Growth performance in Africa: further evidence on the external shocks versus domestic policy debate

ECONOMIC COMMISSION FOR AFRICA

Development Research Papers Series

Growth Performance in Mrica:

Further Evidence on the External Shocks Versus Domestic Policy Debate

[CAC

338.24 DRP6 c.:!

Charles Chukwuma Soludo

UNECA Development Research Papers Series No. 6 November. 1993

United Nations Economic Commission for Africa Socio-Economic Research and Planmng DiviSIOn

ECONOMIC COMMISSION FOR AFRICA

Development Research Papers Series

Growth Performance in Africa:

Further Evidence on the External Shocks Versus Domestic Policy Debate

Charles Chukwuma Saluda

UNECA Development Research Papers Series No. 6 November, 1993

United NaOom Economic Commission for Africa Socia-Economic Researcil and Planning Division

problems and their solutions. The aim is to encourage and promote discussions of development research findings and methodologies relating to the African region and to make available to a wider audience the results of research, especially in the areas of basic development policies alld trends, economic projections and forecasting, socio-economic transformation and the dynamics of change, and economic integration.

Additional copies of the published papers can be obtained by writing to:

The Director

Socio-economic Research and Planning Division United Nations Economic Commission for Africa P.O. Box 3001

Addis-Ababa, Ethiopia Tel. (25H) 51 72 00 Telex 21029 UNECA ET FAX (251-1) 514416

The views expressed in the Development Research Papers Series are those of authors alone and do not necessarily represent the views of the UNECA.

Copyright © 1993, United Nations All rights reserved

Printed in Ethiopia

GROWTH PERFORMANCE IN AFRICA:

FURTHER EVIDENCE ON THE EXTERNAL SHOCKS VERSUS DOMESTIC POLICY DEBil.TE·

By

Charles Chukwuma Soludo

UNECA Development Research Papers Series No.6 November 1993

- - .

...

_-

This paper was written whilst the author was a post-doctoral felllow at the Socia-Economic Research and Planning Division of the United Nations E,;onomic Commission for Africa Im-I'jiB.

List of Tables . . . , . . . , , . . . , .. , v

List of Appendix Tables . . . . , , , , , .. , . . . , . , . , , . . . . , . , . , , .. , " v 1. Introduction . . . . , . . . " . . . , . . . , , , . . . . , . . . , , . . ., 1 II, Nature, causes and consequences of extemal shocks in African countries . , .. 4 A, Nature and Causes of External Shocks . " , . . . ' , ' , . , " 11 B. Consequences of the' shocks

...

¹⁵

i. Consequences on govemment revenue-expenditure behaviours 15 ii. Direct conseql.wnces on economic growth . . . , ' , . . 17 Ill. Do domestic policies really matter more for growth? , , . , . . .

A, Government expenditure, Taxation and growth " " "

B, Openness, Trade Regime and Growth . . . , , . . . . , . , C, Financial Intermediation and growth . . . . ,

20

21

22

23 D. Other Macroeconomic Policies and Growth " . . . . " , .. , . . . . ' 25

IV, Model specification and empirical evidence . . . , . . . , ' , . . , . . . , 27 A. Analytical Framework , . . . , . . . _ , 27 B. Model Specification and Estimation results . . . , . , . , . . . . , , . , 29

Appendix Tables . , , ' , . . . _ , 41

References , . . , . , , . , . . , . . . . , . . . . , . , . . . , , . , . , . . , . . . . , . 52

IV

Table 2.1: Africa: Key Macro-economic Indicators . . . . , . . . .. 5

Table 2.2: Africa in 1990 vs. Asia in 1965 Differences in means of Economic & Social Indicators . . . , . . . .. 6

Table 2.3: Real GDP Growth by Sub-Region (at constant 1985 market prices), 1988-92 (Annual percentage changes) . . . 7

Table 2.4: Contribution of Domestic Demand & Trade Balance to GDP Growth (at 1985 constant market prices), 1988·1992 (Percentage points) . . . . . .. 8

Table 2.5: Value of Exports and Imports of African Countries (in million US$) " 9 Table 2.6: Share of Major African Commodity Exports on World Exports . . . .. 9

Table 2.7: Share of Sub-Saharan Agricultural Export Earnings by Crop . . . 10

Table 2.8: External Debt Outstanding and Debt Service Payments for Africa, 1988-92 (USS billions) . . . 11

List of Appendix Tables

Table A-I: Real GDP Growth Rates (1989·1992) . . . 41

Table A - 2: Commodity Composition of Africa's Exports (1989) . . . 42

Table A - 3: Terms of Trade Estimates (1985

=

1(0) . . . 43

Table A • 4: Per Capita GNP and El(ternal Debt . . . 44

Table A - 5: Public Finance Statistics of Africa by Sub-Regions, 1988-92 " ' " 45 Table A - 6: Changes in External Income and GDP Per Capita. . . . 46

Table A • 7: Net total financial flows from all sources (MiUions of US Dollars) . . . , . . . . , .. , . , .. , , , . 47

Table A . 8: Macroeconomic Policies and GDP Per Capita (period average) .. , . 48

Table A - 9: Real Exchange Rate and GDP per capita (index 1980 = 1(0) . . . . 49

Table A - 10: Macro-economic Policies and Export Performance in some· A frical! countries (Average Annual GrO'.vth Rate in Real Exports) . . . " . . . 50

Table A - II: Domestic Policies and Value-added in Industrial Sector (Average Annual Growth Rate) . . . ', . . . 51

v

While ecollOmic growth in all C'oumries follows an S-CUlW, all COImtril'J

do.

nOf necessarily follow tIuJ smrre S-curve. iflStead, the S-curvt'

is squeezed in some

countries,

and

stretched out in

Ol/~rs;

in otMr words, cll/mtries diJfer in tIuJ rlJles

lJI

which they move from one phase to anmher of the logistic po.ttem, and the rlJles

at

which they move within

t'61~h

phase. 'fherefore, an important requireme7ll of grQwth theory is to explain dilferellCes

ill tIuJ

S-CUlW followed

by

diJferem coulllries

lJI

diJferent times (Swulrum 19.90: 273).

It is ilmazing to observe the fluctuations in the fortunes of nations and the great vnri.ltion

iJ1 income levels among countries. Over time, leading economic powers have been relegated to the status of poor performers, and the poor economies of the past have become the /lew economic giants. So also have disparities in income levels widened over Ii me, ranging from a per capita income level of less than USS200 in the least developed countrks of Africa and Asia to over US$20,OOO in the United States, 2.00 some European, Middle East and Asian conntries.

Obviously, countries differ very much in their natural endowments, economic instituthns and political circumstances, location, cultural heritage, and commilrilent to econolnic developrm:nt.

Differences in per capita income may nat therefore be surprising, but the magnitude! of the c.ifferences is one that evokes some curiosity.

