The Time is Always Ripe: Rushing Ahead with Economic Reform in Africa, Lecture by Anne O. Krueger, First Deputy Managing Director, International Monetary Fund
June 9, 2005
Anne O. Krueger
First Deputy Managing Director, International Monetary Fund
Lecture to the Economic Society of South Africa
Thursday, June 9, 2005
As Prepared for Delivery
Good morning, and thank you for that kind introduction. I want first to thank the Economic Society of South Africa for inviting me to speak today; my thanks also go to Investec Bank for hosting this morning's event.
I am very pleased to be here in South Africa. This is an auspicious time to be visiting your country for the first time. Economic performance has been, and continues to be, encouraging. Much progress has been made in developing a strong foundation for the rapid economic growth that will bring jobs, reduce poverty and raise living standards for all South Africans.
But much remains to be done, of course, if the reduction in unemployment and poverty that we all want to see is to be achieved in the coming years. The potential in South Africa is for a much higher growth rate, if the appropriate structural bottlenecks can be rectified.
South Africa is the largest economy in Africa. More rapid growth here matters primarily for South Africans, of course. But success in this part of the continent matters for the rest of Africa, too, above all because of the example it can set for others to follow.
This may be my first visit to South Africa, but this trip—I was in Madagascar earlier in the week—is my third to Africa in the past eighteen months or so. The Fund's Managing Director, Rodrigo de Rato, was here in South Africa in September last year; and he visited West Africa just a few weeks ago, on his third visit to the continent in a year.
These visits highlight the central importance of Africa for the Fund. And so today I want to focus on Africa as a whole; the challenge of transforming the continent's economic performance and prospects; and the role that the Fund can play in facilitating and supporting this transformation. A radical improvement in the economic prospects for much of Africa is essential if the Millennium Development Goals are to be realized. Achieving the higher growth rates needed for meeting the MDGs ultimately lies in the hands of Africans themselves. But helping African countries bring about lasting economic improvement is one of the key challenges facing the Fund and the international community as a whole.
I want to examine what has been achieved thus far; and to consider how best to harness the economic potential of this great continent.
An improving record
This is a continent rich in natural and human resources but which, over a long period, failed to fulfill its potential. We are all familiar with the disappointments of the past. For too many years, inappropriate policies resulted in slow or no growth. In many countries, living standards declined, and the continent as a whole fell further and further behind the rest of the world. Real per capita income in Africa is roughly the same as it was thirty years ago.
Yet important progress has been made in recent years. There are many positive achievements that we need to acknowledge. We have begun to see what might be achieved with ambition, persistence and the appropriate policies.
In South Africa, growth has accelerated since the introduction of democracy: in the period 2000-2004, real GDP growth averaged 3.4 percent, roughly double the rate before democratization—though it is still low relative to most parts of Asia. Inflation has been brought under control and is comfortably within the 3-6 percent target band. Real interest rates have been reduced. Fiscal discipline has been established. The external position has been strengthened. The short-term outlook remains favorable, with growth of around 4 percent projected for this year, and something close to that for 2006.
And South Africa is not alone. Madagascar, where I spent the first part of the week, has experienced real GDP growth of over 5 percent a year since 2003, with growth forecast at 6.3 percent for this year. Madagascar still has some way to go to achieve the macroeconomic stability that South Africa is now experiencing. Inflation in Madagascar is still in double digits. But the firm adherence of the authorities there to the fiscal and monetary policy targets now in place should permit the sharp reduction in inflation needed if macroeconomic stability is to be achieved.
In sub-Saharan Africa as a whole, real GDP grew by 5.1 percent in 2004, the highest rate of growth in eight years, with real GDP per capita rising by 2.8 percent. In a third of the non-oil producing countries in Africa, average real GDP growth exceeded 5 percent. In some of these countries—Ethiopia and The Gambia—the acceleration in growth reflected a recovery in agricultural production after drought. But there has been broad-based growth elsewhere. Ghana, Mozambique, Sierra Leone, Tanzania and Uganda have all continued to experience growth rates that were significantly higher than has been the historical norm in Africa. But these growth rates remain below what is needed to make substantial progress in reducing poverty; and below what experience in other parts of the world demonstrates can be achieved.
