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Can the “invisible hand” solve Africa’s poverty?

Thursday, October 13, 2011
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At last night’s Senior Economics Society at Oundle we had a riveting talk by Hywel Rees-Jones, Managing Director of CDC, which covered so many areas of the issues of development economics. The talk was entitled “Can the invisible hand solve poverty in Africa?” Whilst conceding that some of the statements were broad generalisations across a variegated continent, Hywel discussed some of the key issues facing Africa.

CDC is a Development Finance Institution (DFI), owned by the UK Government’s Department for International Development. Their aim is to be a pioneering investor, stimulating the private sector and demonstrating the power of enterprise and private capital to reduce poverty in the poorest places of the world - to harness the power of the private sector in reducing poverty.

The key message was that CDC feels that there are many impediments in Africa which has prevented Adam Smith’s “invisible hand” to function efficiently; which have particularly deterred private sector capital flows and investment, for value-generating activities.

Hywel had some fascinating anecdotal evidence of his experiences of having spent many years working across different countries in Africa.

Here are some of the key things that were discussed:

- Whilst GDP/capita is not a perfect measure of wellbeing, there is a pretty good correlation between the HDI and GDP/capita rankings (excluding the oil producers, the correlation coefficient is close to 0.8).

- In 1960, South Korea had a lower GDP/c than Ghana

- By 2010, South Korea’s GDP/c was 16x higher than Ghana, so what has been some of the key issues?

What have been the main impediments to growth in Africa?

o Conflict: Over 1/3 of the economies in Africa have suffered some kind of warfare from Rwanda, Sierra Leone, Eritrea, Uganda, Somalia

o Fiscal imbalances: New governments in Sub-Saharan Africa (SSA) have wanted to do lots of positive things with the finances they have had access to, but there has been a lot of mismanagement / government failure.

- Many foreign donors who have given aid to build hospitals and schools have not considered the longer run recurrent/maintenance costs of these projects, which many local governments cannot afford, such as the salaries.

- With a narrow tax base, governments have borrowed and become heavily indebted. In this race to the bottom, governments have had to offer even more attractive interest rates on their borrowing, which has crowded out private sector investment. As banks have taken deposits and used them to buy the very attractive government debt at high interest rates, but this has meant that the private sector has found it very hard to raise funds. Furthermore, the private sector now needs to achieve even higher hurdle rate of returns to make projects viable, deterring investment.

- Many countries (most infamously, Zimbabwe) used the printing press as a way to try to solve their fiscal problems (in the 1980s, a Z$1 bought around US$1.47… by 2007, shortly before its currency was dollarized, US$1 officially bought Z$30,000 (and over Z$600,000 on the black market).

o Trade

- Ricardo’s theory of comparative advantage explains that if countries specialise in the production of the good/service in which they have a comparative advantage, then all countries can move outside their PPF and gain from trade (although how the gains from trade themselves are distributed depends on the actual terms of trade).

- For trade to occur, one of the things you need is an efficient medium of exchange. In many countries in Africa, there is not the sufficient foreign exchange currency to be able to do this. Private firms need this forex to import raw materials, technology etc but commercial banks didn’t have enough access to this. It ultimately led to an overvalued exchange rate, (which whilst causing exports to suffer), also led to a parallel black market exchange rate markets to emerge.

- Government intervention in trade markets led to many distortions. These varied from distorting incentives with tariffs on imports to protect strategic industries, which kept inefficient businesses in business with poor quality goods/services. Furthermore, marketing boards focussed on agricultural products also meant that farmers stopped production of goods that they were the best at producing, and switched to ones that the marketing boards prioritised. This distorted the countries comparative advantage and led to the failure of goods that were key FX earners.

- The welfare gains from trade were very much in favour of wealthy industrialists at the expense of consumers within the countries.

- This has been compounded by the fact that terms of trade have moved against many African commodities in decades past (Prebisch-Singer hypothesis) - less so these days; and EU CAP policies and North American protectionism not having helped either.

- Free trade has not really happened in Africa in the past 25 years.

o Human capital

- With mean years of schooling being around 5 years for the continent, the quality of human capital still needs work.

- Given local governments have issues of paying its teachers, many teachers are often absent from schools (‘ghost schools’ in Tanzania).

- This has led to certain social networks to grow, whereby parents have got together in local areas to pay directly for teachers to school their children.

o Health

- From malaria to TB, health issues are a big concern in Africa still. This has impacted productivity rates (despite having cheap nominal wages, relative unit labour costs have risen in light of this). This is costing Africa some of its comparative advantage.

o Power

- It wasn’t until the 1980s that the UK saw electricity and gas boards privatised, rather than being natural monopolies regulated by the government. This still hasn’t happened in much of Africa. SOE’s, with their fiscal constraints and capital expenditure restraints suffer from myopia and short termism.

- When the rains fail, and a lack of hydro power, and electricity generation power, power cuts ensue which impacts international competitiveness, which in turn affects manufacturing sectors, particularly those who operate in industries that involves processing such as diary (where these power cuts lead to huge inefficiencies through wasted batches being spoilt).

