Just How Important Is Finance for African Development?
- I. Patel
- Published Date:
- December 1992
Evidence for the Unimportance of Finance
The paper by the Economic Commission for Africa (ECA) presents an overtly gloomy view of Africa’s economic prospects, seeing difficulties on all fronts and little scope for an easing of present belt-tightening. The World Bank paper strikes a more optimistic note but it too can be read as cautionary, for it is able to arrive at a positive conclusion only on the basis of very optimistic assumptions about improvements within African countries in saving rates and in the productivity of capital. It is only on this basis that it can arrive at a financing gap to be filled through external support that is within the realm of the possible.
The case for finance in support of Africa’s adjustment and development efforts can be expressed as follows. (1) There is a need to augment the limited availability of, and capacity for, domestic saving in order to achieve levels of investment necessary to sustain reasonable rates of per capita income growth. (2) External finance is also needed to augment foreign exchange earnings, so as to permit the import volumes necessary to sustain the levels of capital formation, capacity utilization, and consumer incentive goods needed for development. (3) Finance is further needed in support of adjustment programs: to ease the period of transition, reduce the social costs, and reinforce the political sustainability of the process. This case is familiar and needs no elaboration here. But should we take it for granted that finance is commonly the binding constraint on African adjustment and development? There are a number of reasons for doubting so.
First, we all know we should not equate economic growth with development. If we introduce questions about how the benefits of growth are distributed across society (and across generations), and the issues relating to human development recently emphasized by the United Nations Development Program (UNDP), the linkage between what we regard as economic progress and the availability of finance is modified, probably weakened. If we further add environmentalist concerns about the long-term sustainability of the modernization model of development, the connection becomes further attenuated. Additional doubts are generated by the limited success of IMF and World Bank financial backing for stabilization and adjustment programs in sub-Saharan Africa.1
Nevertheless, gross domestic product (GDP) growth is an important indicator of the pace of development; so, does the evidence bear out the proposition that finance is the binding constraint on growth in sub-Saharan Africa? On this, see Chart 1, which is a scatter diagram of the relationship in 1980—88 between gross domestic investment (GDI) and GDP growth in 27 sub-Saharan African countries.2 No connection between the variables is evident there. Investment ratios converged around 15 percent, but the associated GDP growth rates varied from around—1 percent a year to over 5 percent. Three countries (Gabon, Niger, and Togo) maintained investment rates well above 20 percent but bad negative or negligible growth. Three countries (Burundi, Cameroon, and Chad) achieved growth rates of around 5 percent on investment ratios of only 15 to 18 percent. This is naive evidence, of course, because so many other factors have an effect on growth, but it is at least suggestive and is consistent with the results of other studies, not confined to sub-Saharan Africa, which throw doubt on the power of investment to generate growth.
Chart 1.GDP Growth and Gross Domestic Investment, 1980–88
Its suggestiveness is reinforced by evidence on the impact of development assistance on Africa’s growth and other performance indicators, summarized in Table 1. The figures speak for themselves: comparatively massive levels of aid to sub-Saharan Africa were accompanied by a far worse economic performance than for other developing countries taken as a group. Again, there are many reasons why this might be so (see below), but at the very least one must conclude that the past decade’ s aid has not been strikingly effective in economic terms. Other, more sophisticated, tests point to the same conclusion. Why, in this case, might we think that yet higher levels of assistance would produce superior results?
|Aid per capita (in U.S. dollars)||21.8||5.5|
|Aid as percent of per capita income||4.9||0.8|
|Aid as percent of gross domestic investment||33.5||3.3|
|Aid as percent of imports||25.7||5.2|
|Performance indicators (annual rates of change)|
|Per capita income||-6.4||+0.8|
|Per capita private consumption||-1.1||+0.8|
|Daily calorie supply per capita||-0.6||+0.8|
Figures relate to net disbursements of overseas development assistance from all sources
Figures relate to net disbursements of overseas development assistance from all sources
One reason why investment may not be closely correlated with growth in sub-Saharan Africa relates to the difficulties that the very open, import-dependent economies of the region had during the 1980s in sustaining the import volumes necessary for growth, despite the comparatively massive aid inflows. Indeed, we suggested earlier that one of the cases for financial support was to augment import capacity; however, see Chart 2.
