Effect of Trade Deficit on Tanzania's Maccroeconomic Policy

In what ways has the sustained existence of a trade deficit influenced the conduct of macroeconomic policy in African states such as Tanzania?

Since independence African states like Tanzania have sought to use macroeconomic policy to pursue economic development to meet their own agendas as independent states (Mkandawire, 2004, p295). States sought to assert their new status in the world whilst raising living standards for their people. The states’ ability to exhibit autonomy of action has been limited by the realities of their starting point, and world economic events, sustaining trade deficits influencing their actions.

First we look at the concepts of national income accounting underpinning the conduct of macroeconomic policy and at the states’ economic objectives. Next are consideration of the states’ starting position at independence and the conduct of policy. Factors include capability of the state and its degree of autonomy in taking actions to meet its policy objectives. Consideration of the way in which sustained trade deficits, a key area of the economy, has affected the conduct of macroeconomic policy then follows. We start with understanding national income accounting concepts.

National income (Sawyer, 2006, pp320-327) can be defined from earnings or expenditure and considered from aspects of activities of the residents of a state and with inclusion of flows of money into and out of the state. Gross Domestic Product (GDP) is the value of all the output produced within a national economy. GDP can be measured from an expenditure approach as:-

GDP=Consumption+Investment (in productive output)+Government Expenditure+Exports-Imports

Gross National Income (GNY) is defined as GDP plus income or transfers from abroad (eg remittances from residents working overseas or development aid).

GDP plus imports provides the resources available to an economy to use as consumption, investment and the production of exports. The resources used have to be equal to the resources available so the domestic absorption of resources on consumption, investment and producing exports has to equal the GDP plus imports and the net balance of transfers from abroad:-

Resources used=Consumption +Investment+Exports=Resources available=GDP+Imports+Net income from abroad

States can target progress for these components in their economy, the degree of public ownership of economic activities and setting taxation and local interest rates. They can target currency exchange rates but not the world markets’ view of their currency’s value or world interest rates. They cannot control world price levels for exports (unless they have a near monopoly as for diamonds in Africa). They cannot control how well other world economies perform and hence demand for exports. Hence states have to take action in response to events to try to ensure their policies deliver their goals. What goals will they set?

States wishing to raise its people’s living standards and improve their quality of life has to achieve this by developing the economy, creating economic growth and increasing the economy’s productive capacity. Population growth reduces each person’s share; alternatively the population would have to reduce. Raising productivity requires investment, eg bringing more land into use, building and equipping factories, educating the workforce to raise skills, improving health to ensure people can work effectively and providing the required infrastructure (roads, ports, water and power supplies).
This investment can be funded by governments and the people forgoing consumption now to pay for the things that will benefit them in the future. That is not easy in a poor country with low levels of income and hence saving. Poverty limits levels of government taxation and resulting funds for investment. Remittances from abroad will depend upon people securing well paid work abroad to be able to send savings home, but risks losing productive workers. Running a trade deficit gains additional resources but the deficit has to be funded externally by loans or aid from abroad. These funds can have conditions governments find unacceptable, requiring clarity of the most necessary investments and how to fund them.

Political beliefs, as much as practicality and capability, will shape views. Most states were, and remain, poor with limited resources. States’ economic objectives involve real economic growth and real and stable per capita income growth. Improved well being requires investment in health and education as well as raising incomes above the poverty level. Investment in infrastructure and social services requires above subsistence levels of earnings.

Earnings requires exports to earn foreign currency to buy imported goods the country cannot or does not wish to produce, or raw materials and intermediates for manufacturing or agriculture. Such earnings allow scope for investment to provide jobs and to raise local productivity. This improves the competitiveness of a country’s products against imports and in world markets to improve export earnings. Earnings provide taxation to fund government expenditure.

Government expenditure provides internal and external security. States may also wish to play a role on the world stage taking part in activities by the UN or other institutions such as the WTO. By achieving real economic growth and improving living standards a state may seek to be envied by other states, improving its relative position as well as its absolute one, a demonstration of the results of political independence. What was the ability of African states to pursue essential economic growth?

