Archives for category: Frontier Markets

A recent report released by the World Economic Forum  says that border administration and infrastructure are the biggest problem to international trade.

Reducing supply chain barriers to trade could increase GDP by nearly 5% and trade by 15%

If every country improved just two key supply chain barriers – border administration and transport and communications infrastructure and related services – even halfway to the world’s best practices, global GDP could increase by US$ 2.6 trillion (4.7%) and exports by US$ 1.6 trillion (14.5%). For comparison, completely eliminating tariffs could increase global GDP by US$ 0.4 trillion (0.7%) and exports by US$ 1.1 trillion (10.1%). The estimates of the impact of barrier reduction are conservative; they reflect improvements in only two of four major supply chain categories.

Why is lowering barriers so effective? The reason is that it eliminates resource waste, whereas abolishing tariffs mainly reallocates resources. Moreover, the gains from reducing barriers are more evenly distributed among nations than the gains from eliminating tariffs.

Of course, reducing supply chain barriers requires investment, while tariff reductions require only the stroke of a pen. However, many barriers can be traced to regulation. Detailed analysis can enable policymakers to prioritize the investments that are most critical and cost-efficient.

Tariffs are of course very important (see figure).

Source: WEF (2013)

Source: WEF (2013)

But removing supply-chain barriers would be even more successful, especially  in Africa (click on the image to enlarge).

Source: WEF (2013

Source: WEF (2013

There is an old joke in East Africa that the EAC (East African Community) will succeed only when Tanzanians learn English, Ugandans learn Swahili, and Kenyans learn manners. Fortunately language barriers and old stereotypes are not the main drivers of the current policy agenda. The priority is instead to speed-up economic integration and establish (actually, “re-establish”) a common currency –the East African Shilling – across the 5 EAC countries: Kenya, Uganda, Tanzania, Rwanda and Burundi. Is this is a good idea?

Let’s start with a little theory first –a primer on economic integration as I studied in my undergrads. Look at the figure below (source)

Stages of economic integration

Theory says that there are 5 steps to economic integration: you start with free trade area, which abolishes partially or completely the custom tariffs between member countries. In the second step, a Custom Union is formed when member countries agree to uniform external tariffs towards third countries. The common market adds the free movement of the factors of production, including services, capital and labor. In the fourth step, the economic union introduces a common currency as well as common monetary, fiscal and budgetary policy. Usually this is complemented by the harmonization of tax and welfare policies. Finally, the very last step is the full political integration with the establishment of a common government.

Where is the EAC?

The EAC established a customs union in 2005, a common market in 2010 and now it aims at the fourth step with the establishment of an economic union. I must admit that I am excited about the idea but also very worried. Here’s a list of my concerns:

First, the EAC is only half way through to the third step (common market), and it is jumping already into the fourth (economic union). The truth that everybody knows is that free movement of capital and labour is far from being achieved. Labour cannot move freely because of long-standing legal and regulatory barriers. Goods cannot move freely as well, especially because non-tariff barriers are still a huge burden. Just a silly example, I’ve learnt from personal experience that many bus companies ship packages from Uganda to Kenya, but not the other way around. Reason? I was told it was “a problem at the border with Uganda”. Who knows what that means…

Second, you cannot create a common currency without creating common fiscal and budgetary policies. The EAC governments seem aware of this issue, and in fact they proposed the establishment of an “East African Financial Services Authority”, “East African Surveillance and Enforcement Commission” and the “East African Statistics Bureau”. This all sounds wonderful, but the real issue is whether national governments are willing to give up sovereignty over such important matters. Let me borrow some sentences from an article on Columbia Communique:

Is the wish for closer relationships a good thing? Absolutely. Does it have to be achieved as fast as possible and through the handcuffs of a currency union? Absolutely not. Not only will this process take many years, it will also require full commitment. They can’t have their cake (the currency union) and eat it too (maintain sovereignty in all areas).

