UNITED NATIONS
ECONOMIC AND SOCIAL COUNCIL
Distr.; LIMITED
E/ECA/ESPD/EXP.6/7 8 March 1997
ENGLISH
Original: FRENCH
ECONOMIC COMMISSION FOR AFRICA Meeting of the Intergovernmental
Group of Experts Addis Ababa, Ethiopia
25-28 March 1997
ECONOMIC COMMISSION FOR AFRICA Sixth session of the Conference of
African Ministers of Finance Addis Ababa, Ethiopia
31 March - 2 April 1997
EXCHANGE POLICY OF AFRICAN COUNTRIES IN THE FRANC ZONE AREA- RECENT DEVELOPMENTS AND FUTURE OUTLOOK**
** This paper has been prepared by a consultant for the United Nations Economic Commission for Africa (ECA). The views expressed in the paper are those of the author and do not necessarily reflect
those of ECA.
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TABLE OF CONTENTS
Page
INTRODUCTION 1-2
PARTI THE FRANC AREA: GENERAL DEVELOPMENTS
AND OPERATION [1945-1993] 2-9
1 Institutional restructuring between 1945 and 1993 2
1.1 Experience of francs of the colonial era (1945-1949) 3
1.2 Consolidation of French influence on currency
flotation (1949-1972) 4
1.2.1 Replacement of former colonial banks by new institutions 4 1.2.2 Coordination of currency-issuance in French Equatorial
Africa (AEF) and French West Africa (AOF) 5
1.3 Slight decline of France's domination 5
1.3.1 Consolidation of African States' independence from France 6
1.3.2 Role assigned to monetary policy 7
2 Characteristics of the franc area 7
2.1 Monetary cooperation and the French Treasury's guarantee 7
2.2 Pegging of currency . 8
2.3 Regulatory unit and free transferability 8
PART II THE JANUARY 1994 CHANGE IN THE PAR VALUE: FROM REASONS FOR DEVELOPMENT TO A REVIEW OF THE TRACK RECORD . . . 9-24 1. Justification of the devaluation of the CFA franc
against the French franc 9
1.1 Economic gloom in African member countries of the Franc area 10
1.1.1 Chronic deterioration of terms of trade 12
1.1.2 Tax rate incidence in the economic difficulties of
African countries in the franc area 12
1.1.3 Capital flight 12
1.1.4 Ill-conceived budget policies in the area's countries 13
1.1.5 Failure of domestic adjustment measures 13
1.2 Need for currency adjustment to counter the overvaluation
of the CFA Franc 16
2. Anticipated outcome of the January 1994 devaluation '8
2.1 Balancing of public finances 8
2.2 Enhancement of competitiveness 19
2.3 Restoration of an atmosphere conducive to capital inflow 19
2.4 Maintaining a low inflation level 19
2.5 External debt relief offers a glimmer of hope 20
3. Rough assessment of the January 1994 devaluation in
African member countries of the franc area 21
3.1 Maintaining a relatively low inflation level 21
3.2 Improvement of the real GDP growth rate 22
3.3 Increase in financial resources . . 22
3.4 Signing of external debt relief agreements 23
3.5 Consolidation of regional integration 24
3.6 Ineffective mobilization of public receipts and
delays in the implementation of structural reforms 24
PART III THE FRANC AREA: WHAT IS THE FUTURE OUTLOOK? 25-39
1. Prospects of the Franc area from the viewpoint of
immediate economic results 25
1.1 According the export sector greater importance 25
1.2 Need for area economies to be more competitive and flexible 27
1.2.1 Grounds for the analysis advocating greater
competitiveness and flexibility 27
1.2.2 Contradiction of the old approach by the new one > -. 29
1.3 Decline of poverty - 30
2. The franc area in the face of imminent European
currency unification 32
2.1 Avoiding responsibility: Line of least resistance - 33
2.2 Road to salvation: effective construction of a regional
economic space 36
CONCLUSION 39
Annex I Developments in the value of the CFA and CFP francs, dollar, mark
and Swiss franc in French francs 40
Annex II General development of the franc area, 1993-1994 41
u
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INTRODUCTION
1. The franc area, created by the French decolonization process after the Second World War has undergone great transformation. It has nevertheless retained the primary characteristics of a monetary area. Although the principle of free convertibility of currencies within the area was slightly undermined by decisions taken by the Central Bank of West African States (BCEAO) on 17 September 1993 to no longer repurchase currencies exported beyond the West African Monetary Union (UMOA) and by the Banque centrale des Etats de TAfrique centrale (BEAC) on 17 December 1993 to no longer repurchase currencies exported beyond its area, the fact remains that currencies are exchanged within the franc area at a fixed rate.
2. In addition to France and its overseas departments and territories, the franc area currently comprises Mayotte and fourteen independent African states. With the exception of the Republic of the Comoros which has its own Central Bank , the other thirteen countries of the franc area belong to two unions; the West African Economic and Monetary Union (UEMOA) which consists of Benin , Burkina Faso, Cote d'lvoire, Niger, Senegal and Togo and BEAC made up of Cameroon, the Central African Republic, Congo, Gabon, Equatorial Guinea and Chad. On 16 March 1994, BEAC member countries formed a new body: the CflTlfflu^ Economique et Mnnetaire de l'Afrique Centrale (CEMAC). Both groups use the CFA franc, with a different symbol for each subregion1.
3. Exchange arrangements of African countries members of the franc area are characterized by the pegging of these countries' currencies to the French franc in a fixed parity. In such an exchange system, changes in par value are part of the economic policy instruments. More specifically, in the event of external shocks, a country may be compelled to devalue its currency.
In theory, devaluation triggers off two types of effects on the economy: a price effect and a substitution effect. The price effect concerns changes in the relative prices of merchandize (upsurge in the national currency-denominated prices of imports, and downturn in hard currency- denominated export prices). The substitution effect is a result of the price effect, which should revive domestic need for national products. Such a change in the demand should have a positive impact on national production. In view of the hard currency-denominated decline in the price of exports, (which entails increased competitiveness internationally), the quantity of exports rises, thereby strengthening the anticipated impact on national production. From this standpoint, devaluation can contribute to economic recovery.
