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African Economic DevelopmentEvidence, Theory, Policy$

Christopher Cramer, John Sender, and Arkebe Oqubay

Print publication date: 2020

Print ISBN-13: 9780198832331

Published to Oxford Scholarship Online: July 2020

DOI: 10.1093/oso/9780198832331.001.0001

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PRINTED FROM OXFORD SCHOLARSHIP ONLINE (oxford.universitypressscholarship.com). (c) Copyright Oxford University Press, 2021. All Rights Reserved. An individual user may print out a PDF of a single chapter of a monograph in OSO for personal use. date: 14 June 2021

The Trade Imperative

The Trade Imperative

Chapter:
(p.110) 5 The Trade Imperative
Source:
African Economic Development
Author(s):

Christopher Cramer

John Sender

Arkebe Oqubay

Publisher:
Oxford University Press
DOI:10.1093/oso/9780198832331.003.0005

Abstract and Keywords

Economists from very different backgrounds often counsel against a fast growth of imports—and it is certainly true that the balance of payments constraint all too easily derails growth episodes. But the level of output is more important than an obsession with the obsessive pursuit of macroeconomic balance; macroeconomic policy has to serve productive goals rather than vice versa; and policy needs to enable rapid import growth to raise the overall level of output. African countries urgently need to push for rapid export expansion. This chapter argues against International Monetary Fund (IMF) balance of payments approaches. It also argues that the evidence undermines the export pessimism common among many structuralist economists. There is compelling evidence suggesting the need for competitive (undervalued) exchange rates; these are more effective when combined with targeted policies encouraging investment in specific activities that satisfy the criteria we set out here and in other chapters.

Keywords:   growth of imports, balance of payments, IMF, exchange rates, macroeconomic policy, structuralist economics, investment, export pessimism

5.1 Introduction

In mainstream development economics, the pursuit of macroeconomic stability is elevated above all other objectives, including growth in production or employment. Macroeconomic stability is regarded as the fundamental prerequisite that unlocks growth in output and then, if markets are suitably flexible, other positive outcomes like employment expansion. This mainstream view also determines trade and exchange rate policy: balancing the external account is the primary objective of policy, rather than the level of output at which these accounts (have to) balance. The key to both stability in the balance of payments and broader macroeconomic stability, from this perspective, is restraining aggregate demand. This, as we will explain, typically leads to policy advice designed to ensure low- and middle-income economies rein in import growth. Rapid import growth may signal ‘easy’ credit—representing excess demand—thereby upsetting the balance of payments applecart. The two main ways of curbing excess demand in an open economy are, first, to restrict ‘excess’ credit to the economy, and, second, to raise the relative cost of imports through exchange rate devaluation.

Non-mainstream development economists also often warn against rapid import growth, albeit for different reasons. The main reason for their anxiety is a pessimistic outlook on the possibility of financing imports. Export pessimism has long been entrenched in much of the advice emanating from, for example, United Nations Conference on Trade and Development (UNCTAD). In some versions, this pessimistic reflex reflects a broader anxiety about the dangers of integrating into the world economy. The implications for exchange rate policy are not always clear, although some economists taking this stance criticize International Monetary Fund (IMF) calls for devaluation: they argue that there is little point attempting to boost export revenues through reducing the price offered to international buyers by devaluing; they also berate IMF policy proposals because devaluation has inflationary consequences that hit the poor particularly hard.

African policymakers are surrounded by economists who espouse trade and exchange rate policy arguments derived from these (and similar) traditions. It is, therefore, not surprising that they often feel the case against rapid import growth being pressed upon them—by visiting consultants, or economists installed within government ministries, departments, and prime ministers’ offices. Warnings about rising and ‘unnecessary’ imports seem, at first sight, to be eminently reasonable.

(p.111) In this chapter, we advocate a different approach. We insist that production, technological change, and employment growth should be primary policy objectives, and that macroeconomic policy should serve them. Furthermore, we argue that what matters is the level of activity at which the external accounts balance out, rather than a myopic focus on balance for balance’s sake (see Chapter 6). Finally, we argue that African governments have to find ways to benefit from integration into the global economy, rather than making a virtue out of retreat (into relying overly on the domestic market or on regional intra-trade).

To accelerate growth and structural change, governments need to stimulate a rapid rate of growth of imports—especially of producer inputs and capital goods. For example, imports of capital and intermediate goods—embodying foreign technology and contributing to domestic technological change—accounted for more than 80 per cent of all imports by China between 1965 and 2007. Even as China’s economy has evolved and its rate of innovation accelerated, imported inputs have remained very important; although the share of imported inputs in the value of manufactured exports has declined, it remains higher than 40 per cent. Furthermore, the total value of these imported inputs has continued to rise sharply since the late 1990s or so (see Figure 5.1). More generally, as soon as the East Asian ‘tiger economies’ began to grow rapidly, their ‘investment boom required an increase in imports’.1

The Trade Imperative

Figure 5.1 Imported inputs required to produce China’s manufactured exports, 1998–2017

Source: UN Comtrade.

But—as we set out in Chapter 3—the thirst for imports characteristic of rapidly developing economies can easily threaten the sustainability of growth. This in turn means any strategy for growth and structural change cannot ignore the need for a rapid rate of growth of export volumes and earnings.

The evidence presented in this chapter shows that, historically, all experiences of sustained economic development and structural change have involved rapid and sustained import growth rates. Rising incomes, higher labour productivity, and higher wages in Africa lead to a thirst for both imported consumer goods and for the intermediate and capital goods needed to produce, for example, electricity. In many countries, growth and structural change have historically required policies encouraging a fast increase in imports, especially of producer goods, though also of consumer wage goods including food. The experience of these countries highlights the importance of the balance of payments constraint and leads to the policy conclusion that, in order to sustain import growth, African economies (even oil exporters flush with revenues) will need to allocate resources so as to ensure a dramatic increase in the growth rate of their export earnings.

