1 Economic Alternatives for Sub-Saharan Africa: MDG-Based Policy Implications Terry McKinley International Poverty Centre, Brasilia MDG-Based National Development Planning Training Workshop, Dar es Salaam, Tanzania 27 February – 3 March 2006

2 Does Africa Suffer from a Poverty Trap? Gross domestic savings are low: 17% of GDP in 2003 Net National Savings are lower: 6% of GDP The Implication: ODA is necessary to scale up public investment What will be the impact of a Big Push in ODA on National Savings? How can domestic resources be: 1) raised and 2) directed to investment?

3 Gross and Net National Savings (% of GNI, 2003) Low- Income Countries East Asia & Pacific South Asia Sub- Saharan Africa Gross National Savings Net National Savings

4 Did Domestic Savings Contribute to Growth in Success Cases? 14 African countries are on track to halve extreme income poverty by 2015 (1.5% per capita yearly growth, ) Their investment is relatively high (20% of GDP) But little correlation exists between their Growth and Domestic Savings ODA (& FDI) have financed investment Over time Domestic Savings has not improved

5 Country Gross Domestic Savings % of GDP, 1990 Gross Domestic Savings % of GDP, 2003 Benin2 5 Ghana Tanzania Uganda1 7 Burkina Faso 5 4 Ethiopia7 1 Guinea18 7 Mauritania5 3

6 Growth-Oriented Policies for Africa Need for a Post-Stabilization, MDG-Oriented Policy Agenda Move From Stabilization to Capital Accumulation: 1. Improve Public Finance 2. Focus on Public Investment 3. Avoid Inflation-Targeting 4. Gear Financial Policies to Investment 5. Spend and Absorb ODA

7 Improve Public Finance The Revenue Base of most developing countries is too small, not too big Revenue needs to reach 20-25% of GDP Many African states command less than 15% A priority is to boost revenue to this minimum threshold So avoid Potential Revenue Losses: 1. VAT compensates for only 30% of lost tariff revenue after trade liberalization in poor countries 2. Do not greatly reduce top rates on corporate and personal income (this is ineffective)

8 Improve Public Finance Maintain vertical equity in tax systems where possible 1. Property taxes, such as on urban real estate 2. Excise taxes on luxury items 3. Maintain moderately high rates on corporate profits (except for small enterprises) 4. Direct and Indirect taxes will grow as the formal sector grows -- Build and maintain a buoyant system -- Build and maintain a buoyant system

9 Expanding Fiscal Space Governments should be able to run moderate fiscal deficits (3% of GDP) Monetization of deficits: under-funded states need revenue from an inflation tax Africa: primary deficits 1.6% of GDP but overall deficits 5% of GDP The large external debt remains the initial problem for expanding fiscal space

10 Fiscal Deficits in Africa (% of GDP) Primary Deficit Overall Deficit

11 Improve Public Finance How to Add Revenue of 5-6% of GDP: 1. About 2% of GDP from relieving debt service 2. About 2% of GDP from restoring, at the minimum, 1990 levels of ODA % of GDP from additional domestic revenue (adding revenue of 2% of GDP is common over the medium term and easier below 15%)

12 Focus on Public Investment The Central Role of Public Investment 1. Stimulate Aggregate Demand 2. Expand Productive Capacity 3. Focus Resources on the Poor Public Investment has been in long-term decline in many countriese.g., Africa By raising private-sector productivity, public investment can crowd-in private investment

13 The Decline of Public Investment Region1970s1980s1990s East Asia Latin America Middle East South Asia Sub-Saharan Africa

14 Focus on Public Investment The state has to ensure adequate economic and social infrastructure: This is part of accelerating capital accumulation Fiscal retrenchment has led to depletion of public capital stock In low-income countries, the ratio of public investment to GDP should be higher than in rich countries Public investment is one of the most concrete ways to stimulate private-sector development

15 Avoid Inflation Targeting Moderate Rates of Inflation (5-15%) are compatible with growth Targeting 3-5% can dampen growth (through high real rates of interest) In Africa, part of inflation is cost-push (Food, ToT shocks, rising oil prices) Role Reversal needed: Monetary policy should be subordinate to fiscal policy Gear the interest rate to long-term growth

