies, there can be a rapid positive response, as was seen in Mauritius. After the government’s implementation of a raft of reforms in Mauritius in 2006, within a year or so annual company registration more than doubled from just over 2,000 to almost 5,000. At the same time, in what had become a more open system, there was also more Schumpeterian creative destruction. The annual closure rate for companies rose to 2,700 a year in the second period, compared with less than 500 a year in the first period. In part, this large amount of churn also reflected the global financial crisis. From 2007 to 2010, the annual closure rate was only 50 percent higher: an average of 650 businesses closed each year.

Further analysis reveals interesting social developments that were occurring in Senegal. Figure 2.2 suggests that, relative to the high-growth countries, Senegal spent a comparable percentage of GDP on public expenditures for education and health. However, in Senegal this spending did not translate into a similar increase in its Human Development Index score. Senegal’s score was comparable to that of the high-growth low-income countries in 1990 and even slightly ahead of the sub-Saharan African countries, but it fell behind both over the period. This suggests that spending was much more efficient in the high-growth countries and highlights the importance of investment in these sectors.

Figure 2.2.Public Spending on Education and Health, High-Growth Countries and Senegal

(Percent of GDP)

Source: World Bank, World Development Indicators.

Note: For a list and definition of the 24 high-growth countries, see Annex 2.1.

In conclusion, to achieve the goals set in its Plan Sénégal Émergent, Senegal would need to devise and implement a critical mass of reforms to encourage private investment, including foreign direct investment; open up space for small and medium-sized enterprises; and encourage and expand exports.

Promoting Exports and Export Quality and Expanding to New Markets

In determining how to move Senegal in this direction, it may be useful to consider the experience of Mauritius. Mauritius is one of the high-growth comparator countries and also one of the peer countries with which Senegal is building a partnership. Indeed, Mauritius achieved growth objectives similar to those of the Plan Sénégal Émergent, maintaining average purchasing-power-parity per capita GDP growth of 4 percent over 28 years (from 1987 to 2015). It did so by promoting exports, opening space to small and medium-sized enterprises, and leveraging trade agreements (see Mansoor 2016). Despite the country’s limited natural resource endowments and high vulnerability to external shocks, the Mauritian story offers an example of how carefully orchestrated reforms, underpinned by the right institutional setup, can support successful structural transformation.

In its postindependence era, Mauritius has relied on preferential arrangements in the sugar industry and on preferences set by the Multi-Fiber Arrangement to promote exports of sugar and textiles. Between 1980 and 2000, GDP per capita more than tripled to reach $3,800 in 2000. Exports increased more than tenfold to reach 60 percent of GDP in 2010. To become an upper-middle-income economy, Mauritius expanded progressively from relying mainly on the primary sector (sugar), to adding secondary sector activity (textiles), to expanding the tertiary sector (tourism and financial services).

Senegal’s growth strategy could greatly benefit from an integrated and coordinated export strategy. This strategy could leverage both the African Growth and Opportunity Act to export to the United States and the Economic Partnership Agreement to expand exports to the European Union.13 The Plan Sénégal Émergent envisages such leveraging together with a boost in exports to Senegal’s neighboring countries in West Africa. Currently, however, less than 1 percent of public financing in Senegal goes directly to an export strategy.14

The Mauritius experience suggests that a well-calibrated, aggressive trade policy, leveraging trade agreements, could yield great results in Senegal. More specifically, existing exports could be boosted through better coordination of assistance to export-oriented industries to support their exploration of markets and to provide market intelligence, better access to appropriate financing, and facilitation of improvement in quality and other standards. For example, despite preferred access to the US market through the African Growth and Opportunity Act, US imports from Senegal have remained marginal since 2000 (Figure 2.3). This failure to expand exports further highlights the need to improve the competitiveness of Senegal’s economy through the reforms suggested in this book.

Figure 2.3.Bilateral Goods Trade between the United States and Senegal, 2000–12

(US$ millions)

Source: IMF staff estimates and projections.

Mauritius also used special economic zones effectively. Its export processing zone, which was more a concept than a physical zone, addressed the need to create a liberal and open trading platform in an economy that was highly regulated. By creating a regime outside the system in which entrenched interests were, by definition, not present, it became possible to apply liberal policies on labor, regulations, and taxes. Importantly, although there were episodes in which tax holidays were granted, the export processing zone worked well when there was a tax system with low rates (15 percent)15 and there were arrangements to facilitate and simplify compliance. China has adopted a similar system, including short-term tax holidays to cover the initial start-up period but with low tax rates prevailing for most of the period of active production.16

For Senegal to achieve Plan Sénégal Émergent growth rates, it will have to double the growth rates recorded in the past two decades. This can happen only if there is a new economic model based on a structural break with the past. From 1995 to 2013 economic expansion in the country was modest and volatile. GDP growth averaged 4 percent (1 percent per capita) with a 1.7 percent standard deviation. Senegal therefore has been a victim not only of low growth, but also of economic uncertainty.