More rapid growth across the continent has been accompanied by an improvement in inflation performance. For sub-Saharan Africa as a whole, the average inflation rate in 2004 declined to 9.1 percent, the lowest for more than 25 years. Twenty eight African countries achieved single-digit inflation last year, compared with only 10 countries a decade ago. And only three countries recorded inflation rates above 20 percent last year.
These are encouraging developments. What has happened in the past few years has underscored the importance of having a stable macroeconomic framework in place. Indeed, studies show that those African countries that made most progress in lowering inflation rates in the 1990s were also those that experienced the most rapid growth. The average rate of inflation in those countries that grew most rapidly over this period was 12 percent, compared with an average rate of 21 percent in the countries that grew most slowly. Lower rates of inflation meant that these more rapidly-growing economies also had lower fiscal deficits. And they achieved higher rates of revenue collection which contributed to improved budgetary management.
A stable macroeconomic framework is the sine qua non for the rapid economic growth that is vital for poverty reduction. When macroeconomic stability is lacking, the resulting distortions lower the sustainable growth rate. Without sustained rapid growth, lasting reductions in poverty are almost impossible to achieve. It is not a question of redistribution, of cutting the cake a different way. Only by making the cake bigger—much bigger—can we hope to reduce poverty on a large scale over a prolonged period.
Yet the improvements we have seen are just the start. Growth performance must—and can—improve still further if widespread poverty reduction is to be achieved. Even the higher growth rates we have seen recently are insufficient to ensure that the Millennium Development Goals are achieved. Only a significant further acceleration in growth can bring the MDGs within reach. And only far-reaching structural reforms can make raising the potential growth rate to the extent needed a realistic prospect.
Achieving macroeconomic stability, then, marks the beginning of the reform process. Experience has taught us that more rapid sustainable growth can only be achieved with structural reforms—the adoption of market-friendly policies that provide the right economic incentives for all actors; that foster competition and encourage business; that promote trade liberalization; that raise employment by deregulating labor markets; and by introducing more flexibility into the economy enable it to adapt to changing circumstances.
Pressing ahead with the further reforms needed to enable more rapid growth is vital. Sticking with the reform process, and accelerating the pace of reform, will permit governments to reap further benefits from the achievements thus far—and will also help bolster public support for the reform process by advancing the point at which the payoffs start to show.
Benefiting from experience
Perhaps one of the most striking lessons from the progress of recent years is that sound economic policies bring results regardless of national circumstances. What works elsewhere works in Africa too. All countries, no matter which continent, have important national characteristics. These, in part, will determine the appropriate policy mix, just as the national circumstances that vary from country to country will determine policy priorities.
But the extent to which successful economic policies in one part of the world are those that succeed in another is remarkable. The policies that deliver rapid sustained growth in one country do the same elsewhere. Low inflation is just as important for Africa as it is for Asia or Latin America. Policies geared towards opening up economies to the rest of the world, and encouraging exports and trade, will be as effective in Africa as they have been in Asia. And state-owned enterprises have acted as a drag on growth in industrial as well as developing countries. Indeed, state protection of monopolies—whether they be publicly or privately owned—benefits the few at the expense of the many and results in the inefficient allocation of resources regardless of the state of development. This is true whether we are talking about protection from foreign imports or from greater domestic competition.
We know from experience in other parts of the world how important structural reforms are in raising the attainable rates of economic growth. Look at the experience of Korea in the second half of the twentieth century. In the 1950s, Korea was the third poorest country in Asia; it was seen by many as an economy that was not viable without indefinite reliance on foreign aid. It now has one of the highest per capita incomes in Asia, the living standards of its citizens having risen spectacularly after decades of equally spectacular growth rates. From the 1960s, Korea's real per capita GDP grew by as much every decade—somewhere in excess of 7 percent a year—as Britain had achieved in the whole of the nineteenth century.
