[BLOG] African Development: The Role of the Global Financial System
The development of African countries has been at the heart of the international community for as far back as the period within which the continent politically liberated itself from overt colonialism and all its tendencies. There has always been a responsibility on the colonial masters, developed nations and international community to see to the development of underdeveloped countries in Africa.
This is primarily as a result of the effects of trade and the spillover effects of economic challenges that exist in one country over the other. Thus the pursuit of an economic equilibrium on the global scale is a quest that has transformed many nations, and will continue in that direction. However one may wonder why after years of co-operation with international financial institutions which belong to the global financial system, many countries in Africa have rather retrogressed, or not benefited as other countries elsewhere may have.
This essay seeks to identify in brevity some fundamental challenges with the mechanism that has been employed over the past years and propose some areas that the international global financial system could be considering in order to avoid loosing gains on progress they might have made over the past decades on the development of the African Continent.
Development economists over the years argued that the Marshallian plan which worked in Europe some decades ago was the way to go and in fact the international community pursued this agenda for over sixty years sending over one trillion US Dollars to Africa. Against the two gap econometric model, the development of countries was seen primarily as a function of investment, which in-turn was determined by the level of savings and as such a limitation in savings implies limited investment which would hinder development. Thus savings and investment gaps had to be bridged by injection of additional capital, which could come from donors or the international financial system provided the financial system of the focal country cannot solely and adequately generate this capital.
This strategy for catapulting nations and their economies into development worked effectively under the Marshallian plan. There was therefore evidence to suggest that this same diagnosis could be used to solve the developmental challenge in Africa today, which was pursued. How far have we come in providing these solutions?
To answer this question, we need to conduct a test for capital injection into a less developed country; first of all by donors (free financial assistance; official development assistance/aid), and secondly, capital acquisition from the international financial system.
Financially distressed countries could obtain grants and aid from donors (countries that are willing to give finance which attracts no interest, and in extreme cases the money is free). From a micro-economic level, any economic agent (individual/business organization) facing any financial difficulty can go to any local financial institution to obtain funds to support their operations and reverse their unfavourable operational trend.
When such assistance is received at no cost to the individual or the organization, and seemingly will be available anytime there is distress, there is no motivation to improve upon operational efficiency of that individual or business organization. The success of the organization now becomes a moral responsibility of doing what is right with the free resources provided.
Drawing a macro extension from this reality, the case of governments and other economic actors on a macro-level, the moral duty of doing what is right, conflicts with pursuit of individual objectives which might not inure to any benefits to the economy as a whole, resulting in cases of corruption, and high incidence of poverty, political instability, all of which in turn shoot the economy in the foot, preventing any form of development. No matter how simplistic this may sound it is worth examining, which leads to the examination of the second test for the acquisition of capital from international financial system.
The global finance system comprising of institutions such as the World Bank (IBRD), International Monetary Fund (IMF), World Trade Organization (WTO) among others collectively monitor and regulate the financial system to ensure stability and development across the globe.
As a financial system, it can provide funds to financially distressed countries particularly developing ones, against the backdrop of the gap econometric model. If this finance is provided for free, the possible effect will not be different from the case of donors mentioned in the preceding paragraph. Now lets add an element of cost of capital.
The cost associated with the capital being acquired serves as an incentive to invest the money into profitable operational activities to generate sufficient income to defray the costs of capital together with the capital from a micro perspective (individuals and business organizations). “Ceteris Paribus” there is the tendency that funds will be better applied when there are costs associated with them better than absence of cost of capital.
It cannot be empirically established at least in this paper that the introduction of the cost of capital for governments and economies will generate the same results as the case of the individual and small business organizations. Assuming that micro and macro-economic units operate with the same variables then there would be reason to suggest that the introduction of cost of capital would spur developing countries on to developmental heights as suggested by the gap model. Thus the introduction of cost of capital on the global financial system could be an alternative to freebies (aid).
Again on a micro level, when a financial institution (Banking and non banking) is bailing any business out, the institution must demonstrate beyond all reasonable doubt the viability of the investment, and kind of project in which it will invest. In some cases, technical expertise is provided for the institution to monitor the operations and developments ensuring that unfavorable operational trends are reversed. Replicating this strategy on a macro-level, “all factors being equal” could yield the same results for countries / economies.
It is imperative that in ensuring global financial and economic stability the role of the global financial system will be as crucial as ever particularly in the cases of developing countries in Africa, majority of who are characterized by high levels of public corruption, political instability, high costs of living, and unfavorable economic conditions of trade among other.
These negative factors create unfavorable environments for businesses and for foreign investment to thrive. Cases in point include, Somalia, regarded currently as a failed state, Sudan, and other countries below the Sahara.
The development agenda of African countries should be spearheaded by the international financial community of which the global financial system should take a key role. African countries generally have a capital/investment deficit which should be augmented by the international community. For the past decades, investment from overseas has been falling at the foot of central government, who has the capacity to provide all requirements needed for this financial assistance.
These resources when obtained do not trickle down to close the gap between savings and investment let alone induce investment to spur economic growth. These resources are either lost to corrupt governments, unproductive economic policies that are not favorable to trade, and a host of other factors.
Following from the above, a new dimension of foreign investment should be pursued. Foreign investment must now make private sector its priority. This is not in any way to suggest hostile take-over’, of businesses that are doing well in Africa. Rather a seasoned technical and financial partnership with tactical managers and well meaning private businesses that have identified good opportunities which have multiplier effects on the African economy should be pursued.
In most countries beneath the Sahara, sound economic policies are paving way for businesses to thrive. The case of Ghana, is a glaring example. The economic policies pursued by the governments sometimes are at the beck and call of global financial institutions and other donors. I strongly believe that amidst all of these frameworks the governments are developing, there will be the need for the international community to focus on supporting private equity funds, and businesses rather than government.
This is because the seeming negative effects of democracy have not completely been dealt which has resulted in slower than expected growth in most of these countries. Take the case of Ghana where I come from, sound economic policies such as liberalization of trade, removal of high financial restrictions on new foreign entrants, adequate management of inflationary rate, for which reason the country was regarded as an economic gateway to West Africa, was rather compensated for by the leakage of the public purse by over two hundred and fifty million US dollars in 2010/11 fiscal year
To avoid losing such economic gains, a partnership by the international financial institutions with the private enterprises in very lucrative business endeavors could answer the question of development for Africa, whiles the various governments pursue political reforms that will create the enabling environment for businesses to thrive.
In conclusion, I am not suggesting that official development assistance is not good. There is a moral imperative on countries and the international financial system to support countries free of charge in times of disasters such as floods, disease outbreaks among others. The concern is really about what kind of capital injection the global financial system should pursue. ODA’s can get people to go to school in countries where this is not possible, it could provide some relief to disaster stricken countries, and so will freebies” from the global finance system.
It will however not perform the function of bridging the gap between savings and investment to spur growth and development, thus in our pursuit of global economic development we must shy away from grants and aid, free monies from the international financial system earmarked as funds to augment capital stock and thus promote development in less developed countries, because it will rather worsen their developmental challenges by fueling corruption, create political instability, a disincentive for attracting foreign direct investment which is the next point of focus.
Written by Stephenson Patrick
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