Its growth fluctuations have partly been caused by uneven agricultural production, exogenous shocks, and—most important—an insufficiently diversified economy. Low growth has reflected major bottlenecks in the supply side of the economy; the dominance of rent generation and rent sharing is an obstacle to wealth creation based on globally competitive activity. This is seen, for example, in the fact that the largest employer outside government is the sugar company, Compagnie Sucrière Sénégalaise, which employs 6,000 workers, where the value addition is small and comes at a high cost to consumers and the economy from the opportunity cost of sustaining inefficient production (see Chapter 17). Bureaucratic infighting, which may sometimes also relate to rents, will also need to be addressed if Senegal is to develop the clear regulatory framework required to achieve a high and balanced growth path.

Senegal faces important supply constraints that hamper growth and development. Increased infrastructure spending, especially in transportation and power generation, will be crucial to address these constraints and unlock growth. Such investment is particularly important if Senegal is to be a hub for regional and international trade. The country will also need significant private investment, particularly foreign direct investment, to complement investment in public infrastructure and in human capital (education, health, and social safety nets).

The Plan Sénégal Émergent foresees a virtuous circle of growth by unlocking these supply constraints. However, it is not specific about how this can be set in motion. In Senegal, embarking on the journey envisaged by the Plan Sénégal Émergent will require providing incentives and space for unlocking new wealth creation. In turn, this will require reforming the regulatory framework to put in place institutions and policies friendly to those outside the elite and to Senegal’s international partners.

In addition to unlocking inclusive growth through more and better-paying formal-sector jobs and opportunities for small and medium-sized enterprises to emerge and grow (see Chapter 16), the proposal for a new approach to special economic zones can also help achieve the Plan Sénégal Émergent’s social objectives. These include rural electrification and access to clean water, education, health care, and social safety nets. These social objectives will be facilitated by the combination of increased tax revenue to pay for them from the new activities and the increased purchasing power the population will gain from better jobs and economic opportunities arising not only in the special economic zones but from linkages to the rest of the economy.

Skirting Rents and Lobbies: a New Model of Special Economic Zones

Unleashing Senegal’s growth potential requires taking action in six areas:

  • Taking strong action on supply constraints, such as the regulatory framework, and cultivation of a business climate friendly to foreign direct investment and to small and medium-sized enterprises.

  • Investing in human capital and infrastructure.

  • Reducing inequality of opportunities by expanding private employment in the formal sector and providing broader access to education and health services.

  • Counteracting gender disparities.

  • Developing a new social contract between elites and the rest of the population that fairly shares the benefits of new activity.

  • Planning for adverse shocks to ensure adequate fiscal space to sustain the Plan Sénégal Émergent investment plan.

The first five of these action areas can be implemented through a properly conceived approach to special economic zones. The last area requires continuing the reforms in public financial management that the Ministry of Finance has initiated.

Ideally, rent seeking should end in Senegal, and the energy spent on generating and sharing rents should be redirected to new wealth creation. At a minimum, Senegal could continue to live with the sharing out among the privileged elite of existing rents, but only if space is also created for small and medium-sized enterprises to grow and for foreign direct investment to be aimed at globally competitive production using Senegal as a platform. In a new zone with no lobbies or rents to worry about, it should be possible to adopt liberal economic policies rapidly, as was done in the special economic zones in China and the Mauritius export processing zone.17 This would lead to the virtuous circle that many of the high-growth countries have unlocked. Improved growth performance would raise revenue and, subsequently, increase fiscal space for investment spending without putting unsustainable pressure on the deficit or public debt.

Efforts to improve the overall business climate are important and should continue. However, if improvements in the climate only continue at the current pace, in a decade’s time Senegal’s overall business climate would still rank in the bottom half among all countries. Given the entrenched interests that make more rapid progress in moving to a business-friendly regulatory framework unlikely, an alternative strategy may be needed. The best bet, as in China and Mauritius (which faced similar political economy issues), may be for Senegal to use special economic zones.

Some caution may be required in adopting this approach, however. Farole and Akinci (2011, 4) warn that “special economic zones have had a mixed record of success. Anecdotal evidence turns up many examples of investments in zone infrastructure resulting in ‘white elephants’ or zones that largely have resulted in an industry taking advantage of tax breaks without producing substantial employment or export earnings.” Senegal’s own experience in this regard has been one of failed special economic zone policy, with firms moving from one failed special economic zone to the next one with no new investment (Baissac 2001).