4. From 1948 until 12 January 1994, however, African countries of the franc area rejected this instrument, preferring to support the parity in force. The growing economic hardships they faced from the mid-eighties notwithstanding, they were slow to review the exchange rate between the CFA franc and the French franc. Their economic recovery efforts mainly focused on
1 The African financial community franc for UEMOA countries, and the franc for financial cooperation in Central Africa for CEMAC countries.
domestic restrictions, thus relegating to second place the review of their currency's parity. The
failure of these domestic recovery measures increased pressure from international organizations, particularly Bretton Woods institutions, which considered readjustment of the parity between the CFA and French francs as the automatic solution to the recession spiral.5. Justifiably, one may now wonder what the actual effects are of the January 1994 devaluation of the CFA franc on the economy the franc area's member countries. Stated differently, what is the outcome of the change in the par value, and what are the franc area's ftiture prospects subsequent to the devaluation? Interest in this issue may be defined in terms of
hope for some and apprehension for others. More importantly, however, African countries ofthe franc area, whose currencies have until now been pegged to the French franc, can hardly remain indifferent to the prospects of monetary unification in Europe and the attendant abolition
of the French franc.
6. Having presented the background ofthe franc area (at institutional and operational levels), this study now assesses the effects of the January 12, 1994 change in par value and considers the future of the franc area in the light of European monetary unification.
I. THE FRANC AREA: GENERAL DEVELOPMENTS AND OPERATION [1945-
19931
7. Difficulties plaguing colonial powers compelled them to strengthen ties with their colonies as early as the 1929 crisis. The French government, thus, consolidated customs barriers erected around its national territory and its overseas territories. In 1939, an exchange control system was
established prohibiting all commercial transactions between the French empire and the outside
world. That was the genesis of the franc area, defined as a geographical space within which currencies are subject to common protective regulations but remain convertible. The area, however, came into actual being in 1945. It has since undergone various institutional changes that have sometimes affected its general operational principles.1. Institutional restructuring between 1945 and 1993
8. In spite of the fact that the "franc area" monetary entity gained international recognition in 1939 with the institution of a common exchange policy for all French territories, it was not until 1945 that the area came into actual being. Given past experiences of colonial era francs, France played an overwhelming role in the initial stages of currency flotation. Gradually, however, France's looming importance subsided, giving way to the increased independence of
African states.
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1.1. Experience of francs of the colonial era (1945-1949)
9. The area of circulation of the CFA franc was defined on 26 December 1945 through a communique (the second part, entitled "set-up of the franc area" of which, officially inaugurated the monetary space) from the French Minister of Finance. Admittedly, the area had in fact been in existence since 1939, but it was not until December 1945 that France, supported by a number of French government decrees, was able to consolidate trading links with its empire. The decrees defined a geographical area within which currencies were convertible, and prohibited colonial France from conducting any trading activity outside the area. Subsequently, French colonies were assimilated with their colonial power with regard to exchange arrangements.
10. With the December 1945 devaluation of the French franc, French monetary officials decided to adopt separate solutions for currency circulating in France and that in circulation in certain overseas territories. The result was the emergence of two new currency units, each with its own exchange rate, in a number of French colonies; the franc used by French colonies in Africa (CFA) and that used by French colonies of the Pacific (FCFP). The former circulated in African colonies, Madagascar, Reunion, Comoros and the North Atlantic. The latter circulated in Polynesia, New Caledonia and the territories of the New Hebrides. For its part, the franc in circulation in the colonial power remained legal tender in other territories (such as Tunisia, Morocco and Algeria). Initial parities between the French franc and the colonial francs were established as follows:
1 FCFA = 1.7 FF 1 FCFP = 2.4 FF
11. The 18 October 1948 devaluation of the French franc altered the relationship between these currencies. Thus, whereas the CFA franc was pegged to the French franc in the parity of 1 FCFA = 2 FF (a parity which the transformation of the French franc to a hard currency allowed to be rendered as: 1 FCFA = 0.02 FF), the CFP franc was pegged to the dollar.2 For a period of 18 months, this system with various exchange rates was in operation and the CFP franc appreciated regularly with regard to the French franc.3 The system was abandoned on 20 September 1949, when French authorities decided to stabilize the value of the French franc against the dollar and suppress the two-tier market. While allowing the French franc to regain
IFCFP = average dollar rate on the free market x 1/49.625.
See annex I.
its pivotal role within the franc area, this decision also restored the area's unity and did away with colonial francs.
1.2. Consolidation of French influence on currency flotation (1949-1972)
12. Prior to the Second World War, France controlled currency-issuance in its colonies through equity participation (usually minority) in the capital of currency- issuing agencies. With the nationalization on 2nd December 1945 of the Banque de France, however, came an increase in public equity participation in the capital of former colonial banks. Some of the latter lost their authority as currency- issuing agencies and the Caisse Centrale de la France d'outte mer (CCFOM) replaced them, assuming this authority in French Equatorial Africa (AEF) and in overseas departments until new organizations were created.
1.2.1. Replacement of former colonial hanks hv new institutions
13. In North Africa, the Banque de l'Algerie was nationalized on 17 May 1946. Following a 12 January 1949 decision it, subsequently, became the Banque de l'Algerie et de la Tunisie.
with 50% of its capital being allocated to the territories of Algeria and Tunisia. In the face of mounting nationalism in Indo-China, the Banque de 1'Tndnchine lost its privilege as currency- issuing agency on 25 September 1948. The privilege was then granted to a new public organization: the Institiit d'Anissinn de rindochine. Nevertheless, following the war in Indochina, three autonomous central banks were created on 1st January 1955, after which this region's former French territories withdrew from the franc area.
14. In Madagascar, the Banque de Madagascar was restructured and became a semi-public corporation on 29 March 1950. The restructuring helped increase the bank's capital and enabled public authorities to retain a majority.
15. In West Africa, public authorities allowed the Fanqvc ti? !'Afrifl"? Occidental (BAO) to retain its privilege as currency-issuing agency for a few years.
16. Therefore, in spite of national liberation movements and some territories' acquisition of independence, French authorities endevoured, through institutions of the franc area, to maintain the now independent countries under monetary domination. However, reform initiatives were made in 1955 to restructure currency-issuance in countries of the franc area.
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1.2.2. Coordination of currency-issuance in French equatorial Africa (AEF) and French West Africa (AOF't
17. On 20 January 1955, currency-issuing operations in AEF and AOF were assigned to two new public organizations: the Institut demission de 1'AEF et du Cameroun and the lostitut d'&nission de l'AOF et du Togo. These two currency-issuing agencies were governed by identical constitutions.4 Each of the constitutions stated that the agency it concerned:
is a French public establishment whose headquarters shall be in Paris.
shall receive, from the French Government, a capital stock of 500 million metropolitan francs;
shall be administered by a Council only a third of whose members shall represent the territories that enjoy the privilege of currency-issuance;
shall issue bank notes that are legal tender in its area of operation, and put hard money into circulation in this area.
