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Private investment under uncertainty in Ghana
WorldDevelopment,
Vol. 22, No. 8, pp. 1211-1221, 1994 Copyright 0 1994 Elsevier Science Ltd Printed in Great Britain. All rights reserved 0305-750x/94 $7.00 + 0.00
Pergamon 0305-750X(94)30040-5
Private Investment Under Uncertainty in Ghana ERNEST ARYEETEY
University of Ghana, Legon Summary. - Ghana’s Economic Recovery Program saw considerable growth of the economy during 1985-91. This commendable performance slackened after 1992, a fact which is attributable to poor private investment response following reform. This article shows that the poor growth in private investment may be attributed to the perception of uncertainty in the political and economic environment since 1982. The uncertainty is derived from the low credibility of government as it has been unable to assure investors that earlier decisions that showed a bias against private wealth will not be repeated. Economic incentives arising from reforms do not provide guarantees against poor credibility.
investment climate is not perfect, it has improved significantly. The recent changes in taxation will further improve the environment (USAID, 1992).
1. INTRODUCTION Ten years after the pursuit of macroeconomic reforms in Ghana began, growth, which has sometimes been remarkable, has not been consistent and this has been attributed to poor private sector investment response in the medium to long term (World Bank, 199 1). What is not clear is the cause of poor private sector response. The poor response originates from a number of pass-ible factors, including inadequate institutional support, perception of inconsistencies in reform policies, general mistrust for government intentions, etc. This article discusses how the credibility of govemment (and not just policy) is affected by unstable conditions and how the resulting uncertainty discourages private investments, even after reforms. Private investments in Ghana are generally seen as having only recovered in limited terms, and considerably less than expected since the reforms began. As a percentage of GDP, the target for private investments was 15% per annum for the second half of the last decade, but private investment actually only increased from 2.9% in 1983 to 5.4% in 1985 before tumbling to 2.4% in 1986. During 1987-90, private investment increased from 5.5% to 8.7% including a sizeable increase in foreign direct investment in the gold mining sector, which accounted for more than half of the recorded growth. Putting aside foreign investments in the mining sector, which are heavily supported with multilateral loans, performance of the rest of the private sector, particularly manufacturing, has not been encouraging. The situation baffles donor agencies that have suggested that Ghana has made great strides in recent years in creating a positive environment for increased investments and exports. The foreign exchange regime is favourable, and while the
While we do not seek to carry out an evaluation of the Ghanaian Economic Recovery Programme in this article, we have increasingly become aware of the fact that there is a general dissatisfaction both in official and donor circles about the limited response by the private sector to reforms. The major question is “why is the private sector not investing as is desirable and expected?” There are a number of views on this question, both in Ghana and in the donor community. There are those, including the World Bank, who believe that the reforms have not gone far enough as yet in addressing substantive issues (mainly institutional) affecting the operations of potential investors, in spite of the fact that all manner of incentives arising from macroeconomic and other sectoral reforms have been provided. Other views expressed by many Ghanaians suggest that the issue is one of credibility with regard to the sustainability of reforms in the medium to long term. The reform program has been based on short-term stabilization and medium-to-long-term structural adjustment. Stabilization measures mainly focus on the financial disequilibrium, i.e. the fiscal and external accounts and the rate of inflation, while structural adjustment policies aim at restructuring the productive capacities in order to increase their efficiency and help restore growth. It has been argued by Rodrik (1990) that in practice stabilization has proven not to be a short-term measure, as many economies undergoing structural adjustment have perpetually remained unstable in macroeconomic terms. It has been either impossible or extremely difficult to put the public sector budget on a sustainable course.. He argues further
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that policies of liberalization applied in strong doses in an unsuitable host environment may not be sustainable in the medium term. Governments therefore have to ensure that the goal of sustainable policies takes precedence over liberalization. Policies must generally be perceived by the private sector to be sustainable since they will base their investment decisions on these policies. Private sector investment is indeed crucial to the stability of adjustment since growth is an essential component of any successful adjustment program. He writes that for policy reform to be successful, entrepreneurs, workers and farmers have to respond to the signals generated by the reform. For example, outward-oriented exchangerate and trade policies can service their purpose only if the desired export response materializes (Rodrik, 1990) Entrepreneurs will withhold a part of physical investment until they can be sure that a reform policy is irreversible. The key components of a sustainable policy environment (are): stable macro policies. chiefly a small fiscal deficit and a realistic exchange rate policy; (b) a credible and predictable set of microeconomic incentives. widely expected to be sustained into the near future; changes that (cl the absence of sharp distributional would create politicial pressures to reverse course down the line (Rodrik, 1990, pp. 931-935) (a)
When reform policies are not sustainable, they create instability in two ways-by fostering uncertainty as to their own life span, and by aggravating instability elsewhere in the economic system, primarily in macroeconomic imbalances. For example, the stillhigh level of inflation in Ghana, following dramatic exchange rate adjustments and continuing distortions in the market system, has led to a series of temporary palliative measures including constant introductions of new Bank of Ghana rediscount rates and constant revisions of the reserve requirements of banks. The resulting variability of credit flow to the private sector, among other things, undermines their confidence in the banking system and the tendency to view the investment climate with uncertainty. In any event, there would be the tendency to perceive public policies as only short term measures. But “such shortening of time horizons is the chief obstacle to eliciting the desired private sector response to economic policies” (Rodrik, 1990). This is because private investors cannot make mainly irreversible decisions and commit investment capital to long-term projects when they perceive a high probability of change in policy in the short to medium term. Hence, this discomforting conclusion that the success of policies may depend in no small part on the psychology
of private-sector expectations. A reform can end up being reversed for no other reason than a shared expectation that it will not last (Rodrik, 1989, p. 2).
Essentially, therefore, sustainable and successful reform rests on the credibility of the government. The objective of this article is to show that in spite of significant achievements in macroeconomic performance following reform. the far-less-than-expected growth in private investments is attributable to the perception of uncertainty in the political and economic environments since 1982. In view of the widespread mention of policy credibility and sustainability as constraints to enhanced private investments. we explore in this article some conceptual underpinnings to the issue of credibility as a constraint. We discuss various concepts that might shed light on how the private sector would perceive the reform program if the environment were considered unstable. and therefore not sustainable. and the likely impact of this perception on private investments. The conceptual discussion provides a prelude to an account (sometimes anecdotal) of relevant private investment experiences. and how they have been affected by perceptions of poor credibility. In the next section we discuss some relevant literature on the relationship between an unstable economic environment and investments. This is followed by a review of the reform program in Ghana, providing evidence of instability in the policy environment and a consideration of the general outcome of reforms. We also look at the private sector response to incentives provided and conclude the article with a consideration of how low rates of growth for investment have taken their toll on the economy.
2. THE RELATIONSHIP BETWEEN INSTABILITY AND INVESTMENTS There is a growing theoretical literature on the consequences of reforms that lack credibility. These tend to rely on game theory and the theoryof principal and agent (see van Wijnbergen, 1985 and Dornbusch 1988). We first analyze the issue of how investors behave in the face of uncertainty within the context of the theory of principal and agent. The theory of principal and agent (Rees, 1987) is intended to explain situations of the following nature: An individual, called the agent, and denoted by A. must choose some action a from some given set of actions (a). The particular outcome x resulting from this choice depends also on another given set of states of the world (Cl),and which element from that set actually prevails at the relevant time, thus making uncertainty intrinsic to the situation. It is important that the outcome generate utility to a second individual, the principal, denoted by P. A “contract”, broadly defined, has to be in place to
PRIVATE
INVESTMENT
ensure that P makes a payment y to A. The utility that A derives from the arrangement is dependent on y and the value of a. The theory’s purpose is to characterize the optimal forms of such contracts, applying various assumptions relating to the information A and P possess. In view of the much wider application of the theory and its principles it will be relevant for our consideration of private investments under uncertainty in Ghana if we could perceive the private investor as the agent A and government (representing the state) as the principal P. The contract between the two is an implicit one in which the government’s (P) utility is measured by increases in private investments and its productivity and the payment it makes to the investor (A) is the private benefits from trade reform, such as the reduction in tariffs and other institutional support. Since the core problem of principal-agent theory is to find a “payment” schedule which optimally trades off the benefits of risk-sharing with the costs of providing an incentive to the agent we can set out a general optimization model in which the value of the investor’s action arbitrarily fixed at a = aa. If it was assumed that a and 0 could be costlessly observed, so that y depended only on 0, the solution of the risksharing optimum by which a payment y*(Q is made by the government (principal) to the investor (agent) may be expressed as
max I ‘u(.x(LI~,0) - y(@)flEQ& 0
s.t.
J‘v(a0, y(e)He)de
2
vo
0
where vu is the minimum level of A’s utility. The solution for y* (0) is characterized by the condition 4(x-y*)
+ vy = 0,
e E. [O,11
For Ghanaian investors, the solution would represent the package of incentives arising from policy reforms that would encourage maximum private investments. Applying game theory on the other hand, Rodrik (1989) has also attempted to conceptualize the relationship between “policy uncertainty and private investment in developing countries” as government pursues reforms. The situation before reform may be conceptualized as one where the entrepreneurs’ yield from capital had been artificially depressed to r-to, where r is the marginal product of capital and to is the policy-induced distortion, probably an explicit tax or the effect of an entire complex of distortions. After reforms to is reduced to t, i.e. to < t. Capital in altemative employment (e.g., trading) may be denoted by P*. Thus, before reform,
UNDER UNCERTAINTY
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r - to < I*, with the hope that after reform r-t>r*. The objective of reform therefore is to get capital to move in the direction that will minimize the gap between r and r*. Policy uncertainty is modeled in the form of a probability (x) that the reform will be reversed. Treated as a constant by individual entrepreneurs, n measures the likelihood (per unit of time) of policy reversal. Thus, if a reversal indeed occurs f will revert to its original position to. For purposes of analysis we take R as given. But capital investment is partially irreversible since there are sunk costs of entry and exit when physical capital is committed. This condition ensures that, with costly resource allocation, uncertainty can have large effects on behavior (even without risk aversion), and large enough changes in the policy environment can have lasting effects on resource allocation even when the initial changes are eventually fully reversed. In this situation, how will an individual entrepreneur (who we presume to be risk-neutral) behave when a reform is put in place? His choice is between leaving his capital where it earns r* and moving it to a sector where it would earn r - t. The former option (in a macroeconomic sense, capital flight) yields flow benefits of r* with no uncertainty. According to Rodrik (1989a), if we denote an investor’s discount factor by 6, let E stand for entry costs per unit of capital and p exit costs per unit of capital, the decision will be based on (assuming a large policy reversal) whether (r - t) - r* 2 x (E + p) + E8 or, alternatively, tS(r-r*)-&E8-X(e+P).
