Reforms after reforms: Do they have feet of clay? (2)
Continued from Friday, August 28, 2015
The third module brings out distinctively, the set of operative forces that interact with the level of income and pattern of income distribution.
Essentially, the three modules are perceived as dynamically interactive. The existence of gaps between the needs that have to be catered for and the actual product mixes will necessitate adjustments in the parameters and values of variables relating to the factor income generation and allocation. This will ensure the closing of the gaps. The major policy directions of AAF-SAP as enshrined in the document include: enhanced production and efficient resource use, greater and more efficient domestic resource mobilisation, establishing a pragmatic balance between the public and private sectors, creating an enabling environment for sustainable development and food self-sufficiency among others.
To accomplish the policy directions outlined above, a number of policy instruments and measures were put in place. These instruments and measures were categorised into three groups; namely, (a) strengthening and diversifying production capacity; (b) improving the level of income and the pattern of its allocation; and (c) expenditure of income for satisfaction of critical needs. In addition, there were institutional measures introduced to ensure the efficient operationalisation of AAF-SAP (ECA, 1989).
Some of the measures under category one include land reforms for better access and entitlement to land for productive use, enhancement of the role of women as agents of change and modernisation of the food production sector, devotion of at least 20-25 per cent of the total of public investment to agriculture, increased foreign exchange allocation to importation of vital inputs for agriculture, sectoral allocations of credit using credit guidelines that would favour the food subsector, manufacture of essential goods as well as creation and strengthening of rural financial institutions.
In respect of increased efficiency in the allocation and judicious use of resources, some of the measures introduced included enlargement of the tax base and improved efficiency and probity of the tax collection, reduction of government expenditure on defence and on non-productive public sector activities, removal of subventions to parastatals other than those in the social sector and nationally strategic basic industries, use of limited realistic and decreasing deficit financing for productive and infrastructural investments and guaranteed minimum price for food crops managed through strategic food reserves (ECA, 1989).
Measures adopted under the third category included expenditure switching to raise government outlays on social sectors particularly in education and health. Others included use of subsidies and appropriate pricing policies to increase the supply of essential commodities required for maintaining a socially-stable atmosphere for development, selective use of trade policy including banning of certain specific luxuries, high tax rates on conspicuous consumption and competitive factor inputs that have domestic substitutes, strengthening intra-African monetary and financial cooperation as well as payments and clearing arrangements, limitation of debt service ratios to levels consistent with sustaining and accelerating growth and development. It needs be emphasized that AAF-SAP was generally a-theoretical and many SSA countries were more attracted to the IMF World Bank conditionalities, which carried financial incentives, or borrowing opportunities for cash stripped economies.
Research on economic reforms
My studies on economic reforms focused on its impact on the performance of the African economies in terms of some macroeconomic fundamentals. I have equally examined the key issues that are relevant to the design of development reform policy in general. My contributions are both theoretical and empirical. The first theoretical study looked at the implications of the African domestic structure for the adjustment programme in addressing the crises in the region. I analysed the structure of the African economy and discovered the following: (1) it was essentially exchange oriented in nature (2) narrow and weak production base with weak inter-sectoral linkages (3) high sectoral and regional imbalances coupled with high income/wealth inequalities and (4) high openness and dependency with warped industrialization.
The structure of the African economy has major implications for structural transformation and recovery. One, even if the financial imbalances or disequilibria are eliminated, the fundamental structural imbalances will still remain if not aggravated. Two, the very nature of development or transformation is a disequilibrium process that must create disequilibrium. This simply means that economic reforms should not focus on just the removal of disequilibria or imbalances per se but on the need to increase the pace of development and satisfying the critical needs of the majority of the population in the process (ECA, 1989; Akinlo 1991, 1992). In a related study, Akinlo (1992) identified the institutional factors and in-built-destabilisers inherent in the economic reform package of 1986. The paper identified weak structure in particular, the monolithic nature of the economy, the investment reduction impact of devaluation as well as restrictive monetary and fiscal policies, which could cause stagflation and the big issue of credibility. The paper found that even though credibility was demonstrated in terms of government’s willingness to carry out the programme despite its implied social cost; however, credibility in terms of public perceptions about the programme was very low. This credibility problem derived partly from the past history of frequent policy swings and failed macro adjustment attempts and partly from the financial behaviour of public functionaries which was not in any way consistent with the philosophy of the reforms.
