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Wednesday, June 27, 2012

Rwanda’s Economic Success: How Free Markets Are Good for Poor Africans

If the Rwandan government continues to be limited, the private sector will flourish.

Societies have turned around and succeeded after passing through a period of vicious conflict and ruthless violence. Rwanda is an example. Since the brutal genocide of 1994, when about 20 percent of the population was killed, the political and social situation has stabilized, making possible, together with free-market reforms, a sustained economic expansion in a relatively peaceful environment.

Rwanda is a small landlocked country located in east-central Africa with a population of about 11 million inhabitants. Its two major ethnic groups—the minority Tutsi and the majority Hutu—had been clashing with each other since before the Belgians took control of the country after World War I. (The country became independent from Belgium in 1962.) The constant social and ethnic tensions ended in a genocide that took the lives of some 800,000 people—mainly Tutsi.

In consequence, the economy sharply contracted—by about 50 percent—that year, but the recovery was quite fast and solid, with GDP growing at 35 percent in 1995. It has managed to sustain high growth rates ever since, not even losing steam in the last decade. The economy grew an average 6.6 percent per year from 1994 to 2010, substantially higher than the sub-Saharan African average.

In 2001, Rwandan inhabitants lived on an average of 50 cents a day; today this figure has risen to $1.50 a day. Recent poverty and welfare indicators—taken from the Third Household Living Conditions Survey—are also encouraging. For the last five years poverty has been drastically reduced, from almost 57 percent to 45 percent of the population. In contrast, the drop was only 2 percentage points in the previous five years. What’s more, extreme poverty has registered an unprecedented fall, from 37 percent to 24 percent. Improvements have also taken place beyond the poverty figures, including maternal and infant mortality.

According to British development economist Paul Collier, the results of the survey were “deeply impressive.” Collier also acknowledged that Rwanda had been able to achieve three key goals: rapid growth, sharp poverty reduction, and reduced inequality.

Fortunately, Rwanda is not an exception in Africa. The International Monetary Fund estimates that sub-Saharan African GDP will expand by 5.4 percent and 5.3 percent in 2012 and 2013, respectively. In contrast, advanced economies are unlikely to grow at rates higher than 2 percent in the next couple of years.

Furthermore, poverty on the continent as a whole is diminishing more quickly than is commonly believed, as economists Maxim Pinkovskiy and Xavier Sala i Martín concluded in a 2010 paper, “African Poverty Is Falling . . . Much Faster than You Think.” The last update of the World Bank’s poverty estimations indicated that between 2005 and 2008 the absolute number of poor sub-Saharan African people had fallen for the first time in recent history, despite the region’s remarkably high population growth.

The economic growth in Rwanda has been primarily driven by liberalization in the agricultural sector—mainly coffee and tea, the country’s main exports. These reforms allowed producers to greatly benefit from an export boom, increasing incomes and boosting productivity through capital investments. Dynamic tourism and industrial sectors—mining and construction—have also contributed to the recent economic success.

However, the country’s economy is still vulnerable and unstable. To progress faster Rwanda would need to move toward production of high-value added products, since the potential increases in productivity and exports in the traditional sectors are limited.

Entrepreneurship, usually the main driver of economic growth, and innovation should lead this transition. In the Rwandan case there has been noteworthy dynamism in household enterprises, which are dedicated to nonagricultural activities and usually located in rural areas. Even though they only employ 10 percent of the labor force, more than 30 percent of families relied on these enterprises for income in 2006.

Despite being low-productivity activities (such as styling hair or manufacturing simple products), these enterprises play an important social role given the country’s high levels of illiteracy and poverty. Moreover, wages in these household enterprises are higher than those offered in agriculture, which explains why they are attracting workers out of the primary sector. In this regard, the development of the financial market and banking system is important since these initiatives need access to loans.

On the other hand, regional trade integration has facilitated a shift in imports from Europe to neighboring countries, which benefit from lower prices and increased exports. Yet landlocked Rwanda’s poor roads and nonexistent railway system mean transport costs are too high. This is improving: While in 2006, 11 percent of the roads were considered to be in good condition, this figure rose to 52 percent in 2009.

The country’s relative business dynamism would not have been possible without an improvement in the regulatory and institutional framework. In the latest Doing Business report (2012), Rwanda ranked 45th in business regulation; only four years ago it was 148th. The country also ranks third among African nations in the Heritage Foundation/Wall Street Journal Index of Economic Freedom. While its overall score was less than 40 in 1997, this year it is 64.9, with notable improvements in business and trade freedom. (The closer to 100, the more economic freedom.) No wonder Rwanda is considered the country with the most-improved economic environment. The reason is widespread liberalization, with the most significant areas of change being the registry of property, protection of investors, trade openness among African countries, and access to credit.

