services

Economic Agenda for the Incoming Government

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This article first appeared in my weekly column with the Business Daily on August 13, 2017

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With elections complete, it is time to focus on how the next five years can be fully leveraged towards making concrete socioeconomic gains in the three main sectors of Kenya’s economy.

The first economic setor is agriculture which constitutes 35 percent of the GDP and 61 percent of total employment. One problem with this sector is that on one hand the export-oriented segment of sector is very productive and profitable, yet domestic food security is still a major concern. Tea was the largest export earner for the country in 2016 alongside coffee and horticulture, yet domestic food consumption is constrained by subpar production exemplified by the maize crisis which was exacerbated by a severe drought. The next administration should focus on several issues: first is increasing allocations to the sector from the current 1.8 percent of the budget to, at a minimum, the African average of 4.5 percent. Secondly, effort must be made to address the challenges in sector coordination between national and county governments; clear roles and responsibilities must be delineated for each level of government. Finally, there ought to be a focus on active learning from productive agriculture sectors and lessons shared with less productive sectors with a focus on smallholder farmers.

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(source: https://www.iatp.org)

The second sector is manufacturing which is a mere 9.2 percent of GDP; the share of manufacturing in GDP has actually declined over the last five years and the sector formally employs only 300,000 people. Manufacturing can play a central role in driving economic transformation and job creation in Kenya as there is a window of opportunity for Kenya to capitalise on positive underlying factors in the global economy, including rising wages in Asia, the rebalancing underway in China, and expand Kenya’s capabilities and presence in export-oriented, labour-intensive manufacturing within the next 20 to 30 years. The incoming administration ought to make sure that the country’s manufacturing strategy as articulated in the Kenya Industrial Transformation Programme be prioritised in the implementation of the third Medium Term Plan of Vision 2030 due to start in 2018.

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(source: http://www.kenyaengineer.co.ke/media/k2/items/cache/672afa8031e8618a8e9b5df0ce808169_XL.jpg)

The third sector is services which is currently driving Kenya’s economic growth, constituting about 55-60 percent of GDP. Leading sub-sectors include food and accommodation, ICT, real estate and, transport and storage. However, the key service sub-sectors that ought to be prioritised are education and healthcare. Interventions in health should focus on better fiscal support to the sector. In FY 2017/18 donor funding of development expenditure in healthcare is estimated to be up to 63 percent; such dependence is concerning. Secondly, there should be an emphasis on building the capacity of county governments, especially in terms of technical and administrative human resources, to better meet the health needs of their constituents. In education the focus should be on better aligning curricula and training to better meet labour market needs as well as reorient the country’s economic structure to one in which manufacturing plays a larger role. Finally, county governments ought to be supported in better equipping and expanding the reach of Technical and Vocational Educational Training Institutions (TVETs) and link students to practical apprenticeships at county level.

Anzetse Were is a development economist; anzetsew@gmail.com

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Kenya: What should be demanded of the next administration

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This article first appeared in the Business Daily on February 12, 2017

The election year in Kenya is contextualised in two conflicting realities: on one hand the country is among those growing the fastest in Africa and the world and is successfully attracting mega investment. On the other hand, companies have shut down or left the country, poverty and unemployment levels remain high and cost of living continues to rise. How do we reconcile these two conflicting realities?

The first is to acknowledge that the economy is growing; by 6.2 percent in Q2 and 5.7 percent in Q3 of last year. Juxtapose this with an African GDP growth rate of about 1.4 percent and a global growth rate of about 3.4 percent in 2016. Analysts point to several sources for this growth; agriculture, forestry and fishing; transportation and storage; real estate; wholesale and retail trade as well as mining and quarrying. Kenya was not only buffered from the decline of commodities, Kenya saved nearly KES 50 billion in the first half of 2016 alone due to low global petroleum prices. Further, the Kenya Shilling remained steady with regards to major currencies, standing at around KES 100 to the US Dollar. This is important for Kenya which is an import economy; currency depreciation places upward pressure on inflation. With regards to inflation, the country remained within the Central Bank of Kenya’s (CBK) inflation target range of 5 plus or minus 2.5 percentage points; annual average inflation dropped from 6.5 percent in November to 6.3 percent in December, the lowest reading since November 2015. In addition, the country made progress on the Ease of Doing Business Index. Kenya ranked 92nd up from 113 in 2015; this is the first time in seven years Kenya has ranked among the top 100.