16 Avoid Inflation Targeting The real interest rate should equal the sustainable growth rate of GDP per capita (No more than 3%?) Average inflation in Africa was under 12% in and under 8% in 2004 Cost-push factors can keep inflation higher than 5% Raising interest rates to keep inflation low cannot address demand shocks (oil prices)

17 CPI Inflation Rates (% per year) Africa39.8%20.6%11.8% Developing Countries 53.2%13.1%5.7%

18 Avoid Inflation Targeting High real rates of interest (e.g., 10%) are grossly misaligned Gear monetary policy, as well, to real variables: growth, employment, income poverty Poor households suffer from under- employment and lack of income as well as high prices Why do we focus only on inflation as the primary problem?

19 Exchange Rate and Capital Management Policies Policy instruments are needed to balance both the current and capital accounts Since the exchange rate is not wholly market-determined, use a managed float Combine a managed float with regulation of the capital account (e.g., capital outflows) Otherwise there can be no independent monetary policy

20 Link Macro-policies to Growth Four policy instruments: fiscal, monetary, exchange-rate and capital-account policies Fiscal policies (mostly public investment) should focus on growth Previously, macro-policies were focused on stabilization: none were focused on growth Financial policies should focus on private investment

21 Gear Financial Policies to Investment Financial liberalization has been neither pro-growth nor pro-poor Banks provide short-term, high-cost credit: working capital, T-Bills, consumer durables, trade High and Rising Interest-Rate Spreads (from 8 to 12 ppts) have dampened savings and investment Banks hold large amounts of excess reserves (idle national savings)

22 Gear Financial Policies to Investment Banks Short-Circuit Capital Accumulation (Even the accumulation of public revenue) Why is this the case? What can be done to improve their functioning? Two Strategic Options: 1) Provide incentives to private banks to lend for productive investment and social purposes 2) strengthen public banks to serve these objectives

23 Gear Financial Policies to Investment Various Policy Options: Develop longer-term public debt instruments: relieve short-term pressure of domestic debt Experiment with deposit insurance programmes: the need to boost savings Use differential reserve requirements: direct credit to certain sectors (those with employment intensity or high employment multipliers)

24 Gear Financial Policies to Investment Provide partial loan guarantee schemes Example: Recent recommendations from a UNDP draft Report on an Employment Targeted Economic Program for South Africa Proposal provides guarantees for 25% of productive investment in the country Guarantees cover 75% of loans and assume a 15% default rate Projected Cost: 1-2% of national budget

25 Gear Financial Policies to Investment Publicly Owned or Controlled Banks: What have been their strengths and weaknesses? Strengthen Agricultural Banks and SME Banks: for pro-poor growth Strengthen Development Banks where feasible: satisfy the urgent, unfulfilled need for long-term loans

26 Spending and Absorbing ODA Key Question: will an upsurge of ODA weaken international competitiveness? ODA should enable the government to spend more (run a larger deficit) ODA should finance a larger trade gap (more imports, less exports) Some appreciation of the exchange rate is likely to accompany this process

27 Spending and Absorbing ODA Bottlenecks in Domestic Policymaking: 1. Governments are unwilling to spend ODA 2. Central Banks are unwilling to sell forex What Are the Reasons? 1. Governments fear higher inflation and crowding out of private investment 2. Central Banks, fearing financial instability, would rather sterilize (sell bonds), driving up real rates of interest

28 Spending and Absorbing ODA Governments should use ODA to finance increased public investment Governments should use ODA to finance imports of technology and capital goods The private sector should be encouraged to do the same There need be no trade-off between current human well-being and long-term growth

29 The Tragedy of HIV/AIDS ODA is available, in some cases, but cannot be disbursed The Reason: Restrictive Macroeconomic Policies are a roadblock (e.g., budget ceilings) Will such ODA destabilize the economy? Contradiction: This Human Development Crisis has to be addressed quickly Answer: Directly import if possible, spend aid (effectively) and carefully manage the sale of foreign exchange