Government Intervention and Market Structure

Central to government’s policy was the creation of “ujamaa” villages modeled along the lines of Mao Tse Tung’s Chinese communes. Ujamaa villages were established in areas with scattered homesteads with the objective of replacing the individual farms with a network of village communities in which land could be collectively owned and production collectively organized. This resulted in an increase in the population residing in settled villages from 5 percent of rural population at the start of the program to 60 percent by the end of 1975 (Lofchie 1989).

Production in remote areas was heavily subsidized by the government directly, through inputs subsidies, and indirectly, through the system of pan-territorial prices. The latter involved the setting of the same prices in all regions with the transportation costs absorbed by the state. Pan-territorial prices were introduced in the early 1970s and adjusted upwards several times in the mid-1970s. This encouraged production in potentially productive but remote areas (Amani et al. 1992; Geir 1995).

The government intervened significantly in setting of food prices as this was considered a captive market.²⁰ Stringent price controls were increasingly applied from the early 1970s as inflation increased in order to encourage production of domestic food crops and support the low wages paid to civil service. Producer prices were announced before the start of the season and were designed to induce production while ensuring equitable distribution of welfare across all the regions. In order to stimulate domestic production of maize higher prices were offered in the ten most important maize growing areas in the country. However, consumer prices were also subsidized with little regard to the actual costs of marketing maize.

The cost of the villagization program coupled with weak state marketing agencies, loss making parastatals and unsustainable attempt at providing universal access to social services resulted in a sharp decline in foreign reserves and shortage of goods. The villagization program, which was based on collective production with farmers sharing the profits of their labor, provided a strong disincentive to work particularly as output was divided without due regard to effort. The food crisis of 1974/75 is linked to drought but also to the collectivization policy. The villagization programme was eventually quietly abandoned as the costs entailed in relocating families escalated and production in the newly established villages remained low.

State marketing and import controls strategy spawned a large underground economy with thriving parallel markets. The pan territorial pricing system penalized the producers near the major urban centers, by cross-subsidizing distant producers who faced higher transportation costs of getting their products to the market (Jayne and Jones 1997).²¹ Maize shortages emerged as inefficiencies in the marketing system and distribution costs of inputs increased

In response to the food shortages, the government introduced dual producer and consumer prices in 1982/83 for some major and minor crops as a means to provide an incentive to growers in designated regions for producing a crop for which it was felt the area had a comparative advantage. Consumer prices were also varied depending on whether the region was a major producer of the predominant staple food or not. The consumer prices were subsidized with little regard to the actual costs of marketing maize.

In order to increase ownership of industry, government policy focused on expansion of public industrial sector and consolidated these initiatives with institutional foundations for socialist development. In addition reflecting the equity objective, the link between industrial development and rural development was emphasized. To achieve this, the government encouraged the development of small scale industries and adopted a decentralization policy identifying nine towns where industries would be located. ²² The government emphasized the importance of structural transformation of the economy in terms of product mix. It also sought to increase the manufactured valued addition in exports and widen the range of manufactured products to include not only consumer goods but also intermediate and capital goods.

Industrial growth remained high in the first few years after the Arusha Declaration reflecting the effect of the creation and expansion of the sector. The sector grew from roughly 40 entities in 1966 to about 450 entities by the mid 1980s. Though backwards and forward linkages were strong when compared to other African countries the industries remained loss-making and were characterised by low productivity. The sector benefited from protection and transfers from the government. Moreover, though the investment program was driven by the public sector, most of the investment undertaken was donor funded.

The industrial sector was vulnerable to the external position of the country due to its reliance on the state subventions for foreign exchange. The sharp decline in foreign reserves following the external shocks in the late 1970s had an adverse impact on the industrial sector since it depended on imports for its capital goods and more critical intermediate goods and relied heavily on state support for its financing. The shortage in foreign exchange resulted in an abortive import liberalization in 1978.

In the face of the adverse exogenous shocks, the government did not realign the exchange rate partly as it felt that devaluation would hinder the development of the parastatals. Instead import restrictions supported by donor inflows were employed to maintain the overvalued exchange rate in the face of balance of payments crisis. This had a sharp adverse impact on the very sector it was designed in part to protect. The industrial sector recorded negative growth rate towards the end of the 1970s and early 1980s on account of sharp cuts in raw material, intermediate inputs and capital goods. The government argued that it was not microeconomic inefficiencies but macroeconomic weaknesses that needed to be resolved. The government underscored that the high costs of basic intermediates substitutes were a key factor behind the poor performance of the parastatals. It favored the support of parastatals through maintenance of a strong currency.
3.1.2. Softening the Control Regime and Modest Recovery of Growth (1985 – 95)
The period was characterized by government withdrawal from direct involvement in production, processing, and marketing activities retaining only its role in setting policies. The large losses incurred by the state agencies coupled with the food shortages and rampant smuggling forced the government to reform the food crop sector (Putterman 1995; Bank of Tanzania 1981). These reforms gained momentum after the government expedited the implementation of the structural adjustment program emphasizing current account liberalization. Initially producer prices were increased and tariffs were reduced. During the period there was a gradual move towards liberalization of marketing of food and cash crops, removal of the monopoly export powers of crop export marketing boards and restructuring of several parastatals (World Bank 1994a). In addition, the government increasingly phased out the implicit subsidy on mineral fertilizers. This moved from 80 percent in 1988/89 to 70 percent in 1990/91 and was finally terminated in 1994/95.

