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Why Africa Needs Structural Adjustment

The World Bank*

Despite the efforts to improve the macroeconomic environment, open up markets, and strengthen the public and financial sectors, most African countries still lack policies that are sound by international standards. Even Africa's best performers have worse macroeconomic policies than the newly industrializing economies in Asia. Few besides Ghana come close to having adequate monetary, fiscal, and exchange rate policies. And Ghana lags behind other adjusting countries elsewhere—Chile and Mexico, for example—in trade and public enterprise reform.

In trade, many African countries have, by eliminating extensive import controls, returned to the regimes they had before the crisis—helped in many cases by successful exchange rate depreciations that restored competitiveness. Other countries that never experienced a severe macro-economic crisis, such as Kenya and Zimbabwe, have moved slowly toward import liberalization. The current policy stance in countries with flexible exchange rates is free of the heavy administrative controls that characterized the period before adjustment, but most African countries still have some nontariff barriers and high and dispersed tariffs.

The policy stance for agricultural pricing and other price controls is more difficult to quantify. Most countries have eliminated price controls and restrictions on the marketing and pricing of food staples, and many have eliminated costly subsidies for fertilizer (with no apparent reduction of fertilizer use) and liberalized its distribution. But governments continue to intervene heavily in the marketing of export crops.

The scarce evidence on public enterprise reform suggests that there has been no significant reduction in financial flows to public enterprises or in the volume of assets held by the government. Nor has there been a sustainable improvement in the efficiency of enterprises remaining public. The paucity of data partly reflects institutional weaknesses, but it probably also reflects the lack of government commitment to results.

Financial reform lags behind as well. The financial position of the banking sector is weak because of poor macroeconomic management, which induces the monetization of fiscal deficits through the banks. It is also weak because of the slow pace of reform in the public enterprise sector. And it reflects continuing government interference in the management of the financial sector. A large share of bank lending still goes to the public enterprise sector, making it more difficult for the private sector to borrow.

Although public spending on health and education did not decline in the adjustment period—an achievement given the fiscal problems of African countries—there is little evidence of an increase in that spending. Nor is there much evidence that public spending within those sectors is being reallocated away from costly tertiary programs and toward the basic services most likely to reach the poor.

The Road Ahead for Adjustment

Drawing on successful experiences elsewhere and taking Sub-Saharan Africa's circumstances into account, three principles can guide African governments undertaking reform programs.

• Get macroeconomic policies right. Keeping budget deficits small helps in controlling inflation and avoiding balance-of-payment problems. Keeping a realistic exchange rate pays off in greater international competitiveness and in supporting convertible currencies.

• Encourage competition. Competition means higher productivity, and firms forced to compete are more efficient than those with privileged access to credit or foreign exchange. A top priority for reform in Africa is to increase competition through domestic deregulation, trade reform, and the privatization of public enterprises.

• Use scarce institutional capacity wisely. Because most African countries have limited capacity to govern well, high priority should be given to reforms that minimize unnecessary government involvement in markets. For example, marketing boards should be abolished, public enterprises privatized, and import restrictions replaced by tariffs.

Many African countries are moving in the right direction with their macroeconomic, agricultural, and trade policies, and most policy makers agree on what still needs to be done. But there has been little progress in reforming public enterprises and the financial sector, and there is much less consensus on how to proceed. Reform in these sectors is particularly difficult because of the powerful vested interests that have been created through government intervention. A strong social consensus on the need to improve governance is thus a prerequisite for progress.

Moving Forward Where There Is Consensus

Getting macroeconomic policies right. Countries should continue with the current strategy: avoiding overvalued exchange rates and keeping inflation and budget deficits low. Good macroeconomic policies have paid off in East Asia, and they will pay off in Africa, too—indeed they are already starting to do so.

Most countries in the region still need to cut budget deficits and indirect fiscal losses (those covered by the banking system) in order to lessen the need for inflationary financing or additional external financing. There is little scope for cutting overall public spending in many countries, although the composition of spending can and should be improved. Increasing tax revenues is thus the best avenue for reducing deficits, but the increase should come by levying broad-based taxes that do not unduly penalize businesses and by granting fewer exemptions that favor the politically well-connected.

Domestic savings, which are low in Africa relative to other developing regions, must increase to finance investment. Eliminating large negative real interest rates is a crucial first step. But given the complexity of devising additional policies to encourage private savings, raising public savings is the best option in the short run. The surest way to increase savings in the long term is to boost growth, because growth and savings reinforce each other in a virtuous circle, with high growth leading to high saving and to higher growth.

Taxing agriculture less. In agriculture the main task is to continue reducing the taxation of farmers by liberalizing pricing and marketing and by reducing the protection of industry. Progress has been made, but countries need to do more to help farmers, and the elimination of agricultural marketing parastatals, particularly for export crops, must be high on the agenda. Liberalizing markets so that private agents can compete with parastatals and linking producer prices to world market prices may be useful transitional mechanisms in the near term. These reforms can help farmers reap the full benefit of the exchange rate depredations, which might otherwise merely shore up the financial profitability of parastatals.

