Economic Liberalisation Reforms and Growth
CHAPTER 1
INTRODUCTION AND THEORETICAL BACKGROUND
Economists through out the world are searching for what really are the major determinants of growth of an economy and different policies have been used in pursuit of the answers. The world as large has gone through a lot of economic problems, such as depressions of 1930s, 1970s and 1980s. The 1930 depression led to employing of the Keynesian policies of strict government intervention. However, the 1970s depression made policy makers lose faith in Keynesian economics. Nevertheless, most Third World countries continued with their central planning type of economic policies. There was strong disenchantment with this type of policies, which led growing number of economists and influential international development organisations to begin, in recent years, to advocate the increased use of the market mechanism that is to liberalise the markets, as the key instrument of promoting greater efficiency. In this regard economic liberalisation implies minimisation of government intervention in allocating economic resources and letting the market forces play the cardinal role, doing away with all forms of government distortions in running the economy. The market forces should play a leading role in financial, trade, labour, commodity markets and other sectors, increasing reliance in market forces is normally accompanied by stabilisation programs, (Krueger 1978,1985).
There has been an increasing call for the private sector to take up the challenges of national development. According to Robert Barro (1996), most empirical facts point to primacy of government choices; countries that have pursued broadly free market policies, in particular trade liberalisation and maintenance of secure property rights, have experienced higher growth, than those which pursue central planning type of policies. For this reason, there have been calls for the privatisation programs.
On the other hand Rodrik, (1992) argues that trade reforms is frequently met with scepticism on the part of the private sector and may lack support, the country implementing them suffers from terms of trade deterioration which may result into reduction of capital inflow and increase capital flights. He goes on to say that this is coupled with inflation and low zero growth. Krueger (1978) points out that to avoid this, appropriate macroeconomic policies need to accompany the increase in price of foreign exchange (devaluation), or else domestic inflation would soar and affect the intended benefits of liberalisation. That is why stabilisation programs, such as reduction in government expenditures, accompany liberalisation by cutting on government consumption, which is often negatively related to the growth of an economy.
However Wha Lee (1993)’s findings in the case of Korea are very interesting, Korea gave subsidies to some firms manufacturing exports, managed to grow faster. He argues that the theoretical predictions about the link between growth and open trade may be ambiguous and misleading. According to critics, tariffs can either enhance or decrease growth rates, depending on which sector is protected. This is the argument of infant industry. Krueger (1985) notes that LDCs have been protecting infant industries for decades, but they have still remained infants; this is an indication that there is something wrong with the economics of protectionism. Nevertheless Wha Lee (1993) notes that since the current theory of liberalisation is inconclusive, as is the empirical evidence, the link between trade policy and dynamic efficiency is vague, depending on the industry considered.
Kirkpatrick (1995) argues that the orthodox arguments concerning the role of trade policy as the determinant of industrial performance are seen in the major role of creating price incentives. This is because liberalisation and a neutral incentives structure between import substituting and export activities is expected to yield both static and dynamic effects, static in form of technical efficiency and dynamic in the form of switching process. However, many models, both for planning and explaining the development process, according to Krueger (1978), have made a foreign exchange central to determination of the growth rates. This focus is on the role of foreign exchange (forex) in complementing domestic savings needed to support domestic investment. The effect on economic growth will be via an increased volume of exports and reduced imports due to liberalisation and devaluation respectively. It is argued that if trading partners removed tariffs, we expect the market to expand which will ultimately lead to growth of exports. Exports are also viewed as a stimulus to greater capacity utilisation, greater horizontal specialisation, increased familiarity with absorption of new technologies transmitted through trade, greater learning by doing, as a result of the increased market size and output levels and stimulation effects of having to achieve international price and quality. Expanded market economies of scale enable a producer to cast or spread a “net” widely on various consumers who may be helpful by sending back comments on how to improve the quality of the products. Since tariffs tend to be reactionary, if a country adopt liberalisation policies, its trading partners will also do away with tariffs the moment one country scraps trade restrictions, so the market size will expand.
