Three Propositions on African Economic Growth

This paper describes the African economic growth and asserts the establishment of a growth-conducive environment is the unifying purpose of the IMF’s extensive involvement in Africa. A major purpose of the IMF’s extensive involvement in Africa is to promote high quality growth. As to the specific basis for the IMF’s original perspective on growth, it may be found in the debate that followed the debt crisis of the 1980s, when the concrete relevance of growth as a determinant of the sustainability of balance-of-payments positions and of the viability of a country's payments system became evident. Although the elimination of financial instability is essential to remove trade restraints, and thereby to promote growth, growth in turn is necessary if trade restraints are to be averted. The point of anchoring the domestic system of relative prices to the international system through open trading and an equilibrium exchange rate is to provide signals that will guide the efficient utilization of domestic resources; the whole approach becomes pointless if these signals are blocked by domestic price regulation.

Abstract

This paper describes the African economic growth and asserts the establishment of a growth-conducive environment is the unifying purpose of the IMF’s extensive involvement in Africa. A major purpose of the IMF’s extensive involvement in Africa is to promote high quality growth. As to the specific basis for the IMF’s original perspective on growth, it may be found in the debate that followed the debt crisis of the 1980s, when the concrete relevance of growth as a determinant of the sustainability of balance-of-payments positions and of the viability of a country's payments system became evident. Although the elimination of financial instability is essential to remove trade restraints, and thereby to promote growth, growth in turn is necessary if trade restraints are to be averted. The point of anchoring the domestic system of relative prices to the international system through open trading and an equilibrium exchange rate is to provide signals that will guide the efficient utilization of domestic resources; the whole approach becomes pointless if these signals are blocked by domestic price regulation.

Three Propositions on African Economic Growth

African economies are diverse, and some selectivity is necessary if a proper perspective is to be established. Yet they are too often lumped together in the public view, where the highly publicized plight of some is allowed to overshadow the progress of many. Conversely, the Fund’s extensive involvement in Africa is often perceived as an endless series of rescue operations; the common constructive thread is not always evident. In view of these perceptions, this paper puts forward three simple propositions: (1) the unifying purpose of the Fund’s involvement in Africa is the methodical pursuit of “high quality” growth based on efficient use of resources; (2) apart from the civil war cases, most countries have achieved substantive progress toward that goal; and (3) the key to continued progress is an increase in savings ratios.

I. The Fund in Africa

A major purpose of the Fund’s extensive involvement in Africa is to promote high quality growth. To quote the Fund’s Managing Director, “Our primary objective is growth. In my view, there is no longer any ambiguity about this. It is toward growth that our programs and their conditionality are aimed. It is with a view toward growth that we carry out our special responsibility of helping to correct balance of payments disequilibria and, more generally, to eliminate obstructive macroeconomic imbalances.” 1/

The Fund’s growth orientation has a general basis as well as a specific one. The general basis is provided by the Fund’s Articles of Agreement, and notably by Article I, which states, “The purposes of the Fund are … (ii) to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy…,” As to the specific basis for the Fund’s original perspective on growth, it may be found in the debate that followed the debt crisis of the 1980s, when the concrete relevance of growth as a determinant of the sustainability of balance of payments positions and of the viability of a country’s payments system became evident. Thus, while the elimination of financial instability is essential to remove trade restraints, and thereby to promote growth, growth in turn is necessary if trade restraints are to be averted. In effect, growth and stabilization are both subsumed in a broader concept of efficient use of resources. It is this fundamental complementarity between adjustment and economic growth that is the original message of the Fund (Guitián, 1987).

