The Mauritian Economy: A Reader

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THE MAURITIAN ECONOMY

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Also by David Greenaway and published by Palgrave INTERNATIONAL TRADE POLICY: From Tariffs to the New Protectionism CURRENT ISSUES IN INTERNATIONAL TRADE THEORY AND POLICY (editor) ECONOMIC DEVELOPMENT AND INTERNATIONAL TRADE PIONEERS OF BRITISH ECONOMICS: Volume 2 (co-editor with J.R. Presley) CURRENT ISSUES IN MACROECONOMICS (editor) GLOBAL PROTECTIONISM (co-editor with R.C. Hine, A.T. O’Brien and R.J. Thornton) TRADE AND INDUSTRIAL POLICY IN DEVELOPING COUNTRIES (with C.R. Milner) TRADE, DEVELOPMENT AND GROWTH: Essays in Honour of Jagdish Bhagwati (co-editor with V.N. Balasubramanyam) REGIONAL INTEGRATION AND TRADE LIBERALISATION IN SUBSAHARAN AFRICA: Vol. 4, Synthesis and Review (co-editor with A. Oyejide and B. Ndulu) TRADE AND FISCAL ADJUSTMENT IN AFRICA (co-editor with D. Bevan, P. Collier and N. Gemmell)

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The Mauritian Economy A Reader Edited by

Rajen Dabee Associate Professor of Economics University of Mauritius

and

David Greenaway Professor of Economics University of Nottingham

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Selection, editorial matter and Chapter 1 © Rajen Dabee and David Greenaway 2001 Individual chapters (in order) © Roland Lamusse; Rajen Dabee; David Greenaway and Nishal Gooroochurn; Chris Milner; Ramesh Durbarry; Oliver Morrissey; Shyam Nath; Wyn Morgan; K. Junglee; Chris Milner and Peter Wright; Shyam Nath; Malati Pochun 2001 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1P 0LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2001 by PALGRAVE Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE is the new global academic imprint of St. Martin’s Press LLC Scholarly and Reference Division and Palgrave Publishers Ltd (formerly Macmillan Press Ltd.) ISBN 0-333-69965-3 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data The Mauritian economy : a reader / edited by Rajen Dabee and David Greenaway. p. cm. Includes bibliographical references and index. ISBN 0-333-69965-3 1. Mauritius–Economic policy. I. Dabee, Rajen. II. Greenaway, David. HC597.5 .M358 2000 338.9698¢2 – dc21 00-065208 10 10

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Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham, Wiltshire

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Contents List of Tables

vii

List of Figures

x

Preface

xi

Notes on the Contributors

xii

1

2

3

4

5

6

7

8

9

10

Introduction and Overview Rajen Dabee and David Greenaway

1

Macroeconomic Policy and Performance Roland Lamusse

11

Exchange Rate and Balance of Payments Policy Rajen Dabee

45

Structural Adjustment and Economic Growth David Greenaway and Nishal Gooroochurn

62

International Trade and Trade Policy Chris Milner

79

The Export Processing Zone Ramesh Durbarry

105

Tax Policy Oliver Morrissey

130

Government Expenditure and Economic Development Shyam Nath

150

Agriculture and Sugar Wyn Morgan

166

Evolution of the Financial System K. Junglee

185

v

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Contents

vi 11

12

13

Labour Market Adjustment Chris Milner and Peter Wright

206

Local Government Finance Shyam Nath

232

Population and Demographics Malati Pochun

258

Index

289

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List of Tables 2.1 2.2 2.3 3.1 3.2 3.3 3.4 3.5 4.1 4.2 5.1 5.2

6.1 6.2 6.3 6.4 6.5 6.6 6.7 7.1

Government finance statistics: summary table (Rs million) Bank of Mauritius and commercial bank credit and aggregate monetary resources Expenditure on gross domestic product at current prices Exchange rates for selected currencies, 1976–83 (Rs) Main suppliers of imports for selected years, 1980–93 (percentages) Nominal effective exchange rate, 1970–80 (base year 1975) Nominal effective and real effective exchange rates, 1980–97 (base year 1990) Selected entries from the balance of payments, 1970–97 (Rs million) Content of lending operations of World Bank Growth and structual adjustment Pre-trade liberalisation pattern of assistance to Mauritian industries Average rates of effective protection in the Mauritian manufacturing sector, 1980 and 1990 (per cent) Foreign direct investment in the EPZ by main countries of origin, 1985–94 (Rs million) Number of firms and employment in the textile and non-textile sectors Average daily earnings in EPZ by industrial group, 1989–99 (Rs) Sugar exports and EPZ exports, 1980–97 (Rs million) Direction of EPZ exports, 1980–97 (Rs million) EPZ exports of textile and non-textile products, 1982–97 (Rs million) Net foreign exchange earnings of EPZ and sugar sectors, 1975–97 (Rs million) Tax structure in Mauritius compared to regional averages vii

20 22 24 48 49 51 52 54 64 75 87

89 113 114 117 119 120 120 121 140

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viii 7.2 7.3 7.4 8.1 8.2 8.3

List of Tables

Composition of tax structure in Mauritius Illustrative income tax burdens Progressivity of income tax, 1992/93 and 1994/95 Government size: international comparisons Growth of government expenditure Economic classification of consolidated general government expenditure (percentages) 8.4 Trends in budgetary deficits (Rs million) 8.5 Trends in financing of aggregate spending (percentages) 9.1 Sectoral share of GDP in Mauritius (%) 9.2 Indices of agricultural production in Mauritius 9.3 Mauritian trade (100,000 US$) 9.4 Mauritian sugar trade 9.5 Price range of selected commodities (1982–92) 10.1 Suggested sequencing of macroeconomic and financial sector policies 10.2 Sequence of financial reforms, 1988–96 10.3 Changes in reserve ratios, 1969–97 10.4 Stock market performance, 1989–97 10A.1 Evolution of commerical banks, 1970–96 10A.2 Performance of selected financial institutions, 1970–95 11.1 Sectoral employment and wage changes following trade liberalisation in traditional trade models 11.2 Employment equations for Mauritian industry 11.3 Wage equations for Mauritian industry 11.4 Simulated total response coefficients for sectoral employment and wages following an output shock 12.1 Functions of local government in Mauritius 12.2 Trends in fiscal decentralisation (% of general government expenditure and revenue) 12.3 Expenditure trends (Rs million) 12.4 Per capita expenditure of towns (Rupees) 12.5 Revenue trends (Rs million) 12.6 Indicators of tax performance (Rs million) 12.7 The grant system 12.8 Local expenditure and grants (Rs million) 13.1 Population growth in intercensal periods, 1846–1990 13.2 Life-expectancy by sex at specified ages, 1942–92

141 143 145 154 156 157 159 160 167 169 169 170 172 190 192 194 198 202 203 208 220 222 225 238 239 244 245 246 249 250 253 260 262

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List of Tables 13.3 13.4 13.5 13.6 13.7 13.8 13.9 13.10 13.11 13.12 13.13 13.14 13.15

13.16 13.17 13A.1 13A.2 13A.3 13A.4

Percentage of females married by age group, 1931–90 censuses Fertility rates 1962–97, selected years Official long-term emigrants by sex, 1956–94 (annual average) Gender ratio as enumerated at each census, 1846–1990 Gender ratio by selected age groups, 1990 and 1997 Age structure of the population by occupational characteristics, 1931–96 (percentages) Dependency ratio, 1931–96 Projected population by sex and growth rate, 1996–2036 Projections of the resident population at selected ages, 1996–2036 (in thousands) Projections of the resident population at selected ages, 1996–2036 (percentages) Projections of the age structure of working age population, 1996–2036 (percentages) Projections of the dependency ratio, 1996–2036 Projections of population by occupational character and the pensioner support ratio 1996–2036 (in thousands) Estimated future income and expenditure of the National Pensions Fund (Rs million) Percentage of people aged over 60, selected countries, 1990 and 2030 Crude birth and death rates, rate of natural increase and infant mortality rates, 1901–98 Dependency ratio by gender, 1962–96 Implied life expectancies at birth by sex, 1991–2036 Net migration by sex, 1996–2036

ix 264 265 266 268 269 270 272 273 274 275 277 277

279 280 284 285 286 287 287

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List of Figures 3.1 3.2 3.3 4.1 6.1 6.2 6.3 6.4 8.1 9.1 9.2 10.1 11.1 11.2 11.3 11.4 12.1

Trade balance, current account and foreign exchange reserves, 1968–97 Traditional and non-traditional exports and tourism earnings, 1968–97 Total imports, imports of raw materials and equipment, and food and beverages, 1968–97 Liberalisation and growth Employment in the EPZ, 1970–99 Evolution of EPZ firms, 1971–98 Employment in agriculture, tourism and the EPZ, 1973–98 Sectoral distribution of GDP 1980 and 1998 Trends in tax and expenditure shares in GDP, 1968–95 Employment in Mauritius (000s) World sugar prices, 1950–92 Real interest rate determination Importables and exportables employment within manufacturing, 1968–1990 Male and female employment in exportable manufactures, 1972–92 Average real wage rates in manufacturing exportables and importables, 1968–90 Average real wage of importables relative to that in exportables, manufacturing sector 1968–90 Impact of grants

x

56 57 58 65 110 111 116 118 155 168 175 187 214 214 215 216 252

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Preface There has been longstanding collaboration between the Department of Economics at the University of Mauritius and the School of Economics at the University of Nottingham. This collaboration has embraced teaching, research, staff development and examining. This volume is a further output from that collaboration. We are grateful to both Universities for the goodwill and financial support in sustaining our links. We are also grateful to the British Council for supporting a Link Agreement that was a vital ingredient to sustaining momentum. University of Mauritius University of Nottingham

Rajen Dabee David Greenaway

xi

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Notes on the Contributors Rajen Dabee is Associate Professor of Economics and Dean of Faculty at the University of Mauritius. His research interests are international economics and the economics of adjustment. Ramesh Durbarry is Research Fellow at the Business School, University of Nottingham. His research interests are economics of tourism and economic development. Nishal Gooroochurn is a postgraduate student at the Business School, University of Nottingham. His research interest is the economics of tourism. David Greenaway is Professor of Economics and Pro-ViceChancellor at the School of Economics, University of Nottingham. His research interests are international trade policy, economic development and European integration. K. Junglee is Lecturer in Economics at the University of Mauritius. His research interest is financial economics. Roland Lamusse is Emeritus Professor at the University of Mauritius. His research interest is macroeconomic adjustment. Chris Milner is Professor of International Economics and Head of the School of Economics at the University of Nottingham. His research interests are international economics and trade policy. Wyn Morgan is Senior Lecturer at the School of Economics, University of Nottingham. His research interests are microeconomics and futures and commodity markets. Oliver Morrissey is Reader in Development Economics at the School of Economics, University of Nottingham. His research interests are economic development and public finance. Shyam Nath is Professor of Economics at the University of Mauritius. His research interests are economic development and public finance. xii

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Notes on the Contributors

xiii

Malati Pochun is Associate Professor at the University of Mauritius. Her research interests are population studies, gender and economic development. Peter Wright is Senior Lecturer in Economics at the School of Economics, University of Nottingham. His research interests are labour economics and applied econometrics.

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1 Introduction and Overview Rajen Dabee and David Greenaway

The Mauritian economy pulled itself from stagnation and embarked on a path of self-sustaining growth as from the 1970s. Since then it has steadily maintained an average real GDP growth rate of about five per cent per annum for the past three decades. Its per capita GDP, in constant 1995 dollars, rose steadily from an average of US$1,285 in the 1960s to US$3,796 in 1997 and is expected to rise above US$4,000 during the year 2000. More importantly, the economy has undergone significant transformation from a monocrop economy to an industrialising economy with a well developed manufacturing sector and a fast expanding services sector which includes tourism, offshore banking, offshore business and a newly established free port. This remarkable performance has recently attracted the attention of researchers and analysts interested in the factors which have led to economic transformation. Some studies have examined the nature of the development strategy adopted by Mauritius (Kearney, 1990; Romer, 1993) whereas others have examined the evolution of the Mauritian Export Processing Zone (EPZ) which was a major driving force behind the take-off of the economy in the 1970s (Alter, 1990; Hein 1989). Still other studies have examined the impact of selected policies, especially trade policies. These include an analysis of changes in the effective rate of protection (Greenaway and Milner, 1989), an assessment of the nature of trade liberalisation and its macroeconomic impact (Dabee and Milner, 1999), the impact of trade liberalisation on employment and wages (Milner and Wright, 1998) and the liberalisation of foreign exchange and financial markets (Bundoo and Dabee, 1999). And the international financial institutions have brought out reports commending the Mauritian growth record (World Bank, 1989 and 1992). Finally, at the national level, regular reviews of economic performance have been published since the late 1960s by the Ministry of Economic Planning and Development (now renamed Ministry of Economic Development, Productivity and Regional Cooperation) and the Bank of Mauritius. 1

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Introduction and Overview

International sources do, therefore, throw light on some aspects of recent Mauritian economic experience and there are a significant number of national reports on the economy. However, anybody interested in understanding the Mauritian economy has difficulty finding a recent publication, which gives a comprehensive and consistent analysis of the economy. This volume tries to meet that lacuna by bringing together a series of specially commissioned papers which review the major policies to have transformed the economy over the past two to three decades. The volume is intended for three categories of readers. First, university students taking a course on the Mauritian economy will find an analysis of the major problems, issues and policies facing the economy. Secondly, economics students preparing their Cambridge Higher School Certificate examinations (and other similar examinations) should be able to follow the gist of the discussions in all the chapters. More importantly, they will find a significant number of examples of national economic problems and policies, which should strengthen their understanding of economics, and of the Mauritian economy. Thirdly, the general reader interested in understanding the remarkable performance of the Mauritian economy will find a discussion of the special factors behind the Mauritian growth experience in most of the chapters. The general reader may omit the more technical sections of the book. The first substantive chapter is Chapter 2, on macroeconomic policy and performance by Lamusse. This is an appropriate starting point as it begins by reminding us of the special characteristics of small economies and the constraints, which they imply for economic performance. Small economies tend to have higher fiscal and balance of payments deficits; they also tend to have higher rates of imported inflation, which they find difficult to curb with demand management policies. These unfavourable macroeconomic conditions in fact obtained in Mauritius over the period 1978–82, which Lamusse qualifies as ‘a destabilisation phase’. However, there was a marked improvement in economic performance over the period 1983–86, mainly as a result of policies adopted in the context of the 1979–86 structural adjustment programme (SAP). But after the successful completion of the SAP, there was pressure on government to relax some of its restrictive polices. The economy has, nonetheless, continued to perform quite well in the post-SAP period. As for future prospects, Lamusse believes that the sugar industry is likely to face difficult times, given the erosion of preferences in the EU. Textile exports from the EPZ will also face tougher competition as the Multi-

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fibre Agreement is gradually phased out. However, there is likely to be a rapid expansion of the tertiary sector, which includes banking, insurance and offshore services. In Chapter 3, on exchange rate policy and the balance of payments, Dabee first reviews the four different exchange rate regimes adopted since the establishment of the Bank of Mauritius in 1967. The rupee has been successively pegged to sterling, the Special Drawing Right, and an undisclosed trade-weighted basket of currencies. Finally, as from July 1994, there was an important move towards market determination of the exchange rate with the floating of the rupee and the setting up of an inter-bank market in US dollars. The reasons behind each of these changes are also discussed.As for the nature of exchange rate policy, Dabee argues that the monetary authorities tried unsuccessfully to pursue a policy of exchange rate stability in the 1970s. This led to an overvaluation of the rupee, which was corrected by the devaluations of 1979 and 1981. But from the 1980s, there was an important shift in exchange rate policy. An implicit policy of real depreciation was adopted and it has been maintained until now. This has had a favourable impact on the balance of payments. It has given a boost to exports from the EPZ and to earnings from tourism. As both sectors rely heavily on imported inputs, imports have also tended to increase. In fact the current account has tended to show deficits right from the 1970s. However, unlike the 1970s, the later deficits have been completely offset by the inflow of foreign direct investment and portfolio investment. Dabee argues that this can be attributed to the sound macroeconomic conditions prevailing since the early 1980s In Chapter 4, on structural adjustment and growth, Greenaway and Goroochurn argue that the SAP which Mauritius underwent in the early and mid-1980s may have been an important factor behind the transformation of the economy. Structural adjustment lending (SAL) usually supports a whole range of policies and institutional changes which are expected to have a positive impact on economic growth in the medium term. However, the empirical evidence is not conclusive. But, as the authors point out, one aspect of structural adjustment, which has been neglected in empirical work, is the dynamics of the adjustment process. When this is modelled, the empirical evidence does suggest a positive association between trade reform and growth. The authors in fact try to capture the lagged effect of structural adjustment on growth in Mauritius by estimating a simple growth model. Before presenting their model, however, they provide a succinct account of the stabilisation programmes initiated in 1978 and discuss

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Introduction and Overview

in detail the strategies and polices designed to restructure the economy. The determinants of growth included in their model are labour, capital, exports, human capital and the terms of trade. Structural adjustment is modelled by using a dummy variable. The empirical evidence shows that, as expected, the effects of export growth, human capital growth, labour growth and capital growth are positive and, except for capital growth, all significant. The terms of trade effect is negative and significant. The coefficient of the dummy variable is negative, indicating that in the short run the economic and social adjustments required during SAPs negatively affect the growth rate. However, the coefficient is not significant. But does SAL work in medium term? The authors re-estimate their model with a new dummy for the post-SAP period. The striking result is that the coefficient is positive and significant, all the other coefficients having the expected signs and remaining significant. The evidence does therefore suggest that structural adjustment positively affects growth, although with a lag. However, the authors conclude that the transformation of the Mauritian economy cannot be ascribed to the SAP alone as other important factors were also at work. In Chapter 5, on international trade and trade policy, Milner sets out to make an assessment of the role played by trade and trade policies in Mauritius from the 1960s and moves on to examine how trade strategy and trade policies need to be revised in the context of changing domestic and international conditions. To understand the role of international trade and trade policy, we must remember that according to theory, a small country should normally adopt liberal, outwardoriented trade policies. However, in the early 1960s, policymakers in Mauritius opted for an inward-looking strategy, encouraging the setting up of import substitution industries. It was feared that, given the high rate of unemployment and underemployment (estimated at around 20 per cent of the labour force), labour intensive firms producing cheap exports would drive down wages to socially undesirable levels. But within a few years it became obvious that import substituting industries could not possibly generate adequate employment opportunities, which would absorb the excess supply of labour. An export strategy based on labour intensive manufacturing was perceived as more viable long-term solution. Hence the establishment of the EPZ in 1970. Incentives for import substituting firms were maintained, so that one finds a very mixed trade strategy in place in the 1970s, characterised by proximate free trade status for the EPZ and a high degree of protection for import substitution firms. There