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Further, Kenya’s profile as an attractive investment destination grew in 2016. FDI Markets ranked Nairobi as Africa’s top foreign direct investment destination with inflows surging by 37 percent in 2015. Indeed, reports indicate that Kenya recorded the fastest rise in FDI in Africa and the Middle East. The FDI intelligence website indicates that a total of 84 separate projects came into Kenya in real estate, renewable and geothermal energy as well as roads and railways worth KES 102 billion, all of which provided new jobs for thousands of Kenyans. Additionally Peugot announced a contract to assemble vehicles in the country joining Volkswagen which opened a plant last year, Wrigley invested KES 5.8 billion in a plant in Thika and a contract worth KES 18.74 billion was signed with the French government to build a dam.

However, the reality elucidated above seems theoretical in the minds of millions of Kenyans, most of whom are not feeling the positive impact of all these rosy statistics. Media reports indicate that that thousands jobs were lost last year due to company restructuring or company shut down altogether. 600 jobs were lost when Sameer Africa announced that it would shut down its factory. Flourspar Mining Company also shut down, leading to a loss of between 700-2000 direct and indirect jobs. Oil and gas logistics firm Atlas Development also wound up operations and the Nation Media group shut down three of its radio stations and one television channel. But perhaps it is in the banking sector where job losses were most pronounced. This paper reported that more than six banks announced retrenchment plans in 2016: Equity Bank released 400 employees; Ecobank announced it would release an undisclosed number of employees following a decision to close 9 out of its 29 outlets in Kenya; Sidian Bank, formerly known as K-Rep, made plans to release 108 employees, and the local unit of Standard Chartered announced plans to lay off about 600 workers and move operations to India.

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(source: http://youthvillage.co.ke/wp-content/uploads/Fired.jpg)

Why is this happening? How can economic growth be juxtaposed with massive lay-offs and economic hardship? There are several factors at play here. With regards to the employment cuts in the banking sector, these are linked to two factors, the adoption of technology and the interest rate cap. Technology adoption has translated to the reality that millions of Kenyans no longer have to visit banks to access financial services as they can make financial transactions digitally, transactions that range from money withdrawals and transfers, to loan applications and disbursement, and the payment of bills. This automation has led to the attrition of jobs.

Secondly, the interest rate cap has placed pressure on the profit margins of banks leading to job forfeiture. The interest rate cap effected by the government stipulates that banks cannot charge interest rates above four percentage points of the Central Bank Rate (CBR). Interest rate spreads have several functions for banks, of which perhaps the most important is insulating banks from bad borrowers. There is an asymmetry of credit information in Kenya due to the fact that the creditworthiness of most Kenyans cannot be established. As a result, when banks make loans to Kenyans, they often do not know if the borrower will be a good or bad one. Thus to insulate themselves from the risk of lending to bad borrowers, interest rates are raised in order to ensure that the bank recovers as much money from the borrower in as short a time as possible. In removing this provision, the interest rate cap is essentially forcing banks to lend money to both good and bad borrowers at the same rate. This in turn threatens profit margins as there is a real risk that the bank now has no buffer against bad borrowers. As a result, some banks have responded to the interest rate cap by shedding jobs to cut down operating costs and safeguard profits.

