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Institutions and Macroeconomic Policies in Africa

by Jean-Paul Azam

Appropriate macroeconomic policies are necessary for African countries to make progress in the fight against poverty. As discussed by Augustin Kwasi Fosu in this edition of the WIDER Angle (see pages 1-3) stagnating economic growth in Africa has been associated with inappropriate policies (‘policy syndromes’). Moreover, as he points out, wrong policy choices are often endogenous, that is to say the outcome of the institutional environment in which it originates. In this article I discuss, by using examples from the Madagascar and the CFA Zone, how African institutions matter for macroeconomic policy choices, and how institutions mediate the impact of macroeconomic events on poverty.

We first need to note that the standard policy tools taught in basic macroeconomics work differently in different institutional environments. Indeed, the recent experiences of a number of African countries have emphasized that there is a gap to fill between the simple models that we used for building our intuition at university and those that can shed some light on the actual experience of poor countries. Among the latter, the wide variety of institutional frameworks makes the construction of applicable models even more daunting.

In Africa, having a clear understanding of the different roles of the formal and informal sectors, and the interaction between them, is important when trying to determine the impact of macroeconomic events on poverty. Take the case of exchange rate policies. Beside the CFA Zone and the Rand Zone, most African countries have an inconvertible currency. There was a time when all of the countries of the latter group had a parallel (‘black’) market for foreign currencies, while the government was running an official segment of the market. Behind the smokescreen of officialdom, the latter was really used for diverting foreign currency into the pockets of cronies and dangerous political rivals whose cooperation had to be paid for. Formal institutions had thus been performing an ‘informal’ function. While parallel markets have disappeared in many countries, it is still active in a country such as Zimbabwe. In such a framework, macroeconomic stability is nearly impossible to maintain. For one, the formal or official market is pre-empting the flow of foreign currencies before it reaches the government budget, and creates an inflationary fiscal deficit. Moreover, most of the fiscal resources of poor countries are levied on foreign trade, at the official exchange rate. Thus, the parallel market premium (i.e. the discount given to friends and rivals through the official segment) spills over onto importers whose tax liability is computed at the official rate. The inflation tax is thus used for financing the ‘political gifts’ channelled by the official market.

Macroeconomic students trained in rich countries tend to pay little attention to inflation—and inflation often seems unimportant to people used to live in a stable monetary environment. However, inflation can kill vulnerable people in poor countries. In particular, when people are expecting a high rate of inflation (perhaps because they expect the government to run short of foreign currency in the near future) they try to get rid of their cash by any means. For most people in Africa, the only inflation-proof asset that they can find is storable food. Grain and livestock are the most commonly assets held in Africa, as it has been for several millennia. Indeed very few people would or can approach a bank for acquiring inflation-proof assets in Africa. With grain as asset, speculative attacks against the national currency would simply send grain prices to skyrocketing levels that would inflict significant hardship on the poorest segments of the population. Take the example of Madagascar. This country experienced a speculative attack against its currency in 1993- 94 after running a persistent fiscal deficit. Then, those who bought paddy (i.e. un-husked rice, what can be stored for more than a year while rice rots within a few months) in June 1993 and sold it in April 1994 made a 49 per cent capital gain in real terms. Those who had sold the paddy at harvest time, in June 1993, were starving in April 1994. This example serves to illustrate that macroeconomic stability (low inflation) is protecting the poor at least as much as it is protecting the rich.

Another example of the adverse impact of inappropriate macroeconomic policies on poverty comes from the CFA Zone in West Africa (1). In the CFA Zone, the rich are the wage earners of the formal sector. They seldom account for more than 4 or 5 per cent of the labour force, but they earn a lot more than the rest of the population. Before the 1994 devaluation of the CFA Franc, they were earning on average more than 12 times the estimated value of GDP per capita. In Burkina Faso, the government employees were earning on average more than 15 times the value of GDP per capita. Faced with such a state of affairs, most economists would complain about the high level of inequality. However, one needs to go beyond the surface and look at traditional institutions to get a correct understanding of the way this highly skewed distribution of income affects poverty and the working of macroeconomic policy. In many African countries, including those in the CFA Zone, there is a sustained flow of migration between the ruralbased subsistence agricultural sector and the urban-based (or mainly so) modern sector. The typical villagebased African extended family is the decision-making unit that sends its best offspring to the city. This is a costly decision for those remaining behind in the village society, as young labour is thus departing and hence increasing the burden of those remaining behind for working in the fields. This family-based costly decision is made because of the high returns that it promises. Migrants will send back remittances that will help support the villagers later on. These remittances are not only paying dividends on the initial investment made, but they will also serve as an insurance mechanism helping the village family to cope with the vagaries of agricultural yields in Africa, which are severely exposed to droughts and pest invasion. The much-awaited devaluation of the CFA franc provides a reallife natural experiment that sheds a lot of light on the interaction between traditional institutions and macroeconomic events.

Before the 1994 devaluation of the CFA Franc, a fair estimate of the number of people living off one formal-sector wage or salary within the extended family was about 40. A massive flow of transfers was thus funded out of these high wages and was keeping a lot of people above the poverty line. During the pre-devaluation structural adjustment phase, the formal sector workers were saving a large share of their high wages. They were thus anticipating the cut in their real income that they felt was bound to occur at the end of the adjustment process. The so-called ‘informalization’ of the economy was a reflection of that anticipation, as a large number of new firms emerged in the informal sector as the well-off were investing their precautionary savings that way. The young brothers and sisters from the village were massively migrating to the cities for working in these firms. Hence, while the village-based family was investing labour in the urban informal sector, the migrants were investing money to employ them. Then, when the devaluation came, the average wages in the formal sector were cut by about 40 per cent in real terms, within the next two or three years, and there was no more saving going on for creating new firms in the informal sector. Moreover, the formal sector workers were then induced to run down their assets, reducing drastically the creation of new firms in the informal sector. A massive increase in urban poverty resulted in the first few years after the devaluation, with some spill over to the rural sector, as migration to the cities was abruptly reduced and the demand for food went down in the cities. In the end, the devaluation helped growth to recover in many of the CFA Zone member countries, by reducing the cost of labour in the formal sector and restoring profits there with a huge impact on productive investment. In due course, poverty was drastically reduced in the countries where the resulting growth process was sustained long enough. Senegal is a good example where the new opportunity opened by the devaluation was used most productively by the government who used the improved fiscal situation to launch a massive and timely public investment programme. This created a very favourable investment climate, and productivity has increased beyond expectations within the post-devaluation decade. Poverty went down so much that the government was reluctant to publish the results of the 2001 household survey, by fear of being accused of fiddling with the data.​

For example, the reshuffling of income distribution that resulted from the CFA franc devaluation has changed African society. One welloff formal sector worker is now sustaining only about twenty people, half the pre-devaluation estimate. The weight of the extended family is thus becoming lighter for migrants, as more young brothers become financially more independent. This might strengthen migration with positive development impacts for both rural and urban inhabitants.

(1) See Jean-Paul Azam (2005) ‘Poverty and Growth in the WAEMU after the 1994 Devaluation’, in David Fielding (ed.): Macroeconomic Policy in the Franc Zone, chapter 7, pp 121-142, Palgrave Macmillan in association with UNU-WIDER.

Further reading: Jean-Paul Azam has just published Trade, Exchange Rate and Growth in Sub-Saharan Africa, Cambridge University Press (2007). 

Jean-Paul Azam is Professor of Economics at the University of Toulouse and at the Institut Universitaire de France. He was a contributor to the WIDER project on ‘Long-Term Development in the CFA Zone Countries of subSaharan Africa’ (2003).