This Selected Issues paper examines competitiveness and the equilibrium real exchange rate for Ghana. It estimates a behavioral equilibrium exchange rate model for Ghana to establish to what extent real effective exchange rate (REER) movements have been driven by an adjustment to its equilibrium values, consistent with changing fundamentals. The paper discusses measures of Ghana’s external competitiveness other than the gap between the actual and the estimated equilibrium REER. Achievements, challenges, and priorities in the areas of public financial management, wage policy, tax administration, and tax policy are also described in detail.

Abstract

This Selected Issues paper examines competitiveness and the equilibrium real exchange rate for Ghana. It estimates a behavioral equilibrium exchange rate model for Ghana to establish to what extent real effective exchange rate (REER) movements have been driven by an adjustment to its equilibrium values, consistent with changing fundamentals. The paper discusses measures of Ghana’s external competitiveness other than the gap between the actual and the estimated equilibrium REER. Achievements, challenges, and priorities in the areas of public financial management, wage policy, tax administration, and tax policy are also described in detail.

IV. Growth Constraints in Ghana1

A. Introduction

1. The stated goals of the government of Ghana are to accelerate growth to the 8 percent range in the medium term and reach middle–income status by 2015. Central to the strategy are large infrastructure projects, more efficient use of public resources, and expanded and diversified exports. The government, together with the World Bank and the IMF, has identified specific growth-critical areas: infrastructure, financial development, trade, efficiency of government spending, the business environment, and labor markets. This chapter starts from the premise that these are constraints to growth in Ghana.2 The objective is to shed some light on how they constrain growth in order to gain insight on which channels and indicators to monitor to gauge how well the constraints are being ameliorated.3

2. Methodology is somewhat challenging: single-country growth regressions are problematic because of data limitations. Another possible approach is to apply a Cross–country empirical growth regression to forecast growth in Ghana, or measure the required contributions from various growth determinants to reach particular growth rates. That is fraught with difficulties because the models have robustness problems.4 A simplistic approach is adopted here: (i) examination of some aggregate and disaggregate data that are relevant to the main channels through which these factors may constrain growth; and (ii) comparisons of Ghana to subgroups in sub–Saharan Africa (SSA), such as the countries that have achieved the highest growth rates over the last decade.

3. This chapter is organized as follows: it begins with information on past sources of growth, cross–country comparisons of long–run growth, and a discussion of the accuracy of IMF short–run growth projections (Section B). Next, Section C discusses identified growth constraints. Finally, subject to a number of caveats, a recent growth acceleration model is applied to illustrate how relieving these and other constraints could affect an acceleration in growth (Section D).

B. Background: Historical Growth Record

Ghana’s Relative Long–run Growth Performance

4. Since the early 1990s Ghana has been one of the stronger, though not one of the top, growth performers in SSA. Based on the distribution of real GDP per capita growth rates, Ghana was in the top third for SSA for the decade ending 2006 and for 2000–06, ranking 12 and 16 out of 42 countries for those periods (Table IV.1).

Table IV.1.

Ghana: Real GDP per Capita Growth and Export Growth per Performance Classification, 1996–20061

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Source: IMF and Economic Trends in Africa Database.

Data not available for Eritrea and Liberia.

5. While cross–country regressions may not be suitable for growth projections, they can be useful for assessing historical long–run growth in an individual country. Here the two models used may be less susceptible to problems identified in the literature: one uses only exogenous growth determinants, and the second is based on advanced econometric robustness analysis.

6. Ghana also did relatively well in the 1990s. In a growth benchmarking analysis comparing actual growth outcomes with those predicted by a cross–country regression based on exogenous opportunity variables, Ghana was one of the top ten “growth surprises” for 1990–2000 (Pattillo, Gupta, and Carey (PGC), 2006).5

7. Ghana’s long–run growth was lower than that of countries in other developing country regions because its policies were weaker and there was less factor accumulation. Cross–country growth regressions can address the question of what Ghana’s long–run growth could have been if policies or factor accumulation rates had been at the same level as in other developing country regions or the average for SSA. A model using robustness analysis6 suggests that Ghana’s growth in 1960–2000 was substantially lower than in East Asia (for example) partly for policy reasons but even more so because of lower factor accumulation rates (Table IV.2). While the growth shortfall due to poor policy lessened somewhat in the 1990s, that due to lower factor accumulation increased. Compared to SSA generally, however, if its factor accumulation and the policy variables in this model had been at the average for SSA countries in the 1990s, Ghana’s growth would have been slightly lower.

Table IV.2.

Ghana: Foregone Growth in Ghana Relative to Other Regions

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Source: Tsangarides (2005); Pattillo, Gupta and Carey (2006).Notes: Draws on an expanded model specification. Bayesian model averaging techniques are applied using a panel data system, and generalized method of moments (GMM) estimator.