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was in fact a high degree of anti-export bias in the trade regime. It is only towards the latter part of the 1979–86 adjustment period that some trade liberalisation measures were introduced. This led to a sharp increase in exports, especially EPZ exports and helped to bring about a significant structural transformation of the economy. Moving to the second part of the chapter on the need for reviewing trade policies, Milner points out that in the case of Mauritius, trade strategy and trade policy are influenced more by international than by regional trade developments. Thus, profound effects on EPZ exports and sugar exports are expected to follow from the Uruguay Round agreement. The author argues that there is clearly a need to diversify agriculture, and especially EPZ manufacturing, where the high degree of concentration on textiles and clothing has to be reduced by moving upmarket and diversifying into a broader range of products. The expansion of services like offshore services and warehousing services can also lead to a further diversification. There is also a need for further trade liberalisation and reduction in anti-export bias. The level of protection of import substitution firms can be reduced further. This could allow them to become competitive producers of inputs for EPZ firms and favour the integration of EPZ and non-EPZ enterprises. Finally, dependence on trade taxes can also be reduced. In Chapter 6, Durbarry examines the development of the export processing zone in greater detail. He explains how crucial the EPZ has been to the development of the manufacturing base and the growth of manufactured exports. Following an appraisal of strengths and weaknesses, he goes on to speculate on its future prospects. As well as being conditioned by internal factors these will be fashioned by external pressures, not least is the phase out of the multi-fibre arrangement as agreed in the Uruguay Round of multilateral trade negotiations. In Chapter 7, on tax policy, Morrissey discusses the four criteria for a good tax system: it should be equitable, efficient, simple to understand, and easy to administer. Out of these four criteria, economic efficiency deserves greater emphasis in the case of developing countries as they tend to rely heavily on trade taxes. Such taxes distort the prices of importables and exportables, inducing inefficiencies in the allocation of resources. Viewed from this perspective, the recent reduction in the average level of tariffs and the abolition of the export tax on sugar in Mauritius should be regarded as a movement towards greater efficiency. However, with tariffs still contributing 40 per cent

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Introduction and Overview

of government revenue, Morrissey argues that their adverse effects on resource allocation may be non-negligible. Tariffs can still be reduced and rationalised. One of the objectives of tax policy in Mauritius should be the progressive replacement of tariffs with income tax, which has a high degree of buoyancy and should therefore become an increasingly important source of government revenue. Reduced dependence on tariff revenue is likely to be facilitated as the recently introduced Value Added Tax (VAT) is further consolidated. One of the advantages of the VAT is that it has relatively high tax elasticity and it is also buoyant. More importantly, it is likely to contribute to a reduction in price distortions when combined with a reduction in the rate of taxes on imports. This leads Morrissey to conclude that prospects for an improved tax system in Mauritius are very good. In Chapter 8, Nath examines the relationship between government expenditure and economic development. He first points out that in any society a minimum level of expenditure is required for the provision of pure public goods and also for a range of merit goods. Any additional expenditure is likely to depend on the goals which government sets for economic growth, income distribution and stabilisation. Over time, government expenditure tends to rise with the level of economic development, as the international evidence seems to suggest. However, in the case of Mauritius, the rate of growth of government expenditure has in recent years been much slower than the rate of growth of GDP. And recurrent expenditure continues to make up a little more than 80 per cent of total expenditure, constraining the growth of capital expenditures and adversely affecting the role of government in the development of infrastructure. The budget deficit is financed increasingly by government borrowing, given the decline in the relative importance of taxes. Nath recommends that the size of the capital budget be increased to finance additional infrastructure requirements. However, there is a need to monitor the efficacy of the different components of government expenditure. In Chapter 9, on agriculture and sugar, Morgan emphasises that the agricultural sector in Mauritius essentially means sugar. Although the relative importance of the sector has declined in recent years as the manufacturing sector and tourism have expanded more rapidly, sugar continues to play a significant role in the economy. It provides substantial export earnings which directly influence private investment as well as government revenue. However, export earnings from sugar can be highly volatile. This can result from drastic reductions in output brought about by cyclones. And the price of sugar itself can be

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quite volatile, as shown by the dramatic increases which occurred during the sugar boom years of 1972 to 1975. But volatility can be a major source of macroeconomic instability and can lead to economic crisis. This is precisely what happened in Mauritius in the 1970s. The boom was perceived as a temporary phenomenon by producers; private saving rose above trend, followed by increases in private investment. Government revenue from the tax on sugar, which was normally eight per cent of GDP, rose to 17 per cent in 1974. Instead of treating the boom as a temporary phenomenon, government in fact behaved as if it was permanent. It significantly increased its current expenditures – food subsidies and public sector wages – rather than capital expenditures, putting a severe strain on its long-term budget. The government response to the boom was largely responsible for the economic crisis of the late 1970s when the assistance of the IMF and the World Bank had to be sought. It must be remembered that all these changes were triggered by a price shock, without any change in the policy environment in the sugar market. What will happen if the policy environment does change? Morgan argues that there are currently pressures at the level of the World Trade Organisation to reform and possibly scrap trading agreements and this may seriously affect the Lomé Convention – including its Sugar Protocol. Any change in the policy environment would have a significant impact on sugar producing countries like Mauritius. One way of warding off any negative impact is to diversify the economy. This has been successfully progressed in Mauritius and should be further intensified. However, this does not mean that sugar should be neglected. In fact, there is a need to enhance investment and management strategies so as to ensure the production of high quality and competitively priced sugar. Before moving to a discussion of the evolution of the financial system in Chapter 10, Junglee gives us an insight into the broad range of issues, which are discussed in the literature relating to financial development. Issues which are of particular interest are financial repression, financial liberalisation as part of a stabilisation package, financial liberalisation and the supply of credit, the structure of the financial sector and interest rate liberalisation, and the direction of causation between financial development and economic development. According to Junglee, from the 1970s, policymakers in Mauritius have tried to develop the financial system, keeping in mind the long-term objectives of price stability, economic growth and a strong balance of payments position. They have in fact gradually transformed

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Introduction and Overview

the financial system from a highly regulated one to a market-based system. Initially monetary policy concentrated on direct controls – reserve requirements, credit ceilings and administered interest rates – but from the early 1990s there has been a shift to indirect controls like open market operations. This shift has been accompanied by the establishment of a wide range of new financial institutions and by a consolidation of the regulatory framework. The recent policies have definitely helped to increase the level of financial development. However, as Junglee argues, further development is impeded by the heavy concentration in the banking system and by thin money and capital markets. In Chapter 11 Milner and Wright model labour market adjustment to liberalisation. They begin by setting out a theoretical framework, which can be used to investigate both short run and long run effects in a multi-sector setting with specific factors. They then document the main developments in the Mauritian labour market. Their empirical framework is a panel model, which permits them to test for the effects of liberalisation on sectoral labour demand and wages. The estimated responses of employment and wages in the exportables sector are consistent with the model’s predictions: in response to liberalisation, employment and wages increase in the long run, after facing downward pressure in the short run.Where importables are concerned, contrary to the model’s predictions, employment and wages expanded following liberalisation, outcomes, which are probably driven by expansion of the economy. In Chapter 12 on local government finance, Nath points out that there is an increasing recognition of the need for decentralising fiscal responsibilities to the level of local government authorities. In spite of the scarce empirical evidence on the suitability of decentralisation in small countries, Nath argues that there are strong arguments for local provision of public services in Mauritius. Yet an analysis of Mauritian local government finance reveals a very low degree of fiscal decentralisation. Local government expenditure accounts for a tiny fraction of total government expenditure. The revenue obtained by local authorities – municipal and district councils – from property tax, tenant tax and trade licences is largely inadequate to meet expenditures. The bulk of expenditure is therefore financed by grants from central government. Nath argues that as the demand for local public services grows with rising living standards, expenditures must be increased to ensure an increase in the supply of these services. There is a need to revitalise local taxes by making them more buoyant. Nath

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recommends the use of standardised property values as a basis for taxation. He also argues that the current grants system could be made more responsive to the growing expenditure needs of local authorities by linking grants to central government finances. The final chapter on population dynamics by Pochun provides a very rich source of data on the demographic changes, which have occurred in Mauritius since 1851. It starts by looking at trends in population growth. The population of Mauritius doubled to 360 thousand over the period 1851–81, mainly as a result of the inflow of immigrants from India. Once immigration had practically stopped in the 1880s, population growth slowed down to one half of one per cent per annum up to 1944, due to very high death rates, which were barely offset by equally very high birth rates. After 1944, however, there was a dramatic increase in population growth, as death rates declined significantly with the eradication of malaria and the control of infectious diseases. The population doubled in about thirty years and projections made in the 1960s showed that the population would increase to a staggering size of three million by the turn of the century. Alarmed by these projections, the government put in place a whole range of policies aimed at lowering the fertility rate. These polices were successful as they led to a dramatic reduction in birth rates. The population in fact increased to only 1,124 thousand in 1998. The paper makes a detailed analysis of fertility and mortality rates, and looks at the economic implications of recent changes in age structure which show a definite ageing of the population. It concludes with a presentation and analysis of the medium variant projection putting the population at 1,371 thousand for the year 2036.

References R.G. ALTER (1990) Export Processing Zones for Growth and Development: The Mauritian Example, Working Paper 90/122 (Washington, DC: IMF). S. BUNDOO and B. DABEE (1999) ‘Gradual Liberalisation of Key Markets: The Road to Sustainable Growth in Mauritius’, Journal of Internal Development, 11, 437–464. B. DABEE and C. MILNER (1999) ‘Evaluating Trade Liberalisation in Mauritius’, in A. Oyejide et al., Regional Integration and Trade Liberalization in Sub-Saharan Africa, volume 2 (London: Macmillan). D. GREENAWAY and C. MILNER (1989) ‘Nominal and Effective Tariffs in a Small Industrialising Economy: The Case of Mauritius’, Applied Economics, 21, 8, 995–1009.

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Introduction and Overview

P. HEIN (1989) ‘Structural Transformation in an Island Country: The Mauritius Export Processing Zone (1971 to 1988)’, UNCTAD Review, 1, 2, 41–58. R.C. KEARNEY (1990) ‘Mauritius and the NIC Model Redux: or How Many Cases Make a Model?’, Journal of Developing Areas, 24, 2, 195–216. C. MILNER and P. WRIGHT (1998) ‘Modelling Labour Market Adjustment to Trade Liberalisation in an Industrialising Economy’, Economic Journal, 108, 447, 509–528. P. ROMER (1993) ‘Two Strategies for Economic Development: Using Ideas and Producing Ideas’, in L.H. Summers and S. Shah (eds), Proceedings of the World Bank Annual Conference on Development Economics, 1992 (Washington, DC: World Bank). WORLD BANK (1989) Mauritius: Managing Success (Washington, DC: World Bank). WORLD BANK (1992) Mauritius: Expanding Horizons (Washington, DC: World Bank).

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2 Macroeconomic Policy and Performance Roland Lamusse

2.1

INTRODUCTION

This chapter is divided into five sections. Following the introduction, Section 2.2 describes the broad macroeconomic background of Mauritius as a mini state and analyses the constraints of small size on the country’s economic performance. Section 2.3 focuses on the problems which the island faced between 1976 and 1982, a period marked by a severe financial crisis which brought Mauritius to a situation of virtual insolvency and the effect of the measures taken under the Structural Adjustment Programme on the subsequent economic recovery. By analysing the economic performance during the crisis and recovery phases, the aim is to identify the factors, which determine the economic performance and the importance of government policy in this regard. Section 2.4 on recent developments analyses the performance during the post structural adjustment period. During that period government policy departed in a number of ways from the measures taken during the second phase. The economy continued to grow at a satisfactory rate but the growth was uneven between sectors. Besides there was a resurgence of the deficits in the public accounts and external accounts and an increase in inflation. Finally, Section 2.5 analyses the major developments in international trade and technology and the opportunities they provide as well as the challenges they pose for the future performance and prospects of the Mauritian economy. 2.2 2.2.1

THE MACROECONOMIC BACKGROUND Definition and Characteristics of a Mini State

Mauritius is a mini state. A mini state has been defined as one whose ‘exposure to foreign trade is so important that economic events 11

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Macroeconomic Policy and Performance

are largely beyond its control. Goods, which are produced, tend to be exported; goods, which are sold domestically, tend to be imported and the commodities, which are both produced and consumed in the state, tend to be services. Even a substantial amount of these services may be purchased by foreigners in a mini state which specialises in tourism, offshore banking, offshore insurance or tax avoidance facilities’ (Dommen and Hein, 1985, p. 152). These mini states are extremely dependent on external factors. The domestic sector, for its part is generally a mere appendix of the export activities, largely dependent on them and cannot be planned exogenously. Indeed in many small island economies the foreign sector is the economy, the domestic sector being confined to a quarter-master function providing wages, goods and services to local workers or inputs into export activities – ownership of dwellings, government services, construction, transport, distribution and trade, maintenance and repairs, and a few other support activities. These activities would have no reason to exist were it not for the market provided by exports or by workers whose income is derived from exports. Moreover as growth proceeds there is every indication that the degree of external dependence and openness will become even greater. This underlines the extent of these countries’ exposure to external events and their vulnerability to external shocks. As a result many of the conditions and circumstances that influence the rate of growth and prospects of mini states are dependent on outside events and are therefore outside the control of local authorities. This tends to restrict considerably the degree of control of local authorities in the management of the economy. There are two distinct aspects, which need to be considered in the economic characterisation of smallness. First, the international aspect of smallness: a small economy is typically an economy, which is relatively open to international trade. Secondly, the techno-economic aspect of smallness, which can almost always be related to some scale factor: in the presence of economies of scale and increasing returns, smallness of scale must result in certain distinct disadvantages. Small size imposes a number of binding constraints on the growth potential of small countries. Comparative advantage in international trade is essentially related to the concept of labour productivity and size may act as the fundamental bottleneck in sustaining growth in labour productivity in a small country. Thus the economic size of a country can produce both an absolute disadvantage – when no positive growth in labour productivity is possible – and a comparative disad-

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vantage which makes its international trading position unsustainable over time. Economic size – either in the form of a minimum employment level, or in the form of a minimum investment level – plays a critical role in maintaining growth in labour productivity. Without some critical minimum size in terms of employment or investment a small country would not be able to sustain its comparative advantage in international trade over time (Bhaduri et al., 1982).1 Related to the dependence of small countries on international trade is the concept of economic dependency. A dependent economy is highly permeable to international events.This can be observed at every level of the economy whose structure reflects this dependence. ‘An underdeveloped economy is made up of sectors that carry out only marginal exchanges among themselves, their exchanges being made essentially with the outside world. The disarticulation of the economy prevents the development of any one sector having a mobilising effect upon the rest. Any such effect is transferred abroad . . . External dependence is at once the origin and the result of this situation’ (Amin, 1974, quoted in Selwyn, 1975). Besides external dependency is not confined only to economic activities and institutions; it also influences and moulds the attitude of the people in the country. 2.2.2 The Objective of Macroeconomic Policy: Sustainable Economic Development From what has been said about the characteristics of mini states it follows that their size and structure imposes some fundamental constraints on the growth potential and prospects of these countries which strongly influence the direction and scope of their macroeconomic policy. The following constraints maybe mentioned: – –

–

the geographical aspects of small size: a small area and narrow resource base narrowly limits their development; the economic aspects of small size: characterised by a small population and small domestic market. This restricts the level of domestic output and income, hence the rate of investment and saving; it also leads to a high degree of concentration of production and exports; the international aspect of small size: perhaps the most important characteristic of small island economies is their extreme dependence on international trade in goods and services and hence their high degree of economic dependency.

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Macroeconomic Policy and Performance

The following subsections will consider how far the conventional tenets of macroeconomic policy – economic growth, fiscal balance, equilibrium in the external accounts, full employment and stable prices – are applicable to small island countries.

2.2.3

Economic Growth with Income Distribution

In a resource-constrained situation which is characteristic of small states the rate of economic growth must depend to a large extent on an increase in the productivity of factors and particularly on an increase in the level of labour productivity. It has been argued above that labour productivity depends on a minimum level of employment and investment. Below this level, a small economy may not be able to achieve the conditions necessary for self-sustaining growth. Hence the importance of some outside force to provide the initial push and overcome the inherent impediments which may hold back economic growth. Besides, in a resource-constrained situation, a substantial increase in demand would lead inevitably to a resource gap which, given the highly specialised production system of small states and their very high marginal propensity to import would translate into an increase in prices or an increase in imports and a larger deficit in the balance of trade. Economic growth in Mauritius is essentially export led. The whole economy may be said to revolve around the export sector. Exports are at the same time a large component of aggregate demand. In these conditions a substantial increase in exports would lead to an increase in GDP and income; it would also lead to a substantial increase in demand and to a rise in private and public investment. Besides an increase in exports leads to an increase in the supply of foreign exchange hence to an increase in money supply. To that extent, it may be said that money supply lies outside the control of government, which must intervene frequently to mop up the excess liquidity in the economy. In small plantation economies resources are highly concentrated in the export sector. There are generally high disparities in the distribution of income and wealth and a substantial increase in export proceeds would tend to aggravate these inequalities. With a monocrop economy the income distribution in Mauritius was thus highly uneven (Meade, 1961 and 1967).