However, Trade liberalisation alone is not an answer. For this to be successful, there is a need to liberalise the financial sector, so that exporters can have ready capital for re-investment; nuisance taxes have to go, so that most of the foreign exchange earnings are retained by the exporters. This creates incentives to them. Macroeconomic stabilisation also has to be enforced so that inflation will not impede planning, and if this creates confidence in investors, exports should increase.
Pro-liberalisation economists have argued that more open economies are more efficient in absorbing exogenously generated innovations, since, without barriers, not only will this increase the volumes of essential imports, but it will also facilitate the entry of new technology which developing countries are able to absorb and assimilate easily in order to expand their manufacturing base. Edwards (1992), finds strong evidence supporting the hypothesis that, with other things being equal, more liberal economies tend to grow faster than those which are not. He calls this learning by doing type of process, “technical progress ” where more contact with new commodities and technology enhances efficiency, which result in higher production. He argues that if the rate of technical progress is positively affected by the gap between the stock of the world and domestic knowledge with respect to the foreign source of technological improvement, then the country’s ability to appropriate world technical innovations depends positively on the degree of economic trade liberalisation. Therefore more open economies have an advantage of absorbing new ideas from the rest of the world. He finds that countries with more open and less distortive trade policies have tended to grow faster than those with more restrictive commercial policies. His results are in conformity with the catch up theory effect. Wha Lee (1992), points out that international trade is perceived as a vehicle through which foreign inputs are provided to domestic production. According to him trade distortions caused by tariffs and exchange rate controls decrease the long run growth rates more significantly in a country that needs to import more.
Therefore, it can be summarised that liberalisation enhances international trade which provides comparative advantage and also provides an additional source of competition to domestic firms. Subsidies to ailing industries, no matter how much they may alleviate economic distress in the short run, represent an effort to decelerate growth, reduce incentives for mobility and lock in resources in the inefficient industries that should contract in the process of economic growth.
However, there is a problem of measuring the benefits of trade liberalisation, which even Kirkpatrick (1995) acknowledged. Kirkpatrick admits that measuring of trade liberalisation benefits is a difficult and frustrating task. It involves two considerable methodological problems; it is important to assess the extent to which the World Bank’s conditions have been adopted. This is because most of the liberalisation policies of LDCs are not unilaterally adopted, but imposed, and therefore may lack consistency. The other problem is the assessment of the reforms that were implemented. It is complicated by problems of separating causality from association. According to him, it is difficulty to establish counter factual, and separating out the effect of multiple influences on economic performance.
Larry Sjaastad (1982) noted that the economic liberalisation that swept Southern cone during the 1970s and 1980s was a clear reaction to the failures of preceding economics of protectionism. Uruguay and Argentina, once prosperous nations had fallen on hard times by the mid 1970s. Real per capita income in Uruguay had been declining at a rate of 1 percent in 20 years. Chile, though never a prosperous country, was crippled with a continuos fiscal deficit and an inflation of 1000 percent. Their economies were characterised by inefficient state enterprises, which despite massive tariff protection, regularly required subsidies to sustain their operating loses. Price controls, tariffs, subsidies and export taxes severely distorted relative prices with much of the private enterprises devoted to production of luxury goods. Regulatory bodies administered import duties and quotas, interest rates, credit allocation and wages. The monetary and financial sectors were dominated by the state banks with special rediscount privileges at the central bank. Their economies were in a bad state. Therefore all these countries introduced liberalisation programmes in the1980s, but their results were disastrous. The Southern cone experiences, according to Sjaastad (1982) are widely interpreted as evidence of the failure of economic liberalisation.
Zambia like Argentina, Uruguay and Chile had almost the same type of economic policies, with nationalised economy before the liberalisation program which swept the country in 1991. Its economy was characterised by inefficient state enterprises with massive tariff protection in order to enhance import substitution industries. Price controls, nuisance custom duties, subsidies on production and consumption, export taxes, foreign exchange controls. Private enterprises had to declare all their export earnings to the central bank, as it was illegal to hold forex. Zambia, before privatisation and liberalisation, had regulatory bodies to administer import quotas, interest rates, credit allocation and wages. All the macroeconomic factors were determined by political decree. The monetary and financial arenas were dominated by the state banks, with special rediscount privileges to the Bank of Zambia. According to the advocates of the liberal markets, poor rates of growth, massive inflation and balance of payment problems experienced by LDCs, and Zambia in particular, during the 1970s and 1980s were because of the rising burden of public spending through parastatal companies, excessive price distortion and inward looking trade policies which are the order of the day in the planned economy.
