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Good luck or good policies: Are the chickens coming home to roost?
Prof Sylvanus Ikhide

Post-financial crisis stabilisation policies which focus on aggregate demand reduction might hurt the Euro area in particular and Africa in the long run.

. English    

In the wake of the economic problems that most economies in Africa encountered in the late 1970s and early 1980s, IMF- and World Bank-sponsored economic reform programmes became a popular resort in a bid to escape the rot. Most literature described the decade of the 1980s and 1990s as lost decades in Africa's slow march to economic and sometimes political emancipation, as attested to by low and often negative economic growth rates, political conflict, human degradation and the scourge of HIV/AIDs, malaria and tuberculosis.

The popular view was that these economies suffered the consequences of years of economic mismanagement and poor political leadership, and that strict stabilisation policies were needed to reverse the downward spiral. Most reform programmes consist of two categories of policies – stabilisation and structural adjustment policies. Stabilisation policies include all demand-side policies (fiscal, monetary, credit restraint) embarked upon to bring absorption in line with output and sustainable capital inflows; while structural adjustment policies (resource mobilisation, public sector resource allocation, privatisation and rationalisation of unprofitable public enterprises, market liberalisation and other institutional reforms) refer to all policies aimed at removing supply bottlenecks and enhancing long-term growth in the economy.  

By its very nature, a stabilisation policy which has, as its core, the reduction of budget deficits is short-term and often painful as it is aimed at restoring temporary internal and external imbalances through a control of the level of aggregate domestic demand. The distinction between stabilisation and structural adjustment policies is sometimes foggy, since a structural adjustment policy that will not harbour some elements of stabilisation policies is inconceivable. However, within the context of our discussions in this short piece, it is a distinction that must be made.

The year is 2009 and the countries are now Greece, Ireland, Portugal, Spain and Italy (GIPSI) and maybe Belgium, and more on the line. Styled the European Sovereign Debt Crisis (ESDC), many of these countries are embroiled in rising debt which they are unable to refinance without a resort to third parties. As usual, the major policy prescription has been stabilisation policy, specifically reduction of government debt. So far, the response to the stabilisation policy has been far from successful. In the early 1980s, it was Africa and a couple of countries in Latin America negotiating for a debt rescheduling. The story is quite different today – the chickens may have come home to roost. 

No doubt, both in terms of the genesis of the crisis and the structure of the economies concerned, it is overly presumptuous to compare the economic crisis that enveloped Africa in the 1970s and 80s and the sovereign debt crisis in the Euro area in recent times on any appreciable scale. However, a few lessons might be worth their while.

The Euro area, to all intents and purposes, enjoyed relatively stable economies (low and stable inflation, low unemployment and relatively stable economic growth) prior to the present crisis. Spain, for instance, recorded on average, an annual growth rate of about 3,7 per cent between 1989 and 2006. Most analysts have attributed this robust performance to good polices. Macroeconomic stability engendered by fiscal stability, it is argued, ensured low deficits. Good monetary policy led to low and stable inflation and stable exchange rates. Why were these stable economies not able to resist the shocks? The literature on "good luck rather than good polices" argues persuasively (in some cases with robust econometric findings) that if the Euro area pre-crisis performance is due to good policy, policy makers should be fairly confident that the turbulence of the 1970s will not return. The onset of the crisis triggered by the global financial crisis is simply a pointer to the absence of adverse shocks (good luck) during the boom period rather than good stabilisation policies as enshrined in the EU Act. This then raises the issue as to whether the current bout of stabilisation polices will be able to resolve the crisis and present a lasting solution.

Not all economists have been quick to conclude that stabilisation policies have been very effective in Africa's economic 'recovery' before the global financial crisis. The damage that was done to infrastructure through a rash cut on government spending, double-digit unemployment in some of the countries that have reduced deficits considerably, and the persistent crisis in the banking sectors of some of these economies due to poorly sequenced stabilisation programmes may further confirm that African countries grew, not because of stabilisation policies, but targeted growth (structural adjustment) policies combined with 'good luck' resulting from an international environment that favoured commodity exports in the late 1990s. The point that is being made here is that stabilisation policies which focus on aggregate demand reduction might hurt the Euro area in particular and Africa in the long run. Polices that enhance growth must complement stabilisation. But what is the scope for African-type growth policies in the Euro area?

Furthermore, the typical one-size-fits-all policy of the IMF will need to be carefully evaluated against the origin of the crisis in the different economies. This was the bane of the stabilisation policy in most African economies. Spain and Ireland had relatively stable government debt ratios before the crisis. In both countries, the structural budget deficits were lower than in the Eurozone. Moreover, the private sector – especially housing and banks – were the origin of the debts. Greece and Portugal had a long period of upward-trending sovereign debt which was only compounded by the financial crisis. The strong reliance on market fundamentalism, which treats mildly countries' peculiar circumstances and immediate problems, raises serious equity and welfare issues. The public reaction to stabilisation policies in Greece is an issue in question here. Would the treatment of these economies have been moderated by their pre-crisis economic circumstances?

In conclusion, the poor response of the GIPSI economies to stabilisation plans, including debt restructuring, calls for reflection. Growth enhancing policies such as government intervention to bail out problem enterprises, rather than strict market fundamentalism, should be the core of policies. The mechanism for increased growth are more (not less) trade and aid and an improvement in the investment climate. This will benefit Euro area trading partners and help to mitigate the looming disaster that stabilisation policies represent.  


This article was written by Prof Sylvanus Ikhide, lecturer in Economic Development Perspectives in Africa at the University of Stellenbosch Business School (USB). He is head of the USB's Doctoral Programme. Prof Ikhide's field of expertise and research is Development Finance. 

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