The study of business cycles, :hilt is, what determilles the irregularities surrclmding wbatever growth trend aggregate economic activity follows, or more genenuly, what det,;rmines tbe wealth of nations and its evolution ^Q ver time, is at the hean of macroel'.onomics, llnd the question has perplexed economists since the beginning of the di~dpline. Ever since Adam Smith published his seminal work on the determinants of the wealth of nations, several path-b::'t",aking theorie.s of economic growth have emerged in the liternture (see for example, Ramsey (1928), Harrod (1939), Domar (1946), Solow (19.56), Arrow (1962), Romer (1986}, Lucas (198:~), etc).

Most of the theories belong to the neoda.>skal tradition- mainly production fnnction-<iril'en ,md concerned with capital accumulation. When confronted with data, howevl:r, the theorie~ could explain only a fraction of the variations b growth rates and ttli~

rest

was attributed to tc,hnical progress. II needs to be observed that attempts to explain technical progress have not bt.:n very successfuL It appears that in spite of the revival of interest in growth theories since thi' 19505 and 19605, theories of growth are

yet

to resolve the apparent puzzle about the C<·:lse~ of differences in the wealth of nations. In some instmces, these theories have been ac(:usee of irrelevance. A review of growth theori<:s ill the 19705 concluded that ".~rowth ecom.nllCS is guided much more by logical curiosity than by a taste for relevance" (Sen, 1970: 36), and that

"by abstracting from those factofS that determine the growth of tile economy, economic growth models of the vintage ... developed arf~ open to the charge of being irrelevant" (Kr.lUS5 and Johnson, 1974: 334-5). In spite of the: apparent disrepute of the neo-cl:!.ssiCal production functions in explaining the growth procesSf's, tb~ search fOf more plausible theorres has predominantly concentrated around the rdinements and extensions of the production fUHctions.

Surprisingly, there has been very little fOCU3 on the influence of macroeconomiclxJlides and the extemal environment on the grown process. However, the recent attempts by the World Bank and the I.M.F to formulate and ir.sist on the: implementation of their 'growth-oriented adjustment programs' indicate new and growing recognition of the rolf: of macroeclllllJmic policies as growth inducing factors, especially for developing countries. TIle results of the adjustment programmes so far are mixed: some: countries have succeeded in growing out tlf their economic crisis, some had temporary reliefs and redined to wonie economic condition!i, while others have experienced worse economic ,;irculllsl<inces. The:>e events havle. hei,ghtened deba.tes and controwrsies about the efficacy of certain policy instruments to restore growth or .""hether in some countries, especially in Africa, growth could be said to be 'exogf,nously' determined.

Thus, the I1~SUItS of the adjustment programmes so far and the change.i ill the fortum~s of industriaI countries in the last three dc~:ades sugg,est that a lot is still to be learned atuut the determinants of economic growth.

A lot of controversy surrounds Ihe analysis of the causes and appropriate r,;m,!dial measures for Africa's economic stagna.tion. As Ghai, (1991: J.6) aptly notes:

"There has been a tendency, esp/'cially by economists, to single ow inappropriate policies as the culprit in the crisis. W1zile they have played rol~'s of varying imponance in different countrie's

at

differt!rIt times, il stretches credulity to atIribwe a dominant role to lhem in tile interuijication of the crisis in rile 1980s.

1ndeed, as shown subsequently, African co:untries have undenakm signijicaru economic reforms in the 1980s; /;w it is qfren 7IOt clear that these have had a positive effect. On the contrary, they have tended to be overwhelmed by a strong negative international emiroru7wl'U"

Hardly anyone denies that the current ITIRcroeconomic crisis in Africa is a consequence of past policy errors; weak economic structures and negative external shocks. What is ;Jerhaps controversial is the relative weights of the,se sources of si1o<:ks in determining ewnumic performance and thus the nature and IiOllIces of remedial measures require:d. The contmversy is heightened by the hypothesis canva:;:"xI by some policy analysts and donor agenc'ic!s that African countries, through appropriat,~ policies, have full control over their economic development. Specifically, two strands of the debate and prescriptions for actio ns are discernible:

the first school admits that some form of domestic. poJj,;y reform. (but not necessarily the type currently implemented under the structural adjustment prog:ramme, (SAP) ) are neces:,ary; it however argues, ttlat becausf: of Africa's structural dependence on the rest (·f the world and the natlire: of negative external shocks impacting on it, policy reforms would produCl! little or even negative results unless solutions to the a(~verse t~xternal environment are sought..

the other school argues that domestic pol ides are thc~ major determinants of economic growth in Africa, anc tilat while. extemal shocks have some negative

effects, their effects can be outweighed by the effects of policies; it implicitly argues that certain kinds of domestic policies can either aggravate or attenuate and possibly reverse the negative impacts of the external shocks.

A common ground between the two points of view however, is a recognition that negative external shocks can have some negative impacts on growth. But while the later position has been a subject of numerous empirical research especially by staff of the World Bank, the former has relied mainly on casual empiricism.II Yet, interminable debates about the relative impacts of domestic policies and external shocks on growth performance and hence on the effectiveness of alternative remedial measures continue to plague most policy dialogues in Africa. Empirical research efforts to dl;!epen understanding about the controversy can provide policy-maker3 and their analysts with better insights and informed basis for policy actions. The major objective of this study is thus to provide some, albeit tentative, empirical estimates of the relative contributions of the external shock~ and domestic ,macroCCQ!lQIDi(; lIDli;j~ in Africa's growth efforts.

The rest of the paper is organise.J in four sections. Section two provides insights ieito the nature, causes and consequences of external shocks in African countries; while in section three the potentials of domestic policies for determining growth performance are eValuated.

Section four discusses the model specification and empirical estimation results .

. V

There is scarcely as yet any rigorous empirical research that demonstrates the dominant '--_ _ _ _ jm~pa'--c_ts_o"_fexterna1 shocks in determining economic performance in African countries,]

II. Nature. causes and consequences of external shocks in African countries

Analysis of causes and consequences of external shocks in Africa can be beset with problems of aggregation and generalizations from regional data. The 51 African countries are diverse in several important aspects, with differences in siu, structure, and nature of external influences. Negative external shocks for some countries (for examp1.e, oil price increases) may be realised as windfalls in other countries. Regional data may therefore obscure much of the individual differences. For analytical reasons, African economies can be classified at'cording to several criteria depending on the purpose of the study. For example, countries may be classified by income levels- middle and low income countries; geographical contiguity and sub- regional economic groupings such as the Preferential Trade Area of Eastern and Southern Africa (PTA), Economic Community of West African States (ECQWAS). etc; oil exporting or non-oil exporting; countries undergoing structural adjustment programmes (SAP countries) and nOfl-SAP countries; or they may be classified according to the dominant export commodities.

While there may be much in national characteristics and experiences which are peculiar, there are also several similarities across countries which would warrant some generalizations.