Currently the EAC countries have very different import-export mixes, making them vulnerable to changes in world goods prices to different degrees. Without strong fiscal centralization including a counter-cyclical mandate and no adjustment mechanisms such as inflation or devaluation, a currency union can have devastating effects on countries hit hard by an external shock.

My last point is that the EAC has to learn from the experience in the EU: a monetary union must be able to deal with both periods of economic growth as well as periods of crisis and recession. How will the EAC act in case of fiscal mismanagement? What will it do if a country enters a period of financial and economic crisis? Will the regional powerhouse (Kenya) step in and help the “periphery”?  I know that using these terms is quite a stretch in the EAC context. But the region cannot ignore the experiences in other parts of the world. And more importantly, the EAC cannot ignore that it already failed in forming a monetary union in the past – neglecting its own history would be the worst of the mistakes.

Uhuru and Ruto wrote in the Jubilee Manifesto that they plan to establish a development Bank to “prop up the private players”. Although nobody is talking about it, and although we have no idea if that will happen anytime soon, this could be a huge deal for the future of Kenya. What is a development bank? And is it a good or a bad idea for Kenya?

A traditional definition of a development bank is one which is a national or regional financial institution designed to provide medium-and long-term capital for productive investment, often accompanied by technical assistance, in less-developed areas. Development banks fill a gap left by undeveloped capital markets and the reluctance of commercial banks to offer long-term financing. [full “primer on development banking” here]

We have to keep in mind is that UhuRuto provided no details about how a development bank fits into their grand scheme for economic development in Kenya. For example, we don’t know if the objective is to promote small businesses (like the informal sector or SMEs), whether they want to finance large infrastructural projects, agriculture or large manufacturing industries.  However, the sure thing is that whenever the plan is to increase the government role in the economy, you attract both huge praise and criticism:  that’s the difference between the “industrial policy view” and the “political view”

According to the industrial policy view, development banks do more than just lending to build large infrastructure projects. They also lend to companies that would not undertake projects if it was not for the availability of long-term, subsidized funding of a development bank. Furthermore, development banks may provide firms with capital conditional on operational improvements and performance targets. In such circumstances, we would expect to see the firms who borrow from development banks increasing capital investments and overall profitability after they get a loan.

According to the political view, on the other hand, lending by development banks leads to misallocation of credit for two reasons. First, development banks tend to bailout companies that would otherwise fail (this is the soft-budget constraint hypothesis, e.g. Kornai, 1979). Second, the rent-seeking hypothesis argues that politicians create and maintain state-owned banks not to channel funds to socially efficient uses, but rather to maximize their personal objectives or engage in patronage deals with politically-connected industrialists.

So, whether a development bank is a good idea or not for Kenya entirely depends on your opinion on the current political class: will they be committed-to-development or good-old rent-seekers? For now I want to keep on the optimist side.

It’s the “floating middle class”. From the Semacraft Blog:

the floating middle class has grown to over 20% of the population. This segment between the poor and the established middle class, is the only part of the economic pyramid that has had significant growth over the last 20 years achieving 100% growth in the last 30 years. They maybe susceptible to shocks that easily push them back into poverty but unlike their counterparts living in abject poverty, they have money to spend. With a population of 1 billion people, approximately 700million of whom have mobile devices,  I can easily suppose a significant number of the floating class are connected

Not everybody agrees with this view, however. When the African Development Bank coined the term last year (pdf), it attracted lots of criticism.

Without knowing, people leading the same miserable lives have suddenly been catapulted in the enviable position of middle class. Nothing has changed except the label.

..The ten poorest countries in the world are in Africa but AfDB with innovative statistic has changed the status of a lot from poor to floating middle class. They are floating on a busted canoe, scooping out the water in order not to sink. The canoe is the asset.

I see the point here: calling “middle class” people earning 2 to 4 dollars a day is a  is bad idea. To me, that seems closer to extreme poverty than to the actual middle class. But at the same time, if a large chunk of the population has really increased its earning capacity, as the AfDB study suggests, this is undoubtedly good news. I think that there’s nothing bad in acknowledging these new realities, however imperfect they are, and seeing them as a new opportunity for promoting markets and further upward mobility among the low-income population.