However, the interest rate cap is having a more insidious effect on the economy. A report by the IMF released last month states that the interest rate controls introduced in Kenya could reduce growth by around 2 percentage points each year in 2017 and 2018. The IMF also expects a slowdown in the growth of private sector credit linked to the cap. Additionally, the growth of the economy has been revised downwards due to the cap. What does this mean for the average Kenyan? The interest rate cap means that SMEs and individuals who used to get loans, albeit at higher rates, are likely to get no credit at all. Banks will simply not lend to individuals and businesses whom they think cannot service the debt credibly at that capped ceiling. Sadly it is the most vulnerable who will be disqualified first as these are seen as high risk and high cost borrowers. As they are shut out of credit SMEs cannot implement growth plans and are unable to create jobs and wealth. The contraction in liquidity engendered by the cap may also mean there will be less money moving in the economy; Kenyans will feel that there is less money around and feel more broke as they cannot get loans to grow their business or meet personal costs.

However, one of the biggest factors behind why Kenyans don’t feel the rosy statistics is because most Kenyans operate in the informal economy whose performance is generally not captured in official figures. GDP growth and Ease of Doing Business data do not capture the reality of dynamics in the informal economy where over 80 percent of employed Kenyans earn a living. Therefore, one cannot extrapolate positive overall statistics as reflective of performance of the informal economy. Perhaps the incongruence Kenyans feel stem from the fact that the economy from which millions earn a living is largely ignored. The hardship and challenges of Kenyans living and working in the informal economy continues to be neglected and thus policies and action that could help most Kenyans are never developed or implemented. Until the gross negligence of the informal economy is addressed, one can expect the average Kenya to feel a disconnect between economic growth and their lived reality in the informal economy.

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(source: https://farm6.static.flickr.com/5062/5581243427_2cf2343c46_o.jpg)

An additional factor leading to the disconnect between economic growth and the lived reality of most Kenyans, is that the country seems to be in a ‘jobless growth’ rut where GDP growth doesn’t lead to formal job creation. This is partly because Kenya’s economic growth is services driven, and services produces far less jobs than manufacturing. Until the manufacturing sector is given the attention it requires such that economy is driven by export-led manufacturing, the ‘jobless growth’ challenge will continue. Bear in mind that manufacturing in this country is under threat because the cost of doing business for manufacturers in Kenya remains high particularly with regards to electricity, transport, cross-county taxes and, frankly, corruption. Kenya is currently deindustrialising as the manufacturing sector grows at a slower rate the economy. The manufacturing sector grew 3.6 percent in the Q1 and at 1.9 percent in Q3 of 2016. Compare this with a GDP growth rate of 6.2 percent in Q2 and 5.7 percent in Q3 of 2016; this means the share of manufacturing in GDP is shrinking. This should be of concern because, as analysts point out, industrial development is crucial for wealth and job creation. Exacerbating the already slow growth of the sector this year are the drought and cheap imports. As the Kenya Association of Manufacturers points out, the drought is having an impact on raw materials in sectors that rely on agricultural products. The drought will also lead to a higher cost of goods and services for Kenyan as electricity tariffs are adjusted upwards. The manufacturing sector is also threatened by the fact that the country has allowed the entry of cheap goods, particularly from Asia, to flood the market; goods that benefit from protection and subsidies in their home economies which is not reflected here.  These constrain the growth of the sector in Kenya.

Finally, financial mismanagement at both national and county levels is compromising growth. The top allegations of the financial mismanagement of public funds according to media reports include the laptop tendering debacle, NYS scandal, Ministry of Health and the GDC tendering scandal. It seems that government funds that are meant to be economically productive and generate economic activity do not reach intended projects. Thus the economic stimulus that ought to be garnered from public never happens because projects are either under-financed or not financed at all as public officials siphon money away from them. Further, business routinely complain that bribes have become a basic expectation of county officials around the country. A report released by the Auditor General last month revealed that Kenyans are asked to pay up to KES 11,611 by county officials; Mombasa County officials top the list of bribe-seekers followed by Embu, Isiolo and Vihiga. As long as this continues, jobs and wealth that government investment and financing could have created will not materialise.