18. The two agencies were ineligible for equity participation and could neither grant direct loans to individuals nor territories. However, each agency was authorized to:
effect transfers between the colonial power and the overseas territories, purchases and sales of gold and hard currency;
discount short-term paper and grant banks credit for periods of less than six months;
grant advances on government securities (with less than six months before maturity) and discount customs duty bills;
grant banks discounts for representative medium-term credit paper, for a maximum period of five years, to fund the development of production means and the construction of buildings;
centralize banking risks.
4 Decree No. 55 104 of January 1955 concerning reforms on currency issuance in French Equatorial Africa and Cameroon, and in French West Africa and Togo.
19. To ensure the convertibility between the CFA franc and the French franc and guarantee the value of the currency of the franc area's African countries, the French Treasury opened, in its accounts, operation accounts on behalf of two new African currency-issuing agencies. There were no limits to the operation accounts' debit.5 From then on every movement of funds between the colonial power and a country in Equatorial Africa or West Africa had an impact on the balance of the operation account of one of the two currency-issuing agencies.
20. Subsequently, it was only the prospect of independence of French colonies in Sub-Saharan Africa that compelled French authorities to once again restructure currency-issuance in these territories. By amending texts in force, the French authorities, on 4 April 1959, replaced the AEF and AOF currency-issuing agencies with two central banks: the flanque Cgfltrale ties EtatS rie l'Afrique Equatorial et du Cameroun (BCEAEC), and the Central Bank of West African States (BCEAO). Beside changing the names of the currency-issuing agencies, the decrees of 4 April 1959 modified the composition of each of the agencies' Boards of Directors. France and the African countries were represented by an equal number of office bearers. Nevertheless France, by virtue of the casting vote of the board's president, who in conformity with the constitution had to be a French office bearer, was still able to impose its decisions.
1.3. Slight decline of France's domination H 972-19931
21. In their desire to promote monetary integration, West African members of the franc area officially created the West African Monetary Union (UMOA) on 12 May 1962. For their part, the area's central African member countries concluded multilateral monetary agreements in 1972.
Accordingly, two separate conventions for monetary cooperation were signed in Brazzaville: the first on 22 November 1972, among the five BEAC member countries; the second on 23 November 1972, between these States and France. The agreements between France and African States members of the franc area, signed between 1972 and 1973 heralded significant institutional reforms within the franc area. The object of the reforms was to consolidate African States' independence from France and tailor the monetary policy to African economic development.
1.3.1. Consolidation nf African states' independence from France
22. The 1972 reform culminated in a monetary cooperation convention among central African States, a convention that assumed ail the characteristics of a monetary union. With the creation
5 The convention of 29 November 1955 which defines the relations between the Treasury and the two currency-issuing agencies stipulates that when the operations account of a currency - issuing agency has a debit balance, the French Treasury collects the interest. When the agency has a credit balance, the French Treasury deposits interest into the former's account.
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of a joint monetary committee, Africans were initiated to greater responsibility in the structure.
The committee, comprising Finance ministers of the area's five central African member States and of France, was responsible for ensuring the enforcement of the monetary cooperation convention between the five States and France.
23. The 1973 reform strengthened the role of African authorities within UMOA. Thus, the Union was headed by the Conference of Heads of State, which could intervene in all matters concerning changes in the letter's composition.
24. The number of French representatives to the Board of Directors of the two central banks also diminished. It declined from half to a third, then to a quarter in central Africa, and from a third to a seventh in West Africa. Africanization of the two currency-issuing agencies involved even the senior-most positions. In fact, at one point the president of the board of directors and the governors of the two banks were Africans.
25. Furthermore, new monetary cooperation agreements paved the way for the transfer of the headquarters of the two banks from France to Africa. Thus, on 1st July 1977, the BEAC headquarters was established in Yaounde and on 26 May 1979, that of BCEAO was set up in Dakar.
1.3.2. Role assigned to monetary policy
26. With the Africanization of the management of central banks came the expansion of their operational capabilities for the development of the countries concerned. Consequently, these banks had greater facilities to advance funds to Treasuries (particularly for development activities), more flexible lending conditions for medium-term loans and a discriminating credit- granting process for priority sectors,small and medium-sized African enterprises.
2. C^qnnc.teristics of the Frflnq $$■€#
27. The franc area is characterized by three major traits: the guarantee of convertibility, pegging of currency and free transferability.
2.1. Monetary cooperation and the French treasury's guarantee
28. The principle of convertibility provides for the unrestricted mutual convertibility of the area's various currencies. This guarantee of convertibility from the French Treasury was established by monetary cooperation conventions signed by African countries members of the franc area and France.
29. In the framework of the BEAC area, article 2 of the convention signed on 23 December 1972 stipulates that such cooperation be based on France's unlimited guarantee of the currency issued by the Bank. Further on, article 9 of the said convention provides for the unrestricted convertibility of the CFA franc against the French franc.
30. Concerning UMOA, article 1 of the agreement signed on 4 December 1973 provided for France's support for UMOA to help the latter ensure free convertibility of its currency.
31. The foregoing means that the French Treasury guaranteed unrestricted convertibility of CFA francs into French francs. This made CFA francs internationally recognized and convertible. The French Treasury pledged to supply, through operations account mechanisms, whatever quantities of French francs might be required by African currency-issuing agencies, be it for the settlement of obligations within the area or external payments in hard currencies.
2.2. Pegging of currency
32. The value of the CFA franc is defined in terms of the French franc with which it has a fixed parity. Agreements and conventions signed between France and African countries of the
area provided for this pegging of currencies.
33. Concerning the BEAC area, article 9 of the convention signed on 22 November 1972 stipulates that member States' legal currency unit is the franc for financial cooperation in central Africa (CFA), whose parity with the French franc is fixed.
34. Regarding the UMOA area, article 2 of the monetary cooperation agreement signed betweefi UMOA member countries and France states that transactions between the French franc and the Union's currency are to be effected at a fixed rate, on the basis of the parity in force.
35. Changes in the par values between the CFA franc and the French franc may only be effected through an agreement between the area's African member States and France. Since 12 January 1994, the CFA franc's rate has been as follows: 1FCFA= 0.01 FF. Because there was little likelihood that it would change, the pegging, for a while, constituted a principal
element of the area's external credibility.
2.3. Regulatory unit and free transferability
36. Free transferability within a monetary area is one of the basic criteria that govern the existence of such an area. Free transferability means that within the area, transfers are totally
unencumbered, be they commercial transactions or capital movements.