Care must be taken not to undermine market liberalization efforts with restrictive licensing procedures and other interventions that give marketing parastatals an undue competitive advantage. Traders often face a thicket of regulations for licensing, transportation, the movement of goods, trading hours and locations, and weights and measures. Eliminating these burdensome obstacles is essential for increasing profitability and production in agriculture. Simultaneous progress in the development agenda is also important. Improving the quality of public spending for transport networks, rural infrastructure, and agricultural research and extension will enhance the payoff to improving agricultural policies.

Putting exporters first. Because exports are so beneficial for growth, countries should consider the needs of exporters carefully and apply an "exporters first" rule. One easy way for government to help exporters is to remove unnecessary policy impediments—by providing automatic access to foreign exchange, eliminating export monopolies, and facilitating access to intermediate inputs and capital goods. Governments also need to welcome foreign participation, because foreign firms can bring the contacts and production knowledge needed for penetrating global markets. But governments and international agencies should abandon the practice of trying to pick "winners"—that is, pushing particular exports—because they have consistently made poor choices in the past. Export processing zones have seldom been more effective than simple free-trade zones and bonded production areas, so it is important to find other mechanisms to help exporters avoid administrative, regulatory, and tariff impediments. A high priority is developing workable schemes to provide exporters access to duty-free inputs.

The potential for export growth is great, because African countries are starting from a very low base. Even modest success in increasing their share of world markers will translate into tremendous growth. The future is in nontraditional exports, but traditional exports still need to be part of an outward-oriented strategy. Gaining just a very small foothold in the world market for such traditional, labor-intensive goods as clothing and footwear would substantially increase the region's exports. But this does not mean that Africa should neglect its traditional export of primary commodities, even those that face limited world demand. Although the region already has a large market share in a handful of agricultural commodities, notably cocoa, it is possible to expand that share further. Good policies and investments in infrastructure and research and extension activities can help to raise the productivity of African producers and displace higher-cost producers elsewhere (as Indonesia and Malaysia have demonstrated).

Rationalizing import barriers. There has been progress in liberalizing imports, but most countries have gone only halfway. African countries should continue to eliminate nontariff barriers (NTBs) to rationalize the trade regime and increase transparency. The focus should be not on fine-tuning tariff levels but on establishing a credible schedule for substituting tariffs for NTBs. Even very high tariffs, if imposed only for a clearly limited period, can support the objectives of adjustment. The next steps on the agenda are to simplify the tariff structure, reduce the highest rates to more moderate levels, and institute a minimum tax—so long as effective systems are in place to provide exporters duty-free access to imports. These reforms can often generate enough revenue to offset a fairly substantial overall lowering of tariffs, while leading to a more competitive environment and productivity gains. Beyond that, further progress toward a low and completely uniform tariff structure should not sacrifice fiscal revenues.

Rethinking Adjustment Where There is Less Success— and Less Consensus

Privatizing public enterprises. The efforts to privatize state corporations and to improve their performance have yielded meager results so far. African governments have resisted privatization, especially of the most important public enterprises. But the alternatives—imposing hard budget constraints, granting the enterprises greater autonomy, and putting them on a commercial footing—seldom work.

Countries elsewhere are getting around the obstacles to privatization, and their experience might be useful in Africa. Some of these countries have fostered broad-based ownership by giving private citizens vouchers for shares in public enterprises, or reserving shares for employees. Others are using various types of private investment and holding companies to improve corporate management. Non-asset divestiture—through leasing, concessions, and incentive-based performance contracts—can increase private sector management of the public utilities and other natural monopolies and improve their productivity.

Prudent financial reform. The overall approach to financial development is on target, but reforms have suffered from too much faith in quick fixes. African countries need to continue with a three-part strategy of reducing financial repression, restoring bank solvency, and improving financial infrastructure. But adjustment programs have been overly hasty in cleaning balance sheets and recapitalizing banks in an environment where institutional capacity is weak and the main borrowers (the government and public enterprises) are financially distressed. Many programs were based on the assumption that banks could improve their performance simply by removing the bad loans from their balance sheets, replacing managers, and injecting new capital to bring assets up to international standards. This usually was insufficient for several reasons: reforms were not accompanied by needed macroeconomic and structural changes, bank managers continued to be exposed to political interference, and regulatory and supervisory capacities were inadequate and could only be developed over time.

A more prudent strategy to restore bank solvency involves downsizing publicly owned banks, privatizing them where possible, and encouraging new entrants. Because most African countries lack the capacity to regulate and supervise, the challenge is to devise a financial system that offers extra cushions against risk-by setting higher-than-normal capital-adequacy ratios, relying more on foreign banks, and limiting entry to reputable banks with a solid capital base. Countries must strike a balance between the need to increase competition and to ensure solvency of financial institutions.