Sources of Growth

8. Government investment and exports have contributed to recent growth, although the contribution of exports is low compared to other countries. Investment—particularly government investment—has been a significant engine of growth since 2001, in contrast to the 1992–2000 period when average annual real growth was negative (Table IV.3). The contribution to growth of exports and government investment in 2001–06 was approximately the same, though the contribution of exports fell from the previous period. Background work for the World Bank Country Economic Memorandum (CEM) shows that the contribution of exports to total GDP growth in Ghana has been the lowest among rapidly growing comparator countries (Bogetić et al, 2007).

Table IV.3.

Ghana: Composition and Growth of Gross Domestic Product by Category, 1980–2006

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Source: Ghanaian authorities and IMF staff estimates.

GNFS denotes “goods and nonfactor services.”

9. Investment to GDP ratios are high in Ghana compared to other SSA countries, but export growth is low. Ghana’s investment ratios have been historically higher than the average for SSA countries and similar to or higher than the fastest–growing SSA countries (Figure IV.1). Since 2003 the investment ratio has increased rapidly. Consistently, imported capital goods (from trade data) also began increasing in 2003 (Figure IV.2). Growth rates of total exports (goods and services) in Ghana have been low compared to other SSA countries; in 2000–06 Ghana ranked 30 out of 42 countries (Table IV.1).

Figure IV.1.
Figure IV.1.

Ghana: Total Investment as a Ratio of GDP, 1984–2006

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: IMF Economic Trends in Africa Database.Note: Sample excludes Equatorial Guinea.
Figure IV.2.
Figure IV.2.

Ghana: Machinery and Transport Equipment, 1980–2005

(as a percent of GDP)

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: World Bank, World Integrated Trade Solution and World Economic Outlook.
Figure IV.3.
Figure IV.3.

Ghana : Infrastructure Stock and Quality Indices, 1995–2000

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: Calderon and Serven (2004).Note: The indices are an average of 1995–2000 infrastructure stock and infrastructure quality index.

10. Sectoral growth has been broad–based and structural change limited. Growth rates of agriculture and industry accelerated in 2001–06, while the growth rate of services declined slightly, although services still made a larger contribution to growth than industry, given their larger share in value–added (Table IV.4). Sizable increases were registered in the agriculture subsectors of livestock and cocoa, and smaller gains were posted for manufacturing and construction. However, there has been only limited structural change in Ghana’s economy over the last decade: the share of agriculture fell slightly, that of services increased, and industry’s share held constant.

Table IV.4.

Ghana: Composition and Growth of Gross Domestic Product by Sector, 1980–2006

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Source: Ghanaian authorities and IMF staff estimates.

11. Growth in total factor productivity is now strongly contributing to economic growth. Ghana’s sources of real GDP growth can be decomposed into the contributions of factor accumulation—including that from human capital—and the residual attributable to total factor productivity (TFP). While the contribution of TFP growth to real GDP growth was negative during both the 1980s and 1990s, a major turnaround occurred in 2001–06 as policy improved (Table IV.5).7 Bogetić et al. (2007) find that a large proportion of recent TFP growth came from the agriculture sector and can be attributed to productivity increases mainly in cocoa, but also in some grain, cereal, and fiber crops.8

Table IV.5a.

Ghana: Sources of Real GDP Growth, 1960–20051

(by decade)

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Source: IMF World Economic Outlook 2006; World Bank World Development Indicators; Bosworth and Collins (2003), and IMF staff estimates.

Alpha = 0.4, delta = 0.06, return to schooling = 0.07, capital output ratio = 2.0.

Table IV.5b.

Ghana: Sources of Real GDP Growth, 1960–20051

(Annual percentage change)

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Source: IMF World Economic Outlook 2006; World Bank World Development Indicators; Bosworth and Collins (2003), and IMF staff estimates.

Alpha = 0.4, delta = 0.06, return to schooling = 0.07, capital output ratio = 2.0.

Growth Projections

12. For 2003–06 IMF projections tended to underpredict Ghana’s growth. While one–year program forecasts for the previous two PRGF–supported programs (1996–2002) were consistently overoptimistic, real GDP growth was underpredicted in each year of the 2003–06 PRGF program (Table IV.6). Two– and three–year forecasts also tended to underpredict growth. While growth forecasts in PRGF countries are generally too optimistic, Ghana’s September current year and one–year WEO forecasts also underpredicted real GDP growth for 2001–05, according to a report evaluating WEO forecasts (Timmerman, 2005) (Table IV.7).

Table IV.6.

Ghana: Program Projections and Outturns

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Note: Projection refers to the projection made in the staff report of the previous year.Source: IMF staff reports.
Table IV.7.

Ghana: WEO Forecasting Accuracy, 1991–2005

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Source: Timmerman Report (2005).Explanatory Notes:1. Forecast errors are defined as actual minus projection.2. If forecasts are accurate, forecast errors on average are zero, otherwise, forecasts are biased. A negative bias indicates a tendency toward systematic over–prediction and a positive bias indicates a tendency toward under–prediction.

