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Trade deficits in LDCs. Ruth Tarrant The Open University and Peter Symonds College . Outline . Issues facing (African)LDCs post WW2 Independence and its implications for development The size and funding of trade deficits for LDCs Focus on Tanzania African LDCs today . - PowerPoint PPT Presentation
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Trade deficits in LDCs
Ruth TarrantThe Open University and Peter Symonds College
Outline
• Issues facing (African)LDCs post WW2• Independence and its implications for
development• The size and funding of trade deficits for LDCs– Focus on Tanzania
• African LDCs today
The (African) colonies post WW2
Exploitation of primary products for reconstruction
Foreign exchange generated by exports kept by colonial powers
No import-substitution measures allowed. Colonies = markets for colonial powers
Allied victory / creation of UN led to social pressure for independence and progress
Colonial powers prevented secondary / tertiary education
Independence
Neo-colonialism
Nation building / gain
authorityKeynesian
Aid / trade dependent
Diplomatic pressure
‘removal’ of ‘hostile’ leaders
Heavy state intervention:
banking, education,
infrastructure‘developmentalism’
ideology led to authoritarian governance Mimic USSR:
achieve growth
BUT
INEQUALITY• basic needs not met• focus on capital intensive industry• rate of urbanisation > rate of wage growth
PRIMARY PRODUCT DEPENDENCY• No manufactured X• decline in terms of trade = vulnerability• World Bank!
NO TRANSFORMATION OF AGRICULTURE• urban – rural income gap• need to import food• no growth
FAILURE TO ENCOURAGE ENTERPRISE• ideological aversion to entrepreneurship• education still lacking
RENT-SEEKING GOVERNMENTS• short-termism• inability to consider longer-term growth/development
The ‘crisis years’, 1974-early 1980s
• 1975-1983: only 3 years saw any positive growth, on average, in Africa
• 1983: African economies’ GDP per capita fell on average by 5%
• Why?– Falling commodity prices and falling demand
• Recession in the developed world
• Consequences– Balance of payments crises– Economic stagnation and decline
The ‘crisis years’ – available policies
• Option 1– Accept BoP crisis as
structural & long-term
– Restructure economy
– Change the development model
• Option 2– See BoP crisis as
temporary– Borrow from abroad
to finance the deficit– Advice and pressure
from external lenders e.g. World Bank / IMF
The adjustment years, early 1980s to mid 1990s
• Option 2 ‘chosen’– Copy East Asian model• Rely on markets, not gov’t intervention• Export orientation rather than import substitution is
key– Slash public sector spending– Focus on primary product comparative advantage
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“While some aspects of this [Asian] model (for instance, greater political insulation of economic policy makers) could reasonable be achieved in African countries, the extensive co-ordinated economic interventions of the East Asian states are well beyond the administrative
faculties of most African governments”Lewis, 1996
“...no major expansion occurred in the diversity of products exported by most of the sub-Saharan African countries, although there one or two exceptions like
Madagascar and Kenya. Indeed, the product composition of some of the African countries’ exports
may have become more concentrated”Ng and Yeats, 2000
Far from supporting a minimalist approach to the state, these examples have shown that development requires an effective state, one that plays a catalytic, facilitating role, encouraging and complementing the activities of
private businesses and individuals...History has repeatedly shown that good government is not a
luxury but a vital necessity. Without an effective state, sustainable development, both economic and social is
impossible”Wolfensohn, 1997
A familiar macroeconomic framework
GDP = C + I + G + X – M GDP = (C + I + G) + X – M GDP = Domestic Absorption + X – M GDP + M – X = Domestic Absorption GDP + trade gap = Domestic Absorption
So, if an economy spends more on final goods and services than it can produce, its imports will exceed its exports by the value of the excess expenditure over GDP. This ‘trade deficit’
must be financed i.e. paid for
Tanzania persistently has a trade gap about 10% - 18% above GDP, although now shrinking
LDCs and trade deficits
• Very common in 1980s and 1990s!– Dramatic fall in commodity prices– Global recessions of 1981-82 and 1991-93– Increased protectionism in developed world
against LDC exports
Financing trade deficits using current flows
• Factor payments• Wages, rent, interest and profit
• Transfer payment• Payments not made in return for providing factors of
production– Official grants from govt’s, NGOs or international institutions– Money received from permanent overseas factors
Tanzanian factor payments have a negative balance, and transfer payments historically fund around a
quarter of the trade deficit
Other methods
• Draw on official foreign exchange reserves• Capital account transactions– Dealing in financial assets (public and/or private)– FDI from abroad• Requires good rates of interest!
LDCs such as Tanzania hold very limited foreign exchange reserves. Small, low income countries also
tend to have limited access to capital markets, as their economies are vulnerable. Historically, Tanzania found it difficult to attract FDI but rising tourism and demand
for commodities from China is helping.
Remaining options?GDP + trade gap = domestic absorption
Now subtract Consumption (public + private)from both sides
Savings + trade gap = Investment
Rearranging, gives:
Trade gap (i.e. M – X) = Investment - Savings
This is the key relationship for many macro policy makers in LDCs
Mean African current account deficit (% GDP)1960 to 2000
Implications for LDCsLow income
Low savings ratio Low absolute savings
Investment cannot be funded domestically
Aid is an essential source of finance for investment
Aid used for investment in:- Import-substituting industry- Capital-intensive industry
Investment managed by donors
Foreign aid ‘matched’ by domestic spending
- Gov’t had to print money!- Rising inflation
- Falling real incomes- More aid = more inflation = more
poverty
Consequences
Falling real income, overly rapid urbanisation, mass unemployment due to investment in capital-intensive
industries, internal political strife
Increasing trade deficit
Even more aid!
Worsened by falling terms of trade!
1987 - 20011. Export volumes increased
by 9.9% p.a.2. Exports of services
(tourism) grew most quickly, and agricultural exports least quickly
3. Rate of increase in export volumes not matched by rate of increase in purchasing power of exports – negative for agricultural exports!
‘Reversion to the mean’
Shocks aside, most African current account deficits now appear to be stable
(exceptions are Burkina Faso, Ghana, Lesotho, Mauritania and Senegal, which will become more reliant on international transfers)
Attempts to reduce deficits (e.g. devaluation) will only have short-run, temporary effects – no difference to
long run deficit
Chinese FDI
Rising terms of trade
Rising purchasing
power
Shelter from financial crisis
Debt relief
Political stability
Chinese FDI
Incredible growth
Sound economic
management
Recent Tanzanian key economic data
1998 2007
Gov’t spending as % of GDP 12.4% 20.8%
Investment as % of GDP 14.6% 45%
Consumption as % of GDP 82.8% 72.3%
GDP (2001 = 100) 80.5 152
Value of Exports (2001 = 100) 82 183
Value of Imports (2001 = 100) 95 178
• Shrinking trade gap• Reduced reliance on aid• Productive investment
Conclusions
Hope!
Thanks to...
• Mark Holmes, Loughborough University• Thandika Mkandawire, the UN, the Open
University, DfiD and the LSE• Marc Wuyts and Sam Wangwe, the OU
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