Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa (15 page)

Pooling risk invariably introduces a free-rider problem; that is, the risk that one or more countries take relatively more cash out of the pot than they deserve (or add more risk to the pot than is desirable – although in this case the group of countries could simply choose to exclude the country, thereby forcing it to the markets on its own, to earn its stripes). A way around this problem
would be to divide the spoils on a GDP-weighted basis – the bigger the country, the greater the share of the bond pie it receives; or on a needs basis (based on countries’ per capita income) – the greater a country’s needs, the more of the bond proceeds it would receive.

There is another risk mitigant, which is to offer some type of insurance or payment protection in the event that a country defaults. Like any other credit guarantee, the guarantor (usually of higher credit standing than the country issuing the bond) would promise to cover some part or the full value of the bond if a country reneged on the repayment of its debt obligation.

A recent example of this is South Africa’s Pan-African Infrastructure Development Fund (PAIDF). Launched in 2007, the PAIDF invests in infrastructure projects (transport, energy, water and sanitation, and telecommunications) across Africa, while the South African government guarantees the fund’s multi-billion-dollar investments.
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With its respectable triple B credit rating, South Africa is effectively underwriting the risk of the whole continent, and is able to provide comfort to investors, who might otherwise see the fund’s investment pool as too risky. As of October 2007, the PAIDF had raised approximately US$625 million from Africa itself (suggesting, as discussed later, that a lot of untapped cash exists on the continent).

Another innovative example in risk mitigation is that of the Republic of Argentina, which issued a US$1.5 billion bond consisting of six bonds, guaranteed in part by the World Bank. Each bond was for US$250 million maturing at different times (one year, eighteen months, two, three, four and five years).

The guarantee structure worked quite simply: the first bond was fully guaranteed by the World Bank. Once Argentina repaid this bond, the guarantee rolled forward to the second bond. Thereafter, it rolled to each successive bond, and so on.

The idea of the guarantee was that if Argentina failed to repay any bond at maturity, the World Bank would immediately step in and repay it. If Argentina then repaid the World Bank within sixty days of the bond’s maturity, the guarantee of the World Bank
would roll to the next bond. However, if Argentina failed to repay the World Bank within sixty days (which unfortunately it eventually did), the guarantee would be lost on all the remaining bonds. Because of the World Bank’s guarantee, each of Argentina’s bonds in the series achieved a highly coveted investment grade rating based on the AAA-rated guarantee of the World Bank. Despite Argentina’s default on this structure, this is exactly the type of innovative financing structure that can help bring Africa into the global fold.

Finally, securitizing a bond issue can also mitigate risk and reduce the cost of borrowing. The process of securitization involves ring-fencing, or setting aside, specific cashflows to pay off a debt obligation. Take an oil-producing nation as an example of how this works. The country issues debt with the understanding that all payments (interest and principal) due on the bond will be repaid by specified income earned from oil exports. Of course, there is the risk that something happens to the income stream (again, think of the Brazilian frost and the income lost on the coffee crop), but in general investors are reassured if they can see exactly how they will be repaid their investment money.

In ‘Ending Africa’s Poverty Trap’, the economist Jeffrey Sachs et al. estimated the money needed to meet the Millennium Development Goals (MDG) (excluding government and household contributions) for Ghana, Tanzania and Uganda. They argued that this is the amount that donors would have to provide in order to finance the MDG intervention package.

For Ghana, he estimated the total investment needs for meeting the MDG would average US$2 billion a year (or US$82.8 per year, per person). Of this total, Sachs proposed that US$1.2 billion would need to be funded by annual external assistance. Yet, although Ghana’s 2007 foray in the bond markets was only for US$750 million, it was heavily oversubscribed to the tune of US$5 billion of unmet investor demand. On the basis of Sachs’s estimate, this would have been enough to cover at least the foreseeable next five years’ MDG requirements.