It is not sufficient to recognize a general need to expand exports. It is also important to identify the specific types of economic activity and subsectors where investment may yield the fastest and largest gains in productivity and in exports, (p.112) as well as the accompanying policies required to achieve expansion of output. These priorities, and the need to target investment, have been ignored in ‘common-sense’ policy advice to create an economy-wide ‘enabling environment’ and to avoid overambitious interventions that ‘pick winners’. We argue that it would be a mistake to follow other ‘common-sense’ policy advice too, especially warnings not to invest to expand primary commodity exports because of a ‘fallacy of composition’. This misguided policy advice is based on the assumption that these investments, if undertaken by a number of low-income countries, will cause the market to become flooded, and therefore fail to increase export revenues. If such warnings have been taken seriously by African policymakers, this may go some way to explaining the region’s declining share in the world market for so many primary commodities.

A better theoretical guide to these issues would be based on Thirlwall’s adaptation of Kaldor’s Growth Laws, which emphasize the centrality of manufacturing. We broaden this, by also arguing for investment in higher-productivity, export-oriented agriculture. This is partly on the grounds that Kaldor-type growth effects increasingly operate in agribusiness enterprises, meaning they should be considered an integral part of Africa’s industrial production (see Chapter 3). (p.113) We also argue that the labour intensity of many African agricultural exports makes it possible to accelerate the shift of (especially female) labour from low-productivity to high-productivity rural employment. In developing this argument, we propose that policy officials redefine what is understood by structural change.

Any investment strategy designed to facilitate a rapid rate of growth of imports must incorporate an effective exchange rate policy. This chapter discusses the consequences of over- and undervaluing exchange rates in Africa, as well as the difficulties of achieving (and defining) an appropriate exchange rate for any particular country and time. We set out some of the main arguments used in mainstream economics to address exchange rate questions, and we introduce some criticisms of these arguments. Overall, we argue that African governments should aim at competitive (i.e. undervalued) exchange rates—not in the vain hope that market prices are sufficient to balance the books and unleash entrepreneurial spirits, but as part of a set of policies designed to promote faster growth and accelerated structural change.

The accumulation strategy presented here differs markedly from that proposed by neoclassical economists. It also differs sharply, perhaps even more, from that proposed by many heterodox economists. Our argument in this chapter, as throughout the book, favours ‘possibilism’ (see Chapter 3) about import growth over the impossibilist lament of many structuralist development economists. We also query the views of economists who ignore the limits and costs of South–South trade, and who believe that foreign direct investment by developing country firms offers greater potential benefit to Africans than investment by other corporations.

5.2 The IMF and Macroeconomic Management

Many lower- and middle-income countries, faced with a rapid shift in the balance of payments leading to an immediate problem in paying for vital imported inputs, have to approach the IMF. The problem may have been caused by: a surge in import costs (as a result, for example, of a spurt of productive infrastructure investment); a terms-of-trade shock; or a spike in debt service obligations (if, for example, dollar-denominated debt obligations jump on the back of US interest rate hikes). Whatever the cause, the IMF tends to respond by looking for profligacy and policy mistakes in deficit countries. The burden of international payment adjustments must, as agreed at Bretton Woods after the Second World War, always be shouldered by deficit countries.2

Frequently, the negotiation of a Fund programme is an act of desperation. There may be few alternatives, as an IMF seal of approval is often necessary to (p.114) unlock other concessionary finance, and it is also believed to calm the nerves of commercial lenders and investors. So it is important to understand the core principles and practice of IMF programmes, which tend to emphasize three things: first, ‘adopting demand-restraining measures consistent with available financing’; second, securing ‘available financing’; and, third, putting in place reforms supposedly promoting ‘adjustment’ and growth.3

We will discuss how the Fund has made subjective assessments of ‘available financing’ later in this section. Here, we emphasize the central policy prescription of IMF programmes: a rapid cut in the trade deficit achieved by reducing the demand for and the volume of imports.4 At the heart of the Fund’s thinking since the late 1950s lies the Polak model, which can be used to show that a fall in a country’s reserves—a balance of payments deficit—happens when domestic credit increases beyond the demand for and supply of money. The model can also be used to disaggregate an increase in the stock of money into private and public credit creation, pinpointing government borrowing and fiscal expansion as the culprits for balance of payments deficits.

The model sees output as determined by the level of available finance and the propensity to import.5 IMF staff have to assess the likely availability of external finance. If, for example, they think bilateral donors will not provide additional concessional finance to a government proposing a particular set of policies, they will insist more firmly on sharp changes to those policies. However, assessing ‘likely availability of external finance’ is a matter of judgement, and such judgements are open to dispute.6 For example, in 1997, a former World Bank Chief Economist lashed out at the IMF’s (in his view) baseless assessment that Ethiopia was unlikely to secure further international finance without a severe contraction of economic activity. The IMF had suspended its programme support and was insisting on drastic policy reforms, including financial sector liberalization, but the Ethiopian government resisted.7 Despite IMF claims, there was little evidence that major donors were prepared to abandon Ethiopia—their military ally in a sensitive geostrategic zone. In fact, they seemed (confirmed by later experience) to be increasingly confident about Ethiopia’s economic performance.

Some argue that Fund lending programmes can be quite flexible, and that the emphasis on demand repression is greater where fiscal imbalances (governments spending more than they receive in taxes) are the source of crisis, than where balance of payments difficulties are brought about by terms-of-trade shocks. Again, this raises the question of how to determine if budget deficits are ‘unsustainable’—the Fund’s record in forecasting key macroeconomic variables is unimpressive.8 Fund programmes may also include some commitment to supporting growth, typically taking the form of ad hoc adjustments to balance of payments (p.115) targets that allow for a slightly faster import growth rate than the model’s core equations model would accept. One problem is that the Fund’s opaque decision-making processes make it difficult to ascertain the relative importance of this element of flexibility in negotiating positions (compared, for instance, to the influence of the most powerful members of the IMF’s Board) on the outcomes of negotiations.9

The global financial crisis of 2008 and its aftermath led to some soul-searching statements about the limitations of the traditional Fund analysis and policy stance. But the evidence—from crisis packages negotiated with European countries in particular, as well as from recent programmes in Africa—suggests that hopes for a less deflationary and more flexible IMF approach to balance of payments difficulties may have been overblown.10