Chart 2.GDP Growth and Import Growth, 1980–88
We see there that a few countries were able to achieve quite rapid GDP growth with little, if any, expansion in the volume of imports, while a few others managed to sustain quite rapid expansion of imports but achieved only slow economic growth (implying declining per capita incomes). Admittedly there is a little more sign of some correlation here, with most of the regressing economies also experiencing declining imports and most of the more rapidly growing economies achieving at least some positive import growth. Again, this kind of evidence can only be suggestive because of the need to control for the various other influences on economic growth, but it does at least suggest that the connection is not dominant, which again raises questions about the centrality of finance.3
There is, then, a strong conflict between the macroeconomic case for additional financial support for sub-Saharan African economies and the evidence of its past ineffectiveness. If the quantity of neither capital formation nor imports is a prime determinant of economic performance, we are led to focus instead on the quality, or productivity, of investment and foreign exchange utilization. This line of thought is consistent with the conclusions arrived at in the literature that investigates the sources of long-term growth in industrial and other economies, which has often found investment per se to have limited explanatory power, leaving a large unexplained residual influence, which has to do with various factors affecting the productivity of resource use. Chart 3 shows evidence of a drastic long-term decline in the productivity of investment in sub-Saharan Africa, which is why the World Bank paper looks for a sharp reversal of this trend. So the question arises, what are the determinants of this productivity?
Chart 3.Comparative Rates of Return on Investment
Source: World Bank, Sub-Saharan Africa: From Crisis to Sustainable Growth (Washington, 1989), p.26
Influences on Resource Productivity
What might we identify as the chief influences on the productivity of investment and foreign exchange in sub-Saharan Africa? To respond to this question we draw on the results of a recent study I undertook of the developmental effectiveness of aid to that region (Killick (1991)). The discussion was organized around a distinction between factors primarily located within recipient countries, which were broken down into (1) the policy environment and (2) institutional, or absorptive capacity, questions; and those relating primarily to conditions and policies in donor countries, classifying these into (i) questions concerning the world economic environment and (ii) the policies and practices of aid agencies.
The policy environment was identified as having had especially strong influence on aid effectiveness. There is now rather general acceptance—reflected in the debates during this symposium—that past policy environments in sub-Saharan Africa have often not encouraged good economic performance and, therefore, aid effectiveness, even though there has been major progress in some countries in recent years. Instead of presenting familiar donor views on this, we can quote an important African voice, in a document endorsed by a meeting of African ministers of finance and planning and development: “Government interventions in Africa have so far become discredited, not because there is an effective alternative in the form of an efficient market mechanism but because of inefficient management, poor results and misallocation of resources,”4 or Ndulu (1986, p. 102):
The current economic deterioration in sub-Saharan Africa has partly been caused by internal economic mismanagement. Wide state intervention in the productive spheres and in markets for resources and products has led to an inefficient use of scarce resources not only in the “Pareto efficiency” sense, but also in relation to the development goals adopted by those countries. Serious biases against the development of the export and agricultural sectors have produced stagnant economic growth, arrested social development, increased dependence on food imports, and debt burdens requiring frequent reschedulings.
In its most recent report on sub-Saharan Africa, the World Bank compared the rate of return on investment in sub-Saharan Africa with that in South Asia (Chart 3). Among the chief reasons it identified for the low and deteriorating productivity of investment in Africa were poor public sector management; price distortions, often created by policy interventions; and high cost structures, also much influenced by government policies. It also stressed the heavy costs imposed by Africa’s loss of export market shares, which it suggests are considerably larger than losses caused by deteriorating terms of trade and which can also be linked to past policy mistakes, most notably on exchange rates. In this connection, the current weaknesses of the Franc zone arrangements, leaving several Francophone African countries with seriously overvalued real exchange rates that it is impossible to adequately correct without a change in those arrangements, can be seen as a continuing obstacle to effective resource utilization in the affected countries.
The parlous state of public finances in many sub-Saharan African countries is a further illustration. Budgets are often heavily in deficit, so much so that governments have to borrow to finance part of their current expenditures, as well as for the capital budget. One consequence is that the public sector has become a large dissaver and the chief reason for the serious decline in overall saving rates that has occurred, absorbing resources that could otherwise be devoted to productive investment and partly offsetting the benefits of capital inflows. There is also evidence that the large claims of the public sector on bank credit to finance budget deficits further competes with the private sector, by crowding out the latter’s needs for credit; and that the expansionary effects of deficit financing are an important source of inflationary and balance of payments pressures.
As concerns institutional and absorptive capacity, defined as the ability of the economic system to put additional aid to productive use, there are various well-known proximate sources of difficulty: skill shortages; institutional weaknesses; budget constraints; and “the recurrent costs problem.” These, however, do not go to the heart of the matter. Of” more fundamental importance are the basic structural weaknesses of sub-Saharan African economies and the adverse characteristics of some political systems and processes. The reference to structural deficiencies is non-controversial, relating to the weak industrial base, poorly functioning factor and product markets, limited saving and tax capacities, dependence on commodity exports and vulnerability to external shocks, small economy size and undiversified output, and the weak policy instruments available to governments.
