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Note: This document is from the archive of the Africa Policy E-Journal, published by the Africa Policy Information Center (APIC) from 1995 to 2001 and by Africa Action from 2001 to 2003. APIC was merged into Africa Action in 2001. Please note that many outdated links in this archived document may not work.


Africa: Economic Policy Lessons, 1

AFRICA ACTION
Africa Policy E-Journal
August 2, 2003 (030802)

Africa: Economic Policy Lessons, 1
(Reposted from sources cited below)

The Economic Commission for Africa (ECA) annual Economic Report on Africa, released on July 30, painted a sobering picture of slowed growth rates for 2002 and "mixed" prospects for 2003, while citing successes in some countries. In addition to a continent-wide review, the report also contains detailed studies of Mauritius, Rwanda, Ghana, Gabon, Egypt, Mozambique and Uganda

An earlier E-Journal posting contained summary observations from the report on the current economic situation in Africa. Today's two postings contains the sections from the report's overview with policy proposals emerging from the country studies. The full report is available in PDF format on the ECA website at
http://www.uneca.org/era2003

+++++++++++++++++end summary/introduction+++++++++++++++++++++++

DISTILLING LESSONS FROM THE SEVEN COUNTRIES

The countries profiled in this year's Report reveal the range of African policy challenges. Summarized here are four key challenges in accelerating the pace of development:

I. Escaping poverty--going beyond averages. [below]

II. Achieving fiscal sustainability--exiting aid dependence. [below]

III. Energizing African bureaucracies--enhancing the capacity to deliver. [see part 2]

IV. Moving to mutual accountability and coherence--taking the best route to development effectiveness. [see part 2]

The purpose is to highlight best and worst practices, draw lessons from the experiences of the seven countries, and provide overall policy guidance to African countries. The countries profiled this year are Egypt, Gabon, Ghana, Mauritius, Mozambique, Rwanda, and Uganda.

I. ESCAPING POVERTY--GOING BEYOND AVERAGES

The remarkable consensus and commitment for poverty reduction from governments around the world led to the Millennium Development Goals, to reduce the proportion of people in poverty by 50% by 2015 and to reduce other forms of human deprivation. Even if the absolute poverty goal is achieved and prospects for doing this are good for several African countries deep pockets of poverty will remain within countries. People chronically poor suffer poverty for many years, often for a lifetime, and are likely to transfer their poverty to their children. These are the people who benefit least from economic reforms. They experience social exclusion, because of gender, ethnicity, disability, caste, or social position.They often live in remote ar1eas under harsh agroclimatic conditions.

Recent evidence suggests a strong relationship between poverty and agroclimatic conditions in various African countries (ECA 2002). Large differences in living standards between regions in the same country are correlated with unequal distributions of natural assets, differences in agroclimatic conditions, or differences in geographic conditions, such as remoteness from markets and transport routes (Bigman and Fofack 2000). This is intuitive. Households in remote areas, living on fragile lands, would be expected to have fewer opportunities and face greater risks and vulnerability than households in better-endowed areas. It is also consistent with the fact that poverty is more severe in rural Africa than in urban. Several country profiles underscore this important point the need to focus on spatial and temporal dimensions of poverty. Uganda's solid economic growth averaging 6% a year over the past decade has been accompanied by substantial poverty reduction, but there remain vast regional disparities in the incidence of poverty, with a clear spatial pattern. The more affluent central crescent area around Lake Victoria has made great strides in economic development, while the drier, more disadvantaged northern part of the country has fallen even farther behind. Uganda's case is of concern because the spatial divide in poverty has been accentuated by almost two decades of civil conflict.

The spatial dimensions of poverty are also evident in Egypt, Ghana, and Mozambique. In Egypt--one of Africa's emerging modern economies--the absolute level of poverty has declined, but in upper Egypt it increased between 1996 and 2000. In Ghana, national statistics show a decline in poverty from 52% to 40% over the past decade lifting 2 million people out of poverty. But those statistics mask an increase in poverty in 3 of 10 regions central, northern, and upper east. In Mozambique one of the fastest growing economies in Africa poverty remains stubbornly high at 62% of the population, but it is clearly worse in the north.