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2.2.4 Fiscal Deficits and Macroeconomic Performance: The Second Tenet of Macroeconomic Policy According to the World Bank (1993), the size of the government deficit is the most reliable indicator of overall macroeconomic stability. High public deficit may give rise to imbalances – inflation, a shortage of foreign exchange, the crowding out of private sector investment or a foreign debt crisis. Capital projects account for a substantial proportion of government expenditure. The public sector capital budget finances mostly infrastructural projects – housing, roads, schools, hospitals, water and energy. These projects are generally lumpy with long recoupment periods and the prices for their services generally aim at covering the marginal costs. Hence there is a substantial degree of indirect subsidisation in the pricing of public sector services. This is an important source of disequilibrium in the public sector finances, which could become a prime source of inflation. In Mauritius it has been estimated that the deficit of parastatal enterprises which operate and manage the main infrastructural services – electricity, water, public housing, education, public transport, and so on – currently account for 40 per cent of the public sector deficit. Public sector solvency is a necessary and sometimes sufficient condition for domestic and external stability. One way of assessing public sector solvency is to compare actual deficits with ‘sustainable’ public sector balances, defined as those consistent with stable public debt to output ratios, low inflation and non-repressed financial markets. According to the World Bank (1993), estimations for many countries suggest that sustainable public deficits range between 2 and 6 per cent of GDP, a range determined by the country’s seigniorage revenue, public debt stocks, real interest rates and the rate of GDP growth. Under certain assumptions a growth rate of 5 per cent could sustain a deficit of 4 per cent of GDP. But if the growth rate is only 1 per cent, the sustainable deficit would be just 2.4 per cent. 2.2.5

Equilibrium in the External Accounts

Another important aspect of macroeconomic policy relates to equilibrium in the external accounts. This is especially important in the case of small economies where, as noted earlier, conditions on external markets determine to a large extent the pace of activities in the

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Macroeconomic Policy and Performance

domestic economy. Research carried out by the World Bank and other sources have established that there is a strong relation between the deficits in the public sector accounts and external deficits. In fact, it has been argued that external imbalances are due primarily to fiscal deficits. Fiscal deficits and external deficits tend to move together with a strong causal relation between them. In a supply constrained economy the volume of trade is limited by the amount that the economy can produce and supply. Excess demand is resolved in two distinct ways. Part of the excess demand generates an upward thrust on the domestic price level. The balance spills over into the international market allowing imports to close the demand-supply gap. In theory either of those two processes can eliminate excess demand. In an autarkic situation, the domestic price rise alone should clear the market. On the other hand, in a completely open economy, imports should eliminate the demand gap without a domestic price rise. In practice both effects contribute to the elimination of excess demand because both the domestic price rise and the inflow of imports are spread out over time by the speed of adjustment to excess demand. There is also the additional consideration that most of the goods demanded are not produced in the country. In that case the question of eliminating the excess demand by price increases does not arise. The excess demand triggers import orders and domestic price rises simultaneously and the final mix of the two effects depends on the time frame and relative speed of adjustment of the two forces. However the eventual price increase is limited by considerations of domestic liquidity while the extent of the increase in imports is determined by the trade gap that remains after the price rise (MEPD, 1993). Besides as the level of income per head rises the pattern of consumer demand shifts from basic commodities with low income elasticities to more sophisticated higher-value goods.The more sophisticated the commodity the higher will be the import content. Since domestic output in small countries is supply-constrained an increase in level of income per head would therefore almost inevitably lead to an increase in imports and to a deficit in the balance of trade, provided, of course that the increase in income does not result from an increase in the value of exports. 2.2.6

Full Employment

An increase in employment leading to full employment is another fundamental objective of macroeconomic policy. From the narrow

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economic point of view unemployment or underemployment is one of the more common symptoms of macroeconomic imbalance and wastage of resources. Added to this there is the social cost of unemployment. In developing countries much of the unemployment is of a structural nature on account of the high degree of specialisation and concentration of resources in production, weakness of internal linkages and lack of cohesiveness. Changes in the conditions of demand and supply of international trade leads inevitably to rearrangements in the domestic economy. Under certain assumptions – well functioning and competitive factor and commodity markets, absence of institutional rigidities and a fullyemployed economy – these internal adjustments can be portrayed diagrammatically by a movement along the production possibility frontier. A movement along the production frontier involves a number of adjustments: a shift of resources from one activity to another, a change in the methods of production and a change in factor prices and the distribution of income. In addition, there are changes in consumption as a result of the price and income changes. Accordingly even a small movement in the supply and demand vectors of international trade may require a substantial reorganisation of the economy. In a mature economy with relatively efficient factor and commodity markets, the process of adjustment can be fairly smooth. This is not the case in small developing economies with highly specialised production systems, segmented markets and extensive governmental interference in commodity and factor markets. In these conditions, these internal adjustments can lead to substantial disruptions with inflationary pressures in the expanding sectors or industries and a fairly high rate of structural unemployment in the lagging sectors. Owing to their openness to international trade these countries must continually adapt to the changing conditions in overseas markets. 2.2.7

Stable Prices

There are inherent inflationary tendencies in small economies because of the relatively large size of the public sector, the narrow resource base, highly skewed pattern of production and the dependence on external markets. Besides diseconomies of small scale and distance from markets add significantly to the cost of production. On the other hand, changes in the exchange rate and export earnings have

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Macroeconomic Policy and Performance

much influence on money supply. To that extent the local authorities have little control over these important elements of macroeconomic policy. Studies have shown that imported inflation accounts for a substantial part of the rate of increase of domestic prices in small open economies. This implies that demand management policies may have little impact on domestic prices, which are principally determined by the price of imported commodities and the exchange rate. The exchange rate in turn must adapt to changes in the terms of trade over which the small economies have no control. In the second half of the 1970s there was a growing divergence between the exchange rate of the Mauritian rupee and the island’s terms of trade. This was an important cause of the deterioration in the island’s external accounts, which led to the devaluation of the rupee in October 1979. This will be discussed further in the next section.

2.3

CRISIS AND RECOVERY (1976 TO 1988)2

During the period 1976 to 1988, Mauritius went through two distinct economic phases. During the first, 1976 to 1982, the island economy grew at a mediocre average annual rate of 2.6 per cent. This period was characterised by growing deficits in the public accounts and the balance of payments. The budgetary deficit (the excess of government current expenditure) increased from Rs144 million in 1976 to Rs671 million in 1982, while the deficit in the current account of the balance of payments amounted to 10 per cent of GDP at market prices. During that period Mauritius experienced two devaluations of the rupee – the first devaluation of 30 per cent in October 1979 and a second devaluation or realignment of 20 per cent in September 1981. Other important developments in the monetary sector concerned the growth of domestic credit and the rate of inflation. Swelled by a six fold increase in government borrowing, total domestic credit grew nearly 31/2 times between 1976 and 1982. On the other hand, on account principally of the restrictions imposed by the authorities credit to the private sector increased at a much lower rate. During that period the consumer price index increased at an average annual rate of 16.2 per cent. That was a new experience for Mauritius, which had a long previous record of relative price stability. Other factors, which have contributed to the increase in the CPI, have been the inflation

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in import markets and the devaluation of the rupee. The years 1976 to 1982 can be described therefore as the destabilisation phase. In contrast, the years 1983 to 1988, saw a striking improvement in the performance of the Mauritian economy. GDP grew at an average annual rate of 6.9 per cent – and even at a higher rate of 7.5 per cent between 1984 and 1988. Following the measures taken by Government in the context of the Stabilisation and Structural Adjustment Programme (SAP), the deficit in the government current account gave way to surpluses in 1987 and 1988. These results favourably influenced the external accounts. The deficit in the trade account of the Balance of Payments – the trade gap – was considerably reduced. In 1986 Mauritius achieved a surplus under this item. Monetary policy played an important role in the stabilisation and revival of the economy since 1983. There was a sharp reduction in the rate of growth of domestic credit, due essentially to a drastic cut in the outstanding public debt.The elimination of the deficit in the public accounts and sharp reduction in government borrowing from the banking system made possible an alleviation of the restrictive measures on credit to the private sector. The outcome was a rapid increase in bank loans to that sector to meet the financial needs of rapid economic growth particularly those of priority productive sectors.A study of the data shows that monetary measures were instrumental in bringing about the recovery of the Mauritian economy. 2.3.1

Structure and Trends in Domestic Expenditure

In this section we analyse the structure and trends in domestic expenditure. Between 1976 and 1983, domestic demand was driven by private and public consumption expenditures. Fuelled by large wage increases and a profligate government policy, aggregate expenditure increasingly outpaced the GDP. As a result the resource gap – the excess of aggregate expenditure over GDP at market prices – reached 11.8 per cent of GDP in 1979. Stabilisation measures, particularly the restrictive wage policy and close monitoring of public expenditure taken in the context of the SAP, turned the resource gap into a surplus. The monitoring of the public accounts was a key element in the package of measures of economic stabilisation prescribed by the International Monetary Fund (IMF) at the time of the first devaluation of the rupee in October 1979. Table 2.1 summarises the government fiscal performance. It shows the discrepancy between current

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Macroeconomic Policy and Performance

20 Table 2.1

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 14.1. 14.2. 14.2.1. 14.2.2. 14.2.3.

Government finance statistics: summary table (Rs million)

Current revenue Tax revenue Non-tax revenue Capital revenue Total revenue (1 + 4) Grants Total revenue and grants (5 + 6) Current expenditure Capital expenditure Total expenditure (8 + 9) Lending minus Repayments Total Expenditure and Lending minus Repayments Overall Deficit/ Surplus (7–12) Financing Abroad Domestic Non-bank Deposit Money Banks Monetary Authorities

1978/79

1979/80

1,417.0 1,260.7 156.3 – 1,417.0

1,810.7 1,601.5 209.2 – 1,810.7

1.0 1,418.0

1981/82

1982/83

2,059.1 1,801.1 258.0 – 2,059.1

2,220.9 1,953.4 267.5 – 2,220.9

2,802.6 2,436.5 366.1 – 2,802.6

2.0 1,812.7

13.9 2,073.0

67.8 2,288.7

22.6 2,825.2

1,669.1 466.3 2,135.4

1,971.9 398.0 2,369.9

2,471.0 482.7 2,953.7

2,892.2 444.0 3,336.2

3,222.6 360.4 3,583.0

164.8

339.4

412.6

340.9

402.3

2,709.3

3,366.3

3,677.1

3,985.3

-1,388.4

-1,160.1

23,002

1980/81

-882.2

-896.6

-12,933

882.2 309.1 573.1 82.8 92.2

896.6 217.2 679.4 180.1 132.8

1,293.3 707.2 586.1 132.4 -139.1

1,388.4 797.5 590.9 -3.1 123.8

1,160.1 -175.0 1,335.1 389.3 626.0

398.1

366.5

592.8

470.2

319.8

(i) From 1978/79 to 1985/86 the data relate to budgetary central government. (ii) From 1985/86 they include in addition the figures for extra budgetary units of central government, i.e. NPF and other government agencies. Source: CSO, Digest of Public Finance Statistics.

expenditure and revenue between 1976 and 1982, and subsequent improvements. In 1976 current revenue covered 82.8 per cent of total expenditure and net lending; in 1982 current revenue only covered 60.4 per cent of total expenditure and net lending; the balance was met by borrowing, with external sources providing 40.6 per cent of the loans, compared with a mere 9.4 per cent in 1976. The sources of financing of the deficit in the public accounts may have an important influence on macroeconomic equilibrium and the sustainability of government economic policy.3 In 1976, following the record sugar crop proceeds of 1973 to 1975, internal sources of credit

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1983/84

1984/85

1985/86

1986/87

1987/88

1988/89

1989/90

1990/91

3,069.8 2,802.7 267.1 – 3,069.8

3,396.2 2,993.0 403.2 – 3,396.2

4,128.3 3,697.4 430.9 – 4,128.3

5,202.6 4,538.4 664.2 – 5,202.6

6,466.8 5,781.9 684.9 – 6,466.8

7,212.6 6,665.8 546.8 – 7,212.6

8,335.8 7,654.6 681.2 – 8,335.8

9,535.9 9,025.7 510.2 – 9,535.9

52.9 3,122.7

165.9 3,562.1

233.0 4,361.3

187.7 5,390.3

214.4 6,681.2

67.6 7,280.2

116.4 8,452.2

61.4 9,587.3

3,393.7 349.5 3,743.2

3,691.3 585.2 4,276.5

3,843.4 601.5 4,444.9

4,146.6 978.4 5,125.0

5,257.2 1,119.5 6,376.2

6,461.4 1,086.9 7,548.3

7,551.0 1,388.1 8,939.1

8,510.1 1,631.1 10,141.2

236.7

109.6

262.9

211.2

217.2

683.4

278.8

235.9

3,979.9

4,386.1

4,707.8

5,336.2

6,593.9

8,231.7

9,217.9

10,377.1

-857.2

-824.0

-346.5

+54.1

+87.3

-951.5

-765.7

-779.8

857.2 -140.6 997.8 354.5 -18.5

824.0 717.4 106.6 432.2 26.5

346.5 -113.9 460.45 178.5 661.4

-54.1 148.2 -202.3 107.1 1,660.6

-87.3 601.2 -688.5 -16.9 977.0

-1,412.4 -460.9 929.0 865.4 1,216.2

936.0 -170.3 327.8 158.8 1,172.8

1,062.2 -282.4 280.5 -324.3 1,507.1

661.8

-352.1

-379.5

-1,970.0

-1,648.6

-1,152.6

-1,003.8

-902.3

financed up to 91 per cent of the government overall deficit. The financing was provided largely by the commercial banks and other institutional lenders and the Bank of Mauritius. As the financial situation deteriorated an increasing percentage of the public sector borrowing had to be financed from external sources. Besides in the face of growing domestic credit stringency, government was compelled to have increasing recourse to the Bank of Mauritius to cover the deficit in the public accounts. External financing of the public sector deficit rose from 9.4 per cent in 1976 to 55.2 per cent in 1981, with a concomitant increase in the country’s external debt, while the Bank of Mauritius provided an increasing proportion of the government domestic credit requirements (Table 2.2). Government borrowing from the Bank of Mauritius was responsible for the rapid growth in Aggregate Monetary Resources (AMR). In 1976 claims by the bank

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22

Table 2.2 Bank of Mauritius and commercial bank credit and aggregate monetary resources (Rs millions) Bank of Mauritius

Commerical Banks

Year 1

Claims on Government 2

Claims on Government 3

Claims on Private Sector 4

Total Domestic Credit 5

4/5 (%) 6

Aggregate Monetary Resources 7

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

1.1 331.2 694.4 912.8 1,183.1 1,275.7 2,029.3 2,404.0 2,995.1 3,106.6 3,455.2 2,391.6 788.8 0.3 0.3 0.5 2,822.3 1,133.1 810.2 1,527.2

518.7 247.0 258.1 430.6 533.3 854.3 717.8 1,161.2 1,225.1 1,412.0 1,679.3 2,610.9 3,611.5 5,149.5 5,858.5 7,361.6 3,956.7 6,451.2 8,329.5 10,344.4

743.6 1,141.8 1,406.8 1,580.2 1,825.3 2,016.7 2,259.1 2,460.9 2,796.9 3,407.3 3,900.3 4,403.4 7,033.0 8,940.3 10,850.7 13,043.4 15,234.2 18,684.9 23,923.8 28,714.4

1,137.6 1,736.4 2,379.5 2,917.2 3,535.5 4,134.0 4,988.3 5,990.6 6,989.0 7,880.6 8,995.9 9,198.5 10,979.1 13,465.0 15,709.1 17,526.2 22,003.2 26,273.5 33,010.9 40,736.6

58.9 82.2 84.5 78.6 77.4 70.2 75.9 67.9 69.5 70.7 69.9 62.8 66.1 63.5 64.9 64.1 79.5 74.3 74.2 73.5

1,946.7 2,084.0 2,351.6 2,861.5 3,113.7 3,837.4 3,992.5 4,926.9 5,428.2 6,195.8 7,403.0 9,169.4 13,310.4 17,569.2 20,279.0 24,570.2 29,956.4 34,702.0 49,275.1 45,043.0

Source: Bank of Mauritius, Annual Reports.

on the public sector represented 16.2 per cent of AMR; they amounted to 55.2 per cent of AMR in 1983. Thus in order to cope with the growing deficits in the public accounts, government was actively ‘priming the pump’ of central bank credit.4 2.3.2

Resource Mobilisation and Resource Use

At the same time, concerned about the inflationary effect of a rapid increase in monetary resources, the authorities introduced a number of restrictions on the supply of credit to the private sector. Thus, while credit by the commercial banks to the private sector represented two-thirds of domestic credit in 1976, it dropped to 40 per cent in 1983; subsequently following the improvement in the public accounts, the private sector share of domestic credit increased to 69.5 per cent

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in 1988. The financing of the public sector deficit thus ‘crowded out’ the loans to the private sector and the increasing monopolisation of financial resources by government impeded the island’s economic growth. Owing the importance of the public sector and external trade in the Mauritian economy, a deficit in the public accounts will have a direct bearing on the current account of the balance of payments. It may also lead to a substantial transfer of resources to government as public sector borrowing from the banking system may lead either to a crowding out of loans to other sectors or inflation. A close monitoring of public expenditure was an essential element in the package of measures, which accompanied the first devaluation of the rupee in 1979. Between 1976 and 1982, government recurrent expenditure increased at an average annual rate of 16.8 per cent; after 1982 the increase was more moderate at a rate of 12.4 per cent (1982–88). The reversal of the profligate policy of the earlier decade and the implementation of an austerity programme relied to a large extent on a restrictive wage policy and freezing of vacancies in the public sector (see Table 2.3). One of the striking facts which emerges from an analysis of government expenditure between 1976 and 1988 is the growing burden of debt on the public treasury. From 5.8 per cent of current expenditure in 1976, interest charges amounted to 23.3 per cent of current expenditure in 1986. The interest on external debt at Rs8.4 million represented 0.5 per cent of export earnings in 1976; it amounted to Rs409.7 million and claimed 7.1 per cent of export proceeds in 1985. Another important element in the package of measures taken by government in the framework of the SAP programme consisted in ‘holding the line’ on wages in the public sector. There was a slow but continuous relative decline in the share of wages and salaries in public expenditure, especially after 1979. In 1975/76 wages and salaries accounted for 42.2 per cent of current expenditure; in 1980/81 they represented 35.6 per cent of current expenditure. It thus appears that the public establishment bore the brunt of the government austerity programme. On the revenue side, there were various changes in the tax structure between 1979 and 1988. There was increasing reliance on international trade taxes and the Sales Tax, introduced in 1983, has become a major source of government revenue. The change in government policy in this regard, with the relative decline of direct taxes as a source of revenue forms part of a strategy aimed at stimulating the

Source: CSO, National Accounts of Mauritius.

12. 13. 14. 15.

11.