Most of the economies share similar structural problems and experienct' similar shocks. Much of the inferences and discussions will refer to the aggrcgate ,\frican experience while emphasising individual country peculiarities where nc,cessary. In some cases, inferences will refer to sub-groups like sub-saharan Africa (which excludes North Africa), and the Republic of South Africa is excluded from all African regional data.

The myriads of Africa's economic woes together with a catalogue of their causes are all too well documented to warrant detailed rehearsal here. In comparison with other regions, Africa remains the weakest (structurally) and poorest region in the world. After an impressive grow~h

performance in the 1960s through early 1970s, African economies experienced stagnation and even deterioration in incomes so much so that by the early 19805, many had lower GDP per capita than they did before independence. A graphic illustration of the level of development of African economies is provided in table 3.2 below. The Table compares the mean~ of some social and economic indicators for Africa in 1990 and three Asian countries in 1965,

Indicators 1988 1989 1990 1991b 1992·

L Real GDP Growth (%) 4.8 4.2 3.4 2.6 1.9

2. Inflation (%) 17.0 17.9 15.9 23.7 19.7

3. Fiscal Deficit (% of GDP) 10.8 8.0 7.5 7.7 6.2

4. Growth of Money Supply (M2)d 22.9 16.0 24.9 17.6 15.5

5. Export Growth, Volume (%) 3.6 -3.4 4.8 3.8 1.7

6. Import Growth, Volume (%) 2.6

.1.3

12.8 -5.2 1.1

7. Terms of Trade -11.9 8.5 9.4 -8.6 -4.2

8. Trade Balance ($ billion) -11.3 -8.6 -1.1 -4.1 -12.4 9. Current Account ($ billion) -15.4 -11.3 -2.5 -4.6 -10.8

10. Current Account (% GDP) -5.1 -3.7 -0.7 -1.4 -3.8

11. Debt Servicing (% of Exports) 26.7 28.7 25.1 28.6 32.4

Source: ADB Estimatesfor 1.2.4.5.6

aJUl 7;

and IMF for

3.8.

9,10 and 11

• African countries except SoUlh I\frica

• Provisional

<

Preliminary estimates

d

Excluding ZaJrefor the year 1991

Note: Items

5 and 8

relate to merchandise trade From I\frican Development Bank (1993, p. 15)

- - -

... -

Characteristics

Table 2.2: Africa in 1990 vs. Asia in

1965

Differences in means of Economic & Social Indicators

Mean Value for For Asia 1965

Indonesia,Malaysia, Thailand

For Africa 1990 All of the countries GDP per capita (USS, ICP)

Agriculture share GDP Manufact. share GDP (%) Saving share GDP (%) Investment share GDP (%) Exports (gnfs) share GDP (&) M2 share GDP (%)

Urban Pop. share (%)

Pri mary Education (% eligible pop.)

Secondary educ. (% eligible pop.) Adult illiteracy (% adult pop.) Population (1000) per physician Infant mortality (per 1000) Life expectancy (year) Population Growth Rate

870.0 37.0 10.30 17.0 16.0 24.3 19.6 18.3 80.0 18.0 35.3 15.0 90.3 52.7 2.7

Source: Policy Research Depanmem, The World Bank (1993, p. 1.16)

658.0 35.3 11.5 8.7 18.1 23.5 19.45 27.9 71.4 17.6 53.0.

20.6 106.9 50.7 3.2

Evidently, Africa was worse-off in 1990 than these Asian countries were 25 years earlier. Over 65 percent of Africa's labour force is engaged in agriculture, and this sector accounts for an average of 40 percent of GDP. Productivity of resources is lowest in Africa, and over half its population is said to live below poverty line.

Table 3.1 above summarises some basic macroeconomic indicators for Africa's 51 countries for the period 1988-92. Table 3.3 indicates growth performances by economic grouping, while appendix table A-I shows real GDP growth rates by countries. While aggregate data indicate positive but declining growth rates (except the ECCAS in sub-regional data), the

country specific data are more revealing. Table 3.4 demonstrates the dominance of private consumption in the GDP and the dismal contribution of trade to GDP.

Tahle 2.3: Real GDP Growth hy Sub-Region (at constant 1985 mark!'\ prices), 1988-92 (Annual percentage changes)

-~~

....

==========~===~==,,;;,,==-,;;"',.,,;,=

... _.

'-~='~--.-.==--=

Sub-region 1988 1989 1990 1991' 1992'

..

^~-

RMCS 4,8 4.2 3.4 2.6 1.9

ECCAS -1.4 -0.7 -2.0 ·2,7 -2.5

ECOWAS 8.2 5.7 6.7 4.] 3.4

MAGHREB 2.4 3,8 2.7 3.2 1.6

PTA 5.1 3.5 2,3 1.1 ^-0.4

NET OIL EXPORTERS 4.8 4,8 4.6 ^{},3 ~} 1. 7

NET OIL IMPORTERS 4.7 2,9 0.9 1.1

0.0

= ~=-"'---="~''':;<e....-",,-=,,-~

Sources: ADB Estimates Notes: • Provisional estimates Africa:

ECCAS:

ECOWAS:

MAGHREB:

PTA:

NET OIL

Regional member countries (RMCs) of the African De,'dopment Bank l!conomic Community of Central African Stales (Burur.di, Cameroon, Central African Republic, Chad,Gabon, Rwanda,Sao T.'Jme awl Principe and Zaire)

Economic Community of West African States (Benin, 8urkina Fas'), Cape Verde, Cote d'Ivoire, Gambia, Gharw, Guinea, Guinea-Bissau, Uberia, Mali, Mauritania, Niger, Nigeria, Senegal. Siena Leone and Togo) Algeria, Libya, Mauritania, Morocco, and Tunisia

Preferential Trade Area of Eastern alld Souther.; Africa (Burundi, Comoros, Djibouti, Ethiopia, Kenya, LesOlho, Malawi, Mauri:ius, Rwanda, Somalia, Swaziland, Tanzallia,

Uganda,

Zambia and Zimbabwe) EXPORTER5:Algeria, Angola, Cameroon, Congo, l::'gypt, Gabon, Ubya, Niseria ami

Tunisia NET OIL

IMPORTERS:Al/ countries excluding the net oil etporters, as defined

above,

From African Development Bank (1993, P. 20)

Table 2.4: Contribution of Domestic Demand & Trade Balance to Gnp Growth.

(at 1985 constant market prices), 1988-1992 (Percentage points)

-_=====~~~~======~~====lli=_=

..

==~4n.~'~_'=<='~=~

Domestic Demand Private Consumption Government Consumption Gross Domestic Investment Trade Balance

Exports of Goods & Services Imports of Goods & Services GDP at Constant Market Prices

Sources: ADB Estimotes

• Provisional

b

Preliminary estimates

1988

5.9 3.5

1.9

0.5

-1.1 0.8 1.9 4.8

From African Development Ballk,1993

1989 1.7 0.0

0.2

1.5

2.5

2.8

0.3

4.2

1990 199i' 1992^b

3.5 2.5

3.1

2.2 2.0

1.8

1.1

0.2

0.6

0.2 0.3 0.7

·0.1 0.1 .1.2

2.3

·0.4

-^0'7 .'

