Chapter

3 Lessons on Regulatory Reform: Kenya’s Experience

Editor(s):
Laura Wallace
Published Date:
January 1999
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Author(s)
Harris Mule

A properly functioning economy requires a set of laws and regulations to govern rights and obligations among the economic agents. The laws cover, among other things, property rights and commercial transactions. In Kenya’s case, the law on property—especially land rights—is governed by both statutory and customary law, complex issues that go well beyond the purpose of this presentation. This presentation, therefore, confines itself to laws and regulations that are directly related to issues of economic management. Specifically, it addresses laws and regulations that impinge, positively or negatively, on economic efficiency.

The Policy and Regulatory Framework

Kenya has always enjoyed a relatively open economy. Immediately after independence in 1963, the Kenyan government opted for a mixed economy with a robust private sector. The policy allowed for ownership of property and enterprises by both the state and private sectors. Its laws, enshrined in the constitution, protected individual and corporate property rights, encouraged private enterprise—both domestic and foreign—and advocated Kenya’s participation in the world economy via international trade, private foreign investments, and tourism. In addition, the policy advocated a strong public sector with government ownership and control of key enterprises, especially in energy, transportation, communications, banking, insurance, and manufacturing.

The government also inherited and expanded a complex set of laws and regulations governing the workings of the economy. The laws were both economywide and sectorwide, but also industry specific.

At the macroeconomic level, exchange rates and interest rates were fixed, determined by the governor of the central bank, in consultation with the minister of finance. The wage rates were determined by the industrial court, within guidelines formulated by the ministers of finance and labor. External and domestic trade were governed by laws and regulations under the authority of the minister of commerce and industry, and so was the establishment or expansion of manufacturing plants. In particular, laws and regulations were in place to govern exports of what were deemed essential commodities, particularly foodstuffs and imports. Similar laws and regulations—including licensing requirements—governed operations in mining, quarrying, transportation, communications, and the rest of the service sector.

There were also extensive laws and regulations covering prices of all manufactured goods with heavy weightings in the low-income price index, services that affected the low-income groups, and virtually all agricultural commodities. In agriculture, this included laws that governed, and still govern, land ownership and use—laws that indirectly affect prices. There were laws, regulations, and procedures that governed producer and consumer prices for agricultural products. There were, and still are, regulations that govern quality and other standards for those commodities. Of all agricultural commodities, only horticulture was not subjected to these regulations.

Beyond prices controls, institutional arrangements were in place to govern procurement, processing, and the movement and marketing of agricultural commodities, including maize, wheat, other cereals, sugar, dairy, meat products, cotton, and pyrethrum (an insecticide)—the latter two being marketed by state or quasi-state monopolies. There were also regulatory authorities created to monitor and supervise production, procurement, processing, and marketing of dairy products, pyrethrum, sisal, tea, and coffee.

This regulatory framework, inherited at independence, was expanded after 1963. New state corporations were created to promote activities in manufacturing, commerce, and tourism. Labor laws were amended to establish an umbrella trade union organization. And state- or quasi-state-owned corporations were created to implement the import-substituting industrialization policy that was in place then.

Moreover, the 1973–74 oil crisis—and the pressures it created in the balance of payments and domestic prices—gave rise to even more controls. Quantitative restrictions were imposed against specified commodities, especially those that competed with local manufactures. Parastatals, especially in the manufacturing sector, were awarded more protection, including monopoly or quasi-monopoly status. Control over exchange rates and interest rates was intensified, and the coverage of items under the price control regimes was expanded. Yet in spite of—or perhaps because of—these controls, pressures on the balance of payments, general price levels, and the budget intensified following the second oil shock in 1979. It was at this stage that the government accepted that reform was clearly in order.

Story of Reform Efforts

Kenya’s reform efforts began with partial decontrols on several fronts, supported by a Stand-By Arrangement with the IMF in 1979 and two Structural Adjustment Programs with the World Bank in 1979 and 1982. Foreign exchange regulations remained in place, but exchange rate management was made more flexible with regular adjustments based on a currency basket of Kenya’s main trading partners. Similarly, the management of interest rates was made more flexible, with the aim of making deposit rates positive relative to inflation. Some quantitative restrictions were abolished, and in general, import restrictions were relaxed, with greater reliance placed on tariff protection—which was also made uniform. Less sensitive commodities were removed from the price control lists, and the Banking Act was amended to streamline registration policy and procedures for licensing new banks and for strengthening bank supervision.