In part, early failures reflected overly restricting the zones to manufacturing, making it difficult to organize ancillary services. However, in Senegal the most important barrier to success may be that the special economic zones set up there to date have been used as yet another source of rents, because they have overemphasized tax benefits at the expense of fixing the business climate and logistics framework.18

It is also noteworthy that attempts to imitate the Chinese approach have failed in India. In the case of India, Aggarwal (2006) notes that critics have seen special economic zones more as vehicles for real estate development than as venues for promoting exports. Although he argues that these zones in India have had a catalytic effect on new sectors such as jewelry and perhaps information technology, Aggarwal also concludes that their economic contribution has remained miniscule at the national level. This has been due, he argues, to their failure to attract investment and promote economic activities—an experience similar to that of Senegal. On a more positive note, Wei Ge (1999) points out that in China, special economic zones served as a policy means to facilitate trade and financial liberalization, enhance resource utilization, and promote economic growth and structural changes.

The objective in Senegal would similarly be to use special economic zones as a vehicle to put in place rapidly a business climate that would be in the top 10 in the world. This would enable Senegal to attract investors, whether domestic small and medium-sized enterprises to be brought in from the informal sector, start-ups, or foreign direct investment aiming at globally competitive production for the world market.19 (In this context, Annex 2.2 provides additional analysis that justifies the relevance of action to open opportunities for formalization so that informal enterprises can grow and contribute to the creation of new wealth and jobs.)

Indeed, it may be useful to refer to the analysis of Baissac (2010), who describes the impact of such reforms in Mauritius. The export processing zone has played an immense role in the secular transformation of the island, attracting foreign direct investment, generating massive technology transfers, integrating Mauritius into global commodity chains, and leading the way toward the creation of a series of growth poles (the Freeport, the International Banking Center, the Integrated Resort Scheme, the Cybercity, the new special economic zone, etc.) whose combined effect has been enormous. Also of fundamental importance has been the zone’s contribution to political stability, through the provision of employment and the creation of a virtuous circle of growth and development. Overall, the Mauritius export processing zone has acted as an important contributor to transforming the island into Africa’s premier country in many comparative rankings (Baissac 2010).

For the proposed special economic zone model to be effective and different from the current special economic zone regime on offer in Senegal, the government will need to shift its notion of special economic zone away from the current emphasis on tax giveaways and instead promote good economic governance. An important part of this better governance will be more proactive involvement of stakeholders. In particular, workers and investors in the zone and in nearby local communities all need to have a voice.

One way to think of this approach is as “one country, two systems.” Such a shift should be encouraged; the law that created the special economic zone already endows its governing authority with the mandate to make laws and regulations in all areas except those in the domains of the ministries of interior, finance, and foreign affairs. As such, the first priority would be to appoint a governing board that could make decisions and implement and modify the regulatory framework. This governing board should be in place within the first month of the special economic zone’s launch.

In the case of the special economic zone to be jointly operated with the government of Mauritius, this governing board could be made up of representatives from Agence nationale chargée de la promotion de l’investissement et des grands travaux (APIX), Fonds souverain d’investissements strategiques (FONSIS), the Ministry of Finance, and the agency responsible for industrial platforms (Agence d’aménagement et de promotion des sites industriels, or APROSI), representatives appointed by the government of Mauritius (which could include someone from the Joint Economic Council, representing private sector interests), representatives from the Senegalese investors who set up in the zone (including for small and medium-sized enterprises and for larger firms), representatives from foreign investors (including for the investor selected to develop the zone), representatives of the workers who will actually be working in the zone (both blue collar and white collar), and one representative of nearby local communities. The board could appoint a small management team to put in place and update the regulatory framework, to find and oversee the investor who will develop the zone, for human resources and administration, and for mobilizing investors to invest in the zone and provide it with the appropriate services (including small and medium-sized enterprises and start-ups). At the outset, the board could adopt all the laws of Senegal as they currently stand, but subsequently modify them based on consultation with and recommendations from investors, workers, and their representatives on the board. Similarly, the zone could at the outset adopt the Mauritius tax regime and further modify it as required. The board’s mandate would be to modify the rules and regulations so that, within six months, the special economic zone has one of the top 10 business climates in the world.

The approach outlined would allow operations to begin rapidly, keep the focus on creating a good business climate, and end the long discussions regarding what approach to take.

Unlocking Supply Constraints

To emulate Mauritius and other comparators, Senegal would also need to address key supply constraints that also limit its growth potential. As discussed at greater length in Kireyev and Mansoor 2015, a short-term growth rebound is unlikely to result from a demand effect related to increased public spending: fiscal multipliers tend to be small for developing countries—and sometimes even negative. The multipliers are low because demand-driven stimuli are hampered by supply constraints. This is likely to be the case in Senegal, where electricity, transportation, and human capital available to the formal private sector all require policy attention. Moreover, the large informal sector and low levels of foreign direct investment are the result of a poor business climate, clearly signaled by Senegal’s low rankings in the World Bank’s Doing Business Index.