The countries covered in this report suggest several ways of tackling spatial-temporal poverty. This overview highlights three particularly innovative strategies: poverty-sensitive distribution formulas for fiscal transfers, public expenditure tracking systems, and private provision of social services.

Government spending should be poverty sensitive

Uganda has found that government expenditures (through various fiscal transfer mechanisms) do not adequately redress regional inequalities. The current transfer payment formula allocates 85% of transfers according to the size of the district population and 15% according to the geographical location, with no consideration to poverty.

The regional distribution of transfers to local governments indicates that the western region has received the largest share (27%), followed closely by the eastern (26%), the central (25%), and the northern (22%), where poverty is highest. But if the transfer payment formula considered poverty across districts, in addition to population and size of the districts, more transfers would go to the northern districts. Such a povertysensitive distribution would allocate 29% to the northern region, 26% to the western, 23% to the central, and 22% to the eastern.

Public expenditure tracking systems

Addressing spatial poverty also depends on how resources are translated into basic services for the poor in such areas as health, education, water and sanitation, and energy. Public spending on these services is often biased against the poor and against rural dwellers. Ghana shows significant inequality in the distribution of educational facilities among the 10 regions and between rural and urban areas. Literacy and enrolment rates are lower in the poorer northern regions, with poor school conditions, low quality, irrelevant curriculums, and a lack of teachers. Accentuating the problems: the higher cost of schooling, with poor parents having to bear any additional costs.

Even when public spending is reallocated towards the poor, the delivery of services too often fails the poor.This may be due to corruption, imperfect monitoring of local government expenditures, and weak capacity of local governments. Rwanda and Uganda have tried to improve services by involving poor people in services through the Poverty Reduction Strategy process and by improving local expenditure monitoring systems.

Uganda has had impressive results with its Public Expenditure Tracking System, introduced in 1996. The flow of intended capitation grants reaching schools shot up from 13% (on average) in 1991-95 to about 80-90% in 1999-2000.

Private participation in service delivery Most public delivery systems are highly centralized, with almost all human development programmes designed and controlled by central authorities. Given the weak national institutions, this centralization reduces the effectiveness of human development efforts. These overly centralized systems focus on inputs rather than outcomes, are associated with low transparency and accountability, and ultimately produce inferior service delivery (Jimenez 1995;World Bank 2000).

To improve service delivery, governments are relying more on private provision and financing, as for health and education in Egypt and Ghana. Private participation in the provision of health services in Ghana is quite intensive, with about 42% of health facilities owned by the private sector. But private facilities are concentrated in the urban areas. Only mission hospitals are predominant in the poor regions. The best way to improve private participation in poor rural regions? Encouraging community-based, NGO-run health and education facilities.

II. ACHIEVING FISCAL SUSTAINABILITY--EXITING AID DEPENDENCE

Many countries profiled in this report depend on foreign aid to fund large amounts of government spending, consumption, and investment. For instance, aid accounts for more than 50% of Uganda's budget, 60% of Rwanda's, and 70% of Mozambique's. Yet there is mounting evidence that aid in large quantities is a double-edged sword initially helping but eventually weakening a country's economic performance (Lancaster and Wangwe 2001). Recent research shows that foreign aid crowds out private investment a damning indictment, because the early rationale for foreign aid (the two-gap model) was to narrow the gap between savings and investment in poor countries (Clemens 2002). Private investment is the most robust variable in explaining cross-country growth. And if foreign aid crowds out private investment, the prospects for greater prosperity in aid-dependent countries are slim.

Nowhere is this more evident than in Ghana, which has undertaken significant reforms over the past 20 years but has little to show in tangible benefits for the majority of its people. The high aid dependence reflected in poor fiscal sustainability has hurt the Ghanaian economy, with fiscal woes providing an important explanation for the lacklustre economic performance. A chronically weak fiscal position resulting in huge budget deficits and associated spikes in inflation often associated with political economy issues heightened uncertainty over the credibility of government policies. This increased the risk premium associated with investing in Ghana, leading domestic and foreign investors to adopt a wait-and-see attitude.