Building on these foundations, the Fund has developed what can be termed a doctrine of growth. This is properly a doctrine, that is, a set of operating principles based on the interaction of theoretical insights and of experience, a pragmatic but principled approach in which theoretical analysis opens up perspectives, and experience decides on relevance. At its core are four postulates for sustained economic growth:

Postulate 1: Sustained economic growth depends on openness to foreign trade. The main line of argumentation behind this first postulate rests on a solid theoretical foundation: nations gain, individually and collectively, by specializing in those activities in which they have a comparative advantage; the weight of evidence is that this sort of specialization makes an extremely powerful contribution to growth. Comparative advantage, however, can only be safely identified when trade and payments are free of restrictions, so that the country’s relative price structure can interact freely with world prices; then relative prices provide optimal guidance for the allocation of resources. A subsidiary--but also highly relevant--line of argumentation focuses not on the benefits of openness, but on the costs of restrictions: it is a universal experience that trade and payments restrictions are a hotbed of corruption and, more generally, favor the development of “directly unproductive profit-seeking activities” (Bhagwati, 1992).

Postulate 2: Sustained economic growth also requires that the exchange rate be close to equilibrium. An equilibrium exchange rate is the level of the exchange rate that is consistent not only with external but also with domestic balance (Clark et al., 1994). This second postulate is necessary because unrestricted trade and payments systems per se do not necessarily lead to an equilibrium exchange rate. The absence of restrictions ensures external equilibrium, but not always internal equilibrium. As a topical example, the external current account consequences of a terms of trade loss can be offset by restrictive demand policies; these policies can be sustained, so that the trade and payments system remains unrestricted, but the cost is a prolonged slump. This was the experience of the CFA franc countries in 1985-93. Thus, in deciding whether the exchange rate is adequate for growth, countries need to consider both the external and the internal conditions.

Postulate 3: Sustained economic growth further requires domestic price flexibility. The point of anchoring the domestic system of relative prices to the international system through open trading and an equilibrium exchange rate is to provide signals that will guide the efficient utilization of domestic resources; the whole approach becomes pointless if these signals are blocked by domestic price regulation. Of primary concern in this respect is the extensive range of monopolistic practices found in many countries, covering utilities, energy prices, farm prices, financial services--including the interest rate--transportation, and others.

Postulate 4: Sustained growth requires an ability to exercise flexible control over domestic demand. High and unstable inflation rates inhibit the transmission of price signals to the real economy. Sustained growth therefore requires appropriate control over domestic demand to achieve moderate inflation; this, in turn, depends on efficient fiscal systems and flexible labor markets.

Together, these four postulates form a solid underpinning for the doctrine of growth, a doctrine that has been extensively put to the test in recent years. Fund arrangements in place at end-1994 support the policy programs of 20 of the 43 member countries covered by the Fund’s African Department, and more are being negotiated; this represents over one third of the arrangements in place, worldwide, with Fund members. All African country programs include a strong structural component. The majority of them have been developed under the aegis of the Fund’s enhanced structural adjustment facility, which has been designed specifically to focus policy attention, beyond stabilization issues, on efficiency in resource use.

II. The Scorecard

Drawing on the extensive experience that has been accumulated in testing the Fund’s doctrine of growth, it is possible to state (1) that the four postulated requirements have increasingly been satisfied, and (2) that growth rates have responded favorably.

(1) Considering the four postulates in turn, the incidence of trade and payments restrictions, in the first place, has been sharply reduced. Telling evidence in this respect is given by the spread between official and parallel exchange rates, a good indicator of the severity of payments restrictions, which has declined markedly in almost all countries (with the major exception of Nigeria since early 1994). The evolution of this spread summarizes a wide trend to the simplification and eventual unification of exchange systems; by the end of 1990, 6 of 23 non-CFA franc, non-rand area countries had reached virtual unification; their number had risen to 12 countries in mid-1994. 1/ More broadly, an informal survey of 26 non-CFA franc African economies, in which exchange systems were classified as “liberal” or “restrictive” on the basis of selected criteria, rated 11 countries as liberal in 1987, 14 countries in 1990, and 21 countries in 1993: 2/ notwithstanding the methodological pitfalls of such a restrictive taxonomy, the change is clear, and it is sweeping.