Extending the analysis further, Akinlo and Odusola (1995) showed that the debt crisis in Africa was a symptom of structural weaknesses of the Sub-Saharan African economies. Therefore, the various debts and debt related policies in the adjustment reforms that focused on financial structures would not assist much in solving the debt problem in Sub-Saharan Africa. We argued that debts and debt related policies in the reform package should address the structural weaknesses in the economies including subsistent production mode, high degree of openness and high vulnerability to external shocks, among others.
In related papers, Akinlo (1997, 1998) and Akinlo and Odusola (1998), looked at the implications of the economic reforms for urban poverty and unemployment and psychological well-being. The analysis clearly showed that where economic reforms result in mass retrenchment (which is often the case in the short run), the cognitive, motivational and emotional status of those laid-off could be damaged, with adverse effect on productivity. The mechanism of operation is clearly summarized in Dairy and Goldsmith (1996)
… unemployment reduces the quality of the workforce history embedded in the labour force, which by the intermediate run damages the psychological health of the group. To the extent that unemployment leaves a psychological imprints that persists following re-employment, individuals suffer lower self-esteem, learned helplessness and a loss of the latent by-products of working (like practice in management), and their personal productivity is likely to suffer (p.132).
The loss in productivity could further lead to decrease in employment, real income, real consumption, real investment and real savings. Indeed, even if economic reforms engender more employment in the long run, it might be difficult for the labour force to regain its initial level of psychological well-being for two main reasons: (a) unemployment creates a salient and lasting impression, (b) re-employment in a dissatisfying job usually fails to improve psychological health (O’brien and Feather 1990). Moreover, as pointed out by Burchell (1994), those who find upon re-employment that they harbour feelings of job insecurity-due possibly to loss of seniority, skill depreciation or a belief that further lay-offs are forthcoming-may not experience an improvement in psychological health. Indeed, Darity and Goldsmith (1996), argued that even if the original level of psychological well-being is eventually restored, the economy is not likely to return to its prior market clearing point due to income and wealth changes in the adjustment process to equilibrium.
As regards the impact of economic reforms on the environment, Akinlo (1994) identified various channels through which the policies in the reforms could affect the environment: (a) attainment of technical efficiency by firms through the use of less polluting modern technology would impact positively on the environment; (b) scale and allocative efficiencies are positively related to the environment as greater output is achieved with lower resource inputs. Price efficiency could result in reduction in consumption and output thereby reducing waste.
Moreover, removal of subsidies to industrial firms in the form of preferential access to fund, or through protection from foreign or domestic competition could have positive impact on the environment. This is because inefficiencies precipitated by these subsidies have been found to worsen pollution. Consequently, removal of subsidies could help to reduce pollution. The same applies to the removal of subsidies on energy, which may promote the growth of less-polluting industries and the adoption and diffusion of cleaner technologies with higher energy efficiency. Asides, the increased cost of energy could discourage wastage of natural resources. If the removal of subsidies could lead to a reduction in manufacturing activities and more rational use of energy in manufacturing sub sector; air pollution could thus be reduced.
In the same way, allowing the exchange and interest rates to find their real levels could benefit the environment. If such policies lead to increased production costs in the manufacturing sector, unit prices could increase leading to decrease in demand and thus output. In a sense, this could mean conservation of available resources, but where the increased production costs and unit prices work to affect the poor, the environment could be adversely affected in view of the link between poverty and the environment.
