The Challenge of Ugandan Reconstruction,

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized The Challenge of Ugandan Reconstruction, Paul Collier World Bank Public Disclosure Authorized This draft November 2, 1999 Public Disclosure Authorized The findings, interpretations, and conclusions expressed in this paper are entirely those of the author. They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent.

2 1. Introduction Ugandan economic performance is now among the most successful in the world. Rapid growth is reducing poverty, prices are stable, and investor confidence has increased more than anywhere else in Africa. This is the main example of successful African economic liberalisation and so it is important to understand the process. However, Uganda s current success can only be understood in terms of its past. Over the period both the Ugandan economy and Ugandan society collapsed. By 1986, when the National Resistance Movement captured Kampala and formed a government, Uganda had suffered the predations of Idi Amin and three further transient presidents, including civil war, mass emigration of the skilled, and mass murder. Current success is thus a recovery from conflict. Indeed, Uganda is the main example of successful African post-conflict recovery. The preceding collapse made the attainment of rapid growth easier in some respects, and more difficult in others. It was easier in that there were resources to draw upon, for example, there was the scope to induce repatriation of human and financial capital. It was more difficult in that social and institutional collapse left a persistent inheritance, such as low trust and high opportunism. This makes Ugandan success more complex, but also potentially even more illuminating than if it were a straightforward story of economic liberalisation. Most of Africa s currently problematic economies will need to replicate Uganda s transition to rapid growth from an inheritance of social decay. Our study thus aims to understand the twin processes of liberalisation and reconstruction, and their interrelation. The need for social reconstruction changed the liberalisation program both by constraining it, and by introducing new priorities. The need for liberalisation similarly changed the reconstruction program. This chapter analyses post-1986 performance from the perspective of the inheritance of socio-economic collapse. What is distinctive about an economy newly emerged from internal conflict? How successful was the Ugandan government in meeting the twin needs of enhanced security and poverty reduction? First, we attempt to quantify the inheritance of social disorder which faced the NRM in How prone was the society to further conflict and how had the level and structure of economic activity been altered? We then turn to the implications for government security policy. As we show, the government had little choice but to attach some priority to making Uganda a safer society. We ask how this might have been achieved, and to what extent NRM policy succeeded in reducing the risk of conflict. Finally, we turn to the implications for economic policy. How should the inheritance have changed priorities, and to what extent was this recognised in practice? 2. The Inheritance of Disorder In 1972 President Idi Amin declared `economic war against the large and commercially dominant Asian community in Uganda. This marked the beginning of an economic collapse and of escalating political and social disorder. By 1979 when Amin was overthrown, up to 500,000 Ugandans had died as a result of the regime and there had 2

3 been two insurgency attempts by exiles. The overthrow of Amin produced a period of extreme instability and mass murder. By 1986, which marks the return of political order, some 7% of the population were displaced. Since 1971, per capita income had declined by around 40% and the composition of economic activity had changed radically. The causes of political breakdown in Uganda were various. It is important to consider them so as to distinguish between those factors which make Uganda intrinsically prone to conflict, and so must be addressed in the post-conflict phase, and those which were idiosyncratic to the episode itself. In particular, we need to distinguish between the extent to which Uganda was simply unfortunate to be led by particular personalities, notably Idi Amin, and to what extent personalities were merely the instruments of deeper social forces. Naturally, there is no way of providing a definitive answer to such a question, but recent analyses of the causes of domestic conflict can serve as a guide. Globally, four factors have been shown to have powerful effects upon the probability of conflict (Collier and Hoeffler, 1999). Countries with little education and high poverty, high dependence upon natural resources, partial democracy, and ethnic and religious homogeneity are most at risk. In Table 1 we apply the probit regression which Collier and Hoeffler find best explains the risk of civil war globally, to estimate the risks to Uganda in 1965 and Table 1: The Risk of Civil War in Uganda in the Ensuing Five Years; 1965 and 1985 Factors determining risk coefficient contribution to risk Factor value in 1965 value in Education Primary exports Primary exports Fractionalization Democracy Democracy Population(ln) Constant TOTAL [ln(p/(1-p)] p (= risk of war) Notes: Education is the mean years of education per head of population; primary exports are the share in GDP; fractionalization is the square of the product of ethno-linguistic fractionalization and religious fractionalization. On a scale of 0-100, measuring the probability that two randomly drawn people will be from different groups, ethnic fractionalization in Uganda is estimated for the entire period at 90, and religious fractionalization at in 1965 and in Democracy measures the extent of democratic rights according to the Polity III scale, with 7 being full rights and 0 being no rights. The coefficients on these variables are taken from Collier and Hoeffler. The contribution to risk measures the product of the value of the variable and its coefficient. The sum of these contributions shows the value of [ln(p/(1-p)], where p is the probability of civil war in the ensuing five years. In 1965, prior to Amin s coup, Uganda is predicted to have had quite a high risk of conflict: a nearly one-in-four chance during the ensuing five years. The factors causing 3