The huge fiscal deficits led to explosions in domestic debt. Financing the domestic debt has crowded out credit to the private sector, further constraining financing options for firms. Financing deficits by issuing high-yielding treasury bills inverted the yield curve for government securities, giving higher rewards to investors in short- dated securities than in long-dated securities.With many investors preferring short-term government treasury bills, private firms have had trouble raising long-term capital. This has also shifted resources from the securities market to the government bill market, leaving the securities market thin and illiquid.

Egypt's fiscal deficit has also been on the rise. Like Ghana, it has seen rapidly rising domestic debt, with interest payments on this debt, along with the wage bill, taking up around half of public expenditure. Because these areas of expenditure cannot be cut back easily, they seriously reduce the authorities' room for maneuver in fiscal policy. With sluggish economic growth and high domestic interest rates the ratio of domestic debt to GDP is likely to continue to rise, posing difficulties in macroeconomic management.

Heavily Indebted Poor Country status confers benefits and risks

Foreign aid provided through concessional loans to many African countries over the past several decades has created large debt overhangs and significant debt servicing obligations. The poor fiscal state of several African countries and their high levels of external debt led the World Bank and the International Monetary Fund (IMF) to develop the Heavily Indebted Poor Countries (HIPC) Initiative. The programme contemplates forgiving a fraction of these countries' bilateral and multilateral debt.

The funds freed by debt relief are to be devoted to effective social programmes, which in the eyes of the multilateral institutions will reduce poverty. In addition, the country is expected to impel broad economic reforms to strengthen the productive sector and increase the potential for growth. An important principle guiding the programme is that in the post-HIPC era the country will achieve "external sector sustainability", and thus not require new rounds of debt forgiveness. The Bank and the IMF (2001, p. 4) have stated this principle in the following way: [B]y bringing the net present value (NPV) of external debt down to about 150 percent of a country's exports or 250 percent of a country's revenues at the decision point, [the programme] aims to eliminate this critical barrier to longer term debt sustainability for these countries.

An important question tackled here is what type of fiscal policy will be consistent with maintaining debt sustainability in the post-HIPC era. As the excerpt above suggests, the multilaterals have focused on policies required to stabilize the ratio of external debt to exports. The Ghana profile shows that a comprehensive answer to the fiscal sustainability question requires going beyond the country's external debt to the sustainability of aggregate public sector debt, including both foreign and domestic debt. Ghana has accumulated a significant stock of domestic debt, purchased by the local banking sector, pension funds, and individuals. Indeed, by ignoring domestic debt, sustainability analyses may underestimate the fiscal effort that poor countries will have to make in the post-HIPC era.

Such large fiscal adjustments could have important political economy consequences (Edwards 2002). First, the adjustments may reduce the funds available to implement the antipoverty programmes. And second, very large reductions in primary expenditures may lead to political instability and backtracking on reform.

Slipping back into the debt trap

Unless HIPC countries, such as Ghana, Uganda, and Rwanda, receive substantial concessional aid in the future, their public sector debt is likely to become unsustainable once again. Uganda, the first country to graduate from the enhanced HIPC programme in 2000, is in a difficult situation. The debt and debt service indicators in net present value terms show that its debt sustainability has not improved since it received HIPC debt relief. The net present value of debt to exports ratio increased from 170% in 2001 to 200% in 2002 and is projected by the IMF to increase to 208% in 2003, well above the threshold of 150% under the enhanced HIPC framework. Similarly the net present value of the debt-GDP ratio is projected to increase from 20% in 2001 to 22% in 2003.

The reason for sliding back into the debt trap: without large volumes of concessional assistance, these countries would be forced to undertake major fiscal adjustments to achieve sustainability (Edwards 2002). Adjustments of this magnitude usually crowd out social expenditures, including poverty alleviation programmes, and tend to create political economy difficulties.

The optimal size of a fiscal deficit

The fiscal sustainability question in Rwanda is slightly different. Tensions are emerging between the requirements for macroeconomic stability and for poverty reduction and post conflict construction. The fiscal deficit, on the rise in recent years, is projected to remain high over the medium term. The reason is the increase in public expenditures to address poverty reduction goals set out in the Poverty Reduction Strategy and the need for post-conflict reconstruction for demobilization and for establishing peoples courts, the genocide survivors fund, and governance commissions. Some development partners recommend that a country like Rwanda, with large fiscal deficits financed by grants and international borrowing, should reduce the deficit in the medium term rather than mobilize additional resources.

