The high cost of government economic intervention

By Tunde Obadina

In its Economic Development in Africa Report 2012 published recently, the United Nations Conference on Trade and Development (Unctad) focuses on the continent’s dependence on natural resources as drivers of economic growth. The agency noted that though Africa has experienced relatively fast growth since the start of the new millennium, the pace of the expansion is unsustainable. Also the growth has not been matched by poverty reduction. Unctad is right to be concerned at Africa’s current situation of little or no industrialisation, rapid urbanisation and its growing working population. According to the UN body, for African countries to avoid the future consequences of depleted natural resources and economic underdevelopment they must sooner than later undergo a process of structural transformation to create economies that are driven by gains in productivity in manufacturing, services as well as agriculture.

Few people would disagree with the assertion that African nations should move away from reliance on producing primary products and at the same time transform their agricultural sectors to boost their productivity. The question is how this process of economic evolution will occur? Unctad proposes a leading role for the state. It urges African governments to become proactive in promoting structural transformation, including introducing subsidies and regulations to induce producers to adopt productivity enhancing technologies. The problem with this advice is that it ignores the fact that state intervention has largely been to blame for the inability of individuals and companies in resource-dependent countries to diversify and industrialise.

The challenge facing people in Africa is how to produce a much wider variety of goods and services that consumers want and at prices they are prepared to pay. It boils down to supply and demand. What is lacking are modern productive units; i.e., firms that are organised for the sole purpose of creating goods and services for the market. There are tens of millions of subsistence farmers in rural areas and petty traders in cities who exist by scratching out a living, doing all sorts of things. But there are relatively few modern firms. It is they that provide the organisational context for the efficient combination of the factors of production. Firms do this largely through a division of labour, which enable workers to specialise in one or a few functions within the production unit.

Before we can talk of pre-industrialised societies increasing industrial productivity to generate more wealth and better utilise scarce natural resources, there must first exist firms with capacity to maintain modern economic production. When a country has few factories there is little sense in advising it to boost manufacturing productivity. What it needs at the initial stages of economic development are more factories. There must be initial investment in bringing together the ingredients of production in a modern form of production before major gains in productivity are attained. The reality is that most African countries lack an industrial base from which to grow.

A primary reason for this unfortunate situation is that the overall costs of production for most goods and services in most African countries are too high for potential investors to reasonably expect to profit from establishing production units. In other words, entrepreneurs will not deploy money or effort to set-up businesses in an environment that offer investors little or no prospect of worthwhile gain. It is the bleak outlook for making profit that more than anything else explains the shortage of investment in manufacturing in Africa. High production cost is a more important impediment to industrialisation in Africa than is the often cited explanation of lack of financial capital. If the business operating conditions in a society are conducive to making profit we can be sure that capital will flow there.

Many factors contribute to the high operating cost environments in Africa. Most of these stem directly or indirectly from state intervention in the economy. Government policies and the behaviour by state agents that hinder the flow of economic resources, such as trade restriction and corruption at sea port, minimum wage laws, inefficient tax regimes and excessive bureaucratic regulations, have an impact on production costs. State monopolies in energy provision and fixing of energy prices are often largely to blame for shortages of electricity supplies and their high cost. Virtually every economic decision taken by government has cost implications for some or all producers. For example, when the state prohibits the importation of certain goods, ostensibly to protect local industry, the resulting delays and corruption at ports of entry increase the costs of shipment clearance for all importers. Government deficit spending that leads central banks to print money and thereby fuel inflation, push up borrowing costs for producers.

Most African countries have abundant supply of low wage, low-skilled labour but this is not enough for industrialisation in the 21st century, even via labour-intensive activities. Unfortunately, most African countries lack the skilled workers to fuel rapid growth in manufacturing and high-skilled services and too often misguided government policies impede the inflow of human capital from abroad. For example, immigration restrictions make dearer the cost of hiring foreign workers to perform tasks that can raise productivity and for which there is shortage of capability in the local labour market.

Governments do have an important role to play in the structural transformation of underdeveloped economies. This role is to stop impeding the effort of their citizens to create wealth for themselves. As labour costs rise in China, there are increasing opportunities for some African countries to enter export orientated labour intensive manufacturing. To achieve this, African governments must cut private enterprises some slack to enable them to produce at costs and quality levels that are competitive with growth hungry Asian countries outside of China and under-exploited inland areas in the Asian powerhouse.