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37. Regarding the BEAC area, article 10 of the convention signed on 23 November 1972 stipulates that all transfers of funds between member States and France be free. Concerning UMOA, article 6 of the agreement signed on 4 December 1973 provides for free financial relations between France and the Union's member States. These stipulations indicate that there should be no exchange regulations applicable to franc area member countries. The reality, however, is that there are impediments to free capital flow within the area. In an effort to restrict capital outflow, African countries of the franc area instituted regulations to the free movement of capital in their space. Thus for instance, the cooperation agreement with UMOA takes into account the possibility that needs and circumstances may compel a government to waive the principle of free transferability. For their part, BEAC member countries set a ceiling to the amount in BEAC notes that travellers could take out of the franc area, the BEAC area or to another country of the BEAC area.
38. The most recent form of restriction to the principle of free transferability of capital is a decision made by heads of State of African member countries of the franc area on 2 August 1993. Through the enforcement of this decision, BEAC and BCEAO made it known that they were suspending the repurchase of notes exported beyond the franc area. This measure was followed by the BCEAO decision of 17 September 1993 to no longer repurchase notes exported from the UMOA area. BEAC instituted the same measures from 17 December 1993.
39. Institutional changes that have taken place within the franc area since 1945 have gradually diminished France's dominance, paving the way for the Africanization of the area.
Along with these important changes came some reviews of the area's operational principles.
Such was the case with the principle with free transterability, the review (during the second half of 1993), of which was a precursor to the devaluation of the CFA franc on 12 January 1994.
II. THE JANUARY 1994 CHANGE IN THE PAR VALUE: FROM REASONS FOR DEVALUATION TO A REVIEW OF THE TRACK RECORD
40. Exchange rate manipulation is not a common practice in the franc area. The relative stability of the exchange rate between the CFA franc and the French franc bears this out. For nearly forty six years (between 1948 and 1994), the rate remained unaltered. The same would be true today, had the opinion of those concerned (in this case the African countries of the franc area) been taken into account. Most of these countries remained skeptical about the positive effects of devaluation on their economies. It appears that forces greater than these countries eased the way for change in the par value in January 1994.
1- Justification of the devaluation of the CFA franc against tftft Fyynph franc 41. The devaluation was justified by two factors: the ailing economies of the franc area's African member countries, and the need to rectify over-valuation of the CFA franc.
l.l. Economic gloom in African nrmfr* countries of the Fraac area
42 Towards the end of the 1980's the economic crisis was becoming increasingly acute ifj
$ub-Saharan Africa in general, and in the franc area's African countries in particular, Forced to resort to international institutional sources even for operational expenses, economies had to
comply with demands by the International Monetary Fund and the World Bank for changes inthe franc's par value as a condition for the resumption of international fund flows. The bleak economic situation in the franc area's member countries was attributable to a number of factors such as the deterioration of terms of trade, interest rate increases, debt increase, capital flight,
lax budget policies, etc..
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TEHMS C? TRADE
;00 '985
■=■]
IMF Wor.tir.g paper August 1393
1.1.1. Chronic deterioration of terms of trade
43. Between the mid-seventies and the mid-eighties,the increase in the prices of products exported by African countries members of the franc area was these countries' major source of income and enabled them to effect development based on the production of raw materials (cocoa, coffee, cotton, petroleum, etc.). From 1985, however, these countries were twice jolted by external events: the protracted deterioration in the prices of their principal exports, and the decline,subsequent to the February 1985 Plaza Conference, of the United States dollar (peg for international trade) against other major international currencies. These two phenomena combined resulted in the considerable deterioration (estimated at 50%) of terms of trade between 1985 and
1993.
44. When one realizes how dependent these countries are on a small number of raw export products that at times earn as much as 2/3 of the overall export revenues, the extent of the disruption in the macro-economic balances following this double blow becomes appreciable.
1.1.2. Tax rate incidence in the economic difficulties of African countries in the franc
area
45. The second oil shock marked a cyclical reversal in industrialized countries. The 1980s saw, in these countries, a strengthening of monetary policies, with the management of inflation gaining priority among these economies. They opted for the management of the money stock as a means to fight inflation. The outcome was an increase in American interest rates which levelled-off in 1980 at 20%. The widespread application of the policy for the increase in interest rates had two adverse effects on the franc area's African member countries: firstly, since the greater proportion of these countries' debt had been contracted at varying interest rates, the increase in the latter had resulted in heightening the burden of such debt; secondly, the increase in the debt burden had contributed to the abandonment of a number of investment projects, need for supplementary revenues to make up for increased lending rates having made it impossible to
implement the projects.
1.1.3. Capital flight
46. African countries in the franc area have not been spared by capital flight, a symptom of financial repression in developing countries. Its convertibility against the French franc enables the CFA franc's holders to obtain hard currencies. This advantage has led to intensive capital flight, the principal beneficiaries being English and Swiss banks. For the 1992-1993 period, the repurchase of CFA franc notes from outside the area involved annual sums of 9 to 10 billion French francs. Such was the magnitude of this phenomenon's adverse effects on the area's economies that in 1993 monetary authorities were compelled to suspend the convertibility of
these notes. Firstly, bank liquidity declined. Secondly, investment suffered as a result of the
capital flight, thereby perpetuating unemployment in the area's African countries.
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1.1.4. Ill-conceived budget policies in the area's countries
47. It is believed that the budget policies implemented during the 1970s and 1980s, subsequent to the two oil shocks, were particularly ill-advised. As early as the period following the first oil shock, and during the ensuing frenzy, there were budget deficits attributed to increased public spending that exceeded revenues. Between 1975 and 1985,the budget deficit on average represented 5% of the GDP of the area as a whole.6 This tendency towards excessive increases in public spending was fueled by belief in the stability of the exceptionally high prices of export raw products. However, the time came when the prices started slipping.
Current budgets of African countries in the franc area, meanwhile, hampered all efforts to significantly reduce public spending. Consequently, budget deficits for the entire area rose to an average of 7.6% of the GDP between 1986 and 1993.7
48. A part from deteriorating terms of trade which played a role in the reduction of export earnings, and the unproductive increase in public spending, the magnitude of budget deficits is attributable to inadequate tax receipts. According to S. Michailof, the mandatory tax rate slumped from 22.3% during the 1981-1985 period to 17.8% between 1986 and 1991, which is over four points below the average for the African continent.8
49. Faced with declining receipts and the reluctance of the various governments to trim their current budgets, States increasingly resorted to external resources. Concurrently, they suspended a proportion of their debt to enterprises, by refusing to pay for goods and services ordered and by using public enterprise funds.