So what should Kenyans demand from those vying for power in this year’s general election? The first and foremost is ending financial mismanagement where even opposition is culpable as counties under opposition engage in corruption as well. Kenyans must demand a clear plan that will take serious steps to make financial structures more robust and punish those engaged in the financial mismanagement of public funds. Secondly, Kenyans should push for the government to provide a detailed analysis on the impact the interest rate cap is having on Kenyans and the economy. If the analysis elucidated herein is anything to go by, Kenyans should also seek the reversal of the interest rate cap as soon as possible. Thirdly, Kenyans ought to demand the development of a policy aimed at supporting and developing the informal economy at both national and county level. The gross neglect of this sector must end given that it is in the informal economy where most Kenyans earn a living and are employed. Finally, Kenyans should push for a detailed plan on industrialisation for the country. While the Ministry of Industrialisation has developed the Kenya Industrial Transformation Programme, a detailed work plan and timeline of deliverables ought to be developed and shared so that Kenyans can reap the dividends that green industrialisation can create.

Anzetse Were is a development economist; anzetsew@gmail.com

How important are services to economic growth?

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This article first appeared in my weekly column with the Business Daily on March 21, 2016

A report by the Overseas Development Institute (ODI) analyses four services sectors in Kenya to determine the role of services in economic growth. The four sectors analysed are the financial sector, IT services, transport services and tourism services.  The report argues that services are becoming increasingly important, even for non-industrialised countries such as Kenya, as they have a direct contribution to GDP, exports and employment.

Indeed according to the report, services account for 50.7% of the share of GDP; a fact with which the World Bank agrees. Kenya has already become a major exporter of services in areas such as transport services, financial services and, less significantly, ICT. In terms of exports, the export of services from Kenya nearly tripled from $1.9 billion in 2005 to $4.9 billion in 2012; far more than the exports of goods. The ODI report goes on to state that ICT and financial services in particular makes companies in other sectors more productive, help develop value chains and safeguard jobs, while tourism creates numerous jobs within suppliers. Further, services have an important role to play in the ‘servicification’ of manufacturing. Indeed the World Bank survey made the point that in Kenya, services  constitute at least 62% of the cost of manufactured goods illustrating the extent to which manufacturing relies on services.

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(source: http://www.simplexityconstruction.co.nz/assets/Uploads/SERVICES.jpg)

The position ODI takes goes contrary to dogma in economic theory which argues that the most effective path to development is linear with a progression from agriculture to manufacturing and finally into services. Yet here is Kenya, a non-industrialised economy, with services as the engine of economic growth.

Given this scenario, the questions to ask include: what are the implications of a services-led economy in the context of a non-industrialised county? Is a service-driven economy sustainable in the long term? Does a preponderance of services have a negative effect on the development of agriculture and manufacturing?

Well, the report acknowledges that there are weaknesses in the service-driven model, especially in non- industrialised countries. The dominance on services means that it pulls labour in from the other sectors such as manufacturing. This could result in the exacerbation of deindustrialisation as manufactured jobs are replaced by low-productivity services jobs.  This is a key concern for Kenya which has a significant informal economy, most of which is not very productive and in which services are a notable constituent. Is Kenya facing a scenario where labour is being pulled into services from other sectors, not into high productivity services which are typically in the context of formal employment, but rather into low productivity informal employment in services?

Further there are questions as to whether the dominance of services in Kenya will lead to skills shortages in agriculture and manufacturing. The report rightly makes the point that there is a risk emerging where the development of skills for the service sector will preponderate, perhaps to the detriment of skills development in other sectors. More and more young Kenyans will opt to train to become bankers and HR specialists because it will be easier to find jobs in those areas of speciality than it would be if they had trained as engineers and scientists. What does this bode for the future of the country?

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The final risk of service-driven growth is that, as ODI point out, too much export-oriented services have opportunity costs. It could lead to Dutch disease effects where the shilling appreciates thereby damaging the manufacturing industry as locally produced goods become expensive and uncompetitive due to a strong shilling.

