Tanzania: Explaining Four Decades of Episodic Growth1 Chapter 13 of volume 2



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Tanzania: Explaining Four Decades of Episodic Growth1

Chapter 13 of volume 2

Nkunde Mwase and Benno Ndulu2

Contents


List of Tables
Table 1a: Tanzania: Contributions to Growth

Table 1b: Sub-Saharan Africa (SSA): Contributions to Growth

Table 2a: Augmented Solow Model

Table 2b: Tanzania: Contribution to Growth Based on Fitted Growth from the

Augmented Solow Model

Table 3a: Baseline Pooled Regressions and Contributions to Growth

Table 3b: Tanzania: Contribution to Growth from Pooled Model

List of Figures

Figure 1: Augmented Solow Model: Actual and Predicted Real GDP per capita (In

percent)

Figure 2: Residuals from Augmented Solow and Policy Models

Figure 3: Pooled Policy Model, Actual and Predicted Real GDP per capita (In percent)
1. Introduction
Tanzania’s growth experience during the first three decades after independence can be characterized as unsustainable, with a sudden death after early success during the first 10 years of independence. In terms of long-term growth, a strong control regime (1970- 1985) based on socialist principles spawned high private investment risk, epitomized by nationalization and widespread controls of markets for products and resources; an injudicious public investment program that did not follow rigorous project appraisal; and an overextended public sector that faced both capacity and revenue constraints to operating and maintaining an ambitious redistributive development program. The last decade and a half has seen a very significant change of course from this paradigm to a market-oriented one accompanied with a strong revival of sustained growth which has averaged nearly 5 percent annually since 1995. One additional important change during this period is Tanzania’s adoption of competitive democracy, which unlike the short-lived experience just before and after independence, seems to be taking deeper societal root.

Despite its coastal location, sustained donor support, and large labor force Tanzania’s growth experience during the control regime period was low, largely on account of economic mismanagement. The egalitarian undertones in government policymaking resulted in the subordination of economic incentives to political objectives. Economic policymaking during the 1970s and early 1980s was designed to support the political goal of achieving equity at the interpersonal, interregional and rural-urban levels. Weak governance and weak incentives from the “socialist – type” policymaking resulted in sustenance of a large, loss-making public sector. Inefficient and loss-making state marketing agencies and parastatals, and heavy taxation of agriculture and exports, coupled with an expansionary government expenditure aimed at providing universal access to social services resulted in unsustainable fiscal deficits, a sharp decline in foreign reserves and shortages of consumer goods. Government policy was unable to address the economic and structural problems, and as a result, the economy stagnated during the late 1970s and early 1980s.

It is noteworthy that as early as 1981, President Julius Nyerere encouraged a home-grown review of Tanzania’s economic model of development. As Muganda (2004) notes, the openness and inclusiveness of the consultative process of the 1980s internal debates, led by the University of Dar es Salaam, brought together reformers and nonreformers, helped clarify and broaden the understanding of issues, and legitimized the need for economic reforms. In combination with experimentation with homegrown programs - such as the National Economic Survival Programme (1980 - 81), Tanzania’s own Structural Adjustment Program (1982 - 85), partial import liberalization via the Own Funded Import Scheme (1984) - it provided the government space to test, learn from, and adapt reform measures to country circumstances; to minimize alienation of support groups; and build confidence in the government to scale up the reform measures systematically (p.6).

Although the initial process of liberalization of trade and prices in 1984 and 1985 occurred under Nyerere’s regime, the entrance of a new political actor, President Ali Hassan Mwinyi, in 1985 enabled the government to carry forward the shift towards a market-based economy much more decisively. This period was marked by rapid easing of controls, in particular price and trade liberalization. The policy environment improved significantly following the resumption of the adjustment programs during the period 1985 to 1990. The government embarked on an intensified adjustment program, focusing on devaluation of the shilling, in order to improve external competitiveness and spur growth. In addition, measures were undertaken to address the incentive structure in order to stimulate growth by gradually increasing producer prices, reorganizing public enterprises and removing subsides.