Total Expenditure Private Consumption Expenditure (PCE) PCE % GDP (at market prices) Gross Dom. Fixed Capital Formation GDFCF % GDP Gross National Savings (GNS) GNS/NDI GDFCF-GNS (Savings Invest) GDFCF (Private Sector) GDFCF (Private Sector) % GDP (at market prices) Public Expenditure (Government Consumption expenditure and public sector GDFCF) Public Expenditure % GDP (mp.) Balance of Trade Overall balance of Payment (fiscal year) Saving Investment gap % GDP 24.6 -2,143 +2,728 2.1%

7,079

29,299 17,565 61.2 8,090 28.1 7,910 27.1 +180 4,655 16.2

1988

19.2 -3,132 +1,996 1.4%

6,428

34,038 21,280 63.9 8,680 26.0 8,752 25.7 -172 6,330 19.0

1989

23.2 -4,007 +3,041 6.1%

9,087

42,017 25,370 64.6 12,030 30.7 10,185 25.4 +1,845 7,560 19.3

1990

19.9 -2,803 +3,113 2.4%

8,840

45,955 28,085 63.4 12,680 28.6 12,440 27.2 +240 9,030 20.4

1991

21.1 -2,332 +3,048 –

10,445

50,504 30,999 62.4 13,810 27.8 14,564 28.4 +754 9,060 18.2

1992

20.0 -4,104 -909 –

11,257

58,625 35,738 63.3 16,065 28.5 15,641 26.9 +424 11,630 20.6

1993

21.5 -7,252 -962 5.1%

13,557

67,573 40,361 63.9 19,350 30.6 16,136 25.1 +3,214 13,655 21.6

1994

Expenditure on gross domestic product at current prices (Rs million)

20.3 -7,037 – –

13,885

69,712 44,592 65.1 16,750 24.5 16,931 24.2 -181 11,235 16.4

1995

20.3 -8,901 – –

15,560

76,980 49,275 64.5 18,730 24.5 19,525 25.1 -795 12,145 15.9

1996

24

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Table 2.3

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productive, income-generating forces by means of lower individual and corporate taxes with the aim of transforming Mauritius into a relatively lower taxed and dynamic economy. In 1984, the rate of company tax was reduced from 55 per cent in the case of public companies and 65 per cent for private companies to a uniform rate of 35 per cent.5 With regard to personal income tax, the maximum tax rate was reduced in 1985 from 70 per cent to 35 per cent. This was accompanied by a reduction in the number of tax bands. All households with a chargeable income of less than Rs30,000 were exempted from tax. That measure removed some 28,000 households from the income tax roll. 2.3.3

Changes in the Rate and Allocation of Investment

There was a sharp drop in the rate of investment after 1978, in both the public and private sectors but the causes differed (Table 2.1). The attractiveness and expected profitability of projects the cost of credit and the business climate are major determinants of private investment decisions while public sector investment depends to a large extent on government social and economic objectives and its taxing and borrowing capacity. In Mauritius, the sugar industry has been traditionally the predominant source of private investible funds and the biggest recipient of those funds. Following the bumper sugar crops of 1973–75 there was a substantial outflow of funds to other sectors especially the Export Processing Zone (EPZ) and tourism. In a 1983 report, the World Bank referred to the importance of the sugar industry for the programme of industrialisation in these terms: ‘The decline in the profitability of the sugar industry is a major factor leading to the decline in domestic real investment in manufacturing. The sugar industry is traditionally a major source of investible funds for manufacturing, tourism and other sectors of the Mauritian economy. The decline in the sugar industry’s profitability since 1975, has shifted the industry from a net lender to a net borrower substantially reducing the credit available to other sectors’ (World Bank, 1983). This statement is borne out by the fact that there has been a relative decline in local investment in the EPZ and tourism in the late 1970s and early 1980s, as a result of the financial difficulties of the sugar industry and the drying up of investible funds from that source. We have noted above that public sector investment is determined

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to a large extent by the government taxing and borrowing capacity. Public sector investment concerns mostly infrastructural works and social services – health, education, housing and community services and amenities – with very long pay-off periods. For that reason public sector investment is largely influenced by social considerations. In Mauritius the decline in the volume of public investment after 1978 can be attributed to the growing deficits in the public accounts which compelled government to defer or discard a number of large capital projects. Turning now to the sectoral allocation of investment, investment in agriculture fell from 11.7 per cent of total investment in 1976 to 3.3 per cent in 1986. There was also a sharp relative decline in manufacturing investment between 1976 and 1983 (from 25.8 per cent of GDFCF in 1976 to 14.7 per cent in 1983). It picked up again strongly afterwards to 28 per cent in 1987. The decline in agricultural investment was due in large part to the financial difficulties of the sugar industry. Since 1977 a radical change occurred in the financial position of the industry due to a combination of factors, the main ones being the decline in sugar export proceeds and an increase in the rate of export duty. From a net profit after export duty of Rs379.5 million at the peak of the sugar boom in 1975 – the sugar industry experienced a series of losses and mounting indebtedness. Between 1977 and 1982 the total accumulated losses of the sugar industry amounted to Rs765.3 million. This led to a sharp curtailment of investment in the sugar industry. There was a substantial increase in real terms in manufacturing investment during the early 1970s with a twelvefold increase of investment in that sector between 1970 and 1976. Since 1976 however investment has fallen with the 1979 and 1980 levels being almost 60 per cent below the 1976 peak (World Bank, 1983). The sharp increase of 1970 to 1976 and subsequent plunge in manufacturing investment was associated with the rapid growth of the EPZ in the early 1970s and the subsequent stalemate in that sector. 2.3.4

The Public Sector Investment Programme

An important element in the stabilisation programme adopted by government in October 1979, was a curb on capital expenditure. This led to a sharp decline in public sector investment (Table 2.1). During the post sugar-boom period, 1976 to 1978, government launched an ambitious public investment programme and capital expenditure in

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the public sector rose at an annual rate of 26.5 per cent. Many of those projects consisted of unemployment relief works with very low rates of return, the objective of government being to counter growing unemployment by an increase of jobs in the public sector. With the adoption of the stabilisation and adjustment programme, there was a fundamental change in the government policy towards public investment.The aim of the Public Sector Investment Programme was henceforth to provide supportive infrastructure for the directly productive sectors and essential public services – roads, water, electricity and industrial buildings. Thus government now saw public investment no longer as a means of financing job creation at the expense of the public treasury but as a catalyst for private activities which would promote employment through economic growth. This change of outlook was also reflected in the government policy towards parastatal bodies. Subsidies and loans to parastatal bodies may be a serious drag on the public treasury in developing countries. Expenditure under this item amounted to over 12 per cent of public expenditure in 1980. It dropped to 2.6 per cent of public expenditure in 1984/85.6 The three main recipients of transfers from central government under this item were: the Central Water Authority (CWA), The Central Housing Authority (CHA) and The Tea Development Authority (TDA). Part of the burden of readjustment in the public accounts thus fell on these parastatals through a reduction of subsidies for operating losses or cuts in their capital expenditure. 2.3.5

Exchange Rate Policy

The situation of economic dependency, which characterises small economies, sets narrow limits to their ability to determine their economic policy. Prices of exports are determined by bilateral, multilateral or international agreements or the world market, while domestic prices are to a large extent determined by prices of imports. In these conditions the trade-off between export proceeds and domestic costs takes a more intractable and acute form. The situation of economic dependence in these countries has been aggravated by the uncoordinated and unpredictable fluctuations in exchange rates, which may have serious destabilising effects on domestic prices, employment and income. In order to control their balance of payments and safeguard their foreign exchange reserves, small states are compelled to adapt closely to the conditions prevailing in the international economy.

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Macroeconomic Policy and Performance

In a small dependent economy, a well-conceived and flexible exchange rate policy can go a long way to offset the destabilising effects of erratic movements in international exchange rates. On the other hand, a rigid exchange rate system determined by conditions outside the control of local authorities, as was the case when the Mauritian rupee was pegged to the pound sterling and subsequently to the SDR,7 can lead to growing divergence between international and domestic prices and increasing deficits in the public accounts and the balance of payments.The link of the rupee to sterling and the SDR was a root-cause of the economic problems of the island in the second half of the 1970s. Between 1976 and 1983, the Mauritian rupee was pegged to the SDR and was strongly influenced by changes in the value of that unit and the value of the US dollar which had a high weightage in the SDR basket.8 The rise of the dollar on foreign exchange markets pulled the rupee up against the currencies of Mauritius’ main overseas customers especially the EU. However, after 1976 there was a sharp deterioration in the island’s terms of trade resulting from the increase in import prices following the second oil price shock and the plunge in the price of sugar on the world market. The terms of trade index dropped to 49.5 in 1982 on a 1975 base. The deterioration in the terms of trade lead to an increasing over-valuation of the rupee at the prevailing exchange rate. Faced with growing deficits in the external accounts and a severe drain of the island’s foreign exchange reserves, government in October 1979 devalued the rupee from Rs7.70 to Rs10 per SDR. A combination of adverse factors compelled Government to have recourse to a second devaluation – or realignment – of the rupee against the SDR in September 1981, when the value of the rupee was fixed at Rs12 per SDR. In February 1983 the Mauritian government changed the peg of the Mauritian rupee to a trade-weighted basket more representative of the Mauritius trade pattern. Since then the Mauritian authorities have pursued a flexible (managed floating) exchange rate policy. As a result between 1983 and 1988, the real effective exchange rate of the rupee depreciated by 20 per cent against the currencies of the island’s major trading partners. Since 1983, however, there has been a remarkable improvement in the island’s terms of trade.9 Just as adverse terms of trade contributed in a large measure to the deterioration in Mauritian external accounts between 1976 and 1981, the substantial improvements after 1983 have been instrumental in eliminating the chronic deficit in Maurititius’

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trade balance. As a result of the combined effect of favourable terms of trade and a depreciating currency, in 1986, for the first time in eleven years, Mauritius had a surplus in its balance of trade and the foreign exchange reserves increased sharply. According to the World Bank, in the pursuit of its policy of economic growth and employment generation through export promotion and diversification, the Mauritian government has been highly successful in maintaining the country’s export competitiveness through appropriate exchange rate and wage policies. Changes in the exchange rate may mean little when considered in isolation from changes in relative prices. The objective of exchange rate policy should be to maintain the stability of the real exchange rate.10 In a small open economy like that of Mauritius stabilisation of the international purchasing power of the local currency is a necessary first step in stabilising the domestic purchasing power. This implies that the nominal exchange rate should be adjusted so as to depreciate (or appreciate) the local currency as much as the domestic inflation rate exceeds (or is lower than) the foreign inflation rate. The difference between the nominal and real exchange rate relates to differences between the domestic and foreign price movements. When the domestic inflation is lower than foreign inflation, the relative purchasing power of the local currency is enhanced. Between 1976 and 1979, consumer prices in Mauritius increased at an annual rate of 11.2 per cent, which was fairly comparable to the average rate of inflation in the UK, France and The United States which was 10.2 per cent. After the 1979 and 1981 devaluations, the rate of inflation in Mauritius exceeded those of the UK and the US. With 1980 as base, the Consumer Price Index (CPI) in Mauritius stood at 158.0 in 1988 while the average CPI in the UK, France and the United States was 152.5.11 This could partly explain the accelerated depreciation of the rupee against those currencies in the 1980s. But it cannot entirely account for the rate of depreciation of the rupee between 1984 and 1988 when the real effective exchange rate index of the Mauritian rupee fell from 93.4 to 79.2 (1980 = 100). The government exchange rate policy in the 1980s would appear to have been prompted in the first instance by the need to protect foreign exchange reserves in the wake of a ‘dramatic step towards trade liberalisation’ (World Bank, 1987) with the elimination of import licensing and eventually the complete liberalisation of foreign exchange transactions. It may also be explained by government

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concern to build up sufficient reserves as an insurance against adverse internal and external contingencies to which a small fragile economy like that of Mauritius is particularly prone. 2.3.6

Monetary Policy and Interest Rates

The Mauritian economy is highly monetised. It is a wage economy where the bulk of the employed labour force consists of salaried workers. Out of an estimated labour force of 399,000 in 1986, 60 per cent were employed in large establishments, while another estimated 125,000 to 135,000 were working in the informal sector mostly as salaried employees. Aggregate monetary resources amounted in 1987 to 59 per cent of GDP, a much higher proportion than for many other economies at a comparable level of development. Control over the growth of credit was a key element in the stabilisation and adjustment programme initiated by Government in 1979, and a fundamental condition of IMF assistance. As mentioned before, the aim was to put a brake on the expansionary monetary policy which characterised the government economic policy in the 1970s. Between 1970 and 1976, money supply (M1) increased at an average annual rate of 29.8 per cent while GDP increased at a rate of 26.5 per cent close to the increase in money supply. Between 1976 and 1980 – before the implementation of the SAP – money supply increased at a rate of 12.6 per cent and at a rate of 9.0 per cent between 1980 and 1987. In fact during the latter period M1 increased at a lower rate than GDP at factor cost (14.4 per cent). In the implementation of its monetary policy, government relied mainly on a strict regulation of domestic credit to the private sector. Although interest rate policy also played a certain role, institutional controls had taken away from interest rates much of their function in the allocation of financial resources. As in the case of many other developing countries, the government was actively involved in managing the banking system, using it to mobilise financial resources and to allocate those resources in ways which supported its economic policy. Commercial bank credit to the private sector increased from Rs1,142 million in 1976 to Rs4,403 million in 1986 at a rate of 14.2 per cent. During that time bank lending to government including claims on government by the Bank of Mauritius and the commercial banks increased at a rate of 24 per cent (Table 2.2). Judging by the sectoral distribution of credit, controls on lending to the non-priority sectors appear to have been quite effective. Between 1980 and 1986, the share

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of credit to that category fell from 31.5 per cent in 1980 to 24.4 per cent in 1986. Following a relaxation of controls12 it rose to 27 per cent in 1987. In an open economy like that of Mauritius, where export proceeds amount on average to 36.4 per cent of GDP at market prices the money supply depends to a large extent on export earnings. An increase in net export earnings increases the reserves of the banking system and the level of domestic credit. The foreign assets of the banking system were 11.8 per cent of the money supply in 1979, the year of the first devaluation. They increased to 145.2 per cent in 1988, after four years of unprecedented growth of export proceeds. Clearly in those conditions changes in export proceeds exert a strong influence on the liquidity of the banking system. Government is thus compelled to intervene frequently in order to regulate the level of domestic credit. One of the common instruments of monetary management – access of commercial banks to Central Bank credit – has played a very little part in the conduct of monetary policy in the island. Commercial banks in Mauritius have tended to have mainly recourse to the interbank money market for their liquidity requirements. As a result of the absence of an active money market and on account of the importance of external factors on the level of domestic liquidity, variations in interest rates did not have a significant impact on the supply of credit in the island. Changes in the bank rate were used by the Bank of Mauritius to signal desired policy changes rather than to influence the level or sectoral allocation of bank credit.

2.4

RECENT DEVELOPMENTS

This section analyses the performance of the Mauritian economy over the six years 1990–96. We have seen in section 2.3 that the measures of stabilisation taken by the government eliminated most of the imbalances, which had plagued the island’s economic performance during the years of destabilisation, 1976 to 1982. With the first stand-by Agreement with the IMF in 1979 and subsequently the first Structural Adjustment Loan with the World Bank, there began a process of economic reform which focused both on demand management with the containment of the public expenditure and on supply factors. Between 1979 and 1987, economic policy was determined primarily by the conditionalities attached to these agreements. The government tried

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Macroeconomic Policy and Performance

nonetheless with a certain measure of success to preserve as far as possible its social welfare policy. It maintained throughout a measure of autonomy and self-confidence in negotiations with the international organisations (Gulhati and Nallari, 1990). This may have been instrumental in securing popular support for the Government austerity measures. The main objectives of the economic stabilisation program were: (i) to reduce the overall level of public expenditure in the economy; (ii) to limit capital expenditure to levels conducive with the targets set for the overall budget deficit. The successful implementation of these measures transformed Mauritius from a ‘sugar-locked’ society and economy into a dynamic and diversified economy (MEPD, 1994). The cuts in public expenditure which were a fundamental element of the stabilisation programme reduced government financial commitments and delayed infrastructural development. On the other hand with the spectacular revival of the economy, there emerged a number of shortages and bottlenecks in the infrastructural facilities of the country. There were pressing calls on the authorities to redress the situation. In 1987 government put an end to the policy of austerity. 1987 also marked the end of the adherence of government to the IMF/World Bank prescriptions in domestic economic policy and particularly wage policy. 2.4.1

Output Performance

GDP at current factor cost increased by 13.7 per cent between 1988 and 1996. The EPZ continued to play a leading role although the rate of growth of that sector was well below its performance during the previous decade. The sugar industry performed relatively poorly due to a combination of factors: unfavourable climatic conditions, shrinkage of the area under cultivation and a freeze of the EU price. As a result the share of sugar in the economy continued to decline. With an average annual growth rate of 18.2 per cent in gross earnings since 1988, tourism has emerged as the leading sector in the economy. This is due to a substantial increase in the number of tourists – an annual average of 9.3 per cent – and in the number of tourist nights and the number of hotels. The leading hotels have developed into world-class resorts in terms of amenities and quality of service. The tourism industry operates in a highly competitive world market

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and the performance of the sector depends to a very large extent on an attractive holiday environment and good infrastructure facilities in which internal and international transport and communications are key elements. Financing, Insurance and Business Services has also emerged as a high growth sector on which much of the island’s future performance may depend. It recorded an average growth rate of 17.64 per cent between 1988 and 1996; this is due to the stabilisation of the financial situation, the increase in liquidity, the introduction of new financial institutions and instruments and the growth of offshore activities. 2.4.2

Expenditure and Savings

During that period, expenditure on consumption and investment increased at a nominal rate of 12.8 per cent. Consumption expenditure increased by 13.5 per cent and investment by 11.1 per cent annually. The growth of investment was spurred by the increase in private investment particularly in the EPZ. After 1983 there was a surge of investment in that sector which reached Rs900 million in 1995 – an annual rate of 25.8 per cent. However there has been a decline lately in the capital inflows into the EPZ particularly from foreign investors. Other sectors where there has been substantial investment are the Financial Services and Transport and Communications. However, private sector investment is expected to drop to 15.9 per cent of GDP in 1996, the lowest rate since 1988. During the period savings increased by 12.7 per cent annually and the savings rate averaged 25.5 per cent of GDP. It slackened somewhat in 1994 and 1995, but may recover in the near future with the expected drop in the rate of inflation, the increased level of liquidity in the economy and the development of new financial institutions and instruments. 2.4.3

