Economy-twin deficit trap

Source: Economy-twin deficit trap – Sunday News Jan 15, 2017

ZIMBABWE now has a “twin deficit” with both the fiscal or Government budget and the current account running in deficit for a long period.

As this would naturally lead to declining foreign reserves and inflationary pressures, it can pose serious risks to macro-economic stability as well. External and fiscal deficits are sometimes interrelated, but the causal relationship can go both ways.

For example, a twin deficit in Zimbabwe has been caused by a decline in export revenues, which has led to lower Government revenues, while imports have continued to increase and Government expenditure maintained at high levels, or even increased resulting in both external and fiscal positions deteriorating with time, to date.

In addition, a twin deficit in Zimbabwe has also originated from the Government budget with an increase in public spending, that is, recurrent expenditure that has not been accompanied by or matched with higher public revenue in the form of taxes or private net savings that could have generated domestic investment, causing both fiscal and external positions to deteriorate.

A combination of lower export earnings and higher public expenditure has led to a twin deficit in Zimbabwe.

The Government in the 1980s to 1990s widely used financial budgetary support from International Monetary Fund, World Bank and other international financial lenders. The over reliance on external borrowings to finance the national budget and its deficits led to the accumulation of huge debt obligations that is still a burden for the country today.

In 1999, the country started defaulting on its payment obligations and as a result, was labelled not credit worthy. This led to the withdrawal of financial assistance by these international financial institutions. The Government then resorted to domestic borrowing, resulting in domestic debt stock progressively increasing as well over the years. Lack of macro-economic policy implementation credibility, inconsistent policy formulation and high inflation levels, culminated over the period leading to 2008 hyperinflation, and saw the maturity structure of domestic debt becoming more concentrated towards the shorter end of the market.

The prevention of these unsustainable twin deficits requires not only prudent fiscal policies, but also competitive real exchange rates, notwithstanding the fact that Zimbabwe is in a no exchange rate phenomenon, i.e. in the absence of a domestic currency, and further improvement in conditions for domestic firms or industry revival and foreign direct investment inflows.

Both fiscal and external deficits would then eventually decline. If the remaining current account deficits were to a large extent financed through FDI they would be sustainable, as this type of financing does not increase external debt and also helps control domestic government borrowing.

However, the first fiscal policy announcement in Zimbabwe in 1980 in particular, saw the Government making a commitment of fiscal soundness, targeting a reduction in the rate of growth of net current expenditure to levels below seven percent in real terms or one percent below that of Gross Domestic Product (GDP) per annum. This was meant to reduce the budget deficit and allow sustainable fiscal policy management. Unfortunately, this trajectory was to be short lived, leading the country to development traps.

Defining the development traps

Zimbabwe has in the circumstances highlighted above, been caught in the following development traps: poverty trap and middle-income trap, and thus ranked among the low-income countries. The structural challenges highlighted above have hindered Zimbabwe to explore the factors that ultimately determine the possibilities of a developing economy, such as Zimbabwe to surpass its dual character and enter a path of successful catch up with the advancing economies in Africa in general.

There are two distinguishing characteristics features that set Zimbabwe in a development trap. The first feature is the presence of an extended traditional or informal sector that has ballooned over the years (i.e., a large portion of the country’s labour force working in extremely low productive activities that use obsolete technologies and mainly produces for their own subsistence). The second feature is the existence of an important degree of technological backwardness in the non-traditional sectors (i.e. a significant technological gap in the modern activities as compared to the advancing economies in the region, such as South Africa for example).This has been exacerbated by the country’s fiscal policy thrust dating as far as the 1980s.

That is, Zimbabwe’s budget has always been expansionary, that is, recurrent expenditure at the expense of infrastructural and technological development. We have always seen very little budget vote towards infrastructural development for example, setting the country in a serious development trap.

The focus of the development trap trajectory that I am pointing out here is premised on the failure of the dynamical interaction between these two features I have mentioned above, in the process of Zimbabwe’s economic growth and development. From this perspective, successful development would have entailed a joint improvement in these two dimensions up to the point at which modern activities not only become dominant but also manage to catch up with the general world frontier. That is, Zimbabwe managing to close the technological gap while absorbing most of the workers or labour from the traditional sector (informal sector) into the modern developed sector (modern industrialisation).

In conclusion, the main focus of this instalment is to investigate economic development as a process of structural transformation that I wrote about in previous instalments.

In particular, this article postulates that there are two key transformations that need to be achieved in order to catch up with the rest of the advancing countries in Africa: on one hand, the absorption of an increasing share of the labour force in the modern part of the economy (structural change); on the other hand, the technological upgrading of these modern sectors (technological catch up). Failure to achieve either of these transformations will eventually lead the country to poverty-trap, when the country is endowed with such natural resources.

Dr Bongani Ngwenya is a Bulawayo-based Economist and Senior Lecturer at Solusi University’s Post Graduate School of Business. He can be contacted on ngwenyab@solusi.ac.zw or nbongani@gmail.com