Update II: Introducing Dutch Disease in Uganda

Is the discovery of Oil likely to be a blessing or a curse?

We finished our European cycle in Amsterdam, capital of the Netherlands, a city with a rich economic history built around strong trade links over the centuries. One concept famously associated with Europe’s 5th largest economy is the dreaded ‘Dutch Disease’, coined by the Economist newspaper in 1977 to describe the negative impact of the discovery, in 1959, of natural gas reserves on the rest of the economy. I flew from Amsterdam to Uganda and started the African leg of the Economic Cycle in Kampala with a visit to Makerere University. Here I met with two budding economists to discuss whether Dutch disease was a threat to Uganda as well as other challenges for African policy makers.

Meeting Joseph & Paul at the EPRC

Joseph Mawejje and Paul Lakuma are both research analysts at the Economic Policy Research Centre, a think tank attached to the economics facility at the university. Having both graduated from Makerere, they completed Masters degrees in Norway and  the UK respectively. The think tank, founded in 1993, is well regarded internationally and helps the Ugandan Government measure the success of its policies and identify challenges ahead.

With respect to natural resources, Dutch disease effectively describes how inflows of capital and foreign exchange into that specific sector can cause a decline in the other tradable sectors (usually manufacturing). This occurs by two mechanisms - less investment into other sectors reduces their relative productivity with a knock-on effect on the competitiveness of those exports while inflows of foreign exchange can cause a real appreciation of the exchange rate with a similar effect on overall competitiveness.

Is this a threat in Uganda? Whilst oil was discovered in 2006, it has yet to start the extraction process and thus it is too early to tell: ‘Yes, things have been slow, as they often are’, says Joseph, but he points out that ‘they don’t yet have the effective institutions to deal confidently with the process’ and that ‘a slow pace may help Uganda to avoid the pitfalls experienced by other economies who have discovered resources’. Certainly, he and colleagues have been working hard at modelling the impact (e.g. using DSGE models) although he admits that it has been difficult to find directly comparable countries, a typical frustration experienced by most economists, especially in the developing world.

Both Joseph and Paul agreed that investment in non-resource sectors will be important to avoid Uganda experiencing Dutch Disease, a message echoed by DFID’s chief economist Stefan Dercon in a recent lecture in Kampala:

“There are plenty of lessons from the rest of the world that these negative effects do not need to materialise. Much has already been done in the country to avoid this, compared to many other countries in the region. However, to take full advantage of new resource wealth, the country needs to take advantage of the possible delay to invest in high potential tradable sectors, including those focused on regional export.’

So Dutch disease is hopefully avoidable for Uganda! Perhaps more interestingly, I asked Joseph and Paul about the other key challenges facing their nation and Africa in general. Six themes emerged, several of which I hope to explore more as we cycle down to Cape Town and then up through Asia (a reminder of our route is below):

1) FX Volatility & Macroeconomic Imbalances:
The recent depreciation of the Ugandan Shilling (some 35% versus USD since November 2014) might be good for tourists like me and exporters but it has been worrying economists, fearful of the impact of imports and cost-push inflation on high prices. (Remember that Uganda is still importing oil). Its trade deficit (c. 5% of GDP) has contributed to the weakness of the shilling. Moreover, and linked to 2 below, the government is running a significant budget deficit (7-8% GDP), perhaps explaining the 100% increase in the cost of the visa that surprised us on entry - now a whopping 100USD, compared to the the $50 quoted on the Ugandan high commission website before we travelled (TIA- This is Africa!)

  
Should we leave some 'Feedback'?

2) Political Risk:
Like many African states, the current president’s portrait sits on the walls of most offices and shops around the country. In Uganda’s case, Yoweri Museveni’s has been there longer than most: come next year’s presidential elections, he will have held power for 30 years. Uncertainty leading up the election is reducing investment and extra government spending is contributing to higher inflation, albeit lower than when I cycled through in 2012.

3) The Role of China:
‘Chinafication’ of parts of the global economy has been an increasing theme in recent years and much of Africa is closely affected by the world’s new economic super-power. This is a topic I considered back in 2011 when focused on Zambia. Similar to then, Joseph referred to the positive impact on large scale investment, helping to ‘unlock infrastructure hurdles’ but governance and the impact on Uganda SMEs is something he worries about. More prevalent now is the impact of the Chinese slowdown on growth. With China only representing 2.5% of Ugandan exports, the impact on direct growth may be limited but reduced FDI could be a greater concern. Other African economies, such as Zambia or Angola, may be harder hit. This BBC article is a great summary of the effect of China’s slowdown on Africa.

4) Technology & African ‘Leapfrogging':
The impact of mobile technology is exciting for development economists and East Africa has been leading the way in areas such as mobile banking, as I highlighted back in 2012. Both Paul & Joseph acknowledged the positive impact of bringing more of the population into the formal banking sector but regulating the sector was proving harder to do effectively and the unit cost of transactions was higher than many users realised. An example of asymmetric information? Either way, it has been amazing how widespread the use of smartphones have been on the journey so far and the scope for Africa to leapfrog the traditional route of industrialisation. I’ve also just read an article suggesting that the first drone highway could be in Rwanda by next year!

5) Demographics:

Africa’s population continues to grow quickly with experts predicting a doubling of the population by 2050. Although not its biggest negative externality, congestion is already a massive issue in capital cities such as Kampala as was clear on my motorbike taxi ride to/from the university. From a basic economic perspective, faster population growth generally means faster GDP but that doesn’t mean better conditions for citizens. Like the rest of Africa, the population in Uganda is young: both Joseph and Paul are in their early to mid 30s but see themselves as old! Interestingly, they see the large young population as a concern given that the economy isn’t expanding fast enough to absorb the bigger workforce and the education sector isn’t coping.

Africa's population is set to out-pace the rest of the world in the 21st Century

6) Aid - Dead or Alive?:
Finally and probably the most contentious issue that has surrounded African development since the independence movement in the 1960s is Aid. This will be the topic of my next blog from Rwanda. Interestingly, as a recent Spectator article highlighted, many of the fiercest critics are intellectuals from the developing world such as Zambian economist Dambisa Moyo in her famous book ‘Dead Aid’. Joseph and Paul were more circumspect (they weren’t try to sell a book!) but did agree that ‘Africa needs to own its own development’.