5.3 Structuralist Fear of Imports

UNCTAD And IDEAs

The logic of many UNCTAD reports runs as follows. The import elasticity of growth in advanced economies has shrunk. As they continue to grow—slowly—they spend less of any additional income on imports. This makes it even more difficult for developing countries to grow, and to manage balance of payments challenges, by exporting to such economies. And when, as of late, the advanced economies are growing slowly, developing countries can only expand their exports by eating into other countries’ share of world exports. Given these global economic conditions, developing countries should give ‘greater attention to domestic and regional demand’ and ‘align their production structure more closely with their demand structure’.11

Others, for example, members of the International Development Economics Associates (IDEAs) network, talk of a ‘collapse in developing country exports’ following the 2008 global financial crisis—though admitting this is a price phenomenon, given that the growth rate of trade in terms of volume was barely any different in 2010–17 compared to 2000–9.12 This message is driven home with claims of the ‘exhaustion of advanced capitalism’.13 Consequently, the ‘export obsession that formed the basis of macroeconomic and development strategies is no longer useful’.14 Against these pessimistic prognoses, it is worth noting that global import contractions have, thus far, occurred only rarely in the capitalist era. (p.116) In fact, between 1880 and 2010, global trade has contracted in just 12 per cent of years. Furthermore, the idea of a worldwide collapse in imports masks the actual heterogeneity of experience. Imports fell by far less in some countries than others; and overall they fell by significantly less in 2008/9 compared to the previous major episode of world trade shrinkage, the 1929 crash.15

There are other arguments advanced for focusing on domestic markets, or at least prioritizing trade with other ‘Southern’ or neighbouring countries at (presumably) similar levels of development. A fast rate of growth of imports may be dangerous because the dynamics of increasing returns give a competitive advantage to those already established in particular activities: ‘when countries are open to external trade in a world in which increasing returns activities are significant, the chances are greater that such trade will cement existing divisions of labour between countries’.16

A Secular Decline in the Net Barter Terms of Trade?

Although trade pessimism has taken different forms over the decades, at its core is the idea that there is a structural (‘secular’) decline in the terms of trade—average export prices relative to import prices or the net barter terms of trade—faced by developing countries trading with richer economies. In its original form, as set out by Prebisch and Singer, this identified a trend in the export prices fetched by primary commodity exports relative to the price of imported manufactured goods.

The original Prebisch–Singer hypothesis laid the basis for import substitution strategies, as well as strengthening pessimistic views on whether developing countries could successfully pursue development through primary commodity exports. Combined with observations on the greater price volatility of unprocessed primary commodities, it inspired recommendations (by UNCTAD for example) that developing economies should diversify the number and type of their exports and that, prior to exporting, they should invest to process primary commodity domestically.17 Later iterations of the pessimistic terms-of-trade argument suggest that even developing countries that achieve success in building up light manufacturing export sectors will soon suffer from falling terms of trade. One reason for this decline in the relative prices of manufactured exports from poor countries is that the world market is becoming flooded with such exports. Meanwhile, poor countries continue to expand their imports of more sophisticated manufactured goods from higher-income economies.

An adverse movement in the terms of trade, especially if it persists, can reduce growth rates. Even so, it is rash to take the Prebisch–Singer hypothesis as (p.117) reason to neglect investment in primary commodity exports, or to neglect export opportunities more generally in favour of national or regional self-sufficiency. First, the evidence for a secular decline in the net barter terms of trade remains unclear, despite a torrent of research studies.18

Second, there is no doubt that primary commodity prices are volatile, just as liable to undergo protracted surges as to tumble. While this is often taken to mean governments should not over-rely on commodity exports, it also opens up the opportunity to take advantage of price booms. The differences—for example—between Chile’s long-term investment in copper mining and Zambia’s poor long-term record in global copper production, are stark.19

Third, the Prebisch–Singer hypothesis has had an influence on academic debate and policy for more than fifty years; but in that period there have been lengthy periods of very strong prices for many commodities. The growth of China and a number of other economies—including Brazil, Mexico, India, Indonesia, Russia, and Turkey—led to a sustained increase in consumption and prices of energy, metal, and even some foods. Recently, these countries have together accounted for a larger share of consumption of coal, base and precious metals, and most foods, than the G7 economies.20 Furthermore, over the long-term history of modern globalized capitalism, there can be no great confidence in the idea of a secular decline in Africa’s terms of trade. A new long-run dataset of African commodities shows there was a prolonged rise in the terms of trade for African countries between 1820 and the 1880s, and that this terms-of-trade boom was larger in Africa than it was elsewhere.21

Fourth, primary commodity prices do not all move together, as is clear, for example, in Figure 5.2. It is misleading to take policy inspiration from an average commodity terms of trade. Income elasticities of demand for different foods vary hugely. While elasticities of demand for grains are typically less than one (i.e. growth in demand is slower than growth in incomes), they are higher for foods with a greater fat and protein content—as people get better off they can afford more of these. Furthermore, as discussed in Section 5.5, there is increasing scope within food production (and related commodities such as flowers) for branding and product differentiation, which is one of the factors distinguishing ‘non-commodities’ from commodities in trade. Indeed, income elasticities of demand (and price trends) for macadamia nuts, avocados, specialty arabica coffees, and other crops are extremely high. It is clearly important, when designing investment, trade, and diversification strategies, to disaggregate the terms of trade. While the wider group of ‘emerging’ economies account for much of the global consumption of metals, energy, and foods, the higher-income economies—especially the (p.118) European Union (EU)—are the most important market for ‘processed agricultural’ products. Despite this, some African countries have, in recent years, experienced a fall in the share of such high-value processed agricultural products sent to the EU.22

The Trade Imperative

Figure 5.2 Commodity prices: peanuts, wheat, and maize (US$ per metric tonne)

Source: IMF Commodity Prices (2018).