Identification of political weaknesses within sub-Saharan Africa as a second fundamental source of limited absorptive capacity is, of course, more controversial, but even here the ECA and World Bank are in general agreement. First, the ECA’ s Khartoum Declaration5 states that
… the political context for promoting healthy human development [in Africa] has been marred, for more than two decades, by instability, war, intolerance, restrictions on the freedom and human rights of individuals and groups as well as overconcentration of power with attendant restrictions on popular participation in decision-making.
Next, the Bank (1989 pp. 60-61) states that
Underlying the litany of Africa’s development problems is a crisis of governance. … Because the countervailing power has been lacking, state officials in many countries have served their own interests without fear of being called to account. In self-defense individuals have built up personal networks of influence rather than hold the all-powerful state accountable for its systemic failures. In this way politics becomes personalized; and patronage becomes essential to maintain power. The leadership assumes broad discretionary authority and loses its legitimacy. Information is controlled, and voluntary associations are co-opted or disbanded.
As both these quotations imply, a connection is seen between the prospects for development (and hence productivity of resource utilization) and the nature of political systems, with the ECA calling for greater political accountability and a more grass roots approach.
Political scientists have similarly noted a connection, with “patrimonial” states in many African countries, which are seen as inimical to economic efficiency and development. Patrimonial states refers to a system of personal rule based on communal or ethnic loyalties. In this view, the state becomes dominated by the pursuit of individual and communal welfare and does not act as the guardian of the national interest. Profits accrue to those who can manipulate the instruments of state, rather than through production, but this creates a self-reinforcing spiral of political and economic decay. Development and adjustment are frustrated. Take, for example, the following account of policymaking in an unnamed African country (Lamb (1987, p. 18)):
A consistent and timely response to the deepening crisis was impeded by the fragmentation of information and decision-making. All major decisions … are visibly concentrated in the person of the Head of State, but many other decisions are taken in a dispersed, haphazard way throughout the administration .... What planning has taken place has largely been in a formal bureaucratic sense and rarely linked to what has actually to be done to make what is planned materialize … economic considerations are relegated to second priority, because first priority is granted to short-term political considerations, often in a disconcertingly erratic manner.
More than one country situation fits such a description.
We are not here suggesting that there is some simple connection between political systems and the quality of economic policies. But policies are the outcome of political processes, so that the nature of these processes can strongly influence the policy choices. Some regime types (which might have a range of different formal characteristics in constitutional terms) are so unrepresentative, unaccountable, ineffectual or corrupted that they are either not interested in using resources for development whose benefits are widely shared or are incapable of so doing. We do not imply that such regimes are universal, or even very common, in Africa, nor that reform is impossible. To quote Ndulu again (1986, p. 103):
The current political-economic situation is not sustainable, but political constraints to change do exist. Nevertheless, the professed distribution of resources and power among various groups has been eroded and a more malleable situation has emerged as unofficial adjustments are being made by different groups in reaction to changing conditions.
There is much political diversity on the continent, and economic hardship does often set corrective forces in motion. In some countries, it is difficult to see a way forward without a revolution. In most, the position is less desperate, and in many it has been possible to make economic progress, so that even in the lean years of 1980–87 13 out of 41 sub-Saharan African countries for which data are available experienced positive per capita income growth.
Furthermore, the evidence does not support the view that the benefits of this are invariably concentrated in a small ruling group to the exclusion of the masses. Ultimately, bad governments that run down the economy are apt to be removed; the worst policies and practices tend eventually to generate counteracting forces. Nonetheless, it would be difficult to justify on developmental grounds continuing flows of finance to some of the governments of sub-Saharan Africa, and for those it is surely right to withdraw support pending political reforms.