International experience suggests that growth can be unlocked by relaxing supply constraints. However, this may take longer than expected, because a critical mass of reforms needs to be in place before growth can be unleashed. A particularly clear illustration of this concerns electricity. Even if other bottlenecks are addressed, when electricity supply remains limited and unreliable, businesses may not invest in additional capacity, and production will therefore fail to respond to the other reforms. While it is easier to understand the challenge with a tangible issue such as electricity, the same dynamic applies with more abstract issues, such as those related to the regulatory framework. Because the reforms to the regulatory framework are extensive, it will take time for them to be enacted. This suggests that one ought to be both more ambitious about the scope of reforms and more patient in revising the speed at which Senegal could reach a growth rate of 7–8 percent. What is clear is that a “big push,” with front-loaded public investment, cannot lead to rapid gains in growth unless sufficient supply constraints are addressed to crowd-in private investment.

It may be useful to clarify that the high-growth economies did, in general, boost their public investment, and clearly Senegal will also need to do so (as envisaged by the Plan Sénégal Émergent) in order to unlock sustainable and inclusive growth. However, the issue is not so much the necessity of public investment but, as discussed earlier, the necessity of reforms. For such a boom to have positive and lasting effect instead of mainly producing debt, it needs to be accompanied by reforms that unlock foreign direct investment and give space to small and medium-sized enterprises for globally competitive production. Such major reforms to improve the regulatory framework and business climate for foreign direct investment and small and medium-sized enterprises might not happen quickly, given the influential lobbies favoring the status quo. Moreover, as has been seen with Senegal’s program to expand electricity production, in undertaking new investment projects it takes time to increase effective productive capacity.

Our review of high-growth countries suggests that for Senegal, while gains in growth may be more gradual, they could indeed be significant over the medium term as reforms tackle the supply constraints. Successful countries maintain growth for long periods rather than having very high growth spurts that fizzle out. In our sample of 25 high-growth countries, GDP per capita growth increased by more than 3½ percent and doubled living standards within 20 years. Furthermore, the potential gains in Senegal could, in the long term, be even more significant than envisaged in the Plan Sénégal Émergent if the growth spurt is not a sprint but a marathon. With the right reforms, an improved business climate, and sound fiscal policy, Senegal could attract the private investment, particularly foreign investment, required to achieve its growth potential.

Promoting Inclusive Growth

Plan Sénégal Émergent policies aimed at promoting inclusive growth will be critical to sustaining higher growth. A critical challenge faced by many emerging markets and developing economies is in their capacity to sustain growth over time.20 Typically, sub-Saharan African countries’ periods of growth in GDP per capita, on average, last approximately 11 to 13 years, which is 10 to 11 years shorter than the growth spells enjoyed by advanced and fast-growing emerging market economies (see Berg, Ostry, and Zettelmeyer 2012). In addition, sub-Saharan African countries’ growth periods have tended to end with prolonged stages of negative growth (between –3 and –7 percent). The end result has been overall weaker growth performance, even though most of these countries did experience periods of high growth.

As mentioned earlier, Senegal’s growth performance is relatively poor compared to that of the average sub-Saharan African country. First, continued periods of growth of GDP per capita have lasted only about eight years in Senegal (compared with the sub-Saharan Africa average of a dozen or so years); second, the average growth rate itself has been lower than the average for sub-Saharan Africa.

Berg, Ostry, and Zettelmeyer (2012) provide a useful framework for comparing Senegal with the high-growth economies. Many of these countries had a similar level of income per capita in the early 1990s, but have moved ahead over the past quarter century and achieved growth similar to that aspired to in the Plan Sénégal Émergent. Berg and his coauthors find four critical factors that appear to explain why countries enjoy prolonged periods of positive growth: income equality, trade openness, political institutions (that is, the degree of democratic space), and foreign direct investment (Figure 2.4). Three main stylized facts emerge.

Figure 2.4.Factors in Prolonged Periods of Positive Growth and Senegal’s Growth Performance

Sources: Berg, Ostry, and Zettelmeyer 2008; and authors’ calculations.

Note: For each variable, the height of the bar shows the percentage increase in spell duration resulting from an increase in the variable for the 50th to the 60th percentile, with the other variable at the 50th percentile (except in the case of autocracy, which is not a continuous variable). For autocracy, the figure shows the effects of a move from a rating of 1 (50th percentile) to 0 (73rd percentile).

FDI = foreign direct investment.

First, Senegal received relatively high levels of foreign direct investment during its growth episodes compared with other high-debt cases. Simultaneously, Senegal’s foreign direct investment was less than half that of the high-growth comparators, which suggests scope for catch-up if the right policies are in place. This underscores the importance of Senegal focusing on reforms to attract foreign investors. In addition to creating a special economic zone business climate among the top 10 in the world, it will be important to have continued improvements in the overall business climate. In this regard, Senegal would do well to follow in the footsteps of Rwanda, which rapidly improved its business climate, and Mauritius, which strove to be in the top tier in Africa. Peer learning in this area has been supported by the World Bank and could be usefully explored.

