Trade and Investment for Inclusive Growth, Evidence and Elements of a Coherent Policy Framework Lessons from Southern Africa Paper For Presentation at the ARTNeT-PEP Policy Forum on Trade, Investment and Domestic Policy Coherence for Inclusive Growth Date: 9 December 2008 Venue: Dusit Thani Hotel, Manilla, Philippines Ramos Mabugu Financial and Fiscal Commission, South Africa 1. Introduction One of the major challenges facing Southern African society is combating poverty and inequality. Trade has played a very important role in the region s policies for growth. Governments have sought to pursue an export-oriented strategy, while successive trade and industrial policies have highlighted the need to support exports and international competitiveness. The Southern African Development Cooperation 1 (SADC) has called for increased focus on regional integration. The drive towards SADC trade liberalisation is a goal that is emphasised in most documents of the SADC Secretariat, including the protocol on trade and the regional indicative strategic development plan (RISDP). This trade liberalisation aims to deepen regional integration through increased intratrade between SADC member states, which was to be facilitated by the removal of trade barriers. Up to now, the only barriers that have noticeably been reduced are import tariffs. At the same time individual member states are required to meet the growing challenges of global and regional competitiveness. The trade profile of an average SADC member country is characterised by high reliance on few products for trade revenue, which also contribute enormously to the value of total trade, and also has most prospects of industrial development. Therefore, the need for competitiveness is dependent upon the ability to protect the very same sectors that are being liberalised. Although infrastructure is a core component of regional integration, the reality is that investment in infrastructure in Southern Africa has been on the decline and the contribution of the 1 The nine founding member states were Angola, Botswana, Lesotho, Malawi, Mozambique, Swaziland, Tanzania, Zambia and Zimbabwe. Namibia joined after independence in 1990, followed by South Africa in 1994 after the idea of isolating South Africa was removed from the agenda (Alleyne, 2002). Mauritius and Democratic Republic of Congo (DRC) joined in 1995 and 1997, respectively (SADC Secretariat, 2003). Madagascar is the last member to accede to SADC in 2005 1
private sector through private public partnerships (PPPs) is also on the decline. Meanwhile, poverty and inequality are still high. The observation that trade induced economic growth has not reduced inequality in the region suggests the need for a coherent approach to trade, investment and equity issues. This paper uses the experience of two Southern African countries to do just this. The paper discusses selected results from studies on South Africa and Zambia with a view at drawing lessons as to how a coherent approach to trade, investment and inclusive growth may look like. Results of this paper should be interpreted with caution as they are mainly based on only two countries and a few studies. More work will be required to check further the results and derive much tighter policy recommendations. 2. South Africa At the policy making level, South Africa s trade and investment policies are driven by the Department of Trade and Industry 2 while poverty is handled by several multitude of ministries as it is perceived to be a cross cutting issue. According to Bell (1992, 1997), trade policy was broadly geared towards import substitution between 1925 and the 1970s. In the 1980s there were attempts to open the economy through export stimulation policies. Quantitative restrictions continued to be reduced throughout. The policy stance has been geared towards steering the country towards neutrality through a mix of rationalisation and liberalisation. By 1994 most of the quantitative restrictions had been removed. South Africa has made a lot of progress towards trade liberalization. These measures have resulted in substantial trade liberalisation. Average tariff rates have been halved. The largest absolute declines in protection have been on consumables. The total number of Harmonised System (HS) (8-digit) commodity lines declined to 6,700 in 2004. The HS 8-digit lines bearing formula duties declined from 1900 in 1993 to 5 in 2002 (World Trade Organization (1998, 2002)). The number of lines with specific tariffs fell from 500 in 1993 to 195 in 2002. Commodity lines with mixed non-ad valorem duties have fallen from 160 in 2000 to 60 in 2004. Despite these efforts towards a deep and sustained trade liberalisation strategy and far reaching reforms, it is unclear whether this has been good for growth, equity and poverty reduction. 2 Trade policy is guided by multilateral arrangements as well as by bilateral and regional agreements. The Southern African Customs Union between South Africa, Botswana, Lesotho, Namibia, and Swaziland is the oldest Customs Union in the world. There are two Free Trade Areas between the European Union and the Southern Africa Development Corporation that the country has so far concluded. The country also benefits from the United States of America s African Growth and Opportunity Act. There are planned Free Trade Areas with India, the United States of America and MERCOSUR countries. 2
There has been a debate around the effects of trade liberalization on employment and wages (see Roberts, 2006). Many researchers have blamed unemployment on technology and rigidities in unskilled and semi-skilled wages. Using a model featuring perfect competitition and efficient markets, Fedderke et al. (2001) find that trade has led to higher returns to both labour and capital, while technology has induced lower wages. Given this, the main reason for high unemployment is suggested to be excessive wages (above what they would see as the market clearing wage rate). This implies that they believe labour market outcomes are not unequal enough and that low paid workers should be earning even less despite the wages of a large proportion being too little to meet basic housing, transport and nutrition requirements for an average family (Roberts, 2006). Fofana et al. (2007) apply full microsimulation CGE techniques to trade reform in South Africa. The simulation involves a complete removal