Further contradictions have emerged with Rwanda's HIPC status. The use of exports in the HIPC debt ratios implies that absolute levels of debt per capita will be particularly low for a closed economy, such as Rwanda. This has increased the debt relief but it will also reduce the possibilities for new borrowing. So, over the medium term, rising spending needs for poverty reduction and post-conflict reconstruction mean that Rwanda is unlikely to adhere to low debt to GDP ratios as required by HIPC.

The reason? Doing so would reduce the government's ability to contract new loans. It is clear that adherence to HIPC debt ratios has hidden costs that may easily outweigh the benefits.

Several lessons from Rwanda question the relevance of current modalities in the HIPC programme. First, as illustrated in the profile, Rwanda's underlying debt sustainability indicators appear to be flawed. Much of the sustainability analysis by the World Bank and IMF is based on rather optimistic assumptions for future economic performance, the external environment, and projected financing needs.

Second, macroeconomic sustainability cannot be divorced from political sustainability. The legacy of violence must be considered, especially with past civil violence a strong predictor of future violence. The needs of social and political reconciliation are therefore critical. And a macroeconomic programme that does not address these issues could be dangerous.

An alternative to the HIPC criteria would be to link debt relief to a proportion of revenues needed for essential spending, possibly with different limits set for different groups of countries. One proposal is to add a criterion for countries emerging from conflict putting an upper limit to the fiscal revenues used for debt servicing. HIPC needs must also take greater account of external shocks and the critical role of declining terms of trade in the buildup of debt, an issue so far neglected (Birdsall and Williamson 2002; Nissanke and Farrarini 2002).

Even strong performers are concerned about fiscal imbalances

The Mauritius profile highlights another angle in fiscal sustainability. With stellar macroeconomic performance, the economy grew 5 6% a year over the last 20 years. Inflation remained in single digits. And the fiscal deficit averaged about 4% a year between 1985 and 1999. But in 2001 it jumped to about 6.7% of GDP, and for 2002 it is expected to remain around 6% 6.5%, narrowing to previous levels from then onward.

These higher deficits are the result of a massive investment programme by the government to prepare the Mauritius workforce and infrastructure for economic diversification away from the traditional sectors of sugar, textiles, and apparels, now losing their potential as engines of growth, and towards a knowledge-based economy. There is concern among some development partners that higher deficits will threaten fiscal sustainability. The analysis here shows that this may not be the case.

The main issue is to resolve the tension between higher deficits in the short term and investment that may yield higher returns in the medium to long terms.

A smooth exit requires a strong private sector

Exiting aid dependence and improving the fiscal position of African countries will require governments to implement policies and use resources to promote growth that will expand public revenues and obviate the need for future aid.

A strong private sector is critical to achieving this goal. Only through a strong private sector that contributes to the state's coffers will the abysmally poor fiscal position of African countries be improved. The point is not that countries should not improve tax administration and reduce leakages due to inefficient spending it is that they should also take actions to broaden the tax base, so that they can get more tax revenues for the same marginal tax rate.

Managing the transition to less development assistance and more private capital flows will require a combination of measures to increase domestic resource mobilization, provide greater debt relief, reform the current aid regime, improve market access, and enhance the policy environment. This will include improving the business climate strengthening corporate governance, commercial justice systems, and the regulatory environment. It will also include improving pricing and access in electricity, transportation, and telecommunications, igniting the private sector's supply response.

+++++++++++++++++++++Document Profile+++++++++++++++++++++

Date distributed (ymd): 030802
Region: Continent-Wide
Issue Areas: +economy/development+


The Africa Action E-Journal is a free information service provided by Africa Action, including both original commentary and reposted documents. Africa Action provides this information and analysis in order to promote U.S. and international policies toward Africa that advance economic, political and social justice and the full spectrum of human rights.

URL for this file: http://www.africafocus.org/docs03ej/eca0308a.php