Before independence African states had limited sovereignty and autonomy. Their controlling power ruled the country even if this was via local civil servants or tribal leaders and controlled external relationships. There was limited acceptance of the right of the people of an African state to act as a political community and chose leaders who could make decisions or choices on citizen’s behalf. Any local decision making was subject to ratification by colonial masters. Economic structures were directed towards supplying raw materials to their colonial masters.

Upon independence governments were created, with sovereignty over the people, recognised externally by joining institutions like the United Nations, IMF and World Bank. The states also wanted to exert their own autonomy by making their own decisions independently of pressure from others. This included making and implementing macroeconomic policy.

Most African countries at independence had high agricultural content in their economy geared towards own consumption and some sale abroad. Manufacturing and services (such as tourism) were limited. Any mineral extraction might not involve local processing. Independence was an opportunity to direct investment to get a more balanced economic structure and raise standards of living. Economic and trade decisions were now their responsibility even if requiring new capabilities.

Autonomy had some limits as states had to gain capabilities or continue to depend to some extent upon the colonial power. Former colonies may have turned to the former Soviet Union or Cuba, who were seeking Cold War allies, to get guidance or help on economic development, trade or international relationships. Many African states had socialist outlooks and wanted to directly control their economies to achieve their aims. The internal availability of funds for economic development was often limited so African states had to seek loans or aid. From the 1960’s this was often project aid, associated with infrastructure, developing mineral extraction and creating manufacturing. With their political support much sought after, the African states had reasonable autonomy in directing aid to their chosen projects.

New or developing industries had a large state involvement in their direction or control. Imports were controlled, by tariffs or quotas, to develop infant industries and reduce demand for foreign exchange. States were in control even if money was not necessarily spent wisely. Use of donors’ resources for projects might not give the best or most effective technology. Projects may not be delivered to plan or expected benefits. Money was spent on military equipment with no real economic benefit. Whilst growth was maintained, and attempts made to pay interest or loan principal, development strategy could continue. Until the early 1970’s when problems arose.

African states in the early 1970’s suffered from escalating oil prices spending greater proportions of their foreign earnings on oil. Oil-producing states such as Nigeria and Angola initially benefitted and other states gained from consequential general commodity price increases. The resulting world recession saw falling demand and lower prices reducing export earnings. Local inflation increased exacerbated by the way many projects were funded.

Projects required some local funding. Local labour is paid in local currency and often not as part of the aid or loan. The African state, with limited revenue from taxation, often resorted to ‘printing money’, ie borrowing money from the Central Bank to pay wages. This raised the amount of money in circulation creating inflation. Raising interest rates to combat this increases costs across the whole home economy. This can conflict with a growth policy as increased interest rates lowers the attractiveness of investment returns, cause further cost push inflation and/or reductions in demand as people on fixed or low incomes cut back on consumption.

Reduced consumption reduces taxes and government ability to help maintain living standards and projects conflicting with their policies for growth. Countries with high inflation become less attractive to invest in. Inflation can cause a decline in the external value of the currency as the local more expensive goods produced for export will only secure the same world prices as before. Imported goods will cost more in local currency reducing demand and economic activity. The states power to control this may be limited and changes in exchange rates have a wider importance.

World currency markets are driven by supply and demand for currencies. African states have to trade in currencies such as the dollar rather than theirs as commodities are priced in dollars. There is likely to be little foreign demand for local currencies outside of tourism. Part of macroeconomic policy decision making is to whether to attempt exchange rate management for predictability of import and export prices. Fixed exchange rates have to be actively managed - difficult for small states to support without creating mismatches with world rates and opportunities for arbitrage, black markets, shortages and often corruption as in Zimbabwe in recent years. Floating exchange rates make African states have to bear the risk of world price changes. This is worsened by their size as producers and buyers on the world stage and so having to be price takers.