Fifth, African terms of trade held up well from the 1950s to 2000, even holding steady after the oil price hike of the early 1970s when overall commodity terms of trade fell. But whatever the trend in the net barter terms of trade for commodities over a given period, this is absolutely no guide to the net barter terms of trade for any individual country, or even group of countries. Thus, ‘there is little evidence of a stable, long-run relationship between the commodity terms of trade and the national net barter terms of trade for the majority of the countries of Sub-Saharan Africa’.23

There is no convincing reason that African governments should neglect investment efforts to expand primary commodity exports. Instead, they should design policies maximizing their command over imports. This requires an investment strategy targeting those exports where the greatest medium-term gains—in foreign exchange, but if possible also in employment—are likely. It also means overcoming—rather than caving in to—difficulties that are sometimes used as excuses to shy away from participating in global trade. For example, some African government officials wring their hands at the strict phyto-sanitary standards necessary to thrive in global agricultural commodity trade, although Kenya’s (p.119) exporters have invested to meet many of these standards. In South Africa, complaints about the imposition of these standards justify a strategy of making a virtue out of investment failure—a claim that it is too difficult to succeed in international markets helps turn trading with other African economies into a rhetorical campaign of solidarity.

If the Prices Don’t Get You, the Rules Will

While there has been a proliferation of non-tariff barriers (NTBs) in the wake of formal trade liberalization (the reduction in tariffs and quotas),24 this is often only a partial reason at best for weak export performance. Again, South Africa’s experience provides more convincing reasons for lacklustre export performance. Access to large markets for apples, pears, and other fruits in China and Thailand has been blocked, not by overly zealous phyto-sanitary rules, but by the South African government’s failure to take the required action. Government officials took years to provide basic information required by the Chinese authorities on the amounts of pesticides used in apple orchards, while ‘South Africa’s fruit exporters have been denied access to Thailand since 2008 because the South African government has failed to update the phyto-sanitary rules applicable to the sector, thus hindering the certification process’.25

Prior to 2015, South Africa had not exported any plums to China for 10 years. Trade pessimists and some South African officials might complain of ‘market access’ problems. But Chile had managed to export large quantities of plums to China during the same period. Chile invested in a massive trade negotiation effort and succeeded in gaining access to the growing East Asian markets; South Africa did not make this effort and access remains very limited. Similarly, Peru managed to export avocados to US and Japanese markets, while South Africa failed. Thus, behind the nationalistic stress on market access difficulties, there is often a weakness in trade negotiation.

The WTO and ‘Policy Space’: Rules and Ruses

Similar weaknesses undermine the ability of many governments to make the best of prevailing World Trade Organization (WTO) rules, although much of the literature emphasizes that the governments of low-income countries have very limited opportunities to evade the strict requirements of WTO membership. For example, some critics fear that the WTO is little more than a crowbar wielded by (p.120) the richest economies to force open developing country markets while continuing to protect their own competitive edge. The key argument here is that the WTO has, since its inauguration in 1995, reduced developing country ‘policy space’, making it virtually impossible for such countries to adopt industrial policies of the type used in earlier developing economies (in East and South East Asia especially). As Robert Wade argues:

the main international agreements from the Uruguay Round—TRIPS, TRIMS and GATS—systematically tip the playing field against developing countries [ … ] Taken together, the three agreements greatly restrict the right of a government to carry though policies that favour the growth and technological upgrading of domestic industries and firms.26

Without doubt, the rules of the trading game have changed over recent decades. There are now bans on quotas for manufactured imports (making infant industry protection more difficult); limits on subsidies (making it more difficult for states to back national exporting champions); bans on local content requirements, as well as other trade-related investment measures (TRIMS), that might be used to direct the behaviour of foreign direct investors; and demands for a dramatic reduction in import tariffs. Tariffs are generally ‘bound’ at an upper limit, though they are often ‘applied’ at a different, lower rate. The Trade-Related Aspects of Intellectual Property Rights (TRIPS) agreement makes it harder for developing countries to secure technology transfer in time-honoured (piratical) ways, and is said to have facilitated a large flow of patent-related profits from ‘Southern’ to ‘Northern’ countries. Additionally, using the WTO Dispute Settlement Understanding (DSU) is costly for resource-constrained developing countries.

In parallel with the WTO, there are many preferential trade agreements (PTAs) and regional trade agreements (RTAs) that also often impose restrictions on developing countries. Thus, while a PTA such as the African Growth and Opportunity Act (AGOA) might give preferential access to the US market for some African exports, this comes at a price. Conditions imposed by the preference-giving country might include general commitments—to privatization or market liberalization—and/or more specific commitments, for example, regarding the relaxation of environmental standards or government procurement policy. Sometimes, these rules and conditions are more restrictive than the WTO, as the preference-giving country is able to negotiate better terms than they would have been able to achieve faced with stronger collective action among a larger number of developing countries.27 Critics have also argued there may be quite (p.121) high costs and limited benefits as a result of economic partnership agreements (EPAs), negotiated between the EU and a number of African regional blocs.28

The rules of trade can be tough. But these rules and constraints do not eliminate the scope for policy initiatives: African policy officials do have room for movement—‘policy space’. The rules themselves allow for a range of government interventions that can support industrial expansion and exports. Furthermore, the evidence is clear that governments can stretch these rules to expand the range of interventions in support of exports. Besides, policy officials can and should promote exports by adopting many other types of intervention not covered or prohibited in WTO rules. For example, targeted infrastructure investments—railways, ports, roads, and dams serving areas with a high capacity for foreign exchange and job creation—are fine, as are targeted and subsidized investment in skills formation. African states can intervene to provide marketing services to domestic champions, as well as tax concessions to selected foreign firms.29 State financial institutions in search of economies of scale can adopt measures to bring about mergers of firms in strategic activities. Governments can set up public research and development (R&D) centres designed to generate and transfer technology to firms at ‘competitive’ prices (rather than at prices set to extract patent rents). States can use public procurement policy—especially in developing countries that are not signatories to the current agreements among only some WTO members—to foster domestic firms that may later go on to build export capacity.