My paper also looked at OECD-country influences on aid effectiveness. The hostile global economic environment, often aggravated by donor-country policies, is a major—but familiar—entry into our list of determinants. Of these, the adverse effect on Africa of trends and policies that worsen its terms of trade, debt-servicing burdens, and access to world savings should be particularly stressed. So also—and despite the enhanced structural adjustment facility—should the long-term difficulties that the IMF has experienced in tailoring its approach to balance of payments policy and the terms of its financial support to make them more appropriate to the circumstances of sub-Saharan Africa. We should note, however, that the donor community has responded to the region’s special problems by devoting much increased proportions of total aid to it, and by special (although still inadequate) debt-relief initiatives.6
There is also a variety of donor-country policies and practices that reduce the quality of financial support offered and thus its potential developmental value. Many of the difficulties stem from the use of aid to promote foreign policy or commercial objectives. This leads to confusion and to practices that substantially reduce the real value of the assistance offered. Procurement-tying is the most obvious example. Most estimates put the direct cost of this, in terms of the higher price that has to be paid by buying from donor-country suppliers by comparison with the cheapest source, in the 15—30 percent range. But procurement-tying imposes indirect costs, too: adding to the bias toward capital and import intensity; placing additional demands on scarce administrative resources; creating an obstacle to aid coordination; and so on. Donor agency weaknesses further diminish the value of aid: inadequate staffing; pressures to spend; short time horizons; biases toward large, capital-intensive projects; and practices that undermine budgetary discipline in recipient governments. There are also various proliferation problems: of donors; of projects; of policy conditions. Donor coordination is also a weak spot, partly because both donors and recipients are ambiguous about it. The donors who so frequently urge policy reforms in developing countries need also to reform their own policies.
In short, what is suggested here is that the many influences on the efficiency of resource use adumbrated above are of more immediate importance for the development of Africa than the volume of finance it receives. To put it another way, finance injected into an efficient economic environment will be highly potent, but there is little point—other than to meet humanitarian concerns—in channeling more to countries that do not meet minimum standards for productive utilization. The priority needs are to improve the policy environment among both African recipients and donor countries; and investments in education, training, health, financial sector and institutional reforms, and other key influences on absorptive capacity.
Politics arguably deserves even higher priority, however. On this it is for the peoples of Africa to determine—and secure—the political systems they want. They appear increasingly to want multiparty democracy, not merely for the greater freedom that it offers but also because of the safeguards it provides against self-serving governments insensitive to the aspirations of their peoples. Failing political reform, there is little developmental case for providing more finance in support of some existing governments. The task, in this case, is to apply scarce assistance selectively in those countries that have a demonstrated ability to put it to good use. Such selectivity is liable to be a more effective response by the donor agencies than attempts to impose policy—let alone constitutional—reforms by conditionality. But the donor community, including the IMF and the World Bank, have difficulties with country selectivity, and improvements in this area may themselves require a political breakthrough among the donor (and shareholder) countries.
Khan, Mohsin, andMalcolm D. Knight,“Import Compression and Export Performance in Developing Countries,”Review of Economics and Statistics (May1988).
Killick,Tony,“The Development Effectiveness of Aid to Africa,”PRE Working Paper, No. 646 (washington;World Bank, 1991).
Killick, Tony,MoazzamMalik, andMarcusManuel,“What Can We Know About the Effect of IMF Programs?”ODI Working Paper, No. 47 (London: Overseas Development Institute, September1991).
Lamb, Geoffrey,Managing Economic Policy Change: Institutional Dimensions, World Bank Discussion Paper No. 14 (washington: World Bank, June1987).
Ndulu,BennoJ.,“Governance and Economic Management”in Strategies for African Development,ed. by Robert J. Berg andJennifer SeymanWhittaker (Berkeley: University of California Press, 1986), pp. 81-107.
World Bank, Sub-Saharan Africa: From Crisis to Sustainable Growth (washington, 1989).
World Bank, World Development Report (1990).
United Nations, Economic Commission for Africa (ECA), African Alternative Framework to Structural Adjustment Programmes for Socio-Economic Recovery and Transformation, UN Doc. No. E/ECA/CM. 15/6/Rev. 3 (Addis Ababa, 1989).
Killick, Malick, and Manuel show that of all programs entered into by the IMF; and sub-Saharan African governments during 1980-90, and due to be completed by the end of 1990, 48 percent broke down before their intended completion date and could not be fully drawn down.
Based on data in World Bank (1990). The investment data for each country were means of the ratios in 1980 and 1988.
In a regression in which both grass investment and import growth were included as explanatory variables, neither yielded statistically significant explanatory value for GDP growth, with an R2 of only 0,23. Note, however, that Khan and Knight (1988) did find a positive and significant correlation between import availability and developing-country export performance.
United Nations (1989), page 47.
United Nations (1989), page 7.
While global aid flows increased only slowly in real terms (partly because of the collapse in aid from the Organization of Petroleum Exporting Countries (OPEC)), there was a major redistribution in favor of sub-Saharan Africa, with its share of total net aid receipts rising from 9.0 percent in 1960-61, to 18.7 percent in 1970-71, to 25.8 percent in 1980-81, and to 34.5 percent in 1987—88. Moreover, the terms were softened and many past aid loans written off.