Economic performance improved, albeit gradually, however the industrial sector did not recover. Though farmers responded positively to the increases in prices in the mid-1980s, weak marketing and poor distribution chain hindered an increase in food supplies to urban areas and a sharp increase in cash crop exports between 1987 and 1989. In addition, though controls on exchange rate were relaxed the underground economy reacted somewhat slowly reflecting concerns about tax implications of resurfacing and uncertainties about possible policy reversals. The increased emphasis on removing structural impediments to growth in the late 1980s increased the responsiveness of output to the changing policy environment. As a result growth in marketed output and export crops was strong. By 1990 the increased food availability had eliminated the need for food imports. In addition nontraditional agricultural exports sector increased fivefold between 1985 and 1991 (Mans 1994). The revival of the industrial sector was not achieved mainly on account of delays in implementation of structural reforms, in particular, privatization and divesture of parastatals. Weak management and rent seeking, particularly in the early 1990s hindered the necessary adjustment needed to improve investment productivity.

The reform process has succeeded in attracting foreign direct investment and through this changing the structure of exports. During the period, the share of exports has increasingly shifted from traditional exports (cotton, coffee, tea and tobacco) to other exports, in particular mining and marine exports. Tanzania is currently one of the highest recipients of foreign direct investment in Africa. According to UNCTAD (2004), investors rank Tanzania as the most attractive destination for investment in Africa (excluding South Africa).²⁴

Labor productivity remained low as there were no incentives to raise performance and competence. The hiring of cronies weakened the capacity for innovation and was exacerbated by the hierarchical organizational structures. The assurance of lifetime employment and seniority as basis for promotion further reduced incentive to perform. The low wages aggravated the situation encouraging petty corruption and ‘moonlighting’.

The centralized manpower planning geared towards the public sector stifled the development of a skilled private sector. The sharp expansion of the public sector resulted in an increase in demand for high and middle level manpower. This was achieved through a major change in the allocation of graduates from government to parastatals in an attempt to speed up localization of top posts in the parastatals and the government employing the pool of professional trained workers. This instilled a perception, which one can argue still persists, that participating in private owned entrepreneurial activities reflects low skill base and career drive.

The focus on creating inter-personal equity created a culture of state dependence and free riding. Punitive taxes were introduced to ensure that equity in the distribution of income was maintained. During the control regime period, income tax rates of over 80 percent were not uncommon. However, it must be underscored that without investment in creating a united nation out of diverse ethnic groups, Tanzania would probably have succumbed to inter-ethnic squabbles leading to political and/or civil instability like some her neighbors. Though Tanzania is ethnically diverse, political stability and harmony among all the ethnic groups have been maintained. Tanzania’s legacy of peace and ethnic cohesion is therefore largely a result of early investment in creating national harmony and strong focus on poverty reduction.

Over time there has been an increasing emphasis on performance based remuneration. The third regime government, in particular, through civil service reform has made significantly strides in raising salaries, wages and other conditions in order to reduce petty corruption and increase efficiency.
3.3. Financial Markets
3.3.1. The Strong Control Regime (1967 - 85)
The financial system was entirely state-controlled. It was characterized by state-owned financial intermediaries geared towards provision of finance to specific sectors, in particular, housing, agriculture and industry. Banking was essentially a form of quasi -government financing for state-owned enterprises, rather than genuine financial intermediation. Ceilings were imposed on nominal lending and borrowing with the goal of discouraging private sector borrowing. The financial sector was repressed as reflected in negative real interest rates, low broad money to GDP ratio and high fiscal deficit to GDP ratio. The degree of financial deepening was low even compared to other SSA countries.