The WTO has ‘green light’ exemptions that allow for state subsidies: to support R&D; to support disadvantaged regions of a country; and to help existing facilities switch to environmentally cleaner technology. A country can introduce ‘trade restrictive’ protection to encourage infant industries where the rate of aggregate import growth threatens to provoke balance of payments difficulties (under Article XVIII). It can also do this to protect a specific industry against an import surge (Article XIX), as well as to protect an industry against unfair trading practices (dumping, etc.) by other countries. Additionally, export taxes, for example, can be imposed to discourage exports of unprocessed commodities. There will, of course, be overt and covert attempts to interfere with the design and implementation of policies such as these. There is substantial variation in how WTO rules are agreed and applied. For example, rather than having tariff rates forced down by WTO diktat, the governments of some countries have willingly reduced them below what is agreed through their WTO commitments.30 United Nations Economic Commission for Africa (UNECA) deserves credit for acknowledging the degree of variation and what is possible:

[I]n carrying out such policy measures, the real test becomes that of the policymakers’ commitment to maintaining emphasis on industrial policy efforts. The (p.122) situation is challenging, but if policymakers are swayed by the prevailing orthodoxy from the outset [or, we would add, by those who gain from that orthodoxy], the lack of policy space will only be accentuated.31

Since the creation of the WTO, developing countries have been able to ‘game’ the system effectively. Amrita Bahri’s research has shown that ‘With better bargaining and litigation strategies, and with the consequentially enhanced capacity to raise credible litigation threats, Member States can improve their “terms-of-trade”.’32 This may involve both knowing the rules, and stretching, interpreting, testing, and adjusting favourably to them: ‘strategic lawyering’.33

Brazil, for example, has used the WTO’s dispute resolution system in a variety of ways to protect domestic firms and support exporters, such as the formerly state-owned aircraft manufacturer Embraer. Not only were Embraer’s export markets successfully defended against Canadian aerospace interests, careful preparation for litigation stimulated deeper productive relations between the Brazilian state and private sector. The Brazilian experience suggests that developing countries seeking to make the international trading system work for them need the services of experienced trade lawyers (and plenty of them); politicians with the nous to decide which cases to litigate and which to leave alone; and officials who can monitor trade practices in other countries.

African policy officials may be encouraged by another, even more dramatic, example of how to use the WTO system to promote and protect domestic industry:

Despite expectations that China would abandon its more protective industrial policies after entering the WTO, during the past decade the Chinese government has increased its reliance on WTO-inconsistent measures as a key tool for managing the country’s economy.34

China’s officials have been astute in adopting policies, then holding out until they are challenged in the WTO. They then continue with the policies through what is typically a long, drawn-out period of negotiation and WTO procedures, before finally, if they are ruled against, scaling back protective or ‘trade restrictive’ measures. By the time this stage is reached, the policies have often already done much of the work needed to support a new domestic industry.

Foreign firms are pressed to operate through joint ventures with Chinese firms, pushed to transfer technology in key sectors, and persuaded to meet local content requirements. Meanwhile, the Chinese state promotes new sets of activity through state-owned enterprises, many of which are incompletely privatized, and sponsored through measures such as subsidies and cheap, targeted credit. This kind of approach was adopted in sectors such as wind power, high-speed railways, and (p.123) solar power. When China was challenged in the WTO, the resultant negotiations took years. One tactic that drew the negotiation process out even longer was the neglect, by the Chinese negotiating team, to translate key documents into English, French, or Spanish (the three official WTO languages).35

A concerted attempt to adopt at least some elements of China’s approach and tactics could begin to halt Africa’s declining share of world markets, allowing faster growth in the imports required for accumulation.

5.4 Exchange Rates as Development Policy

Exchange rates can, along with other prices, be manipulated or ‘got wrong’ for productive, transformative, and competitive purposes. The standard economics textbook approach to exchange rates treats them as relative prices that balance or can create a tendency to equilibrium in the external account. But exchange rates are, rather, about the pace of change in an economy; they are key to the level and rate of growth of economic activity at which external accounts balance.

There are two main reasons why some economists are wary of government intervention to make exchange rates ‘competitive’ or ‘undervalued’. The first is simply the belief that any intervention in markets is distortionary, leading to perverse economic outcomes. This follows from the approach noted in Section 5.2, in which the exchange rate is key to maintaining balance in external accounts (irrespective of the level of activity); and this approach prioritizes macroeconomic balance and equilibrium above production, growth, structural change, and, frankly, human welfare. These economists emphasize the possible costs of competitive devaluations, arguing, for example, that large deviations from ‘equilibrium’ prices can be harmful for growth.

This goes for both large undervaluations and large overvaluations. If the exchange rate is undervalued for any length of time, the consequences may include: an inefficient build-up of low-yielding foreign reserves; inflation and macroeconomic instability, especially if there are no countervailing measures to restrain wage growth; a reduction in the scope for using monetary policy to manage efficient levels of investment; and reductions in consumer welfare and overall demand, because undervaluation can act as a tax on consumption spending—though this ignores the scope for dynamic effects of an undervaluation, as discussed later in this section.36 From this perspective, the role of central banks is limited, intervening in currency markets only to minimize large short-term swings in the real exchange rate; otherwise, they should use the exchange rate as a price helping to secure low inflation.37

(p.124) The second source of anxiety about exchange rate undervaluation derives from different theoretical and political concerns. Partly, it is based on very reasonable fears about the impact devaluation might have on the price of wage goods and aggregate demand, and hence on growth. Economists within a Kaldorian or structuralist tradition—including staunch supporters of Tanzania’s efforts in the early 1980s to resist IMF demands for devaluation—anticipate a redistribution of income away from wage earners, largely because workers’ wages are unlikely in the short term to increase in step with the prices of already scarce imported goods.38 This may increase political instability and encourage capital flight, as well reducing overall demand because wage workers—who have a relatively high propensity to spend their income—are experiencing falls in their real wages. With overall demand declining as a result of the devaluation, growth may slow. Another risk is that if external debts have been contracted in foreign currencies, then devaluation exposes an economy to deeper debt-servicing difficulties.