In terms of the way forward, Kenya should continue to reap the benefits of service-driven growth but go through a deliberate process of rebalancing where highly productive agriculture and manufacturing play a stronger role. Further, there is a need to ensure that as long as services preponderate, it is associated with noteable job creation and secondary effects that benefit the economy as whole.

 Anzetse Were is a development economist; anzetsew@gmail.com

The missing middle of Kenya’s economy

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This article first appeared in my weekly column in the Business Daily on September 20, 2015

 The World Bank makes the point that the structural economic transformation in Africa is not following the path that other developing countries have followed as they expanded and sophisticated their economies. To put this statement into context, different sectors of the economy contribute to GDP growth and these are typically characterised as three core sectors: agriculture, industry and services. Typically the path to economic development is one where there is a shift from the traditional sector of agriculture into industry and manufacturing. From there the economy tends to evolve further into services. However, this is not the pattern of growth that Africa is undergoing; Africa seems to be diversifying away from agriculture, not into industry but directly to services. Indeed in Africa, services contributed 62 percent to the cumulative growth in GDP, while manufacturing contributed 25 percent and agriculture 13 percent. Manufacturing is not really taking off on the continent and Africa is leapfrogging industry straight into services. Services here refers to a broad body of activity such as health, education, information and communication, hospitality, public administration, wholesale and retail trade, finance and insurance, and real estate among others.

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(source: http://sostg.com.au/wp-content/uploads/2013/03/iStock_000014887823Medium.jpg)

Kenya falls right in line with this trend; indeed recent statistics indicates that agriculture contributed 29.3 percent to GDP, industry stood at 17.4 percent and services an overwhelming 53.3 percent. So while the share of GDP is contracting for agriculture, industry is remaining fairly stagnant and there is rapid growth in services.

But why is this important? Why should Kenya and indeed Africa be trying to industrialise? Shouldn’t Kenya be happy that we are leapfrogging industry into services? Can this not be perceived as an advantage? The answer to that is a qualified no and here’s why; firstly historically manufacturing been the driver of economic growth and has allowed countries, particularly developing countries, to catch up with advanced economies. From1950 to 2005, the pattern of industrialization has closely reflected changes in global patterns of development.

Secondly, industry is an important job creator and it creates jobs job opportunities for variously skilled levels of labour. Indeed, in services, the sub-sectors important to GDP tend to have low wage employment intensity (employment per KES million) and in Kenya, employment within the services sector has been declining since 2000. Given levels of unemployment in Kenya, it would be prudent to boost a sector that can meaningfully contribute to this problem. Further, manufacturing is traditionally the main sector responsible for the diffusion of innovation and productivity change. The development of industry allows countries to employ technology in building productivity and learning.

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(source: http://www.clker.com/cliparts/6/0/a/c/12065559172064609959chlopaya_Building.svg.hi.png)

Finally, there are risks of services leading the path to economic growth because Kenya does not have the necessary components that form the foundation on which services can function effectively and efficiently. Simple factors such as poor electricity supply, low levels of infrastructure penetration and expensive travel costs negatively inform the extent to which services can lead economic growth. Bear in mind that it is more likely that some of these deficits would have been addressed had the country been diversifying into industry. Additionally the price of services tends to increase more rapidly than that of manufacturing goods; thus a preponderance of services growth may lead to a plethora of activities that cost Kenyans more than if growth had been led by industry. Add to this the fact that in Kenya, labour tends to move away from agriculture but into low skill services with relatively low productivity growth mainly in informal retail trade; this has been dubbed premature deindustrialisation.

This discussion should not make one conclude that services (or agriculture) does not play an important role in economic development, clearly it does. The emphasis should rather be on how to build industry in a manner that allows it to play its true potential role in economic development and do so in a manner that fosters links between agriculture and manufacturing and between services and manufacturing.