Second, the past decade has been marked in most countries by a sharp real depreciation of the exchange rate, suggesting that the exchange rate has moved toward its equilibrium level. Chart 1 presents a perspective on this issue. The chart covers 36 countries, which are all the countries in the Fund’s African Department, with the exception of South Africa and those countries where the breakdown of civil order precludes the continuing relevance of standard economic analysis. The countries in Chart 1 are classified into three groups: the CPA franc countries; Nigeria, singled out because of its size; and 22 other countries. The feature that is common to all three groups is the sharp loss of terms of trade in 1985-94; the feature that differentiates them is the behavior of the real effective exchange rate, which adjusted early and massively in Nigeria, gradually but thoroughly in the 22 other countries, and belatedly in the CFA franc countries. Notwithstanding the differences, the eventual response of the exchange rate has been general, and the real depreciation has been massive. While a “massive” depreciation is not necessarily “adequate”--and besides shifts in terms of trade, there are many other determinants of changes in equilibrium exchange rates--at least some significant progress toward equilibrium must have been achieved. 1/

CHART 1

EXCHANGE RATES AND TERMS OF TRADE, 1985-94

(Index 1985=100)

A01ct01

It is difficult to make broad generalizations about the third postulate--the rollback of monopoly pricing--because of the great diversity of the issues involved. The World Bank’s recent Policy Research Report on adjustment in Africa (World Bank, 1994) provides an extensive review of the subject, and suggests a mixed picture. Notable progress appears to have been achieved in decontrolling producer prices in agriculture, as well as consumer goods prices. However, achievements appear to have been more limited as regards energy prices, transportation, and other activities commonly involving public enterprises, and progress toward the market determination of interest rates has been uneven.

Finally, many countries have yet to establish flexible control over domestic demand. Real interest rates, conveniently measured by the central bank discount rate at year-end, and the average rate of change in the CPI in the previous year and in the following year, were negative in 1990 in at least 7 of the 36 African countries in Chart 1; that number had only declined to 6 in 1993. Regarding fiscal policy, 23 of these countries experienced deficits, over and above grants received, in excess of 3 percent of GDP in 1990, a number that rose to 30 in 1993; more fundamentally perhaps, in many countries, revenue mobilization continues to be the Achilles heel of macroeconomic stability.

(2) Notwithstanding the shortcomings in financial control, economic growth has responded favorably to the policy adjustments described above. Positive views of the growth performance of the African continent are usually greeted with more than a grain of skepticism. One reason for this lies in the unwarranted lumping together of diverse experiences, or, put another way, the failure to distinguish between heterogeneous country groups (Hadjimichael et al., 1995). African economic aggregates that include those countries where, as mentioned, civil order has collapsed are of little significance. Furthermore, a proper characterization of country groups must allow for the markedly delayed response of the real exchange rate to losses in terms of trade in the CFA franc countries, relative to the rest of the continent. Thus, the country groupings used in Chart 1 provide a minimum degree of disaggregation for any sensible assessment of African output performance.

On this basis, the facts of African economic growth since 1985 are reported in Chart 2. Both Nigeria and the group of 22 countries have achieved real GDP growth averaging about 4 percent per annum in 1985-94. This is remarkable, considering that Nigeria suffered a terms of trade loss of no less than 50 percent in the period, and the other countries a loss of 26 percent. By contrast, the CFA franc countries have attempted to overcome a 41 percent terms of trade loss while avoiding a nominal exchange rate realignment; the cost has been a stagnation of output throughout the period.

CHART 2

REAL GDP, 1985-94 1/

A01ct02
Source: ETA Tables, March 1995.1/ Index, 1985=100; at 1990 prices and U.S.$ exchange rates, log scale.

The main conclusion is that economic growth has been strong among those countries whose policies have evolved in line with the growth strategy outlined above. In fact, 12 countries 1/ achieved annual real GDP growth in excess of 4 percent in 1985-94. This result is impressive, even though population growth and technical progress should, in normal circumstances, amply warrant it; that such a rate of growth could be sustained by many countries over an extended period of time despite the strong terms of trade losses is testimony to the powerful effects of removing the restraining influence of previous adverse policies.