4 this were the combination of high dependence upon natural resources, and a low level of education. Natural resources are readily lootable, and so both increase the incentive for rebellion and make it more readily financable. A low endowment of education implies low returns to labor, and hence a low opportunity cost of participating in rebellion. Offsetting these disadvantages, Uganda s major advantage was its very high level of social fractionalization. Ugandan politics reflected its social divides of which two perhaps stood out: that between the Buganda and the non-buganda, and that between the predominantly Moslem and poorer north and the predominantly Christian and more commercialised south. However, these divisions were mitigated by many further ethnic, and religious distinctions; indeed it was among the most highly fractionalized societies in the world. In popular perception this would be a factor increasing the risk of civil war. Differing social groups usually dislike each other, and so highly fractionalized societies are typically characterised by a noisy discourse of inter-group grievance. However, empirically, fractionalization is a powerful source not of risk but of safety. The reason for this is that rebellion in the pursuit of justice needs to overcome a collective action problem which fractionalization makes more difficult. A successful rebellion requires a degree of mass cooperation which highly fractionalized societies find difficult. Uganda s other advantage as of 1965 was that it had a fully democratic constitution. The level of political rights was, however, in rapid decline as President Obote used the army to crush the political opposition of the Buganda, the largest ethno-linguistic group, accounting for around 30% of the population. The relationship between political rights and the risk of conflict is not straightforward. As rights decline from full democracy, the risk of war initially increases. However, further political decline into severe repression reduces the risk of war. Between 1965 and 1975 Uganda made a rapid transition from full democracy to complete repression. With a one-in-four risk of civil war in each five year period, it was more likely than not that Uganda would experience a war within the first thirteen years of independence. To the extent that it is possible to form a judgement, it therefore seems reasonable to conclude that Uganda was intrinsically prone to conflict. This is not, of course, to say that it was inevitable. The society was evidently unfortunate to face the repression of political rights under President Obote, and to have someone with the character of Idi Amin as head of the army. Social conflict and political breakdown have various effects (see Collier, 1999). First, conflict produces the physical destruction of assets. Both government and rebels become predatory. For example, many households lost livestock to soldiers. Secondly, transactions become disrupted as the mechanisms for contract enforcement start to break down. Faced with opportunism by the political leadership, the legal system and the civil service become opportunistic. Businesses respond to this by retreating into a hard core of known relationships, not daring to risk new clients. For example, the major banks in Uganda were extremely reluctant to take on new business customers. Transactions thereby became both more costly and less competitive, fostering the emergence of informal cartels. Thirdly, government expenditure is diverted from its economically productive functions to the objectives of predation and defence. A graphic example of 4

5 this in Uganda was the contraction of the police force and the rise of the army. Fourth, because conflict causes a phase of economic decline, there are strong incentives for households, firms and government to dissave: since incomes are perceived as temporarily low, there will be an attempt to maintain consumption. Fifth, households will shift their assets, including human capital, out of the country, to environments where they are both safer and more productive. The process of shifting assets may itself be very costly. For example, consider the problem of shifting the assets constituted by a building, a coffee tree, or an installed machine out of Uganda. In one sense, these are all immovable. However, to remain as productive assets they all need expenditures upon maintenance. Hence, the owner can gradually liquidate the asset by cutting maintenance expenditures. If the money saved on maintenance is used to purchase illegal foreign exchange and this is held in a foreign bank, the immovable asset is gradually transformed into flight capital. By 1986 over half of Uganda s private wealth was held abroad. 1 These five effects of conflict affect both the level and composition of economic activity. Table 2: The level and composition of economic activity in Uganda, 1971, 1986, 1993/94 and 1996/ / /97 GDP per capita (Uganda shillings 000) War-vulnerable activities: (percentage share of GDP at 1991 constant prices) activities intensive in assets and in transactions (manufacturing) transaction-providing activities (transport and commerce) asset-providing activities (construction) total War-invulnerable activities subsistence activities excluding livestock and construction Unassigned Activities Source: Collier (1999), updated from Statistical Abstract, Collier, Hoeffler and Pattillo (1999) provide estimates of how private wealth was held for 56 countries as of 1990 based on cumulating investment and capital flight since The figure reported here uses their data but measures the stock as of