Korea's remarkable economic performance was no accident, however. It was the result of radical policy reforms that opened up the economy to the rest of the world, that exposed the domestic economy to competition, that encouraged exports and that were implemented with a single-mindedness on the part of policymakers that has rarely been equaled. These are exactly the sort of structural reforms from which African countries could derive benefit.
Or take Chile. Structural reforms covering most areas of the economy were first implemented in the mid-1970s, and further reforms followed in the 1980s. Trade liberalization was an integral part of both phases of reform, with tariffs progressively reduced. Today Chile is one of the strongest and most open economies in Latin America. It has one of that region's most diversified export structures. And as a result of the fiscal and other structural reforms begun three decades ago, it has enjoyed rapid growth; it is able to weather global downturns better than most of its neighbors; and remains more resilient in the face of external shocks.
Korea and Chile have both benefited from reform programs that have been adhered to over long periods. But they aren't alone in experiencing the payoffs from structural reforms. After reforms were introduced in India in the early 1990s, that country experienced a significant rise in its growth rate. As structural reforms were implemented, India became one of the most rapidly-growing emerging market economies during the 1990s. Britain in the 1980s and 1990s; Australia and New Zealand in the 1980s; Brazil and Turkey currently—all are examples of countries where macroeconomic stability was taken as the starting point for structural reforms intended to bring about a long-term acceleration of economic growth.
Reforms bring significantly higher payoffs if carried out in conjunction with other reforms. The broader and deeper a reform program is, and the more rapidly it is implemented, the greater will be the returns. Thus, for example, labor market reform and trade liberalization will deliver a much greater payoff if implemented together than if one is done without the other. A deregulated labor market will make it easier for firms to exploit the export opportunities that will flow from trade reform because hiring or redeploying workers will be easier.
So the whole is greater than the sum of the parts, a point that strengthens the case for setting ambitious objectives—and sticking to them.
The medium-term challenge
Even in countries like South Africa, where macroeconomic stability has largely been achieved, the authorities are, rightly, concerned to ensure that this progress is maintained.
But once a stable macroeconomic framework is in place, governments can focus increasingly on raising an economy's growth potential and so tackling the longer-term problems of high unemployment and widespread poverty. And this means an ongoing process of structural reforms, aimed at making economies more flexible and responsive and thus able to exploit fully the benefits of globalization.
So what is the agenda for structural reform that can create market-friendly policies that will permit the higher growth rates that African—and all low-income—countries need? I'm talking here about policies, and the accompanying institutional framework, that enable countries to exploit the economic benefits that markets can bring. In most cases markets, by allowing price signals to work freely, provide much better incentives for the efficient allocation of resources. But for markets to work well there needs to be a level playing field for all economic actors, public and private. And there needs to be flexibility in the economy so that firms and individuals learn how to adapt to altered incentives.
In most cases, government intervention distorts and/or rigidifies markets and makes them function less well. The emphasis should be on effective regulation of markets, to curb monopoly power, for example. Regulation that further distorts markets is counter-productive. So is providing unfair benefits to one sector of the economy. Subsidized capital, for example, induces firms to use foreign-made machinery rather than locally-hired labor.
Even in rich countries, the efficient allocation of resources is important. In poor countries, government policies historically have meant huge waste of resources. In developing countries, it is crucial that governments, facing so many more demands for scarce resources, ensure they are allocated wisely. The less governments spend on subsidizing industry, or protecting state enterprises which are almost always inefficient, the more scope they have for concentrating public expenditure in those areas where it can do most good. Providing basic infrastructure makes private investment more attractive; it increases trade; and so helps create jobs. Similarly, improving the provision of education and health contributes to improved labor productivity as well as to an improved quality of life for a country's citizens.
Institutional reform is a vital accompaniment to such policy reforms. Government itself, the civil service, the courts: all need to be well-run and to function effectively. They need to be transparent and free from corruption. There needs to be an independent judiciary that can enforce property rights and other contracts; regulators to police commercial codes; a level playing field for all economic actors. These are all important if individuals and firms are to be able to respond appropriately to market incentives.