A second aid boom occurred in response to the positive policy environment. Unlike the future aid booms, this one essentially substituted monetary financing of the deficit but left the fundamentals behind the large deficits unaddressed. The single most important success of this regime was the freeing up of the key product and resource markets and removal of the rents associated with price and exchange controls.

After the initial wave of successful reforms, commitment to further reforms weakened, partly reflecting the vested interests involved in the second-order structural reforms being pushed from 1990 onwards in order to address both the incentive and fiscal gap issues. In addition, institutional weaknesses emerged as key economic actors sought to obtain “rents from sovereignty” arising from the escalating aid inflows. The increase in tax exemptions and laxity in public finance management was symptomatic of corruption and governance issues. The implicit role of donors as adjudicators and monitors of government’s performance was demonstrated through the withdrawal of assistance in the mid-1990s.

The emergence of the third regime government in 1995 provided a fresh platform to ground the economic reforms undertaken in the previous decade in fundamental institutional and legal changes. The government undertook fundamental changes to underpin macroeconomic stability by taking measures that directly reduced the fiscal deficit sharply and granting autonomy to the central bank whose mission was reconstituted to focus primarily on ensuring price stability and prudent exchange management. These measures were accompanied by structural reforms emphasizing the importance of restricting the role of the state to providing an environment conducive for private sector growth. Reflecting the government’s concerns about raising the welfare of the people, poverty alleviation programs were also implemented. However, the government underscored the importance of increasing the efficiency and effectiveness of projects, providing targeted basic social services to the poor and emphasizing the importance of growth for sustained delivery of social services. This marked a departure from the over-expanded government model of the 1970s, which emphasized universal provision of all social services, which were largely funded by aid. Owing to the strong track record of policy implementation, the country experienced a resumption of, and subsequently a sharp increase in, aid and private foreign direct investment, both of which have remained high throughout the period.

From the foregoing, three features stand out regarding Tanzania’s development experience. One of them is Tanzania’s sharp swings across development paradigms, starting with a market–oriented economic regime for the first decade after independence; a sharp shift to a hard economic and political control regime, based on socialist principles, for the next two decades; and a sharp turn back to a market-oriented economy and a democratic political regime thereafter. The second feature is the process of intense internal debate and consensus building prior to the change from the hard control regime to the market-oriented one, which has helped to underpin a sustained reform process since 1986. To a large extent, the debate was paralleled by wide exercise of exit options from controls by economic agents, in the form of mushrooming parallel markets and the underground economy, which served to underscore the weaknesses of the failing regime. And thirdly is the strong donor support and role in all these stages, notwithstanding the sharp swings in the approach to development.

The rest of this paper is organized as follows. Section 2 describes the macroeconomic performance of the economy, decomposing growth into three periods: 1970 – 84, 1985 - 95, 1996 – present. It presents the growth decompositions from the growth accounting and regression estimates. Section 3 describes the market system in operation with a particular focus on the goods, labor and financial markets. It presents the market structure, including the constraints and the performance in view of the opportunities available. Section 4 examines the responses of household and firms to the constraints with a focus on the factors hindering an increase in income per capita and growth, respectively. Section 5 discusses the politico-economic dimension of growth experience highlighting the linkages between the pace of the reform process and the politico-institutional framework. Section 6 concludes.

2. Growth Experience
Four features characterize the growth opportunities of Tanzania: (i) easy access to the international market given its coastal location; (ii) rural labor surplus and the low productivity of agriculture; (iii) political stability and ethnic cohesion built around a common national language, Swahili, and as a result of an early and persistent effort to forge and sustain national unity; and (iv) more recently mineral wealth discovery, predominantly gold and gemstones, as well as natural resource-based tourism.3

By far the most dominant long term growth potential relates to the combination of coastal location and labor surplus. The capital intensive nature of the booming mining sector limits its importance in translating growth into high welfare for the Tanzanian population. Translating growth into higher employment is important in light of the large labor surplus in agriculture and can be achieved through the use of market friendly policies to attract lucrative labor intensive private sector activity. Though Tanzania is ethnically diverse with 133 tribes, there is a high degree of ethnic cohesion and political stability. This has created a environment conducive for movement of labor and partly explains the relatively high degree of interregional labor mobility in Tanzania as well as absence of acrimonious political geography.