6 The level of economic activity is reduced through two routes. The stock of physical and human capital is diminished by destruction, dissaving, and flight. Additionally, productivity is reduced by disruption and expenditure diversion. As shown in Table 2, per capita GDP declined by around 40% between 1971 and This severe decline was larger than is globally typical for periods of domestic conflict. Collier (1999) estimates that on average such conflicts reduce growth by 2.2% per annum relative to counterfactual growth. The Ugandan economy declined in absolute terms by 1% per annum, and given rapid population growth, counterfactual growth could scarcely have been less than 2-3%. Hence, either the Ugandan economy was atypically vulnerable to social disorder, or the disorder was severe even by the normal standards of civil war. Since, as we show below, subsistence agriculture is relatively invulnerable to disorder and Uganda had a large subsistence sector even prior to the outbreak of conflict, its economy should not have been abnormally vulnerable to disorder. Hence, the more likely interpretation is that Uganda suffered an unusually severe social collapse. The decline in aggregate expenditure was even more severe than the decline in output. Aid inflows ceased and the government was manifestly unable to borrow commercially. As foreign flows to the government ceased, an illegal outflow of private capital started. The composition of GDP is altered by social disorder because activities are affected differentially. As transactions costs rise and the capital stock declines, the activities which are intensive in transactions and in capital, such as manufacturing, decline relative to those which have opposite characteristics, such as arable subsistence agriculture. Similarly, the sectors which supply transactions services, such as transport and finance, and which supply capital, such as construction, decline because the demand for their output falls. Table 2 classifies the components of GDP according to these principles into three groups, those likely to be differentially vulnerable to social disorder, those which are likely to be differentially immune, and those for which, a priori, there is no particular reason to expect a differential effect. As Table 2 shows that based on this classification there was a remarkable change in the composition of activity between 1971 and Subsistence activities (excluding livestock and construction which were asset-dependent) increased from 20% of the economy to 36%. The share of manufacturing and the other vulnerable sectors virtually halved. To summarize, the economy inherited by the NRM in 1986 was both much poorer than that of 1971, and it had retreated into subsistence activities. Each of these had implications for post-conflict recovery. 3. The Restoration of Peace The policy objectives of a post-conflict government such as that of Uganda in 1986 are likely to differ from those of a government conventionally embarking upon economic reform in that greater priority will be given to the security of the state. Sometimes such a reaction is sensible and sometimes it reflects needless paranoia. It is sensible if the fact of the civil war is information that the country has underlying characteristics which make it particularly prone to conflict, or if the civil war has changed characteristics in such a way 6

7 as to have increased risk. It is paranoid if the society is intrinsically safe but has simply been extremely unlucky: a householder whose house has been hit by lightening should not spend large resources defending it from a future strike. Above, we have suggested that even as of 1965 Uganda was intrinsically prone to conflict. Between 1965 and 1985 the economy and the society changed, partly due to the experience of social disorder, and this may have changed the risk of conflict through several routes. Firstly, there had been a radical decline in per capita income of around 40%. Collier and Hoeffler find that internationally the best proxy measure for the opportunity cost of rebellion is the endowment of human capital, and despite the exodus of skilled labor, this did not decline. As shown in Table 1, when human capital is measured as the average number of years of education of the population, the expansion in the schooling system more than offset the skill exodus. However, it is evident that the returns to schooling must have declined radically over the period, so that the increase in the mean years of education is a misleading indicator of how the opportunity cost of rebellion changed. Given the decline in income, the opportunity cost almost certainly fell, increasing the risk of rebellion. This had severely increased poverty and so increased the risk of conflict. The young men who form the recruits for rebel movements had less to lose by joining up in the late 1980s than their equivalents of the 1970s. That poverty is a cause of conflict has two distinct implications for policy. First, to the extent that the government can raise the incomes of those most likely to rebel it enhances security. Secondly, other things being equal, the poor are more likely to rebel than are higher income groups. Poverty reduction reduces the risk of conflict by raising the opportunity cost of participation in rebellion for the young men who might join rebel forces. Such an increase in opportunity cost is partly achieved as a by-product of economic growth. On average, historically, income growth has been distributionally approximately neutral within societies, so that the opportunity cost of conflict tends to rise across the society. However, it is possible to use policy to target income growth towards particular groups and a government concerned to enhance its security should target income growth towards those people most likely to rebel. The most straightforward way in which income growth can be targeted is spatially. Infrastructure always have a spatial dimension. Expenditure of public services such as education can be differentiated spatially. There is evidence that education reduces the risk of conflict more effectively than generalised income growth, perhaps because it is better targeted to raise the opportunity cost of rebellion for the age range and the income groups most likely to find rebellion attractive. Further, the structure of economic activity often differs spatially: for example, cotton is grown in northern Uganda and coffee in the south. The ability to target income growth spatially is important because often rebellions have a spatial dimension: a particular locality rebels against the government. Hence, if it can be determined how the risks of rebellion differ spatially, then spatially targeted income growth can be used to enhance security. Four considerations might guide the estimation of spatially-specific risks of rebellion. First, since poverty is a cause of conflict, the poorer districts are more likely to rebel. 7