Some further readings here.

Half of Africa wants to join into a single free trade area.

Plans to create a 26-nation free trade area by integrating three existing African trade blocs by July 2014 are on track and the only major sticking point is likely to be harmonising rules of origin, the three blocs said on Friday.

The East African Community (EAC), the Common Market for Eastern and Southern Africa (COMESA), and the Southern African Development Community (SADC) aim to create a free market of 525 million people with an output of $1 trillion when they unite.

Although African economies are growing fast – second only to Asia – the continent has attracted criticism over its slow pace of integration, a delay that is seen as driving up the cost of doing business.

I hope it’s not just wishful thinking. The article reports some interesting facts about the growing intra-African trade:

regional integration had led to a doubling in trade among EAC states after its member states entered a customs union in 2005.

… trade among SADC nations grew 18 percent last year. However, without South Africa, the region’s most economically competitive state, the growth rate was 4-6 percent, exposing a lack of competitiveness among the other members.

We mentioned several times that Kenya has a huge problem with its current account deficit (the country’s imports are way larger than its exports) and this was one of the main causes of last year’s massive depreciation of the Kenyan Shilling. What can Kenya do about it?

Wolfgang Fengler suggests a three-pronged strategy: a) Increase exports b) Encourage long-term capital inflows c) Get a share of China’s manufacturing jobs (over the next decade)

In order to balance its current account, Kenya would have to more than double the volume of its three top exports—tea, tourism and horticulture. In addition, Kenya is vulnerable to shocks, like increasing oil prices.  Oil is one of Kenya’s top imports, and the oil import bill alone rose from $2.7 billion in 2010 to $4.1 billion in 2011, further weakening Kenya’s fragile current account.  A large current account deficit does not automatically translate into a falling currency, so long as capital inflows fill the gap. But in Kenya, capital inflows have increasingly been short-term (by contrast to Foreign Direct Investment which finances factories and offices). Short-term capital can leave a country as fast as it comes, and this uncertainty is an additional source of fragility for the national currency. [..]

Kenya’s first engine—domestic consumption—which is fuelling vibrant service and construction sectors, has always been strong. But the second engine—exports—needs to perform better. If not, Kenya will continue to operate below potential, for years to come.

What products could Kenya realistically export? Picking winners is typically not a good idea. The government needs to provide the conditions—such as infrastructure, the rule of law, and basic social services—for businesses to thrive, but not run them. At the same time, it is clear that Kenya needs to move into new products, because it cannot grow rich on tea and flowers alone. The natural starting point is manufacturing.Kenya has a good location and a skilled labor force, which is rapidly urbanizing. The global manufacturing market is also changing. Today, Asia is the world’s workshop, producing almost everything from clothes, shoes, toys and increasingly cars. But Asia’s economic success translates into higher wages, and many manufacturing jobs will soon leave its emerging economies. The World Bank projects that 85 million manufacturing jobs will leave China over the next decade. Where will these jobs go? Can Kenya get a share?

More here

Wolfgang Fengler, the lead economist for Kenya at the World Bank, writes in the excellent Africa Can .. End Poverty

Kenya could be the first EAC country to reach Middle Income status by 2020, but only if it achieves its potential of about 6 percent uninterrupted economic growth.  However, if Kenya’s economy only grows at 3.7 percent (the average of the last decade), the train will likely be overtaken by Rwanda, Tanzania and Uganda in the next ten years. Middle income status would still be possible, but only by 2037.

Today, Rwanda, Tanzania and Uganda have per-capita incomes of around US$ 550, substantially below Kenya’s.  If past trends continue, Kenya would still be ahead in 2020 but the gap would gradually narrow (see table) and by 2022, Rwanda would take first place soon followed by Tanzania and Uganda.