2.4 -0.5 0.5

3.4 2.6 1.9

-,

.--=~.,;=~-===:::=

A major source of shocks to the economies is their stru.ctural deficiencies. These reiarc to weak industrial base, small size economy and dominance of agriculture as economic activity, poorly functioning factor and product markets, limited savings and tax capacities, dearth of skilled labour force, dependence on primary commodity exports, and weak policy instruments available to governments (Killick, 1992:

204-205).

Tables

3.5,

3.6,3.7 and appendix table A-2 reveal a lot about the structural composition and share of Africa's exports in world Llade.

Africa's share of world exports has been declining over the years and in 1992, it accounted for about two percent of world exports. The share of primary commodities in total exports !S (lver 80 percent, and over 60 percent of Africa's trade is with western Europe. Tables 3.6 and 3.7 show the limited number of agricultural commodities exported by Africa. ;\side from tt'..a ~Hd

tobacco, Africa has been losing substantial market shares in the other commodities. In addition to deterioration in export volumes, there has also been severe volatility if! the prices of these commodities with many of the prices consistently declining over the years, In the face of rising import prices, the terms of trade and balance of trade have been deleliorating (;,ee appendix table A-3). The aggregate data however obscure5 the favourable terms of trade cnnditions cnj0yed by some countries over the years.

..

Year

J970 1975 1980 1985 1990 1992"

Table 2.$: Value or ExpOl-ts and Imports

ot

^AtriCllD Countries (in million trS$)

= .' ^- - ⁼⁼

't"III~

Arab Africa Other Africa Total Africa % share of \Vorld Exports Imports Exports Imports EJtports Imports Exports Imports

- - - , ^..

_-

5246 3992 7522 7090 12768 11082

4.1

3A

16298 18889 19628 19586 35926

38475

4.1 4.:1

46106 32229 48554 42011 94660 ^{74240 4.7}

M

28939 27148 33052 27029 61991 54177

3.2

^2.7

34384 39052 39713 37101 74f»7 76153

2.2

^:2.l

33520 38455 32036 32779 655:56 71234 1.8 1.9

= ^~

-'

^{w • •} ':"'iI:."~

• Eslimales

Source:

UNCTAD Commodity flta.rbook (v(ll"iolLl' years)

Table 2.6: Share

ot

Ml\jor Afri<!aD Commodity ExPOIU on World Exports

. . " r~ = = ,:~==::c:

Average 1970-79

(%)

Average 1980--87

(%)

--_._---=---,--

Percentage ch;l1lge between tirsl an.!!

_ _ . ~nd peri.:l«~ _ _

,Cocoa 14.2 65.2 - 12,

J

Blister Copper 44.7 42.4

Coffee 30.3 2:~.5

Cotton 18.4 15.0

Tea 17.5 19.6

Tobacco 9.6 J 2.3

-5, I

·22 1

·185

\2.0 l!U

Sugar 6.1 5.2 . 14.8

.--~=---~,,;:

..

~---=,::=g.

..

-.~=~--,=-~=.,;:,,,,,,",,=

Note:

The shares were

calculated

with ritlla

from

UNCTAD,

Commodif.y,

Y~gl~2.12k (various iSSlN!s)

Source: Elbadawi, et. al. (1992,

p.

40)

Table 2.7: Share of Sub-Salaa.ran Agricultural Export EarniniilS by Crop

=-" ==

_=='__

:::=-::::a

=..

'~,==:I:I:

1961-69 1970-79 1980-89 1989-90

--- ---,

.. ^-~.~--

Bananas _1.3 0.7 0.5

0.7

Cocoa 16.1 20.6 21.9 ;95

Coffre 19.2 25.9 26.7 :W . .'i

Cotton 10.0 9.1 8.5 :2.0

Groundnut> 10.9 5.5 2.1 2. S

Rubber 2.6 1.7 2.1 3.0

Sugar 4.0 4.7 5.8 7.0

Tea 2.1 2.6 .3.7 ^4.2

Tobacco 3.9 3.2 4.8 6 .. 4

Nine. major 70.0 74.1 76.0 75 .. 9

crops

~-

-- ---

^._. _::~==..:...--=z

Source: FAD

Policy Research Departmenl, The Worl4 Bank (1993, p. 14)

Aside from the structural issues, 8110ther m,lior characteristic of these economies relevant to present analysis is the external debt burden. TOlaloutstanclingextern.Ll debt obligation:. of Africa was about US$255 billion in 1992, with debt serVice payments amounting to 32 percent of total export receipts (see table 3.8 below). Greater insights.into the severity of tiile debt burden for individual countries can be gained by examining appendix tab!!: A-4. Debt 10 GOP ratios for some countries are well OV(;]" 100 percent while some have ratios of less I han 50 pc:rcent. On the average however, tht: d;;:bt to GDP ratio is ahout 90 percent for Afric". The mounting debt service payments with volatile export earnings (also main source of gOY-, rnment revenues) is seen by some analysts as a major cause of disequilibrium in Africa's intemal.and external balances.

Table 2.8: External Debt Outstanding and Debt Service Payments for Africa", 1988-92 CUSS billions)

1988 1989 1990

Total Outstanding Debt 223.24 233.95 241.86

Short-Term 20.27 22.62 22.28

Long-Term 203.07 211.34 219.58

To Official Creditors 154.88 162.75 168.81 To Financial Institutions 37.06 39.85 41.26 To Other Private Creditors 31.40 31.35 31.79 Ratio of Debt Service

Payments to Exports of Goods & Services (%)

Debt Service Ratio' 26.74 28.74 25.10 Interest Payments Ratio' 12.07 12.17 9.54 Amortization Ration' 14.67 16.57 15.56 Source: 1MF Research Department, December 1992

• Comprises only regional member countries of the AVB

b Estimates

, Amonization payments on long-term debt and interest payments

d On IOtal interest payments

1991 1992'

246.79 255.21 21.79 23.04 224.65 232.17 170.78 179.99 38.89 35.50 36.78 39.73

28.55 32.38 13.70 13.42 14.85 18.97

• On amoniZaJion payments (i. e. principle repayments) on long-term debt only.

From African Development Bank (1993, p. 39)

The key features of African economies summarised above, together with the weak and limited policy instruments available to the governments make them susceptible to impacts of external shocks. The nature and implications of the shocks are discussed below.

A. Nature and Causes of External Shocks

The increasing interdependencies of the global economies make national economies susceptible to policy and non-policy induced shocks emanating from the rest of the world. All economies reap the benefits and suffer the consequences of the increasing interdependence.

