We Bless The Rains Down In Africa

It’s been a while since my last entry. I’ve been busy changing my job, studying, taking care of my relationship, repairing my car and doing other economics-related activities.

For this entry I want to talk about the continent that isn’t in the news. The continent which contains high potential for rapid economic growth but also many obstacles for this growth. The world's second-largest and second-most-populous continent. The continent on which the mankind was born. The continent on which Toto and Shakira have sung beautiful ballads. Africa.

Africa has been one of the biggest centers of economic activity since the golden days of industrialization. The United Kingdom, France, Spain, Portugal, Belgium, Italy and Germany started to invade the African countries in the hope for cheap labor and raw materials during colonialization in the 19^th Century. Even today Africa still remains one of the biggest exporters of raw materials such as diamonds, oil, coffee, gold and copper.

Like the all developing countries, the countries in Africa have been in the interest of modern foreign direct investments and multinational corporations for a long time. Yet to be developed markets and economies of Africa offer multinational corporations high potential to growth and to gain revenue and influence on their business.

Already few years back during my economics-classes I wrote a commentary on how many multinational corporations such as Google, for instance, have been investing heavily in Nairobi, the capital of Kenya. These reasons include development of infrastructure, strong internal market, accessibility to better natural resources, better macroeconomic policies and the increased quality of labor. All the factors mentioned attract FDI and multinational corporations into Nairobi. MNC’s would have better accessibilities to growing markets such as Nairobi, where the middle class has been estimated as 30 million consumers.

Let’s us first consider what this kind of an increase in investments means for a country like Kenya. Figure 1.0 shows us the situation, where the interventionist supply-side policies of the government of Kenya have shifted the long-run aggregate supply curve to the right. These policies can be for example the provision and maintenance of infrastructure and investment in human capital to increase the quality and quantity of labor.

As we can see, the economy’s real output has grown from Y1 to Y2 and thus economic growth has occurred. The economy produces now in the output of Y2 and in the average price level of P2. In the diagram we use the new classical long-run average supply curve and suppose that the economy is working at full employment in its level of output. That’s why the LRAS-curve is presented as perfectly inelastic.

Let us see what happens next. The improvements in the aggregate supply have also decreased the average price level from P1 to P2 and thus the inflation decreases. The lower price level, lower rate of inflation and the improvements in the aggregate supply attract now more foreign direct investment into Nairobi. Since investment is one component of the aggregate demand, the total number of goods and services demanded in an economy will increase and AD will thus shift from AD1 to AD2 as we can see from Figure 2. It seems that this kind of a situation is a win for the multinational corporations and for the developing country.

However, to attain these kinds of supply-side policies and economic growth require peaceful and stable circumstances. There exist several argued pitfalls for the economic growth and stability in Africa.

The first problem is the current political instability in the African states. We all have read from the news about the revolutions, mutinies and wars across Libya and Egypt and not to mention the horrors of Boko Haram in the central Africa. Also in the Republic of South Africa, the remains of Apartheid are still remembered. All these kinds of actions and pressures coming from the western world are causing political instability currently in Africa. Achieving the conditions for economic development will demand political stability to the African states. How to achieve that, is a whole different story.

The second common problem is transfer pricing. Transfer pricing happens when a subsidiary of the firm is selling goods and processes within the enterprise, for example for the parent company. In practice, this means tax-avoidance and profit shifting in a hope to attribute the net profit before tax in the country where the corporation is operating. This is currently a major issue in Africa and OECD has been setting regulations for years to stop this kind of transfer pricing.

The third and highly argued matter is the development aid. Several research suggests that there appears to be no significant correlation between the level of aid given to Africa and the growth of GDP. Also long-term provision of food aid may force down domestic prices in the agricultural sector, which harms the economic growth even more. The nature of the aid given for Africa should be assessed very carefully to support the conditions for economic growth, although the humanitarian aid is considered very important in the countries with critical conditions.

Even though the conditions mentioned would be achieved, there would still be no guarantee that the foreign direct investment would increase employment and economic growth in Africa. Although FDI may provide more employment to the economy, the MNC’s might still outsource their own educated staff to the country to work for the company.

If the governments in Africa wish to avoid possible negative effects of the FDI, they must ensure the provision of domestic employment in the multinational corporations and to ensure that the taxation system is efficient enough to prevent the transfer pricing. Also the nature and the amount of development aid should be assessed very carefully to not to harm the domestic production. With these conditions, Africa could be the next big engine of rapid, global economic growth.

And most of all, if we want to bless the rains down in Africa, Africa requires political stability. And we shouldn't force it down everyone's throats with 9K720 Iskander missiles.

Text: SW
Pictures don't belong to me