8 Secondly, given that Uganda is bordered by several politically problematic states, the border regions might be more prone to rebellion: rebels could use neighbouring states both for safe havens and for logistical support. Third, those regions with the largest stock of former soldiers are potentially the easiest recruiting grounds for rebel organisations. Finally, those regions least represented in the government are least able to achieve their objectives by political means. On all these criteria as of 1986 the most risk-prone region was the North. It was much the poorest region with the least education. It bordered on Sudan and Zaire. It had been the principal recruitment ground for Amin s army, a force which had subsequently been largely demobilised. It was somewhat underrepresented in the NRM: in the 1996 presidential elections, which were the first nationally comparable measure of electoral support, the North was the only region in which the opposition secured a majority. There was therefore a strong case for targeting poverty reduction efforts in the north. We now turn to the second underlying cause of conflict. Globally, the larger are export of primary commodities as a share of GDP the greater is the risk of conflict. This is partly because during the conflict rebels can extort revenue from the export trade which helps to finance them, and partly because the prospect of the eventual control of the tax revenue acts as a lure. Both in 1965 and in 1985 Uganda was highly dependent upon primary exports. Although coffee had been highly taxed during the period of disorder, output was relatively inelastic with respect to this taxation, and so its share of economic activity had remained fairly constant. In terms of Table 2, primary exports were neither war vulnerable nor war invulnerable. However, in absolute terms the coffee sector had declined along with the overall economy, and its revival was central to the government s development strategy, since it would augment the supply of foreign exchange. This gave rise to a potential trade-off. The revival of the coffee sector was central to economic recovery and to poverty reduction, and so through this route tended to enhance security, but by increasing the importance of primary commodity exports in GDP it would tend to reduce security. The government could hardly neglect the recovery of coffee on these grounds, but the negative effects of primary commodity exports implied that the diversification of the economy into other activities would be desirable on security grounds. The third underlying influence on the risk of conflict is the level of political rights. By 1985 Uganda was classified on the Polity III scale as being completely lacking in democratic practices. Especially in highly fractionalized societies, a lack of democracy is a major impediment to economic growth. Collier (1999a) finds that in a society as fractionalized as Uganda, the change from repression to full democracy will typically increase the growth rate by nearly 3%. However, repression is globally fairly effective in reducing the risk of civil war. While repression and full democracy generate similar risks of conflict, Uganda started from repression and so would probably only reach full democracy by a transition process in which democratic rights accumulated gradually. This unambiguously increases the risks of conflict: partially democratic societies are considerably more prone to civil war than are repressed societies. Hence, Uganda again faced a short-term trade-off between economic growth and security from conflict. Of course, in the long term the faster growth would raise the opportunity cost of conflict, and 8

9 once full democracy was reached the society would in any case not be significantly more conflict-prone than when repressed. However, this long term outcome could only be reached by a transition phase which would increase the risks of conflict. Finally, the underlying high fractionalisation of Ugandan society was potentially a major asset. However, a sense of political identity is not a given, but depends upon history and government behaviour. The experience of conflict may have tended to polarise Uganda s initially highly fractionalised society into North versus South and Buganda versus non- Buganda. Hence, to restore security the government could attempt to rebuild diversity, encouraging the historic identities not only to re-emerge, but to generate a multiplicity of political parties and allegiances. In addition to the changed risks associated with these four factors, there are various other reasons why the experience of conflict might have made Ugandan society more or less prone to further conflict. On the negative side, the large armies of both the former government and the NRM would be expensive to maintain, but if demobilised, their members might either take to violent crime, or be ready recruits for new rebel movements. Additionally, violence had become normal as a means of conducting political disputes and there was a legacy of atrocities which legitimated revenge. On the positive side, Ugandans had come face to face with the horror of societal breakdown. Just as Germany s experience of hyperinflation convinced a whole society that price stability was essential, so Uganda s experience of conflict might have convinced its citizens of the need for peace. Hence, in principle, post-conflict societies can be either more or less prone to renewed conflict as a result of their experience. Collier and Hoeffler (1999) provide a composite estimate of these other effects. They add to the variables of Table 1 a dummy variable which is activated if the society has had a previous conflict (since 1945). They find that it is insignificant. On average, post-conflict societies are neither more nor less prone to renewed conflict than are societies which have the same underlying characteristics but which have been at peace for a long time. 2 Hence, in aggregate, all these other possible influences on the risk of conflict appear to cancel each other out. On the analysis of Table 1, the society was slightly less risky in 1985 than it had been in However, this is probably spurious because, as discussed above, the increase in human capital probably mis-states the change in the opportunity cost of rebellion. However, even on the reduced estimate of Table 1, the society was still highly prone to conflict, with a risk of around one-in-five that there would be a conflict during a five-year period. Thus, unless it reduced the causes of conflict, the NRM government faced a chance no better than one-in-two that it would reach the millennium without civil war. Further, its economic and political priorities of reviving the primary export sector and democratising would, in the short term, worsen these odds. Evidently, the government needed to attach considerable priority to improving the prospects of internal peace through whatever means it had available. 2 A further implication is that the variables included in Table 1 are a complete account of the factors which are both persistent and which are significant in causing civil war. If there were omitted variables of this type then those societies with multiple conflicts would tend to have high values of them and would appear collectively as a significant dummy variable. 9

