This is a bit longer.

April 4, 2008

I wish I could wrap up posts about really interesting topics like the non-existent Brazzaville-Kinshasa bridge or the real meaning of King Alfonso’s letters to the King of Portugal or the reality of atavistic ethnic voting but they’re in limbo due to constant re-writing propelled by incomplete proof-reads. So instead I’ll just keep wondering about how CATO Institute recruits its African fellows, associates and sponsored writers.

So today’s topic is Andrew Mwenda wrong argument in this Cato foreign policy brief.

The World Bank argued that Uganda “deserved” debt relief because government had created a “good policy environment” through macro-economic policy reforms that led to impressive and sustained economic growth rates for over a decade. On the flip side, the World Bank argued that Uganda “needed” debt relief because its debt burden was unsustainable and not only was going to undermine future economic growth but also was going to put economic reforms in jeopardy.

If Uganda “deserved” debt relief, then it should not have “needed” it. When a government implements good reforms leading to high growth rates, those growth rates should then enable the government to meet its obligations to its creditors. Conversely, countries that need debt relief often don’t deserve it because they have pursued wrong-headed economic policies. In such cases, debt relief could encourage them to continue down the wrong path.

And later

From independence in 1962 to 1998, Uganda’s debt grew to US$3.2 billion. In the five years following the HIPC debt relief of US$2 billion, the debt rose to US$4.9 billion. Uganda did not accumulate that debt burden because of “mismanagement” under the brutal regime of Idi Amin. On the contrary, over 90 percent of Uganda’s debt was incurred during the implementation of World Bank– and IMF-sponsored economic reform policies of stabilisation and structural adjustment, beginning in 1981. If those policies had worked as their advocates argued, Uganda should have been able to pay its way out of debt.

I should start by making clear that this is not his core argument against foreign aid. His main complain is that the share of foreign aid in Uganda’s budget makes the government less accountable to its people and in a way I do agree with that. So this is a side argument set up to explain the unintended consequences debt forgiveness and foreign aid had on Uganda.

Yet, it’s still wrong. It is true that colonial governments and early independence ones managed to have somehow balanced budgets. And it is true it seems illogical that a country that has implemented reforms that has generated growth shouldn’t need more aid (or debt forgiveness) to sustain itself. But that’s only if you don’t think about how government revenue and some aspects of spending are actually handled.

To start with spending, at least in the beginning, colonial administrations didn’t face much pressure. Force and patronage were used to extract revenue while spending was either limited to the needs of colonists and their businesses (in infrastructure mostly) or mostly done by religious organisations with their own financial sources (education and to a lesser extend health). That surely makes balancing a budget easy. But as nationalistic political pressure mounted, spending followed. In a the late years most colonies in Africa ran deficits as schools, hospitals were built and civil servants hired in a late attempt to buy off support and coercion was harder to use to generate revenue. The newly independent governments inherited those demands, only exacerbated by the expectations they generated while making their nationalist case. But even beyond that, Uganda’s population went from 5 millions in the early 50’s to almost 30 millions nowadays. So not only the percentage of the population benefiting from government services increase but the total population doubled every twenty years.

Yet, one could expect the Ugandan economy to have grown and therefore generated more revenue in the same period. Well, that is where the revenue collection side start to matter.
The Uganda Economy did in fact grow before the Structural Adjustment program but quite slowly (and with downturns like during the second Obote rule). As a result, at best the GDP per inhabitant stayed constant. Not exactly the best way to face ever increasing spending demands (the per capital GDP went from 8% of that of the United States in 1950 to 3% nowadays, compare that to Korea going from 10% to almost 50%).

And that’s where the main idea insight behind Structural Adjustment Programs comes in. Basically the argument was that low-performing economies were low performing because of policies that distorted economic activity. Such distortions could be labour laws, macro-economic imbalances but also and perhaps most importantly how governments generated revenue.

Africa, still hasn’t reached the levels of standardisation and bureaucratisation most western economies had when income taxes became the main source of revenue. Because of that, other means have been used. Using forced labour or establishing export monopolies for key products or putting high tariffs in place or selling licences to operate or privatising some social expenses were the ways used to finance colonial states. Independent governments continued to use those instruments, only even more bluntly. “Marketing Boards” notoriously bought exportable products at prices much lower than the market rates, legislation obligated companies to provide housing, healthcare, pay for infrastructure, companies had to purchase a plethora of licences, merchants could only work in official state-owned markets with high rents, firms were nationalised to put more money in the state coffers. As a result, farmers didn’t have as many incentives to produce more exportables, companies concentrated on high-revenue sectors in which high operation costs weren’t that much of an issue, prices of goods in markets stayed high, entrepreneurship was limited to the well-connected, the rich or the very patient, investors were scared off etc.. All those very efficient way to collect taxes were indeed limiting economic growth (the share of government in Uganda’s GDP was the highest during the late 70’s recession).

The Washington Consensus proposed to remove all of those distortions. Governments were supposed to generate revenue through a simplified tariff system and the two modern forms of taxation: Value Added Tax and Income/Corporate Tax which all grow as fast as the economy without slowing it down (as far as the rates are reasonable) But may be because the people are the IMF are actually a bit realistic, they did realise that there would be an imbalance in government budgets in the short run. After all, it would take time for the growth to happen, it would take even more time for the economy to formalise and the relevant services to modernise. Furthermore while public service wages were frozen and some expenses cut, it would have been politically impossible to cut spending enough. Making the transition too hard is the best way to nurture nostalgia for the inefficient good old days, just look at Russia. That’s why budget support and more loans and aid were a crucial part of the package even if the new policies are designed to eventually generate the necessary growth.

I’m not sure I emphasised enough on how much modernisation is necessary for an African state to rely exclusively on VAT, income and corporate taxes. Only people and companies in the formal economy pay those. You’ll need your petty merchants and your small farmers to actually keep accounting books and have an incentive to declare high profits or an incentive not to lie. You’ll need every worker to declare most of his income and yes that include the money one makes from import 5 phones during a vacation to London or the wages of your cook/cousin/baby sitter/gardener. You also need your civil servants to be trained to analyse and understand the paperwork and probably pay them well enough to make bribes less tempting. You also need them to actually be present outside of Kampala. In this context, tax evasion may even happen involuntarily. That’s why simply reducing the highest marginal rate is not really the solution, especially when one says that “the rich and politically well connected don’t pay taxes”. If one can get away with not paying thanks to political connections, one wont pay no matter what the marginal rate is. And improving spending will require as much effort and investment since someone would have to be paid to properly clear an update those military payrolls.

Andrew Mwenda however does make some interesting point like when he mentions total military spending or prestige expenses. However I strongly doubt that someone who believes basic health or primary education are a waste of money and who is capable of making as dogmatic and uninformed arguments as the one I discussed really wants to discuss government efficiency, accountability, growth and modernisation and is not just trying to please the crowd and advance his own political status. And CATO still looks desperate by publishing any pro-market anti-government African argument no matter how wrong it is.


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