Following the intense debate on the fiscal deficit during the U.S. presidential campaign, fiscal consolidation continues to dominate discussions in policy circles and academia. The large fiscal deficit in the U.S. and sovereign debt woes in the eurozone are used by proponents of the ‘small government’ mantra as a means to advance the belief that fiscal consolidation is the only way to bring the economy back to sustained growth and full employment. While the arguments are not new, the current circumstances of a global recession and a slow recovery in the U.S. make it somehow easier for proponents of this school of thought to fool the public into believing that tying the hands of the government is the only road to salvation.
African countries and developing countries in general know too well about the ravages of austerity programs; they certainly would not want to revisit the era of the 1980s that left permanent scars from fiscal retrenchment. While arguments for the alleged benefits of fiscal consolidation in terms of accelerated recovery and long-run growth are built on shaky empirical grounds in the case of developed countries, they are even more tenuous for African countries. First is the chimera of “expansionary fiscal contraction” whereby fiscal consolidation is arguably supposed to boost growth through expansion of private spending driven by improved business confidence. In the case of developing countries, fiscal retrenchment typically involves substantial cuts in public expenditures including infrastructure, which worsens rather than improves the business environment by raising production costs. So, “expansionary fiscal contraction” isn’t, and can’t be, a developing country phenomenon.
Second, it is alleged that fiscal consolidation would cause interest rates to decline, thereby raising private investment and consumption. The fact is that interest rates in African countries and in developing countries in general are sticky downward, notably due to pervasive distortions in credit markets. Furthermore, investment in that part of the world is constrained less by the cost of credit than by other economic and non-economic factors, so that a deficit-reduction-induced decline in interest rates – to the extent that they actually decline – will have limited effects on private investment. In contrast, countries will most likely suffer substantial decline in private investment following a reduction in public investment associated with fiscal consolidation.
Third, it is argued that the negative impact of fiscal contraction would be mitigated by the effects of the depreciation of the national currency on trade – raising exports and reducing imports. In African countries, exports are price-inelastic, especially given the predominance of primary commodities. Moreover, the increase in global demand is typically met with a lag due to supply-side constraints. In contrast, a depreciation of the national currency carries heavy costs due to the increase in the bill associated with imports of indispensable goods such as raw materials.
It is also alleged that the negative impacts of fiscal contraction, especially if due to a cut in public expenditures, can be mitigated by a monetary stimulus. The problem is that African countries have limited space for such stimulus, especially given their commitment to low inflation. This means that their economies would most likely absorb the full blow of fiscal contraction.
So, if African countries can’t look westward for models on fiscal management during hard economic times, where can they turn to? First, African countries can learn from their good performance during the global recession. While they suffered a decline in public revenue, this did not translate in a proportional decline in public expenditure (see Figure 1). In fact on average the continent managed to maintain the general upward trend of public expenditure which has sustained the growth resurgence over the past two decades. Second, African countries can leverage untapped potential for domestic saving through innovative mechanisms such as local-currency infrastructure bonds. When the government of Kenya floated an infrastructure bond for Sh31.6 billion in 2010, it was oversubscribed by 18 percent. Other countries can emulate the Kenyan example and leverage increased appetite for fixed-income instruments in the context of high market uncertainty. African countries can raise more domestic resources by expanding the tax base and exploiting other revenue generating instruments, both in the public and private sector. All this is to say that African countries have plenty of lessons to learn from the continent itself in managing a demand-led recovery and sustaining robust long-term growth. They must choose a fiscal policy stance that sustains, not stunts the growth momentum.
Source: World Bank, African Development Indicators; IMF, World Economic Outlook database.
 See IMF (2010) “Will it hurt? Macroeconomic effects of fiscal consolidation.” In World Economic Outlook: Recover, Risk and Rebalancing. Washington, DC: IMF.
 See Kasekende, Ndikumana and Brixiova (2010) “Africa’s counter-cyclical policy responses to the crisis.” Journal of Globalization and Development Vol. 1(1), article 16, January 2010.