[…]

Today, the EAC [East African Community] is one of the fastest growing regions in the world.  If Rwanda, Tanzania and Uganda maintain their ongoing growth momentum and if Kenya accelerates, all four countries will reach Middle Income status within the next ten years. For the first time since independence, sustainable development appears possible for East Africa, even for countries that started off from very difficult positions.

Here’s the full post. Interesting throughout.

One of the biggest obstacles to industrialization in Africa is that African countries trade very little between themselves, only 10-12 percent of total trade, whereas regional trade accounts for 63% in EU, 40% in the US and 30% in Asean countries. Why do we have such daunting figures?

In addition to the well-known problem of tariff and non-tariff barriers, economists often argue that the root-cause is much more structural: African economies are excessively small and similar to trade among each other, so they must rely on international markets. From this view, intra-African trade is unlikely to promote growth in the short term.

However, the World Bank just-released report “De-fragmenting Africa” (highly recommended), tells a different story:

It has been commonly argued that regional integration can only play a limited role in Africa because of the similarity of endowments between countries. However, this does not reflect  the enormous opportunities for cross-border trade in agricultural products from areas with a food surplus to food deficit areas that result from differing seasons and production patterns. For example, Southern Malawi is not well endowed with agricultural potential and is a persistent food deficit area. Nearby Northern Mozambique is a productive area for growing maize, the main staple of the region, but it is distant from the main area of national consumption in the south of the country. Differences in weather patterns entail low correlations in production between countries and that regional production is less variable than production at the country level.

There is also another point: intra-African trade is already much bigger than statistics reveal, but most of it is informal:

There is a significant amount of cross-border trade that takes place between African countries that is not measured and therefore official statistics considerably understate the amount of intra-regional trade. (…) Surveys indicate that in some African countries, informal regional trade flows represent up to 90 per cent of official flows. In Uganda, for instance, informal trade grew by 300 percent from 2007 to 2009, where informal exports to neighbors is estimated to account for around 86 percent of official export flows to these countries

It would be interesting to have comparable data on informal cross-border trade, in particular on manufacturing goods, but I didn’t see any in the report. The graph below shows interesting patterns of (formal and informal) trade of food commodities in East Africa.

Read the full report here (PDF)

Despite the efforts to improve the “ease” of doing business within the East African Community, exporting goods to Tanzania is not getting any easier. There is a huge problem with non-tariff barriers:

[Tanzania] has added rather than subtracted checkpoints along the main export corridor within its territory; it charges imports of Kenyan plastics at up to 25 per cent tax, even though they are zero-rated under the treaty; it charges Ugandans $50 a visa, even though it should be free; and it has banned the sale herbal products at home unless they are Tanzanian. In a particularly astounding move, it won’t let cargo trucks from Burundi, Rwanda and Uganda move around the country, at all, after 6pm.

More at BeyondBrics (FT)

Wealth doesn’t always translate directly into demand for a particular service or product. Malindi’s beach boys who are mostly half educated unemployed dropouts spend most of their time in the cyber making global connections and setting up future business with forthcoming tourists during the low season. Its a boomtime for the local cyber whose revenues can reach as high as Ksh 250,000 a month during this time. In comparison, the cybers in Kajiado [which is supposedly the richest county in Kenya] are lucky to make about Ksh 3000 a month or a little higher when schools have their vacations and the majority of their business is from other services like typesetting, photocopying or scanning et al.

We tend to assume that as population incomes increase their demand for modern technology will increase as well – that prosperity and the world wide web go hand in hand is implicit in so much of the ICT4D frameworks. But every once in a while there comes along an example like Kajiado’s where the exception to the ‘rules’ can be found and it does us good to pause and think for a moment. Maybe not everyone wants exactly the same things we aspire to own, and maybe there is a different path to progress and wellbeing than the one we have taken. And just maybe, the cyber is a pretty cool place to sit and have a cold drink and shoot the breeze with one’s friends on the sofa, and just watch the real world go passing by.

This is Niti Bhan writing on the excellent Semacraft Blog. I discovered it only a few days ago but it is already one of my favorite sources of new ideas.
H/T Africa Unchained