C. Growth Constraints

Infrastructure

13. Recently, high–profile efforts like the UN Millennium Project (2005) have pointed to the severe infrastructure shortage in Africa as a major obstacle to growth. While results are mixed, studies of infrastructure in developing countries have tended to find a positive, significant contribution to output and growth from good–quality infrastructure. The impact is strongest in the telecoms sector, followed by roads and electricity; the evidence on access to water or sanitation is more complex, as these have longer term effects on growth that feed through improved health and education outcomes (Estache, 2006).

14. Infrastructure is becoming an ever greater constraint on growth in Ghana. Based on indicators before 2000, Ghana ranked relatively well in SSA, and infrastructure problems were not the biggest complaint in business surveys in the 1990s. However, for a number of reasons—most strikingly the 2006 energy crisis—infrastructure is emerging as one of the biggest challenges for growth. Infrastructure spending is not increasing fast enough and the needs are massive; cost recovery pricing in the utilities is becoming more difficult in the current environment (political cycle, energy shortages, increasing marginal costs); and infrastructure has been identified as a major constraint to increasing nontraditional agricultural exports.

15. Given comparatively better infrastructure indicators (based on data up to 2000), cross–country regressions suggest lower growth benefits of infrastructure in Ghana compared to SSA averages. In one leading study (100 developing countries, using data from 1970–2000), Calderon and Serven (2004) found that high scores on an infrastructure index measuring stocks and quality of telecommunications (number of main telephone lines), power (electricity–generating capacity), and transport (length of the road network) had a positive effect on growth. Because Ghana’s index of infrastructure stocks and quality was higher than the average for SSA, according to this model the long–run growth benefits from increasing infrastructure are somewhat smaller than for SSA overall. In SSA a one–standard–deviation increase in infrastructure stocks (or quality) would raise the long–run growth rate by 2.7 (0.4) percentage points; the comparable estimates are 0.6 (0.5) for Ghana. One–standard–deviation increases in infrastructure stock imply sizable increases in investment—a seven–fold increase in the number of main telephone lines, though more modest increases in power–generating capacity and road density.

16. There are significant gaps in infrastructure supply, quality, and reliability in Ghana. On roads and coverage of the electricity network Ghana benchmarks relatively well, but access to improved water and sanitation, fixed telephone lines, and Internet use lag regional and low–income country (LIC) standards (Table IV.8). Demand, supply, and planning problems in the energy sector brought on an energy crisis in 2006. Inefficiency in the sector was one warning sign: transmission and distribution losses in Ghana are higher than both SSA and LIC averages.9 Intermittent supply and inability to extend supply to new customers plague urban water delivery. In telecommunications, while mobile telephone use has been growing at exponential rates since 2003, the number of fixed lines has hardly grown at all.

Table IV.8.

Ghana: Benchmarking Infrastructure Access, (Latest Observations), 2000–2006

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Source: Estache and Vagliasindi (2007).

17. Business users see infrastructure deficiencies as a big problem. A 2006 survey by the Association of Ghana Industries found that the quality of power supply came 4th of 13 challenges to doing business in Ghana; not surprisingly, the 2006 load–shedding program in response to the energy crisis was the most severe obstacle. International surveys for the Global Competitiveness Report in 2004 ranked the quality of Ghana’s infrastructure 66th of 104 countries, below regional leaders like South Africa, Mauritius, and Botswana (Bogetić, et al, 2007).

Infrastructure financing and growth

18. Government spending on infrastructure in Ghana is increasing slowly, and private participation is low. While infrastructure spending has been increasing since 2002, the ratios to GDP and to total spending in 2006 are still lower than those for 1999–2000 (Table IV.9). Private participation in infrastructure projects as a share of GDP was lower in Ghana during 2000–05 than the SSA average or than in countries at similar stages of development, such as Kenya, Mozambique, and Uganda (Table IV.10).

Table IV.9.

Ghana: Functional Classification of Infrastructure Expenditures, 1999–2006

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Sources: Ghanaian authorities.

Refers to total discretionary expenditure.

Table IV.10a.

Ghana: Private Participation in Infrastructure, 1990–2005

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Source: World Bank, Private Participation in Infrastructure Projects Database.
Table IV.10b.

Ghana: Private Participation in Infrastructure by Total Projects, 1990–2005

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Source: World Bank, Private Participation in Infrastructure Projects Database.

19. In a model scenario with several-fold increases in infrastructure spending, growth accelerates sharply. The World Bank estimates infrastructure spending needs of about 10–12 percent of GDP, for the next 10 years or so. (Estache and Vagliasindi, 2007)10 The World Bank is also developing a Maquette for MDG Simulations (MAMS) general equilibrium model for Ghana, to assess the prospects for growth and improvement in human development indicators under various scenarios, including a strategy with removal of infrastructure gaps and a full MDG achievement strategy (Bogetić et al., 2007). In the scenario focused on relieving infrastructure bottlenecks, growth accelerates sharply from an average of around 7 percent during 2004–15 to around 7.5 percent. The additional growth is driven by productivity spillovers from infrastructure service provision to the rest of the economy.