- In the absence of power, people turn to generators, but the price of creating energy in this way is about 3.4x more than using power stations, adding to inefficiencies.

o Telecoms

- It wasn’t until 1984 that the UK telecoms industry was privatised, which led to choice, innovation and price falls. Africa on the other hand still had the landline state-monopoly model – with many places such as Lagos having industries that revolved around hand-written message runners, sending messages from building to building.
o Regulations
- It could take up to 30-40 steps to start a business, putting off entrepreneurship drives. Compounding this, many investors faced uncertainty regarding taxes, with one anecdote referring to how tax inspectors could decide arbitrarily, if there was a shortfall in tax revenues for a particular month, to tax a particular firm, or freeze bank accounts until more taxes were paid.

But there is room to be optimistic!!
o Whilst the Structural Adjustment Programmes of the World Bank and IMF in the 1980s had its critics, they did impose conditions of finance which helped engender fiscal responsibility and market deregulation. For example, the budget deficit as a % of GDP for example for Korea and Sub-Saharan Africa is better than the EU and UK. Indeed, for 2011, it is forecast to be an average of 4%, for 2012, 3%... whilst the UK’s is 10%. Ironically… much of Africa would be eligible for the Eurozone’s Stability and Growth Pact, whilst most of the Eurozone/European countries would fail!
o This has helped reduce interest rates, and helped people who are looking to invest.
o A sound macro platform is being developed, with inflation running at 4.4% in the UK, but 2.5% average in SSA.
o Floating exchange rates have become the norm, allowing more FX flows.

o Whilst the Structural Adjustment Programmes harmed education and healthcare programes (due to the fiscal tightening), private provisions for schooling to the poor has been rising. One such scheme is the Bridge International Academies finance model for Nairobi. It utilises the significant collective spending power of the poor who make up the “bottom of the pyramid” – by for example, being able to send a child to school for $4/month. It adopts a prescriptive teaching approach, that does not require skilled teachers, but gives the basic literacy requirements a child should have (A “School in a Box”).

o SSA hasn’t yet embraced the need to generate power. For example the combined power generation capacity of the 48 countries of SSA is 68 Gigawatts – no more than Spain’s. Excluding South Africa, this figure falls to 28 GW, equivalent to the capacity of Argentina (except Argentina has a population of 40 million and Africa has 770 million) (or more starkly, it’s the same as Norway’s generation capacity, but Norway only has 5 million people). Less than 30% of the population of SSA has access to electricity, compared to 90% in East Asia. 71% of SSA’s electricity comes from S. Africa.

o The telecoms market has been deregulated in many areas, including Nigeria where there has been a huge growth in private mobile phone providers – Pay-As-You-Go has become incredibly popular, with thousands of jobs created in this industry (at the expense of the hand-written message deliverers!). They have leapfrogged the first and second-generation technologies, moving from landlines to 3G and fibre optics. Vodafone has done FDI via a group called Safaricom, and introduced a product called M-pesa in Kenya, which allows bills, wages, groceries, to be paid via a mobile phone (like a more secure version of a credit card/cash). In April 2007, over 15% of the Kenyan population were using this method. Broadband has not really taken off yet in Africa (the digital divide) with only 2 per 100 people being connected broadband (compared to say 70/100 in USA). Africa has however got a fibre optic network across the continent now, which doesn’t rely on satellite networks. Information is no longer the preserve of the rich that it used to be, and it has allowed more efficient trade to take place (deliveries, meetings, trade can all take place so much more efficiently now).

o Microfinance from Bangladesh is on the rise in Africa – the idea that poor people can actually be good creditworthy borrowers.

o Corruption and democracy is still an issue – although there were 28 elections in Africa in 2011.

o In 2000, there was only $14 bn of FDI into Africa; by 2008, this had risen to $72 bn – much of which was centred on mining, oil, and gas
sectors (driven by the Chinese). Recently PwC announced they were focussing on Africa as a key area of growth.

o Population: By 2030, Africa is forecast to have the largest workforce in the world, which will attract investment.

The building blocks for Africa to utilise the invisible hand are getting there. SSA grew at 4.9% in 2010, and forecast for 2011 is 5.8% (UK grew at 1.3% in 2010, and will not be far off that, if not lower in 2011). 6 out of the 10 fastest growing economies last year were in Africa. Within the next 50 years, poverty in Africa should be down to a few pockets, as opposed to the current 51% who live on less than US$2 a day. Hywel’s belief is that this will all be down Adam Smith’s Invisible Hand.

Questions from the floor:

- Is Dambisa Moyo right on the curse of aid? Hywel’s view was that he was sympathetic with Moyo, but there are some things which private capital won’t do in a quick enough time frame, so aid works for the short term wins. But ultimately, as China and Korea have proven, it is economic growth that matters, and that drives success.

- Will green energy be embraced by Africa? Whilst there are options for Africa in terms of renewable energy, such as wind farms in Kenya and S. Africa; geothermal resources in Rwanda and the Rift Valley; hydro resources in the Congo;

- Does the free market never fail? The existence of CDC is to try to prove that the perceived risk perception from private markets is wrong – it is perceived to be higher than it actually is. It is hoped that as funds like CDC prove that there is money to be made from private sector investments, private sector will follow. But if there is the (incorrect) perception that the risk is too high, is that not itself a market failure of asymmetric information? Possibly. But the government failures that have occurred to date mean that the private sector is the only real viable opportunity.

- Where is growth in Africa going to come from? Nigeria, Zimbabwe (after the free market reforms it has instigated since dollarization in 2009), South Africa (if they can get it together, but too many different regions and different conditions so it won’t be easy)

Overall, a thoroughly enjoyable lecture full of lots of relevant macro and microeconomics, on a topic that is no doubt going to shape the future of an entire continent.




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