Furthermore, when exchange rates become undervalued, elasticities of supply and demand for African exports may scupper the benefits some economists anticipate. On the supply side, it is not clear that the volume of Africa’s exports responded very positively or rapidly to price increases enjoyed during the post-2001 commodity boom.39 Demand-induced responses may be weakened because much global trade now flows through supply chain links between firms spread across different countries. A country may export goods that are then intermediate inputs in long chains assembling final consumer products. A devaluation in one such exporting country may have only a modest impact on overall global demand for the final product, given the complexity and the number of economies contributing to production of that good. This effect may well vary depending on how significant a given country’s contribution is to the final value chain product.40

It is also difficult to make confident predictions about the results of exchange rate changes for other reasons: a depreciation may make exports more competitively priced internationally, but at the same time it raises the cost of imports and hence of production, which in turn will be reflected in profitability and/or export prices. Thus, where the import content of exports is high—as is the case in many African economies—depreciation may be less effective in promoting export growth.41 In addition, a devaluation designed to stimulate growth in the volume of exports may fail if capitalists prefer to concentrate their investment efforts on high-profit niche opportunities in the domestic market, such as urban property speculation. It may also fail because, as is common in many African countries, there are supply-side rigidities blocking a rapid commodity response to demand signals. Transport infrastructure may be weak or have collapsed, there may be (p.125) frequent power cuts and insufficient R&D to support production and increases in productivity—the price signal of a devaluation may be a faint blinking torch in an empty desert.

So there are reasons why some economic advisors to African policymakers (as well as African leaders such as Julius Nyerere) have argued vehemently against devaluation. But this opposition is usually eventually crushed, and it may be misguided. Exchange rate policy is too important to be guided by gestural opposition to Washington bullies, and insisting on maintaining an overvalued exchange rate can be a way of giving up policy responsibility. The evidence shows that growth episodes are clearly linked to competitive exchange rates, and there are clear mechanisms that help explain why this is so.

This empirical claim is linked to the analytical idea that exchange rate movements help determine the level and the rate of change of economic activity—at which, necessarily, the balance of payments account balances. The link between a competitive and stable real exchange rate and higher gross domestic product (GDP) growth rates is evident in a variety of regression analyses that use a range of datasets for GDP growth rates, as well as in historical case studies of growth episodes. There is evidence, too, that the effect is especially marked in developing countries, although the effect may be strong both in low- and high-income countries, but weaker in between.42 Nonetheless, there is a plenty of evidence suggesting that targeting a competitive exchange rate is an effective growth-enhancing policy for developing countries.

Exchange rates have complex links to the rest of the economy, but some of the dynamics explaining how competitive undervaluations can generate faster GDP growth are beginning to be understood. Policies that shift resources away from non-tradeables towards tradeables can help accelerate structural change and growth, as this shift will often involve transferring resources from low- to high-productivity activities. Not all high-productivity activities fall into the sector conventionally defined as ‘manufacturing’, but many do, and it has long been argued that manufacturing is central to long-run growth and development (see Chapter 3), and that manufactured exports in particular are associated with sustained growth and development.

An undervalued exchange rate can signal profitability and provoke a shift of resources to tradeable activities. In low-income African economies, however, the incentive to invest in higher-productivity activities may have been dulled by the small size of domestic markets, meaning that potential economies of scale cannot be captured. Firms in these economies might be more confident about increasing their profits if a depreciation of the real exchange rate opens up larger international market demand, making it possible for them to benefit from economies (p.126) of scale. This in turn may help unleash the cumulative efficiencies that evolve from spill-overs, linkages, and ‘intimate connections’ among firms within the country. In short, a competitive real exchange rate can set off a virtuous cycle of productivity improvements.

A currency undervaluation—changing relative prices with a view to promoting particular kinds of production—can work like a subsidy, increasing investors’ profits and effectively acting as an ‘infant industry’ protection policy. It ‘gets prices wrong’ in order to create a profitable environment within which developing countries can generate competitive know-how, exploit scale economies, and accelerate ‘learning’. It then works like one of Hirschman’s linkages (Chapter 6), by providing a compelling signal of profitability and calling forth new investments. In one study, 92 episodes of manufacturing export growth were preceded by currency devaluations (facilitating both growth into new export markets and the growth of new export products). Other work confirms the structural change-promoting effect of currency undervaluation.43

Exchange rate policy is one (blunt) instrument, the effectiveness of which is likely to be greater when combined with other policies. These include public R&D; investment in education; and large investments in infrastructure, targeting especially those areas and activities with scope for foreign exchange earnings and employment growth that are also likely to stimulate dynamic increasing returns. There may also be a case for targeting how the subsidy that is an undervalued real exchange rate works—combining fiscal and exchange rate policy as a kind of selective industrial policy. One way to reroute the subsidy away from those tradeables less associated with structural change gains is to tax exports of products with little scope for dynamic increasing returns, productivity increases, or employment.44

In practice, it is difficult to determine the outcomes of exchange rate policy. If the key objective is to sustain a moderate, stable, and credible undervaluation, policy officials will need to agree on how best to assess the current level of under- or overvaluation of the real exchange rate. The importance of monitoring trends in the real exchange rate lies in the information it gives about relative profitability across economies. Most mainstream economists do not focus on this information, believing the main purpose of real exchange rate calculations is to highlight variations in rates of consumer price inflation between countries. However, these variations are not always a clear guide to relative profitability, and an undervalued exchange rate can lower the time preference for saving (increasing the willingness to save). It can also make investment more ‘efficient’, raising the marginal product of capital. Uncertainties about profitability and future flows of investment will continue to confront policymakers, but they can take comfort in (p.127) the finding that investment is more likely to be sustained if there is an expectation that the exchange rate policy will not be subject to big swings.

