Saturday, August 07, 2010

History Versus Expectations in Sub-Saharan Africa

Ngozi Okonjo-Iweala believes that sub-Saharan Africa "is on the verge of joining the ranks" of the so-called BRIC nations:
What trillion dollar economy has grown faster than Brazil and India between 2000 and 2010 in nominal dollar terms and is projected by the IMF to grow faster than Brazil between 2010 and 2015? The answer may surprise you: it is Sub-Saharan Africa... At a time when Asian equity and debt markets are saturated and no longer offer substantial returns, SSA could be poised to provide the best global risk-return profile.
She supports these claims with a wealth of data on recent trends in growth, inflation, exchange reserves, foreign direct investment flows, receipts from international tourism, spreading democratization, declining gender disparities, and improved security.
But Ngozi is also careful to note that this projected take-off is by no means a foregone conclusion. She argues that a concerted development effort is necessary, including a "big push" on investments in education and infrastructure. In order to finance this, she proposes the diversion by donor nations of a portion of anticipated future foreign aid in order to back a current bond issue, effectively securitizing these flows. While such an initiative would help close an infrastructure funding gap over the next few years, Ngozi maintains that its most important effect would be to "change perceptions overnight about Africa as a place to do business."
The idea that coordinated optimism about the future prospects of a region could be a critical determinant of its subsequent growth performance was advanced in a classic paper by Rosenstein-Rodan in 1943, building on earlier work by Allyn Young. The argument is based on the fact that the development of any particular industry may only be privately profitable if an entire set of interlocking industries were emerging simultaneously. Hence the need for a "big push":
Complementarity of different industries provides the most important set of arguments in favour of a large-scale planned industrialisation... It might easily happen that any one enterprise would not be profitable enough to guarantee payment of sufficient interest or dividend out of its own profits. But the creation of such an enterprise... may create new investment opportunities and profits elsewhere... If we create a sufficiently large investment unit by including all the new industries of the region, external economies will become internal profits out of which dividends may be paid easily.
Or, as Paul Krugman put it in his influential paper on history versus expectations, "the doctrine of Rosenstein-Rodan" entails the following claim: "the willingness of firms to invest depends on their expectation that other firms will invest, so that the task of development policy is to create convergent expectations around high investment." 
Krugman's goal in that paper was to point out that there are a many contexts in which multiple equilibria of the kind that concerned Rosenstein-Rodan arise, and to address the question of how one of these is eventually selected: 
Once one has multiple equilibria, however, there is an obvious question: which equilibrium actually gets established? Although few have emphasized this point, there is a broad division into two camps... On one side is the belief that the choice among multiple equilibria is essentially resolved by history: that past events set the preconditions that drive the economy to one or another steady state... On the other side, however, is the view that the key determinant of choice of equilibrium is expectations: that there is a decisive element of self-fulfilling prophecy...
The distinction between history and expectations as determinants of the eventual outcome is an important one. Both a world in which history matters and a world of self-fulfilling expectations are different from the standard competitive view of the world, but they are also significantly different from each other. Obviously, also, there must be cases in which both are relevant. Yet in the recent theoretical literature models have tended to be structured in such a way that either history or expectations matter, but not both... in the real world, we would expect there to be circumstances in which initial conditions determine the outcome, and others in which expectations may be decisive. But what are these circumstances? 
It's clearly an important question, and in order to address it Krugman builds a simple two-sector model with increasing returns in one sector and constant returns in the other. There are two long run equilibria, each of which involves complete specialization in one of the two goods. If the initial state of the economy involves incomplete specialization there will be movement of resources across sectors. But in which direction? 
If shifts in resources across sectors cannot be costlessly reversed, then such movements will depend not only on current inter-sectoral wage differences, but also on anticipated future differentials, which in turn depend on expectations about the future movements of resources across sectors. Krugman shows that there is a range of initial conditions, which he calls the overlap, from which either one of the two long run states can be approached if and only if it is expected to be realized.  If initial conditions lie outside this range, then history is decisive, otherwise expectations matter a great deal in affecting the eventual pattern of specialization.
The overlap may be viewed as a zone of uncertainty within which coordinated optimism can have major economic effects. Outside this zone, for better or worse, we are shackled by our history. Within it, expectations become crucially important. 
The question, then, is whether or not sub-Saharan Africa is now in or around this zone of uncertainty where expectations can be a critical determinant of its future development performance. Shanta Devarajan has recently pointed to a number of success stories that seem to suggest the stirrings of something major:
In recent years, a broad swath of African countries has begun to show a remarkable dynamism.  From Mozambique’s impressive growth rate (averaging 8% p.a. for more than a decade) to Kenya’s emergence as a major global supplier of cut flowers, from M-pesa’s mobile phone-based cash transfers to KickStart’s low-cost irrigation technology for small-holder farmers, and from Rwanda’s gorilla tourism to Lagos City’s Bus Rapid Transit system, Africa is seeing a dramatic transformation.  This favorable trend is spurred by, among other things, stronger leadership, better governance, an improving business climate, innovation, market-based solutions, a more involved citizenry, and an increasing reliance on home-grown solutions.  More and more, Africans are driving African development.
I quoted this passage in an earlier post as a counterpoint to William Easterley's rather startling claim that "78 percent of the difference in income today between sub-Saharan Africa and Western Europe is explained by technology differences that already existed in 1500 AD – even before the slave trade and colonialism." My quarrel is not with this statement as an empirical claim, but rather with its implication that the heavy hand of history will continue to weigh inexorably upon the region. Sometimes we are bound by the past and sometimes not, and it is important to recognize opportunities to break free when they arise. And such an opportunity may well be emerging right before our eyes in Africa.


