Lesotho: Selected Issues and Statistical Appendix

The Selected Issues paper provides an overview of trends, performance export growth, value added, and employment, account of the structure and evolution of Lesotho's textiles during the decade through 2002, and discusses future prospects and key issues. It analyzes the implications of the phasing-out of the African Growth and Opportunity Act and also reviews the HIV/AIDS situation in Lesotho. It discusses the current situation, the measures to enhance financial intermediation, and the Southern African Customs Union Arrangement and its effects on revenues. The paper also includes the summary of tax systems, July 2003, and the exchange trade system.

Abstract

The Selected Issues paper provides an overview of trends, performance export growth, value added, and employment, account of the structure and evolution of Lesotho's textiles during the decade through 2002, and discusses future prospects and key issues. It analyzes the implications of the phasing-out of the African Growth and Opportunity Act and also reviews the HIV/AIDS situation in Lesotho. It discusses the current situation, the measures to enhance financial intermediation, and the Southern African Customs Union Arrangement and its effects on revenues. The paper also includes the summary of tax systems, July 2003, and the exchange trade system.

II. The Fiscal Impact of HIV/AIDS in Lesotho7

36. HIV/AIDS could have a significant negative impact on real GDP. Given current trends, economic growth could be reduced by over 3 percent a year over the next decade. In turn, slower economic growth reduces the growth of the tax base, which may result in a substantially larger fiscal deficit within ten years. The first subsection provides an overview of the HIV/AIDS situation in Lesotho and an informal discussion of the resulting growth impact. The next two subsections present an analytic growth model that estimates the output impact of HIV/AIDS in Lesotho, and discuss the underlying assumptions and results; and the fourth subsection discusses the resulting fiscal impact.

A. Introduction

37. The current HIV/AIDS prevalence rate is estimated at 31 percent of the adult population in Lesotho. The Joint UN Program on HIV/AIDS (UNAIDS) 2002 reported an estimated total of 330,000 cases of HIV infections for people in the 15–49 age group at end-2001. AIDS-related deaths were estimated to have been as high as 25,000, or over 1 percent of the total population in 2001. The number of orphans was estimated at 73,000, or over 10 percent of the total population in the age group 0–14 at end-2001.

38. While the macroeconomic impact of HIV/AIDS will be considerable,8 its magnitude will - in general - be sensitive to country-specific factors. Manufacturing is the engine of growth in Lesotho, and the ratios of labor and capital to output in this sector are important in determining the growth impact. Labor-intensive technologies are more vulnerable to reductions in the labor force than capital-intensive technologies. Therefore, Lesotho’s labor-intensive textiles sector could be hard hit, but the actual impact will also depend on the ability to pull labor into this sector from other sectors. The textiles industry should be an attractive employer, as there is surplus labor in agriculture. The government’s health strategy could significantly affect the spread of the infection and the length of time infected individuals can remain in the labor market.9 In this section, we will not formally analyze the impact of alternate forms of government response but focus attention on the impact of the epidemic through the savings and labor force channels.

39. The skills of the labor force are of immediate relevance to an analysis of the medium-term economic impact of the epidemic. At present, an estimated 80 percent of Lesotho’s population resides in rural areas, where subsistence agriculture is practiced. Agriculture is characterized by primitive modes of production and a large pool of unskilled labor, which could take up textile jobs. Skilled labor is in short supply, and, given the high prevalence rates among civil servants, teachers, and college students, the situation may worsen over the next decade. A recent World Bank study (2000) estimated that the HIV prevalence rate among public sector employees was close to 20 percent and over 25 percent for college students and teachers.

40. The textiles sector has been the engine of growth in Lesotho over the last five years. Production in this sector is labor intensive and does not require costly and lengthy training of new workers. As Lesotho has a significant pool of surplus labor in agriculture, as well as retrenched miners from South Africa, labor can - in principle - be pulled out from agriculture into textiles, provided the cost of migration is limited. Therefore, a two-sector extension of the model is discussed in Subsection D. Surplus labor is transferred from subsistence agriculture to manufacturing, and we analyze the extent to which this mitigates the adverse output impact of HIV/AIDS.

