Robert Pollin on Economic Plan for Kenya

November 9, 2007

James Garang, a Ph.D. student in economics at the University of Massachusetts, Amherst, is studying development and macroeconomics with emphasis on the economics of conflicts. He read An Employment-Targeted Economic Program for Kenya and responded with some questions for Robert Pollin. His perspective is informed by his own history; he fled Sudan as a child and spent nine years at the Kenyan Kakuma refugee camp. He resettled in Salt Lake City in 2001 with many other Sudanese young men, dubbed the "Lost Boys of Sudan."

You state that the focus of the study is to develop effective policies for greatly expending decent employment opportunities in Kenya; and one way of accomplishing this goal is to lower labor costs through wage cuts and sliced benefits. Don’t you think that this approach is self-defeating due to unintended consequences such as an increase in the below-poverty-line working population, a declining living standard, or disruptive social unrest?

As we emphasize in our study, the notion of expanding decent employment through cutting wages and reducing benefits is certainly a self-defeating strategy, and we strongly oppose this approach. The fact that it is self-defeating is true almost by definition, as we take pains to show in the study itself. For example, we roughly estimate the amount of wage reductions needed to increase private formal sector employment by 25 percent, i.e. increasing employment in this sector from about 770,000 to 960,000 jobs. We find that average wages in the private formal sector would have to fall by approximate 42 percent. We further show that a 42 percent cut in average formal sector wages would mean that the workers and his/her family income would have to fall to between 10 and 23 percent below their respective urban or regional poverty lines. Cutting people’s standard of living this much would of course be met with resistance, which would then destabilize the economy. This is exactly what I mean by saying the strategy of wage cutting would be self-defeating. Even in the best case scenario where it creates more jobs, it would do so only by expanding poverty. And it isn’t clear that it would even create more jobs at all, since the ensuing resistance would worsen the investment climate, and thereby bring a decline in spending in the economy.

The study embraces some of the goals that the Government of Kenya is championing and committed to delivering such as generating 500, 000 new jobs per year through 2007 and keeping inflation down to 5 percent. However, it appears that for the last 10 years, the monetary authorities in Kenya have managed to keep inflation below 5 percent just once. How modest are these goals—are these goals attainable in Kenya when sub-Saharan African neighbors such as Zimbabwe are floating in a 6600% inflation environment?

We certainly agree that the government should be focused on expanding employment in Kenya. But we stress not merely the number of jobs, but the quality of jobs. The most serious employment problem in Kenya today is not the lack of jobs per se, but that the incomes people receive from working are very low. For example, we show that among non-agricultural workers, an overwhelming majority of workers who are employed still live under the official poverty line—these are employed people, not the unemployed. Even considering only those workers who are employed for more than 40 hours per week, nearly half of them live in poverty. This is why we are focused on creating decent employment opportunities, not forms of employment that leave working people and their families living in poverty.

We also don’t think the Kenyan government should be fixated on maintaining inflation below 5 percent. You correctly note that the Kenyan economy has almost never hit that 5 percent inflation target. This is mostly because the main sources of inflationary pressures are food and energy price shocks and the inertial pressures that follow from those shocks. We therefore propose ways for Kenya to absorb these shocks without having to restrain economic growth and employment expansion. At the same time, we show that there is no evidence that developing economies need to maintain inflation below five percent to promote economic growth.

While advocating for tight monetary policy, the Government of Kenya is also committed to achieving Millennium Development Goals such as poverty and hunger eradication, universalizing primary education, equalizing opportunities for women, and improving some key health incomes. Won’t tight monetary policies impede employment which will indirectly lower individual welfare?

Of course, tight monetary policies, designed to dampen inflationary pressures, will also hold back economic growth and job creation. That is the point of such measures, so we shouldn’t be surprised when they work as they are designed to work. We therefore favor a more expansionary set of macroeconomic policies—focused on public investments and strongly subsidized credit—as a way to promote employment and poverty reduction. As mentioned above, we then also discuss in some detail inflation control through dampening the effects of supply shocks, and also considering policies to tie wage and profit growth to productivity growth, i.e. “incomes policies.”

The study proposes five ways through which the public could raise revenues to finance the policies that you are proposing. However, it appears that majority of these sources are dependent on the outsiders/donor’s goodwill. In essence, how reliable are external borrowing and debt forgiveness given the fact that Kenya is not part of the heavily-indebted poor countries 'club,' unlike other sub-Saharan African countries?

You are correct that we list five ways of raising funds for the Treasury—increasing tax revenues, domestic borrowing, foreign borrowing, foreign aid, and debt relief. Of these five, we strongly favor the first two—increasing tax revenues and domestic borrowing. We argue that the other three should be seen as relatively modest supplementary sources of public funds. We think that there are large opportunities for increasing tax revenue. The main way to achieve this is to formalize the informal economy. Right now, formal employment amounts to less than 15 percent of total employment in Kenya. Bringing, for example, another 10 percent of workers into the formal sector will mean that these people are also going to be paying taxes. The key here is to make it worthwhile for those now in the informal economy to join the formal economy. We propose that this could happen if the government offers large credit subsidies for micro- and small businesses. The deal would be that these small and micro-businesses wouldn’t be eligible for credit subsidies unless they become formalized and, among other things, pay taxes. For this incentive to work, the credit subsidies will have to be large. We have worked out in some detail how such a credit subsidy program could be made to work effectively.