10 How did the government achieve this core objective of reducing the risk of conflict, and how successful was it? Since 1986 there have been many minor domestic military challenges to the government, especially in the North. However, none has quite escalated to the point where it meets the definition of a civil war. Given the initial odds, the Ugandan government has thus either been fortunate, or it has succeeded in reducing the underlying risks which the society faces. We now assess whether its policies have indeed tended to reduce the risks of conflict. As poverty is reduced, the opportunity cost of participating in conflict rises and so the risk of conflict declines. As Appleton and Guillaume show in Chapter 5, national economic growth has very substantially reduced poverty. However, the reduction has been least in the North, where from a security point of view the need was greatest. The North has indeed harboured the most substantial rebellions and so the failure to achieve a more substantial reduction of poverty in that region is, from the perspective of security, a serious policy weakness. Further, the government initially attached only a low priority to education. It was not until 1997 that resources were shifted into rural schooling. With respect to primary commodity exports as a share of GDP, policy has been successful in generating growth across many sectors. Thus, although a key objective was the restoration of coffee exports, which was achieved by radical reduction in export taxation and the liberalisation of marketing, other sectors have broadly kept pace with export growth. By the end of the 1990s, primary exports were less than 10% of GDP. In terms of political rights the government has made remarkable progress in view of its inheritance. While there is still an embargo on formal campaigns by political parties during elections, so that members of parliament campaign as individuals, in other respects Uganda has achieved a highly open society. The press is free both de jure and de facto, and several major figures have returned to Uganda from exile. There has been a genuinely contested presidential election. This democratization will in the short run have increased the risks of conflict, in comparison with the previous repression. The government has also encouraged the restoration of Uganda s diverse social identities. The kingships have been restored, and there is extraordinary diversity of the press. While it is too early to determine how this will translate into allegiance to political parties, it is possible that the incipient polarisation during the period of disorder may have been reversed, restoring the main strength of Ugandan society, which is its diversity. The government has also been largely successful in its demobilisation strategy. Major demobilisation was delayed until Once they were demobilised, soldiers were taken to their home villages and provided with transitional financial and material assistance. Soldiers appear to have reintegrated. Over the first year of demobilisation there was no tendency for crime to increase in those districts in which many soldiers were demobilised. However, the demobilisation could have been even more successful: overall some 12% of demobilised soldiers reported in advance of their demobilisation that they did not have access to land. These soldiers were around one hundred times more likely than the average Ugandan to commit crimes one demobilised (Collier, 1994). Hence, in 10

11 retrospect, the ideal policy would have either retained the landless in the army or made greater provision for them. While there is no direct evidence as to whether demobilised soldiers have joined rebel groups in significant numbers, the fact that they did not differentially resort to crime suggests that they did not differentially resort to rebellion, since from the perspective of the potential recruit these choices are somewhat similar. Overall, the policies of poverty reduction, sectorally diversified growth, democratisation, social pluralism and demobilisation which the government has implemented, would be predicted to reduce the risk of conflict. Since internal peace has been broadly maintained, it therefore seems reasonable to judge conflict reduction policy as having been largely successful. Table 3 attempts to quantify the impact of policies on risk, although such an estimate must of course be treated with extreme caution. For what it is worth, the estimate implies that the risks of conflict fell by around a quarter between 1986 and As compared with the initial inheritance in 1965, Ugandan society was very substantially safer on the basis of these estimates, the risk of conflict having fallen by around 40%. Table 3: An Estimate of How the Risks of Conflict have been Reduced, Contribution to Factors determining risk Value in 1985 Value in 1999 risk in 1999 Education 1.54 c Primary Exports 0.16 c Primary Exports c Fractionalization c Democracy 0 c Democracy 2 0 c Population(ln) Constant Total [ln(p/(1-p)] P (= risk of war) 0.15 The policies which enhanced security sometimes involved a trade-off with the objective of economic growth. Two policy options which were much more important for security than for overall growth were the targeting of growth on the north, and the expansion in education. The north was the poorest region because it was the least accessible and the least fertile, and so probably offered the lowest returns on public investment. Investment in education would have a long gestation period before returns began to be realised. Hence, in economic terms there were probably higher priorities: as we show below, rehabilitating the road network offered a very high rate of return. However, education would probably have reduced the incentive to join rebel forces, since they drew their recruits disproportionately from illiterate young men. For example, a 1993 census of the Ugandan army, which by then combined both the previous official army and the originally guerilla forces of the NRM, found that its recruits had far less education than the Ugandan average. As shown above, it is typically the best single measure of the 11