Naturally, countries would not complain if such interdependence results in a boom in the commodity e;tports, a rise in coffee prices as a result of frost in Brazil, or an oil boom consequent upon an Iraqi war, or greater demand for commodity imports in industrial countries thereby increasing both pri.ces and volume of exports in developing countries, etc. Shocks are considered bad when they impact negatively on incomes, and become very worrisome if they are severe, persistent, and thus require dramatic and drastic structural changes to cope with them. Positive and negative shocks have income and welfare effects, and depending on how they are managed, positive windfalls can also have destabilizing effects. Our analysis pertain mainly to the negative shocks but positive ones are also considered where necessary.

External shocks, as uncontrollable and unanticipated external events, take different forms.

Some are temporary, leading to short-term fluctuations or destabilization of the economy and thus conventional stabilization measures are applicable. Others are more fundamental and lead to fundamental disequilibria, rearing up primarily jn the balance of payments account and through linkages of the external sector and aggregate economic activities, impact on the domestic economic conditions. There are also natural disasters- earthquakes, droughts, locust infestation, flooding, etc which are experienced by economies as shocks. Their impacts could be temporary or permanent depending on the severity, and the damages inflicted.

In recent years, some of the common shocks which are believed to have constrained economic management in Africa can be identified in several forms. The first is the instability in export earnings. This arises from the concentration of Africa's exports on a few primary commodities. their low income and price elasticities, the sharp swings in their demand and supply, and the geographical concentration of the exports. As a result, the barter terms of trade for sub-saharan Africa dropped annually by 4.2 percent between 1980-87, while the income terms of trade declined much faster at 5.8 percent annually since the output of exports was falling each year by 1.6 percent. Between 1985-1988, growth of one percent in the output of agricultural exports was more than offset by an annual decline in the barter terms of trade, leading to a further drop of 7.3 percent annually in income terms of trade (see Ndulu, 1992:

190).

Second, changes in m~or import prices especially prices of critical imports (such as oil) can have destabilizing effects. Third, changes in cost of foreign borrowing is one type of external shock. Given Africa's stock of existing debt and net'~ for new external borrowing, an increase in interest rate in international capital market can seriously affect government budget.

Tangential to this type of shock is the dramatic reduction in the availability of foreign credit.

The debt crisis of the early 1980s resulted in an unwillingness of international private lenders to lend to many developing countries, and this affected an important source of development finance for many African countries. Fourth, many African countries rely heavily on foreign grants and concessionary loans for their domestic expenditures. Thus, sudden reductions in resource flows from this source can severely destabilize economic activities. Other shocks may relate to sudden reductions in workers' remittances (as occurred in Egypt during the Iraqi war in 1991), in direct foreign investment, in capital flight, etc. Some of these later cases may be substantially caused by poor domestic policies of the countries themselves.

There is a sense in which many of these shocks originate from the deliberate policies of industrial countries. The ties between Africa and the industrial countries have tended to be procyclical, with the result that the impact of any shock is rather amplified than dampened.

Events of the last two decades have shown that recession in industrial countne,s weakens demand for the primary commodity exports of Africa, reduces net resource transfers to the region and thus exacerbates the downturns in Africa's economic activity.

Some analysts have also observed that it is no accident that the fiscaJ deficits in illdustiial and many developing countries have tended to move in concert. It is believed that pa .... t of the explanation for developing countries' deficits is the huge fiscal deficits in industrial countries, Fiscal deticits in major industrial countries raise world interest rates. Since many African countries were burdened with huge external debt obligations to service, and abo in dire need of new borrowings from the international capital markets, they were thus vulnerable to rising interest rates. Rising interest rates affect the ability to borrow from the financial markNs a3 well as the cost of servicing existing obligations.

Other analysts suggest, however, that rather than a curse, the burgeoning deficits in industrial countries benefitted the developing countries through increased demand for the iatter's commodity exports and thus to improvements in tbeir terms of trade.. But for developing countries of Africa that are burdened with external debt and, whose fev, primary ex.port items have very low price and income elasticity, the positive effects of such deficits may be tenuolls.

An increase in global interest rates caused by the deficits in industrial coulitries may cause an increase in Africa's interest payments, which could offset the favourable effects of the increased aggregate demand in industrial countries. This could worsen Africa's balance of payment~.

lower their economic growth, and increase their deficits.

The size of the transmitted net effects would depend on the size of edemal debt and policy reactions in African countries. Initially, a fiscal expansion in industrial countries could have some positive effects on developing countries' exports, terms of trade and output and, consequently, on their fiscal balance. But these are Ekely to be more than offset in the aggregate by the effect of higher interest rates. Higher debt service payments worsen the existing foreign exchange constraints, and thus Jead to export compression and reduction in economic growth. These developments could also imply lower government revenues, increased government expenditure on interest payments, and larger tiscal imbaJances (Mansur and Robinson, 1989: 132-133).

Aside from fiscal policies, the agricultural and import policies of industrial countries car.

also signiticantly explain the structural dependence of African countries on few prirniLry commodity exports for foreign exchange, government revenues and economic livelihood.

Foreign exchange constraints on most African countries have provided (;1)mpel1ing reasons to

seek to expand and diversify their exports. Aside from domestic wostraints to e~port

promotion, namely, weak industrial and production capabilities, biased incentive svstems and poor trade infrastructure, the groy,ing protectionism in industriai countries may 'be another binding constraint. On one hand, increased subsidies of agricultural products by industrial

countries lower the prices of such commodities in the international market thereby edging out new African entrants or potential entrants into such export markets. On the othe.r hand, through tariffs and non-tariff barriers to trade, the industrial countries discourage the cffolts of African countries to diversify their economies into higher-value added and semi-proce~sed agricultural goods. Trade protectionism in industrial countries have, in addition to tariff barriers, taken a variety of other (non-tarifl) forms that circumvent GAIT rules and operate under special exemptions from them. These "non-tariff barriers (such as quotas, voluntary export restraints, variable levies, minimum price systems, countervailing taxes and duties) affe;;:tin a progressive way the entry price of processed commodities· (Elbadawi, et al, 1992: 72).

It is the practice that primary unprocessed commodities from developing countries to industrial country markets, with some exceptions, are either free of import duties 01 face very low tariff rates. But then, all industrial countries follow a pattern of dUlies escalating as the goods undergo increased fabrication. Such tariff escalation constitutes a ba.rrier for increased processing of primary commodities in the developing countries (see African Development Bank, 1993: 133-135). It is ironical that while industrial countries resist imports from developing countries, many of these developing countries are requirerl to liberalil":: trade and pursue 'trade- led' growth in their adjustment programmes. Little wonder that attcmpts at pr,,'Id'lct diversification have scarcely yielded rewarding results especially in Africa

Funhermore, there is also a limit to which rapid expansion in the export of the current primary commodities can bring increased earnings to Africa. There is the 'fallacy of composition' or 'adding-up problem' in the sense that export promotion and expanding market shares may be good for a country, but when all countries pursue the same policies at the same time, and particularly with a large number producing similar prooucts, the beneftts may be minimal or absent. The expon-Ied growth strategy adopted by many developing countries leads to a deterioration in commodity prices from having major producers of primary oom.modities expand their supply simultaneously. In sum, unfavourabk market conditions may, in part, be blamed for the structure of Africa's exports, declining commodity prices and terms of trade <ind, thus the region's susceptibility to external shocks.