The story of Kenya’s adjustment efforts has been told in many reports and articles sponsored by the World Bank, the IMF, and others. The bottom line is that the adjustment performance was not impressive. The laws and regulations governing the price regime remained intact. The control framework also remained in place, although there was some relaxation, both in terms of intensity and coverage, of the controls.

By 1992 and 1993, Kenya was experiencing severe external imbalances and budget deficit crises. The chief culprits were political uncertainties caused by political reforms and the withholding of balance of payments support. In response to the crises, and with prodding from the IMF and the World Bank, the government undertook far-reaching economic reforms in 1993. Most of the reforms that had either been withheld or only partially implemented in the 1980s were now fully adopted.

  • All domestic factors and product prices were decontrolled.
  • Quantitative restrictions on imports were dismantled.
  • Import tariffs were rationalized and lowered.
  • Exchange controls, including controls on the capital account, were abolished.
  • Interest rates were liberalized to reflect market conditions in the money market.
  • Laws and regulations confirming monopoly status to state enterprises were repealed (notable among these was liberalization of the marketing of grains).
  • Laws to curb monopoly practices were strengthened.
  • Measures to privatize nonstrategic state enterprises were set in motion.

Thanks to the serious implementation of economic reforms since 1993, the regulatory framework in Kenya has become market-friendly. But interestingly, this has not been matched by a rebound in economic performance, as Table 1 shows. Indeed, economic performance has been the worst in the last four decades, and one could even say that there has been a negative correlation between the two. Is this surprising? Not really, because economic performance is determined by many factors, of which the regulatory framework is only one. I would like to suggest that while economic reforms and the regulatory framework underpinning them are vital, they are, by no means, sufficient for the resumption of sustained economic growth.

Table 1.Kenya: Regulatory Reform Is a Necessary but Not Sufficient Condition for Growth
PeriodAverage Annual Percent

Change in Real GDP
1963–736.0
1976–805.5
1980–863.2
1986–905.0
1991–952.2
19964.0
1997 (estimated)2.0
1998 (projected)1.0
Source: Government of Kenya, 1997.
Source: Government of Kenya, 1997.

What Happened to Growth?

This presentation is not intended to investigate and determine causal linkages between the regulatory framework and economic performance. That exercise is well beyond the scope of this presentation. Instead, I would like to suggest five hypotheses that could explain the discrepancy between economic liberalization and performance.

  • Economic agents require confidence that the laws and regulations are stable, predictable, and uniformly applied. Kenya’s policy and regulatory environment was not stable in the 1980s. There were many reversals of policy during that decade, and the policies and the regulations underpinning them were not rigorously applied. It can be hypothesized that economic agents were not confident that the far-reaching changes instituted in 1993 would stay the course.
  • Regulations need to be clear, and there must be incentives for administrative agents to enforce them. In many cases, the regulations governing the operations of state corporations, especially in the grain and dairy sectors, were unclear and not completely overhauled. Furthermore, the incentive structure for enforcement favored the existing state of affairs. As a result, new regulations were only partially and tentatively applied, and subject to revision.
  • The administration of laws and regulations must be transparent. This is particularly so when it comes to administering import tariffs. Before the government streamlined the administration of tariffs, with the creation of the Kenya Revenue Authority, there was widespread evasion of customs duties, with deleterious consequences both to government revenue and the domestic manufacturing sector.
  • The time-phasing and sequencing of policy must be carefully thought out. If not, it can undermine the efficiency of regulations. One example was a mismatch in liberalizing fertilizer and maize prices in 1994. What happened was that the prices of fertilizer were decontrolled, while the prices of maize were left unchanged. This led to fertilizer prices rising, while maize prices remained low. As a result, the viability of maize production was undermined, leading to a drastic drop in production levels.
  • Above all else, capacity must be built up. The civil service, in general, and the regulatory agencies, in particular, did not have the needed capacity and incentives to apply the new regulatory regime effectively. Moreover, institutional arrangements to take over the deregulated activities were either weak or nonexistent. This was especially so when it came to privatizing marketing enterprises in the context of a weak private sector.

Conclusion

The evidence shows that regulatory reforms in Kenya have not been matched by corresponding improvements in economic performance. If anything, the evidence points to the contrary. But this should not be surprising given that economic performance is a result of many factors, of which the regulatory framework is only one. Regulatory reforms must be viewed in the context of the overall incentive structure for economic policies, institutional arrangements, and the country’s overall capacity. Moreover, the reforms must be properly time-sequenced and they must be fully owned by the important stakeholders in the economy.

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