12 opportunity cost of rebellion. Each extra year of schooling per capita, reduces the risk of conflict by around 20%. In the event, rebellion has continued to be a costly problem for the economy and so it may have been desirable to accept a slower rate of growth in the first decade of the NRM government in order to reduce the scale of the problem in the second decade. Since 1986 the north has been the region most prone to rebellion, which was predictable. It has grown more slowly than other regions, whereas on security grounds it would have been desirable for it to have grown more rapidly. Similarly, if in the NRM s first decade more children been educated, by its second decade there would have been fewer illiterate youths without prospects for rebel movements to recruit into their ranks. From the perspective of security, UPE should have been implemented a decade earlier. 4. Growth policies in the context of post-conflict We now turn from the objective of security to that of economic growth. As of 1986, Uganda had in place a range of policies and institutions which were likely to be impediments to growth, so that in one respect the government needed to embark upon a conventional liberalisation strategy. However, the fact that Uganda was a post-conflict economy created both opportunities and constraints which would not otherwise have existed. In this section we consider how, given the objective of economic growth, Ugandan economic policy needed to be distinctive because of its post-conflict inheritance. We return to the five effects of conflict discussed above. First consider the policy implications of the destruction and dissaving of assets and the diversion of public expenditure from economic to military purposes. These effects created an evident need for infrastructure reconstruction. This is the aspect of postconflict policy with which donors are most familiar. The government needs to make various infrastructure investment expenditures at a time when its own resources are very limited. In Uganda, the key infrastructure deterioration was probably in the road system which had not been maintained. This was particularly important because the key structural change in a post-conflict economy is the shift back out of subsistence and into the market, and this process needs roads. Collier and Pradhan (1998) show that the rate of return upon Ugandan transport projects during the first years of peace was an astonishing 40%. Hence, these projects needed to be prioritised over other expenditures with lower payoffs. The spending priorities of the Ugandan government broadly reflected these needs. Military expenditure was reduced as a share of total expenditure, the police force was rehabilitated, and in 1994 there was a substantial demobilisation of the army. However, military expenditure remained quite high as the government built a better-equipped force, partly reflecting the continued threat to internal security. The most favored sector was road construction. A survey by Bigsten and Kayizzi-Mugerwa (1994) found that the public service improvement which rural households most appreciated was the road network. However, not all of the restoration of infrastructure was so successful. Electricity, which had received no investment post-1971, gradually became a severe 12

13 problem as supply failed to keep up with demand. Since Uganda is landlocked and so cannot cheaply rent mobile power stations, while the gestation period for increased supply is long, it was all the more important to plan electricity supply carefully. By 1998 Ugandan firms reported electricity as their single most important constraint. Around a third of manufacturing investment was going into private generators, which could only produce electricity at high-cost. Hence, the failure to rectify the neglect of electricity investment must count as one of the major policy errors of the period. Now consider the policy implications of the disruption of transactions through the rise of opportunism and the decline of the police. Such a decline poses a potentially major problem of transition back to a society of trust. Tirole (1994) shows how both high opportunism and low opportunism societies can be locally stable equilibria. In the Ugandan context, the shortening of horizons and breakdown of contract enforcement mechanisms during the period of disorder seems likely to have shifted the society from a low-opportunism to a high-opportunism equilibrium. The restoration of peace may itself be insufficient to shift the society back to the low-opportunism equilibrium even though, had peace been maintained throughout, the society would have remained in the lowopportunism equilibrium. If this is indeed the case, then what are the implications for policy? The high level of opportunism becomes a constraint upon policy and the reduction in opportunism becomes a priority. As a constraint it implies that many aspects of government will function badly because the professional ethics which normally police conduct will have eroded. This was markedly the case in Uganda. The erosion of ethics affected the legal, accountancy, medical, education and civil service professions. Its consequences were far-reaching. If the legal profession no longer enforces standards of conduct then the last-resort means which firms normally use for contract enforcement become unreliable. One important result is that banks would find it difficult to enforce assets as collateral. A survey of banks in 1996 (Kasekende and Atingi-Ego, 1997) found that their single greatest need was for a fast-track legal settlement procedure to enable foreclosure on collateral. In the absence of this, banks will lack profitable lending opportunities and so either restrict credit or encounter a high default rate. If the accountancy profession no longer enforces standards of conduct then accounts cannot be trusted. This impairs both banks and the tax authorities. Banks cannot lend on the basis of balance sheets, and tax authorities cannot levy taxes on the basis of audited profits. In the medical profession standards of prescription had declined. A survey of the leading hospital in the country found a mis-prescription rate of around 50%. Further, many medical staff pilfered drug supplies and sold them privately. As a result, although imports of drugs were approximately adequate for the population, there was continual severe scarcity at the level of the public clinics. As a result, there was considerable hoarding of drugs at the household level. In consequence, households were typically taking homestored drugs, many beyond their expiry date, on the basis of self-prescription. Presumably, this reduced the efficiency of public drug expenditures in reducing illness. In the teaching profession there was a high incidence of non-attendance. Headmasters added ghost teachers to payrolls and ghost students to school enrolments. The decline in civil service conduct impaired public sector performance both in service delivery and revenue 13