(1)
The expression above (1) indicates the condition under which reform will be meaningful to an investor. It suggests that I must be low enough to make the after-tax return on domestic investment comparable to the yield on the alternative in the absence of entry and exit costs. The reform must be large enough to compensate for the alternative of capital reallocation, expressed as ~8, while compensating for the likelihood of a policy reversal, the cost of which is X(E + p). Rodrik (1989b) has another theoretical model to explain how the absence of policy reform credibility could make the reform process costly and lead to welfare losses. The lack of credibility is equated with a distortion in the structure of intertemporal relative prices. This is because, in the absence of credibility, the private sector considers different prices from those expected if the reform was definitively implemented, thus creating a second best environment. In addition to
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this, further distortions may be introduced as government attempts to offset the distortions or to reinforce its credibility. Investors might perceive policy reform as lacking credibility for three reasons. First, the new policy may be inconsistent with other policies of government; second, there might be a time-inconsistency problem, by which the ex-postpolicy strategies differ from ex-ante policy strategies; third, due to asymmetric or incomplete information, the private sector might not know the true objective of government. This last is especially true of countries where governments might feign reform in order to obtain foreign aid. The lack of credibility will induce a suboptimal level of investment due to a fall in private savings in view of the anticipation of higher prices in the future for imported goods. In order to achieve credibility, government will have to implement a larger policy reform than necessary in the absence of uncertainty. At the macro level, van Wijnbergen (1985) has suggested that following trade reforms, uncertainty about future policy reversals as well as the fact that some investment is irreversible impose an option value on foreign exchange, which might lead to capital flight and a decline in aggregate investment This is based on a theoretical model of the rate of return structure of three assets, namely, capital in the export sector (&), capital in the previously protected sector (K,,) and foreign assets (F). in which the rate of return depends on whether or not trade is liberalized. There are a number of empirical studies on the relationship between economic growth and instability, In these, instability is often defined as political instability with a focus on changes in government and the usual policy reversals that come with these. Wheeler (1984) studied 25 African countries and observed that average growth rates were significantly and negatively affected by political instability. Other kinds of instability studied include those of imports as done by Helleiner (1986) who establishes a negative relationship between import instability and economic growth. After comparing currency stability between countries of the CFA Franc Zone and other African countries, Devarajan and de Melo (1987) concluded that the relative currency stability of the CFA Franc made member countries of the Zone enjoy a higher growth rate than other countries in the region. There are not many empirical investigations of investment and investment behavior under uncertainty in developing countries. The nature of risk and uncertainty becomes rather complicated in such settings. Where investigations have been made they are often micro-level surveys of entrepreneurs and their attitudes to risk and investment decision making or cross country investigations of how ambiguously defined measures of instability affect gross investments. Stewart and Venieris (1985) have suggested that instability will affect the productive capacity of a
country through the effect it will have on the country’s aggregate saving. Defining savings as “investment minus net capital inflow,” they used data pooled from seven annual observations on a 60 noncommunist and less-developed countries (including Ghana) in an econometric model specified as follows: S,, = ao + &G,r, + asDN,, + [bo + Cb,Gu, + bsSPI,t]Y,t + beSPIt,i b7EI,, + E,, where i = 1,2 .. ...60 and r = 1,2 .,.., 7. Also, SC, DN,,
Gq
Y,, SPI,,
= gross saving; = a dummy variable whose value is one if saving for country i is gross national, and zero if saving is gross private; = a set of four dummy variables such that G,,I = one for Latin American countries, and zero otherwise, G,Q = one for Asian countries, and zero otherwise, G,,x = one for Middle Eastern countries and zero otherwise, G,N = one for African countries and zero otherwise; = gross domestic product (GDP); = a measure of sociopolitical instability, defined as (1) the number of deaths due to domestic ‘political violence and (2) the number of protest demonstrations.
The model assumes that - economic actors seek to maximize the expected utility from present and future consumption; -future uncertainties are represented by independent subjective probability density functions with distributions that are related to SPI; - current saving is used to purchase a combination of two assets, one riskless and the other risky. The effective rate of return on the risky asset is a random variable; - future real income is uncertain. Underlying the Stewart and Venieris model is the concept that the relation between S and SPI increases the perceived riskiness and lowers the expected values of both future income and the effective return from holding domestic assets. The risk and return associated with hoarding and the holding of foreign assets is further presumed to be much less sensitive to SPI (including irregular changes of government) than risk and return on domestic assets. If temporal risk aversion were assumed, and furthermore, that both consumption and S were normal goods, S would be decreased by a decrease in the expected value or an increase in the riskiness of the effective rate of return on S. It is expected that increased riskiness of future income would have an ambiguous effect on S. In effect an increased SPI would decrease S through its effect on
PRIVATE INVESTh4ENT UNDER UNCERTAINTY the risk and expected return on S and expected future income. But, with the relationship between S and future income regarded as ambiguous, the direction of the total effect has to be determined empirically. The result of the study was a negative relationship between SPI and S, which was highly significant. The authors conclude that given the role of saving in economic development and the presumption that a viable development process is not of short duration, our results imply that continuing levels of even modest instability, compounded over time, could result in falling far short of meeting otherwise attainable development plans (Stewart and Venieris, 1985). While Ghana may have suffered some aspects of the kind of sociopolitical instability analyzed in the Stewart and Venieris (1985) study, our view is that the absence of credibility associated with an unstable policy administration environment could have comparable effects on savings and investment. Their measure of savings is in effect our measure of private investments. A study of entrepreneurship in the Third World by Altaf (1988) focuses on the outcome of the industrialization policy of Pakistan under a cloud of uncertainty. Operating on the hypothesis that the pervasive role assigned to the bureaucracy in Pakistan to formulate policies on industrial development and inconsistency in the performance of this role led to investment decisions that satisfied private ends but were often socially undesirable. Using a questionnaire that sought data on financing methods as a way of gauging risk perceptions, and also on motivation for going into high-risk ventures in an uncertain political climate, Altaf (1988) established that entrepreneurs would act to reduce risk by replacing planned investment activity with less risky activity, albeit not encouraged by government. An example is manufacturers becoming traders. Financial commitments are reduced to those of a short-term horizon.
3. MACROECONOMIC REFORMS, INCENTIVES AND INVESTMENT RESPONSE IN GHANA The Economic Recovery Programme (ERP) initially aimed at laying the foundations for sustained output growth and the attainment of a viable external payments position over the medium term. It also aimed at increasing the capacity of the economy to adjust to both external and internal shocks, while generating sustainable growth and development. Emphasis was placed on a flexible exchange rate policy and the gradual liberalization of the exchange and trade system with a view to improving resource allocation and the external payments position.
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Fiscal policy was directed at raising significantly the levels of government revenue and savings. At the same time government sought to reduce its expenditures in order to make the increased savings, and therefore investments, possible. It was hoped that, with increasing inflows of net foreign financing, government would be in a position to reverse the earlier trend of extensive reliance on the domestic banking system for the finance of the deficit. The crowding-out of the private sector was expected to be eliminated. Tax administration as well as the broadening of the tax base also received government attention during reforms. Indeed, aside from the macroeconomic and administrative measures, there have also been sectoral, structural and institutional reforms aimed at encouraging savings and investment and introducing efficiency. The monetary and financial policies in the era of liberalization have had both stabilization and resource allocation objectives. While they sought to control money supply in order to control inflation, the restructuring of the whole system was intended to lead to improved mobilization of domestic resources, which has been recognized as a precondition for increased investment. In the area of monetary control, initial emphasis was on the use of credit ceilings and selective credit controls. More recently, policies have placed greater reliance on the interest rate and open market operations to affect inflation, domestic resource mobilization and investment. In the restructuring exercise, greater interest in the privatization of the banking system is also being pursued. The establishment of the stock exchange became another instrument for mobilizing resources. The extent to which the government should intervene in the financial market to direct credit is still under discussion. The discussion centers on whether banking reforms should only concentrate on creating “the rules of the game” and capacity building, while the market is allowed to freely determine sectoral allocation of credit or whether those reforms should go beyond that to partially intervene in the allocation process. In view of past unsatisfactory performance with portfolio management which did not encourage efficient financial intermediation, the dilemma facing policy makers is how to identify a monetary policy package that grants banks the freedom to allocate credit and at the same time ensures that credit allocation is not biased against what are generally regarded as priority sectors, such as agriculture and manufacturing.
4. EVIDENCE OF UNSTABLE POLICY ENVIRONMENT? By and large, government showed during 1983-91 a tenacious adherence to the principles of structural
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adjustment, which certainly won for it tremendous international acclaim. While no major broad policy reversals have occurred in the period, there have been instances of policy administration being less than satisfactory. Similarly, some SAP policies have been inconsistent with others in the sense that they undermine each other. Others were revised rather too frequently following their introduction, thereby creating uncertainty in the minds of the public about future policies of the government. Thus, for example, to accelerate the process of financial deepening and the mobilization of financial savings, policies focused on restoring positive real interest rates, through rising interest rates,’ a policy that was generally perceived to have discouraged investment (because of the high cost of credit following ever widening bank spreads) without increasing savings (Aryeetey, Asante and Kyei, 1991). Apparently, the savings level was low throughout the 1980s because of an earlier public loss of confidence in the banking system following direct government intervention in the financial system in 1982, at a time when banks had no real incentive to mobilize more deposits (Aryeetey, Asante and Kyei, 1991). In addition, liquidity reserve requirements were revised downward to ease the liquidity position of the banks in order to increase loanable funds. This has generally been ineffective since the banks were hardly under liquidity pressure, operating with significant excess liquidity. Interestingly, the tight monetary policy under the ERP to control inflation has worked counter to the policy of making credit available to the private sector as the sale of government paper now attracts tremendous resources from the banking sector. With an average return of 34% on treasury bills during 1990-93 it is not surprising that of the 001 billion of treasury bills and stocks issued by September 1993, the non bank public held only @I852 billion (37%). Since 1987, corporate taxes have been revised downward to encourage private investment. But in a situation where very few investments were taking place, in view of the unavailability of capital, such a policy was bound to result only in a loss of revenue to government. This result has caused government to revise other tax rates rather too frequently. In February 1987, for example, the government abolished import duty and purchase tax on all commercial vehicles only to reintroduce them in January 1988. Similarly, the depreciation of the cedi has sharply inflated the cedi value of debts related to past imports of machinery and equipment. One of the problems of the manufacturing sector is the low utilization of installed capacity due to obsolete plant and machinery. Thus the flexible exchange rate policy undermines the objective of increasing capacity utilization in the economy. This is demonstrated in a study by Faini (1989). His study investigates the effects on growth and investment of trade policies and instability
in exchange rates in a number of developing countries. The results suggest that instability in the exchange rate, which he measures by the coefficient of variation, has a significant and negative effect on both investment and growth.