III. The Savings Frontier

As the more immediate policy impediments are being removed, the new frontier of sustained growth is the limited availability of domestic savings. The need for high domestic savings is rooted in the demographic conditions of the continent: with an extremely high rate of increase in the labor force over the foreseeable future, African countries need to generate large additions to the capital stock to support the required increase in employment. The same doctrine that provides a perspective on growth, as discussed above, is also helpful in addressing the savings frontier.

1. The stylized facts of economic growth of developing regions over the past two decades are summarized in Table 1. Estimates in this table are drawn from background studies for the Spring 1993 World Economic Outlook and the 1991 World Development Report. It is hardly necessary to caution that they are subject to a fair degree of uncertainty; indeed, there are significant discrepancies between the two sets of estimates, in part owing to differences in geographic and historical coverage. It is more helpful to focus on the elements of consensus:

  • In Africa as in other regions, the average growth rate of employment has been on the order of 2-2.3 percent over the past two decades.

  • Average apparent labor productivity has risen significantly in all regions, although the estimated gains vary considerably among regions and wide discrepancies prevail between estimates in the two sources; variations in apparent labor productivity are largely related to variations in total factor productivity.

  • Apparent labor productivity growth in Africa has been positive, but lower than in other regions. The average gain is put at 0.3 percent per annum by the World Development Report, as compared with a developing country average of 1.1 percent; the WEO estimates are 1.4 percent and 3.2 percent, respectively. The lower labor productivity gains in Africa would be reflective of lower TFP gains; the gap is put at 0.5 point by the World Development Report and 1.1 points by the WEO.

Table 1.

Developing Countries: Factor Inputs and Economic Growth

(Annual average growth rates, in percent)

article image
Sources: Based on World Bank, World Development Report, 1991 (p. 43), and IMF, World Economic Outlook, May 1993 (p. 48).

2. Current trends imply a major acceleration of the supply of labor in Africa. The World Bank’s (1989) Long-Term Perspective Study (LTPS) puts labor force growth in sub-Saharan Africa in the 30 years to 2020 at 3.3 percent per annum on average, that is, half again as fast as in the previous two decades, and half again as fast as in the recent experience of other regions (Table 2). This projection implies that 350 million new jobs are needed over the next 30 years, compared with the existing employment of 200 million.

Table 2.

Africa: Long-Term Employment Trends, 1990-2020

article image
Source: World Bank (1989).

Annual average growth rate in percent.

3. Attendant on the projection of a rapid labor force growth is a need for large investment effort. The link is provided by the usual growth accounting model in a Cobb-Douglas framework. The investment ratio (I/Yx) that is required to support the creation of new employment is related to the projected labor force growth (nx) and to the desired trend of labor earnings by the following relation:

I/Yx=[nx+δt1a+w/px1a]σ,

where σ is the capital output ratio

  • δ is the rate of depreciation

  • w/px is the target growth rate of real labor earnings

  • t is the growth rate of total factor productivity, and

  • a is the labor share of value added.

Concretely, it is assumed here, based loosely on the indications of Table 1, that real labor earnings would rise at a rate of 1 percent per annum, that total factor productivity gains would accelerate to 0.5 percent per annum, and that the capital/output ratio is 3. Under these and further assumptions, an annual employment growth of 3.3 percent (in line with the labor force assumption) will require an annual investment ratio on the order of 30 percent. 1/ The conclusion is sensitive to the assumption for the capital/output ratio; a capital/output ratio of 2.5 would imply a required investment ratio of the order of 25 percent, which happens to be the LTPS figure.

This analysis provides a basis for the statement that there is a need to sharply increase the investment ratio in sub-Saharan Africa. The average investment/GDP ratio in 1986/93 for sub-Saharan Africa, excluding South Africa, was 18 percent (Hadjimichael et al., 1995). The above discussion suggests a need to target a ratio of 25-30 percent, not unlike the ratios achieved in Southeast Asia in the 1980s. The additional effort required is thus on the order of 7-12 percent of GDP.