14 collection. For example, Ablo and Reinikka (1998) show that only 37% of the money released by the Ministry of Finance for non-salary primary school expenditures actually reached the schools. Reinikka and Svensson (1998) show that private sector firms paying taxes believed that on average much of the money which they paid never reached the government. The decline in professional standards had two key implications for policy. First, since government activities are by their nature atypically dependent upon self-policed standards of conduct in the professions, the efficiency of government expenditure would be unusually low, and the cost of tax collection unusually high. Both of these implied that the optimal size of government would be smaller than in an economy without a postconflict inheritance. Secondly, some private activities, notably banking, were also highly vulnerable to opportunism. The government recognised the constraints on its own efficiency and accommodated them appropriately. Both recurrent public expenditures and revenue were kept low relative to other developing economies with less severe problems of professional conduct. It also attempted to relax the constraints by five strategies. In tax collection the government established a new service, the Uganda Revenue Authority, in which staff were paid well above civil service pay scales and held more directly to account. In customs collection it privatised many functions, using SGS. To improve public service delivery it reduced the size of the civil service and used the expenditure savings to raise salaries. It also decentralised to the distinct level, with the intention of subjecting services to the scrutiny of local electorates and politicians. Finally, it prioritised the courts, bringing in some foreign judges. However, even by 1998 these strategies had had only limited success. Tax revenues remained low, while the Revenue Authority was the subject of considerable complaint in terms of corruption. The productivity of public service delivery remained very low. Hence, the attempt to rebuild professionalism had only limited success. The strategies applied to revenue collection were not extended to service delivery. For example, the health service was not transformed from civil service pay and conditions into a URA equivalent, nor were some functions privatised as with the customs service. The government recognised these constraints and accommodated them appropriately. Both recurrent public expenditures and revenue were kept low relative to other developing economies with less severe problems of professional conduct. With respect to the private sector, the activity most likely to be damaged by opportunism was banking. The Ugandan banking sector inherited by the NRM government had four private banks, all of which had survived by being conservative, and a large governmentowned bank, which had all the problems of the rest of the public sector. The number of private banks was too few to support competition, and so it was desirable to liberalise the sector and attract new entrants. However, this priority was in danger of conflicting with the constraint implied by the high degree of opportunism in society. The latter implied that the policy priority in the sector was for the central bank to combine the design of incentives and the supervision of banks sufficiently to avoid dishonest banking practices. 14

15 In the event, policy probably placed too much weight on the need for liberalisation, and too little recognition of the constraints implied by the high degree of opportunism. By 1998, several of the new banks had got into severe difficulties, and the privatisation of the government-owned bank had proved a fiasco. Finally, consider the policy implications of the massive shift of assets abroad which had taken place during the period of disorder. This created both a major problem and a major opportunity for the government. Recall that by 1986 some 60% of private wealth was held abroad. As a result, the private capital stock per member of the laborforce had been declining, so that it was among the lowest in the world. Uganda was thus chronically short of private capital. In principle, it had three means of recapitalising the economy: through domestic private savings, through attracting in foreign capital, and through inducing the repatriation of its own wealth. Of these, the first was neither feasible nor desirable. There was, of course, some scope for raising the private savings rate, but since incomes had fallen to very low levels, it was important to increase consumption as rapidly as possible. The second faced the impediment that as a result of its history of social disturbance Uganda was not seen as being suitable for foreign investment. A good measure of this is the Institutional Investor risk rating, which is in effect a poll of international business opinion. As of 1986 Uganda had the worst rating of the twenty-five African countries which were then rated. Further, there is evidence that the ratings are quite persistent (al Haque et al, 1999), so that even a rapid improvement in the underlying investment environment would not lead to a rapid reappraisal of Uganda on the part of foreign investors. Repatriation was therefore the most realistic option for recapitalising the economy. If Uganda s own private wealth could be recovered, the private capital stock could more than doubled. Globally, three features influence capital flight: risk, exchange rate over-valuation and the amount of wealth per capita (Collier, Hoeffler and Pattillo, 1999). Table 4 applies this global relationship to estimate the share of Ugandan private wealth held abroad in 1985 and 1998, the approach being analogous to that used in Table 1 to measure the change in the risk of war. 15