Zambia today, according to the World Bank Report (December, 1997), has the most liberal and least nationalised economy in Africa. In 1991, more than 80 percent of the economy measured as a percentage of GDP was state owned. Now, as at 1997, more than 80 percent of the economy is in private hands. The one party state, which ruled Zambia since independence in 1964 from the British, chose the path of nationalisation and centralisation. According to the World Bank report (Dec., 1997), this was ruinous. The government and international organisations such as the World Bank and IMF believe that macroeconomic stability and growth are being achieved after years of inflation and decades of stagnation. According to them, the foundation for higher growth have been laid by liberalising the markets, broad tax and tariff reforms, financial sector reforms and by privatising the state enterprises. The key element in the government’s programme has been the reduction of inflation, which has fallen from 200 percent in 1990 to 20 percent in 1997. This helped the GDP to grow by 6.4 percent in 1996/7 period.
This dissertation investigates whether there are genuine reasons behind economic liberalisation and related austerity measures, using Zambia as the case study, by describing and comparing its economic performance before and after liberalisation. We then use panel data and cross-section regression analysis on selected African countries to see if the econometric analysis results support the calls for liberalisation measures. The dissertation is organised as follows Chapter 1 has provided introduction and theoretical background to economic liberalisation. In chapter 2, Zambia’s detailed account of its pre-liberalisation economic policies is presented. Chapter 3 looks at post-liberalisation economic policies of the country. Chapter 4 presents econometric analysis and empirical results, and Chapter 5 concludes the findings. It should be borne in mind that this study is not about the direct measurement of the effects of liberalisation policies on economic performance. This is due to the problems cited by Kirkpatrick (1995) and the unavailability of many of the data required for undertaking a more detailed study of the country.
CHAPTER 2
THE PRE-LIBERALISATION ECONOMIC POLICIES OF ZAMBIA
Zambia’s economic history traces back to the colonial era. Zambia a former British colony was known as Northern Rhodesia. The British’s main emphasis was the mining of copper, which they exported as a raw material. Zambia obtained independence on 24 October 1964 with an economy characterised by an industrial enclave based on copper mining using British and USA capital (Hawkins, 1991). During this time there was little or no significant investment apart from the mining sector, and before independence most of the copper profits were expatriated and very little was re-invested. However, in the first years of independence 1964-69 the economy unfolded and great progress was recorded (Turok, 1979). The country had a GDP per capita that was amongst the highest in Africa; according to Turok, 1979, it was just below that of South Africa. Copper prices were high and the industry was profitable, so every indication was towards rapid growth and development. The economy was more of a capitalist than a state led.
2.1-Post-Independence Economic Reforms
Few years after independence in 1968 and 1969, President Kaunda, with the then ruling United Nation Independence Party (UNIP), initiated reforms. According to him, this was to lead state control of the whole economy to enhance growth and equal distribution of income. It was also aimed at empowering the indigenous people to control and decide the destiny of their country’s economy. This was characterised by developmentalist philosophy (command economy) and recognition of political realities (Turok, 1979).
The 1968 and 1969 Mulungushi and Matero economic reforms were meant to repossess the foreign economic and business interests, which now became under the state control. The UNIP government also introduced indigenous import substitutions in the industrial sector, this was aimed at reduction in the dependence on foreign manufactured goods. Although a small indigenous and foreign private sector was left, a large public sector was created and maintained by copper revenue and protected and supported by government controlled markets. As a result of the state controlled type of the economy, which emphasised the creation of industrial capacity, commercial agriculture perished and the private sector was crowded out.