Sustainability—cost recovery in the utilities

20. Cost–recovery pricing in the utilities is facing challenges that have implications for the ability of the utilities to maintain and upgrade services and for fiscal sustainability. To meet growing power demand, the government–owned Volta River Authority (VRA), the main energy producer, has been transitioning from mainly hydro generation to a more costly hydrothermal mix. With world oil prices high, for several years Public Utilities Regulatory Commission (PURC) bulk supply tariffs (for sale to large customers like the Electricity Company of Ghana [ECG]) have not enabled VRA to recover costs as thermal generation increases. The utility tariff system has been effectively suspended since November 2006, after gazetted tariff increases, planned for May 2006, were not passed on to customers. Moreover, mines enjoy energy prices that are below the PURC tariffs and VALCO, the aluminum smelter that is a large power user, has a special contract guaranteeing it low–cost power. The financial situation of VRA and ECG deteriorated as a result. In November 2006 the PURC also discontinued the quarterly automatic tariff adjustment, switching to a system where the utility companies apply for adjustments as needed.

21. The authorities have recently announced plans to reinstate the suspended tariff increases by August 2007, and have committed to move toward full cost recovery, with a full tariff review. The closing of VALCO announced in March 2007 will also free up significant amounts of energy for the rest of the economy and should help VRA’s financial position. While these are encouraging developments, utility tariff regulation will need to be carefully monitored to ensure that the system is sustainable and the utilities are financially sound in the long run.

Energy crisis: short–run bottleneck to growth in 2007

22. Both rapidly implementable supply options and investment in generation, transmission, and distribution for the medium term are necessary if the energy crisis is not to impinge on growth in 2007 and beyond. Mining, where energy accounts for 20 to 40 percent of operating costs, and some manufacturing subsectors are important exporters. Electricity demand is expected to increase in 2007–08 with the opening of several new mines. Power supply must be restored to precrisis levels and increased to meet rising demands so that the contribution to growth of these exporters is not choked off. The good job the government is doing with load management, and self–provisioning by most mining operators and some manufacturing and service establishments have helped keep growth resilient to the crisis so far. The government has also been augmenting supply through major investments and reduced exports to neighboring countries, as well as new thermal generation investment that will allow for tapping gas from the West African Gas Pipeline (WAGP), scheduled for completion in late 2007.

Increasing nontraditional agricultural exports

23. Infrastructure is identified as an important constraint to agricultural productivity, particularly for nontraditional exports that have potential for rapid growth. Accordingly, over one–third of the Millennium Challenge Account (MCA) budget of US$547 million will be allocated to the transport component, primarily feeder and trunk roads. Further MCA infrastructure investments include outlays in energy and water, with a large irrigation component. Internal rates of return on these are expected to be high; and the project as a whole is expected to increase medium–term growth.

24. Finally, future monitoring of channels through which infrastructure affects growth requires benchmarking data, which are currently not available in Ghana. Infrastructure is expected to contribute to economic growth through complementarities that foster higher private sector investment and increase productivity, and through support for higher trade.11 These channels are difficult to monitor in Ghana because expenditure–based national accounts are not complete, and there has been no Investment Climate Assessment (ICA) to benchmark the role of indirect costs from infrastructure deficiencies, although the ICA will be completed soon.12

Financial Development

25. Considerable theoretical and empirical literature demonstrates the relationship between financial development and growth. Empirical studies confirm that countries with better–functioning financial systems grow faster, and the result does not seem be driven by reverse causality (Levine, 2004). In this section we look at channels through which financial development contributes to growth, and indicators for monitoring to get a sense of whether the sector’s contribution to growth in Ghana is increasing.

Financial depth indicators

26. Financial depth in Ghana is very low. Financial depth in LICs in SSA is the lowest in the world gauged by such common indicators as the ratio of broad money and private sector credit to GDP. Ghana’s M2/GDP ratio, while now slightly higher than in low–income SSA generally, is still much lower than in other subgroups in SSA, such as the non–CFA countries, middle–income countries, or the fastest growers of the 1990s. That is also true for private sector credit to GDP; even with the very rapid growth in recent years, Ghana’s ratios are still below the fastest growers, and SSA overall (Figures IV.4 and IV.5).

Figure IV.4.
Figure IV.4.

Ghana: M2 as a Percent of GDP, 1984–2006

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: IMF World Economic Outlook.Note: Sample excludes Equatorial Guinea.
Figure IV.5.
Figure IV.5.

Ghana: Private Sector Credit as a Percent of GDP, 1984–2006

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: IMF World Economic Outlook.Note: Sample excludes Equatorial Guinea.

Macroeconomic environment

27. Financial development may not have contributed much to growth in Ghana in the past, given the high inflation. Cross–country evidence suggests that the strength of the financial development–growth nexus depends on inflation, and that the positive effect of finance on growth ceases when inflation is high. One study estimates the threshold at between 13 and 25 percent (Rousseau and Wachtel, 2002). This is consistent with evidence on SSA showing that among the countries with relatively strong financial development indicators, those that grew faster had achieved greater macroeconomic stability; that is, they had much lower budget deficits (including grants) and lower inflation (Gulde et al., 2006).