5. GENERAL OUTCOME OF REFORM PROGRAMME The reform program has generally been hailed by the international community as “a success,” at a time that many Ghanaians failed to acknowledge any such development.2 The economy’s performance is generally perceived to have improved considerably following the strict adherence to reform policies in the period up to 1991.’ The growth of real GDP averaged 5% annually during 1983-90, while end-of-year inflation declined from 142% to 36% in the same period. The overall balance of payments also went from a large deficit into a significant accumulation of international reserves. Even though 1990 saw the economy’s performance slacken, following trade shocks, this was generally perceived to be temporary as the economy picked up again in 1991. Policy implementation was generally seen to be consistent over the period (World Bank, 1991). Indeed, real GDP growth was restored to the 5% level in 1991 as the agricultural, mining, construction and trade sectors performed well. The yearon-year inflation rate fell to 10% in 1991 from 36% in 1990 and this was mainly attributed to improvements in domestic food supplies and a tightening of monetary policy. In addition, during the same period, the govemment’s budget (narrowly defined to exclude the externally financed projects) turned from a deficit of -1.3% of GDP to a surplus of 0.1%. A broader definition of the budget saw a reduction of the deficit from 2.4% to 1.6% of GDP during 1990-91. It is interesting that within expenditure on economic services, there was an apparent shift from direct investment in agriculture and manufacturing to the provision of both social and economic infrastructure since 1983. Expenditure on roads and waterways which constituted only 28.8% of the total expenditure on economic services in 1983, rose to 42% by 1990. At the same time, expenditure on agriculture which had earlier dominated with 48.2%, fell to 27.3% in 1990. The shares of government expenditure on transport and communication, and on and construction in total mining, manufacturing expenditure on economic services peaked in 1986, but have fallen back since then. As monetary policy was tightened, the annual growth of broad money was slowed down from 22.5% to 19.6% in 1990-91. As the Central Bank increased sharply its rediscount rate to 33% in 1990 and to 35% in January 1991, the money market and bank interest rates rose accordingly and the former averaged
PRIVATE INVESTMENT
3 l-38%
by mid-199 1 and lending rates averaged about 26% in December 1991. By the end of 1993, they averaged 3 1%. By 1991, the balance of payments position had improved substantially. The deficit on the current account was reduced and net capital inflows remained unchanged at the previous year’s level. Indeed the deficit fell from US$485 million (8.3% of GDP) in 1990 to US$442 million (6.9% of GDP) in 1991. The reduction in the deficit was attributed officially to the decline in oil import prices and the strong growth in the volume of gold and timber exports. The overall balance of payments recorded a surplus of US$l30 million following an increase in official transfers and net capital inflows. The question that many Ghanaians ask perpetually is “Can these achievements be sustained in the long term?” This question is constantly being asked against the background of tremendous financial assistance enjoyed from the World Bank and the domination of public investments in the investment portfolio.
6. PRIVATE SECTOR INVESTMENT RESPONSE As has been indicated earlier, the performance of the private sector has been less than anticipated
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(World Bank, 1991). In the reform years, new private investments fell well below planned targets and capacity utilization of existing firms remained low. By 1990 the manufacturing sector (which is mainly private) utilized only 37% of its capacity after rising from less than 20% in 1983. The still-low levels of capacity utilization have become characteristic of the private manufacturing sector, indicating the difficulty the sector faces in responding to both the macroeconomic and sectoral policies that have been introduced with reforms. Low investment in the manufacturing sector is also reflected in the fact that during 1984-91, manufacturing sector contribution to GDP averaged only 9%. compared to the peak figure of 20% in 1976. At its lowest point in 1983, its contribution was 7%. Since 1985, the manufacturing sector output has grown unsteadily at an annual average of 9.3%, (even though this growth has not been uniform among its subsectors), helping it to produce by 1991 less than 70% of the 1970 output level (see Table 1). The rapidgrowth sectors are electrical equipment and appliances, cutlery and other nonferrous metal products, nonferrous metal base industries, other chemical products, textiles, clothing and leather products, and cement and other nonmetallic mineral products. With the exception of textiles, clothing and leather products, these subsectors have low shares in the aggregate manufacturing sector output, thus affecting the aggre-
Table 1. Growth rates of manufacturing production by type, 1984-90 Industry Food Beverage industries Tobacco & tobacco products Textile, clothing & leather Sawmill &wood products Paper products & printing Petroleum refinery Other chemical products Cement & other nonmetallic mineral products Iron & steel products Non-ferrous metal base industries Cutlery & other nonferrous metal products Electrical equipment and appliances All manufacturing
1984
1985
1986
1987
1988
1989
1990
Aver
-36.7 41.2
42.7 -1.2
-2.9 26.6
24.4 13.5
6.1 4.5
-10.4 10.1
19.8 -4.1
6.1 12.9
88.1
-3.1
-6.0
-4.7
5.7
-12.1
12.0
11.4
50.0
20.8
19.3
14.0
7.7
-16.4
57.1
21.8
32.2
25.0
5.4
-0.2
24.0
-18.6
-7.2
8.7
-5.8 18.6 117.2
-9.6 27.9 -21.3
8.3 -5.0 19.5
-15.3 -18.2 36.6
-11.6 8.0 30.1
-9.1 28.8 -8.2
11.5 -19.2 -7.1
-4.5 5.8 23.8
-15.7 105.5
50.0 75.1
-25.5 -16.0
4.9 10.6
47.1 -57.3
36.2 -33.9
17.3 47.0
16.4 3.9
10.9
155.3
24.6
7.8
3.3
3.3
34.2
11.0
242.6
59.5
-6.0
3.7
15.2
45.0
371.5
48.7
79.6
88.9
16.4
11.3
0.0
25.5
0.8
9.1
-
-38.2 9.9
-11.0 49.5 4.8
-71.3 10.9
Source: Quarterly Digest of Statistics, Vol. 7, No. 3, & Vol. 9, No. 2, and Ghana Statistical Service.
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gate only marginally. The major subsectors of food manufacturing and petroleum refining (accounting for 34% of sectoral output) grew less rapidly at an annual rate of 6% during 1984-9 1. The subsectors of beverage, tobacco and tobacco products, sawmill and wood products grew at 12%. It is indeed remarkable that since 1989, there has been a slow down in almost all industrial sector activities. The major losers are the beverage. sawmill and wood products, petroleum refinery, other chemical products, and iron and steel. Paper products and printing have consistently recorded negative growth since reforms began. The iron and steel subsector produced in 1990 only 5.2% of its 1977 output. What is remarkable about the response of private sector investments in manufacturing is that it is occurring simultaneously with considerable growth of the service sector in general, and distributive trade in particular. Note that these are activities with relatively lower sunk costs and shorter turnover periods. Currently, the service sector contributes 35% of GDP, more than a half of which originates from the distributive trade subsector. The subsector’s output is marginally below its 1970 level, but its share of sectoral output has been most consistent and growth since 1985 has been steady. The booming distributive trade subsector often encourages the remark in Accra to the effect that “Ghana has become a nation of traders.” There have been newspaper reports of investors obtaining international loans to import inputs for their manufacturing plants with public guarantees, and then diverting these to import finished consumer items for retailing.
7. CONSTRAINTS TO PRIVATE SECTOR EXPANSION We would argue in this section that while there is little empirical or survey evidence of increased risk as a result of perceived instability in policy formulation and implementation, which would lead to a loss of credibility, there is some reason (based on evidence of actual or observed behavior of Ghanaian businessmen as well as the conceptual work presented earlier) to suppose that risk-averse behavior makes potential investors shy away from long-term investment commitments. We first consider the results of some surveys about what investors indicate are their major constraints to expansion and then draw conclusions from their actual behavior to show that the poor response has more to do with other factors than they usually suggest to interviewers. For medium/large scale enterprises in a total sample of I33 firms surveyed by Aryeetey, Baah-Nuakoh, Steel et al. (1993) (hereinafter ABS), it was reported that inadequate finance was the most significant constraint for 53.3%. Even though it was the most impor-
tant constraint for the group, it would appear that finance became more of a problem the smaller the enterprise. For those with financial problems, half of these problems were associated with inadequate working capital and poor access to credit for equipment. Other important constraints identified related to poor demand for products as potential customers “had no money” and the fact that their equipment was too old. These findings were not significantly different from those of a World Bank survey4 which noted that “Out of 3 1 respondents, 21 complained of problems on the demand side, 1 I of the lack of raw materials. and as many as 24 of inadequate availability of credit.” Demand was often seen as a constraint on account of increasing competition with imported goods. On the constraints to possible exports from the non-traditional product sectors, (e.g., rubber, aluminium, pineapples, wood products, handicrafts, etc. ) the World Bank (1990) has noted five major broad areas in which firms of all sizes are affected. These are - Inadequate policy framework: - Inadequate financial mechanisms and incentives; - Inadequate knowledge of markets, product quality, investments and technical knowledge; - Inadequate institutional support; and - Inadequate export infrastructure. These problems are supposed to manifest themselves in inadequate trade policies, poor administrative procedures, inadequate investment finance and working capital, as well as poor development of private sector organizations to protect the interests of members and poorly established public institutions that are expected to facilitate exports. For small-scale enterprises, finance was also cited in the ABS (1993) study as their most significant constraint to expansion. What is interesting here is the greater variation in the source of the financing problem than for medium/large enterprises. The small firms in this survey had more problems with access to credit than the medium/large firms, while the medium/large ones saw more problems with demand than the modem small (not micro) enterprises, even though this was not considered to be the most important constraint. It may be noted also that in general, fewer small firms cited poor demand as a constraint in this later study than in the earlier one by Steel and Webster (1991). This is attributed to the bias in the later sample that focused more on firms that were considered to have good prospects for growth. It is thus obvious, from survey evidence only, that a more vigorous response of private investment appears to have been impeded by a number of institutional, structural, and financial constraints. The apparent dearth of medium-term financing, the rudimentary nature of capital markets, and the weaknesses in financial intermediation in general make it difficult for pri-
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vate businesses to find means of financing other than short-term bank credit. The generally low profitability of many private firms and the low overall level of domestic savings limited the prospects for investment financing from their own resources. Moreover, distortions in the tax treatment of capital and investment income, particularly the high capital gains tax (until 1990) and the withholding tax on dividends, acted as a disincentive to new investment and may have retarded the necessary restructuring of many private enterprises. On the other hand, however, the ABS (1993) study found that a significantly large number of businesses (particularly, medium and large businesses) had had access to formal credit. At the same time, the banking system seemed to suffer from excessive liquidity and yet had no incentive to seek out more loan recipients. These observations make us believe the problem with investment in Ghana is not simply one of inadequate finance and other institutional constraints.