Price takers have no control over earnings and what they can afford with them. Remittances can make up some gap but if they have a trade deficit balancing is via borrowings or aid. Short term fluctuations may be manageable via currency reserves, surplus earnings from previous transactions. African states did build these to some extent during the 1960’s but in the early 1970’s the higher oil prices had a major impact. Any currency reserve buffers were reduced or lost altogether. To maintain investment, or even preserve some level of it, states had to rely on loans or aid.

Aid and grants were the only real source of continuing investment for most African states. The world situation had had an impact upon lenders as well. During the later 1970’s and 1980’s donors considered that African states had not acted in their own best interests. Investments had been made in the wrong projects such as growing manufacturing to reduce imports. Attention should be concentrated on exports of products they had a comparative advantage in, eg agricultural products and minerals. Lenders such as the World Bank and IMF, the ones mainly able to help African states, had differing ideological standpoints being western dominated and their loans had stringent conditions. These required investments in programmes such as health or education rather than import substitution. The Berg Report in 1981 was commissioned and its conclusions required rolling back the state.

From 1982 to the mid 1990’s developing countries were faced with demands to undertake structural adjustment, a concept previously applied to rich countries having to exit ‘old’ industries and retrain and redirect workforces to the ‘new’ industries. Such structural adjustment put huge strain on their resources.

Strain was put on the capability to manage change and whilst limiting the impact upon the economy. Access to developed countries’ markets can be difficult. Agricultural products face tariff barriers from the EU and USA. Former commodities, eg vegetable oils, may no longer of interest as the structure of developed counties’ economies had changed. Economic stagnation followed leaving African states unable to balance resources so needing aid. Ongoing aid dependence ensued with African states having their economic policy progressively determined for them by donors. The states lost autonomy in their decision making. Relationships with lenders became difficult as opinions on the way forward differed. Lenders wanted restructuring, curtailment of prestigious projects and reducing the size of the state.

The restructuring until the mid 1990’s saw the reduction and privatisation of state sponsored and owned industries. The size of the state apparatus was to be reduced to lower costs. Agricultural and mineral exports were central with investment in tourism. States opened up their economies. There was a degree of success and exports grew in the designated product areas. However world prices were often declining in these products. The terms of trade, ie the relative costs of imports to exports, were moving to the African states disadvantage (Mkandawire, 2004, p373). With floating exchange rates required by the donors this meant less export earnings even for more physical volume and effort. Trade deficits continued and states, facing increasing debt burdens could no longer borrow more but had to seek aid instead and accept their attached conditions. This chart demonstrates the distribution of ODA (Official Development Assistance) and debt service as percentages of GDP in 1990. (United Nations, 2008)

Other figures by Hayami (2001, pp40-42) illustrate the problem. These show a correlation of growth rates of GNY per capita (percentage per year) to growth of investment per capita (also percentage per year). The correlation does not work the other way and is poor for sub-Saharan Africa. Low savings rates mean countries have to import capital but high debt service obligations limit this. From 1980 to 1995 the ratio of external debt to exports (an indicator of the ease of repaying loans) increased from 90% to 240%.

This chart (United Nations, 2008) indicates increased dependency over a fifteen year period on aid as trade deficits grew.

With the World Bank’s Comprehensive Development Framework from the late 1990’s moves have been made towards ‘partnership working’ (Mkandawire 2004 p327) needing relationships of equals and consensus. Donors are focussing upon the Millennium Development goals and poverty reduction. Bigger state apparatuses were needed to manage the new development goals. Jeffrey Sachs (Economist, 1997) argued that countries dealt a weak hand by geography (including most of sub-Saharan Africa) needed additional support to increase economic development. This implies others taking helping with policy making. With open economies and currencies of limited interest exchange rate management is not really available to states. States no longer run directly whole sections of the economy and states rely upon income from commodities priced by world markets. Variable economic performance has resulted and continues.

Tanzania is growing at 8% but with a 13.3% of GDP current account deficit and low foreign investment (4% of GDP) still needs aid (Economist, 2008). Some African states have had periods of fortune with comparative advantage in goods the world needs or values with increased commodity prices (Economist, 2004). The chart above shows states with sustained trade deficits still needing aid. Conditionality continues and with states still in poverty local resources are few. Loans cannot be paid and debt forgiveness is very slow. Their ability to influence world economic activity is non-existent so oversight of macroeconomic policy continues.