Advocates of devaluation hope that a cut in domestic purchasing power (among wage earners and local material suppliers) will be offset by a rise in foreign demand for the country’s output. This includes both demand for goods and services exported and demand to invest in assets in the country. If this is the case, then the effect of the currency depreciation will be to raise investment and output in the economy as a whole. As a result, wages may start to rise alongside sustained growth and productivity increases. It is important to emphasize that the positive effects of devaluation/undervaluation may be the result of attracting new flows of foreign investment, just as much (perhaps even more) as through the volume of trade.

It is clear from the discussion here that exchange rate policy is deeply political, involving judgements well beyond the remit (or the competence) of IMF technocrats. Where wages are already very low and the cost of living is rising, will it be possible to persuade people to accept a rise in the general price level? It is well known that the inflationary effects of devaluations can be ‘politically disruptive enough to derail’ IMF programmes.45 As Kalecki noted (see Chapter 4), accelerating wage goods price inflation may lead either to reduced investment, if it has to be accommodated in higher wages and lower profits, or to rising political conflict around falling real wages. An exchange rate devaluation risks something similar. It needs very careful political management (e.g. in the form of a ‘deal’ to secure the temporary acceptance of lower real wages, against the promise of faster growth, rising productivity, and longer-term rising real wages). This needs to be combined with an investment strategy to increase the non-inflationary supply of basic wage goods, as well as short-term market interventions to ensure that the prices of food staples do not rise above a certain threshold.

Finally, policy officials need to be aware of the complexities of judging exactly how much an exchange rate is over- or undervalued. They will in all likelihood find themselves in negotiations with the IMF, whose staff use a variety of methods (some more transparent than others) to make a judgement. How far a particular country’s real exchange rate and current account deviate from the ‘norm’ observed in selected comparator countries will determine the Fund’s estimate of (typically) overvaluation. Sometimes the IMF simply draws a regression line, roughly linking levels of per capita income to the real exchange rate across economies. How far a given country’s real exchange rate veers away from the line of best fit (‘the norm’) shows the degree of overvaluation. For example, this method calculated the Ethiopian birr as being overvalued by 36 per cent in 2017.46 (p.128) Any attempt to achieve a real devaluation of more than 30 per cent would almost certainly have had dramatic and unforeseeable consequences for the Ethiopian economy.

Many would agree that in recent years the birr was not set at an appropriate rate, despite nominal depreciations. Even so, the IMF assessment was probably an exaggeration, and it is hard to make sense of the method used to arrive at this extreme and risky assessment. We argue that because exchange rates really point to differences across countries in profitability, it would be better to gather data from several countries on unit production costs (wages and material/input costs per physical unit of output) for a comparable sample of tradeable and non-tradeable outputs. There is not good data on these for Ethiopia, or for many other African economies.

5.5 Narrow Definitions of Industrial Policy and Manufacturing: Assembly Plants or Plant Assembly?

In the past, economists and policymakers set priorities based on distinctions between broad economic sectors: agriculture or primary commodity production; manufacturing industry; and services. Non-mainstream development economists have emphasized the distinctive features of manufacturing: the link between manufacturing output and overall GDP growth; the link between manufacturing output and productivity in manufacturing; and the link between manufacturing output and productivity in the rest of the economy. Where neoclassical economists saw no distinctive features separating one sector from another, arguing for ‘horizontal’ policies that would affect efficiency across any sector, structuralist economists argued for more ‘vertical’ interventions that would accelerate investment specifically in manufacturing.

Evidence supporting Kaldor’s views about the manufacturing sector’s unique contribution to growth has been accumulating for several decades. The evidence also supports an industrial policy that involves selective interventions in support of particular industries, as well as the wielding of a ‘reciprocal control mechanism’—a disciplining mechanism that ensures support for firms or industries is conditional on performance against specific criteria. In recent years, some neoclassically trained economists claim to recognize the role of industrial policy in economic growth and structural change. Two influences on this change of heart have been, first, advances in technique that have enabled better modelling of increasing returns—in the past, despite awareness of increasing returns, economists were unable to incorporate these returns in mathematical models. The second influence has been the increasing popularity of the ‘market failure’ and ‘information theoretic’ strain of neoclassical economics. These developments have (p.129) helped foster a belated enthusiasm within the mainstream for industrial policy.47 In late 2018, for example, an International Finance Corporation (IFC) official pronounced at a workshop on industrialization in Africa that industrialization was ‘the dominant paradigm’ for development. The only eyebrows raised were those of the few non-mainstream economists around the table not used to hearing any enthusiastic orthodox pronouncements about industrial policy. The same developments lie behind support for specific interventions in industries with a particular proclivity for ‘learning externalities’ and facing other market failures.48 These are contrasted with primary commodity exports. This rediscovery of industrial policy is usually limited in two important ways.

First, the market failure underpinnings of some new advocates of industrial policy leads to a narrow set of policies. This approach is exemplified in the work of Justin Lin and the idea that industrial policy must be restricted to state interventions that ‘facilitate comparative advantage’ in Africa, typically focusing on light manufacturing and on removing red tape, improving the ‘doing business’ climate, and investing in infrastructure. Arguments along these lines do at least acknowledge that some form of industrial policy might be possible in Africa. But we argue that Lin’s restricted view—imagine a car with huge blind spots curbing the view behind and a windscreen so fogged up that only part of the road ahead is visible—unnecessarily limits the possibilities for intervention. It represents a very partial understanding of the evidence on and history of thought about industrial policy.49

Second, while some acknowledge the significance of industrial policy in past experiences of ‘catch-up’ development, they also argue that the policies used (in countries such as Korea or Taiwan) can no longer be deployed effectively. This is partly because the rules of the game (WTO and other regulations) are misleadingly said to prohibit their use, and partly because it is thought that structural changes in the global economy mean that manufacturing is now less central to development: low- and middle-income economies are said to be in the grip of premature deindustrialization. We have already argued (in Chapter 4) that premature industrialization should not be considered an iron law preventing African governments from adopting effective industrial policies. Here, we criticize pessimists’ understanding of the role of manufacturing—and their policy conclusions—in a little more detail.