So too is a tax system that discourages evasion, that is simple and fair. Simplifying personal and corporate taxation and adopting uniform, relatively low, rates can increase tax revenues by encouraging more people to participate in the formal rather than the informal sector of the economy. And on the expenditure front, there is always scope to increase the effectiveness of public spending. When, as in Africa, so many citizens live in poverty, managing public expenditure can be especially difficult. There are so many legitimate demands on the state's resources. But more carefully targeted spending, fewer subsidies that distort the market and benefit the better off, can free up resources for those most in need and finance the infrastructure and other improvements vital for raising growth rates without undermining the fiscal discipline that has to be an essential part of the macroeconomic framework.
As is clear from the experience of countries like Korea and Chile, trade liberalization is crucial. Those countries that resort to trade protection first and foremost hurt their own citizens. Domestic prices are higher than they would otherwise be. Exports, real wages and growth rates are lower. Developing countries impose higher tariffs on each other than they face from the industrial world. It is reckoned that some two-thirds of the gains from a successful agreement in the Doha round of world trade negotiations would flow to developing countries—estimates for which run into hundreds of billions of dollars, in large part because of the lowering of tariff barriers between developing countries.
Opening markets brings significant gains. The competition that results drives down prices to consumers, forces exporters to become more efficient and raises both economic welfare and the growth rate. It is true that those gains would be greater if other countries—developed and developing—removed trade barriers at the same time. But the evidence of the benefits of even unilateral liberalization is overwhelming. No developing country has grown rapidly over a sustained period without opening its economy to trade with the rest of the world; and most of the success stories have liberalized their trade unilaterally.
Rich countries should do their part and eliminate protection and lower subsidies, especially in the agricultural sector. It is in their own interest to do so, and that of their consumers. But even if the industrial countries fulfill the promises they have made, the case for developing countries to press ahead with trade liberalization will remain just as strong, because they have so much to gain from opening their markets.
Reforming labor markets can be challenging, as governments in many industrial countries have found. But liberalizing labor markets make possible a more rapid reduction in unemployment and a rise in real wages for all. The evidence, from many studies, is clear: the easier it is to employ workers, the more rapidly employment grows and unemployment falls. The more expensive and complicated it is to hire workers, the more difficult it is to lay them off, and the more restricted their conditions of employment, the more reluctant employers are to hire workers in the first place.
Let me elaborate on why labor market reform is so important here in Africa, by examining the often perverse consequences of some of the more common elements of well-intentioned labor market regulations.
A minimum wage is often regarded as a tool of poverty reduction, because it guarantees a floor for workers. But imposing a minimum wage actually makes reducing unemployment more difficult because it discourages firms from taking on new low-paid unskilled workers. It encourages the substitution of skilled for unskilled workers and it discourages firms from hiring workers who need entry-level training. And a minimum wage alters the balance of incentives between the use of labor and capital. Firms are more likely to buy new machinery and capital equipment than they otherwise would.
Rules that prevent firms from laying off workers are also intended to provide workers with more stability and prevent unemployment. In general, they do no such thing. Restrictions on layoffs mean that labor becomes a fixed cost and again ensures that firms have a greater incentive to buy machines instead of hiring workers. Employers are cautious about taking on new employees because they are unable to reduce their cost base easily or speedily in the event of a downturn.
Strong union protection is fine for those who have jobs—but it helps keep those who are unemployed out of the workforce. If unions acquire too much power, firms' costs rise to the extent that exports become uncompetitive. This acts as a drag on growth and further reduces the scope for raising employment as a whole.
As many firms in industrial countries have painfully discovered, pension schemes can represent a heavy financial burden that hampers the ability of companies to grow and thus hire new workers. It's hard to exaggerate the extent to which pension schemes can come to dominate a firm's activities—British Airways, for example, has been described as a pension scheme with an airline attached. If firms are obliged to make overly generous and expensive pension provision, employment growth in the formal sector will remain low.
Indeed, as labor market regulation increases, the informal sector grows. But working conditions in the informal sector are much worse, thus widening the gap between the privileged section of the workforce, those in the heavily protected formal sector, and the rest. Letting firms decide when they need new workers and when they need to layoff some employees in order to protect their business offers the best prospect for generating employment growth and reducing unemployment. Similarly letting firms decide what training they need to provide helps avoid wasteful publicly-financed training schemes that, too often, are not directed sufficiently to what firms need.