16 Table 4: The Predicted Change in Flight Capital as a Proportion of Ugandan Private Wealth, Variable Value of the variable in Uganda Coefficient effect on flight: change (change in % of private wealth) Risk rating Exchange rate misalignment Wealth ($) Total predicted (Actual, ) Notes: The risk rating is that of Institutional Investor, averaged for the year. The exchange rate misalignment measure is the Dollar distortion index which measures exchange rate misalignment due to a variety of factors. The value used in the regression is the square of this index. The stock of private wealth per worker for 1985 is taken from the data generated by Collier, Hoeffler and Pattillo (1999). It is estimated for 1998 using their methodology, whereby the ratio of wealth/gdp is assumed constant, so that wealth in 1985 is simply scaled up by the growth in GDP. The coefficients on these variables are taken from Collier, Hoeffler and Pattillo, Table 2A. The contribution to capital flight is the product of the variable and its coefficient in each year. The high level of capital flight as of 1986 is no mystery. The two main drivers of capital flight, poor risk ratings and exchange rate misalignment, were both extreme problems. The risk ratings, as measured by the Institutional Investor survey of private investment opinion, were among the lowest in the world at only 5.1 (out of 100). Similarly, the Dollar distortion index, at 198, showed the Ugandan shilling to be among the most misaligned currencies in the world. The loss of capital gradually reduced the private capital stock per worker: by 1986 capital per member of the laborforce was around 10% below its level of Uganda thus faced a severe problem of undercapitalization. The progress of policy reform divides into two clear phases: and 1992 to the present. In the first phase neither of the major determinants of capital flight were much improved. The Institutional Investor risk ratings were essentially unchanged by 1992, standing at only 5.2. There was greater progress on reducing exchange rate misalignment, but by 1992 the Dollar distortion index was still at the very high level of 87. Hence, our analysis would predict that, because of the lack of reform of these two variables, there would be little change in the experience of capital flight. This indeed was the case. In most of the intervening years capital flight continued to be a severe problem, and as a result, the private capital stock per member of the laborforce continued to decline. By 1992 it had fallen to only 70% of its 1971 level. During the second phase, that is post-1992, progress has been remarkable. The government rebuilt investor confidence by a wide range of measures. It returned confiscated property so that property rights could both be clarified and restored. This was a politically difficult step since it involved handing back assets to an emigrant ethnic minority, sometimes requiring the expulsion of those currently living in properties. The 16

17 second step was to restore investor confidence through simplifying procedures through an Investment Authority. The third step was to attain macroeconomic stability and structural liberalization. Inflation was reduced to single-digit levels and held there, foreign exchange reserves were accumulated, the exchange rate was gradually made fully convertible, and trade policy was liberalized. The fourth step was to signal strong political commitment to the reform process. For example, during the year of the presidential election around a third of the civil service was dismissed. This signalling was reinforced by the response of the International Financial Institutions: Uganda was the first county to gain HIPC status, and thus qualify for debt relief. Cumulatively, these measures had dramatic effects on confidence. The Institutional Investor risk ratings have improved sharply, from 5.2 to 20.3, overtaking countries such as Côte d Ivoire. Similarly, the liberalization of the exchange rate led to a massive improvement in the Dollar distortion index, which fell from 87 to 35 (by 1997). Our analysis would predict that this would lead to a major reversal of capital flight. Indeed, using the coefficients of the Collier- Hoeffler-Pattillo model, these reforms predict a massive capital repatriation, resulting in around 40% of private wealth returning to Uganda. The C-H-P model is a cross-section equilibrium model, and so gives no indication of how long private wealth holders would take to adjust to this new equilibrium. It might, for example, take a decade for portfolios fully to adjust to the new policies. However, the Ugandan data on capital flight show an immediate response. There are four different measures of capital flight available (World Bank, Dooley, Morgan and Cline). Taking the average of these four measures, there has been a clear and dramatic reversal, from capital flight to capital repatriation (Table 5). Table 5: Recent Capital Flight (-) and Repatriation (+) $17.3m $15.0m $16.8m $160.3m $59.0m $108.9m $311.3m Source: World Bank, Development Research Group. The scale of the repatriation as of 1997, although very substantial, was still well short of that predicted by the model. Specifically, by % of Ugandan private wealth was outside the country. By 1991 this had worsened to a peak of 67%. By 1997 (the most recent data) repatriation had reduced the figure to 50%. Thus, 17% of Ugandan private wealth had been repatriated from abroad between the start of the 1992 reforms and The model predicts that around 40% of wealth would be repatriated. This suggests that portfolios had yet fully to adjust to the new equilibrium, so that repatriation could be expected to increase further in subsequent years. To summarize, by 1997 the Ugandan government had turned the tide on capital flight. In only five years 17% of private wealth had returned to the economy. Yet even in 1997, 17