According to Turok(1979), it is commonly accepted that the weaknesses of the economy, which levelled off in 1972 and then began declining, cannot be solely blamed on the falling copper prices, though this might have been one of the contributing factors. This is because, even by 1974 before the collapse of copper prices, foreign exchange had started posing a serious constraint on economic development. A major explanation lies in the economic policies of the day. Despite its inheritance of highly concentrated and buoyant foreign owned mining enclave, the Zambian government was determined to use the state for development. The state sector share of manufacturing output was growing almost every year. Four years after Mulungushi reforms in 1968, in which the government announced its acquisition of major companies it was 53 percent of total manufacturing output and this was concentrated on essential consumer goods required by Zambia. However, despite its size and scope, the state sector which included parastatals had not established an integrated economy with forward and backward linkages, parastatals, though they were import substitution industries (ISI) deeply depended on essential inputs from abroad. The government intervened extensively and imposed a number of restrictions on the private sector, while parastatals’ decisions were made by political leaders and ministers who sat on their boards. The parastatals were to be organised on lines of the country’s philosophy of ‘Humanism’, which was coined by the President as an African socialism. There was intervention in pricing policy, which seemed to be concerned more with social welfare than with pursuing economic development goals.
In 1970, barely two years after the Mulungushi and Matero reforms capital expenditure was only growing at a marginal increase, while consumption expenditure soared. Table 2.1 shows the higher government consumption and lower gross domestic consumption from 1964-90. Due to little emphasis which was made on capital expenditure, in 1973, value added in manufacturing recorded only a marginal increase from 106 Million Kwacha to only 107.5 Million Kwacha in 1976, compared to 480 Million Kwacha in 1965 a year after independence (GRZ Economic Report, 1977). Value added by manufacturing in 1978 real terms was 15 percent lower than 1974. Hence by the mid 1970s, the bells of economic doom were loud enough in politicians’ ears, but pretended to be deaf. They instead nurtured and guarded the inefficient parastatals and the command economy. To make the situation worse, some more parastatals were created and added to the list of inefficiency. After 1970, a substantial part of Zambia’s economy was dominated by parastatal organisation, about 60 percent of the economy in terms of GDP was now in parastatal hands. Most larger companies which had been run and owned by foreigners came under government control through Industrial Development Corporation (INDECO), an agency of a government holding company.
These newly nationalised companies were especially active in such industries as food processing, textiles, auto assembly and mining. Through large- scale capitalisation, using copper revenue, these parastatals became the pillar of the Zambian formal sector. They employed 1/3 of the workforce and maintained their employment levels even during the recession, for political reasons. For instance during recession, the number of employees in private manufacturing fell from 27,370 to 23,390 in 1977, about 14.5 percent reductions, while in the parastatals they remained constant over the same period (Turok, 1979). In these parastatal bodies there were rampant and continuing reports of corruption, inefficiency and mismanagement, but government decided to give it a deaf ear. The Kayope Commission (1976), revealed catastrophic failures in major parastatals and widespread misappropriation of funds, but still the government shelved the report, and continued to give subsidies and protection to these inefficient parastatals. Real Gross domestic fixed investment declined as there was no significant capital formation. The emphasis was put on government consumption while the economy continued to decline. This can be seen in the decrease in capital expenditure which fell in 1979 to its lowest since independence in 1964 as Table 2.1 shows. This shows that INDECO, on which the government relied as agency of intervention was performing poorly.
At independence, Zambia’s economy had poor foundation, domestic production supplied less than one third of the local market for manufactured goods, while total manufacturing goods accounted for only 6 percent, the same setting continued even 10 years after independence, domestic economy was not integrated lacking forward and backward linkages. In trying to enhance domestic integration the government after its 1968 Mulungushi and 1969 Matero economic reforms bought out the private share holders in INDECO which was established in 1965, but reinforced after these reforms, and obtained a larger share of profits from copper by means of higher taxation, which was then used for public investment.
TABLE 2.1: GOVERNMENT CONSUMPTION IN COMPARISON TO GROSS DOMESTIC FIXED INVESTMENT 1964-90 (IN KWACHA MILLION)
Year Government consumption Gross domestic fixed
investment
1964
309.2
76.2
1965
383.4
120.4
1966
435.8
175.8
1967
558
225.8
1968
594
264.7
1969
589.4
253.6
1970
717.5
279.8
1971
801.9
264.7
1972
857.3
381.1
1973
900.7
426
1974
1083.1
560
1975
1241.8
510
1976
1337
483
1977
1547.8
437
1978
1789.3
450
1979
2045.6
65.8
1980
2473.5
566
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