However, the wide dispersion of Tanzania’s agricultural potential and natural resources makes exploitation highly transaction cost-intensive. With a vast geographic area, high agriculture potential and mineral wealth are located around the rim of the country. Tanzania has a poor dendritic transportation network to the coast (access to the international market) and the main domestic market (Dar-es-Salaam), which accounts for more than 60 percent of the income (and hence demand) base. Transport infrastructure is therefore is a major constraint to growth. Furthermore, given the wide dispersion of agricultural potential and population, rules out economies of agglomeration and partly accounts for the high unit infrastructure cost associated with dispersion of services.

With these opportunities in mind, this section aims to provide an overview of Tanzania’s growth experience. The first sub-section provides a brief historical background of Tanzania’s post independence development experience and the motivation behind the strong control regime and its subsequent abandonment. The second sub-section defines the time pattern of growth and identifies the relevant periods of this process. The third sub-section describes the growth models utilized to decompose actual growth into the main factors of production and compares Tanzania’s growth performance relative to other countries. The fourth sub-section presents the empirical results and evaluates the performance of the models.


2.1. Historical Setting
Immediate post-independence period, (1961- 1967), was largely characterized by a continuation of the inherited economic policies and relatively strong income growth per capita (Muganda 2004). Capital formation increased steadily during the period 1963 to 1967 and the economy remained on a positive growth trajectory with an income growth rate per capita of 4.1 percent during this period.4 The rising trend in domestic investment in the early 1960s was supported by a high level of domestic savings. Grain exports exceeded imports and the overall rural development effort in place was quite successful.

The government was not content with the speed of industrial growth and the extent to which indigenous ordinary Tanzanians were benefiting from independence. It highlighted the dangers of becoming trapped in a dependent capitalist development which offered nothing but increased alienation to the peasant majority. The government was concerned about Tanzanian’s continued high external dependence particularly in light of evidence indicating increasing manufacturing capacity in neighboring countries.5 It was argued, that following independence, a dependent but growing African capitalist class had emerged, creating a potential for a dynamic coalition of this elite group with foreign capitalists hence perpetuating dependence on the former colonial powers.

Initially, the government encouraged Africanization of the public sector through covert policies designed to promote the local economic base retaining the capitalist policies in place. Industrial development was promoted by import substitution policy within the context of a fairly open economy. Peasant agriculture was promoted using conventional methods that encouraged agricultural intensification through mechanization and use of fertilizers and pesticides.

However, in 1967 the government enunciated its move to socialism. The Arusha Declaration of 1967 charted a new course of development with a focus of public ownership of major industries, in particular, heavy industry. The government noted that its two overarching aims – stimulating rapid economic growth and achieving self reliance – could not be achieved without government intervention. Self reliance and African socialism were thus enunciated as the means to speed up development under the Arusha Declaration of 1967. The Declaration was specific about ownership noting in particular that foreign investment could not act as the principal agent of industrial investment. This was partly on account of the unreliability of foreign capital inflows, particularly in view of the very poor and frustrating response of FDI relative to the goals of Tanzania’s First Five Year Plan, and due to the inconsistency of foreign led industrial growth with the principles of socialism and self reliance. Furthermore, the Arusha Declaration brought to the core the objective of equity – interpersonal, interregional and rural-urban- with its implication for industrial location and pay structures. The principles of state ownership of rents and the objective of equity found deep resonance with Nyerere’s own Fabian socialism beliefs, which were widely embraced by many of the first generation leaders in Africa (Ndulu 2005). Income growth per capita declined in 1969 and 1970 as the negative effects of the onset of socialist policies kicked in ( Bank of Tanzania 1994).