1-15. Failure of domestic adjustment measures
50. Domestic adjustment measures include the various efforts aimed at restoring macro- economic clearance, without altering the nominal exchange rate, which were implemented by some countries in the early 1980s and became widespread in the area from 1985. The object of these measures was to bring the area's deteriorating economic situation under control solely through domestic restriction. However, the discrepancy between the nominal effective exchange
6 La zone franc; Rapport annuel 1993, p.41.
7 Idem.
s S. MICHAILOF: "La devaluation du franc CFA: une decision inconsumable, une opportunite pour la relance economique de l'Afrique\ Document de travail. Banque Mondiale.
20 April 1994, p.5
rate and the real effective exchange rate was so ..Teat that domestic measures could not singlehandedly bring about economic recovery. S. Michailof believes that domestic adjustment would have produced positive results, had this discrepancy been less significant (say about
51. The domestic adjustment efforts, unfortunately, culminated in failure for the African countries of the franc area. For economic and political reasons, some of the countries such as Congo, Gabon, Niger, the Central African Republic, Chad and Togo were unable to undertake the domestic adjustment programmes. Others (Cameroon, Cote d'lvoire and Senegal) undertook reform efforts for a few years. Showing no prospects for success, however, these efforts had to be shelved. Only Benin, Burkina Faso and Mali whose competitiveness remained intact, managed to pursue their reforms and posted slight growth in their per capita revenues.
Unfortunately, they were unable to sustain the per capita revenues on a long-term basis.
52. There are several explanations for the failure of domestic adjustment programmes adopted by African countries of the franc area.
53. Firstly, there was reluctance to reduce money wages and domestic prices in the modern sector. The reticence proved nearly impossible to overcome owing to the existence of uncompetitive job- markets and of monopolies/ oligopolies. The latter situation explains why deflationary policies occasionally led to diminished production rather than to a drop in prices and wages. For political reasons, it was very difficult to substantially scale down the civil service's wage bill. Expenditure cuts mainly involved investments and maintenance and non-wage operational expenses. The result was a drop in public investment, a drastic decrease in basic service expenditure in such areas as health and education. The budgetary measures taken failed to stem the State's accumulation of domestic arrears. The latter created serious liquidity problems for private enterprises as well as aggravating the financial system's gloomy situation.
Following a long period of recession, wages finally dropped significantly.
54. Secondly, the attempt to enforce restrictive budgetary policies during a recession ,in order to clear budget deficits, only aggravated the bleak pattern. Indeed, the recession contributed to the reduction in the tax base, thereby cutting budget receipts. To make up for the loss, governments often resorted to raising tax rates. However, this measure, considered by transactors as overtaxation was responsible for uncompetitiveness, the transfer of certain modern sector activities to the informal sector and the worsening of the recession.
Idem. p. 15.
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55. Thirdly, implementation of trade policies designed to substitute monetary adjustment proved ineffective. Fraud and smuggling sabotaged efforts to strengthen tariff policies, thus preventing the collection of customs duties. Furthermore, recession-related budget deficits discouraged the payment of export subsidies meant to promote the development of export
industries.
56. Fourthly, domestic adjustment measures had the opposite effects on private investment and the financial system from those desired. Private investment suffered considerable decline owing to the shortfall in profits and the dwindling sources of funding. Concerning the financial system which needed to be restructured to support the formal sector, the gloomy economic atmosphere pervading the area (with the consequent accumulation of the public sector's arrears, upsurge in unproductive credits,and capital flight all contributing to the decline in the banking system's liquidity), foiled any attempt to successfully restructure the system.
57. lastly, whenever the structural reforms implemented by the franc area's African countries achieved success (as was the case in Benin, Burkina Faso and Mali), they did so sluggishly and for very shon periods, so that the process was considered to be "causing suffering without producing results".i0 For political reasons it, thus, became pointless to pursue the implementation of such a reform programme, which explains why authorities in some countries
started to back-pedal.
58. Considering all these reasons and the predictable development in competing countries, sustenance of the domestic adjustment process by African countries in the franc area would have required a considerably long time, between 10 and 20 years,11 with all the attendant social costs and other problems.
59. Bretton Woods institutions (the International Monetary Fund and the World Bank) were from 1992 compelled, by these policies' failure and particularly by the majority of the area's African countries' perceived inability to comply with performance criteria defined by adjustment programmes, to suspend their assistance. The suspension of such assistance, as well as that of other bilateral and multilateral financial backers, put the area's funding needs at over 50 billion French francs for the year 1994,a sum greatly exceeding France's funding capacity. Earlier, in September 1993, France had announced that starting from the end of that year, its financial assistance would be contingent upon the adoption of credible economic programmes advocated by the International Monetary Fund. The noose was tightening around the area's African
10 S. DEVAREJAN and L.E. HINKLE; op. cit. p. 21
11 S. MICHA1LOF; QjLdt-, p. 15.
countries which were now obliged to meet the demands of Bretton Woods institutions. The latter insisted, as a pre-condition for the resumption of their aid flow to African countries of the area, on the devaluation of the CFA franc.
1.2. Need for currency adjustment to counter the overvaluation of the CFA franc 60. Alluding to the overvaluation of one currency against another is tantamount to rinding the exchange rate between the two currencies unrealistic. This calls for the establishing of a balanced exchange rate, which would be tricky, particularly in developing countries. Efforts to establish a balanced exchange rate aim to sustainably rectify an imbalance or anticipate it.
61. Prior to 1985, the issue of the overvaluation of the CFA franc had never been raised so pointedly. Nevertheless, there was an occasional upsurge in the effective real exchange rate, (between 1975 and 1980 , for instance,the effective real exchange rate increased considerably);
but this phenomenon was partly concealed by the favourable terms of trade of African countries in the franc area. It was not until 1985, when the terms of trade started declining and concurrently the effective real exchange rate started rising that there were calls for a change in the par value between the CFA franc and the French franc.
62. In countries regulated by flexible exchange rates, the effective real exchange rate would have been devalued to offset such deterioration in the terms of trade. In African countries of the franc area, however, while the terms of trade became less favourable, the effective real exchange rate was constrained, by the pegging of the CFA franc to the French franc, to remain unaltered.
Furthermore, the 70% appreciation of the French franc against the United States dollar (subsequent to the September 1985 Plaza agreement), and the effective real exchange rate devaluations and depreciations that Asian, Latin-American and African countries had to bear with (to cope with their worsening terms of trade), produced a substantial appreciation in the effective real exchange rate of African countries in the franc area between 1985 and 1989. In certain developing non-African countries (with flexible exchange rates), that are exporters of raw
materials, real currency depreciation even reached 60% between 1980 and 1991.'*
La zone franc; Rapport annuel 1993. p. 45.