of all import tariffs. Government revenue is held constant through the introduction of an endogenous adjustment in indirect taxes. The macroeconomic results suggest small positive gains in output. The complete removal of tariffs leads to slight increases in poverty and inequality. Poverty indicators increase more in rural areas than in urban areas. Poverty increases more among female-headed, collared and black households, whereas they increase slightly or remain stable for male-headed, Asian, white and unspecified households. The reason is that most female workers are employed in the sectors that are hurt by trade liberalisation. These are the initially highly protected sectors. Male workers on the other hand are more concentrated in the export oriented sectors that receive a direct boost from trade liberalisation. African women are the worst affected due to their higher than normal concentration in the contracting sectors. Exploring further the richness of the model, the authors are able to move beyond the household level to the individual level to analyze poverty and inequality impacts separately for men, women and children. They find that poverty increases slightly more among women and children than among their male counterparts. In particular, the elimination of import tariffs is likely to increase poverty more among women and children living in poverty than men. This gender and age bias in the poverty results is particularly strong for individuals in rural areas, female-headed and black households. The authors also show that these results are robust for a wide range of poverty lines. From a time use perspective, the study finds that women suffer from a heavy time use burden given their increased domestic work with trade liberalisation. However, trade liberalisation generally increases labour market participation for both gender groups, although male labour participation rates are higher. The higher participation rates are, however, made possible by reductions in leisure time. 3
While static models continue to be the predominant tool of trade policy analysis, the use of dynamic models is important if we are to understand the role of investment in the trade poverty nexus. Dynamics are important because they relate changes in the flow of income to the stock accumulation of wealth which is an important aspect when measuring poverty. The accumulation of assets can have an impact on the future flow of income and hence impact on poverty vulnerability. Allowing for dynamics helps us understand better the links and interactions between sources of growth and income distribution and poverty. The work by Thurlow (2006a) finds that the trade liberalisation carried out historically by South Africa reduced slightly the incidence of poverty while trade-induced technological change has accelerated growth. Poverty reduction is driven mainly by small gains in employment. However, because of its impact on the production structure of the economy, trade liberalisation led to increased income inequality. Thus, although all population groups are predicted to have benefited from trade-induced growth, the paper finds that richer black and white households are the main beneficiaries while low income Asian and coloured households stand to gain the least. Mabugu and Chitiga (2007) find that trade liberalisation has negative welfare and poverty reduction impacts in the short run which turns positive in the long term due to the accumulation effects. When the tariff removal simulation is combined with an increase of total factor productivity, the short and long run effects are both positive in terms of welfare and poverty reduction. The mining sector (highest export orientation) is the biggest winner from the reforms while the textiles sector (highest initial tariff rate) is the biggest loser. Coloured and African households gain the most in terms of welfare and numbers being pulled out of absolute poverty by trade liberalisation. The picture for trade, investment and inclusive growth for South Africa therefore presents a mixed picture. The role of government is crucial to ensuring that trade and investment policies lead to growth that is inclusive. For instance, trade policy would need to be coupled with other policies that address poverty, fiscal outcome and so on. It is thus a key area for government intervention. The question is whether the choice of focus areas is in line with the desired growth path. There is also the issue of skills shortages which prevents the majority of the population from participating and sharing of the growth fruits. Education policy coupled with trade policy would be good for South Africa as households become more skilled and this will likely contribute to reduce inequalities. However, as shown by Decaluwé and Maisonnave (2008) an education policy eventually results in unemployment for skilled workers in the long run, irrespective of how it is financed. 4
Finally, there is a role that government transfers can play to encourage inclusive trade induced growth. Recent research has confirmed that the various social grants are well targeted at the poor and that they have a significant mitigating impact on poverty (cf. Van der Berg, Yu and Louw, 2008). Fully 76 percent of government spending on social grants accrues to the roughly 50 percent of the population that constitute the poorest two quintiles of households; moreover, grants raise the income share of the poorest 40 percent of households from 4.7 percent of pre-transfer income to 7.8 percent of post transfer income. Figure 1 gives a rough indication of the effect of social grants on the extent of poverty in 2005 (cf. Armstrong, Lekezwa and Siebrits, 2008: 21-22). It compares the actual incidence of poverty among households and individuals at the time of Statistics South Africa's Income and Expenditure Survey 2005 to the incidence that would have obtained if all respondents had reported zero income from social grants. The actual and hypothetical poverty rates for households were 33.2 percent and 43.9 percent, respectively. Hence, if nothing else was different, the incidence of poverty among households would have been 32.2 percent higher in 2005 had the various types of social grants not existed. Similarly, social grants reduced the incidence of poverty among individuals from a hypothetical 55.4 percent to 47.1 percent (i.e. by 15 percent). These numbers are indicative only they rest on the very strong assumption that the availability or otherwise of social grants has no impact whatsoever on the behaviour of households (in terms of labour supply, household formation patterns, etc) but nonetheless suggests that social grants markedly reduces poverty by augmenting the income of poor households. Poverty rates for households and individuals (2005) 100 100 90 90 80 80 Percent 70 60 50 40 33.2 43.9 Percent 70 60 50 40 47.1 55.4 30 30 20 20 10 10 0 0 Households Individuals With grants Without grants With grants Without grants Source: Statistics South Africa (2008) Figure 1 5
