Bailout? The economic genesis of the problem and some solutions

The media has been awash with the bailout buzz over the last couple of weeks. Most commentaries expressed displeasure at the idea that some distressed private businesses would need to be bailed out using public funds. In this article, I look beyond the individuals who have taken centre stage in the heated debate and instead discuss the macroeconomic genesis of the problem and offer some solutions. First I argue that the distress in the private sector points to a much larger problem with a struggling economy, misdirected investments and a weak indigenous private sector.

The genesis of the problem dates back to the years following the global financial crisis. Initially, the Ugandan economy appeared to have been spared the gruelling after effects of the crisis. Economic growth averaged 8% between 2007 and 2009 a period in which the crisis unravelled. That Uganda enjoyed limited integration with the world financial markets helped. The ensuing loss in foreign direct investment, remittances and other private transfers was offset by the expanded trade with South Sudan made possible by the signing of the comprehensive peace agreement and subsequent independence from the Khartoum Government.  The export surge in both formal and informal exports cushioned the economy from uncertain headwinds.

However, growth started falling in the period that followed the crisis and South Sudan has since remained only sporadically peaceful. Interestingly, the low growth coincided with Uganda rolling out its first National Development Plan: a new development blue print that primarily focused on massive investment in infrastructure; understandably Uganda does have glaring infrastructure deficits that inhibit investment and productivity.  Consequently, a large share of the budget is allocated to financing infrastructure development, particularly in the energy and transport sectors.

Two things are worth pointing out here. First, the indigenous private sector has not built capacity to take advantage of procurement opportunities offered by these large public investments. These procurements have therefore largely benefited foreign firms. This limits the scope for the fiscal multiplier that would support domestic economic activity.  Indeed business climate surveys at the Economic Policy Research Centre indicate that the economy has been operating well below potential for long periods of time. Businesses now frequently report low demand as the biggest challenge they face. The consequences are dire: capacity utilization and job creation are low.

Second, the challenges with public finance management in Uganda imply that the public investment projects do not always deliver value for money. It is therefore not surprising that a recent World Bank assessment indicates negative returns on public investment in Uganda. This is even more worrisome considering that the external sources of funds supporting this investment are increasingly on less concessional terms.

Another challenge facing the Ugandan economy is misguided investments. The entrepreneurial class in Uganda seems to favour the less risky non-traded investments. A prime example is real estate and entertainment/bars. Specializations in investments whose products or services cannot be traded across international borders tend to encourage import dependency leading to worsening trade balance, exchange depreciation, inflation and high interest rates. All these challenges abound in Uganda.

Faced with falling domestic demand, Uganda has to look to export markets to shore up the economy. In this respect, the Ministry Of Finance, Planning and Economic Development and the Uganda Investment Authority would do well to guide the local entrepreneurial class to tap into global value chains and to diversify into export oriented portfolios by coming up with bankable export oriented investment proposals.  And with examples such as fruit, coffee, cotton and steel, Uganda is not short of low hanging fruits.