41. The overall fiscal position is likely to deteriorate due to HIV/AIDS. On the revenue side, HIV/AIDS has a negative impact on the tax base: as population growth declines, personal income, consumption, and imports will also fall. Moreover, a loss of civil servants could reduce tax collection levels, and higher morbidity and mortality rates may affect the tax administration adversely. On the expenditure side, certain categories, such as health spending, pensions and benefits to the infected and their families, and personnel costs (due to increased turnover), will increase.

B. The Model and Results

42. HIV/AIDS has a negative impact on both the size of the labor force and savings, which will reduce output and growth in the medium term. A number of recent papers have analyzed the output impact of HIV/AIDS through these channels. The common assumption in most of these papers is to assume permanent reductions in the savings rate and the labor force growth rates. As a result, the steady state capital-labor ratio will decline, which reduces the capital stock and, hence, total output.10 In this subsection, we will develop a simple growth model along these lines.

43. Real GDP in period t, denoted Yt, is given as a function of the input of capital and labor by:

Yt=Kt1Lt1αα;αϵ(0,1),(1)

where, for each t,

(LoborForce):LtLt-1=nt+1;-1<nt<(CapitalStock)Kt=stYt+(1-δt)Kt-1;δt(0,1),st(0,1)(2)

Here, st is the savings rate in period t, δt is the rate of depreciation of capital; n is the growth rate of the labor force; and α is the output share of capital.

44. The parameters s and n will vary with the impact and level of the epidemic; we allow these variables to vary over time.11 Using (2), we may define the capital-labor ratio as

kt=KtLt=stYtLt+(1-δ)Kt-1Lt=st(kt-1nt+1)α+(1-δ)kt-11nt+1(3)

Finally, the rate of growth of real GDP, gt is given by

gt=YtYt-1-1=(kt-1kt-2)α(nt-1+1)α(nt+1)1-α-1(4)

45. The epidemic has a significant negative impact on the size of the labor force and the rate of savings. Our projections of the labor force are based on the estimates of the U.S. Census Bureau’s International Populations Center. Because of higher mortality rates and lower fertility rates, the annual rate of labor force growth will decline from the current level of 1 percent to less than ⅓; of 1 percent by 2010 and less than ⅓ of 1 percent by 2020. On the savings side, some of the reduction in the savings rate over the next five years is explained by the completion of Phase 1 of the Lesotho Highlands Water Project by 2008, which will reduce gross capital formation. Beyond 2008, we estimate a further reduction of 6 percent in the savings rate over a five-year period, as families with HIV patients stop saving or dissave to finance care for the infected.12

46. Slower labor force growth and lower savings rates, which reduce capital formation, will lower output growth. We expect that a combination of these factors will reduce GDP growth over the medium and long term. Annual real GDP growth decreases by an average of 0.4 percent each year between 2005 and 2014, falling from 4 percent to 0.5 percent (Figure II.1). Consequently, in an AIDS scenario compared with a non-AIDS scenario, nominal GDP is projected to be 23 percent lower over this ten-year period and may fall back further by 2020.

Figure II.1.
Figure II.1.
Figure II.1.

Lesotho: Macroeconomic Effects of HIV/ATDS, 2001-21

(In percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2004, 023; 10.5089/9781451823752.002.A002

Source: Fund staff estimates and projections.

47. The adverse impact on output and growth will be mirrored by a decline in the quality of life and will push a greater proportion of people below the poverty line. As in some other southern African countries, the general population in Lesotho is not covered by any social security-type arrangement, and hence the death of income-earning adults will necessarily reduce the families’ net wealth.

C. The Impact of Surplus Agricultural Labor and Labor Mobility

48. The declining real GDP growth projected in the previous subsection is mainly due to the steady decline in the growth of the labor force. Labor training costs are, however, low in the textiles sector and there is a surplus of labor in agriculture. Specifically, most production in Lesotho’s textiles sector has an assembly-line character; hence, the need to invest in sector-specific skills for new employees is limited (relative to the profit margins). The growth of the labor force in textiles can to a certain extent be supported by attracting labor from subsistence agriculture.