It is quite striking that even the hard control phase of Tanzania’s development received quite strong endorsement by development partners as evidenced by the large inflows of aid and official credit to fund the country’s socialist programs. Despite the enunciation of African socialism as the basis for government policymaking aid inflows increased significantly during the period 1967 to 1977 both in absolute terms and relative to other Sub-Saharan African (SSA) countries.6 The “socialist” vision of Mwalimu Nyerere’s Presidency excited widespread admiration and support from academics and policymakers in the capitalist West. As the global developmental paradigm in vogue turned against state-led planning, Tanzania’s policies were increasingly criticized by donors. Despite the decrease in aid inflows during the early 1980s Tanzania received higher inflows than most SSA countries, including Ghana which at the time was considered the “star” performer (Bigsten et al, 1999). Tanzania’s evolving relationship with donors illustrates the endogeneity of the perceived state of the policy environment to the prevailing global developmental paradigm. It also suggests that aid inflows may be subject to a high degree of inertia; once committed they are difficult to terminate.
2.2. Growth Episodes
Tanzania’s average per capita income growth averaged 0.7 percent during the past four decades. Tanzania’s post-independence growth experience is almost in the middle of the pack of African countries but displays a high degree of variation over the period. Following the characterization of the growth experience in the first decade in section 2.1 the rest of the period can be sub-divided into three periods: a hard control regime period, from 1970 to 1985; period of softening of controls, 1985 to 1995; and market friendly and democratic period, from 1995 to date (Table 1). A brief discussion of each period follows.
***Table 1 (both a and b) near here***
2.2.1. 1967 – 1985: Strong Control
Economic mismanagement resulted in low income growth rate per capita averaging 1 percent during the period 1970 to 1985. Early success in achieving income growth rate of 3.4 percent is attributable to the establishment and expansion of the industrial sector. Public investment during the period 1970 to 1985 averaged 9.6 percent of GDP. However, preponderant controls, disincentives to work and invest encompassed in the collective production schemes and import substitution strategy spawned a thriving underground parallel market. With this undercurrent, the adverse exogenous shocks the country experienced during the late 1970s, in particular, the end of the coffee boom in 1978, the oil price shock in 1979 and the costly war against Idi Amin’s Uganda in 1979 prompted a sudden death in growth during the period 1979 to 1985. The tightening of controls in the face of adverse exogenous shocks and dwindling reserves further fueled the thriving parallel markets and undermined the revenue base of government and officially recorded exports.

In the face of balance of payments crisis the government increasingly utilized deficit financing to close the resource gap. This resulted in high inflation rates and sharp declines in real wages – further fuelling withdrawal from the official economy by a wide range of economic agents. Economic policy mistakes by Mwalimu Nyerere’s government in the face of shocks worsened what had already become a crisis. As a result, the economy was in recession during the period 1980 to 1985 with income per capita declining at an annual (negative growth) rate of 1.8 percent. Despite this negative income growth, investment during the period was not curtailed as the government sustained its capacity expansion drive to stimulate growth and sustain the political patronage system. Public investment remained high during the period 1980 to 1985 averaging 8.7 percent, nearly at the historical levels of the previous decade.