8. ANOTHER SIDE TO THE STORY? While survey results may not necessarily reflect the other side of the coin, i.e. credibility, there is the generally accepted fact that deep mistrust by the private sector for a government whose earlier policies (first in 1979, and then in 198243) indicated an antagonistic attitude to private investment, may be a major reason for the absence of long-term private investments? Businessmen may express these views privately when there are no questionnaires in sight. The sentiment is often expressed among Ghanaians that various macroeconomic reforms are pursued only to satisfy donor conditions for assistance. Hence, in the absence of such assistance, government would reverse policies on liberalization. In reaction to this, the private sector chooses to put their capital in shortterm assets and dabble in sectors of the economy with quick and relatively high turnover, such as trading. With relaxed restrictions on imports of finished goods and price liberalization, the stage appears well set for choosing trading over long term physical investments. Following principal-agent theory, the expected incentives from the principal (government) to the agent (investor) y* (t3) to make the latter take the necessary actions (optimal) toward increasing investment appear to be increasing with each survey. What this means in theory is that the agent is not seeking a risksharing solution to the problem, but is completely risk-averse, which is unusual for any kind of private investor. Good reasons for such risk-averse behavior come from information asymmetry as when the private sector is not sure of what government’s next move is going to be. (Do not forget, they have seen situations when government has abolished a tax and reinstated it within one year!)
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Why should Ghanaian investors be highly risk averse? Alternatively, after 10 years of nearly strict government adherence to the ERP, is there any genuine fear of a policy reversal? While there may not be any reason to fear a direct policy reversal under the present political environment, Ghanaian investors have gone through experiences in the last 13 years that make them uncertain about government’s long-term philosophy and ideology in relation to the ownership of capital and its employment. They saw some investors lose all their investments to government in 1979, and also in 1982, following arbitrary decisions of government. While the policy environment has changed dramatically since then, and also stabilized with external support, mixed signals continue to come from certain sections of government, as shown earlier, that have suggested an antipathy toward private investments. Our consideration of the Rodrik (1990) model [t < (r - r*) - ~6 - IT(E + p)] suggests that the most important variable following reform is the value placed by investors on market distortions induced by the actions of government. Thus investors would have moved into manufacturing, for example, if they thought the distortions (r) were overshadowed by (a) the after-tax return on domestic investment less the yield on the alternative (distributive trade) in the absence of entry and exit costs, (b) the compensation for alternative capital reallocation (E6) was large enough, and (a) likely adequate compensation in the event of a policy reversal which is costed at rc(&+ p). It is our view that, while macroeconomic reforms have reduced extensively the value oft, it still remains too high for many private investors. This is not because the reforms are inadequate, but rather because perceived potential compensation for the third component of the inequality on the righthand side (cost of a change in attitude toward selected private investments, and not necessarily a wholesale policy reversal) remains zero in the view of most investors, following the mixed signals they have received from government for more than 13 years. There is no guarantee that they will not lose everything in one day, and therefore, they cannot attach any positive value to that component, thus depressing the right side of the inequality with a negative cost. To argue that investors shy away from long-term financial commitments because of such institutional constraints as, for example, the difficulties relating to business registration and inadequate knowledge of export markets, etc6 begs the question. What prevents investors in a near-liberal market climate (as currently obtains in Ghana) from factoring in costs incurred (both legal and illegal) into the prices of their outputs? Note that in the surveys mentioned above, there have been no suggestions about major difficulties with the output market. In any case, business registration has never been easy in Ghana in the last 30 years and
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Ghanaian traders are known all the world over, involved in transactions with all manner of intemational businesses. Ghanaian investors have become highly risk-averse, but risk-averse behavior from investors is rational only under relatively high levels of uncertainty. Thus, their behavior since 1982 has simply been a rational response to a highly uncertain political and economic environment.
9. CONCLUSIONS: HOW ARE LOW LEVELS OF PRIVATE INVESTMENTS TAKING THEIR TOLL ON THE ECONOMY? The trend of low private investment has been followed by increasing difficulty in ensuring a macroeconomic balance after 1991. Economic developments in 1992 contrasted sharply with developments in the preceding year. Thus, while various macroeconomic policy targets for 1991 appear to have been relatively easily reached, the achievement of similar targets for 1992 and 1992 appeared to the elsuive. By the beginning of the last quarter of 1992, it had become doubtful that the anticipated GDP growth rate of 5% would be achieved in view of difficulty of observing various benchmarks as a result of all manner of shocks and a number of inconsistencies in policy implementation. The first major shock was that there was a smaller than anticipated harvest of cocoa for the 1991-92 crop season, (arising from poor weather conditions), which resulted in a shortfall of US$70 million in export receipts. This trend continued into the 1992-93 season. At the same time, by September 1992, external financial assistance was about US$52 million below programmed levels as the World Bank delayed the release of the last tranche of the third Structural Adjustment Credit. By far the greatest fac-
tor affecting the achievement of various program targets, however, was the considerable expansion of the government bill for wages and salaries which was increased by 38.7% in September 1992 following labor unrest. In addition to this, several factors exerted upward pressure on public development expenditures in an election year. Thus, in the first half of 1992, the narrow fiscal balance (including foreign grants) indicated a surplus of only $6 billion, which was well below the mid-year target of u 2 1.2 billion, which was well below the mid-year target of e 21.2 billion. Moreover, in view of the shortfall in net external financing of about $9.6 billion by mid-year, there was a net domestic borrowing of $3.7 billion which included a net repayment to the banking system of $2.2 billion. The latter figure had been programmed at $32.0 billion. The rapid growth in expenditure on social development projects in rural Ghana as a prelude to the elections in 1992 precipitated the large fiscal deficit. Instead of the programmed narrow fiscal surplus of 1.8% of GDP a deficit of 5% resulted. By the end of 1993, the deficit was 3%. It would appear that government is having to increase its expenditures because the private sector is not spending as much on investments as is desirable to keep the economy growing. At the same time the private sector is unwilling to undertake long-term investments for reasons that include the fact that, while government policies may for the moment not necessarily be reversed or altered, mixed signals from govemment do not indicate a consensus on a development philosophy and, what role the private sector is expected to play. The uncertainty would only be removed under the present fourth republic if adequate legislation is passed to assure investors that property rights would be respected in future.
NOTES 1. Even though policies were successful in reducing inflation, the rate of inflation is still high. This leaves constant increases in nominal rates as the easiest way to make real rates positive. 2.
See Loxley, (1991).
3. ISSER. University of Ghana carried out a thorough analysis of the economy in its report, The Pare of ?he Ghanuiarz Economy 1991, in 1992. 4.
See World Bank (1990).
5.
A number of actions taken by the AFRC and PNDC
Governments in 1979 and 1982 strongly suggested a bias against private wealth. These included the freezing of all bank accounts with balances exceeding $50,000 and the confiscation of various assets through the Citizens’ Vetting Committee. Since then, statements by a section of the leadership suggest that similar attitudes continue to prevail, in spite of the reform. A statement made by the President in May 1993 at the Trade Fair site was generally construed by a section of themass media and the general public as being resentful of private Ghanaian businesses. 6.
That is the position often adopted by donors.
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REFERENCES Altaf, Z., Entrepreneurship in the Third World: Risk and Uncertainty in Industry in Palistan (London: Croom Helm, 1988). Aryeetey, E. Y. Asante, and A. Y. Kyei, “Mobilizing domestic savings for African development and diversification? A Ghanian case study,” Mimeo (Oxford: International Development Centre, Queen Elizabeth House, Oxford University, 1991). Baah-Nuakoh, A., E. Aryeetey, and W. F. Steel, “Background paper on SME demand for finance, for the study of Meeting the Financing Needs of Ghana’s SmallMedium-Scale Enterprises,” (Accra: World and Bank/NBSSI, 1993). Devarajan, S. and J. de Melo, Evaluating participation in African monetary unions: A statistical analysis of the CFA zones, World Development, Vol. 15, No. 4 (1987). Dombusch, R., “Notes on credibility and stabilization,” Mimeo (1988). Helleiner, G. K., “Outward orientation, import instability, and African economic growth: An empircal investigation,” in S. La11 and F. Stewart (Eds.), Theory and Reality in Development: Essays in Honour of Paul Streeten, New York: St. Martin’s Press, 1986). Faini, R., Credibility, Investment and the Real Exchange Rate, Mimeo (Bologna: Johns Hopkins University, February, 1989). ISSER, The State of the Ghanian Economy Report 1991 (Legon: University of Ghana, 1992). Loxley, J., Ghana: The Long Road to Recovery 1983-90 (Ottawa: The North-South Institute, 1991). Rees, R., “The theory of principal and agent,” in John D. Hey
and Peter Lambert (Eds.), Surveys in the Economics of Uncertainty (Oxford: B. Blackwell, 1987). Rodrik, D. “How should structural adjustment programs be designed?’ World Development, Vol. 18, No. 7 (1990). Rodrik, D. “Policy uncertainty and private investment in developing countries,” NBER Working Paper 2999, (Cambridge, MA: NBER, 1989a). Rodrik, D. “Promises, promises: Credible policy reform via signalling”, The Economic Journal, Vol. 99 (September 1989b). Steel, W. F., and L. M. Webster, Small Enterprises in Ghana: Responses to Adjustment, Industry Series Paper, No. 33, (Washington DC: World Bank Industry and Energy Department, 1990). Stewart, D. B., and Y. P. Venieris, “Socio-political instability and the behavior of savings in less-developed countries,” The Review of Economics and Statistics, Vol. 67 (November 1985). USAID “Trade and Investment Project Document,” (Accra/Washington: USAID, 1992). van Wijnbergen, S., “Trade reform, aggregate investment and capital flight: On credibility and the value of information,” Economics Letters Vol. 19 (1985). Wheeler, D. Sources of stagnation in sub-Sharan Africa,” World Development, Vol. 12, No. 1 (1984). World Bank, “Ghana: Progress on Adjustment,” (Washington, DC: The World Bank, 1991). World Bank, “Ghana: Survey of medium and large manufacturing enterprises,” Technical Working Paper No. 5 (Washington DC: The World Bank, July 1990).