Of late urban population has been rising because urban life is being associated with better opportunities. Besides creating jobs as you propose, will increased spending and investing in physical infrastructures, communication, transportation and water infrastructure, clamp down on this urban immigration?

We certainly aim to raise agricultural productivity through investments in transportation and water infrastructure, improved government support for marketing cooperatives, and better agricultural extension services. And we propose credit subsidies for farmers as well. Even with these measures, there will still be large pressures for people to move into urban areas, since the levels of poverty in rural areas remain much higher, even as the extent of urban poverty also is severe. But at least with significant efforts to support agricultural small-holders and other rural working people, the pressures for urban migration should abate somewhat.

The study discusses lessons from sectoral analyses, while underscoring the fact that the Government of Kenya and policymakers have not always paid greater attention to livestock, despite it being the largest single sector within agriculture. Doesn’t this sectoral negligence harm some regions such as Rift Valley province (where many pastoral communities such as Masaai, Turkana, Njemps, and Samburu live) or North Eastern province? Why doesn’t this study put more emphasis on equitable, regional development approach and public support?

We do place a lot of emphasis on balanced levels of support for urban and rural regions. Within the agricultural sector, we also discuss measures that focus on livestock as well as crop development. But you are right in saying we don’t break this down too much on a region-by region-basis. This is work that remains to be done.

You advocate a targeted exchange rate policy and to some extent, active interventions in currency markets. Critics would caution against such a move because of unpredictable volatility induced by the interventionist policies. Won’t such intervention tarnish the hard earned reputation of Kenyan currency market, stir investor confidence and bring about capital flight?

One of the big problems that concerns us is the volatility of the exchange rate, and the ways that speculative financial market activity can serve to destabilize the economy. We think that Kenya should manage the exchange rate for the specific purpose of promoting currency stability and, thereby, a more stable investment climate. As it is, the level of private investment in Kenya has been weak since the early 1990s when the financial system moved in a free market direction. In addition, my co-author James Heintz developed a careful model to show that the Kenyan shilling has been persistently overvalued. This hurts Kenyan exports. We think it is important for Kenya to support its export industries. So this is another reason to develop some effective tools for exchange rate management.

Upon finding a positive relationship between domestic debts and GDP, the study recommends increased internal borrowing to raise revenues to finance public programs. Why do you think countries with higher domestic debt/GDP ratios tend to grow somewhat faster?

First of all, we want to be clear that we do not support the idea that the government should dramatically raise its level of domestic borrowing—that is borrowing money denominated in Kenyan shillings as opposed to foreign currencies, like dollars. Carried too far, we know that excessive domestic borrowing, similar to excessive foreign borrowing, is a very dangerous policy. Governments come to believe they can print money and spend it as they please. This in turn can produce hyperinflation. Right now, the government of Kenya is carrying domestic debt equal to about 19 percent of GDP. The government has proposed cutting that ratio to about 16.5 percent of GDP. Our proposal is to rather maintain the level of domestic debt at its current ratio of around 19 percent. This will provide more funds for public investment and our credit subsidy program.

We show in the study that countries that carry levels of domestic debt significantly higher than 19 percent of GDP are frequently growing at healthy rates. The most important reason is probably that these countries are using these borrowed funds in effective ways, to promote public investment and public services. When done well, public investments in areas such as roads, irrigation systems, and agricultural extension will have very high payoffs, including in terms of a country’s overall economic growth.

Finally, the study indicates that remittances are not documented within the balance of payments account, hence making it difficult to confirm their magnitude. Speaking from personal experience, six years ago, $1 = Ksh 79-80. Today, the exchange rate is about 64 Ksh per $1. Has massive remittance contributed to this appreciation of the shilling? (Note that nowadays Somali Bantu, Sudanese immigrants, who once lived in Kenya, and some Kenya are sending money to Kenya.)

There isn’t an obvious single answer as to why the Kenyan shilling has appreciated. As we discuss in the study, one likely factor is the fact that Kenya is becoming a regional financial center. The financial markets are doing well in Kenya, and the country just received a positive rating from Standard and Poor’s. At one level, these are favorable developments. On the other hand, as I mentioned before, having an overvalued shilling creates problems for the export sector. This means that there is some conflict between the aims of creating a regional financial center with a highly valued shilling, and promoting exports with a somewhat lower shilling. On balance, I would say that promoting exports should be a higher priority.

Beyond this, if remittance flows into the country are large, this will have the same effect of appreciating the currency as inflows of financial investors. We did look at some preliminary and sketchy data on remittances. These indicated that remittances weren’t especially large. But again, these were not especially reliable figures. The main issue in terms of the exchange rate is for Kenyans to decide what their priorities are in terms of promoting exports versus attracting financial flows. We think Kenya has lots of potential for expanding exports, in particular within Africa itself.