Second, over the past decade, Senegal has made two significant changes to its institutions that bode well for achieving Plan Sénégal Émergent growth objectives. First, it has become more integrated into the global economy, with more open international trade and improved diversification.21 Second, Senegal has proved that its democracy functions well, an example being the peaceful and democratic transition of political leadership during the most recent presidential elections in 2012. Thus, Senegal has the basic prerequisites for prolonged periods of high growth as envisaged by the Plan Sénégal Émergent. Indeed, based on empirical results, with these two institutional improvements, Senegal could have achieved a prolonged period of growth of about 24 years instead of the 8 years that it recorded.22 This is exactly what is needed for the Plan Sénégal Émergent.

Third, Senegal may be less vulnerable to worsening inequality due to sustained growth, since Senegal is not far from the high-growth comparators in terms of income inequality (Figure 2.4). Indeed, comparing Gini coefficients between Senegal and comparator countries suggests that Senegal’s distribution of income was only about 1 percent less equal than that of the comparators in 2013. However, in many growing economies, there may be an increase in income inequality as the growth process takes off, unless attention is paid to ensuring that growth is inclusive.

When implementing the Plan Sénégal Émergent, the Senegalese authorities should therefore focus on effective measures to reduce inequality of opportunity. In particular, the most effective policies for lasting improvement in opportunities involve more private formal-sector employment.23 Assuming a supportive regulatory framework, this in turn rests on investment in human capital—through broader access to education and health services and effective social safety nets. In contrast, direct subsidies—especially when they target producers (for example, the electricity sector)—are less likely to reduce inequalities: they do not represent an effective means by which to target the low-income population. They also represent an opportunity cost of forgone spending on health, education, and social safety nets.

Contingency Planning

Planning for contingencies will be critical to avoid derailing Plan Sénégal Émergent targets when risks manifest themselves. An obvious risk relates to Plan Sénégal Émergent implementation falling behind if reforms prove difficult to enact. To mitigate this risk, it would be useful for the team monitoring the plan to track and monitor the implementation of reforms. One potential strategy for gathering data would be to request that each ministry or agency identify the two to three key reforms it needs to implement for the Plan Sénégal Émergent to succeed. This could be built into the monitoring system, set up with assistance from the World Bank. The main reform for any given year would then be linked to the reserve envelope in the budget. Additional funding in the budget would be released contingent on the agreed-upon reform being implemented.

In addition, Senegal is also exposed to spillover risks—that is, risks pertaining to the global economy and largely beyond the control of the Senegalese authorities. Planning for these risks is critical, given that their impact on growth could potentially derail Plan Sénégal Émergent targets. The manifestation of these risks could increase tension in fiscal balances by reducing the fiscal space available for investment in human capital and public infrastructure. Mitigating them will require planning and prioritization in order not to jeopardize the investment spending (both human and physical) critical to the Plan Sénégal Émergent. Such planning could be based on (1) streamlining public expenditure and (2) maintaining prudent fiscal and debt policies to allow Senegal to preserve its access to financing in the event of an adverse shock.

Dealing with these risks will require building on the debt anchor that has been established. The debt anchor provides credibility to the fiscal deficit and debt objectives, but a mechanism is required to rapidly curtail low-priority spending if circumstances so dictate. In coordination with the appropriate line ministries, a unit in the Ministry of Finance could identify those low-priority items that could be cut as part of the next budget if fiscal space were needed to attain Plan Sénégal Émergent objectives while curtailing budget deficits. This contingency plan could be updated annually as part of the budget exercise. Such actions also have merit in the sense that they could reduce the cost of access to capital markets, further increasing fiscal space for investment in human capital and public infrastructure.

Annex 2.1. Identification of High-Growth and High-Debt Countries

High-Growth Countries

The 24 high-growth countries are composed of the 10 fastest-growing countries (measured in terms of GDP per capita) in each of three categories: middle-income countries, low-income countries, and sub-Saharan African countries; there is some overlap between the groups.

High-Debt Countries

The list of 40 high-debt-episode countries is derived by applying the following filter:

  • A country that experienced a growth in debt position of 2 percent a year consecutively for at least five years in trend, with no more than two years of deviation from trend consecutively within the five-year period.

  • The country’s debt position exceeded 40 percent of GDP at some point between 1990 and 2013.

The variables reported in Annex Table 2.1.1 for high-debt countries, including Senegal, are computed as three-year averages before the start of debt episodes and through the end of the debt episode.