Vol. 22, No. 8, pp. 1211-1221, 1994 Copyright 0 1994 Elsevier Science Ltd Printed in Great Britain. All rights reserved 0305-750x/94 $7.00 + 0.00
Pergamon 0305-750X(94)30040-5
Private Investment Under Uncertainty in Ghana ERNEST ARYEETEY
University of Ghana, Legon Summary. - Ghana’s Economic Recovery Program saw considerable growth of the economy during 1985-91. This commendable performance slackened after 1992, a fact which is attributable to poor private investment response following reform. This article shows that the poor growth in private investment may be attributed to the perception of uncertainty in the political and economic environment since 1982. The uncertainty is derived from the low credibility of government as it has been unable to assure investors that earlier decisions that showed a bias against private wealth will not be repeated. Economic incentives arising from reforms do not provide guarantees against poor credibility.
investment climate is not perfect, it has improved significantly. The recent changes in taxation will further improve the environment (USAID, 1992).
1. INTRODUCTION Ten years after the pursuit of macroeconomic reforms in Ghana began, growth, which has sometimes been remarkable, has not been consistent and this has been attributed to poor private sector investment response in the medium to long term (World Bank, 199 1). What is not clear is the cause of poor private sector response. The poor response originates from a number of pass-ible factors, including inadequate institutional support, perception of inconsistencies in reform policies, general mistrust for government intentions, etc. This article discusses how the credibility of govemment (and not just policy) is affected by unstable conditions and how the resulting uncertainty discourages private investments, even after reforms. Private investments in Ghana are generally seen as having only recovered in limited terms, and considerably less than expected since the reforms began. As a percentage of GDP, the target for private investments was 15% per annum for the second half of the last decade, but private investment actually only increased from 2.9% in 1983 to 5.4% in 1985 before tumbling to 2.4% in 1986. During 1987-90, private investment increased from 5.5% to 8.7% including a sizeable increase in foreign direct investment in the gold mining sector, which accounted for more than half of the recorded growth. Putting aside foreign investments in the mining sector, which are heavily supported with multilateral loans, performance of the rest of the private sector, particularly manufacturing, has not been encouraging. The situation baffles donor agencies that have suggested that Ghana has made great strides in recent years in creating a positive environment for increased investments and exports. The foreign exchange regime is favourable, and while the
While we do not seek to carry out an evaluation of the Ghanaian Economic Recovery Programme in this article, we have increasingly become aware of the fact that there is a general dissatisfaction both in official and donor circles about the limited response by the private sector to reforms. The major question is “why is the private sector not investing as is desirable and expected?” There are a number of views on this question, both in Ghana and in the donor community. There are those, including the World Bank, who believe that the reforms have not gone far enough as yet in addressing substantive issues (mainly institutional) affecting the operations of potential investors, in spite of the fact that all manner of incentives arising from macroeconomic and other sectoral reforms have been provided. Other views expressed by many Ghanaians suggest that the issue is one of credibility with regard to the sustainability of reforms in the medium to long term. The reform program has been based on short-term stabilization and medium-to-long-term structural adjustment. Stabilization measures mainly focus on the financial disequilibrium, i.e. the fiscal and external accounts and the rate of inflation, while structural adjustment policies aim at restructuring the productive capacities in order to increase their efficiency and help restore growth. It has been argued by Rodrik (1990) that in practice stabilization has proven not to be a short-term measure, as many economies undergoing structural adjustment have perpetually remained unstable in macroeconomic terms. It has been either impossible or extremely difficult to put the public sector budget on a sustainable course.. He argues further
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that policies of liberalization applied in strong doses in an unsuitable host environment may not be sustainable in the medium term. Governments therefore have to ensure that the goal of sustainable policies takes precedence over liberalization. Policies must generally be perceived by the private sector to be sustainable since they will base their investment decisions on these policies. Private sector investment is indeed crucial to the stability of adjustment since growth is an essential component of any successful adjustment program. He writes that for policy reform to be successful, entrepreneurs, workers and farmers have to respond to the signals generated by the reform. For example, outward-oriented exchangerate and trade policies can service their purpose only if the desired export response materializes (Rodrik, 1990) Entrepreneurs will withhold a part of physical investment until they can be sure that a reform policy is irreversible. The key components of a sustainable policy environment (are): stable macro policies. chiefly a small fiscal deficit and a realistic exchange rate policy; (b) a credible and predictable set of microeconomic incentives. widely expected to be sustained into the near future; changes that (cl the absence of sharp distributional would create politicial pressures to reverse course down the line (Rodrik, 1990, pp. 931-935) (a)
When reform policies are not sustainable, they create instability in two ways-by fostering uncertainty as to their own life span, and by aggravating instability elsewhere in the economic system, primarily in macroeconomic imbalances. For example, the stillhigh level of inflation in Ghana, following dramatic exchange rate adjustments and continuing distortions in the market system, has led to a series of temporary palliative measures including constant introductions of new Bank of Ghana rediscount rates and constant revisions of the reserve requirements of banks. The resulting variability of credit flow to the private sector, among other things, undermines their confidence in the banking system and the tendency to view the investment climate with uncertainty. In any event, there would be the tendency to perceive public policies as only short term measures. But “such shortening of time horizons is the chief obstacle to eliciting the desired private sector response to economic policies” (Rodrik, 1990). This is because private investors cannot make mainly irreversible decisions and commit investment capital to long-term projects when they perceive a high probability of change in policy in the short to medium term. Hence, this discomforting conclusion that the success of policies may depend in no small part on the psychology
of private-sector expectations. A reform can end up being reversed for no other reason than a shared expectation that it will not last (Rodrik, 1989, p. 2).
Essentially, therefore, sustainable and successful reform rests on the credibility of the government. The objective of this article is to show that in spite of significant achievements in macroeconomic performance following reform. the far-less-than-expected growth in private investments is attributable to the perception of uncertainty in the political and economic environments since 1982. In view of the widespread mention of policy credibility and sustainability as constraints to enhanced private investments. we explore in this article some conceptual underpinnings to the issue of credibility as a constraint. We discuss various concepts that might shed light on how the private sector would perceive the reform program if the environment were considered unstable. and therefore not sustainable. and the likely impact of this perception on private investments. The conceptual discussion provides a prelude to an account (sometimes anecdotal) of relevant private investment experiences. and how they have been affected by perceptions of poor credibility. In the next section we discuss some relevant literature on the relationship between an unstable economic environment and investments. This is followed by a review of the reform program in Ghana, providing evidence of instability in the policy environment and a consideration of the general outcome of reforms. We also look at the private sector response to incentives provided and conclude the article with a consideration of how low rates of growth for investment have taken their toll on the economy.
2. THE RELATIONSHIP BETWEEN INSTABILITY AND INVESTMENTS There is a growing theoretical literature on the consequences of reforms that lack credibility. These tend to rely on game theory and the theoryof principal and agent (see van Wijnbergen, 1985 and Dornbusch 1988). We first analyze the issue of how investors behave in the face of uncertainty within the context of the theory of principal and agent. The theory of principal and agent (Rees, 1987) is intended to explain situations of the following nature: An individual, called the agent, and denoted by A. must choose some action a from some given set of actions (a). The particular outcome x resulting from this choice depends also on another given set of states of the world (Cl),and which element from that set actually prevails at the relevant time, thus making uncertainty intrinsic to the situation. It is important that the outcome generate utility to a second individual, the principal, denoted by P. A “contract”, broadly defined, has to be in place to
PRIVATE
INVESTMENT
ensure that P makes a payment y to A. The utility that A derives from the arrangement is dependent on y and the value of a. The theory’s purpose is to characterize the optimal forms of such contracts, applying various assumptions relating to the information A and P possess. In view of the much wider application of the theory and its principles it will be relevant for our consideration of private investments under uncertainty in Ghana if we could perceive the private investor as the agent A and government (representing the state) as the principal P. The contract between the two is an implicit one in which the government’s (P) utility is measured by increases in private investments and its productivity and the payment it makes to the investor (A) is the private benefits from trade reform, such as the reduction in tariffs and other institutional support. Since the core problem of principal-agent theory is to find a “payment” schedule which optimally trades off the benefits of risk-sharing with the costs of providing an incentive to the agent we can set out a general optimization model in which the value of the investor’s action arbitrarily fixed at a = aa. If it was assumed that a and 0 could be costlessly observed, so that y depended only on 0, the solution of the risksharing optimum by which a payment y*(Q is made by the government (principal) to the investor (agent) may be expressed as
max I ‘u(.x(LI~,0) - y(@)flEQ& 0
s.t.
J‘v(a0, y(e)He)de
2
vo
0
where vu is the minimum level of A’s utility. The solution for y* (0) is characterized by the condition 4(x-y*)
+ vy = 0,
e E. [O,11
For Ghanaian investors, the solution would represent the package of incentives arising from policy reforms that would encourage maximum private investments. Applying game theory on the other hand, Rodrik (1989) has also attempted to conceptualize the relationship between “policy uncertainty and private investment in developing countries” as government pursues reforms. The situation before reform may be conceptualized as one where the entrepreneurs’ yield from capital had been artificially depressed to r-to, where r is the marginal product of capital and to is the policy-induced distortion, probably an explicit tax or the effect of an entire complex of distortions. After reforms to is reduced to t, i.e. to < t. Capital in altemative employment (e.g., trading) may be denoted by P*. Thus, before reform,
UNDER UNCERTAINTY
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r - to < I*, with the hope that after reform r-t>r*. The objective of reform therefore is to get capital to move in the direction that will minimize the gap between r and r*. Policy uncertainty is modeled in the form of a probability (x) that the reform will be reversed. Treated as a constant by individual entrepreneurs, n measures the likelihood (per unit of time) of policy reversal. Thus, if a reversal indeed occurs f will revert to its original position to. For purposes of analysis we take R as given. But capital investment is partially irreversible since there are sunk costs of entry and exit when physical capital is committed. This condition ensures that, with costly resource allocation, uncertainty can have large effects on behavior (even without risk aversion), and large enough changes in the policy environment can have lasting effects on resource allocation even when the initial changes are eventually fully reversed. In this situation, how will an individual entrepreneur (who we presume to be risk-neutral) behave when a reform is put in place? His choice is between leaving his capital where it earns r* and moving it to a sector where it would earn r - t. The former option (in a macroeconomic sense, capital flight) yields flow benefits of r* with no uncertainty. According to Rodrik (1989a), if we denote an investor’s discount factor by 6, let E stand for entry costs per unit of capital and p exit costs per unit of capital, the decision will be based on (assuming a large policy reversal) whether (r - t) - r* 2 x (E + p) + E8 or, alternatively, tS(r-r*)-&E8-X(e+P).