The approach can also provide a benchmark for the additional investment effort that is required of each African country, depending on its specific circumstances. With the above parametric assumptions and a capital output ratio of 3, the relationship of the required investment ratio to the projected labor force growth becomes:

I/YX − 3 nx + .195,

which provides an equilibrium schedule noted “I I” on Chart 3. Against this schedule, Chart 3 plots for each of a number of countries the projected growth rate of the working-age population and the actual investment ratio, 1990-94 average, as reported in Table 3. Most country plots lie well off to the left of Schedule I I; the horizontal distance to that schedule provides a graphic illustration of the shortfall of investment, relative to the employment target that would accommodate the projected labor force growth. While the arbitrariness of imposing a unique set of parameters to a diverse group of countries limits the conclusions that can be drawn in respect to any single country, it is clear that, in the general case, a large additional investment effort is required to support adequate employment creation. (The major exceptions include Mozambique, and a few countries with small populations, where, for diverse reasons, the influx of foreign financing is particularly large).

CHART 3.

Selected African Countries: Labor Force Growth and Investment Ratios

(In percent)

A01ct03
Source: Table 3.
Table 3.

Selected African Countries; Population and Investment

(In percent)

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Sources: World Bank, World Development Report, 1991, and IMF, World Economic Outlook, 1995.

These outliers are not plotted on Chart 3.

Weighted.

Based on the assumptions of page 13.

4. Additional savings will need to be marshaled to support the required acceleration of investment. For sub-Saharan Africa, excluding South Africa, domestic savings averaged 11.2 percent of GDP in 1986-93, and foreign savings were close to 7 percent (Hadjimichael et al., 1995). While the foreign contribution may remain high or even increase somewhat if African economies manage to attract sustained inflows of direct investment, the bulk of the additional savings would need to be domestically generated.

How will these additional savings be mobilized? In the first place, as noted by Hadjimichael et al. (1995), “the main message that emerges from the existing empirical literature is that, broadly speaking, the same macroeconomic indicators that are correlated with growth over periods of as long as two or three decades are also correlated with the rate of investment.” In particular, inflation or foreign exchange market disequilibria have a significant adverse impact on capital accumulation (Fischer, 1993). Thus, a stable macroeconomic framework of the kind described in Section 1 is also conducive to improved savings and investment performance.

Second, fiscal policy can make a major contribution. Government savings and investment are presently low in Sub-Saharan Africa, and it would not be unreasonable to expect that they could rise significantly over the medium term in the context of a sustained growth strategy.

Third, private savings need to be actively developed, over and beyond the favorable impact of establishing a stable macroeconomic framework. Of particular importance is the need to develop the housing construction sector, a formidable source of employment and savings mobilization. Also required is a sharp expansion of targeted efforts to promote small businesses, and particularly to improve their access to credit. A striking feature of the projection of employment in the World Bank’s Long-Term Perspective Study (Table 2) is the view that the small and micro-enterprise sector would provide the bulk of new employment in the coming decades. This sector also offers a potential for considerable savings mobilization; however, lack of access to credit is a major impediment. Thus, well-targeted micro-enterprise credit schemes should have a large role to play in Africa’s future.

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1/

I am grateful to A. Basu, J. Clément, E. Maciejewski, R.C. Williams, and participants in an IMF Institute seminar for very helpful comments, and to G. Windsperger for research assistance.

1/

Statement by Mr. Michel Camdessus, Managing Director of the International Monetary Fund, before the United Nations Economic and Social Council, Geneva, July 11, 1990.

1/

See the survey of exchange and trade liberalization in sub-Saharan Africa in the early 1990s by G. Terrier in Dhonte et al. (1994).

2/

Based on a background questionnaire for “Economic Trends in Africa” (Dhonte et al., 1993).

1/

The linkage between terms of trade changes and changes in the equilibrium exchange rate is clearly expressed in Khan and Ostry (1992).

1/

Botswana, Cape Verde, Ghana, Kenya, Lesotho, Mauritius, Mozambique, Nigeria, Seychelles, Swaziland, Tanzania, and Uganda.

1/

It is further assumed that the rate of economic depreciation is .05, and the labor share is two thirds (on this latter point, see M. Knight et al., 1993).