The Ghanaians did the right thing. There was clearly no need
to go down the aid path yet again, and there was a lot of upside to issuing the bond. Although small this time round relative to the investor demand, their approach was prudent – and for this they will be rewarded. In particular, their initial success can be the launch-pad for them to win favour from investors and return to the market regularly in future years.

Tanzania and Uganda’s MDG financial needs are far less modest (US$2.5 billion and US$1.6 billion per year, respectively) but no less unachievable. Although they are both in a position to issue bonds (Uganda has a B credit rating from the Fitch rating agency) towards meeting their MDG needs, they have yet to take the plunge.

Depressingly, and maintaining the status quo, the Sachs estimates all require a doubling of aid for each country.

In the summer of 2005, Lukas Lundin, an intrepid mining entrepreneur, rode his 1200cc BMW motorcycle the full length of Africa – from Cairo to Cape Town (three times the distance of New York to California). The journey would take him five weeks and cover 12,000 kilometres (roughly 8,000 miles), through ten African countries. His expedition took him past the pyramids of Egypt, through the dusty and arid terrain of Ethiopia and Sudan; through the scenic savannahs of Kenya, and past Mount Kilimanjaro in Tanzania. He rode past Lake Malawi, past the Victoria Falls in Zambia, past the Okavango swamps of Botswana, and through the Namib Desert of Namibia; concluding the treacherous ride in South Africa.

At the time, 85 per cent of the roads he travelled on were tarred – of the highest quality, no different from the ones he rode on in California. He was astonished – this was not what he had expected at all. Along the roads, in country after country, there were clues as to how this had come about: signposts proclaiming ‘this road constructed with the grateful assistance of the Government of the People’s Republic of China’.

As this story illustrates, there has recently been a surge of foreign direct investment aimed at Africa. It’s been a long time coming, but in terms of what capital is available it barely scratches the surface.

Some figures to think about: in 2006, global flows of foreign direct investment (FDI – defined by the United Nations Conference on Trade and Development as ‘an investment made to acquire a lasting interest in an enterprise operating outside the economy of the investor’) soared to a record US$1.4 trillion. FDI into developing countries (globally) approached almost US$400 billion. During this period, FDI flows to the whole of sub-Saharan Africa
reached a meagre US$17 billion. The continent as a whole continues to disappoint and has failed to capitalize on the phenomenon of global FDI growth. In 2006, the US$37 billion that Africa received as official foreign aid was more than twice the continent’s foreign direct investment, and today Africa attracts less than 1 per cent of global capital flows, down from almost 5 per cent a decade ago.

The disappointment is justifiable. In theory, foreign capital should flow from richer countries to poor. The marginal product of a unit of capital should be higher in poor countries than in rich (in a rich country US$1 can produce only one pair of shoes, whereas in a poor country US$1 can produce ten pairs – more bang for your buck). Typically in these countries labour is more abundant and cheaper, thus increasing its appeal to FDI.
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Japanese car markets have invested in Eastern Europe, where labour costs are low. So too have low production costs in the textile industry attracted Asian and Chinese investors to Africa – seeking both low overheads and the opportunity to use the African countries’ export quota.

Yet Africa, which should on this basis be the prime target for FDI, continues to be broadly ignored. More figures: in 2006, FDI of US$200 billion accrued to only ten emerging economies (in descending order, China, Russia, Turkey, Mexico, Brazil, India, Romania, Egypt, Thailand and Chile – none in the top ten are in sub-Saharan Africa); 52 per cent of FDI went to Asia; FDI to China alone was roughly US$80 billion – five times the amount for the African continent as a whole.

So why, then, given Africa’s level of development, is it that most of the capital flows have by-passed the most needy of continents?

Few would dispute the fact that Africa is, a priori, ready-made for FDI. Its labour costs are low, its investable opportunities are high, and even theoretically, as home to some of the poorest countries in the world, Africa should be FDI’s natural suitor.

Truth be told, there are hurdles for investors to overcome. For the most part infrastructure (roads, telecommunications, power supply, etc.) is scant, and of poor quality, making the costs of overall production of goods and services (when transport costs are figured in) steep – which explains why it is cheaper to make almost anything in Asia and ship it to Europe, than produce it in Africa, although the continent is much closer.