E/ECA/ESPD/EXP.6/7 Page 17
Franc area countries Real effective exchange rates and terms of trade, 1980 - 84
(weighted by the 1994,1995 GDP = 100)
Sources: IMF, Information notice system; and Worid Economic outlook
An upward trend denotes an appreciation of real effective exchange rates.
2 A downward trend denotes a depreciation of terms of
trade.
63. The CFA franc was increasingly overvalued. In 1993, the overvaluation was estimated at 50%,on average for the African countries of the franc area as a bloc,3 although the overvaluation varied in degree depending on the size of the area's various economies. These countries, consequently lost a large proportion of their market, particularly the foreign market.
The export sector and the import substitution production sector were seriously affected. While the export outlets for traditional merchandize dwindled, competing countries increased their production in order to take advantage of the favourable conditions provided by their domestic prices. The loss of competitiveness reduced the profitability of the area's export sectors, including those with a competitive edge. For their part, import substitution industries were at some point unable to continue playing the role assigned them. In fact, whereas until 1986 (the year the CFA franc started appreciating against the Naira),numerous products were exported from the franc area's African countries to Nigeria, since then, there was a reversal of the flow of trade and Nigerian products having become cheap (owing to the depreciation of the Nigerian currency), flooded the African countries of the franc area. It then became necessary' to lower the real value of the CFA franc.
2. Anticipated outcome of the January 1994 devaluation
64. Three main effects were expected from the 12 January 1994 devaluation of the CFA franc: the balancing of the public finances of the various States, enhancement of the competitiveness of nascent industrial sectors, and the restoration of an atmosphere conducive to the flow of capital into the area. Also desired was the maintenance of the inflation at a relatively low level and the signing of debt relief agreements.
2.1. Balancing of puM
65. The devaluation was expected to help improve the public finances of the area's countries.
The improvement was to be built on two basic principles: increase in tax deductions from the revenues of import sectors and cuts in the wage bill. The export sectors of the area's African countries constitute a substantial tax source. Admittedly, figures concerning certain export products are sometimes treated as state14 secrets, nevertheless such products account for a considerable proportion of these countries9 export receipts. The proportion of the wage bill and, in general, of the current expenditure in State budgets was considered very high on the eve of the devaluation. Thus, there was need to scale down real remunerations in the public sector,
13 S. DEVARAJAN and L.E. HINKLE; op. cit.. p. 15.
14 In some countries of the area, receipts of the petroleum sector are given special treatment, and little is known of the related figures as they are shrouded in secrecy.
E/ECA/ESPD/EXP.6/7 Page 19
since the vanous domestic adjustment programmes applied by these countries had failed to cut such expenditure owing to reluctance to reduce salaries. Furthermore, cuts in current expenditure and the concurrent increase in tax receipts were expected to ultimately lead to a reduction in the public sector's net funding needs and help clear domestic and foreign payment
arrears.
2.2. Enhancement of competitiveness
66. From the realization that African countries of the franc area were uncompetitive came the hope that devaluation of the CFA franc would help to perceptibly enhance competitiveness with regard to other developing counties. In terms of comparative advantages, the devaluation was supposed to strengthen the situation in the area's countries, partly through the increase in export receipts and partly through hard currency cuts in labour costs. The operation was supposed to help channel activities towards export sectors, and encourage domestic consumption of local products (thanks to the increase of import prices in local currencies). The latter, a view held by transactors was expected to bring about a boom in import substitution industries. High profitability in these sectors was to pave the way for the resumption of private investment, generation of employment and the revival of growth. The real GDP, which had shown a downward trend between 1990 and 1993, was expected to increase by an average of 1% in 1994, then by 4 to 6% between 1995 and 1996. Nevertheless, it was expected that such an increase would initially reflect discrepancies between countries, depending on the seriousness of the economic imbalances in each country. Consolidation of regional integration would, gradually, eliminate these discrepancies.
2.3. Restoration of an atmosphere conducive to capital inflow
67. It was supposed that devaluation would restore the confidence of bilateral and multilateral financial backers as well as that of the various private operators. The regained confidence would facilitate capital transfers to the area, thereby promoting the resumption of investment which was
on the wane.
2.4. Maintaining a low inflation level
68. Owing to the rise in the price of imports and of the inputs required for the local manufacture of products, a general price increase was expected, but one that could be quickly brought under control. It was estimated that the inflation rate would rise from an annual average of 0.5% for the 1990-1993 period to 31% in 1994. The rate would then drop to 7% in 1995,
and to less than 5% in 1996. The high inflation rate for 1994 reflects the direct effect of the'
devaluation on the domestic prices of imported goods, as well as the impaa of the ensuing liberalization of prices. Variations in inflation rates from country to country, based on the openness of the individual country and the rate at which it liberalized its prices, had been provided for. It was, however, expected that the consolidation of regional integration would
stamp out these variations.
2.5. External debt relief offers a glimmer of hone
69. In view of the hard currency appreciation against the CFA franc, the change in par value was expected to increase the debt burden. It was, however, announced that the franc area's African countries' debt would receive special treatment as part of fresh negotiations, on debt conditions, with international creditors. It was expected that the negotiations would lead to restructuring, the immediate effect of which would be the reduction of debt servicing.
70. Figures concerning debt that corresponds to Official Development Assistance (ODA) of the franc area's African countries for 1992 are given in the tables below:
Table I: PDA debt (medium-income countries)
(in billions of dollars) Countries
Cameroon Congo
Cote d'lvoire Gabon
TOTAL
Sum 5.4 3.8 10.6 3.0 22.8
France's share 31.0
41.2 42.7 53.5
Source: s Tmpicaux- 21 January 1994.
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Table II: PDA debt (least developed countries)
(in millions of dollars)
Countries Senegal
Mali Benin Togo
Burkina-Faso Central African Republic Chad Comores
Equatorial Guinea
Sum 3000 2400 1300 1100 994 808 666 165 205
10638
France's share of the long-term debt (in %)
24.8 31.9 20.4 13.2 18.5 13.5 16.2 21.9 7.8
Source: Marches Tropicaux- 2rjanuary 1994,
71. France, the major creditor, decided to cancel the total debt owed by the least developed countries and reduce by 50% that of medium- income countries. Such a measure has a far- reaching financial effect. It is a fact that debt servicing features in the various States' budgetary expenditures. Once canceled, the ODA debt no longer figures in public accounts. Consequently, a burden is lifted. This indicates that debt relief can help improve States1 budgetary balances.