Improving public sector management remains a major challenge for the road ahead—but one that probably extends beyond what adjustment-related policy reforms alone can accomplish. Perhaps the biggest challenge is to build a more effective civil service to provide the elements necessary for a well-functioning market economy, including a sound macroeconomic and legal framework and a system for providing basic social services consistent with the development objective of growth with equity. There is increasing recognition that adjustment programs, with their focus on containing civil service costs, have had limited success in tackling the more fundamental problems of the public sector, such as the lack of accountability and transparency, civil service employment and pay practices that are unrelated to technical competence and productivity, regressive patterns of resource mobilization, expenditures that conflict with development priorities, and the limited capacity for policy analysis. Broader approaches that address the difficult tasks of strengthening the administrative structure and creating the conditions for improved governance are thus called for.

More Adjustment—Not Less—Would Help the Poor and the Environment

Findings from Brazil, Côte d'Ivoire, and Peru show that the lack of adjustment is what most hurts the poor and most increases their number. Addressing the fundamental policy distortions that inhibit growth is thus an essential part of a strategy to reduce poverty.

The poor will benefit more from an increase in growth if spending programs to develop human resources are protected during the adjustment process, and if the policy package eliminates the distortions in labor, land, and output markets that disadvantage the poor. More could have been done, and should have been done, to reduce poverty in the context of adjustment programs. This has been changing in the past few years, as adjustment programs strive to improve public expenditure in the social sectors. But the fundamental development challenge of improving Africa's human resource base requires more than policy change—it also requires sustained investment and institution-building.

In addition to reducing poverty, adjustment programs in Sub-Saharan Africa can promote judicious use of natural resources by instituting policy reforms that affect the pricing of agricultural and forest outputs, petroleum products, energy, and so forth. But macroeconomic and broad sectoral policies are very general and cannot substitute for specific environmental interventions. Designing effective systems for environmental protection when institutional capacity is limited is no simple task. It may be preferable to give firms and communities incentives to protect the environment rather than to depend on governmental regulatory and enforcement capacity. As with poverty, many environmental problems require a combination of policy reform, investment, and institution-building.

Aid and Growth

Aid to African countries must be structured in ways that speed, rather than impede, growth. Higher income generates greater domestic savings and, in time, reduces the dependence on foreign savings. But today's large volume of aid poses dangers: it could soften budget constraints and thus finance the postponement of public sector reforms. Expanded aid flows should therefore be linked to strong reform programs and better governance. In financing country-specific adjustment program that have a good probability of yielding substantial reforms, a key issue is to design transfer mechanisms and to allocate aid across countries and sectors so that it supports a policy and investment framework for high accumulation of capital and rising public savings. Another key issue is to design aid so that it supports reforms without adding distortions in foreign exchange or labor markets and so that it builds institutions up instead of wearing them down. One of the major challenges on the road ahead is finding ways to help governments promote widespread ownership of adjustment programs and muster support among the interest groups that have the most to gain from reforms.

Efforts by donors to bring Africa's stock of debt down to sustainable levels can, when linked to strong adjustment efforts, help countries realize the benefits of policy reforms. The debt burden of many African countries is huge, and many will have too much debt even under the very favorable debt relief proposals under consideration. So far, aid flows and concessional lending have more than offset debt service payments. But in the medium and long term, as countries adopt better policies, the debt overhang is likely to deter private investment. And the debt service burden threatens to eat away at increased export earnings and domestic savings that might otherwise be used in pursuit of long-term development objectives. For countries undergoing comprehensive and sustained policy reform, reducing the debt stock burden to a manageable level would improve their development prospects. This means rethinking the current debt relief strategy, which still leaves many countries with debt service requirements beyond their capacity to pay. The focus should be on reducing the stock of debt to sustainable levels, even if that means differences in treatment across countries.

Even with transformed policies, higher savings, and better investments, Africa will still require exceptional external assistance for at least another decade. But countries cannot expect an increased flow of foreign resources without undertaking the economic reforms necessary for growth and poverty reduction. And such economic reforms will probably not take place until the conditions for good governance are established.

Adjustment is the necessary first step on the road to sustainable, poverty reducing growth. But adjustment programs in Sub-Saharan Africa have been burdened with unrealistically high hopes, driven in part by awareness of the real poverty that economic growth can help alleviate. Some proponents of adjustment thought that it could quickly put African countries on a much higher growth path than before. Too often there has been little effort to determine whether Africa's disappointing economic performance in the aggregate represents a failure to adjust or a failure of adjustment. Opponents have wrongly cast and criticized adjustment as an alternative to measures supporting long-term development. The resulting confusion has sometimes led to sterile debate about the efficacy of adjustment policies. More important, it has risked creating undue pessimism among African countries and donors. That pessimism is unwarranted, for there has been progress. The turnaround in growth shows that adjustment—even incomplete adjustment—can put African countries back on the road to development.

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* Excerpted from Adjustment in Africa: Reforms, Results, and the Road Ahead by the World Bank. Copyright © 1994 by the International Bank for Reconstruction/The World Bank. Reprinted by permission of Oxford University Press, Inc.

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