(1)
The expression above (1) indicates the condition under which reform will be meaningful to an investor. It suggests that I must be low enough to make the after-tax return on domestic investment comparable to the yield on the alternative in the absence of entry and exit costs. The reform must be large enough to compensate for the alternative of capital reallocation, expressed as ~8, while compensating for the likelihood of a policy reversal, the cost of which is X(E + p). Rodrik (1989b) has another theoretical model to explain how the absence of policy reform credibility could make the reform process costly and lead to welfare losses. The lack of credibility is equated with a distortion in the structure of intertemporal relative prices. This is because, in the absence of credibility, the private sector considers different prices from those expected if the reform was definitively implemented, thus creating a second best environment. In addition to
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this, further distortions may be introduced as government attempts to offset the distortions or to reinforce its credibility. Investors might perceive policy reform as lacking credibility for three reasons. First, the new policy may be inconsistent with other policies of government; second, there might be a time-inconsistency problem, by which the ex-postpolicy strategies differ from ex-ante policy strategies; third, due to asymmetric or incomplete information, the private sector might not know the true objective of government. This last is especially true of countries where governments might feign reform in order to obtain foreign aid. The lack of credibility will induce a suboptimal level of investment due to a fall in private savings in view of the anticipation of higher prices in the future for imported goods. In order to achieve credibility, government will have to implement a larger policy reform than necessary in the absence of uncertainty. At the macro level, van Wijnbergen (1985) has suggested that following trade reforms, uncertainty about future policy reversals as well as the fact that some investment is irreversible impose an option value on foreign exchange, which might lead to capital flight and a decline in aggregate investment This is based on a theoretical model of the rate of return structure of three assets, namely, capital in the export sector (&), capital in the previously protected sector (K,,) and foreign assets (F). in which the rate of return depends on whether or not trade is liberalized. There are a number of empirical studies on the relationship between economic growth and instability, In these, instability is often defined as political instability with a focus on changes in government and the usual policy reversals that come with these. Wheeler (1984) studied 25 African countries and observed that average growth rates were significantly and negatively affected by political instability. Other kinds of instability studied include those of imports as done by Helleiner (1986) who establishes a negative relationship between import instability and economic growth. After comparing currency stability between countries of the CFA Franc Zone and other African countries, Devarajan and de Melo (1987) concluded that the relative currency stability of the CFA Franc made member countries of the Zone enjoy a higher growth rate than other countries in the region. There are not many empirical investigations of investment and investment behavior under uncertainty in developing countries. The nature of risk and uncertainty becomes rather complicated in such settings. Where investigations have been made they are often micro-level surveys of entrepreneurs and their attitudes to risk and investment decision making or cross country investigations of how ambiguously defined measures of instability affect gross investments. Stewart and Venieris (1985) have suggested that instability will affect the productive capacity of a
country through the effect it will have on the country’s aggregate saving. Defining savings as “investment minus net capital inflow,” they used data pooled from seven annual observations on a 60 noncommunist and less-developed countries (including Ghana) in an econometric model specified as follows: S,, = ao + &G,r, + asDN,, + [bo + Cb,Gu, + bsSPI,t]Y,t + beSPIt,i b7EI,, + E,, where i = 1,2 .. ...60 and r = 1,2 .,.., 7. Also, SC, DN,,
Gq
Y,, SPI,,
= gross saving; = a dummy variable whose value is one if saving for country i is gross national, and zero if saving is gross private; = a set of four dummy variables such that G,,I = one for Latin American countries, and zero otherwise, G,Q = one for Asian countries, and zero otherwise, G,,x = one for Middle Eastern countries and zero otherwise, G,N = one for African countries and zero otherwise; = gross domestic product (GDP); = a measure of sociopolitical instability, defined as (1) the number of deaths due to domestic ‘political violence and (2) the number of protest demonstrations.
The model assumes that - economic actors seek to maximize the expected utility from present and future consumption; -future uncertainties are represented by independent subjective probability density functions with distributions that are related to SPI; - current saving is used to purchase a combination of two assets, one riskless and the other risky. The effective rate of return on the risky asset is a random variable; - future real income is uncertain. Underlying the Stewart and Venieris model is the concept that the relation between S and SPI increases the perceived riskiness and lowers the expected values of both future income and the effective return from holding domestic assets. The risk and return associated with hoarding and the holding of foreign assets is further presumed to be much less sensitive to SPI (including irregular changes of government) than risk and return on domestic assets. If temporal risk aversion were assumed, and furthermore, that both consumption and S were normal goods, S would be decreased by a decrease in the expected value or an increase in the riskiness of the effective rate of return on S. It is expected that increased riskiness of future income would have an ambiguous effect on S. In effect an increased SPI would decrease S through its effect on
PRIVATE INVESTh4ENT UNDER UNCERTAINTY the risk and expected return on S and expected future income. But, with the relationship between S and future income regarded as ambiguous, the direction of the total effect has to be determined empirically. The result of the study was a negative relationship between SPI and S, which was highly significant. The authors conclude that given the role of saving in economic development and the presumption that a viable development process is not of short duration, our results imply that continuing levels of even modest instability, compounded over time, could result in falling far short of meeting otherwise attainable development plans (Stewart and Venieris, 1985). While Ghana may have suffered some aspects of the kind of sociopolitical instability analyzed in the Stewart and Venieris (1985) study, our view is that the absence of credibility associated with an unstable policy administration environment could have comparable effects on savings and investment. Their measure of savings is in effect our measure of private investments. A study of entrepreneurship in the Third World by Altaf (1988) focuses on the outcome of the industrialization policy of Pakistan under a cloud of uncertainty. Operating on the hypothesis that the pervasive role assigned to the bureaucracy in Pakistan to formulate policies on industrial development and inconsistency in the performance of this role led to investment decisions that satisfied private ends but were often socially undesirable. Using a questionnaire that sought data on financing methods as a way of gauging risk perceptions, and also on motivation for going into high-risk ventures in an uncertain political climate, Altaf (1988) established that entrepreneurs would act to reduce risk by replacing planned investment activity with less risky activity, albeit not encouraged by government. An example is manufacturers becoming traders. Financial commitments are reduced to those of a short-term horizon.
3. MACROECONOMIC REFORMS, INCENTIVES AND INVESTMENT RESPONSE IN GHANA The Economic Recovery Programme (ERP) initially aimed at laying the foundations for sustained output growth and the attainment of a viable external payments position over the medium term. It also aimed at increasing the capacity of the economy to adjust to both external and internal shocks, while generating sustainable growth and development. Emphasis was placed on a flexible exchange rate policy and the gradual liberalization of the exchange and trade system with a view to improving resource allocation and the external payments position.
1215
Fiscal policy was directed at raising significantly the levels of government revenue and savings. At the same time government sought to reduce its expenditures in order to make the increased savings, and therefore investments, possible. It was hoped that, with increasing inflows of net foreign financing, government would be in a position to reverse the earlier trend of extensive reliance on the domestic banking system for the finance of the deficit. The crowding-out of the private sector was expected to be eliminated. Tax administration as well as the broadening of the tax base also received government attention during reforms. Indeed, aside from the macroeconomic and administrative measures, there have also been sectoral, structural and institutional reforms aimed at encouraging savings and investment and introducing efficiency. The monetary and financial policies in the era of liberalization have had both stabilization and resource allocation objectives. While they sought to control money supply in order to control inflation, the restructuring of the whole system was intended to lead to improved mobilization of domestic resources, which has been recognized as a precondition for increased investment. In the area of monetary control, initial emphasis was on the use of credit ceilings and selective credit controls. More recently, policies have placed greater reliance on the interest rate and open market operations to affect inflation, domestic resource mobilization and investment. In the restructuring exercise, greater interest in the privatization of the banking system is also being pursued. The establishment of the stock exchange became another instrument for mobilizing resources. The extent to which the government should intervene in the financial market to direct credit is still under discussion. The discussion centers on whether banking reforms should only concentrate on creating “the rules of the game” and capacity building, while the market is allowed to freely determine sectoral allocation of credit or whether those reforms should go beyond that to partially intervene in the allocation process. In view of past unsatisfactory performance with portfolio management which did not encourage efficient financial intermediation, the dilemma facing policy makers is how to identify a monetary policy package that grants banks the freedom to allocate credit and at the same time ensures that credit allocation is not biased against what are generally regarded as priority sectors, such as agriculture and manufacturing.
4. EVIDENCE OF UNSTABLE POLICY ENVIRONMENT? By and large, government showed during 1983-91 a tenacious adherence to the principles of structural
1216
WORLD
DEVELOPMENT
adjustment, which certainly won for it tremendous international acclaim. While no major broad policy reversals have occurred in the period, there have been instances of policy administration being less than satisfactory. Similarly, some SAP policies have been inconsistent with others in the sense that they undermine each other. Others were revised rather too frequently following their introduction, thereby creating uncertainty in the minds of the public about future policies of the government. Thus, for example, to accelerate the process of financial deepening and the mobilization of financial savings, policies focused on restoring positive real interest rates, through rising interest rates,’ a policy that was generally perceived to have discouraged investment (because of the high cost of credit following ever widening bank spreads) without increasing savings (Aryeetey, Asante and Kyei, 1991). Apparently, the savings level was low throughout the 1980s because of an earlier public loss of confidence in the banking system following direct government intervention in the financial system in 1982, at a time when banks had no real incentive to mobilize more deposits (Aryeetey, Asante and Kyei, 1991). In addition, liquidity reserve requirements were revised downward to ease the liquidity position of the banks in order to increase loanable funds. This has generally been ineffective since the banks were hardly under liquidity pressure, operating with significant excess liquidity. Interestingly, the tight monetary policy under the ERP to control inflation has worked counter to the policy of making credit available to the private sector as the sale of government paper now attracts tremendous resources from the banking sector. With an average return of 34% on treasury bills during 1990-93 it is not surprising that of the 001 billion of treasury bills and stocks issued by September 1993, the non bank public held only @I852 billion (37%). Since 1987, corporate taxes have been revised downward to encourage private investment. But in a situation where very few investments were taking place, in view of the unavailability of capital, such a policy was bound to result only in a loss of revenue to government. This result has caused government to revise other tax rates rather too frequently. In February 1987, for example, the government abolished import duty and purchase tax on all commercial vehicles only to reintroduce them in January 1988. Similarly, the depreciation of the cedi has sharply inflated the cedi value of debts related to past imports of machinery and equipment. One of the problems of the manufacturing sector is the low utilization of installed capacity due to obsolete plant and machinery. Thus the flexible exchange rate policy undermines the objective of increasing capacity utilization in the economy. This is demonstrated in a study by Faini (1989). His study investigates the effects on growth and investment of trade policies and instability
in exchange rates in a number of developing countries. The results suggest that instability in the exchange rate, which he measures by the coefficient of variation, has a significant and negative effect on both investment and growth.