Arguments about premature deindustrialization rest on a standard classification of sectors that is increasingly outdated and unhelpful for economic analysis and policy design. The irony is that the traditional three-sector classification is becoming irrelevant just as neoclassical economists are discovering there really are differences between sectors. The special characteristics that in the past were associated with manufacturing have become detached from broadly defined (p.130) ‘sectors’ and attached instead to specific ‘activities’. The categorical boundaries between sectors have become blurred by global technical and economic changes. These have taken two forms in particular. First, there is ‘servicification’, meaning that an increasing share of the final value of many products is derived from services such as logistics or branding.50 Second, there is the ‘industrialization of freshness’: the production of high-value fresh fruit, vegetables, herbs, and flowers is increasingly complex, sophisticated, and—by any reasonable definition—industrial. For example, a fresh orange produced for export from, say, South Africa to the UK, is technically more sophisticated, and industrially more complex, than an apparently more ‘processed’ product such as a carton of orange juice. Producing a consistent flow of top-quality oranges—meeting strict phyto-sanitary rules of market access for the EU, ensuring the oranges are perfectly ripe and juicy, and look the part—is an extremely difficult task. It involves an ‘intricate nexus’ that makes for a ‘roundabout’ production process—exactly the ingredients that make something ‘industrial’.51 Much of this activity is not captured in standard data on industrial output and is therefore missing from the literature on ‘premature deindustrialization’.

This blurring of categorical boundaries, and the resulting need to focus policy not on ‘sectors’ but ‘activities’, should inform the design of structural change policies. The two most important criteria to be applied before allocating resources are, first, what scope an activity has to generate a rapid increase in export earnings; and, second, what scope it has for generating employment (directly and indirectly). Other criteria—the scope for technical learning, for economies of scale, for generating ‘intimate connections’ between firms—may also be considered.

Policymakers need to know if these key criteria are satisfied more fully by, for instance, promoting turnkey garment assembly sheds or supporting the expansion of high-value horticulture and floriculture. Policymakers should also be prepared to ask other detailed and politically difficult questions: for example, whether it is appropriate to subsidize domestic food production when long-term price declines on international markets imply favourable terms of trade for African cereal importers; or whether subsidies should be directed towards the domestic production of food types that make little or no contribution to improving the nutrition of the poorest people.

5.6 Conclusions

We have argued that many policies are available for African governments to use in influencing outcomes from international economic integration. The arguments of (p.131) the trade pessimists are misleading. There are, of course, considerable difficulties in trading with more powerful and wealthy partners, but there are many areas where policy can overcome some of these difficulties. Securing these gains is fundamental to successful structural change.

We have insisted that no simple magic trick policies are available: for example, effective management of an undervalued exchange rate involves many complementary policies, including achieving a non-inflationary increase in the supply of food and other basic wage goods. Above all, though, the argument presented in this chapter is that African governments need to design public investment strategies to achieve a rapid increase in the rate of growth of exports, so that they can relax the balance of payments constraint on growth and allow a sustained rise in imports—of capital goods, intermediate inputs, and consumer goods. Finally, we have raised questions about which economic activities should be the main beneficiaries of public interventions. If governments do not develop clear priorities when designing policy, they may end up at the mercy of individual fancies or the relative power of particular lobbying interests—all claiming to contribute to the people’s welfare, the empowerment of women and the elimination of undernutrition.

Acknowledgements

Besides the references cited, Section 5.4 owes a debt to conversations with Michael Kuczynski and to presentations he made to a group of high-level policy officials from Ethiopia in June 2016.

Notes:

(1) Herrerias and Orts (2013: 783).

(2) Magalhães Prates and Farhi (2015).

(3) Mussa and Savastano (2000: 81).

(4) Taylor (1997: 147).

(5) Fine (2006).

(6) Ibid.

(7) On this controversy see Stiglitz (2002).

(8) An, Jalles, and Loungani (2018).

(9) Killick (1993).

(10) Kentikelenis, Stubbs, and King (2016).

(11) UNCTAD (2014: 102).

(13) Ghosh (2018: 195).

(14) Ghosh (2018: 204).

(15) Van Bergeijk (2018).

(16) Ghosh (2019: 386).

(17) Osakwe, Santos-Paulino, and Dogan (2018).

(18) Spraos (1980); Cuddington and Urzua (1989); Pfaffenzeller (2018).

(19) For further examples, see Cramer and Sender (2019).

(20) Baffes et al. (2018).

(21) Frankema et al. (2018).

(22) Partridge and Pienaar (2015).

(23) Cashin and Patillo (2006: 856).

(24) UNCTAD (2013).

(25) Viviers et al. (2014).

(26) Wade (2003: 622, 630). See also Weiss (2005).

(27) Aggarwal and Evenett (2014); UNECA (2016).

(28) UNECA (2016).

(29) Gallagher (2007: 82).

(30) Aggarwal and Evenett (2014).

(31) UNECA (2016: 117). See also Aggarwal and Evenett (2014); Amsden and Hikino (2000).

(32) Bahri (2016: 642).

(33) Santos (2011: 594).

(34) Oh (2015: 1125).

(35) Oh (2015).

(36) Haddad and Pancaro (2010).

(37) Frenkel and Rapetti (2014).

(38) Singh (1986).

(39) Mold and Prizzon (2010: 3).

(40) Ahmed, Appendino, and Ruta (2015: 17); Cheng et al. (2016).

(41) Ahmed, Appendino, and Ruta (2015: 17).

(42) Rodrik (2008); Rapetti et al. (2012).

(43) Frenkel and Rapetti (2014); McMillan and Rodrik (2011); Freund and Pierola (2012).

(44) Guzman, Ocampo, and Stiglitz (2017).

(45) Taylor (1997: 148).

(46) If the sample of comparator countries had been expanded to include commodity producers, the extent of overvaluation would have fallen to the less extreme figure of 22 per cent. IMF (2016: 32).

(47) Cherif and Hasanov (2019).

(48) Guzman, Ocampo, and Stiglitz (2017).

(49) For a critique of Lin’s new structural economics see Fine and van Waeyenberge (2013).

(50) Lodefalk (2017).

(51) Cramer, Di John, and Sender (2018).