28. High inflation in Ghana up until recently may also have slowed financial deepening. In addition to constraining the growth effect of financial development, high inflation has been shown to have a direct negative effect on financial development (Boyd, Levine, and Smith, 2001; Detragiache, Gupta, and Tressel, 2005). Cross–country regressions following the paper by Detragiache and colleagues and adding more SSA countries to the sample confirmed the negative effect of inflation, along with corruption and banking sector concentration, on financial depth (Gulde et al., 2006).

Channels of influence

29. Lack of credit hinders investment and growth in manufacturing in Ghana. The link between finance and growth has been shown to operate by overcoming external financing constraints that otherwise hinder company expansion. While aggregate data are not available, finance is the constraint most commonly identified by firms of all sizes, but especially small–and medium–sized enterprises (SMEs; Teal, 2005, based on 2002 data).13 The much higher rate of return on capital, measured as profits relative to capital stock value, for SMEs in Ghana relative to some other SSA countries further supports the idea that the financial climate is more adverse for SMEs in Ghana (Teal, 2005). Ghanaian firms use less bank financing for investment than firms surveyed in the ICAs (2002–05) in six other SSA countries (Teal and others, 2006).

30. Abor and Biekpe (2006) found that financing contributed to the growth of nontraditional exporting firms in Ghana. The growth–inhibiting effects of credit constraints may be stronger when these bind dynamic sectors with strong growth potential, such as nontraditional exporters.

31. Credit constraints are also a problem in agriculture. In the MCA project budget, 15 percent is allocated to rural finance. Based on detailed plot–level survey data in southern Ghana, Udry and Anagol (2006) find very large marginal returns not only to cultivation of pineapples (60 percent), an important nontraditional export, but also to other crops in these districts. They conclude that financial market imperfections that impede higher flows of capital to the informal sector are likely to explain why more capital does not flow to these high–return investments in Ghana.

32. Is Ghana’s financial system channeling resources to the most productive uses? Financial sector development contributes to growth both by relieving the constraints to firm investment and growth (evidenced by aggregate private sector credit indicators) and by making resource allocation more efficient so that credit is channeled to sectors and firms with the highest risk–adjusted returns. There is also some cross–country evidence that financial liberalization increases the efficiency of investment (Abiad, Oomes and Ueda, 2004).

33. This channel of influence on the finance–growth link has not been evaluated for Ghana. However, some of the evidence (rates of return for SMEs and some agricultural subsectors) suggest some weaknesses in the financial sector’s ability to channel credit to its most productive uses. Data on bank allocation of loans also show a relatively low share going to agriculture and high shares to the financial, trade, and services areas of the service sector, which may not be fully consistent with the returns and growth potential of different sectors (Table IV.11).

Table IV.11.

Ghana: Sectoral Distribution of Loans, 1999-2006

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Source: Ghanaian authorities and IMF staff calculations.

34. Given Ghana’s high and increasing remittance inflows, their growth impact could be magnified by policies that encourage banking them. The evidence on the direct link between remittances and growth is mixed, but remittances could have an indirect effect on growth by spurring financial development. This idea is behind the argument that banking remittances will help multiply their developmental impact. It could pave the way for low–income households to gain access to other financial products and services (savings and credit), serving directly as a steady stream of loan collateral, as well as adding to bank resources for loans if deposits increase, which could in turn increase aggregate credit. Cross–country evidence has found that remittances have a positive impact on bank deposits and credit to GDP (Aggarwal, Demirgüc–Kunt, and Martinez Peria, 2006; Gupta, Pattillo, and Wagh, 2007).

Trade

35. The link between growth and trade–related indicators—liberalization, openness, and trade volumes—has been well–documented in the literature. 14 Breaking into the global market for manufactured exports has been the foundation of growth in many developing countries; strong growth in manufactured exports was also associated with growth accelerations in PRGF countries (IMF, 2005).

36. Manufactured exports and their share in GDP have not grown as much in Ghana as in other coastal SSA countries— the group with the highest potential given lower transport costs—or in the fastest–growing SSA countries (Figure IV.6). Critical ingredients for manufactured exports, which are transaction–intensive, are a stable policy environment, a supportive business climate, good infrastructure, and relative prices that reflect opportunity costs. A few points on the last area can be noted here:

Figure IV.6.
Figure IV.6.

Ghana: Manufacturing Exports to the World as a Share of GDP, 1962–2005

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: World Integrated Trade Solution and World Bank World Development Indicators.

37. Wages that are in line with productivity are important to the competitiveness of manufacturing exports in Ghana. Large firms in SSA have a much higher propensity to export. In Ghana the number of large firms was approximately constant between the 1987 and 2004 industrial census: new large firms are not emerging. The export profitability of large firms may be lower because they pay substantially higher wages than small firms—wages that do not reflect labor skill differences (Teal, 2005). Labor costs relative to productivity are important to competitiveness,15 which suggests that attention may be needed both to impediments to labor market flexibility and to lowering the cost of doing business to support productivity gains. To the extent that high government wages are linked to wages in large manufacturing firms, government wage policy may affect competitiveness, manufactured exports, and thus growth.