5. GENERAL OUTCOME OF REFORM PROGRAMME The reform program has generally been hailed by the international community as “a success,” at a time that many Ghanaians failed to acknowledge any such development.2 The economy’s performance is generally perceived to have improved considerably following the strict adherence to reform policies in the period up to 1991.’ The growth of real GDP averaged 5% annually during 1983-90, while end-of-year inflation declined from 142% to 36% in the same period. The overall balance of payments also went from a large deficit into a significant accumulation of international reserves. Even though 1990 saw the economy’s performance slacken, following trade shocks, this was generally perceived to be temporary as the economy picked up again in 1991. Policy implementation was generally seen to be consistent over the period (World Bank, 1991). Indeed, real GDP growth was restored to the 5% level in 1991 as the agricultural, mining, construction and trade sectors performed well. The yearon-year inflation rate fell to 10% in 1991 from 36% in 1990 and this was mainly attributed to improvements in domestic food supplies and a tightening of monetary policy. In addition, during the same period, the govemment’s budget (narrowly defined to exclude the externally financed projects) turned from a deficit of -1.3% of GDP to a surplus of 0.1%. A broader definition of the budget saw a reduction of the deficit from 2.4% to 1.6% of GDP during 1990-91. It is interesting that within expenditure on economic services, there was an apparent shift from direct investment in agriculture and manufacturing to the provision of both social and economic infrastructure since 1983. Expenditure on roads and waterways which constituted only 28.8% of the total expenditure on economic services in 1983, rose to 42% by 1990. At the same time, expenditure on agriculture which had earlier dominated with 48.2%, fell to 27.3% in 1990. The shares of government expenditure on transport and communication, and on and construction in total mining, manufacturing expenditure on economic services peaked in 1986, but have fallen back since then. As monetary policy was tightened, the annual growth of broad money was slowed down from 22.5% to 19.6% in 1990-91. As the Central Bank increased sharply its rediscount rate to 33% in 1990 and to 35% in January 1991, the money market and bank interest rates rose accordingly and the former averaged
PRIVATE INVESTMENT
3 l-38%
by mid-199 1 and lending rates averaged about 26% in December 1991. By the end of 1993, they averaged 3 1%. By 1991, the balance of payments position had improved substantially. The deficit on the current account was reduced and net capital inflows remained unchanged at the previous year’s level. Indeed the deficit fell from US$485 million (8.3% of GDP) in 1990 to US$442 million (6.9% of GDP) in 1991. The reduction in the deficit was attributed officially to the decline in oil import prices and the strong growth in the volume of gold and timber exports. The overall balance of payments recorded a surplus of US$l30 million following an increase in official transfers and net capital inflows. The question that many Ghanaians ask perpetually is “Can these achievements be sustained in the long term?” This question is constantly being asked against the background of tremendous financial assistance enjoyed from the World Bank and the domination of public investments in the investment portfolio.
6. PRIVATE SECTOR INVESTMENT RESPONSE As has been indicated earlier, the performance of the private sector has been less than anticipated
1217
UNDER UNCERTAINTY
(World Bank, 1991). In the reform years, new private investments fell well below planned targets and capacity utilization of existing firms remained low. By 1990 the manufacturing sector (which is mainly private) utilized only 37% of its capacity after rising from less than 20% in 1983. The still-low levels of capacity utilization have become characteristic of the private manufacturing sector, indicating the difficulty the sector faces in responding to both the macroeconomic and sectoral policies that have been introduced with reforms. Low investment in the manufacturing sector is also reflected in the fact that during 1984-91, manufacturing sector contribution to GDP averaged only 9%. compared to the peak figure of 20% in 1976. At its lowest point in 1983, its contribution was 7%. Since 1985, the manufacturing sector output has grown unsteadily at an annual average of 9.3%, (even though this growth has not been uniform among its subsectors), helping it to produce by 1991 less than 70% of the 1970 output level (see Table 1). The rapidgrowth sectors are electrical equipment and appliances, cutlery and other nonferrous metal products, nonferrous metal base industries, other chemical products, textiles, clothing and leather products, and cement and other nonmetallic mineral products. With the exception of textiles, clothing and leather products, these subsectors have low shares in the aggregate manufacturing sector output, thus affecting the aggre-
Table 1. Growth rates of manufacturing production by type, 1984-90 Industry Food Beverage industries Tobacco & tobacco products Textile, clothing & leather Sawmill &wood products Paper products & printing Petroleum refinery Other chemical products Cement & other nonmetallic mineral products Iron & steel products Non-ferrous metal base industries Cutlery & other nonferrous metal products Electrical equipment and appliances All manufacturing
1984
1985
1986
1987
1988
1989
1990
Aver
-36.7 41.2
42.7 -1.2
-2.9 26.6
24.4 13.5
6.1 4.5
-10.4 10.1
19.8 -4.1
6.1 12.9
88.1
-3.1
-6.0
-4.7
5.7
-12.1
12.0
11.4
50.0
20.8
19.3
14.0
7.7
-16.4
57.1
21.8
32.2
25.0
5.4
-0.2
24.0
-18.6
-7.2
8.7
-5.8 18.6 117.2
-9.6 27.9 -21.3
8.3 -5.0 19.5
-15.3 -18.2 36.6
-11.6 8.0 30.1
-9.1 28.8 -8.2
11.5 -19.2 -7.1
-4.5 5.8 23.8
-15.7 105.5
50.0 75.1
-25.5 -16.0
4.9 10.6
47.1 -57.3
36.2 -33.9
17.3 47.0
16.4 3.9
10.9
155.3
24.6
7.8
3.3
3.3
34.2
11.0
242.6
59.5
-6.0
3.7
15.2
45.0
371.5
48.7
79.6
88.9
16.4
11.3
0.0
25.5
0.8
9.1
-
-38.2 9.9
-11.0 49.5 4.8
-71.3 10.9
Source: Quarterly Digest of Statistics, Vol. 7, No. 3, & Vol. 9, No. 2, and Ghana Statistical Service.
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WORLD DEVELOPMENT
gate only marginally. The major subsectors of food manufacturing and petroleum refining (accounting for 34% of sectoral output) grew less rapidly at an annual rate of 6% during 1984-9 1. The subsectors of beverage, tobacco and tobacco products, sawmill and wood products grew at 12%. It is indeed remarkable that since 1989, there has been a slow down in almost all industrial sector activities. The major losers are the beverage. sawmill and wood products, petroleum refinery, other chemical products, and iron and steel. Paper products and printing have consistently recorded negative growth since reforms began. The iron and steel subsector produced in 1990 only 5.2% of its 1977 output. What is remarkable about the response of private sector investments in manufacturing is that it is occurring simultaneously with considerable growth of the service sector in general, and distributive trade in particular. Note that these are activities with relatively lower sunk costs and shorter turnover periods. Currently, the service sector contributes 35% of GDP, more than a half of which originates from the distributive trade subsector. The subsector’s output is marginally below its 1970 level, but its share of sectoral output has been most consistent and growth since 1985 has been steady. The booming distributive trade subsector often encourages the remark in Accra to the effect that “Ghana has become a nation of traders.” There have been newspaper reports of investors obtaining international loans to import inputs for their manufacturing plants with public guarantees, and then diverting these to import finished consumer items for retailing.
7. CONSTRAINTS TO PRIVATE SECTOR EXPANSION We would argue in this section that while there is little empirical or survey evidence of increased risk as a result of perceived instability in policy formulation and implementation, which would lead to a loss of credibility, there is some reason (based on evidence of actual or observed behavior of Ghanaian businessmen as well as the conceptual work presented earlier) to suppose that risk-averse behavior makes potential investors shy away from long-term investment commitments. We first consider the results of some surveys about what investors indicate are their major constraints to expansion and then draw conclusions from their actual behavior to show that the poor response has more to do with other factors than they usually suggest to interviewers. For medium/large scale enterprises in a total sample of I33 firms surveyed by Aryeetey, Baah-Nuakoh, Steel et al. (1993) (hereinafter ABS), it was reported that inadequate finance was the most significant constraint for 53.3%. Even though it was the most impor-
tant constraint for the group, it would appear that finance became more of a problem the smaller the enterprise. For those with financial problems, half of these problems were associated with inadequate working capital and poor access to credit for equipment. Other important constraints identified related to poor demand for products as potential customers “had no money” and the fact that their equipment was too old. These findings were not significantly different from those of a World Bank survey4 which noted that “Out of 3 1 respondents, 21 complained of problems on the demand side, 1 I of the lack of raw materials. and as many as 24 of inadequate availability of credit.” Demand was often seen as a constraint on account of increasing competition with imported goods. On the constraints to possible exports from the non-traditional product sectors, (e.g., rubber, aluminium, pineapples, wood products, handicrafts, etc. ) the World Bank (1990) has noted five major broad areas in which firms of all sizes are affected. These are - Inadequate policy framework: - Inadequate financial mechanisms and incentives; - Inadequate knowledge of markets, product quality, investments and technical knowledge; - Inadequate institutional support; and - Inadequate export infrastructure. These problems are supposed to manifest themselves in inadequate trade policies, poor administrative procedures, inadequate investment finance and working capital, as well as poor development of private sector organizations to protect the interests of members and poorly established public institutions that are expected to facilitate exports. For small-scale enterprises, finance was also cited in the ABS (1993) study as their most significant constraint to expansion. What is interesting here is the greater variation in the source of the financing problem than for medium/large enterprises. The small firms in this survey had more problems with access to credit than the medium/large firms, while the medium/large ones saw more problems with demand than the modem small (not micro) enterprises, even though this was not considered to be the most important constraint. It may be noted also that in general, fewer small firms cited poor demand as a constraint in this later study than in the earlier one by Steel and Webster (1991). This is attributed to the bias in the later sample that focused more on firms that were considered to have good prospects for growth. It is thus obvious, from survey evidence only, that a more vigorous response of private investment appears to have been impeded by a number of institutional, structural, and financial constraints. The apparent dearth of medium-term financing, the rudimentary nature of capital markets, and the weaknesses in financial intermediation in general make it difficult for pri-
PRIVATE
INVESTMENT
vate businesses to find means of financing other than short-term bank credit. The generally low profitability of many private firms and the low overall level of domestic savings limited the prospects for investment financing from their own resources. Moreover, distortions in the tax treatment of capital and investment income, particularly the high capital gains tax (until 1990) and the withholding tax on dividends, acted as a disincentive to new investment and may have retarded the necessary restructuring of many private enterprises. On the other hand, however, the ABS (1993) study found that a significantly large number of businesses (particularly, medium and large businesses) had had access to formal credit. At the same time, the banking system seemed to suffer from excessive liquidity and yet had no incentive to seek out more loan recipients. These observations make us believe the problem with investment in Ghana is not simply one of inadequate finance and other institutional constraints.