Mandatory credit ceilings coupled with administratively directed credit allocation to priority sectors undermined allocative efficiency resulting in large non-performing loans. The negative real interest rates discouraged savings mobilization and their channeling through the financial system. In addition, the negative interest rates led to credit rationing by the banking system with adverse impacts on the quantity and quality of investment (Mwega 1990). State control of the financial institution resulted in credit allocation on political rather than commercial considerations. About 60 to 80 percent of the total non-performing loans in the state-owned banks emanated from political pressure on banks to lend to politically connected borrowers albeit with bad credit record. In addition, there was limited competition as the financial system was dominated by a virtual monopoly; the National Bank of Commerce had 85 percent of the market share and the clientele was limited to the government and parastatals.²⁶

Monetary policy was subordinated to supporting government objectives resulting in hyperinflation. The central bank was faced with multiple objectives including full employment, high growth and low inflation. It frequently subordinated the latter to support the government’s expansionary program. As the economic performance and foreign reserves dwindled, the central bank increasingly resorted to seignorage activities in order to bankroll the loss making parastatals and financial institutions.

A cornerstone in the government policymaking was a reluctance to devalue the currency. The government adopted a fixed exchange rate regime and did not realign the currency in the face of widening current account deficits before grants. The currency remained broadly stable against the dollar during the 1970s despite the imbalances in the foreign exchange rate market. This stability of the official exchange rate was largely due to the massive donor inflows the country received. The Central Bank accommodated external terms of trade shocks and other adverse shocks through sales of foreign reserves and external borrowing. In the face of balance of payment crisis in the late 1970s and dwindling donor support, the government relied on capital and current account controls to maintain the exchange rate. These included administrative import controls and mandatory surrender of proceeds from exports. Following the decrease in reserves to less than 1 percent of GDP, during the period 1980 to 1985, pressure on the exchange rate forced the government to devalue the currency. However the realignments undertaken were insufficient to address the misalignment of the currency and the foreign exchange was allocated administratively within the frame of heavy restrictions. As a result, the exchange rate premium increased reaching its peak of over 200 percent in 1985 (Bank of Tanzania 1994; Kaufmann and O’Connell 1997).

Financial sector reforms became subject to powerful vested interests. The reforms were not accompanied by the needed macroeconomic and structural changes: state-owned banks remained captive markets exposed to political interference. Tanzania suffered a sharp contraction of financial depth in the second half of the 1980s but recovered almost half of the fall in the first half of the 1990s. The regulatory and supervisory capacities were inadequate on account of delays in adopting structural reforms.

Exchange rate unification was delayed as attempts were made to maintain patron-client networks through monetary financing and exchange controls. Unification of the black market and official exchange rate initially involved devaluation of the official exchange rate and the de-control of commodity prices that faced foreign exchange rate controls in late 1980s. Reflecting the realignment of the exchange rate in the late 1980, the black market premium decreased in the early 1990s, and was less than 10 percent by 1992. During 1993, the remaining restrictions on current account foreign exchange transactions were removed and the Government introduced weekly Central Bank auctions to registered foreign exchange dealers and banks. In late 1993, the weekly auction was replaced with a daily inter-bank foreign exchange rate market. This provided a mechanism for determining the official exchange rate (Bank of Tanzania 1994). Kaufmann and O’Connell (1997) note that faster unification of the exchange rates would have reduced monetary growth and inflationary pressures.
3.3.3. Market Economy (1995 - to date)
Financial liberalization was one of the key pillars of the reform process. The reforms aimed at deepening the financial system, instituting independent monetary policy and increasing competition in the financial system. Noting that continued disintermediation and negative interest rates in real terms were particularly harmful to the efficient allocation of scarce financial resources, treasury bill auctions were streamlined. To prevent crowding out a cash budget system was introduced and tight fiscal policies employed demonstrating the commitment of the new government to operating within the constraints of the budget framework and maintaining fiscal prudence. To address the problem of wide scale tax evasion and improve transparency in tax regulation, the government rationalized the tax system and improved tax administration. An integrated financial management system was developed to ensure that financial decisions were taken with due regard to availability of financial resources. The Central Bank was provided with legislative powers in 1995 to focus solely on low and stable price stability as the overarching objective.

Fiscal restraint coupled with tight monetary policy had a dampening effect on inflation resulting in an improvement in the external competitiveness of the economy. Liberalization coupled with deregulation induced a large depreciation of the currency. The depreciation of the currency coupled with sound economic management resulted in a decrease in inflation and hence a real exchange rate depreciation. Inflation decreased to its lowest levels in 20 years in 1999 reflecting the government’s adherence to a strictly restrained monetary policy in the context of market-determined exchange rate system. Government deficit halved to an average of 9.3 percent of GDP during the period 1990 to 1997 compared to the period 1985 – 1990 and was lower than 10.3 percent average in SSA. Fiscal restraint coupled with tight monetary policy had a dampening effect on inflation enabling an improvement in the external competitiveness of the economy. This has resulted in an improvement in the competitiveness of the external sector.