OUf discussion of the possible causes of enema! shocks has been Iimite.d to the external environment. It is true that domestic policy environment plays an equally important, if !lot more important, role in aggravating or att(!nuating the crisis engendered hy the e1ttemal shocks. For example, most of the developing countries could be said to face similar hostile external conditions, but the Asian countries in panicular have managed to diversify thf;ir economics by taking advantage of fast growing markets in other developing countries. Inilee.:l, it is easy to

imagine how reckless and unsustainable government budge.t deficits :tccompar.i<>,d with say, a fixed exchange rate regime, for example, could over time, undermine trade performance, economic growth and plunge an ~onomy into severe balance of payments cri~j~. The role of domestic policies will be analyzed later in the paper.

Jl'.

COD.Sequences of the sbocks

The consequences of external sbocks on individual African countries would differ, depending on each country's exposufi! to the shocks, diversification and sophisticalioll of economic institutions, availability of resources, si2e, and policy responses to them. In this soection, some of the possible consequence. on t'nel rel~iona1 economy are considereci 1'he discussion therefore pertains to an average Africall country. The, discussions are in tw,) main parts: first, the consequences of the shocks on govel11ment's fiscal behaviour are surveyt:d and;

second. the impacts on economic growth r.re diS(:uss<~d and empirkal evidence is exarnintd later ill section IV.

I, Con.sequences on government revenue-expenditure behaviours

African economir.s experienced ~hocks of various kinds since independence but the nature, severity and consequences of tbe shocks took dramatic turn since the early 1 980s.

Before then the major external shock tcwJk the form of temporary or permanent terms Qf !fade gains or losses. Avery common response by nlajority of African countries to export boC/ms was to regard SUCII as permanent incomes ,md thus increased public spending by increasing public employment, the amount of tTansfers, investment, and so on. This is becau:;e governmefJ:,~ often appropriate most of the windfalls. Negative u'ade shocks resulting in loss of expol1 income. and government revenues were offset by acc;lmulation of external debt to maintain existin€: kvels of government expenditure. This was the experience of countries such as Nigeria, Zambia, Cameroon etc. during the 1970s and early 19805. III many countries, gOYt~rnment expe',diru,res are usually subject to a ratchet effect (Si~e table A-5 in the appendix on the trend in gov,;mment

expenditure.~ and revenues). Thus, when thc: decline in external earnings came and persisted, many of the coon tries were tied to pa1:t;:rns and levels of expenditure that were diff,cult to c.hange. AN long as the countries contirrtJed to have access toO foreign credit, tney u!,~ it to maintain spending at levels that could lK' longer be sustained with ordinary revenue, 'Vhen foreign credit eventually alld inevitably dried up, and conntries had little option but to ur;clertake sweeping adjustment, the consequences were very serious.

The conse<juences took special dimension l~use of the character and responsi':ility of the state as a modernizing agent in many African '~ountries a~ well as the ~tructul'e oj pulllic finance. For most of the countries, government expenditures are the prime movers of !'~,,)n(lmic

activities. It follows then that fiscal perform311cc of the government is crucial not only for social welfare but also for future growth. Blll: unlike in the industrial countries- where govemrm:nts have greater control over revenue sources, revl~nues are much less tied to the foreign seclCl!, and there is always the option of selling bonds in the domestic market to generate additional revenue in a non-inflationary way- the situation in Africa is very much different. For most African (;ountries, a major proportion of government revenue comes from trade taxes, and the l'ote~ltial

for generation of domestic non-inflationary and non-tax; sources of revenues is severely lill'.\i:fd.

Thus, in the face of limited access to foreign borrowing, and Ofi,;:e the possibility of Haailcing spending through the building up of atrem has b~~n exhausted, there is a limit to the iLmount

of public expenditures (expressed in rea.! ::erm~; or al a share of GDP). Aittempts at exr:eeeing that limit will be inflationary, since the glwernmenl: will have t(ll finance the additional sp'!nlHng through money creation. Of course, tiel!! undesirable consequences of infl.ationary finaJlce can be enonnous, and many African counb-.l!o are already caught in its web.

One obvious consequence of the drasti<; reduction in gOVI!nlment revenues consequent on negative trade shocks, combined with limited foreign financing anti increase in debt seJ"{king,

i~1 the often severe cut in other expendit~res. Tabl,~ A-5 in the appendix shows the distr'bll':ion of government expenditures between comumption and capita.! investments. Because it i., often difficult to reduce current spending in the shOlt run" most of the adjustment pressure is shifll'..d to capita.! expenditures (see Tanzi, 1989: 106-107). As government inveMment spendillg is a cata.!yst to private investment expenditllTL!s, most African colllltries experiencing the n<~gative

consequences of these shocks and thl! consequent adjustmenl: process, are l~haracteri >Cd by declining or even negative investment growth rales.

It is evident from the foregoing lliat the observed synchronization of fiscal imb:llcJ\ces and negative, trade shocks in most African countries originates ;m the institutional framework in which the government relies heavily on th!! edemal sector for its rev€~nue. Such :inkage

b€~tween the budget and the foreign secto:r depends Oil: the high proportion of foreign trade taxes in total revenue; the high proportion of domestic sales taxes collected from imports; th" ht:<wy reliance of (:orporate income taxes on f:XPOrtS of mineral products; the public sector's .(ehance on foreign borrowing or foreign grants: the high pmportion of foreign debt that is public, and so on. In table A-5 in the appendix, ir i~ shown that aside fmill the aids and grants, ,\fnean countries still depend heavily on externe^J] :lOurces til tinance their l:-udget deficits. This e;,dudes external aids and grants which accounts for more than 25 percent of govemment revenlles in many countries. Since these external sou,'ces an! not reliable, it is the case that shortfaJ'i; in the expected external funds will translate ill'to fiscal cri:;is.

Although some individual country cases may differ slightly from trend, the e"idcnce suggests that on the average, most African countries derive upwards of 40 percent of Iheir revenues from the extemal sector. The impact of negative trade shock on fiscal beha,,-j(Jur is therefore immediate, direct or automatic:, This point

is

important because it links the fisci'] crisis (If many African countries to the volatility of the external 5e(:lor, It is probable howev!!c that the fiscal crisis may have originated in unsbible fiscal targets not necessarily related to the external sector, but it is not inconceivabb that external circumstances were responsible for the fluctuations in expenditure, either by affecting the blrget expenditure or by affecting the part of eltpenditure that was an instrument fiJ:r fisee~ acij U.stment (Chl!. 1989: 11:5). It is therefore difficult ¹⁰ attribute changes in fiscal variables to changes in policy alone. This is om~ reason why studies that attempt to estimate fmm observed fiscal cha.nges the fiscalplllicy resp on .. ! to m(ternal shocks are likely to reach misl!~<lding conclusions (I'ami, 1989: 103).

