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