I am grateful to E. Somanathan for reminding me of the paper by Rosenstein-Rodan, and to Joao Farinha for his thoughtful and informative responses to my earlier post on this topic.  


  1. On a related note see the following:

  2. Thanks David... that's an interesting example.

  3. "Sub-Saharan Africa" may not be a very useful level of analysis. Instead, I would expect to see a handful of small, dynamic "African tigers" focused in only key metropolitan areas of a few nation-states to emerge first, while vast areas elsewhere lag behind and eventually are caught up. Even very dynamic economies like China's are predominantly backward regions, punctuated by hot spots that are growing much faster and starting to merge into each other in larger regions.

    The speed with which economic divides emerged between North and South Korea, West and East Germany, and Hong Kong and the rest of China, as examples, likewise cast doubt on how heavy the hand of history is in economic development. A half a century can lead to remarkable economic change.

  4. Andrew, as far as hot spots are concerned, I think you're absolutely right (and Joao Farinha would agree with you based on his comments on my earlier post). But when it comes to perceptions, I think the regional grouping will play a critically important role. After all, it is global perceptions of "China" that have changed, even though growth may be concentrated in Guangdong and a few other provinces. FDI flows may target Kenya or Mozambique at first, but ordinary investors will probably just take an interest in "Africa" funds. These kinds of perceptual shifts could have major economic consequences, that was my point.

  5. @Rajiv

    Thanks for reading the comments and responding thoughtfully. It is appreciated, as are your incredible posts and some of the issues and approaches that should be talked about, but aren't always, in the econ blogging world.

    Your point on the role of perceptions is well taken as well. And there does seem to be quite a lot in the literature about the "big push" need for a group of investors and firms needing to have commitment to an idea for it to prosper. The same thing is true of urban infill development in places like Denver's LoDo neighborhood that our Mayor made his money revitalizing as part of a group of likeminded investors. The economic development literature also talks a fair amount about the need for interrelated industries to all be present at once.

    It is hard to tell how much a decision of someone to buy an "Africa" fund or to simply invest in a target country is a driver of investment and how much it is a follower. But, diversification certainly could help Africa funds dodge political and other risks so you are probably entirely right there.

  6. Andrew, thanks... I have not always been able to respond to your comments in detail but they have been consistently thoughtful and well-informed, and the value of this blog has been substantially enhanced by them.

  7. Dear Rajiv/Andrew,

    What an interesting exchange I was missing. Hope not everyone left the room already.

    I keep coming back to what is exactly the meaning of expectations being attached here, and what it implies/assumes on the way firms take investment and business decisions. Do firms really invest on the expectation that the other firms that are complementary will invest too? I’ll continue to think about this, but perhaps Rajiv can give us another wonderful post on this topic.

    If development (expansion over time of the productive capacity of a nation and its concomitant living conditions) is really constrained by issues of coordination in complementary investments and other productive factors (I’ll get to these below), then we have multiple equilibria. A range of these can be what we call poverty traps, which require a “big jump” out of that equilibrium, i.e. coordinated action in the “jump”. But who coordinates? Can a wave of optimism and good international headlines and cheerleading automatically generate parallel investment decisions in a self-fulfilling manner? Is that all it takes to be in that “zone of uncertainty” that Rajiv talks about? Or does public action need to put some “carrots” and “thought” into the game?