8. ANOTHER SIDE TO THE STORY? While survey results may not necessarily reflect the other side of the coin, i.e. credibility, there is the generally accepted fact that deep mistrust by the private sector for a government whose earlier policies (first in 1979, and then in 198243) indicated an antagonistic attitude to private investment, may be a major reason for the absence of long-term private investments? Businessmen may express these views privately when there are no questionnaires in sight. The sentiment is often expressed among Ghanaians that various macroeconomic reforms are pursued only to satisfy donor conditions for assistance. Hence, in the absence of such assistance, government would reverse policies on liberalization. In reaction to this, the private sector chooses to put their capital in shortterm assets and dabble in sectors of the economy with quick and relatively high turnover, such as trading. With relaxed restrictions on imports of finished goods and price liberalization, the stage appears well set for choosing trading over long term physical investments. Following principal-agent theory, the expected incentives from the principal (government) to the agent (investor) y* (t3) to make the latter take the necessary actions (optimal) toward increasing investment appear to be increasing with each survey. What this means in theory is that the agent is not seeking a risksharing solution to the problem, but is completely risk-averse, which is unusual for any kind of private investor. Good reasons for such risk-averse behavior come from information asymmetry as when the private sector is not sure of what government’s next move is going to be. (Do not forget, they have seen situations when government has abolished a tax and reinstated it within one year!)
UNDER UNCERTAINTY
1219
Why should Ghanaian investors be highly risk averse? Alternatively, after 10 years of nearly strict government adherence to the ERP, is there any genuine fear of a policy reversal? While there may not be any reason to fear a direct policy reversal under the present political environment, Ghanaian investors have gone through experiences in the last 13 years that make them uncertain about government’s long-term philosophy and ideology in relation to the ownership of capital and its employment. They saw some investors lose all their investments to government in 1979, and also in 1982, following arbitrary decisions of government. While the policy environment has changed dramatically since then, and also stabilized with external support, mixed signals continue to come from certain sections of government, as shown earlier, that have suggested an antipathy toward private investments. Our consideration of the Rodrik (1990) model [t < (r - r*) - ~6 - IT(E + p)] suggests that the most important variable following reform is the value placed by investors on market distortions induced by the actions of government. Thus investors would have moved into manufacturing, for example, if they thought the distortions (r) were overshadowed by (a) the after-tax return on domestic investment less the yield on the alternative (distributive trade) in the absence of entry and exit costs, (b) the compensation for alternative capital reallocation (E6) was large enough, and (a) likely adequate compensation in the event of a policy reversal which is costed at rc(&+ p). It is our view that, while macroeconomic reforms have reduced extensively the value oft, it still remains too high for many private investors. This is not because the reforms are inadequate, but rather because perceived potential compensation for the third component of the inequality on the righthand side (cost of a change in attitude toward selected private investments, and not necessarily a wholesale policy reversal) remains zero in the view of most investors, following the mixed signals they have received from government for more than 13 years. There is no guarantee that they will not lose everything in one day, and therefore, they cannot attach any positive value to that component, thus depressing the right side of the inequality with a negative cost. To argue that investors shy away from long-term financial commitments because of such institutional constraints as, for example, the difficulties relating to business registration and inadequate knowledge of export markets, etc6 begs the question. What prevents investors in a near-liberal market climate (as currently obtains in Ghana) from factoring in costs incurred (both legal and illegal) into the prices of their outputs? Note that in the surveys mentioned above, there have been no suggestions about major difficulties with the output market. In any case, business registration has never been easy in Ghana in the last 30 years and
1220
WORLD DEVELOPMENT
Ghanaian traders are known all the world over, involved in transactions with all manner of intemational businesses. Ghanaian investors have become highly risk-averse, but risk-averse behavior from investors is rational only under relatively high levels of uncertainty. Thus, their behavior since 1982 has simply been a rational response to a highly uncertain political and economic environment.
9. CONCLUSIONS: HOW ARE LOW LEVELS OF PRIVATE INVESTMENTS TAKING THEIR TOLL ON THE ECONOMY? The trend of low private investment has been followed by increasing difficulty in ensuring a macroeconomic balance after 1991. Economic developments in 1992 contrasted sharply with developments in the preceding year. Thus, while various macroeconomic policy targets for 1991 appear to have been relatively easily reached, the achievement of similar targets for 1992 and 1992 appeared to the elsuive. By the beginning of the last quarter of 1992, it had become doubtful that the anticipated GDP growth rate of 5% would be achieved in view of difficulty of observing various benchmarks as a result of all manner of shocks and a number of inconsistencies in policy implementation. The first major shock was that there was a smaller than anticipated harvest of cocoa for the 1991-92 crop season, (arising from poor weather conditions), which resulted in a shortfall of US$70 million in export receipts. This trend continued into the 1992-93 season. At the same time, by September 1992, external financial assistance was about US$52 million below programmed levels as the World Bank delayed the release of the last tranche of the third Structural Adjustment Credit. By far the greatest fac-
tor affecting the achievement of various program targets, however, was the considerable expansion of the government bill for wages and salaries which was increased by 38.7% in September 1992 following labor unrest. In addition to this, several factors exerted upward pressure on public development expenditures in an election year. Thus, in the first half of 1992, the narrow fiscal balance (including foreign grants) indicated a surplus of only $6 billion, which was well below the mid-year target of u 2 1.2 billion, which was well below the mid-year target of e 21.2 billion. Moreover, in view of the shortfall in net external financing of about $9.6 billion by mid-year, there was a net domestic borrowing of $3.7 billion which included a net repayment to the banking system of $2.2 billion. The latter figure had been programmed at $32.0 billion. The rapid growth in expenditure on social development projects in rural Ghana as a prelude to the elections in 1992 precipitated the large fiscal deficit. Instead of the programmed narrow fiscal surplus of 1.8% of GDP a deficit of 5% resulted. By the end of 1993, the deficit was 3%. It would appear that government is having to increase its expenditures because the private sector is not spending as much on investments as is desirable to keep the economy growing. At the same time the private sector is unwilling to undertake long-term investments for reasons that include the fact that, while government policies may for the moment not necessarily be reversed or altered, mixed signals from govemment do not indicate a consensus on a development philosophy and, what role the private sector is expected to play. The uncertainty would only be removed under the present fourth republic if adequate legislation is passed to assure investors that property rights would be respected in future.
NOTES 1. Even though policies were successful in reducing inflation, the rate of inflation is still high. This leaves constant increases in nominal rates as the easiest way to make real rates positive. 2.
See Loxley, (1991).
3. ISSER. University of Ghana carried out a thorough analysis of the economy in its report, The Pare of ?he Ghanuiarz Economy 1991, in 1992. 4.
See World Bank (1990).
5.
A number of actions taken by the AFRC and PNDC
Governments in 1979 and 1982 strongly suggested a bias against private wealth. These included the freezing of all bank accounts with balances exceeding $50,000 and the confiscation of various assets through the Citizens’ Vetting Committee. Since then, statements by a section of the leadership suggest that similar attitudes continue to prevail, in spite of the reform. A statement made by the President in May 1993 at the Trade Fair site was generally construed by a section of themass media and the general public as being resentful of private Ghanaian businesses. 6.
That is the position often adopted by donors.
PRIVATE INVESTMENT
UNDER UNCERTAINTY
1221
REFERENCES Altaf, Z., Entrepreneurship in the Third World: Risk and Uncertainty in Industry in Palistan (London: Croom Helm, 1988). Aryeetey, E. Y. Asante, and A. Y. Kyei, “Mobilizing domestic savings for African development and diversification? A Ghanian case study,” Mimeo (Oxford: International Development Centre, Queen Elizabeth House, Oxford University, 1991). Baah-Nuakoh, A., E. Aryeetey, and W. F. Steel, “Background paper on SME demand for finance, for the study of Meeting the Financing Needs of Ghana’s SmallMedium-Scale Enterprises,” (Accra: World and Bank/NBSSI, 1993). Devarajan, S. and J. de Melo, Evaluating participation in African monetary unions: A statistical analysis of the CFA zones, World Development, Vol. 15, No. 4 (1987). Dombusch, R., “Notes on credibility and stabilization,” Mimeo (1988). Helleiner, G. K., “Outward orientation, import instability, and African economic growth: An empircal investigation,” in S. La11 and F. Stewart (Eds.), Theory and Reality in Development: Essays in Honour of Paul Streeten, New York: St. Martin’s Press, 1986). Faini, R., Credibility, Investment and the Real Exchange Rate, Mimeo (Bologna: Johns Hopkins University, February, 1989). ISSER, The State of the Ghanian Economy Report 1991 (Legon: University of Ghana, 1992). Loxley, J., Ghana: The Long Road to Recovery 1983-90 (Ottawa: The North-South Institute, 1991). Rees, R., “The theory of principal and agent,” in John D. Hey
and Peter Lambert (Eds.), Surveys in the Economics of Uncertainty (Oxford: B. Blackwell, 1987). Rodrik, D. “How should structural adjustment programs be designed?’ World Development, Vol. 18, No. 7 (1990). Rodrik, D. “Policy uncertainty and private investment in developing countries,” NBER Working Paper 2999, (Cambridge, MA: NBER, 1989a). Rodrik, D. “Promises, promises: Credible policy reform via signalling”, The Economic Journal, Vol. 99 (September 1989b). Steel, W. F., and L. M. Webster, Small Enterprises in Ghana: Responses to Adjustment, Industry Series Paper, No. 33, (Washington DC: World Bank Industry and Energy Department, 1990). Stewart, D. B., and Y. P. Venieris, “Socio-political instability and the behavior of savings in less-developed countries,” The Review of Economics and Statistics, Vol. 67 (November 1985). USAID “Trade and Investment Project Document,” (Accra/Washington: USAID, 1992). van Wijnbergen, S., “Trade reform, aggregate investment and capital flight: On credibility and the value of information,” Economics Letters Vol. 19 (1985). Wheeler, D. Sources of stagnation in sub-Sharan Africa,” World Development, Vol. 12, No. 1 (1984). World Bank, “Ghana: Progress on Adjustment,” (Washington, DC: The World Bank, 1991). World Bank, “Ghana: Survey of medium and large manufacturing enterprises,” Technical Working Paper No. 5 (Washington DC: The World Bank, July 1990).