The reality is that at present, without growth in industry and manufacturing, Kenya and indeed Africa will face limited growth prospects and will remain vulnerable to external shocks, adverse changes in terms of trade, and remain the eternal producer of raw fuels and metals to which little value is added and which are volatile raw export commodities. With such grim prospects, there should be a greater impetus to boost industry performance in Kenya and indeed the continent.

Anzetse Were is a development economist; email: anzetsew@gmail.com

What the Treasury should do to share county funds fairly

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This article first appeared in my weekly column with the Business Daily, on July 5, 2015

It’s that time of the year again where government arms and agencies grab a piece of the pie from the Treasury. The 47 counties share the funds this way: population is weighted at 45 per cent, poverty index 20 per cent, land area eight per cent, basic equal share 25 per cent and fiscal responsibility two per cent.

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(source: http://www.magazinereel.com/wp-content/uploads/2015/05/BUDGET-BRIEFCASE.jpg)

Population, poverty and land area are used to determine the cost of service delivery: the larger the population and land area, the more money is required. The poverty index acknowledges that if a county is poor, it needs more money to pull to the level of other counties. The basic equal share provides a basic, equal amount to all counties and is intended to cover administrative costs. Fiscal responsibility is meant to measure how well a county manages public finances; currently, all receive the same amount.

But is this how allocation should be determined? The International Budget Partnership (IBP) suggests that there are three key factors that ought to be considered during budget allocations: need, capacity and effort.

Need addresses part of the poverty question in that more should be given to those counties that need more, particularly if marginalised in the past. It also addresses the population density and land area as it encompasses what it will cost to deliver ongoing services to county citizens.

Capacity addresses the poverty issue and is rooted in the sentiment that poor counties should get more because rich counties are better placed to pay to meet their needs.

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(source: http://blogs.worldbank.org/africacan/files/africacan/images/africacan-measuring-poverty-and-inequality-sub-saharan-africa-knowledge-gaps-and-ways-address-them-540.jpg)

Effort rewards hard work and is based on the idea that more should be given to those who work harder to advance themselves.

A central problem is that it is not clear in the current formula whether counties are receiving enough money to meet needs of their residents. This is an inherently tricky question because the “need” of counties is affected by issues such as poverty, land area and population density, but there are additional problems such as inefficiency and corruption.

So in time it may emerge that some counties are not getting what they “need” but a careful analysis is required to determine whether this is because they genuinely do not have enough money to meet the needs of citizens or if this is due to issues such as financial mismanagement and poor organisational efficiency. Perhaps to make the revenue allocation fairer the government needs to develop a system of determining what counties actually need.

As IBP points out, in South Africa they measure health facility visits and risk of disease by province to estimate health service costs. They also look at school enrolment to measure education need. Although both of these are highly correlated with population, one can argue that they get closer to meeting actual needs.

However, such measures are flawed in that in remote areas, government facilities may be visited less not because fewer people need the services, but because fewer people can get to the facilities. The fiscal capacity issue is a tricky one as it is premised on the idea that counties that can better meet own needs (through levies) should get less from the government. No county will tell the central government they want less money. Also this fiscal capacity issue may disincentivise counties from raising generation capacity, seeding a further reliance on central government.

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(source: https://libraryeuroparl.files.wordpress.com/2013/12/05-legalandinstitutionalaffairs-05-01-budgetsandbudgetarycontrol-thematic_week-picture_week.jpg?w=350&h=200&crop=1)

Perhaps focusing on effort can counter the capacity issue because effort rewards those who manage their funds well, premised on transparency and compliance. Effort also measures and rewards the percentage increase in revenue collection over time and will incentivise fiscal independence.

In short, although the revenue-sharing formula will be refined over time, it is important Kenyans begin to engage in these issues so that we can all make informed contributions to future changes in the formula.

Ms Were is a development economist; E-mail: anzetsew@gmail.com; twitter: @anzetse