38. While data inadequacies make it impossible to draw a full picture, there are indications that the relative price of investment goods in Ghana has been increasing in recent years. The high cost of investment goods compared to consumption goods has been identified as a robust growth determinant with a sizable negative impact on SSA growth (Artadi and Sala–i–Martin, 2003). Cross–country datasets use the Penn World Tables PPP data. While Ghana’s investment price ratio was lower than that of other SSA comparator groups previously, this was reversed in the 1990s (Figure IV.7). This may be because of high land or construction costs, possibly relating to the structure of these markets. However, given weaknesses in national accounts data that underlie investment deflators at PPP, these data should be viewed cautiously.

Figure IV.7.
Figure IV.7.

Ghana: Relative Price of Investment in Domestic Currency to PPP, 1965–2000

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: Penn World Tables.Note: Fast growers excludes Equatorial Guinea.

39. The costs of trading across borders seem low, but it is not clear how nationally representative this Doing Business indicator is. According to the World Bank’s Doing Business Report, the cost of trading across borders in Ghana compares favorably with the rest of SSA and on some indicators is close to OECD averages (Table IV.13). World Bank (2007) points to the scope for reducing the time required for exporting and importing goods by finishing installation of computer–based custom inspection procedures. Nonstandardized trade–related regulations and weaknesses in trade facilitation and administration are also an issue. The limitations of Doing Business indicators as nationally representative should be kept in mind. In this category, for example, to make data comparable across countries, the survey assumes that businesses have more than 200 employees, export more than 10 percent of sales, and the traded goods do not require refrigeration and fall into specified product categories. The universe of transactions for which these conditions apply in Ghana may be relatively small.

Table IV.12.

Ghana: External Oversight of Banking Systems, 2003

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Source: World Bank and IMF staff calculations from indices in Barth, Caprio, and Levine (2006).
Table IV.13.

Ghana: The Cost of Trading Across Borders, 2006

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Source: World Bank (2006), Doing Business Database.

Efficiency of Public Investment

40. While empirical studies on the impact of public investment on growth have mixed results, evidence of a positive impact is more robust for developing countries. There is also a budding literature suggesting that the efficiency with which public capital is utilized positively effects growth, with some studies suggesting that how public capital is financed and utilized is as important for growth as the quantity accumulated (Aschauer, 2000).

41. Increasing the efficiency of public spending to strengthen growth prospects is a priority of the Ghanaian authorities. Government investment to GDP is high in Ghana compared to other SSA countries, but its efficiency, measured by the incremental output capital ratio (IOCR) is low. Compared with high–performing SSA and Asian countries, Ghana’s IOCR is among the lowest (Bogetić et al., 2007).16 The government has a plan to scale up investment in order to accelerate growth. However, this growth may not materialize if the investments are significantly less productive than expected, whether because of lower returns on projects, problems with investment allocation and efficiency, or implementation difficulties. The IMF and other development partners are working with the government on ways to increase the efficiency of public expenditure, such as establishing a value–for–money unit to evaluate public investment projects, undertaking public expenditure tracking (PETS) surveys, reforming PFM, and tightening the links between the MTEF and budget implementation.

42. Ghana’s public investment project evaluation, planning, budgeting, and execution need upgrading. One indicator of the quality of investment budgeting is the ratio of investment budgeted by sector relative to actual investment spending. Here, the budget data shows large differences between ministries in the ratios of actual to budgeted investment expenditure. For many of the ministries with the largest investment budgets, the actual spending ratio is less than half (Table IV.14).

Table IV.14.

Ghana: Investment by Ministerial Breakdown, 2003–2005

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Source: Ghanaian authorities.Note: Only includes ministries with the highest budgeted investment for 2005.

43. Baseline data are needed to assess areas where planning, budgeting, and execution could be improved to maximize the contribution of public investment to growth. This would help answer such questions as: Is the composition of public investment optimal for growth? Are capital and recurrent expenditures properly balanced? Are investment budgets linked to MTEF and GPRSII priorities? Could procedures and project execution rates be improved?

The following types of data would be necessary for such an assessment:

  • Sectoral allocation of investment17

  • Investment expenditure by different levels of government (ministries and departments, subvented agencies, local governments)

  • Alignment of investment budget and GPRSII priority areas

  • MTEF investment plan and relation to annual investment budgets

  • Investment allocations relative to operation and maintenance costs by project

  • Investment project execution rates—by sector (for donor and domestically financed)

  • Investment expenditure execution procedures (for donor and domestically financed)

  • Investment expenditures by SOEs.