ANNEX TABLE 2.1.1Average Real GDP Per Capita Growth in High-Income and High-Debt Countries, 1987–2015
RankMiddle-Income CountriesLow-Income CountriesTop 10 Sub-Saharan Africa
1Cabo Verde5.2China8.7Cabo Verde5.2
2Macao SAR5.0Bhutan5.6Mozambique4.9
3Korea5.0Mozambique4.9Mauritius4.0
4Thailand4.3India4.7Mali3.5
5Mauritius4.0Lao P.D.R.4.4Ethiopia3.3
6Malaysia3.9Sri Lanka4.1Uganda3.2
7Poland3.7Mali3.5Seychelles3.0
8Dominican Republic3.4Ethiopia3.3Lesotho2.9
9Panama3.1Bangladesh3.3Rwanda2.8
10Seychelles3.0Uganda3.2Tanzania2.2
11Malta3.0Senegal0.6
Sources: World Bank, World Development Indicators; and IMF staff calculations.
ANNEX TABLE 2.1.2Forty Countries with High-Debt Episodes since 1990
CountryEpisode BeginningEpisode EndEpisode BeginningEpisode EndEpisode BeginningEpisode EndEpisode BeginningEpisode End
Antigua and Barbuda19972004Croatia20082013Jamaica19992003Senegal20062013
The Bahamas20012013Cyprus19952004Lithuania20082013Serbia20082013
Barbados19992013Dominica19972001FYR Macedonia20082013Seychelles19902001
Benin20062013Egypt20082013Malawi20072013South Africa20082013
Bolivia20002004El Salvador20082013Malta19951999St. Kitts and Nevis19962005
Bosnia and Herzegovina20072013Eritrea20042008Montenegro20072013St. Lucia19902005
Central African Republic20002005The Gambia20072013Morocco20082013Suriname19962000
Colombia19962003Haiti19992003Niger20082013Ukraine20072013
Congo, Republic of19901994Honduras20082013Paraguay19962002Venezuela20082013
Costa Rica20082013Hungary20012013Philippines19982003Yemen20082013
Sources: World Bank, World Development Indicators; and IMF staff calculations.Note: Italics indicate countries that have benefited from the Heavily Indebted Poor Countries (HIPC) Initiative.
Annex 2.2. The Size of the Informal Economy: High-Growth Versus High-Debt Countries

This annex aims to describe the developments regarding the size of the informal economy between 1991 and 2015 in a set of 51 low-income countries and emerging market economies.24 Empirical evidence suggests that (1) the size of the informal economy decreased in most countries; however, it declined more in high-growth countries than in high-debt ones; (2) in some highly indebted countries, informality actually increased during the period under study; and (3) high levels of informality appear to be correlated with lack of government effectiveness, regulatory quality, and rule of law, as well as poor control of corruption, particularly in highly indebted countries.

Why Does the Size of the Informal Economy Matter?

The characterization of the informal economy has been debated in both policy and academic circles. There is no unique definition of the informal economy in the literature, and terms such as shadow economy, black economy, and unreported economy have been used to define it.25

Measuring informality is important, given that workers in informal conditions have little or no social protection or employment benefits, and these conditions undermine inclusiveness in the labor market and consequently economic growth. According to the World Bank’s Pensions Database, more than 50 percent of the labor force in transition countries does not contribute to any pension scheme, and this ratio escalates to 90 percent of the labor force in sub-Saharan African countries.26 Most of the informal activity goes underground to avoid the burden of administrative regulation and taxation, thus harming public finances. It is striking, however, that the informal economy plays a much bigger role in high-debt countries relative to high-growth countries.

The Informal Economy in High-Growth and High-Debt Countries

The size of the informal economy has been decreasing, on average, in most countries (Annex Figure 2.2.1).27 However, there are marked differences when comparing high-growth countries with high-debt ones. First, the size of the informal economy was greater in high-debt countries than in high-growth ones from 1991 to 2014, on average. Second, the size of the informal economy has decreased more rapidly in high-growth countries than in high-debt ones, by 12.1 percentage points of GDP in the former compared to 10.1 percentage points of GDP in the latter.28 Third, in some low-income highly indebted countries, informality actually increased during the period under study. The literature suggests many factors underpinning the size of the shadow economy.

Annex Figure 2.2.1.Change in the Size of the Informal Economy between 1991 and 2014

(Percent of official GDP)

Source: IMF staff calculations.

Institutional Quality Matters

Existing research finds a causal relationship between the quality of institutions and the size of the informal economy. Building on this literature (see, for example, Schneider 2012 and Abdih and Medina 2013), a nonparametric Spearman correlation analysis is used to relate the size of the informal economy with four measures of institutional quality: (1) governance effectiveness, (2) regulatory quality, (3) rule of law, and (4) control of corruption.

Spearman’s rank correlation results (Annex Table 2.2.1) suggest that there is a negative, and statistically significant, correlation between the quality of institutions and the size of the informal economy when using the full sample. However, when analyzing the high-debt vis-à-vis the high-growth group independently against the four institutional quality measures, the statistical significance persists only for the high-debt group.

ANNEX TABLE 2.2.1Spearman Rank Correlations for High-Debt and High-Growth Countries
CombinedHigh DebtHigh Growth
Governance Effectiveness−0.378**−0.73***−0.2
Regulatory Quality−0.28**−0.71***0.04
Rule of Law−0.39***−0.71***− 0.21
Control of Corruption−0.25**−0.71***0.00
Number of Observations613031
Source: Authors’ estimations.**p > .05; ***p < .01.