From the survey of manufacturing industries in Nigeria (Akinlo 1995, 1996a,b), we found that exchange and interest rates deregulation engendered increased production costs and unit prices. Increased production costs and unit prices precipitated low sales and accumulation of inventories, and ultimately a decrease in output. The environmental implications of these findings are many. They include a decrease in output production that could help in protecting the environment through a reduction in air pollution; and reduction in production activities that could enhance environmental protection as lower output implies conservation of existing resources. However, it needs be pointed out that conservation of resources could be at the cost of scale efficiency. Essentially, if the positive effect of output reduction on the environment exceeds the negative effect on capacity utilization, then it pays off to focus on output reduction rather than trying to increase capacity utilization (Akinlo, 1994).
Moreover, the rational use of energy by industries arising from the removal of subsidies could also have a positive impact on the environment. More efficient use of energy especially petroleum and electricity could mean less exploitation of natural resources. Interestingly, one of the ways that firms adjusted to the shocks from reforms was increase in the quality of their products (Akinlo 1993b, 1996a). This could well be taken that the reforms had a positive effect on the environment. Increase in quality of goods could translate to high standard of living, and ultimately lower the degree of environmental degradation. It needs be emphasized that increase in the quality of product per se cannot in itself affect environmental quality; rather this depends on consumption patterns of the people (Akinlo 1994).
Akinlo and Odusola (1997) identified the various channels through which economic reforms could aggravate urban poverty. The mechanism is as shown in Figure 2. Adjustment policies (exchange rate, interest rate, trade deregulation, price de-control) leading to increased cost of production thereby generating high unit prices that often lead to decrease in demand and sales. A reduction in sales would translate into accumulation of inventories, which as shown in Figure 2, leads to retrenchment. This in turn, leads to a reduction in both consumption and production. Retrenchment has direct impact on consumption. This is because increased retrenchment among manufacturing industries means increased unemployment in the urban areas. Increased unemployment worsens poverty level as income level decreases. Moreover, when there is a high level of dependence as a result of high unemployment, welfare and poverty level will be adversely affected.
At the empirical level, we have conducted research into the impact of economic reforms in African economies using both aggregate and sectoral data. Akinlo (1997) examined the performance of the African economies after the economic reforms. The analyses showed that the reforms led to stagnated agricultural and industrial production as well as decreased terms of trade. Moreover, the standard of living of the people deteriorated sharply post adjustment, when compared to pre-adjustment periods. We found that attempt to pursue economic reforms as well as maintaining the people’s standard of living led to increase in borrowing. The negative effect of borrowing compounded as interest rates increased, coupled with serious decline in commodity prices, in the late 80s and early 1990s (Akinlo, 1997).
We, however, acknowledged the fact that the poor performance of the African economies after the series of reforms could not be attributed solely to the policies in the reform packages as counter-factual tests to show how the economy would have been without reforms were not conducted. Other explanations of African poor performance even after reforms included institutional weaknesses, corruption, trouble with neighbours, poor economic management and frequent ecological disasters. These factors did not only hamper the working of the various policies in the reform package, but also deepened the crisis in the African continent.
The economic reforms did not produce significant positive effects on the various sectors of the African economies (Akinlo 1993a, 1994, 1996a, 1999, 2000, 2001). Our study on reforms and the manufacturing industries in Nigeria, examined how the various policies in reform packages affected the manufacturing sub-sector in terms of profitability, local sourcing of raw materials, production costs, employment and manufacturing exports. The data utilised were sourced from 360 manufacturing industries in Nigeria. The analyses showed that changes in the exchange rate, trade policy and price had different effects on profits, capacity utilisation, sales, production costs, exports and employment. The results showed that many industries were forced to source their raw materials locally. Increase in the local content of local raw materials had positive effects on subgroups such as food and beverages, textiles and clothing, soap and candy products in terms of capacity utilisation, profits and exports. Likewise, many industries were positively influenced in terms of export promotion, which formed a major plank of the economic reform programme.
Nonetheless, some industries, particularly in the chemical and pharmaceutical, electronics and electrical and metals, were adversely affected in terms of profits, capacity utilization and local sourcing of raw materials. Many firms were quick to identify depreciation of the domestic currency and high interest rate, which increased the costs of production as major constraints to manufacturing expansion (Akinlo, 1999). In general, the results showed that such subgroups as food and beverages, textiles and clothing, leather and shoes, soap and candy products, most of which Nigeria has comparative advantage in, benefitted positively from the reforms.
