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Economic Alternatives for Sub-Saharan Africa: MDG-Based Policy Implications

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. Does Africa Suffer from a ‘Poverty Trap’?.

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Economic Alternatives for Sub-Saharan Africa: MDG-Based Policy Implications

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  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)

  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, 1990-2003) • 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. Growth-Oriented Policies for Africa • Need for a ‘Post-Stabilization’, MDG-Oriented Policy Agenda • Move From Stabilization to Capital Accumulation: • Improve Public Finance • Focus on Public Investment • Avoid ‘Inflation-Targeting’ • Gear Financial Policies to Investment • Spend and Absorb ODA

  6. 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: • VAT compensates for only 30% of lost tariff revenue after trade liberalization in poor countries • Do not greatly reduce top rates on corporate and personal income (this is ineffective)

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

  8. 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’

  9. Fiscal Deficits in Africa(% of GDP)

  10. Improve Public Finance • How to Add Revenue of 5-6% of GDP: • About 2% of GDP from relieving debt service • About 2% of GDP from restoring, at the minimum, 1990 levels of ODA • 2-3% of GDP from additional domestic revenue (adding revenue of 2% of GDP is common over the medium term and easier below 15%)

  11. Focus on Public Investment • The Central Role of Public Investment • Stimulate Aggregate Demand • Expand Productive Capacity • Focus Resources on the Poor • Public Investment has been in long-term decline in many countries—e.g., Africa • By raising private-sector productivity, public investment can ‘crowd-in’ private investment

  12. The Decline of Public Investment

  13. 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

  14. 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

  15. 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 2000-2003 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)

  16. CPI Inflation Rates (% per year)

  17. 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?

  18. 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

  19. 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

  20. 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)

  21. 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

  22. 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)

  23. 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

  24. 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

  25. 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

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

  27. 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

  28. 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

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