Policy Recommendations to Reduce Informal Economies

The quality of public institutions seems to be a key factor for the development of the informal sector. As argued in the literature, the efficient and discretionary application of tax systems and regulations by government may play a crucial role in the decision of conducting undeclared work. Policies aimed at eliminating the corruption of bureaucracy and government officials and at establishing a good rule of law by securing property rights and contract enforceability seem to increase the benefits of being formal.

Other policies have also been found to reduce the extent of informality, such as those aimed at improving the regulatory framework for business, labor market institutions, reducing tax burden (where excessive), and providing informal workers with access to skill upgrading. The last area is of extreme importance, because any inclusive growth agenda should provide all vulnerable groups in the society with access to skills upgrading.

References

    Abdih, Y., andL.Medina.2013. “Measuring the Informal Economy in the Caucasus and Central Asia.IMF Working Paper 13/137, International Monetary Fund, Washington, DC.

    Aggarwal, A.2006. “Special Economic Zones—Revisiting the Policy Debate.Economic and Political Weekly (November4).

    Baissac, C.2001. “Senegal’s Special Economic Zones Program: Historical Performance, Contribution to Reform, and Prospects.Unpublished, World Bank, Washington, DC.

    Baissac, C.2010. “Planned Obsolescence: Export Processing Zones and Structural Reform in Mauritius.Unpublished, World Bank, Washington, DC.

    Beck, T.,A.Demirgüç-Kunt, andR.Levine.2005. “SMEs, Growth, and Poverty: Cross-Country Evidence.Journal of Economic Growth10: 199229.

    Berg, A.,J.Ostry, andJ.Zettelmeyer.2008. “What Makes Growth Sustained?IMF Working Paper 08/59, International Monetary Fund, Washington, DC.

    Berg, A.,J.Ostry, andJ.Zettelmeyer.2012. “What Makes Growth Sustained?Journal of Development Economics98: 14966.

    Cangul, M.,A.Jonelis, andL.Medina.2017. “The Informal Economy in Sub-Saharan Africa: Size and Determinants.IMF Working Paper 17/156, International Monetary Fund, Washington, DC.

    Farole, T., andG.Akinci.2011. Special Economic Zones, Progress, Emerging Challenges, and Future Directions. Washington, DC: World Bank.

    Feige, E. L.2005. “A Re-Examination of the ‘Underground Economy’ in the United States; A Comment on Tanzi.Macroeconomics0501021, EconWPA. Originally published in IMF Staff Papers33(4): 76881 (1986).

    Ge, W.1999. “Special Economic Zones and the Opening of the Chinese Economy: Some Lessons for Economic Liberalization.World Development27(7): 126785.

    Hausmann, R.,L.Pritchett, andD.Rodrik.2005. “Growth Accelerations.Journal of Economic Growth10: 30329.

    Kireyev, A., andA.Mansoor.2015. “Making Senegal a Hub for West Africa.African Department Paper, International Monetary Fund, Washington, DC.

    Mansoor, A.2016. “Political Economy of Reform.Chapter 6 in Africa on the Move: Unlocking the Potential of Small Middle-Income States, edited by L.Leigh andA.Mansoor.Washington, DC: International Monetary Fund.

    Schneider, F.2012. “The Shadow Economy and Work in the Shadow: What Do We (Not) Know?Discussion Paper 6423, Institute for the Study of Labor (IZA), Bonn, Germany.

    Warner, A.2014. “The Next Big Thing for Africa—Public Investment as an Engine of Growth.IMF Working Paper 14/148, International Monetary Fund, Washington, DC.

This chapter draws on and updates Kireyev and Mansoor 2015. The authors also thank Yanmin Ye for putting the data together.

With annual population growth currently at approximately 3 percent in Senegal, this means an economic growth rate of 7 to 8 percent.

Large infrastructure projects offer many opportunities for rent seeking during design, implementation, and operation. The more complex the project and the larger its size, the bigger the opportunities.

This does not mean that reform elsewhere is impossible. However, as argued in various chapters of this volume, coalitions will need to be put together that may involve providing incentives to rentiers so that they prefer change. This does mean that there would be no head-on confrontation by pressing for wholesale liberalization of the economy without negotiating such changes.

The choice of 1987 is based on data availability.

In addition to the work in this chapter, see also Chapters 4 and 13 and Warner 2014.

See Annex 2.1 for a list and criteria for derivation.

Debt of at least 40 percent of GDP at some point in the period and debt growing by 2 percent a year consecutively for at least five years at some point in the period.

Foreign direct investment increased by only 0.03 percentage points of GDP.

Hausmann and his colleagues also find that growth acceleration is frequent but unpredictable. This may be related to issues arising from the political economy of reforms.

For a discussion of volatility and duration in growth episodes, see Berg, Ostry, and Zettelmeyer 2012. For export product sophistication and growth duration, see “Promoting Exports and Export Quality and Expanding to New Markets” later in this chapter.