Employment

The growth of employment in the 1980s was driven by the EPZ. Between 1982 and 1995 employment increased at an annual rate of 7.9 per cent in the manufacturing sector and 9.9 per cent in the EPZ. There have also been increases in employment in Tourism and Financial Services. The outcome is that in the short span of six years – 1982 to 1988 – Mauritius turned from a chronic labour surplus situation,

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Macroeconomic Policy and Performance

with an unemployment rate of over 20 per cent in 1982, into a quasifull employment situation. The rapid increase in employment strained the labour market and resulted in growing absenteeism, high labour turnover and loss of productivity (Lamusse et al., 1991). However since 1993, the process of a restructuring and modernisation in the EPZ has resulted in the loss of about 6,500 jobs and employment in that sector now stands at around 80,000. The rate of job creation in small establishments has outpaced that of large establishments. Over the period 1990 to 1995, while there was a net decline in employment in large establishments, employment in small units grew by an average of 7 per cent annually. The unemployment rate for the whole island is expected to rise to 7 per cent. 2.4.4

Government Expenditure and Revenue

Accounting as it does for around 20 per cent of GDP, government has a large stake in the economy and plays a fundamental part in the direction and pace of economic activities. Besides government financial policy has an important bearing on the macroeconomic equilibrium. In the 1970s government profligate policies were largely responsible for the severe financial problems which Mauritius experienced. Under the Stabilisation and Structural Adjustment Programme, there was a close monitoring of government expenditure, which led to the gradual elimination of the deficit in the public accounts. The remarkable economic performance of the 1980s in terms of economic growth, employment, price stability and the balance of payments owes much to the measures of economic reform implemented by government under the aegis of the IMF and World Bank. The year 1987 marked the end of the government austerity programme. Between 1988 and 1995, government revenue at current prices increased at a rate of 10.3 per cent and total government expenditure – that is government expenditure and net lending to parastatal bodies – by 13.1 per cent. Compared with a growth rate of 17.2 per cent between 1976 and 1983, there was a substantial decline in the growth of public expenditure during the latter period. The growth of government revenue also abated to some extent due probably to a reduction in the rates of import duties and a lowering of tax rates. Government revenue has moved closely in step with the growth in tax revenue. The growth of public expenditure is thus constrained by the country’s

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taxable capacity, the efficiency of tax administration and collection and the buoyancy of the tax system. Between 1987/88 and 1994/95, the growth in public expenditure approximated the growth of GDP. It appears that the authorities were concerned to contain the growth of public expenditure in order to protect public sector solvency and prevent the recurrence of the situation, which nearly scuttled the island economy in 1979. On the other hand, with expenditure outpacing revenue year after year, the deficit in the public accounts increased from Rs987 million in 1988/89 to an estimated Rs2,502 million in 1995/96. The increase in the budgetary deficit has been particularly high since 1991. Hence the need to monitor closely future developments in the public finances. The financing of the public sector deficit came exclusively from local sources, principally from the commercial banks and non-banking sector. The amounts raised locally exceeded the deficit in the public accounts and government was thus able to repay a large part of its foreign debt. Many of these loans were repaid before they matured. The government policy in this regard was in striking contrast to the situation which prevailed in the 1970s when government had recourse extensively to foreign financial institutions to cover its deficit and most of the domestic credit came from the Bank of Mauritius, with obvious inflationary implications. Deficits tend to ‘feed upon themselves’ and cumulate over a number of years. Once an economy’s performance diverges systematically from the equilibrium growth path, forces operate which tend to lead the economy further away from equilibrium. Besides, as argued earlier, in small open economies there is a strong relation between the deficits in the public sector and deficits in the external accounts. To this issue we now turn. 2.4.5

Balance of Payments

There has been a deterioration in the external accounts since 1992 as a result of growing deficits in the balance of trade, the reimbursement of foreign debt and growing overseas investment. From a surplus of Rs3,113 million in 1991, the balance of payments registered a deficit of Rs962 million in 1994 on a fiscal year basis. The trade deficit doubled approximately between 1992 and 1996, due to a surge in imports – in both volume and prices – and a lower growth in exports proceeds. The trade deficit in 1996 was estimated at 11.7 per cent of GDP.

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The trade deficits were partly compensated by surpluses in the services account and net current transfers. The tourism sector registered a strong growth with substantial increases in gross proceeds, year on year, over the last four years. This is due partly to improved air links and a strong promotion campaign. The depreciation of the rupee has also been a contributing factor. Besides in this highly competitive market, quality of service, and the range of leisure facilities are determinant. In this regard Mauritius has managed to project a very good image in overseas tourist circles as a high-class exotic destination. 2.4.6

Financial and Business Services

In small economies the export trade in services may provide the crucial impulse for sustained growth (Badhuri et al.). Singapore and Hong Kong have been cited which have achieved spectacular growth rates through the development of foreign services. In 1994, the Report of The Economic Working Group on the National Long-Term Perspective Study of Mauritius stressed the role that Banking, Insurance and Financial services could play in the future development of the island. In their projections the group anticipated a growth rate of 10 to 12 per cent for that sector over the following twenty-five years, thus making it the leading growth sector in the economy. On that basis, the quaternary sector would treble its share of GDP from 5 per cent in 1994 to 15 per cent in 2020, within an overall growth rate of 5.6 to 7.3 per cent for the whole economy, which would propel the economy forward to achieve a three to fourfold increase in per capita income by 2020. It is the declared policy of government to develop Mauritius into a leading regional financial centre. With that in mind the authorities have given a strong boost to the development of offshore financial services and the Free Port. Government has also opened up the financial market to foreign investors and removed all controls on foreign transactions. Although much remains to be done to develop a fully operational and efficient international network of banking, insurance and business services there have been some encouraging responses on that score from the international business community and the results achieved so far give ground for prudent optimism regarding the future growth prospects of the quaternary sector. Since 1987, financial insurance and business services have been by far the fastest growing sector in the economy with an annual average

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growth of 19.6 per cent, far exceeding the rate of growth of the manufacturing sector (13.9 per cent). In 1996, the quaternary sector surpassed the sugar industry and came close to the EPZ results. If this trend is maintained, financial and business services may soon emerge as the leading sector in the economy. As a percentage of GDP the share of financial and business services has risen from 7.1 per cent in 1987 to 10.8 per cent in 1996. It appears therefore that the sector is well on track to achieve or surpass the target of 15 per cent of GDP by 2020 which was assigned to it in the National Long-Term Perspective Study. 2.4.7

Price Stability

Price stability is one of the main objectives of macroeconomic policy. In the 1970s especially during the destabilisation phase, 1976 to 1983, Mauritius has on a number of occasions experienced two-digit inflation rates. Besides the real inflation rate is higher than the official figures on account of a certain degree of suppressed inflation through the subsidisation of rice and flour imports and government control over the prices of certain commodities and services. In this highly open economy, the exchange rate of the rupee has a strong influence on the prices of imported commodities. Supply of imported commodities is perfectly elastic while demand for basic commodities is very inelastic; in these conditions a drop in the exchange rate of the rupee will lead to a sharp – almost proportionate – increase in the price of these commodities on the domestic market. In small open economies domestic prices tend to be dominated by import prices13 and the stabilisation of the international purchasing power of the local currency is a necessary condition for the stabilisation of domestic prices. It has been estimated that imported inflation accounted for 43 per cent, exclusive of import duties, or 53 per cent with import duties, of the overall rate of inflation in Mauritius between 1967 and 1984. The rate of imported inflation was aggravated in the 1980s, by the continuous depreciation of the rupee. Between 1979, the year of the first devaluation, and 1995, the rupee depreciated by 48 per cent on average against the currencies of our main trading partners. In 1995, the CPI reached 322.5 on a 1980 base. The depreciation of the rupee provided a strong boost to Mauritian exports of clothing and textile products at a time when the bulk of these exports consisted of cheaper standard products, selling

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at the lower end of the international clothing market. It also increased the proceeds in rupee of sugar exports and government revenue. On the other hand, given the high percentage of intermediate imports in the local production of clothing and garments, the depreciation of the rupee increased production costs and impaired the competitiveness of Mauritian exports of basic clothing and garments. It also aggravated the inflationary forces in the economy through various institutional mechanisms – particularly the system of annual wage adjustment and administered prices.

2.5

FUTURE PROSPECTS

In this final section, I shall outline the factors, which may influence the direction and pace of economic change in the island over the next decades. In Mauritius, a mini-state, the path of change and development will be determined largely by the conditions in the large markets and the course of international events. Some major developments have dominated the world economic scene lately and their influence is likely to grow over the next decades. The most important developments have been the increasing liberalisation of world trade and globalisation of markets. Accompanying these developments there have been fundamental changes in the attitude of many countries, some of them major players in world trade, which have taken important steps towards the opening up of their economies. They have also opened their economies to foreign direct investment through the privatisation of a number of state-owned or state-controlled enterprises. With the inroads made by the computer into virtually all fields of economic activities, the degree of knowledge and skills required in production and business has increased substantially. According to a recent study more than half of the total GDP in rich economies is knowledge-based. High technology industries have almost doubled their share of manufacturing output in rich economies over the past two decades and knowledge intensive services are growing even faster. The competitive advantage of nations will depend increasingly on the speed with which workers acquire and apply knowledge. As capital becomes more mobile and the diffusion of technology across borders accelerates in international trade, competitive advantage will accrue to those countries with the largest evolvement of knowledge and skill. We have seen how conditions in the export market deter-

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mine the pace of economic activities in the island. The future prospects for Mauritius will be determined by the changes outlined above and the rapidity and smoothness of the process of adjustment to these changes. 2.5.1

Sugar Industry

The most important change will come with the implementation of the GATT agreement. Under the Lomé Convention Mauritius received a large measure of protection for its sugar on the European market. Under the terms of the Sugar Protocol with a quota of 510,000 tons of sugar14 Mauritius was by far the biggest beneficiary among the ACP countries. It will be the biggest loser under the new agreement. Under the terms of the Protocol, Mauritius had over one-third of the ACP sugar quota and over 41 per cent of the net benefits to the ACP sugar exporters accrued to Mauritius (Borrell and Duncan, 1992). According to an authoritative source the liberalisation of the world sugar trade may lead to a cut of 3 per cent (in real terms) annually in the price paid for Mauritius sugar exports. This would considerably impair the profitability of the industry. The local sugar industry is thus likely to experience a serious set back in the post GATT situation. Over the last twenty years, in spite of the high EU prices, the sugar industry stagnated with an annual growth rate of about 1 per cent. It is envisaged that the annual growth rate of the industry over the next two and a half decades will be 2 per cent compared to 5.5 per cent for the whole economy. The sugar industry will thus lag behind other sectors. Historically there was an inverse relation between the degree of protection received by the sugar industry and technological improvements. In the past, the prospects of an assured market and remunerative prices have tended to dampen the efforts of producers for greater efficiency, while periods of increased competition have often resulted in substantial improvements in field and factory. Economies of scale are important in cane sugar processing. Hence the world wide trend towards ever-larger centralised milling operations. It is also quite substantial in field operations with the mechanisation of operations. Certain authoritative studies have stressed the increasing constraints of size and topography on the viability of the sugar industry in small islands. The comparative inefficiencies that are inherent in the production of sugar in small islands like Mauritius may have been concealed by the high guaranteed prices received by the producers. Under

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Macroeconomic Policy and Performance

the new conditions in the world sugar trade these constraints may become binding on the productivity and profitability of sugar production in these countries. Clearly cost cutting will be the top priority for the sugar industry in Mauritius over the short to medium term. This will necessitate an extensive reorganisation of fieldwork and improvements in the technology of field operations, which will result in the further shedding of labour and shrinkage of land under cane. According to official forecasts, by 2020 acreage under cane would shrink from 81,000 hectares in 1992 to approximately 72,000 hectares and the field labour force would drop from 37,000 workers to around 18,000. On the manufacturing side the centralisation of sugar factories will accelerate with the expected closure of another eight factories during the next decade. These developments will require an extensive reorganisation of the industry. With the liberalisation of the world sugar market and the review of the EU sugar policy, the prospects for the Mauritius sugar industry are cloudy and uncertain. 2.5.2

The EPZ and Textile Products Exports

Another sector, which is likely to be hit by the liberalisation of world trade, is the clothing export sector. Under the Lomé Convention Mauritius had duty-free and virtually unlimited access to the markets of the EU where it sells the bulk of the output of clothing and textile products, at a time when the exports of large Asian producers were regulated by the Multi-Fibre Agreement (MFA) which restricted the access of their products to the European and American markets. With the implementation of the new international trade agreement and the elimination of the MFA, Mauritius will face severe competition from large low cost producers on these markets. Moreover the rapid increase in employment in the manufacturing sector in Mauritius led to a decline in productivity while periodical wage awards and annual wage compensation pushed up wages. This has led to a sharp increase in unit labour costs in manufacturing. As a result Mauritius has lost its comparative advantage in the production of cheap textile products where the large low-cost producers will swamp the export markets. Besides the trend in West European and American markets has been towards more fashionable products with the emphasis on design, quality and variety rather than price. Concurrently important changes

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have occurred in the methods of production and the organisation of the industry with the use of computers and the replacement of the assembly line system of work by smaller and more adaptable units based on polyvalent teams of workers. The future of clothing export industry in Mauritius will depend on the extent to which Mauritius can adapt to the changes in production and demand in the world clothing industry. There will be a substantial shake-up of the clothing export sector with the virtual disappearance of cheap basic products and a shift towards more fashionable, higher value products with shorter lead times. In that context, more intensive utilisation of information technology in enterprises and improvements in communications will be critical in order to adapt to the new trends in the clothing export market. 2.5.3

Services

Earlier reference was made to the substantial growth of services in production and trade and this trend will accelerate further. In The Long-Term Perspective Study for Mauritius 2020 a growth rate of 10 to 12 per cent is envisaged for the quaternary sector, that is banking, insurance and business services, especially offshore services. There are severe limits to industrialisation in a small economy like Mauritius in an open international trade context. The only possible escape route from the constraints of size on productivity may be the development of international services.The export trade in services may thus provide the crucial impulse for sustained growth in Mauritius. This will depend on our access to and ability to use information technology and the development of a cost-effective system of telecommunications in order to position Mauritius as a dynamic regional service centre for manufacturing, education and other services. An analysis of recent performances shows that financial and business services may emerge as the leading sector in the economy. One of the main inputs in developing the services sector is skill. Human resources will be a major constraint for the development of this sector. Local facilities for offering advanced programmes in information technology and other related fields will have to be created or expanded in order to train world class practitioners in this field. Thus national capacity building in these fields should be given top priority.

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Macroeconomic Policy and Performance

Notes 1. 2. 3.

4.

5.

6.

7.

8. 9.

10. 11. 12.

13.

This is subject to the condition that the rise in wage rates is roughly the same across countries over time. This section is drawn extensively from a report on structural adjustment by Lamusse and Burn, 1991. Increasing reliance on external as compared with internal sources of finance implies that government expenditure exceeds the economy’s absorptive capacity and leads to a growing burden of external debt, while reliance on the banking system may lead to either an excessive increase in money supply or a crowding out of private sector and investment or both. An indication of the inflationary pressures in the economy as a result of government borrowing from the Bank of Mauritius can be obtained by dividing the claims of the Bank on the public sector by GDP at market prices. From 7.1 per cent of GDP in 1976 government borrowing from the bank increased to 23.5 per cent in 1983. The reduced rate was levied on the net profit of companies before the distribution of dividends. Previously the company tax was levied on the undistributed profits of companies. In the opinion of the Minister of Finance, that system encouraged the distribution of dividends at the expense of corporate saving and the build up of reserves. According to an estimate by the World Bank, total net transfers to parastatal bodies amounted to Rs2,050 million between 1980 and 1985. Transfers for capital expenditure amounted to Rs2,735.3 million, while net current payments (operating surpluses–operating losses) amounted to Rs600.3 million. Until 1976 the rupee was pegged to sterling at Rs13.33 to the pound. Between 1976 and 1983 the rupee was pegged to the SDR at Rs7.70 per SDR until the first devaluation of October 1979 at Rs10 per SDR until September 1981 and at Rs12 per SDR until February 1983. In 1981, the US dollar had a weight of 42 per cent in the SDR basket. The improvement in the terms of trade resulted from a drop in the import price index after 1985, due to the decline in the rate of inflation in our main import markets, the drop in petroleum prices and the fall in the value of the dollar. A substantial part of Mauritius’ imports are paid in dollars. The real exchange rate is defined as the purchasing-power-parity (PPP) adjusted exchange rate. On account of a certain degree of ‘suppressed’ inflation in Mauritius – through subsidisation of basic commodities – the GDP deflator would have been a more accurate measure of inflation in Mauritius. Namely the abolition of maximum lending rates in 1982, the abolition of lending rates for priority sectors in 1983 and of minimum rates on time deposits in 1984. The government maintains a relatively liberal interest rate policy with minimal administrative control on deposits or lending rates. A number of other factors – notably government fiscal and monetary policy – may also have an influence on domestic prices. But given the

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high ratio of imports in domestic expenditure, import prices tend to have a predominant influence on domestic prices in these economies. Recently the Mauritius sugar quota was increased by 85,000 tons following Portugal’s entry into the EU.