3. Rough assessment of the January 1994 devaluation in African member countries of the franc area
72. It would be delusive to claim to definitively assess the impact of the devaluation of the CFA franc against the French franc. It is nevertheless possible to evaluate the initial effects of this measure on the economies concerned. Such an evaluation must not disregard the measure's initial goals. The goals concern the management of inflation, growth of productivity, increase in financial resources, signing of external debt relief agreements, etc.
3.1. a relatively low inflation level
73. Immediately following the devaluation,there was a widespread increase in prices owing to the rise, in local currencies, of imported goods on one hand, and of the inputs used in the manufacture of local products, on the other hand. The re-introduction of price controls in most countries of the area did nothing but slightly delay the phenomenon as well as prolong and intensity it: controls heralded shortages of certain basic products (sugar, flour, etc.), as a result of either hoarding or diminished production.
74 Today, evidence shows that the upward trend in salaries is under control, and although
some price increases are discernible, they are mostly attributable to States' budget policies
(creation of a series of taxes with a view to increasing state receipts). For 1994, the inflationrate for the entire area was approximately 33%, or 2 points above the projected level.'3
3.2. Improvement "f *he rea* GT>P grawth rate
75 Compared to the 1990-1993 period during which the real GDP dropped by an annual average of 1%, the real GDP for 1994 rose by 1.5%. This result, which is clearly higher than the targeted 1.1%, represents a reversal of the previous period's pattern. However, it is hardly a reflection of the individual situation of the area's countries. Thus, for instance, within the rnmmnnautg Ernnomioue et Mon&aire de rAfrJQue Centrale (CEMAC), such countries as
Cameroon, Congo and Gabon recorded negative growth rates. We hasten to stress that reversal of the real GDP growth pattern is attributable, above all, to positive results posted by countries
of the West African Economic and Monetary Union (UEMOA). The GDP growth rate in thelatter group of countries rose from -1.3% in 1993 to 3.1% in 1994. The pattern reversal
affecting the entire area was astonishing. Growth in quantity could hardly have been expectedwithin such a short time-frame. Indeed, one of the characteristics of African countries of the franc area is that they specialize in the production of raw materials, a substantial increase of
which requires a period of four to five years. It is possible, then, that the increase in export volumes is the result of the produce of marginal orchards (which were low-yielding owing to their age or inaccessibility), unharvested prior to the devaluation. The increase in exports along with the decrease in imports, definitely played a role in the growth of the real GDP beyond the projected value.163.3. Increase *P financial resources
76 As a result of the devaluation, African countries of the franc area enjoyed a tremendous upsurge in the prices of their export products. Between 1993 and 1994, these prices increased twofold in local currencies. This situation, coupled with the repatriation of capital, contributed to an increase of about 1.9 billion dollars in external reserves at the BCEAO and the BEAC, in 1994. Actually, it would be difficult to ignore the scope of this phenomenon in the area. The difficulty of establishing accurate evaluation notwithstanding, it is clear that the sums that had been expatriated were considerable. Take a country like Cameroon, figures concerning the
13 J.A.P. CLEMENT: "Bilan apres la devaluation du franc CFA\ Finances et Ddveloppement. June, p. 24.
16 Cf. Annexe II.
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smuggling of bank notes out of the country were, for certain years, a cause for concern: 128 billion CFA francs in 1988, 109 billion CFA franc in 1989.17 These figures are not very different from the country's investment budgets for those same years. It is hoped, therefore, that the repatriation of capital will, in the medium-term help further the revival of investment and the reduction of unemployment.
3-4. Signing of external debt relief agreement?
77. A major disadvantage of a devaluation is that it intensifies the debt burden of the country that is subjected to it. Already heavily indebted prior to the change in the par value of their currency, African countries of the franc area were no exception to this rule. In 1992, their total outstanding debt amounting to 46,671.4 million dollars, represented 95% of the GDP of these countries as a whole, while the arrears (in interests and principal) alone represented 51.5% of
the GDP."
78. The devaluation was followed by negotiations between African countries of the area and foreign commercial banks and other private creditors, with a view to rescheduling these countries' debt and establishing conditions that are consistent with their capacity for external payments. To-date, nearly all these countries have signed or are about to sign substantial debt relief agreements with the Paris Club. The bilateral debt of some of the countries (low-income ones) was canceled, in particular by France. Average-income countries, which were for a while exempted from debt relief measures, recently benefitted from the conversion, into investment projects, of their debt to France.
79. Although they only serve to temporarily delay problems related to debt servicing, the debt relief measures applied to the franc area's African countries, nevertheless enable the latter to re allocate resources to profitable investment projects. It is, however, regrettable that so-far only France has made noteworthy efforts along these lines. It is hoped that other creditors will effectively implement similar measures.
17 Address by the Cameroonian Minister of Finance to the National Assembly on 4
December 1990.
18 La zone franc; Rapport annuel 1993 p. 38.
3.5, Consolidation ftf r^g™1' integration
80. African countries members of the franc area demonstrated their desire to strengthen regional integration,through: the ratification in June 1994 of a treaty signed in January of the
same year,thereby creating the Vm™ Rmnnmtgnt- et Mon&aire Ouest-Arricaiae (UEMOA) inreplacement of the iininn Mnnetaire Quest-Africaine (UMOA); the creation, on 16 March 1994,
nf the Qjiinnnaiite Ecnnomiquft et Mnnftaire de I' Afriaue Centrale CEMAC). The two bodiesintend to intensify (by means of budget balance and external debt convergence indicators)
monitoring of the various countries in order to avert substantial budget deficits, but moregenerally, to stave off excessive public indebtedness that could jeopardize the area's viability.
Along with the effort to monitor countries, other initiatives are envisaged: financial market development, business and insurance codes, social security arrangements, set-up and follow-up of a regional economic data base. With regard to insurance, it should be noted that a joint code (the CIMA code) is already in force, and this is a step further in the implementation of regional integration. However, in the best case scenario, regional integration reaches the stage where the greater proportion of trade in the area's countries is conducted at the intra-regional level.
