Paul Collier

The Macroeconomics of External Shocks

Until the 1980s the predominant concerns of development economists were sectoral: problems of agriculture, problems of industry, or the interactions between them such as migration. During the 1980s the predominant concern shifted to macroeconomic issues. This shift was not because the sectoral problems had been solved, but because they were suddenly swamped by even more serious macroeconomic shocks. In some countries, for example Tanzania, living standards fell by half in just a few years.2

Consequences of External Shocks in African-type Economies

African countries are prone to external shocks. The typical economy is small, open and undiversified. That is, it is a price-taker on world markets, international trade constitutes a substantial proportion of GDP, and exports are concentrated upon a few primary commodities such as coffee, cocoa, copper and oil. The world prices of these commodities have been subject to large and unpredictable changes. Such shocks will inevitably give rise to some degree of volatility in the economy, but in much of Africa this has been compounded by government policies. We distinguish between two aspects of policy, the constraints upon private behaviour imposed by the ‘control regime’, and the revenue and expenditure decisions of the government in response to the shock. To see how policies affect the response to a shock in an Africa-type economy, it is first necessary to develop a theory of how shocks would affect the economy in the absence of government.

The Potential for Restraint through International Trade Agreements

The liberalization of trade and exchange rate policy has been the core component of African economic policy reforms. Correspondingly, the probability that they will be maintained is the core of the risk assessment made by investors. In this chapter we first briefly review African trade policy and then consider ways of enhancing the credibility of liberalization. In Section 3 we suggest that non-African countries that have faced the problem of limited credibility in trade policy have used inter-governmental reciprocal threats as a restraint. The rest of the chapter then reviews three ways in which African governments could construct such agencies. Section 4 considers using regional cooperation between African governments and concludes that this would be ineffective as a restraint. Section 5 considers a North-South arrangement between Africa and Europe. Section 6 considers using the provisions of the World Trade Organization. Section 7 compares the two latter options.

Exchange Rate Management in Liberalising African Economies

Until quite recently almost all African countries operated fixed exchange rate regimes, either unilaterally or as members of the Franc Zone. Economic reform, particularly in formerly socialist countries such as Ethiopia, has usually led to abandonment of fixed exchange rate systems, often under pressure from donors. It is, obviously, not inevitable that liberalisation should involve the giving up of the fixed exchange rate policy, but there are several reasons for focusing on this case. First, in most African countries the fixed exchange rate regime was in many ways the centrepiece of the control regime: it was the decision to maintain an overvalued exchange rate that made the adoption of other controls (foreign exchange rationing, import licensing and, in many countries, price controls) almost inevitable. In view of the prominent position of the exchange rate regime, it would be extraordinarily difficult for a government to achieve credibility for its liberalisation programme if it were to maintain a fixed exchange rate. For example, at present the Zimbabwean liberalisation programme is not fully credible precisely because the Central Bank has recently (February 7) made it clear that it intends to maintain something like a fixed exchange rate regime.

Introduction: Towards Evidence-based Policy

Economic policy choices profoundly affect the lives of ordinary people. Nigeria is fortunate to have huge opportunities: oil provides large public resources; Nigerians succeed the world over as entrepreneurs; Lagos is a superbly located big city that could rival the exporting cities of Asia. The choice of economic policies determines whether these opportunities are harnessed or dissipated. Nigerians are poor today because of mistaken choices over the past thirty years. Since 2003 the society has begun to correct past mistakes, but policy reform is a continuous process and despite some remarkable successes many issues remain to be addressed. Choices tend to go wrong if they are founded on hunches, special interests, beliefs or textbooks. They need to be based on evidence. The purpose of this book is to show that there is already plenty of evidence from Nigerian experience that can inform policy discussion. In a democracy, economic policy ultimately rests upon popular understanding of the issues. In the vacuum created by a lack of hard evidence, rogue nostrums thrive and confuse. Hence, this book is written not for an audience of technocrats but for all who wish to engage with policy choices.

The Macroeconomics of the Transition from African Socialism

The macroeconomic policy problem is to maintain internal and external balance by means of policy instruments which are consistent with microeconomic objectives. This is common to both socialist and market economies. However, socialist economies are distinctive in their microeconomic objectives and this in turn gives rise to distinctive choices of macroeconomic instruments. The socialist perspective implies suspicion of the market as an allocative mechanism, and suspicion of private property due both to the power and the unearned income which it confers. If the market is rejected as an allocative mechanism, the government has a choice between regulating the private agents who constitute it or replacing them with public agencies. Three microeconomic interventions have had particularly powerful macroeconomic repercussions: the allocation of credit, price controls, and the allocation of foreign exchange.

The Impact of Liberalisation on Private Investment

In many contexts extra investment is seen as socially more desirable than extra consumption, while private investment is seen as more productive than public investment. Since private investment has invariably been very scarce in socialist Africa, it is therefore increasingly becoming a natural objective of government policy. This paper argues that the private investment response is likely to be highly policy-dependent, and that in many circumstances it will be socially sub-optimal.