    The call for coordinating action or big push I think implies the existence of another aspect to this core element in the challenge of development. In addition to the whole story of complementary investments and Marshallian Externalities (did I get this right?), which Rosenstein-Rodan goes on about (btw, Debraj Ray, a colleague of Rajiv I presume, has this very nice paper called “What’s New in Development Economics” that provides a neat taxonomy of all of these coordination issues), I think there are key complementary investments and inputs that have the properties of a Public Good (for which of course, price mechanisms and profit motives don’t work to make them happen and available, no matter how much optimism there is in the market system).

    It gets worse, many of these market failures (for which the public goods are required) are product-specific (I’m talking 4-digit SITC here). This makes it incredibly difficult in terms of identification (even if public provision effort could eventually be effective, which when one starts thinking about the bureaucracies of developing countries, one may conclude it to be a bad assumption). This is especially so when we are talking about “new” products (in which a country hasn’t yet obtained revealed comparative advantage), because there’s no constituency of firms to lobby the Government for provision of that complementary input. (continues in the next comment)

  8. (continuation) Once we came to think about it (and reading plenty of Rodrik, Klinger and Hausmann), me and a few colleagues explored the idea on the ground (we basically stopped asking about the “cost of doing business” ranking, it just takes a small step), and this problem seems to be pervasive… pervasive. We are absolutely convinced about it these days, and the implication is that coordinated optimism is NOT easy to trigger or sustain. “Big Pushes” may not be big enough. This may be one of the reasons there’s no international convergence in income levels over time. Development is not easy, but it is possible to break free from low-equilibrium traps, but that requires a lot of key things to happen from Government also. There must be a coordinator (even if involuntary and decentralized), unfortunately, the coordinator is not always willing, focused or effective.

    So, I agree with Rajiv in that the heavy-hand of history doesn’t need to crush a country’s future possibilities. And I interpret Easterly’s result as evidence of:

    (i) the coordination difficulties referred to above, and that they have made difficult in History for countries to get out of bad equilibria, but in no way as statement of fate and destiny, and,
    (ii) past productive experience of a country does influence the future path of international specialization (see the Product-Space work of Hidalgo, Hausmann and Klinger on this topic – the product space of the World is highly heterogeneous, and there’s plenty of path dependency in how countries change their comparative advantage, which itself seems to face market failures of product-specific nature).

    Development HAS been difficult, that’s all, but not impossible.

    But I disagree with Ngozi’s understanding that the “concerted development effort” is made of broad investments in education and infrastructure, and improvements in business climate (narrowly defined as it is usually). Why such a limited scope for public action? I think it’s much, much more than that. I don’t mean to say a lot of Government is required. but mindful and effective public action in providing the key product-specific public goods that acquiring comparative advantage in “new” products seems to require, and in this way accelerate a country’s structural transformation.

    Now, I think this is somehow what was happening in the East-Asian tigers in the last 40 years, is it what is happening in some parts of Africa too? Maybe and maybe not. Maybe in some countries it is, and in others it isn’t.

    Is Ngozi’s speech based on little else than cheerleading and reading too-much into mere growth spurts? I was not moved by her storyline.

    I also disagree with the idea of the bond issue securitizing future donor flows to immediately fill a so-called infrastructure gap. Not only because I have an aversion to this concept of a gap altogether (and not just that it sounds like what Easterly convincingly criticized a few years ago as another comeback of the Ghost of the Harrod-Domar model), but because there’s a whole macroeconomic dimension of price and exchange-rate problems from massive capital account inflows that cannot simply be dismissed. Think there’s enough evidence to think that these can impair a country’s industrialization and diversification challenge.

    On Rajiv’s comment above regional effects and fixed-capital investors’ perception, it came to my mind a similar argument made by Jonathan Temple in a paper on Indonesia’s growth (a book edited by Rodrik), and how to be in that center of growth and regional attractor of FDI was key. I’ll look it up when I get a chance. But I think Andrew was attaching too much importance to how “fund” managers can impact on Africa’s prospects.

    This got too long, I apologize… again, great post Rajiv! Thanks

  9. Joao, thanks for your comments, there's a lot of wisdom and information there. Interestingly, Rosenstein-Rodan argued that the active involvement of nation states outside the developing zone was a critical component of the big push, but this aspect is missing in Krugman's formulation.

    If you're ever interested in writing a guest post for this blog please email me. You have a lot of interesting things to say on this topic (as does Andrew, but he has his own blog).

  10. Hi Rajiv, just sharing this new work:

    How would this cross with the newly-found optimism on Africa's prospects discussed in this post?