Beside the revenue side, some lin)~s also exist through which external shocks call impact directly and immediately on expenditures. For eumple, some government expendit'.u'cs are financed by earmarked taxes, and so Wht~1I tll(~ revenue source ,tHinks because of external shock,

the expenditures are also affected. Also, the sizes of many subsidies depend on the differences between the international prices and domestic prices of the products. If international prices increase or the exchange rate appreciates, the amount of subsidy and the budget deficit increase.

In many African countries, concessionary loans or grants constitute a significant source of investible resource. Changes in this source of finance also significantly affect the level of investment spending.

Since it is evident that cyclical behaviour of government revenues and thus budget deficit, is largely tied to the instability of the external sector, a major issue in curtailing recurring budget deficits may focus critically on ways of stabilizing revenue sources. Broadening the revenue base in the short and medium runs is not easy, a.T\d external finance is not dependable. The question then is whether government expenditures should fluctuate with the cyclical movements in revenues. Given the critical role of the state in most A frican economies, the implications of such erratic movements in expenditures on aggregate economic activities will be interesting to investigate.

ii. Direct consequences on economic growth

Aside from the impacts on economic activities through government's fiscal behaviour, external shocks also impose binding constraints on economic growth through a number of ways.

Most external shocks WOUld, depending on policy responses to them, manifest in the country's balance of payments account and consequently on domestic economic activities. In a study, KiUick and Sharpley (1984: 32-33) provide strong evidence that "the BoP situation in the non-oil LDCs can only be understood in the global context, and that external factors are the major cause of their persistent shortage of foreign exchange". Dell and Lawrence (1980) analyze deteriorations in trade accounts of non-oil LDCs according to various categories of primary causal factors. Their results show that for the period 1973-76, the foilowing primary causal factors with their percentage contribution to the deterioration of current account were: increases in import quantities (15%), increases in import prices (33%), decreases in export quantities (21 %), and decreases in export prices (31 %).

Extending the study by Dell and Lawrence, Khan and Knight (1982) investigate whether the payments problems of developing countries are mainly due to exogenous adverse changes in their terms of trade. Their study covers 36 non-oil LDCs for the 1973-80 period, and concludes that the worsening current accounts in these LDCs in the 1970s are indeed mainly caused by the deteriorating terms of trade, although this deterioration is not exclusively responsible for their current account behaviour (Killick and Sharpley. 1984: 34).

One major consequence of deteriorating current account balances on A frican economies is to compound the foreign exchange constraints. Investment and production are heavily dependent on imported capital goods, and it can be shown that imports of intermediate goods are the single most important determinant of capacity utilization in most A frican countries. It follows that variability in import capacity as a result of shortage of foreign exchange will limit

access to necessary production inputs, thus impeding production and capital fonnation. Since there is a positive correlation between imports and GDP growth, export perfonnance which is the prime detenninant of import capacity must also be positively associated to income growth.

Moreover, export sector contributes directly to GDP, savings and investment.

Countries experiencing negative external shocks and hence balance of payments disequilibrium may resort to policies that restrain growth of aggregate demand and output. In the last two decades, some countries responded by placing quantitative restrictions on imports, raising tariffs, restrictions on capital movements, andl or rationing available foreign exchange to 'preferred' importers. This was to stem the tide of import demands and thus ease external payments difficulties. Capital· flight was rampant, investment restricted, capacity utilization in most of the cases dropped to below 30 percent and economic growth stagnated. Whatever the nature of policy response, shortages of foreign exchange are expected, at least in the short run, to impact negatively on economic activities.

While plausible linkage mechanisms between external shocks and economic growth may be easy to trace as provided in the prf'.ceding paragraphs, what is perhaps controversial and not easily quantifiable, is the precise weight of external factors in explaining growth in African countries. Some of the analysis often point to loss of potential resources for growth due to declining terms of trade and negative resource inflows.

For example, according to the United Nations Secretary-General's report (August 1991) on the review of five years of the United Nations Programme of Action for African Economic Recovery and Development (UNPAAERD), the worsening of Africa's economic crisis is to a large extent attributable to the external environment. The report indicates that from 1986 to 1990, the fall in commodity prices alone cost Africa about $50 billion. The region's tenns of trade has been deteriorating since the late 1970s. Africa's stock of external debt rose from $204 billion in 1986 to $272 billion in 1990, an increase from 54 % per cent of GDP in 1986 to over 109 per cent in 1990. According to the report, "the combination of depressed commodity prices, the crushing debt servicing burden and capital flight, estimated at some $30 billion in the last five years, added up to $80 billion in potential domestic resources that the continent could not utilize".

A recent research report by the World Bank corroborates the finding that the deteriorating terms of trade faced by many African countries since the 1970s has had adverse consequences.

The report observes that the hardest hit are the mineral exporters whose terms of trade fell by around 50 percent between 1970 and 1990, and resulting in income loss of about 20 percent of GDP for the 20 year period. Exporters of agricultural products and exporters of diversified products experienced 34 percent and 30 percent fall in their terms of trade respectively.

Agricultural producers had income loss of around four percent of GDP. On the contrary, oil exporters enjoyed improvements of more than 100 percent or about four percent of GDP income gain. An estimate of the income loss resulting from the deteriorating terms of trade for all sub- saharan African countries (excluding Nigeria) is around 10 percent of GDP between 1965-73 and

1987-90. Adding Nigeria reduees the 20-year loss to just 3.6 percent of GDP, or 0.2 percent of GDP a year (policy Research Department, The World Bank, 1993: 1.7).

What emerges from the above statistics is that the aggregate regional <tatiSlics mask, the individual country results. No doubt, secular decline in terms of trdde may have irnpacted more severely on some countries than others, but while some are c1(periencing decline, others face some, albeit temporary, booms so that on the average, the income loss as percent of GOP dr.>es not seem very significant. This inference may be querk~ by those ""ho argue tilat the .:external environment has resul~ in greater income loss than the above estimates sllo\\-. The question then is whether countries with better terms of trade and gre.ater nel inflows ,)f e1<ternal financial resources necessarily outperform their less fortunate counterparts.

Evidence on the above question is highly inconclusive. and has been a source of raging controversy. Table A-6 in the appendix presents changes in extemal income by source (terms of trade and net transfer of tinancial resources) and change in per capita Gnp over the period 1981-86 and 1987-91. It thus shows the combmed effects of terms of trade and net financiai transfers. Out of the five countries with the biggest change in their per r.apita GDp·

Mozambique. Nigeria, Uganda, Ghana, and Tanzania. three (Mozambique, Uganda, linG Tanzania) are among the nine countries classified as having the largest incre:~se~ in external income. Nigeria, with the second biggest income change, is about the country with the l~rgest

reduction in external income. Ghana had moderate change in its external income. Denin is among the countries with largest increase in external income, but it is among the four countries with the worst GDP growth, while Cameroon and Rwanda had moderate ex temal income bill are the ones with greatest deterioration in GDP growth performance. Thus, while the case of Mozambique, Uganda and Tanzania may point to a direct and strong corre;pondence between changes in external income and changes in Gnp per capita, the othe.r cases mise the need ^!(l be cautious in interpreting the causal relationshi ps.