49. One implication of our analysis is that the slower growth rate of the labor force in manufacturing will raise the capital-labor ratio and, hence, the wage rate in manufacturing. This makes it easier to attract labor into the textiles sector, provided that migration costs do not increase as much as the wage rate.13 A straightforward simulation, boosting the labor force growth rate in the model, establishes that output growth rises as labor flows into textiles. It follows that as long as there is surplus labor in agriculture and training costs remain at current levels, it may be possible to maintain current growth rates in textiles and, hence, avoid a big drop in real output in the medium term. Textiles and manufacturing are the engines of growth in Lesotho, and transferring labor from low-productivity agriculture to higher-productivity manufacturing will have a positive net effect on aggregate output.

50. However, the ability of agriculture to export labor to the textiles sector depends crucially on the impact of the epidemic upon the size of the labor force. If our assumptions understate the adverse impact on the population size and the labor force shrinks faster in the medium term, then most of the surplus labor in agriculture will be absorbed more quickly, and it will become more expensive to replace this shrinking labor force. In this event, the impact on growth would be more negative and closer to that described in the previous subsection.

D. Fiscal Impact of HIV/AIDS in Lesotho

51. The HIV/AIDS policy of the government is primarily focused on preventive strategies, with donors, including the UN, providing most of the financial support to mitigate the effects of the disease and care for the infected In particular, the government is not in a position to fund a comprehensive and wide-ranging anti retro viral program, nor can it bear the entire financial burden of importing the essential drugs necessary to fight opportunistic diseases among the infected. The hope is that this funding will be forthcoming from donors, nongovernmental organizations (NGOs), and the private sector. The government is planning on increasing financial support for public awareness campaigns to prevent the further spread of the infection in the country and reverse the trend in the prevalence rates.

52. The current HIV/AIDS policy leads to two main assumptions in order to estimate the medium-term fiscal impact of the epidemic. On the revenue side, the revenue-to-GDP ratio is assumed to be unaffected by the HIV/AIDS epidemic. As discussed in the introduction, the negative impact on revenues is generated primarily through a reduction in the tax base, owing, in turn, to a reduction in national income, with possibly a much smaller impact ensuing from factors that affect the revenue-to-GDP ratio, including problems with tax administration.14 On the expenditure side, we assume that the projected level of total government expenditures remains the same.15, 16 We feel that this is a reasonable assumption over the medium term and may in fact understate the impact on expenditures, given that certain items, such as health, pensions, and personnel costs, may incur substantially higher expenditures than at present.

53. The estimated impact of HIV/AIDS on the fiscal position of the government is considerable; the fiscal burden is reflected in an additional deterioration of the overall fiscal balance of 5 percent of GDP by 2010, from an estimated current impact of 1 percent of GDP. In the longer term (2010 through 2020), HIV/AIDS may become the dominant factor affecting the fiscal balance and it could generate a much wider fiscal gap by 2020, if prevalence rates remain unchanged.17

References

  • Haacker, Marcus, 2002, “The Economic Consequences of HIV/AIDS in Southern Africa,IMF Working Paper 02/38 (Washington).

  • World Bank, 2000, “Lesotho: The Development Impact of HIV/AIDS: Selected Issues and Options,Macroeconomic Technical Working Group (Africa Region) (Washington, World Bank).

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Appendix: Model Assumptions; Initial Condition and Parameterization

54. Initial conditions. We take calendar year 2000 to be t = 0, and set k2000 to be a steady state value,18 corresponding to the parameter values for that year (see below). In order to do so, we need the values of the savings rate, s2000, the rate of growth of labor force, n2000, and assumptions about the values of the output share of capital, a, and the annual rate of depreciation of capital, δ. The savings rate is obtained from data reported in the national accounts by the Lesotho Bureau of Statistics. We assume that α = 1/10 and δ = 0.08.

55. Labor force. The growth rate of the labor force is computed using demographic estimates and projections for Lesotho made by the U.S. Census Bureau’s International Populations Center for the period 1985 through 2050. We assume that the labor force is constituted of people between the ages of 15 and 59. We assume a constant labor force participation rate and, consequently, a growth rate of the labor force that is identical to the growth of the population within this age group.