They also explain that they cannot find causality linking small and medium-sized enterprises to growth, but for our purposes this is not the essential point. In any case, there is likely to be a virtuous circle in which opening space to small and medium-sized enterprises creates new wealth that in turn may sustain the reforms, institutions, and policies that allow new entrants and the expansion of firms, resulting in more growth.

Some could argue that these trade agreements offer little advantage compared to the sugar protocol that benefited Mauritius. The Economic Partnership Agreement offers no new market access, and the US market is already open to a significant degree. With the exception of those for clothing, the tariffs are extremely low, and duty-free access is therefore not particularly beneficial. However, these agreements do provide an incentive for using Senegal as a production base either as part of diversification in global positioning or as an alternative to China as costs of production rise there. What is certain is that the margin of preference is too low to make a difference on its own. However, when taken together with the deep reforms being proposed in this book, they would at the margin make Senegal an attractive investment destination.

For example, a tourist office has been opened in New York, though with insufficient budget for promotion.

At certain times the tax rate was set at zero for a tax holiday period. However, firms in the export processing zone were later offered the option of going immediately to a rate of 15 percent or keeping their tax holidays and going to the prevailing rates at the time the tax holiday was awarded. Most opted for 15 percent. Also, the general tax rate for much of the period was in the 30 to 35 percent range, but with a linear reduction to 15 percent to all firms that exported all their products. This regime was also available to firms not in the export processing zone. With the 2006 reforms, the rate was unified for all sectors, and the personal income tax rate was set at 15 percent.

As reported by worldwide-tax.com (http://www.worldwide-tax.com/china/chi_invest.asp), the following rules apply in the five special economic zones in the south of the country: a corporate tax of 15 percent; a benefit of “2 + 3 years,” which means an exemption from tax for the first two years and then taxation at the rate of 12.5 percent for the next three years; for certain projects in basic infrastructure, environmental protection, and energy there is a “3 + 3” tax holiday; while under certain terms, enterprises investing in integrated circuits production can get a “5 + 5” tax holiday.

Rent seekers and labor unions may still protest, but their capacity to disrupt activity or take forceful action will be very limited in a zone where they are not present. Moreover, their attacks would be significantly diffused by having as part of the governance structure representatives of workers who actually work in the zone and of investors who are producing in the zone.

It is noteworthy that the emphasis of recent proposals is on very long tax holidays of 50 years; in debates over reforming the zones to attract investors, discussions focus on what privileges (rents) should be offered and (consequently) on who should and should not have access to these rents. This, perhaps understandably, leads to disagreements on who will be responsible for dispensing the goodies.

Generally, small and medium-sized enterprises would not be exporters, at least not initially. However, such enterprises are likely to produce ancillary goods and services as well as inputs required by exporters. Since they would not be subsidized but only benefit from a good regulatory and institutional framework, by definition their output should be globally competitive, even if it is not traded internationally.

Berg, Ostry, and Zettelmeyer (2012) define “growth spells” as periods of real GDP per capita growth of at least five years, identified as beginning with an “upbreak” of per capita growth above 2 percent and ending with a “downbreak,” followed by a period of average growth of less than 2 percent or simply the end of the sample.

Senegal scored 0 on trade openness during its growth episode identified by Berg, Ostry, and Zettelmeyer (2012), largely because of its marketing board, which was phased out in the early 2000s. Today, Senegal’s trade has been mostly liberalized, which translates into a trade openness index value of 1.

During its identified growth episodes, Senegal had a much lower score for democratic institutions. However, it has since made significant progress, highlighted by peaceful political change and a high score on the Polity IV index similar to those of well-established democracies (http://www.systemic-peace.org/polity/polity4.htm).

We focus here on equality of opportunity. It is fairly likely that Senegal would face a Kuznets effect as labor shifts from agriculture and the informal sector to higher paying jobs in the new activities. Inevitably as a function of mathematics those less behind will be relatively worse off and measured income inequality would increase. At the same time, there can be some offset from improvements in productivity in agriculture. This in turn would require some of the reforms that dismantle rents and create a stakeholder society.

This annex was prepared by Andrew Jonelis, Leandro Medina, and Yanmin Ye (all staff members of the IMF’s African Department).

According to Feige (1986/2005), the informal economy has been used “so frequently, and inconsistently”; he argues that the informal economy comprises those economic activities that circumvent the costs and are excluded from the benefits and rights incorporated in the laws and administrative rules covering property relationships, commercial licensing, labor contracts, torts, financial credit, and social systems.

It should be noted that the high percentage of the labor force in sub-Saharan Africa that are non-contributors to the system should not necessarily be related to high informality, since in sub-Saharan Africa the formal private sector does not contribute to social security either.

The size of the informal economy is based on estimates using the Multiple Indicator–Multiple Cause model found in Cangul, Jonelis, and Medina 2017.

When low-income countries are omitted, the high-debt countries actually reduced their informal economies by 3.4 percent of GDP, on average.

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