2.2.2. 1985 – 1995 : Softening of Controls
There was a sharp recovery in income growth per capita during the period 1985 to 1989, averaging 3.0 percent, mainly due to resurfacing of underground economy as the stringent controls were relaxed. In addition, the large supply response to the increased availability of goods – ending nearly a decade of frustrated demand- had a positive effect on growth. Symptomatic of the improvement of the macroeconomic environment was a rise in reserves from an average of 0.9 months of imports of goods and factor services during the period 1976 to 1985 to 3 months of imports by June 1993. This recovery was followed by a period of setback with low income growth per capita, averaging negative 0.2 percent during the period 1990 to 1995, as adherence to the reform process waned. A key reason behind the slow down of reforms is a near abdication of the government from its reformist role as the first constitutional application of term limits was about to be applied under competitive politics. This period was marked by a rise in corruption reaching the highest levels of government (Helleiner 2000). The reform process was relegated as efforts were employed to accrue ‘rents to sovereignty’ emanating from the second aid boom. The exodus of key donors providing balance of payments support resulted in a decrease in reserves to 1.5 months of imports by 1995.
2.2.3. 1995 – To Date: Market-Oriented Reforms
The deepening and persistence of the reforms has resulted in sustained economic growth, with high growth particularly since 1999. Tanzania has posted an average income per capita growth of 2 percent during 1996-2004. Two important features characterize growth recovery during this recent period. First, the growth trajectory has shifted upwards due to a more diversified economic base. The main growth drivers have been the mining sector (mainly discovery of gold) and tourism, posting average growth rates of 15 percent and 10 percent respectively. A second feature is that growth is now much more export-oriented. There has been a large increase in the share of foreign exchange earnings in total production. Merchandise export earnings increased from an average of $350 million during the period 1985 to 1995 to slightly more than $1000 million in 2004 (with $200 million of these being traditional exports) and earnings from services rose more than three fold, from about 200 million to the current $700 million during the same period. In combination with resumption of aid, official reserves increased from 1.6 months of imports of goods and services in 1985 to the 7.9 months in 2002 and about 1 billion dollars in 2004. In contrast to the immediate previous phase President Mkapa adopted good policy environment as a legacy, even as he faced the constitutional term limit. His focus on binding reform success in legal and institutional reforms augured well for sustainability of the market system beyond the term (Muganda 2004).
2.3. The Growth Models
Two models are utilized to capture the sources of growth in Tanzania: i) standard growth accounting by Collins and Bosworth, and ii) regression based decompositions that tie down growth differences across SSA picking up the ‘contributions’ of various explanatory variables on growth. In essence, the regression-based decompositions explore the idiosyncratic determinants of growth in Tanzania after accounting for growth in SSA.
2.3.1. Collins and Bosworth Growth Accounting Exercise
The standard growth accounting exercise, draws on the Collins and Bosworth framework to estimate contribution to growth of capital, labor and total factor productivity (TFP). A Cobb-Douglas production function using a three factor model with physical capital (K), human capital adjusted labor (h.L) is estimated. Total factor productivity (A) is obtained as a residual in the growth accounting framework.
Yt = At.f(K0.35t, (ht.Lt)0.65) (1)

The model is based on two underlying assumptions: constant returns to scale with capital share of 0.35.7 The capital stock series is generated using the perpetual inventory method where the depreciation rate of 0.04 is assumed.8 Human capital is generated from average years of schooling data under the assumption that each year of additional educational attainment raises marginal product by 7 percent.9


2.3.2. Regression-Based Decompositions
Regression-based decompositions provide an indication of the variables that are likely to be important at the country level. These are based on a panel regression framework in which growth is estimated conditional on a list of plausible determinants of growth. Regression-based decompositions therefore overcome the limitations of the growth accounting exercises in identifying the contribution of country specific variables.
ln yit – lnyit-1 = -αlnyit-1 + x’itβ + z’iγ + eit (2)
where x’it is a vector of time-varying growth determinants; z’i is a vector of fixed effects determinants, and the lagged income variables (lnyit-1) allows for conditional convergence. Two different approaches are taken: the augmented Solow model using general method of moments and the pooled policy model.