References S. AMIN (1974) Accumulation on a World Scale, Monthly Press Review (March). A. BHADURI, A. MUKHERJI and R. SENGUPTA (1982) ‘Problems of Long-Term Growth: A Theoretical Analysis’, in B. Jalan (ed.), Problems and Policies in Small Economies, London Croom Helm. B. BORRELL and R.C. DUNCAN (1992) ‘A Survey of the Costs of World Sugar Policies’, The World Bank Research Observer, 7 (2) July, 184– 5. E. DOMMEN and P. HEIN (1985) ‘Foreign Trade in Goods and Services: The Dominant Activity of Small Island Economies’, in E. Dommen and P. Hein (eds), States, Microstates and Islands, London Croom Helm. R. GULHATI and R. NALLARI (1990) Successful Stabilisation and Recovery in Mauritius, EDI Policy Case Studies: Analytical Case Studies No. 5, World Bank, Washington, DC. J.Y. LAMBERT (1988) La Dynamique d’un Sous-Ensemble du Système Productif Mauricien: La Zone Franche Industrielle d’Exportation, mimeo, Institute of Planning. R. LAMUSSE (1982) Labour Policy in a Monocrop Economy: The Case of Mauritius, PhD thesis, University of Warwick. R. LAMUSSE (1989) Adjustment to Structural Change in Manufacturing in a North-South Perspective: The Case of the Clothing Export Sector in Mauritius, ILO, Geneva. R. LAMUSSE (1985) Macroeconomic Policy in a Small Open Economy: The Case of Mauritius, African Issues Centre, Boston University. R. LAMUSSE and N. BURN (1991) Report on Structural Adjustment, Employment, and Poverty in Mauritius, mimeo. R. LAMUSSE (1996) Mapping the Future of the Mauritian Economy, The Hassam Toorawa Trust Occasional Paper No. 1. R. LAMUSSE et al. (1991) Study on Absenteeism Among Production Workers in the EPZ, University of Mauritius. J.E. MEADE (1961) ‘Mauritius: A Case Study of Malthusian Economics’, Economic Journal, vol. lxxx, 1, September. J.E. MEADE (1967) Population Explosion, the Standard of Living and Social Conflict, London, Macmillan. (Reprint from the Quarterly Journal of the Royal Economic Society, June 1967, vol. lxxvii.) MEPD (1993) A Medium-Term Forecasting Model for Mauritius, MEPD, Mauritius. MEPD (1994) National Long-Term Perspective Study, Report of the Working Group on the Economy, mimeo. P. SELWYN (1975) The Characteristics of Small Island Economies, University of Mauritius.

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WORLD BANK (1983) Mauritius Economic Memorandum: Recent Developments and Prospects, World Bank, Washington, DC. WORLD BANK (1985) Mauritius Adjustment and Growth, Country Economic Memorandum, World Bank, Washington, DC. WORLD BANK (1987) Programme Performance and Audit Review. World Bank, Washington. WORLD BANK (1993) ‘Fiscal Accounts and Macroeconomic Performance’, World Bank Policy Research Bulletin, 4, 3.

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3 Exchange Rate and Balance of Payments Policy Rajen Dabee

3.1

INTRODUCTION

The majority of developing countries were typically pegged to single currencies up to the early 1970s and continued to maintain fixed exchange rate regimes even after 1973 when developed countries moved to floating exchange rates. The reasons for the delay in adopting more flexible exchange rates have been widely documented (see, for example, Aghevli and Montiel, 1991 and Ghatak, 1995). It was partly due to the belief that exchange rate fluctuations would not necessarily lead to an expansion of exports of developing countries as these exports were essentially primary products with low supply and demand elasticities. However, various exogenous shocks – adverse terms of trade effects, the debt crisis, and recession in the industrialised countries – forced developing countries to adopt stabilisation and adjustment programmes which, in many cases, included devaluation and a shift to more flexible exchange rate arrangements. There is some evidence that countries which achieved large real devaluations were able to generate significant increases in exports, especially manufactured exports (Corden, 1993). However, the view that devaluation will lead to export-led growth when combined with contractionary policies has been recently challenged on theoretical grounds by Yotopoulos (1996), who also presents very strong empirical evidence, based on data for 62 industrialised and developing countries, showing that real devaluation is negatively related with output growth. Corden’s empirical evidence is relatively weaker as it is based on a more limited sample of 18 developing countries and one must be cautious in extending its validity to Sub-Saharan Africa (SSA) as only four African countries were included in the sample. In fact, the stagnating effect of devaluation is often predicted for SSA (Yiheyis, 1997). 45

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Exchange Rate and Balance of Payments Policy

The case of Mauritius, however, shows that devaluation, followed by a policy of sustained depreciation, has had significant effects on the exports of manufactured goods and non-factor services, especially tourism. As a result, the balance of payments crisis has disappeared, paving the way for a sound external position, as indicated by the steadily increasing foreign exchange reserves. This experience is examined in the present chapter.1 Following the introduction, Section 3.2 below reviews the four exchange rate regimes which have been adopted since the coming into operation of the Bank of Mauritius in 1967. Section 3.3 then assesses the changes in exchange rate policy: it is argued that after unsuccessfully trying to pursue a policy of exchange rate stability up to the end of the 1970s, the monetary authorities made an important shift by adopting a policy of real depreciation as from the early 1980s. Section 3.4 provides background information on the balance of payments by presenting some of its most salient features. Section 3.5 then considers the impact of exchange rate policy on exports and imports, highlighting the changes which have taken place as from the early 1980s. Finally, Section 3.6 provides the conclusions and implications of the paper.

3.2

EXCHANGE RATE REGIMES

Mauritius was pegged to a single currency up to the mid-1970s before gradually moving to more flexible exchange rate arrangements. Four different regimes have in fact been adopted since the setting up of the Bank of Mauritius in 1967. These are reviewed below. The Sterling Peg Before the setting up of a central bank, the Mauritian rupee was on a sterling exchange standard with the rupee convertible into sterling at a fixed rate. Under this system, it was the amount of sterling received over a particular period which determined the domestic monetary base of high-powered money. Exports of sugar or receipts of loans and grants from the UK brought in sterling which was converted into rupees, while imports were paid for by changing rupees into sterling. If receipts of sterling exceeded payments, the stock of high-powered money expanded. With the coming into operation of the Bank of Mauritius in August 1967, the one-to-one relationship between net sterling receipts and

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the expansion of the domestic monetary base disappeared.The money supply could now be increased by using the traditional instruments of monetary policy. For example, a reduction in the reserve requirements of commercial banks would increase the stock of high-powered money and facilitate increased credit creation. The rupee, however, continued to be pegged to sterling at the fixed rate of Rs13.33. In the initial years of the sterling peg, over 75 per cent of Mauritian exports were directed to the UK and about 50 per cent of imports came from the sterling area. Payment for imports coming from outside the sterling area caused no particular concern to traders who bought other foreign currencies at fixed exchange rates. However, as the share of imports coming from outside the sterling area began to rise rapidly (reaching 80 per cent in 1975) and the international value of the pound began to fall, the rising pressure on the import bill and on the domestic price level made the sterling peg unsustainable. The SDR Peg The rationale for switching to the Special Drawing Right (SDR) in January 1976 was that fluctuations in the individual bilateral exchange rates of the rupee with the sixteen currencies in the SDR basket would tend to cancel out on average and would therefore lead to fairly stable average exchange rates with the country’s trading partners. In fact, the 16 currencies included in the SDR basket accounted for about 75 per cent of imports in 1975. Pegging the rupee to the SDR was also intended to promote price stability, which was another major objective of economic policy. With the SDR peg, the value of the rupee in fact remained fairly stable against the currencies of the major trading partners of the country. Table 3.1 below in fact shows a negligible appreciation over the period 1976–78 against the currencies of four important trading partners which accounted for about 50 per cent of total imports. However, the period 1976–78 witnessed acceleration in the demand for imports following the 1973–75 sugar boom. The level of foreign exchange reserves dwindled from Rs630 million (US$94.9 million) at the end of 1976 to Rs90 million (US$14.3 million) in May 1979 and to Rs15 million (US$2.4 million) in August 1979. Imports could no longer be financed and the country had to seek the assistance of the International Monetary Fund (IMF) to restore equilibrium in the balance of payments. One of the requirements of the stabilisation programme was the devaluation of the rupee. There was a first

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Exchange Rate and Balance of Payments Policy Table 3.1

Exchange rates* for selected currencies, 1976–83 (Rs)

Year

UK Pound

US Dollar

South African Rand

French Franc

1976 1977 1978 1979 1980 1981 1982 1983

12.03 11.47 11.62 13.03 17.84 17.04 18.98 17.85

6.80 6.71 6.29 6.03 7.64 8.76 10.93 11.72

7.86 7.75 7.29 7.16 9.93 10.05 9.34 10.74

1.44 1.37 1.40 1.42 1.87 1.55 1.65 1.54

* As at 30 June. Source: Central Statistical Office, Annual Digest of Statistics, various issues.

devaluation of 23 per cent against the SDR in October 1979 and a further devaluation of 17 per cent in September 1981. Table 3.1 clearly shows the impact of these two devaluations on bilateral exchange rates. A New Trade Weighted Basket One of the main objectives of the devaluations of 1979 and 1981 was to restore the competitiveness of manufactured exports from the export processing zone (EPZ) and of the tourist sector. And it was necessary to maintain this competitiveness. But as the value of the rupee tended to remain stable after a couple of years following the 1981 devaluation, the monetary authorities decided to shift to a new method of determining the exchange rate which would allow them to adjust the value of the rupee more easily. Hence, as from 28 February 1983, the rupee was linked to an undisclosed basket of currencies of major trading partners. An indication of which currencies are important for Mauritius is given in Table 3.2 which lists the countries from which Mauritius obtained at least 5 per cent of its imports over the 1980–93 period. As shown in the table, the French franc, the UK pound, the South African rand and the Japanese yen are among the important currencies required by Mauritius. Although the US dollar is not listed because less than 5 per cent of imports come from the US, it is an

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Table 3.2 Main suppliers of imports for selected years, 1980–93 (percentages) 1980 RSA: UK: Bahrain: France: Australia: Japan:

13.4 11.5 10.9 10.7 5.8 5.2

1985

1990

1993

France: 13.0 RSA: 8.5 UK: 7.9 Kuwait: 7.3 Japan: 5.9 China: 5.3

France: 14.7 RSA: 8.7 UK: 7.1 Germany: 7.1 Japan: 6.1

RSA: France: India: UK: Japan:

14.2 12.6 5.8 7.1 5.9

Source: Central Statistical Office, Annual Digest of Statistics, various issues.

important currency as it is estimated that about 50 per cent of our trade transactions are invoiced in dollars. And it is likely that the US dollar was given a relatively high weight in the basket. Moving Towards a Market Determined Exchange Rate In line with the government’s commitment towards greater liberalisation of the financial market (see Bundoo and Dabee, 1999 for a detailed discussion), there was an important move towards market determination of the exchange rate with the floating of the rupee and the introduction of an interbank dollar market in July 1994. Under this new system, the exchange rate of the rupee is determined as follows. Early every morning the opening selling rate for the US dollar is obtained by averaging out the different selling rates quoted by leading commercial banks which base themselves on the latest developments in the international foreign exchange market. This opening rate is used to convert into rupees market cross rates among foreign currencies used in Mauritius. The exchange rates thus obtained are used by all the commercial banks. Large or undesirable fluctuations in the selling rates quoted by commercial banks can be counteracted by the central bank through sales or purchases of the dollar, which is the intervention currency. Under this latest exchange rate regime, the rupee has continued to depreciate against most major currencies. Over the period June 1994 to June 1998, the rupee lost 26 per cent against the dollar, 31 per cent against the pound, 20 per cent against the franc, and 18 per cent against the mark. However, it appreciated against the rand and the yen by nine per cent and 20 per cent respectively.

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Exchange Rate and Balance of Payments Policy

Looking back at the exchange rate regimes adopted since August 1967, we can see that Mauritius has shifted gradually from a fixed exchange rate regime to a quasi-floating regime. The initial sterling peg had to be given up because the significant depreciation of the pound was associated with very high rates of domestic inflation, which attained an average of 22 per cent over the 1973–75 period. It was also better to link the rupee to a basket of currencies which was more representative of the trade pattern of Mauritius. Hence, the SDR peg was a definite improvement over the sterling peg. But the SDR peg – like the sterling peg – required fiscal discipline. Any sustained fiscal expansion requiring monetary accommodation would lead to an increase in imports and to a continuous outflow of foreign exchange reserves, making the SDR peg unsustainable. This is precisely what happened after the 1973–75 sugar boom when the government significantly increased its budgetary expenditures. Foreign exchange reserves were almost completely siphoned off by August 1979, when they were equivalent to two weeks of imports.As it was combined with exchange control, the SDR peg prevented the exchange rate from moving closer to its equilibrium level and could not favour the expansion of nontraditional exports. As we will argue in the next section, it is the managed float, effective from March 1983 to July 1994, which allowed the monetary authorities to pursue a policy of real depreciation so as to encourage the expansion of non-traditional exports. Under the current regime, the rupee has also tended to depreciate. However, the latest figures available show some appreciation. This is partly due to the rise in the wage level in 1997, which cannot be offset by depreciation, as was possible under the managed float.

3.3

EXCHANGE RATE POLICY

Initially, Mauritius pursued a policy of exchange rate stability. As the bulk of exports consisted of a more or less fixed quota of sugar exports sold at a guaranteed sterling price, there was no question of stimulating exports through changes in the exchange rate. In fact, there was more concern on the import side: to be able to import the same quantity of goods it was better to maintain a stable exchange rate. However, as the percentage of imports from outside the sterling area began to increase significantly in the early 1970s, the depreciation of the pound, to which the rupee was linked, made it more costly to maintain a given level of imports. As the pound continued to depreciate, it

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Rajen Dabee Table 3.3

51

Nominal effective exchange rate, 1970–80 (base year 1975)

Year

EER

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

90.0 90.2 90.9 94.0 95.7 100 109.4 105.9 94.4 97.9 129.8

Source: Author’s estimates based on data from Central Statistical Office, Annual Digest of Statistics, various issues.

was decided to move to the SDR peg so as to maintain exchange rate stability. Table 3.3 shows the nominal effective exchange rate (EER) of the rupee for the period 1970–80. This index has been calculated by averaging the changes in the rupee rate of the currencies of 13 countries which accounted for 78 per cent of the total imports and exports of Mauritius.2 A rise in the EER refers to a nominal depreciation of the rupee whereas a fall in the EER refers to a nominal appreciation of the rupee. As shown in the table, the rupee started to depreciate in 1973, following the floating of the pound. This depreciation was halted by the shift to the SDR peg in 1976. The rupee in fact appreciated slightly before the 1979 devaluation. The 1980s, however, saw an important shift in exchange rate policy. To improve the competitiveness of the export sector, especially of the EPZ, the rupee was devalued twice as part of the IMF stabilisation programmes. Thereafter, the value of the rupee has been falling steadily against the currencies of trading partners. This is confirmed by the rising EER in Table 3.4. Table 3.4 also shows the real effective exchange rate (REER) for the period 1980–97. The REER is a much better indicator of the value of a currency than the EER because it also takes into account changes in relative price levels.3 As the price levels of trading partners rise

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Exchange Rate and Balance of Payments Policy Table 3.4 Nominal effective and real effective exchange rates, 1980–97 (base year 1990) Year

EER

REER

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

66.2 66.6 69.5 69.1 73.2 77.4 77.4 83.6 90.4 93.5 100 103.4 104.6 103.1 108.2 114.0 122.8 122.2

77.9 71.9 78.2 78.7 82.3 86.4 88.3 99.3 102.6 99.7 100 102.0 103.2 95.2 96.2 99.1 103.3 98.8

Sources: Author’s estimates based on data from Central Statistical Office, Annual Digest of Statistics, various issues; and IMF, International Financial Statistics Year Book (1998).

relative to the domestic price level, the REER rises, indicating an increase in the relative competitiveness of domestic goods. As shown in Table 3.4, the rupee has tended to depreciate in real terms over the period 1981–96, with a minor appreciation in 1997 due partly to a general increase in the wage level. It must be pointed out that various price indices can be used in the estimation of the REER, so that various REER indices, rather than a single index, can be obtained for a country. And it is sometimes possible that various REER indices may reveal different trends. Thus, a recent IMF report on Mauritius (IMF, 1996) refers to two indices which show a constant REER over the period 1988–95, and to three other indices which point to a real appreciation over the period 1987–93.4 However, as the report points out, there were no changes in economic conditions warranting a real appreciation. In fact, the trade and foreign exchange liberalisation measures adopted since the

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1980s should have led to a real depreciation of the rupee. The REER reported in this paper does indicate depreciation right from the early 1980s. Looking back at the evolution of the EER and REER, it can be asserted that the exchange rate was overvalued in the early 1970s. Three reasons can be put forward to support this argument. First, highly escalated tariffs, backed by a strict import licensing scheme, were used to keep down the level of imports. Secondly, the central bank used foreign exchange control measures not only for current transfers but also for capital transfers which were heavily taxed. And thirdly, even with the trade and exchange restrictions in force, imports could not be sustained – as indicated by the devaluations of 1979 and 1981 and the eventual abandonment of the SDR peg. By way of contrast, the adoption of a policy of depreciation as from the 1980s has been accompanied by various trade and foreign exchange liberalisation measures. Quantitative restrictions on imports were removed during the 1983–85 period, as part of the stabilisation/structural adjustment programme. The import licensing scheme was abolished in 1991 and tariffs were also significantly reduced. Finally, all restrictions on foreign exchange transactions for current and capital transfers were abolished in 1993 and 1994 respectively. All these measures have helped to move the exchange rate closer to a sustainable level.