The reform agenda I have briefly outlined is a challenging one. As I said at the outset, the principal responsibility for pushing ahead with, and implementing, economic reforms has to lie with Africans themselves. If African governments and African citizens do not believe in the reforms, the prospects of success will be much reduced. But the encouraging progress of recent years, coupled with the currently favorable outlook for the global economy, offers perhaps the best hope of achieving the economic transformation that Africans have sought for so long.
The drive for change has to come from Africa. But there is widespread agreement that reforms in all low income countries should be supported by outside help. This is what lay behind the Monterrey Consensus. There are several emerging signs of a willingness on the part of the donor community to fulfill their part of the bargain. Recent commitments by the European Union and others to increase aid transfers recognize that African countries are seeking to create the conditions for sustained rapid growth and poverty reduction.
This has to be a two way process. Without domestically driven reforms, countries will not have the absorptive capacity to benefit from resource transfers. The risk then is that such transfers simply fuel inflation and put at risk what has been achieved, so undermining the prospect for further progress.
The international institutions have an important role to play here, not least the IMF. We want to see all our members prosper. Higher living standards everywhere are in everybody's interest: the global economy benefits when national economies grow more rapidly and when poverty is reduced.
The Fund helps its poorest members with policy advice; with financial assistance; and with technical assistance, to improve what we call capacity-building.
The launch of the Fund's Poverty Reduction and Growth Facility—the PRGF—in 1999 was intended to make the objectives of reducing poverty and delivering economic growth more central to our lending operations in poor countries. Programs supported by the PRGF have become more pro-poor and more pro-growth; there are currently 20 PRGF programs in sub-Saharan Africa.
Financial assistance from the Fund is not always appropriate or needed, though. In countries that do not seek financial support from us, we can provide policy advice based on the experience gained across our large membership. Economic surveillance continues to be a central aspect of the Fund's work with all member countries: and, indeed, my visit here this week coincides with the conclusion of this year's so-called Article IV consultations with South Africa. Such consultations are carried out with all our member countries, rich and poor, and take place, with few exceptions, on an annual basis.
We have become increasingly aware that there may be scope for an additional role for the Fund, for those countries that are not seeking financial assistance from us, but which still want support for their macroeconomic reform efforts. So our main policymaking body, the International Monetary and Financial Committee, the IMFC, has asked Fund staff to examine the scope for a new Fund instrument—some kind of non-financial arrangement to provide Fund support of a member's economic program. At the request of the IMFC, we are also looking at how to ensure that we have the tools to meet the needs of low-income member countries hit by external shocks. We are currently putting proposals together on both these issues for the consideration of our Board.
Let me sum up briefly.
This is a moment of great opportunity for Africa. The improvements we have seen in economic performance on this continent are encouraging, not least because they remind us of the enormous untapped potential in Africa. They offer a hint of what might be achieved if governments and their citizens build on the progress made thus far and intensify their reform efforts.
But this opportunity will not last forever. The global economic outlook remains unusually favorable, notwithstanding the risks posed by higher oil prices and geopolitical uncertainty. And unless reform efforts continue to move forward, there is always a danger that growth rates will revert to their former levels. The reform process is not static, it has to be ongoing.
The most heartening aspect of recent economic developments is that the policy reforms are essentially domestically driven. This greatly strengthens the prospect that further reforms will be implemented and will bear fruit.
The challenge is formidable. There is much to do if sufficiently rapid and sustained growth is to be achieved, if poverty is to be reduced, and the MDGs are to be met. But the best response to formidable challenges has always been to take them head-on.
These stakes are high: we are talking about lifting millions out of poverty and raising the living standards for all Africans. That has to be a prize worth fighting for. Yes, external help is needed, and should be provided. The IMF is already working to make its contribution. But ultimately, this is a challenge for Africa, and one which I am confident Africa can meet. Look at what has been achieved here in South Africa, in such a short time.
So let me remind you of Nelson Mandela's words, included in the title of my talk today:
The time is always ripe to do right.