The augmented Solow model decomposes growth to capture the ‘contributions’ of initial income10, investment, human capital (proxied by education), replacement requirements and a residual.11 The replacement requirements variable is a composite variable comprising of a linear combination of rate of population growth, technological progress and the rate of capital depreciation12. The augmented Solow model utilizes systems – general method of moments (SY-GMM) approach in order to eliminate the potential biases arising from correlation of the estimated country specific characteristics with other unobserved effects. A two-step procedure is utilized: the first step involves estimation without the measured country specific characteristics. Having obtained consistent estimates, residuals are estimated and then regressed on the country specific variables using the SY-GMM approach.13 However, the model treats technological process as an exogenous process and does not model the effects of changes in policy regime on the variables. Endogenous growth literature has shown that there are various channels through which changes in the policy environment can affect the rate of accumulation and/or the efficiency of factor utilization.14



The pooled policy model incorporates the impact of policy variables to growth enabling it to capture the tragedy of the strong economic control regime, which sacrificed growth in favor of rents to the narrow political and managerial elite and unsustainable redistributive strategy pursued by government. The black market premium, representing policy distortions related to the control regime and institutional soundness are the key variables in the pooled policy model. In addition, country specific variables, such as geography and initial growth are included. The approach is based on Chenery and Syrquin model and utilizes panel OLS based approach in which the baseline regression is first estimated enabling growth to be characterized conditional on country specific variables. This is followed by an examination of the partial correlations of growth with policy variables conditional on the baseline determinants. Finally, the ‘full’ specification is estimated with both baseline and policy variables.
2.4. Empirical Results
Based on Collins and Bosworth model, for the 40-year period, 49 percent of the growth is due to contribution of growth in capital per worker, 6 percent is due to the contribution from education per worker, and 45 percent is due to productivity (the residual). The contribution of capital per worker declined from over 80 percent to 20 percent during the period 1975 to 1985 reflecting the negative impact of the government’s import substitution programme particularly its focus on capital accumulation. The TFP decreased during the period turning negative between 1975 and 1984. This period was characterized by a tragic collapse in investment productivity, decreasing foreign reserves and capital controls. As the public investment projects had been largely financed through external borrowing the sharp rise in interest rates and scaling down of support from the multilateral institutions had a negative impact on growth, precipitating the balance of payments crisis. The rebound of the economy during the period 1985 to 1990 was associated with a sharp rise in the residual. However, in essence this is mainly attributable to the resurfacing of underground activity, as opposed to an improvement in productivity. During the period 1990 to 1997 TFP turned negative as a result of delays in the implementation of structural reforms, in particular, privatization during the early 1990s and lagged effect of the benefits from privatization when it was eventually undertaken. However, capital productivity increased significantly during the period reflecting the impact of increased capacity utilization particularly in the late 1990s. Tables 1a and 1b illustrate the results from the growth exercise by half-decade for Tanzania and SSA, respectively.
The growth projections from the Augmented Solow model, developed using SY– GMM approach, are broadly consistent with the actual pattern of growth and the findings from the growth accounting exercise. Table 2a presents the results from the augmented Solow model for SSA. The results indicate that there is conditional convergence as reflected in the negative coefficient on the initial income variable. This is particularly important since Tanzania’s initial income per capita growth was lower than other countries. Consistent with results from other empirical studies, human capital variable does not affect income growth per capita.15 There is an inverse relationship between population growth and income growth per capita. Though investment is positively related to income growth per capita for the full sample, investment has a negative contribution to growth in Tanzania (Table 2b), due to reasons discussed above.
***Tables 2a and 2b near here***
However, the Augmented Solow model over-predicts Tanzania’s growth throughout the period. It indicates that Tanzania should have grown faster, necessitating an explanation of the large overall residual (Figure 1). The residuals were particularly large during 1975-85. A strong explanatory candidate here is the tragedy of collapsing investment productivity since mid-1970s. A notable feature from the periodization is the sharp decline in the contributions of capital per worker and TFP despite a major public investment drive during the period 1975 to 1985. This is attributed to poor investment decisions, including white elephants projects, resource misallocation resulting from capital subsidization and constraints to capacity utilization as import capacity weakened.
***Figure 1 near here***

The pooled policy model under-predicts growth during the control regime period in which poor economic policy dominated and over-predicts it during the positive policy reform period (Figures 2 and 3). Thus, despite the incorporation of policy effects, the residuals from the policy model are on average of similar size to those in the augmented Solow model. Tables 3a and 3b provide the baseline results from the pooled policy model and the estimated contributions to growth based on the fitted growth rate.