Institutions

44. The government of Ghana has not identified institutions as a growth–critical area. However, the literature shows that strong institutions are vital for long–term growth. Ghana also needs strong institutions to make sustainable policy reforms in other growth–constraining areas. This section will compare Ghana to other SSA countries on measures of basic institutions—laws, rules, and practices that govern property rights; freedom to do business; and the sanctity of contracts.18

45. Spurring large improvements in basic institutions can take a long time and—because causation operates in both directions—may be difficult without sustained growth. A recent IMF study of PRGF–eligible countries found that some were able to achieve sustained growth19 with institutions that at first were quite weak. Institutional measures for Ghana and some other promising SSA reformers are not unfavorable relative to where those countries were when they began their growth acceleration (IMF, 2005, and Johnson, Ostry, and Subramanian, 2007).20

Economic institutions

46. Ghana’s economic governance indicators are strong for SSA, but this is not a high standard, and recently control of corruption has been worsening. On the World Governance Indicators (World Bank, 2006), on four economic institutions measures (control of corruption, government effectiveness, regulatory quality, and rule of law), Ghana ranks substantially higher than the SSA average, but SSA has much lower governance indicators than the rest of the world (Figure IV.8). For 2003–05, three of the four indicators improved, but control of corruption worsened. Ghana is striving for middle–income status—which argues for comparison to countries beyond SSA. Relative to all countries in the world, or all countries with competitive elections, Ghana’s International Country Risk Guide (ICRG) economic governance indicators are average or below (Keefer, 2007).

Figure IV.8.
Figure IV.8.

Ghana: Governance Indicators, 2003–2005

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: World Bank, World Governance Indicators Database.Note: The charts depict the percentile rank on each governance indicator. Percentile rank indicates the percentage of countries worldwide that rate below the selected country (subject to margin of error). Higher values indicate better governance ratings.

47. Ghana does very well on the institutions component of the Country Policy and Institutional Assessment (CPIA). The CPIA is used in determining debt sustainability thresholds and IDA aid allocations. Public sector management and institutions is one of its four main components.21 For this component in 2005, Ghana had higher rankings on each of the subcomponents than SSA and the average for all IDA countries, although equal or slightly lower than the average for the “strong performers,” i.e., those in the top quintile of CPIA scores (Figure IV.9).

Figure IV.9.
Figure IV.9.

Ghana: Public Sector Management and Institutions by Component, 2005

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: World Bank International Development Association.

48. Economic institutions have been improving over time but are still below those of the fastest growers in SSA. Ghana’s ICRG economic risk index was below the SSA average until 2003, although it had been also been above in earlier periods; still in 2005 the indicator was below that for the fastest–growing SSA countries (Figure IV.10).

Figure IV.10.
Figure IV.10.

Ghana: International Country Risk Guide Economics Risk Ratings, 1984–2006

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: International Country Risk Database.

49. Land rights issues are complex and may be a constraint to growth. Ghana does relatively well compared to SSA on the World Bank’s Doing Business indicators. However, the Doing Business indicators which are the primary source of economic activity in Ghana and other SSA countries. Ghana ranks slightly worse than other SSA countries and the fastest growers on urban and rural land property rights and frequency of land–related conflicts (Figure IV.11). Land rights that are not secure can especially hinder agricultural investment. Goldstein and Udry (2006) show that the relationship of landholders to traditional leaders in Ghana significantly affects agricultural investment and productivity, which hints at productivity and investment losses related to the operation of land markets.

Figure IV.11.
Figure IV.11.

Ghana: Land and Property Rights in Sub–Saharan Africa, 20041

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: World Bank (1994); and World Bank database on land and property rights in Africa 2004.1 Land Property Rights (Higher index = worse environment)

Political institutions

50. On political institutions, Ghana compares very favorably with SSA on all the major indicators,both those for the most recent period (voice and accountability and political stability in the World Bank’s World Governance indicators) and those measuring longer periods. Ghana’s rankings began surpassing SSA averages in the early 1990s for the ICRG political risk indicator; in the mid–and late 1990s for the World Bank’s Database of Political Institutions (DPI) executive and legislative indexes of political competitiveness; and about 2000 for the Polity Project’s general political rights indictor (Figure IV.12).

Figure IV.12a.
Figure IV.12a.

Ghana: International Country Risk Guide Political Risk Ratings, 1984–2006

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: International Country Risk Database.
Figure IV.12b.
Figure IV.12b.

Ghana: Political Institution Comparison, 1975–2004

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: Polity IV Database, 2004.
Figure IV.12c.
Figure IV.12c.

Ghana: Political Regime Index, 1960–2004

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A004

Source: World Bank, Database of Political Institutions, 2005.

51. Improvements in political institutions are linked to those in economic institutions in Ghana. While the quality of economic institutions is correlated with the quality of political institutions, the linkage between changes in political and economic institutions in SSA generally is tentative (Johnson, Ostry, and Subramanian, 2005; PGC, 2006). For Ghana, however, the correlations are stronger and persist into the most recent period, reflecting continued improvement in both political and economic institutions.