Apart from mitigating poverty, social grants are also having a significant influence on household formation: they empower old people, keep them in the community, reduce their dependence on their children and keep them at the centre of households rather than in old-age homes. Poor children often join or remain in pensioner households; hence, grant income also offers them a major source of support in the absence of enough jobs. This, however, has had a variety of effects. It has perhaps been one of the reasons why there is less migration to urban areas and a smaller informal sector in South Africa than one would have expected in a middle-income country with such high levels of unemployment (Kingdon and Knight 2004; Klasen and Woolard 2002). Social grants also may have had important impacts on savings behaviour and private provision for retirement. The poorest in South African society are those who now have neither social grants, nor employment. 3. Zambia Zambia is well endowed with natural resources. It is landlocked and this serves as an import tax protecting domestic import-competing industries. Zambia borders 8 countries and plays an active role in regional trade. However, the landlocked nature means that reaching global markets and realizing economies of scale is a problem which affects ability to export bulky low value products (e.g. farm products) and requires well-developed air transport and an emphasis on high value, low weight and volume goods. Ianchovichina and Lundstrom (2008) carry out work aimed at identifying the key constraints on inclusive (and sustained) growth in Zambia and to sequence them to get inclusive growth going. The main purpose of the analysis is to identify the key constraints on inclusive (and sustained) growth in Zambia and to sequence them to get inclusive growth going. The method outlined is inspired by growth diagnostics along the lines of Hausmann et al (2005). It looks at both supply and demand side conditions that prevent the poor from taking part in the growth process. On the supply side the idea is to look at constraints that hamper employability and access to labour markets while on the demand side the focus is on obstacles to job creation and productivity improvements. The study finds that Zambia has experienced broad-based and stable growth in recent years. However, poverty rates have not fallen appreciably. They cite low returns to self employment most notably in agriculture, and limited growth of and/or access to wage employment) as the main reason for this lack of an appreciable impact on poverty. The main finding from the analysis is that 6
the main binding constraint is negative coordination externalities. This refers to poor access to domestic and international markets, inputs, services, and information. It further covers high indirect costs on infrastructure and service related inputs into production including energy, transport, telecom, water, insurance, marketing and professional services. It is noted that "the services needed require simultaneous, large-scale investments in various sectors of the economy." As far as infrastructure is concerned, it is pointed out that poor infrastructure services including energy, transport, telecom, water have led to increases in indirect costs. Insurance, marketing and professional service has also inhibited inclusive growth. The authors cite the real appreciation of the exchange rate as another serious threat to the competitiveness of export-oriented and import competing sectors and to job creation. The work is exploratory in nature and as a result does not propose policies to deal with the binding constraints to inclusive growth. However, the findings point to important areas that a coherent inclusive growth strategy will cover. Based on this study, it would appear that for inclusive growth should encompass: 1. Measures to increase productivity of the labour force 2. Measures to increase access to capital are important 3. Measures designed to lower indirect costs of production associated with service delivery 4. Monetary and fiscal policy that respond to the real appreciation 5. An education policy that improves quality and access to secondary and tertiary education as well as continuing the fight against HIV/AIDS 6. Accountable governance institutions 4. Towards a coherent policy framework for inclusive growth This paper has discussed selected results from studies on South Africa and Zambia on trade, investment and inclusive growth. The aim has been to come up with a coherent list of interventions for Southern Africa that will make trade and investment outcomes that are more inclusive. Results of this paper should be interpreted with caution as they are mainly based on only two countries and a few studies. More work will be required to check further the results and derive tighter policy recommendations. However, as it stands the work suggests the following strategy for the region: 1. Scale up infrastructure spending 7
2. Develop sound macroeconomic policies that are critical for both growth and human development indicators to deal with the consequences of scaling up infrastructure (avoid appreciation). 3. Improve productivity 4. Improve access to capital 5. Social Protection: Government transfers to the indigent in the form of social grants should be an important policy component of fighting poverty 6. Education and Health: Poverty relevant social services such as health and education remain vital 7. Improve the quality of and access to secondary and tertiary education. 8. Improve governance as this is key to successful development. 9. Improve tax revenue collection 10. Improve government s financial management 11. Improved public sector efficiency and monitoring 12. Improve infrastructure quality and quantity 8