A clear picture of the inconclusiveness of the evidence can be got from closely examining tables A-I, A-3 and A-7 in the appendix. Tables /\-3 and A· 7 show trends in individual countries' terms of trade statistics and the net total financial flows from ali sources respectively.

A comparison of these trends with each country's Gnp growth rates over the period i()89-1992 raises the critical question about the importance of the relationship between the major sources of external shocks and domestic income even in the short-run. From the tables, Mozambique, Mauritius and Tanzania are among the countries with significant improvements in their Gnp growth over the period. Mozambiqlle experienced positive terms of trade as well as iarge ni:!

external transfe.rs, Tanzania had significant external transfers, while Mauritius cxpericm:,':(i poSitive terms of trade shock over the period. One observes also that 7..ambia and Sudan had deterioration in their Gnp performance despite being among the countries with better terms of trade and net external transfers. Despite greater inflows of net external tran.,fefs. Zaire and Ethiopia did not improve their Gnp growth. On the other hand. countries with either deterioration in both terms of trade and net extem~J transfers (Nigeria) or in one of them bur without improvements in the other (Uganda, Ghana. Botswana, etc) appear to have outperformed most others with better improvements. The conflicting evidence raises the need for further empirical analysis of the contributions of external factors in economic perfor;r.:l.11Ce of i\ friean countries.

III. Do domestic policies really matter more for growth?

As Killick and Sharpley (1984:30) observe, 'The reason for distingui,hing between external and domestic sources of disequilibria is not to apportion blame, but to design better policy measures for developing countries to deal with stabilization problems'. Most of the earlier studies have focused undue attention to apportioning blames for Africa's economic crisis.

Our motive in analyzing the relative importance of the domestic policies and external factors in explaining Africa's growth performance is different. It is not to share blames. It has been shown earlier that external shocks have appreciable impact~ on growth, and domestic policies may not stop several of the shocks. Since there is little that African count.ries ^Gan do to control the external environment facing them, the only handle they have is their domestic policies. The focus on the relative importance of domestic policies is therefore to assess the capacity of certain policy instruments to promote growth despite the adverse external shocks.

Domestic policies can also make countries more or less susceptible to certain kind8 of shocks and affect the flexibility of stabilization or adjustment to thelll. It has often been said that other developing countries which at one time had similar economic characteristics as Africa (East Asian countries for example) have succeeded in diversifying their economies and promoting growth despite having faced the same external environment as Africa. Linn and Wetzel (1990: 10) and many other economists have argued that much of the difference in trade and development performance must be attributed to the clllllulativeimpact of the different policies pursued over the last two to three decades in these country groups, including trade and puhlic finance policies.

The nature of domestic policies is therefore seen to be a crucial determinant of long-term growth. Of utmost priority in this regard is the maintenance of macro-;x;onomic stability whi.ch is seen as prerequisite for sustainable growth. Sound macroeconomic policies are seen to create an environment which promotes private entrepreneurship and productivity. Generally. the specific kinds of policies that are thought to be very robust to growth are ably summarised in report by World Bank staff, Fardoust and Dhareshwar (1990:56) which, in part, observes thaL

... one lesson from the 1980.1 is that the key to successful economic devel{lpment lies in the domestic policies of the developing countries themselves. C{luntries thut have built resilielll eCOlwmies have adopted prudent macroeCl)!1omic policies, implemented strnctural reform by liberalizing trade and financial policies, OIiented their economies toward illlernalional trade, Taken advantage of technical and scielllijic progress by investing in physical and human capital, pursued (1

more equitable distribution cifincome, and relied increasingly on dom!'st!.: savings to jina1lCe investment. Such efJorts must be illlensified in the 1990., v"hen the challenges for development of the poorer coul1!ries will be,

if

anything, more daunting.

In general, the basic indicators of the 'SOUild' macn>l',conomic policies are low rates of imlalion, a prudent fiscal stance, realistic excharlge rates, and moderate but positive real interest ]'ate on bank deposits. In most studies, it is shown that countries that significantly reduced lh,' black market premium (by effecting real devalll1tion:.), mduced inflation and budget deficits an often the most successful economies. A summary of the relationship between some policies and growth is provided as follows:

A. Government expenditure, Taxation ,and growth

The precise role (If government's fiscal actions in economic growth has been amlJject of continuing debate. Many studies have examined the contributions which the ).ize of government. usually proxied by either till! ratio of g,overnment expenditure to GDP or that of government revenue to GDP, make to growth and s~'veral of such studies have found a negative relationship between government spending and growth. 11:Ie observed negative correbtiofl is justified because increased government spending has to be paid for thro'Jgh either increased taution or higher levels of deficit fmance, and the~ie activities would imply increased di,(oJ'tion of resource use and crowding out of the private sector activities. Some of the studies t"lwcver distinguish the various components of government spending, ,and thus argue tha." these components have differential effects on growth. Wh(~reas govemment consumption expenditures are found to be negatively correlated with growth, capital spending (public: investm(mt) on physical infrastructure and human capilai formation are found to be growth inducing. These expenditures are complimentary to private investment and thus will have a positive e:i'fect on growth. nle composition of government spending is therefore central to wlderstanci, ng the expenditure- growth nexus.

Analytically, since increased government !ipending is mainly financed by illereused

!antion, the, structure of tax system is believed to be central to determining the potential effects of government spending. On one hand it can be argued that provided Ricardian equivalence is not complete, an increase in tax to GOP ratio would rdise the rate of domestic saving and government capital spending, and thus tile rate of economic growth would rise. Thl.,re .may l:owever be inherent distortions and dhi.n:entives in the tax structure that ma.y adversely affect the efficienL), of resource allocation an<; thus growth. For instance, tax on various ~"ving

instruments which effectively lowers their yields reduces the propcensity to Slwe and u!l:mately reduces growth. Also, import-export Laxes which inhibit foreign competition and ac',~ess to foreign technology would lower growth.

Excessive and sometimes persister;t deficit financing embarked Upotl by most de\(!loping countries can have negative effects on Crowth. Countries often borro,", from dome; tic a'ld external markets or resort to printing money. H~gh fiscal deficit to GDP ratio will Cie-ate macroeconomic imbalances - cause uncertainty and distort expectations about the future pr()sJX~1s

of the economy- and hence negates growth prospects, Assuming the private se<.1or be\iel{e.~ that government deficits are unsustainable, it may be ullwilling to invest or may decide to ,,'lk,! its capital abroad. The manner of financinf! ~.he deficit may have added implications. For instance,