3.4

MAIN FEATURES OF THE BALANCE OF PAYMENTS

Before examining the impact of exchange rate policy, we may find it useful to consider the important features of the balance of payments for the period 1970–97, as summarised in Table 3.5 below. Reference may also be made to Figure 3.1, in Section 3.5 below, showing the traded goods balance and the current account position for the period 1968–97. A Chronic Deficit in the Traded Goods Balance The value of goods imported exceeds the value of goods exported over most of the period, with the exception of 1970, 1972, 1974, 1975 (the latter three years being part of the sugar boom period) and 1986. This chronic deficit occurred in spite of a rapid increase in exports. The value of real exports, at 1990 prices, was about four and a half

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Exchange Rate and Balance of Payments Policy Table 3.5

Selected entries from the balance of payments, 1970–95 (Rs million)

Current Account Goods: Exports Goods: Imports (fob) Services: Credit Services: Debit Net Transfers Capital Account Of which: Direct Investment: Credit Direct Investment: Debit Errors and Omissions Allocation of SDRs Overall Balance Reserves and Related Items Of which: Foreign Exchange Reserves Use of IMF and Other Credit

1970

1975

1980

1985

1990

1995

1997

42 388 -360

127 1,848 -1,672

-911 3,332 -3,964

-459 -1,783 -380 6,639 17,914 26,756 -7,050 -21,921 -31,246

-1,894 33,694 -42,875

160 -167 21 29

481 -600 70 240

1,156 -1,594 159 522

2,286 -2,890 556 -73

8,595 -7,809 1,438 1,416

14,999 -2,652 1,763 417

19,806 -15,181 2,682 244

9

33

86

350

2,166

325

1,164

–

-4

-57

-129

-539

-63

-67

8

-16

191

790

3,809

1,858

1,630

15

–

28

–

–

–

-92

94 -94

351 -351

-170 -170

258 258

3,442 -3,442

1,895 -1,895

-92 92

-49

-308

-495

-61

-2,688

-1,883

739

-20

–

655

-196

-645

–

–

Source: Bank of Mauritius, Annual Report, various issues.

times higher in 1997 compared to 1970. This significant increase in exports was brought about by the emergence of the EPZ in 1970 and its rapid expansion, especially as from the late 1980s. The growth of real imports, however, significantly exceeded the growth of real exports. At 1990 prices, imports were a little more than six times higher in 1997 when compared to 1970. The rapid expansion in imports is itself due to the rapid expansion of the productive sectors which have significantly increased their demand for raw materials, machinery and equipment. Services: From Deficits to Surpluses Mauritius has traditionally been a net importer of freight, insurance and transportation services which dominate the services account over

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the period 1970–97. Net investment income has also been typically negative on account of higher profits paid out to foreign businesses established in Mauritius (for example, banks, insurance companies, consultancy firms) than received from overseas investments. Furthermore, the increase in foreign direct investment, mostly in the export sector, has meant an increase in payments made out overseas. Hence, the services account has also traditionally shown deficits. In fact, there was a deficit every year over the period 1970–86. As from 1987, however, there seems to have been a shift to annual surpluses due to the rapid expansion of the tourist sector. Earnings from tourism have in fact helped to offset the deficits in the services account. Persistent Current Account Deficits and Increasing Capital Inflows Given the persistent deficits in the merchandise account which dominates the current account, the overall account inevitably shows deficits for most of the period 1970–97, with important surpluses occurring during the sugar boom (1972, 1974, 1975) and more recently in 1986, 1987 and 1996. It is useful to distinguish two episodes of current account deficits. The first episode, starting from 1976, marks a period of unsustainable deficits. And the second episode, starting from 1988, shows deficits which are completely offset by capital inflows. The first episode is characterised by high deficits (9.7 per cent of GDP over the period 1976–79) which emerged, ironically, after the sugar boom period of 1973–75. They were triggered by the rapidly increasing demand for imports from consumers and also from government which had stepped up its investment programme. The deficits were not sustainable as they were not adequately financed by capital flows. In fact, they had to be met by running down the level of foreign exchange reserves. From a record level of Rs1,143 million (US$172 million) at the end of 1995, foreign reserves declined steadily to reach a record low of Rs15 million (US$2.4 million) in August 1979. Imports could no longer be financed and the assistance of the IMF had to be sought for the restoration of equilibrium in the balance of payments. This was successfully achieved by the mid-1980s. The deficits of the second episode are not only much lower (2.5 per cent of GDP over the period 1988–97) but can be considered as sustainable for three reasons. First, controls on imports were gradually relaxed, culminating in the removal of all restrictions on payments for current account transactions in 1993. Secondly, all taxes on capital outflows were abolished. Thirdly, since the late 1980s, there have been more significant inflows of private and, especially, official capital which

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56

have fully offset the current account deficits. As a result, foreign exchange reserves have been increasing from Rs2,450 million (US$186 million) in 1986 to Rs21,775 million (US$976 million) in December 1997.

3.5 THE IMPACT OF EXCHANGE RATE POLICIES ON THE BALANCE OF PAYMENTS As indicated in Section 3.3, Mauritius initially pursued a policy of exchange rate stability but shifted to a policy of depreciation as from the early 1980s. Section 3.5 examines the impact of this policy shift on foreign exchange reserves, exports, imports, and capital flows. Foreign Exchange Reserves The overall impact of the policy of depreciation on the balance of payments is captured by the rapid increase in foreign exchange reserves which occurred from the late 1980s. As shown in Figure 3.1,

1,000.0

800.0

400.0

200.0

1996

–200.0

–400.0

–600.0 Trade balance

Figure 3.1

Current account

Foreign exchange reserves

Trade balance, current account and foreign exchange reserves, 1968–97

1997

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

1979

1978

1977

1976

1975

1974

1973

1972

1971

1970

1968

0.0 1969

Millions of US$

600.0

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the level of reserves was declining in the late 1970s and remained mostly unchanged during the first few years following the 1979 and 1981 devaluations. However, as from 1986, the level of reserves began to rise steadily. From an average of US$25 million over the 1982–85 period, the reserves attained a record level of US$893 million in 1991, after which they declined slightly, averaging US$800 million over the 1992–97 period. The reasons for these significant changes are discussed below. Exports A policy of exchange rate depreciation is usually expected to lead to an increase in the international competitiveness of domestic exports. In Mauritius, the depreciation of the rupee in the 1980s did give a boost to the expansion of non-traditional exports (essentially manufactured exports from the EPZ). As shown in Figure 3.2, these exports

1,400.0

1,200.0

Millions of US$

1,000.0

800.0

600.0

400.0

Non-traditional exports

Figure 3.2

Traditional exports

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

0.0

1968

200.0

Tourism earnings

Traditional and non-traditional exports and tourism earnings, 1968–97

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58

were non-existent in 1970 but they outstripped traditional exports (sugar exports) as from the late 1980s and they currently provide about three times as much foreign exchange as traditional exports. The depreciation has also given a boost to the tourist industry. Gross earnings have been increasing significantly since the late 1980s and they currently also exceed the value of traditional exports. Imports The level of imports started to fall in the early 1980s, as shown in Figure 3.3. However, this decline was only partly due to the depreciation of the rupee. It was in fact accentuated by various measures adopted to reduce imports in the wake of the 1979–86 stabilisation and structural adjustment programmes. First, an import levy of 2 per cent was introduced immediately after the first devaluation of 1979. The levy was payable at the time of issue of permits required for virtually all imports, except EPZ imports. This levy was progressively

2,500.0

Millions of US$

2,000.0

1,500.0

1,000.0

Total imports

Figure 3.3

Raw materials and capital equipment

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

0.0

1968

500.0

Food and beverages

Total imports, imports of raw materials and equipment, and food and beverages, 1968–97

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increased until it reached 17 per cent in 1983. Secondly, on top of the import levy, a surcharge of 10 per cent was introduced in 1983. Thirdly, even though quantitative restrictions on imports were removed by 1985, a very comprehensive import licensing scheme was maintained until 1991. Fourthly, import permits were granted depending on the availability of foreign exchange. In spite of the control on imports, which was mostly directed to consumption goods and not to raw materials and machinery, there was a rapid increase in total imports as from the late 1980s. The expansion of EPZ exports led to a significant increase in the demand for raw materials and machinery. As shown in Figure 3.3, the value of these imports increased steadily from a little less than US$300 million in 1985 to US$1,400 million in 1997. Capital Flows The policy of depreciation was initially associated with a marked improvement of the current account: the persistent deficits of the late 1970s were gradually eliminated and surpluses were recorded in 1986 and 1987. This improvement, as we have seen, was due to the rapid expansion of the EPZ and the tourism sector. Although these sectors continued to grow at reasonably high rates, the current account again recorded sustained deficits over the period 1988–97, with the exception of 1996. These deficits, however, have been more than offset by capital inflows. It can be argued that the relatively sound macroeconomic conditions prevailing since the early 1980s have attracted these capital inflows. This is indicated by the composition of these flows in more recent years. Two important components are foreign direct investment (FDI) and portfolio investment. FDI averaged US$27.9 million per annum over the period 1988–97, equivalent to 38.5 per cent of the average annual deficit in the current account over that period. This is in sharp contrast with the negligible inflow of FDI in previous years, including the take-off period of the early 1970s which saw the establishment of the EPZ and the tourism industry. Portfolio investment occurred for the first time in 1994, spurred by the relatively good performance of the recently established stock market and also by the complete liberalisation of the foreign exchange and capital markets in 1993 and 1994 respectively. Overseas investment in the stock market averaged US$61.6 million over the period 1994–97.

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60 3.6

CONCLUSIONS AND IMPLICATIONS

We have argued that, as from the 1980s, Mauritius moved towards a flexible exchange rate regime which has been associated with a depreciation of the rupee. This depreciation has so far had a significant impact on the expansion of the export sectors and it has certainly helped the economy to sustain an average growth rate of a little over 5 per cent per annum as from the 1980s. However, there are other exogenous and policy induced factors which have contributed to the overall performance of the economy. The exogenous factors include the rapidly increasing demand for Mauritian exports from Europe and the USA, and an unprecedented inflow of investments from Hong Kong in the late 1980s, partly spurred by political and economic uncertainties over Hong Kong’s future and partly attracted by the prospects of duty free access of Mauritian goods to the European market. Policy induced factors include a progressive liberalisation of trade and foreign exchange as well as financial liberalisation with emphasis on offshore business, and a stable macroeconomic situation favourable to domestic and foreign investment. Although the policy of exchange rate depreciation, pursued since the 1980s, has had favourable effects on the real economy, it is at present uncertain to what extent such a policy can be maintained in the future. The exchange rate regime adopted since mid-July 1994 makes it more difficult for the monetary authorities to target a given level of real depreciation. For example, the 9.7 per cent rise in the wage level in 1997 could not be offset by exchange rate depreciation and the real exchange rate in fact appreciated by about five per cent in 1997. The implication is that the competitiveness of Mauritian exports should be reinforced by other policies which can increase the productivity of the export sector. These include, for example, the adoption of more capital intensive technologies and the upgrading of skills.

Notes 1. 2.

The Mauritian experience can be compared with that of Fiji, which has an economic and social structure quite similar to that of Mauritius. See Jayaram, 1997. A geometric index was calculated for these 13 countries which accounted for an average of 78 per cent of the trade of Mauritius over the period 1974–76.

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A geometric index was calculated using the CPI indices of the 17 countries included in the REER. See Milner and McKay, 1996 for a discussion of alternative real exchange rate concepts and their application to Mauritius.

References B.B. AGHEVLI and P.M. MONTIEL (1991) ‘Exchange Rate Policies in Developing Countries’, in Emil-Maria Claassen, Exchange Rate Policies in Developing Countries and Post-Socialist Countries (San Francisco: Institute for Contemporary Studies Press). S.K. BUNDOO and B. DABEE (1999) ‘Gradual Liberalization of Key Markets: The Road to Sustainable Growth in Mauritius’, Journal of International Economic Development, 11, 437–64. W.M. CORDEN (1993) ‘Exchange Rate Policies for Developing Countries’, Economic Journal, 103, 198–207. S. GHATAK (1995) Monetary Economics in Developing Counties (London: Macmillan and New York: St Martin’s Press). IMF (1996) Mauritius – Background Papers and Statistical Annex, Country Report No. 96/1 (Washington, DC: IMF). T.K. JAYARAM (1997) ‘Fiscal Imbalance and Real Exchange Rate Movements in Fiji: An Empirical Study’, Asia Pacific Development Journal, 4, 1, 83–103. C. MILNER and A. MCKAY (1996) ‘Real Exchange Rate Measures and Trade Liberalisation: Some Evidence for Mauritius’, Journal of African Economies, 5, 61–91. Z. YIHEYIS (1997) ‘Output Growth and Adjustment to Devaluation Episodes in Sub-Saharan Africa’, Canadian Journal of Development Studies, 18, 1, 93–117. P.A. YOTOPOULOS (1996) Exchange Rate Parity for Trade and Development: Theory, Tests, and Case Studies (Cambridge and New York: Cambridge University Press).

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4 Structural Adjustment and Economic Growth in Mauritius David Greenaway and Nishal Gooroochurn

4.1

INTRODUCTION

In the 1960s the Nobel Laureate, published two famous papers on Mauritius (Meade, 1961 and 1967) where he set out a fairly gloomy prognosis for the island’s development, which he characterised as a ‘case study in Malthusian economics’. In the event the transformation in the Mauritian economy over the last twenty years has been quite remarkable. What was at the beginning of the 1970s a monocrop, low income, low growth, high unemployment economy had become, by the mid-1990s, a diversified, upper middle income, high growth, full employment economy. The obvious question to ask is what was responsible for this transformation. The explanation is multifactorial. Many aspects of structural change are addressed elsewhere in this volume. One contributory factor may have been the structural adjustment programme (SAP) which the economy underwent in the early and mid 1980s. That is the central focus of this chapter, where we will evaluate the SAP and offer an assessment of its impact vis-à-vis other factors. The remainder of the chapter is organised as follows. Section 4.2 sets the context by providing an overview of the World Bank’s Structural Adjustment Lending (SAL) operations. Section 4.3 looks specifically at the SAP that was agreed in Mauritius and the complementary IMF Stabilisation Loans. Section 4.4 estimates a model of growth in Mauritius and evaluates the role played by the SAP. Section 4.5 concludes.

62

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4.2 WORLD BANK STRUCTURAL ADJUSTMENT LENDING POLICIES The World Bank is the largest and most active multilateral lending agency in the world. In this capacity it administers a wide portfolio of lending programmes. One of the most important, and probably its most visible, is the SAP. This was initiated in 1980 and was quite different in concept to any other component of its lending activities. (Greenaway and Milner, 1993 provide an overview of the programme.) The Bank’s Operational Manual defines SALs as: non-project lending to support programmes of policy and institutional change necessary to modify the structure of the economy so that it can maintain both its growth rate and the viability of its balance of payments in the medium term. The distinctive characteristics of SALs are that they are medium term, they offer greater flexibility than many other project or sector specific loans and they are conditional on policy reform. This last characteristic is especially important. It is not unique to SALs; IMF Stabilisations Loans (SLs) had been conditional on policy change for a long time before 1980. What was, and remains, distinctive about SALs, however, is that the conditionality applies by and large to supply side reforms. Thus, whereas IMF conditions refer to control of public spending or control of the money supply, i.e. classic demand management policies, the conditions associated with SALs, as Table 4.1 shows, typically refer to targets designed to alter incentive structures and stimulate structural change. These include trade policy, exchange rate policy, labour market reform, utility pricing, public sector reform, agricultural policy. The fundamental purpose of a SAL programme can be explained by reference to the simple two-sector model set out in Figure 4.1. PR is the pre-reform production frontier and PD some set of distorted relative prices. Initially the economy is at some under-employment equilibrium represented by point a. Reforms are then targeted at changing relative prices from PD to PW. In the short run, this allows the economy to shift from a to b, and achieve an allocation of resources consistent with comparative advantage. In addition, however, this particular allocation stimulates more rapid factor accumulation in the long run pushing the economy from b to c, i.e. it stimulates growth in the medium term.

Supply-side, growth-oriented polices: Trade policies Sectoral policies Industry Energy Agricultural Financial sector Rationalisation of gov’t finance & administration Public enterprise reforms Social policy reforms Other Absorption reduction polices: Fiscal policy Monetary policy [Money Supply Targets] Switching policies: Exchange rate Wage policy 16 13

18 23

14

16

57 58 13 42

51 44 11 28 69

30 12 62 26

22 15 45 31

51

58

SSA (84)

58

All countries (183)

20 5

13

41

50 34 9 17

16 14 33 31

67

HICs (64)

22 25

14

78

71 49 11 33

25 21 56 40

64

SAL (73)

13 6

16

34

38 40 11 25

20 11 37 25

55

SECAL (110)

0 20

10

30

10 40 10 10

10 30 30 20

30

Hybrid (10)

9 4

7

47

51 31 4 7

24 15 44 16

60

79–85 (55)

18 8

16

51

53 49 20 27

20 14 35 35

69

86–8 (49)

20 7

13

53

40 33 0 20

27 7 27 27

33

89 (15)

EIAL countries

11 11

11

33

44 33 22 33

22 22 89 44

56

79–85 (9)

22 29

24

58

55 56 11 51

20 16 53 40

55

86–9 (55)

Other AL countries

Notes: 1. Numbers in brackets are total number of loans. 2. All countries. All conditions called for in all loan agreements or other actions called for in all Presidents’ Reports. Source: World Bank (1990), based on an analysis of 183 SALs and SECALs to 61 developing countries.

3.

2.

1.

Content of lending operations of World Bank

Share of loans with loan-agreement conditions in various policy areas (per cent)1

Table 4.1

45 22

42

67

72 65 24 49

44 27 62 51

79

Share of loans with actions in various policy areas2 (per cent)

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There is now a very large literature on the process of structural adjustment lending and its economic effects. We will in the next two sections examine both for the particular case of Mauritius. Before doing so, however, it is useful to have a more general overview. Take process first. Typically what happens is that some initial appraisal of the policy environment in the borrowing economy, by the lender takes place. This is used as background to negotiations between the government and the bank. Out of those negotiations will come a set of agreed targets for reform and, where there is more than one area of policy affected, the timing and sequencing of various components. Once the government has committed to the programme the loan is disbursed. However, typically it is tranched with future disbursements being subject to compliance with the conditions agreed at the outset. Failure to comply, or non-compliance without good cause, can result in the renegotiation of terms and conditions, deferment of disbursements or withdrawal of funding. What are the effects of SALs on growth? Do they result in the transformation mapped out in Figure 4.1? A considerable number of studies, both single country and multi-country; cross section, panel and time series have now been completed.1 Isolating the impact of trade reforms is not absolutely straightforward for various reasons. First, one never knows exactly what would have occurred in the absence of the SAL. In other words, there is a classic counterfactual problem. Second, SALs and SLs are often in place simultaneously and there may be M

P¢

P

a

c

b

PD PW

O

Figure 4.1

Liberalisation and growth

R

R¢

X

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problems disentangling the effects of the two. Third, countries are often subject to exogenous shocks during a lending programme; shocks that may well jeopardise the longevity of the programme. Nonetheless, a substantial literature has accumulated. The results where growth is concerned are not completely conclusive. Some studies point to a positive association between SAL induced trade reform and growth, others a negative association and yet others no association at all. For example, in countries like Nigeria, the Philippines, Malawi and Mexico, growth was much lower than countries like Mauritius, Korea, Ghana and Thailand during and after SAL programmes. Conflicting outcomes are of course partly an inevitable result of differences in methodology and sample. They are also fashioned by the dynamics of the adjustment process itself. The speed of supply side response will vary from one economy to another depending upon the extent of any pre-existing distortions, market structures, how radical the reforms are, how they are sequenced and so on. Typically empirical analysis does not explore the dynamics very effectively. In this regard it is notable that the recent paper by Greenaway, Morgan and Wright (1998) did identify a positive association between trade reforms and growth, crucially however this was a lagged rather than instantaneous response. To summarise then, the World Bank’s structural adjustment lending programme has become one of its most important lending windows and loans are conditional on policy reform. The SAP has been responsible for trade reform programmes being initiated in more than 100 developing countries. Programme design, the timing of implementation and its sequencing vary considerably from one country to another. This together with the methodological problems associated with disentangling the effects of SALs from other policy and nonpolicy influences makes assessing their economic effects complicated. The work that addresses growth effects is not unambiguous in its findings. There is, however, recent evidence which suggests that liberalisation impacts favourably on growth, albeit with a lag. Let us now look at the specifics of the Mauritian case.