Evidence from econometric approach using both cross sectional (Akinlo, 1999), and time series data (Akinlo, 1996c, 2001), showed that significant mutual causation existed between output, employment, capacity utilisation, production cost and profitability. The results from econometric analyses showed that exchange rate depreciation led to increase in production costs while it reduced employment, capacity utilisation and profitability. Specifically, we found that a one per cent depreciation of the exchange rate caused 1.25 per cent decrease in output, 0.05 per cent decrease in employment, 0.61 per cent decrease in capacity utilisation and 0.24 per cent decrease in profitability. Interest rate equally produced the same pattern of effects as the exchange rate. Our results showed that one per cent increase in interest rate led to 0.623 per cent increase in production costs while it reduced output, employment, capacity utilisation and profitability by 0.521, 0.202, 1.52 and 0.582 per cent respectively. Local sourcing of raw materials had a positive effect on output, employment, production cost and capacity utilisation. The same result was obtained for credit supply to domestic economy.
The results have significant implications for the current economic policies being adopted by the Central bank of Nigeria (CBN), particularly exchange rate depreciation and upward review of the interest rate. These policies will have adverse effect on macro fundamentals such as output, employment, savings and investment. Essentially, for countries that are highly dependent on imported raw materials and intermediate goods, exchange rate depreciation will lead to increase in cost with possible adverse effects on output, investment, savings and capacity utilisation. In the same way, in most sub-sectors of sub-Sahara African countries, stock of raw materials, semi-manufactured goods and intermediate ones are financed through credit. This, by implication, means that credit is a component of input cost. Thus, by mark-up pricing rules, high interest rate will lead to high prices. This, indeed, is in support of Wijnbergen’s (1981) assertion:
Under monopolistic market structure, a high cost of credit will not only lead to a short run cost push effect, but also lead to a reduction in real output, as real input costs have gone up.
The adverse effects of these policies on output, employment and production costs can only be reduced where firms are encouraged to source their raw materials domestically and government provides the basic infrastructural facilities such as electricity, good roads and security that are needed for production. Provision of these basic infrastructure will help to reduce the cost of production with possible positive effects on costs, employment, output and economic growth.
We further examined the impact of the reforms on local production of spare parts and steel products in Nigeria (Osinkolu, Akinlo, Pelemo and Ibitoye, 1998). The study was based on the sample of 15 foundry industries, 17 forging industries and 10 wire and steel industries in Nigeria. Our study analysed the impact of liberalisation policies on such variables as employment, unit price, profitability and capacity utilisation. Our results showed that majority of the industries indicated that their profit levels decreased after the reforms.
However, few of the respondents in the machine tool, and wire and steel industries reported that their profits increased marginally with the reforms. 59 per cent of the respondents indicated that liberalisation did not enhance their efforts toward sourcing their raw materials locally. In fact, the calculated average percentage values of the raw materials sourced locally ranged from 19 – 23 per cent. Majority of the respondents (58 per cent) indicated that their productive capacity levels decreased with adjustment.
In the same way, most of the sampled industries signalled that liberalisation had negative effects on employment level, production costs and unit prices of their products.
On how manufacturing firms perceived and adjusted to the shocks from the reform; our study, in Akinlo (1993b), found that managers viewed the reforms with considerable scepticism. The responses of manufacturing industries showed that they did not respond to the reforms instantly. However, despite cautious attitude of the industries, our study showed that there were some important adjustments by firms. Some major adjustments made by firms included increase in the quality of the products, changes in the inventory decisions, changes in marketing strategies and greater caution in financial management. Others were increases in unit prices of industries’ products and reduction in labour force. Finally, firms identified credit sales, advertising, changes in product quality and competitive prices as the main factors behind their continuing participation in the market during the period of the reforms (Akinlo, 1993b).
Professor Akinlo delivered the inaugural lecture at Obafemi Awolowo University, Ile-Ife, Nigeria.
TO BE CONTINUED