3.6. Ineffective mohili7*tinn of puhHr rrafrts and delays in the imPlementatlQfl Of
81. One of the objects of the devaluation was to help the various States meet their funding needs through increases in public resources, due to the mechanical rise in receipts resulting from
customs duties, and the strengthening of tax recovery methods. It was, therefore, necessary,inteXLaiia, to curb or, indeed, stamp out smuggling, which represents 20 to 30% of official exports, and generates dead losses in public finances. Compared to the goal defined mobilization of public receipts remains modest. The area's amalgamated receipts (exclusive of donations) rose by a mere 37% in 1994, compared to the projected 49%.» With regard to this
poor performance, CEMAC countries once again trailed behind, their public receipts havingdwindled between 1993 and 1994. Failure here is attributable to social problems resulting in
taxpayers' non-compliance, the disruption of market facilities, and the decline or even loss ofthe government's authority in some countries.
J.A.P. CLEMENT; ojLflt, P- 27.
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III. THE FRANC ZONE AREA: WHAT IS THE FUTURE OUTLOOK?
82. In an effort to determine the future outlook of the franc area, certain approaches rely on an analysis confined to projections on prospective economic results of member countries. These approaches, overlook the issue of the area's future as an institution, particularly in the face of the development of the European Union. We, however, consider this a crucial issue that should be a focal point of the various discussions on the franc area.
*• Prospects Of the franc area from the viewpoint of immediate economic results 83. Based on the fact that the CFA franc's devaluation against the French franc would impact on export prices, some analyses exhibit a great deal of optimism concerning economic recovery in African member countries of the franc area. Such optimism is built upon the possible adoption by, these countries, of a new development strategy. The latter should help resume growth and alleviate poverty.20 The principal elements of such a strategy are: according the export sector greater importance, developing competitive and flexible economies, and accelerating the process for the alleviation of poverty.
!•! According the export sector greater i
84. Recent studies indicate that growth resulting from export activities is the only form of
development that can help African countries of the franc area to achieve rapid and sustainableimprovement of their living conditions. While promoting local industry, this type of growth
at the same time attracts sufficient stocks of hard currency for the importation of intermediate products and capital goods. In point of fact, devaluation promotes exports by making them relatively cheaper tor the foreign market. Devaluation is, likewise, expected to change thebehaviour oflocal transactors; they are expected to focus their demand on local products, thereby
boosting the import substitution industry.
85. While the relevance of such an analysis is indisputable considering the experience of
certain East Asian countries, nevertheless it must be pointed out that export products of the African countries in the franc area are different from those of East Asian countries. Whereas the latter have managed to rapidly develop the exportation of finished products, the former are still exporters of raw materials. The point is that growth resulting from exports presupposes the replacement of primary export products by manufactured goods. This is a strategy that involves the development of export activities that are competitive on the world market, using the most abundant and least costly production factor (labour).20 S. DEVARAJAN and L.E. HJNKLE, ojLcjt., p. 27.
86. The success of this strategy in newly industrialized countries of Asia (Korea, Hong-kong, Singapore and Taiwan ) and Brazil can be explained by the following reasons:
outlets were not restricted to the domestic market, and enterprises managed to rapidly take advantage of economies of scale;
export substitution had a favourable impact on employment and the distribution
of revenues;
the substitution had positive effects on the balance of payments and indebtedness.
87. Korea, for instance, initially specialized in the manufacture of products such as garments, simple electronic equipment, baskets, etc, the choice of which was determined by the size of the world market and the.low investments that such manufacturing activities involved. This strategy
was responsible for gradual recovery in the various manufacturing sectors. Thus, with regard
to textiles, garment- making which had initially depended on imported fabrics eventually switched to local ones, because the country started producing and exporting fabrics, and later, weaving machines. Having set up low value added and high labour industries, Korea focused its production towards more capitalistic sectors using such advanced technology as electronics, computers, capital goods, etc. Furthermore, the government played a key role in industrial development through investment and production planning:nationalization of certain major banks in order to implement planning objectives;
application of competitive exchange policies (devaluations) and export subsidies;
management of foreign investments to minimize their contribution to the overall
investment.
88. Admittedly, between 1970 and 1985, growth in African countries of the franc area depended on the exportation of primary products, however, this was at a time when demand for such goods was relatively high. Today, development of synthetic products and the attendant rise in their supply (considering the ever increasing presence of Latin-American producers) raises the question of whether African countries of the franc area have the capacity to achieve similar results without first changing the products exported and diversifying their trading partners.
Therefore, it is not through a devaluation as some insist21 (which at any rate caught the area's African countries unprepared), that living conditions in these countries will be rapidly improved.
89. The assertion, therefore, that devaluation can be instrumental for rapid and sustainable improvement of the living conditions of African countries in the area is debatable. We have already mentioned the principal impediments; the type of products exported by these countries and the surplus supply of goods on the market. Besides, even if there were no surplus of goods
S. DEVARAJAN and L.E. HINKLE. op, cit.
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to adversely affect prices, African countries of the franc area would still need to increase, on a short-term basis, their supply of export products, which would be difficult to achieve unless these countries resorted to the development of marginal orchards.
1.2 Need for area economies to be more competitive and flexible
90. The world economy is undergoing rapid change. The recent crumbling of the Eastern Bloc has played a role in speeding up the transformation of the world economy. The latter has veered towards a market economy, which involves increasingly fierce competition. It is believed that under these circumstances, rigid economies are condemned to greater marginalization on the world market. Consequently, African countries of the franc area must adapt to the new world economic environment without delay. Ridding themselves of unprofitable public enterprises which influence price control regulations (because such enterprises are subsidized), and abolishing monopolies/oligopolies should help these countries promote production'(through prices that encourage the manufacture of marketable goods). It is through the positive development of production activities that growth can be achieved in the area of private investment. Such an analysis, which totally contradicts the old theory on development is based on what might be called the new theory on development.
1-2.1 Grounds for the analysis advocating greater competitiveness and flexibility
91. Advocacy for greater economic competitiveness and flexibility is based on the new hypothesis on development formulated in the 1980s, according to which understanding of development phenomena is built upon the following three factors:
the development of a nation largely depends on its openness to the outside world;
development is all the more rapid if the incentives offered to transactors are socially compatible;
the overall supply is governed by the allocation of rare resources. However, the allocation can not be optimal except in a competitive market.
92. The last factor fully supports the argument for government withdrawal from economic activity. Market facilities are, therefore, preferable to government intervention. This theory (without altogether disputing the need for the public sector to assume responsibility for certain activities that provide considerable externalities) lays emphasis on three considerations:
(i) * Government intervention (through price, quantity and information controls) greatly interferes with resource allocation, whereas in a market situation, such allocation is determined by transactors' preferences. It must be stated that protectionism and government intervention create a situation characterized by the accumulation of unearned income, that might encourage contractors to use a significant proportion of rare