***Figures 2 and 3 near here***

***Tables 3a and 3b near here***


The under-prediction of growth by the pooled policy model during the period 1970 – 1984 suggests that there were other factors that bolstered growth. The focus on equity and poverty alleviation attracted financial support from numerous development partners despite the weak policy environment.16 Tanzania’s dependency on foreign assistance increased in spite of its rhetoric policy of self reliance, with foreign aid excluding technical assistance rising from 0.5 percent in 1970 to 5.2 percent of GDP in 1984 (Helleiner 2000). The foreign assistance cushioned the adverse impact of adjustment measures on the economy enabling Tanzania to maintain relatively higher import levels than would have been possible without the aid given the steep collapse of exports and foreign reserves. Drawing on the Hansen-Tarp (1999) findings that aid has a positive impact on growth even in economies characterized by weak policy environment, it can be argued that the higher-than-projected growth was partly supported by the sustained aid inflows. However, it must be emphasized that the donor inflows merely delayed the adjustment process and induced a decrease in external competitiveness as inflation soared during the period. In addition, Tanzania’s legacy of low investment productivity in comparison to other SSA countries is largely attributed to the overextended public sector and high capital accumulation.

However, the pooled policy model over-predicts income growth per capita during the period 1985 – 1989. Though the policy initiatives had some positive effects, the achievement of sustainable growth remained constrained with growth in income per capita being lower than the average for SSA. For example, though the reforms succeeded in reviving agricultural production, structural bottlenecks such as poor transportation and marketing of agricultural commodities and weak inter-sectoral linkages were not addressed. As a result, agricultural exports remained stagnant. In addition, inflation remained high as the distribution of food across the country was poor. Moreover, the delays in unification of the exchange rates (in the official and parallel markets) had severe fiscal and monetary ramifications for reinforcing inflationary pressures. The burden of external adjustment was placed on exchange rate controls and concessional financing as opposed to realignment of the exchange rate or aggregate demand management (Kaufmann and O’Connell 1999).

The pooled policy model over-predicts the growth performance during the period 1990 to 1997. The poor performance of the model in tracking growth per capita during this period is linked to limitations in the model with respect to capturing policy reversals and exogenous shocks. The black market exchange rate premium, a key measure of policy in the model, continued to fall (indicating continued improvement) as the process of unification of the foreign exchange market proceeded with substantial amount of aid continuing to flowing into the country during 1990-93. The government’s waning commitment to reforms particularly after 1992 reflected its laxity in public finance management, illustrated by the massive tax evasions, resulted in a re-emergence of serious macroeconomic imbalances as reflected in a soaring inflation rate and large and widening fiscal imbalances. This led to the negative growth in 1992 and had a dampening effect on growth in the ensuing years before its resurgence after 1996 as the third phase government returned to a durable reform path.

The impact of exogenous shocks resulting from the El nino rains in 1997 were possibly larger than that captured in the model. The rains had a detrimental effect on inflation and aggregate industrial production through their negative effect on the transport infrastructure, electricity generation and food crop production. Reflecting these negative developments, actual GDP per capita turned negative in 1997. As a result, despite the prudent fiscal policy inflation remained double digit and the period 1996 – 1998 was characterized by periods of negative per capita growth.

The productivity effects of structural reforms, resulting from foreign capital injection and know-how, were felt towards the end of the 1990s and early 2000s. Moreover, as Moshi and Kilindo (1999) note, the response of investors to these policies differed. Thus, while there was a swift positive reaction from private investors to the trade liberalization policies, the response to privatization was more gradual. These factors reinforced the low growth rate in the mid-1990s.




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