52. Thus, on these broad measures of economic institutions, Ghana compares favorably to SSA generally, though not always to the fastest–growing SSA countries; and of course the indicators are much more positive in the rest of the world. Corruption indicators in Ghana are moving in the wrong direction, and land rights is a questionable area. However, institutional quality in Ghana does not seem to be a critical constraint that would choke off the possibility of a growth acceleration that would help further improve institutions.

D. Growth Acceleration

53. Using long–run econometric growth models to try and quantify growth impacts of policy changes in Ghana, as noted, is an exercise fraught with difficulties. Here we use a different type of model—a growth acceleration model—though it is subject to similar robustness problems as long–horizon growth regressions. The advantage is that the method is geared squarely at addressing the basic policy question: how likely is it that Ghana will experience a growth acceleration that is sustained for a period of time? Following a methodology introduced by Hausman, Pritchett and Rodrik (2004; HPR), PGC (2006) estimate a growth acceleration model for SSA countries. The results highlight the roles of trade, investment, productivity, and policy and institutional soundness in supporting growth acceleration (see paper for details on the methodology).

54. There are disadvantages to this approach that should be noted. Robustness is a problem; this is a new literature and the models have not been tested through extensive applications. In addition, like similar models, the PGC model has very limited explanatory power—the correlates explain only a small fraction of the variation during an acceleration, and in–sample predictive power is low. Given these caveats, the discussion below simply illustrates the method and the type of analysis that could be pursued as the performance of the model improves.22

55. To apply the model to Ghana we apply projected paths for selected macroeconomic variables to the coefficients estimated from the probit regression model in PGC (2006). Using data for SSA countries from 1980–2004, this regression explains the probability of a given year being an acceleration year, meaning a year that is part of a five–year interval in which per capita growth was at least 2 percent and was 2 percent higher than the previous five–year interval, with growth in the latter interval being positive.

56. Data from the Ghana macro framework provided the projected paths for the (time–varying) endogenous variables in the model: changes in the real effective exchange rate, investment, terms of trade, NPV of debt to exports, budget deficit, and inflation. Assumptions must be made about two other important variables: TFP growth and a measure of institutional and policy quality, the ICRG country risk indicator. For the latter, we use the ICRG’s 1–year and 5–year ahead “best case” assessments; for TFP growth we develop two scenarios: high TFP growth (0.5 percent higher for each future year) and low TFP growth.

57. This exercise yields paths for the projected probabilities of a year being in growth acceleration for 2006–20. The estimated model does not explaining the timing of an acceleration—the probability that an acceleration would start in a given year—but rather the probability of a year being part of an acceleration episode. The estimates provide the change in the probability of an acceleration year for small changes in the right–hand–side variables.

58. A number of different scenarios were analyzed: (1) using all coefficients in the model, whether or not they were significant, and low TFP growth; (2) all coefficients, high TFP growth; (3) excluding the budget balance and inflation variables from the model (since they are not statistically significant in the regression), low TFP growth; (4) excluding nonsignificant variables, high TFP growth.

59. The four scenarios yield roughly similar predicted paths, with differences in the magnitudes of projected changes in the probability of an acceleration year. The probabilities are flat in 2007, increase marginally until about 2010–11, and then decline but remain positive through 2020. In 2011, the peak year, the additional probabilities range from about 3 to 5 percentage points, which is sizable given the relatively low overall probability of accelerations in the sample. The ICRG institutions/risk indicator, the budget balance and TFP growth are important contributors to the increased probability, as is investment. One important divergence between the different paths arises from whether the inflation and budget balance variables are included. The path for inflation and the budget deficit (slow decline in inflation, improving deficit) increases the probabilities of being in an acceleration period. The scenario with the highest probabilities is the one that includes these variables and assumes high TFP growth.

E. Conclusion

60. This chapter has examined areas identified earlier as growth–critical in Ghana and shown how they constrain growth: infrastructure, financial sector development, some aspects of trade, and the efficiency of public investment. More recently, in the 2007 Ghana CEM being prepared by the World Bank, four challenges to accelerating growth in Ghana have been highlighted (overlapping, to some degree, with the areas covered in this chapter): strengthening macroeconomic stability, improving productivity and innovation, closing the infrastructure gap, and strengthening the investment climate.

61. The chapter also selectively reviewed Ghana’s historical growth record and past sources of growth. Since 2000 Ghana’s economy has been growing strongly, and since 2002 growth has significantly exceeded the historical trend. A growth acceleration model is used to illustrate scenarios for some of the variables related to growth constraints that could affect the likelihood of a significant and sustained growth acceleration in Ghana.

62. A number of questions remain unanswered: Why has the contribution of exports to growth been relatively low? Why has the private sector not taken more of a lead in the growth process? and How efficient is current public sector investment? The evidence reviewed here supports the emphasis the authorities have been placing on large public investments in infrastructure to raise growth potential. However, it will be equally important to increase TFP growth by making public spending more efficient, and to sustain macrocritical reforms, such as PFM, financial sector, and investment climate reforms.

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