Coffee Sector: Free Markets Are Good for the Poor

The benefit of economic liberalization is best illustrated by Rwanda’s coffee sector, on which more than half a million families depend. (We draw on Karol Boudreaux’s Mercatus Center paper “State Power, Entrepreneurship, and Coffee: The Rwandan Experience.”)

Only two decades ago this sector was tightly regulated and controlled by the government; it was the key source of revenue. Farmers were forced to devote at least a quarter of their land to growing coffee, which a government agency bought at a below-market price. The government then sold the coffee on the markets at the higher price and kept the difference. On top of this implicit tax, farmers had to pay an export tax.

This unjust interventionist scheme supported the corrupt government and enriched its cronies. The farmers were legally plundered. However, because of its inherent unsustainability and the destructive effects of the genocide, the scheme finally broke down.

It was not until the late 1990s that Paul Kagame’s government liberated the coffee sector. The reform removed legal requirements and made it possible for farmers to freely trade with buyers from any part of the world. That of course increased incentives to invest and innovate. The Rwandan people—partly helped by the West—focused on increasing quality rather than quantity, raising efficiency and productivity. This fostered farmers’ and entrepreneurs’ business relationships and opportunities to trade, encouraging them to acquire better skills.

Thanks to these improvements, prices soared. Consequently, about 50,000 households saw their incomes from coffee production double. For the first time, families could afford to pay school fees for their children, pay medical bills, buy clothing, fix their homes, or invest in their small businesses.

As Karol Boudreaux highlights, liberalization not only improved the economic opportunities and potential of the people, it also enhanced social cooperation and cohesion among Tutsi and Hutu, which was desperately needed after the genocide.

The Curse of Foreign Aid

The country still has severe problems, some of which are common to other low-income economies. These mainly consist of high rates of malaria and AIDS, lack of access to safe drinking water and electricity, and a strong dependence on subsistence agriculture, a sector that employs about 70 percent of the labor force.

Furthermore, the Rwandan economy suffers from a number of vulnerabilities that may hinder its growth. First, the country depends excessively on foreign aid, which covers as much as 40 percent of the government’s budget and amounts to 18 percent to 20 percent of GDP. Second, the poorly diversified economy—primarily coffee and tea, and other agricultural products—makes Rwanda more vulnerable to particular shocks. Third, chronic budget and trade deficits (symptoms of other problems) have created high levels of government and external debt that will have to be repaid.

Although at first sight these three issues may seem independent of one another, the truth is that they are interrelated. For instance, the debt problem may be partly caused by the increasing levels of development aid. The fact that about three-fourths of Rwanda’s total debt is owed to the World Bank illustrates this point. As African economists Dambisa Moyo and George Ayittey claim—echoing the great development economist Peter Bauer—and as President Kagame believes, foreign aid may actually be hurting the very countries and communities it is intended to help. First, the resources are often used in nonproductive or even destructive ways, with perverse social consequences. Second, even if the money reaches the poor, it creates a pernicious dependency—similar to that which welfare-state handouts create in developed countries. Poor countries need productive investment and entrepreneurship, not handouts.

Nevertheless, no country has ever developed overnight. Rather, economic development is a long-term process of sustained growth that requires good doses of patience and the people’s ability to overcome numerous bumps in the road, like natural disasters or political instability.

Rwanda Vision 2020

With this in mind, the Rwandan government recently launched an initiative called Rwanda Vision 2020. It focuses on long-term development goals, such as the transformation of the current agricultural and subsistence economy into a more solid and diversified economy, less dependent on foreign aid. The government appears to understand that the solution to poverty must come through free markets, not government activism.

Thus, as explained in the outline of Rwanda Vision 2020, the government will not get involved in providing goods and services that can be offered more efficiently and competitively by the private sector. Assets will be privatized to help reduce the prices of goods and services, widen supply for consumers, and attract foreign investors. In addition, the free movement of people and goods will be promoted.

Despite Rwanda’s difficulties, pro-market economic policies are already bearing fruit. Besides strong growth and reductions in poverty, Standard & Poor’s showed a positive outlook for Rwanda in 2011.

For Rwanda’s success to be sustained in the long run, the country will need to keep increasing economic freedom and removing barriers to productive activity. Moreover, Western countries should abolish trade barriers that hurt African producers.

If the Rwandan government continues to be limited, the private sector will flourish and the Rwandan people will further benefit from global markets.

Find a Portuguese translation of this article here.