Hence the ongoing trade deficits remain a major influence in the conduct of macroeconomic policy limiting states freedom of action to pursue their growth policies. They have gained sovereignty in independence but not full autonomy.

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References

Hayami, Y. (2001) Development Economics, Oxford, Oxford University Press p 144

Economist (2004) (Unattributed article) ‘Coming into flower’, The Economist, 14th October 2004

Economist (2008) (Unattributed article) ‘An African success story?’, The Economist, 16th June 2008

Mkandawire, T. (2006) in Dawson, G., Athreye, S., Himmelweit, S., Sawyer, M., and O’Shaughnessy, T. (2006) Economics and Economic Change, Macroeconomics, Harlow, Pearson Education Limited and Milton Keynes, The Open University

Sachs, J., (by invitation) Economist (1997) ‘Nature, nurture and growth’, The Economist, 12th June 1997

Sawyer, M. In Dawson, G., Mackintosh, M., and Anand, P. (2006) Economics and Economic Change, Macroeconomics, Harlow, Pearson Education Limited, and Milton Keynes, The Open University. pp318-347
United Nations, (2008) “Human Development Report 2007/2008”, Available from http://hdrstats.undp.org/buildtables/ accessed on 8th May 2009. The following countries were included in the analysis: South Africa, Algeria, Mauritius, Gabon, Botswana, Côte d 'Ivoire, Egypt, Equatorial Guinea, Angola, Morocco, Tunisia, Swaziland, Namibia, Cameroon, Seychelles, Togo, Kenya, Lesotho, Guinea, Comoros, Nigeria, Sudan, Chad, Central African Republic, Benin, Senegal, Mauritania, Ghana, Zimbabwe, Djibouti, Tanzania (United Republic of), Gambia, Burkina Faso, Mali, Zambia, Uganda, Niger, Cape Verde, Ethiopia, Madagascar, Mozambique, Sao Tome and Principe, Congo (Democratic Republic of the), Guinea-Bissau, Rwanda, Malawi, Congo, Sierra Leone, Eritrea, Liberia, and Burundi

References: Hayami, Y. (2001) Development Economics, Oxford, Oxford University Press p 144 Economist (2004) (Unattributed article) ‘Coming into flower’, The Economist, 14th October 2004 Economist (2008) (Unattributed article) ‘An African success story?’, The Economist, 16th June 2008 Mkandawire, T. (2006) in Dawson, G., Athreye, S., Himmelweit, S., Sawyer, M., and O’Shaughnessy, T. (2006) Economics and Economic Change, Macroeconomics, Harlow, Pearson Education Limited and Milton Keynes, The Open University Sachs, J., (by invitation) Economist (1997) ‘Nature, nurture and growth’, The Economist, 12th June 1997 Sawyer, M. In Dawson, G., Mackintosh, M., and Anand, P. (2006) Economics and Economic Change, Macroeconomics, Harlow, Pearson Education Limited, and Milton Keynes, The Open University. pp318-347 United Nations, (2008) “Human Development Report 2007/2008”, Available from http://hdrstats.undp.org/buildtables/ accessed on 8th May 2009. The following countries were included in the analysis: South Africa, Algeria, Mauritius, Gabon, Botswana, Côte d 'Ivoire, Egypt, Equatorial Guinea, Angola, Morocco, Tunisia, Swaziland, Namibia, Cameroon, Seychelles, Togo, Kenya, Lesotho, Guinea, Comoros, Nigeria, Sudan, Chad, Central African Republic, Benin, Senegal, Mauritania, Ghana, Zimbabwe, Djibouti, Tanzania (United Republic of), Gambia, Burkina Faso, Mali, Zambia, Uganda, Niger, Cape Verde, Ethiopia, Madagascar, Mozambique, Sao Tome and Principe, Congo (Democratic Republic of the), Guinea-Bissau, Rwanda, Malawi, Congo, Sierra Leone, Eritrea, Liberia, and Burundi