56. HIV/AIDS prevalence and savings rate. UNAIDS estimates that the adult HIV/AIDS prevalence rate at end-2001 is 31 percent. We assume in the model simulations that the prevalence rate among the labor force remains at this level through 2015 and thereafter declines at a constant rate of 1 percent per annum through 2020.19 Savings rates through 2002 reflect data and estimates provided by the Lesotho Bureau of Statistics, and for 2003–08 are based on latest IMF staff projections. From 2009 onward, we assume that the savings rate declines over a five-year period from its 2008 level, reflecting the weaker savings propensities of HIV/AIDS patients and their families. From 2013 onward, we assume that HIV/AIDS patients do not save at all.20

57. Real and Nominal GDP. A benchmark [4.5] percent annual rate of real GDP growth for the medium term in the absence of the epidemic forms the basis for a comparison with an AIDS scenario. In the absence of a sectoral GDP deflator series, nominal GDP for Lesotho is projected forward, using projections of the real GDP growth and the consumer price inflation. Specifically.

NGDPt+1=NGDPt(1+gt+1)(1+πt+1)(5)
7

Prepared by Jay Surti.

8

Haacker (2002) in a study of a group of nine Southern African economies estimated that in the medium term, per capita output could be reduced by 4 percent to 10 percent. The estimate for Lesotho was a cumulative reduction of 7 percent over the medium term.

9

In particular, a comprehensive program of antiretroviral treatment has the potential to significantly lengthen the life span of infected individuals and improve their quality of life. Governments in southern Africa, with the exception of Botswana and South Africa, are not in a position to provide financing for such programs on a wide scale.

10

See, for example, Haacker (2002) for an application of this method to southern African economies. This paper also contains a comprehensive bibliography of the literature that investigates the savings and labor force channels.

11

The rate of depreciation of capital, δ, will be assumed constant throughout, as will the share of capital in output, α.

12

An appendix provides further details on the methodology used to estimate the impact on the savings rate.

13

We are assuming here that labor is paid its marginal product; i.e., the labor market is competitive.

14

Through 2008, we adopt the medium-term staff projections of the revenue-to-GDP path, and, for 2009 and beyond, we assume that this ratio grows annually at the average annual percent change between 2003 and 2008.

15

Based on staff projections through 2008 and for 2009 and beyond, we assume that the annual rate of growth in total expenditure is the average annual percent change between 2003 and 2008.

16

Hence, the revenue-to-GDP ratio and the level of total government expenditures is assumed to be the same in the AIDS and non-AIDS scenario. Since nominal GDP is lower in the AIDS scenario, the expenditure-to-GDP ratio and the fiscal deficit will be higher in the AIDS scenario than in the non-AIDS scenario.

17

The long-term numbers are meant to be indicative—as opposed to precise calculation—of the substantially larger impact in the long term over the medium term that may be expected of an epidemic left unchecked.

18

The steady state value of capital is obtained by holding fixed n and s at their CY 2000

values, k*=(sn+1+δ)11-α(n+1)

19

In earlier studies, the World Bank (2002) estimated that prevalence rates among the age group 15–49 would continue to rise through 2010, while Haacker (2002) held labor force prevalence rates constant for his medium-term growth impact analysis.

20

Our assumptions regarding the savings propensities of HIV/AIDS patients is weaker than Haacker’s (2002), who assumes that they do not save throughout the forecasting horizon. In the case of Lesotho, our weaker assumption may be justified on the grounds that, in the short to medium term, capital formation will largely be driven, as at present, by investments in the textiles industry (financed by entrepreneurs through foreign sources of finance) and in the Lesotho Highlands Water Project (financed primarily through grants from South Africa and Lesotho government financing), both of which are relatively unaffected by the epidemic. However, investment in textiles may reach a saturation point in the medium term, and the water project is expected to wind down by 2008.

Lesotho: Selected Issues and Statistical Appendix
Author: International Monetary Fund