How Macroeconomic Policy Can Support Economic Development in Sub-Saharan African Countries

1. How Macroeconomic Policy Can Support Economic Development in Sub-Saharan African Countries James Heintz, University of Massachusetts, Amherst IEA/World Bank Roundtable, July 3-4th, 2012 Industrial Policy in sub-Saharan Africa

2. Macroeconomic policy and industrial policy • Conventional wisdom: macroeconomic policy creates the enabling environment for industrial policy. • Industrial policy manages the details of economic development within the boundaries determined by macroeconomic management. • Argument of this paper: in sub-Saharan Africa, institutional and structural constraints limit the scope for conducting macroeconomic policy. • Challenge: to relax structural constraints which would replenish the macroeconomic toolkit

3. Example: Liberia • Context: ILO study of the impact of the crisis on Liberia • Balanced budget constraint imposed. • Market for government bonds did not exist. • Economy was largely dollarized. • Trade taxes accounted for a large share of revenues • Almost no scope for any kind of macroeconomic policy • But the institutional constraints could be relaxed to support productive sector development.

4. Three policy areas • Real exchange rate • Monetary and financial sector policy • Fiscal policy: domestic resource mobilization

5. Real exchange rate • Maintain real exchange rate at a level which encourages allocation of productive resources to tradable sector • Economies of scale, scope for productivity improvements, access to export markets. • But can interventions to manage the nominal exchange rate work in SSA? • High levels of pass-through. Little scope for lowering the real exchange rate

6. Domestic price levels • Average price levels are higher in sub-Saharan African countries compared to countries with similar productivity levels. • Reduces competitiveness of tradable sector. • Indicator of relative prices: PPP conversion factor to nominal exchange rate ratio.

7. Macro conditions for competitiveness • Problem: high domestic prices can lead to an uncompetitive real exchange rate. • Possible reason: lower productivity of the non-tradable sector (e.g. infrastructure, distribution services, etc). • Solution: raise productivity of the non-tradable sector, rather than manipulating the nominal exchange rate.

8. Monetary policy I • Inflation targets and inflation targeting • May introduce a pro-cyclical bias into monetary policy formulation when inflation due to supply-side/external price shocks is common. • Hard to isolate a measure of “core inflation” in many sub-Saharan African countries. • Need for a broader approach to monetary policy, including developing indicators for real economic activity.

9. Monetary Policy II • Even in the absence of strict inflation targets, can monetary policy support industrial development through credit extension? • Institutional problems in SSA: excess reserves in the commercial banking sectors constrains credit extension. • Other issues: limited long-run credit due to structure of deposits, imperfect information. • Possible solution: financial sector reforms which improve credit allocated to industrial development which goes beyond liberalization.

10. Mobilizing domestic resources • Tax revenues: tax revenues in sub-Saharan Africa, as a share of GDP, have increased since the 1980s, but much of this improvement has been driven by revenues from natural resource exploitation. • Institutional weaknesses/poor tax administration constitute barriers to mobilizing resources in the region . • Two interventions: • re-organizing the administration of tax collection on a functional basis • establishment of statutory bodies which specialize in tax collection, but not tax policies

11. Mobilizing domestic resources • The ability to mobilize domestic credit to the public sector to support industrial development is constrained. • Very high costs of domestic debt v. external debt. • Short-term structure of debt & concentrated ownership raise costs of debt service. • Institutional reforms could help change this situation: introducing longer term bonds, efforts to deepen the bond market (i.e. a wider range of ownership).

12. Conclusions • Need to go beyond seeing macro policy as simply creating an enabling environment. • In order for macroeconomic policies to support industrial development, institutional reforms are needed to address existing problems which limit their effectiveness. • Structural transformation is required to enhance and deepen the scope of macroeconomic management. • The exact nature of the institutional and structural reforms would necessarily vary from one context to the next.