However, physical constraints are nothing when compared with man-made disincentives: widespread corruption, a maze of bureaucracy, a highly circumscribed regulatory and legal environment, and ensuing needless streams of red-tape.

Doing business in Africa is a nightmare. The World Bank’s annual ‘Doing Business’ survey provides data on the relative ease (or difficulty for that matter) with which business can be conducted around the world. The results are all too revealing, and do much to explain why Africa remains at the bottom of any FDI investors’ list.
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In Cameroon, it takes an investor who seeks a business licence on average 426 days (that is almost a year and three months) to perform fifteen procedures; whereas in China it takes 336 days and thirty-seven procedures, and in the USA, only forty days and nineteen procedures. What entrepreneur starting a business in Angola wants to spend 119 days filling out forms to complete twelve procedures? He is likely to find South Korea a much more attractive business culture, as it will take him only seventeen days to complete ten procedures.

It’s not only the red-tape. It’s also the opacity. Investors don’t know where to go, or who to ask. In a number of mining-dependent countries, rather than the government offering parcels of land in open auction, prospective investors are expected to provide the government with specific land coordinates. The geological survey offices know where the ore lies, but they just can’t be bothered to help the investors along. Though the countries’ livelihoods depend significantly on such entrepreneurs coming in, given the nature of doing business it is hardly surprising that this much-needed investment stays away.

It may all sound insurmountable, but just like a click of a switch it is perfectly possible (and easy) for an enterprising government to reduce the paperwork, supply the coordinates, and speed up the process. Unfortunately, the reality may not be as simple as that, but it is has been shown that improving regulations for business could lift GDP by 2.3 per cent a year (Djankov, McLiesh and Romalho). The Commission for Africa notes that Uganda’s economy grew by around 7 per cent between 1993 and 2002 when the country improved its regulatory climate. It also reduced the number of people living on less than a dollar a day from 56 per cent in 1998 to 32 per cent in 2002 after the government introduced measures to attract investors.

Africa continues to have a bad reputation. The former UN Secretary-General, Kofi Annan, put it this way: ‘For many people in other parts of the world, the mention of Africa evokes images of civil unrest, war, poverty, disease and mounting social problems.
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Unfortunately, these images are not just fiction. They reflect the dire reality in some African countries, though certainly not all.’

Unless Africa does something about it, this image is bound to remain fixed in the minds of investors. Continent-wide economic growth won’t accelerate unless African governments improve conditions for investment. African policymakers would do well to remember that there are other developing regions where it is much easier to generate similarly attractive returns with considerably less hassle. This is probably not accidental – their leadership just happens to care more.

As a first port of call, Dongo needs to recognize that FDI is an engine for economic growth. Besides the welcome cash raised to support development initiatives, there are other benefits that FDI will bring: it will create more jobs, assist in the transfer of new technology, help stimulate the formation of Dongo’s capital markets, improve management expertise, and aid indigenous firms
to open up to the international markets. Furthermore, satisfied FDI investors would be happy to introduce the country to other forms of capital – bank lending and venture capital.

The more foreign cash Dongo can attract, the more foreign cash Dongo will get.

But Dongo has some work to do. It needs to give its moribund legal and regulatory system teeth. Investors need to know and believe they have some means of recourse – somewhere to go if and when their contracts falter.

Dongo also needs to recognize that it must woo FDI investors, who are used to being courted by all manner of other emerging nations. Attractive tax structures are a great way of luring investors in. For example, in order to bring in foreign mining investment in the late 1990s, the Zambian government reduced royalties to a minuscule 0.6 per cent. (Although on the back of the surge in copper prices the tax rate was raised to 3 per cent.) Beyond this, because FDI investors perceive their capital differently from bank capital – the former looking to invest in a country over longer periods of time than the latter – they will look to countries that are keen, and that are seen, to invest in their infrastructure (economic, political and social – notably education).