4.3

ADJUSTMENT LENDING IN MAURITIUS

Background Between 1970 and 1983 real GDP growth in Mauritius averaged 4.8% per annum, hardly spectacular for a low income developing country.

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Equally, however, it is hardly disastrous given the rather hostile external environment, which included two oil price shocks and two recessions. This is, however, misleading since growth in 1973 was 11.8% and in 1976 was 16.7%. If one excludes these outliers, average annual growth was 2.8%. These outliers both had a common cause, a very rapid escalation in world sugar prices. At that time three quarters of exports and one quarter of GDP were accounted for by the sugar sector. It is hardly surprising therefore that sudden, externally generated, hikes in sugar prices should be amplified through to peaks in GDP growth. These numbers tell us two important things about the Mauritian economy in the 1970s and lead on to others. First, it was an economy that was very heavily dependent on exports of a single commodity, namely sugar. Second, like many monocrop economies, variations in GDP growth and economic activity were closely tied to variations in the (exogenously determined) world price of sugar. When the sugar price boomed, GDP growth boomed. So too did government revenues. In principle, government could treat such tax windfalls for what they were, i.e. transitory gains in savings, and use them to smooth activity. In practice, governments are more likely to treat them as if they are permanent (see Bevan, Collier and Gunning, 1993). This is what happened in the Mauritian case: revenue windfalls were treated as if they were permanent and unsustainable commitments to expenditure were made. As a consequence, during the post-sugar boom, i.e. during 1976–79, there was a sharp turnaround of the TOT that declined by 28% compared to a peak level in 1975. The debt service ratio rose from 1% in 1976 to 10% in 1979. In 1980, fiscal and current account deficits were 10% and 20% of GDP respectively and the annual rate of inflation was 24%. These were the proximate triggers for a series of IMF Stabilisation Loans which preceeded the SALs (see Greenaway and Lamusse, 1999). But the structural problems in Mauritius were more deep rooted. As well as heavy dependence on sugar and low mean/high variance growth, the economy also had high structural levels of unemployment (averaging close to 20% in the early 1970s), low productivity growth and chronic balance of payments problems. Of course all are interrelated and government was not unaware of the need for diversification and expansion of manufacturing activity. Indeed, as early as 1970 an Export Processing Zone (EPZ) had been established. Its impact by the late 1970s had been disappointing however, in part because of instability in the macroeconomy but more so because of the overall structure of incentives in the economy. Specifically, manufacturing

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activity in the import substitute sector was very heavily protected, with the protection there being significantly in excess of that offered to export oriented producers in the EPZ (see Greenaway and Milner, 1986). Thus, macroeconomic instability, a severely distorted supply side and overwhelming dependence on sugar were the immediate backcloth to structural adjustment. IMF Stabilisation Policies in Mauritius Before examining the details of World Bank adjustment lending programmes, we should first comment on the IMF Programmes. The first IMF Standby Loan in Mauritius was agreed in February 1978. It was intended to adjust demand downward. But this Agreement was unsuccessful and was quickly followed by a second in October 1979. This was negotiated for a period of two years. Its main aim was to reduce the current account deficit. The government depreciated the currency by 23% in October 1979. A 75% surcharge on the sugar export tax was imposed to capture the windfall gain resulting from devaluation. The prices of rice and flour were doubled to reduce subsidies but opposition in the Legislative Assembly resulted in prices being restored to their original level. In November 1979, interest rates were increased by 15% and the maximum limit on lending rates was abolished. Nominal wages were also increased by 5%. The second agreement was initially successful but collapsed in spring 1980 due to a combination of severe cyclones and the second oil price shock. A third Agreement took into consideration the cyclone induced fall in sugar production and knock-on to GDP and foreign exchange. Its main aim was to limit the BOP deficit on current account to SDR 75 million and the fiscal deficit to 15% of GDP.Taxes and fees were raised to increase revenue by 10%. Expenditures were checked by cutting real wages and subsidies and there was also a further devaluation of 17% in 1981. The aim of the fourth Stabilisation Programme was to curtail further the external account deficit and fiscal deficit to below 13% of GDP. It also expected the TOT to decline by 6.8%, a GDP growth rate of 5% and inflation of 25%. The plan was to stimulate exports by 15% and allow imports to grow only marginally. As for the fiscal deficit, the target was to be achieved by cutting expenditure and increasing revenue from the sugar tax. The scheme was fairly successful since exports grew more than expected and imports fell by 13% leading to a current account deficit of only 5.7% of GDP. The budget deficit was 12.8% of GDP, output growth 5.7% and inflation 13.4%.

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The 1983 Stabilisation Programme aimed to sustain this progress by keeping the current account deficit below 4.6% of GDP and the budget deficit at 9% of GDP. Inflation was to be levelled at 8.5%. The main tools were to maintain a flexible exchange rate and a restrictive wage policy, limit credit creation and remove controls on some prices. In fact, this programme was also successful with a wage increase of only 3.5% as compared to inflation of 5.6%. Moreover, in February 1983, the rupee was pegged to a new basket of currencies leading to a real depreciation of 8.6% during the year, which helped to relieve the current account deficit. The targets for fiscal year 1985–86 were to enhance the economic success of Mauritius, which was being reinforced on the supply side by the World Bank Programmes. Maintaining a flexible exchange rate, decreasing net domestic credit, eliminating all quotas on imports and decontrolling prices were the main strategies used to attain the targeted current account and fiscal deficit to 1.9% and 5.3% of GDP respectively. This was successful since the growth rate was 6% and the current account showed a surplus of 1.8% of GDP for the first time since 1975. Structural Adjustment Programmes Most of these IMF Programmes essentially prepared the ground for the World Bank SALs. The country had two SALs: SAL I and SAL II, during the period June 1981 to June 1982 and March 1984 to June 1985 respectively. In SAL I, the government, with the help of the World Bank, appointed a commission to undertake a thorough diagnosis of the economic situation. SAL II strategies for the reconstruction of the economy were developed. The principal elements of the programme were fourfold: Restructuring of the Sugar Industry and Agricultural diversification; Promotion of Export Oriented Industrialisation; Tourism Development; Improvement in Public Resource Management. Restructuring of Sugar Industry and Agricultural Diversification The analysis of the sugar industry identified two basic problems: declining financial profitability and low productivity of smallholder planters. The most pressing objectives were to rationalise factories by rehabilitating them and centralisation. Six less efficient units were identified of which two were closed and others were merged. It was

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estimated that these would avoid losses of Rs55–95 million per year. Moreover, with massive production, centralised factories could benefit more from economies of scale. There was also a need to rehabilitate virtually all existing firms given their condition and the fact that investment had been falling continuously for some time. Finally the allocation of cane supplies to different factories was to be rationalised according to their capacity. It was estimated that the cost of this programme would be Rs650 million in 1984 prices. Policies to encourage better utilisation of sugar by-products were also considered. Here emphasis lay principally on bagasse. It was estimated that bagasse could supply 250 Gwh of electricity (in relation to a total consumption of 485 Gwh in Mauritius in 1990). This would result in not only a reduction in fuel imports and hence savings in foreign exchange, but also an increase in the revenues of the sugar sector. This required the setting up of two new bagasse-based power stations (at FUEL and Medine) at a cost of Rs330 million. A key source of financial difficulties of sugar factories was the high cost of labour which received high levels of non-wage benefits and were guaranteed a full year of employment. It was estimated that rationalisation could lead to potential savings of 10% per annum for the factories. Thus plots of land were given/sold to settled labourers. This first avoided unemployment; secondly it relieved the ‘unnecessary’ high cost of labour to the firm; and thirdly, firms could concentrate only on production thereby increasing productivity. Finally, since labourers (now small planters) knew that they were the only beneficiaries of a good crop, their productivity would increase. A Planters Service Centre was also established to coordinate planters’ needs and provide support facilities. There was also reinforcement of R&D undertaken by MSIRI (Mauritius Sugar Industry Research Institute) to increase sugar yield. These were both important infrastructure developments that provided extension services to small farmers. In addition, there were modifications in the fiscal and legal framework of the sugar industry so as to relieve the sugar factories and planters. The exemption ceiling on export tax was increased from 75 tons to 1,000 tons. Moreover, the Land Transfer Tax and the Land Development Tax levied at 5% were suspended for a period of five years for plots of land not exceeding 25 arpents. The Company Act was modified to enhance social accountability to widen disclosure requirements and the auditing structure was amended to have uniform treatment across factories.

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Agricultural diversification was important for the stability of the agricultural sector and to reduce dependence upon imports of food. Various crops began to be planted in rotation and interlining with sugar cane. Livestock and dairy products were encouraged by increased availability of fodder on Crown Lands and by ensilation of cane tops. Programmes for fresh water and marine aquaculture, bank and tuna fishing and deer farming were also successfully envisaged by the government. Promotion of Export Oriented Industrialisation In general, in a small market like Mauritius, import-substitute firms cannot fully exploit scale economies. Moreover, DRC and ERP analysis showed that protection of import-substitution firms was highly discriminating against EPZ firms (see Greenaway and Milner, 1986 and 1988). As a matter of fact, between 1978 and 1981, four-fifths of total manufacturing investment was in the import-substitute sector. Moreover, Mauritius, being a labour-surplus economy at that time, should have been emphasising the more labour-intensive EPZ than the relatively capital-intensive import substitution sector. As a result there was a major reorientation of trade policy and industrial incentives to reduce the relative incentives to import-substitution firms and enhance those to EPZ firms. (Details are documented in Chapter 5.) Double taxation agreements were also reached with Germany, France and the UK to attract FDI in the export sector. The Development Bank of Mauritius established an Export Credit Guarantee and Insurance Scheme and the Mauritius Export Development Investment Authority (MEDIA) was set up to ‘carry out planning, executive and advisory roles with regard to investment and export promotion and to have responsibility for developing and operating industrial estates’. A further institutional innovation was the creation of an Industrial Coordination Unit (ICU) which had as a prime objective assisting new investors in setting up in business. There were also fiscal reforms to make the EPZ more attractive. Quotas were to be replaced by tariffs equivalents. The existing complex tariff system was rationalised with the consolidation of the fiscal, customs and stamp duty and surcharges to a unified ad valorem tariff. Moreover, there was a move to a more uniform tariff structure that would lower the ERP and at the same time raise tariffs on goods that had negative ERPs. The duty drawback system was improved by the use of vouchers that could be used for payment of duties on

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imported goods and by the adoption of a uniform tariff rate. In addition to the above, corporate tax was reduced and made proportionate to the amount exported and in June 1984 it was reduced by 2% for each 10% of exports. The corporate income tax was also reduced from 65% to 25%. Finally, import substitute firms had been encouraged by price controls via minimum price and mark-ups. The government decided to remove these controls and during 1984 and 1985 price controls were reduced on about 50 goods. Tourism Development Prior to the adjustment years, tourism was identified as a potentially lucrative industry. In the early 1980s there was a significant fall in tourist arrivals and with this setback a careful diagnosis with relevant recommendations was undertaken under the SAL. Given the remoteness of Mauritius to its most important markets (the United States and Europe), air access policy was rationalised and new air links to potential areas like Tokyo, Singapore, Rome, Zurich and so on were negotiated and it was decided to increase hotel capacity. The tourist infrastructure was also to be modernised. Hotels were to be of a better standard and facilities like car rentals, water sports, wild life parks, etc, were also created. It was also discovered that earnings per tourist were very low.Thus, opportunities like jewellery, handicrafts, duty-free shops and clothes were made available to them. Finally, it was recognised that to be a high-class tourist destination, the human capital employed in the sector would need to be of an appropriate standard and a ‘Hotel and Catering School’ was created. Improvement in Public Resource Management Reforms were undertaken to deal with fiscal problems. The first step was to redirect public expenditures towards efficient projects. Large prestige products like the new airport and oil refinery were abandoned and the resources were used on the maintenance and rehabilitation of infrastructure. Total expenditure on education was also to be reduced, by increasing pupil-teacher ratios. Furthermore, new guidelines were developed to evaluate projects so as to avoid waste. On the revenue side, fewer reforms were undertaken and they were more ad hoc. There were changes in taxation of sugar industries and EPZ firms. Personal income tax rates were reduced and import duties raised. Moreover, a sales tax of 5% was introduced in some

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goods. The government also sought assistance to manage its debt servicing. It was recognised that the parastatals, especially the Development Works Corporation (DWC), The Tea Development Authority (TDA) and the Central Housing Authority (CHA) which had low rates of return, needed to be restructured. Employment in all these institutions was cut. For example, in DWC it was reduced from 14,000 in 1976 to 4,000 in 1982. In TDA, employment fell by 5% over the same period. CHA was eventually closed down. All the workers were transferred to other sectors.

4.4

STRUCTURAL ADJUSTMENT AND GROWTH

As can be seen then, the adjustment lending programmes were negotiated and implemented behind a series of stabilisation measures that had successfully stabilised the macroeconomy. The adjustment programme was broadly based, involving as it did changes in trade policy, industrial policy, the public sector and agriculture. Finally, the reforms were agreed and implemented quickly. What has been the impact, if any, of the adjustment programme on economic growth? To investigate this one has to estimate a growth model that incorporates drivers of growth other than structural adjustment. These should include capital accumulation, growth of the labour force and so on. Although growth modelling remains controversial, a degree of convergence around a core specification does exist. This has been fashioned partly by empirical work building on Levine and Renelt (1992) and ‘new growth theory’ work associated with Romer and others. Levine and Renelt, for example, identified a core model comprising labour, capital and export growth and some kind of proxy for human capital accumulation. Building on this, we have estimated a model with the following specification: Yg = b0 + b1Lg + b2Kg + b3TOT + b4HCg + b5EXg + b6SA + ui where Yg = GNP growth rate Lg = labour growth rate Kg = capital stock growth rate TOT = terms of trade HCg = human capital growth rate EXg = export growth rate SA = structural adjustment dummy

(1)

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Labour growth, capital stock and real export growth are all standard measures. The others require further elaboration. Terms of trade is included since for the period in which we are interested, Mauritius was a significant exporter of sugar and the period encompasses two sugar booms and one collapse in sugar prices. Human capital is an extremely difficult concept to measure but an important variable to include. We proxied it by total government expenditure on education as a whole (HCg1). But since it may be highly correlated with labour (population), we also use expenditure on education per capita (HCg2) just to purge out the effect of labour growth on education since both are used as independent variables. This avoids the multicollinearity problems. It is also difficult to model structural adjustment in this kind of framework. The simplest way of doing so is to include it as a dummy variable. We do so by having the dummy take a value of one when the SAL is operative (SA1), that is for the years 1981–85 inclusive. As an alternative we include cases where a value of one is assigned for the post-structural adjustment period, that is for the years 1986–94 inclusive, and zero otherwise (SA2). Our results are reported in Table 4.2, with data referring to the period 1970 to 1994. From column 1 we can see that export growth and human capital formation have a positive impact on output growth and this effect is significant at the 5% level. By contrast, terms of trade changes have a negative impact, also significant at the 5% level. The labour growth rate is positive but significant only at 10%. The coefficient on capital stock growth has a positive sign, without reaching significance; that on structural adjustment is unambiguously negative albeit without being significant. For the most part the coefficients have the expected signs and a tendency towards significance. That on our structural adjustment dummy is interesting. Recall that the SA1 dummy is active when the adjustment programme was in place. As we saw in our earlier account, the lending programmes were in place at a time of slow growth. But lending programmes need adjustments (sometimes radical) which in the short run will negatively affect the existing growth rate. This is because problems of adapting and adjusting will emerge and new strategies generally need time to be implemented successfully. Moreover, the adjustment often requires the implementation of social adjustment. This can lead to social unrest and political instability. In fact, during these years, there was political opposition and several changes and mutations in the political parties.

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David Greenaway and Nishal Gooroochurn Table 4.2

CONST P I X TT HC1

Growth and structual adjustment

1

2

3

4

0.2100 (2.56)** 0.3825 (1.97)* 0.0079 (0.08) 0.1762 (2.23)** -0.0018 -(2.30)** 0.1696 (2.51)**

0.1620 (2.97)*** 0.4486 (2.70)** 0.1373 (1.89)* 0.1534 (2.27)** -0.0018 -(3.09)*** 0.1379 (2.36)**

0.2116 (2.58)** 0.3823 (1.98)** 0.0086 (0.10) 0.1750 (2.23)** -0.0018 -(2.30)**

0.1627 (2.98)*** 0.4492 (2.69)** 0.1379 (1.89)** 0.1522 (2.25)** -0.0018 -(3.07)***

0.1723 (2.53)** -0.0458 -(1.44)

0.1383 (2.33)**

HC2 SA1

-0.4565 -(1.43)

SA2 R2 F DW N

75

0.71 10.58 2.19 25

0.6112 (3.13)*** 0.79 15.85 2.38 25

0.71 10.66 2.19 25

0.0606 (3.08)*** 0.79 15.74 2.36 25

Note: *, **, *** indicate statistical significance at 10 per cent, 5 per cent and 1 per cent respectively. Source: Authors’ estimates.

Thus, column two reports the results of estimating the same equation but with SA2, that is, the dummy variable being active after the loan period. This is in fact accounting for the after effects of the SAL programme. The striking result here is that not only does the coefficient have a positive sign but it is also significant at the l% level. Moreover, with this specification all of the other coefficient estimates are significant at the 5% level at least, with the exception of investment, which is significant at 10%. (Note it was not significant in the previous formulation.) As can be seen from the panel, the overall explana¯ 2 of 0.79 and there are no tory power of the model is strong, with a R grounds for supposing that autocorrelation is a problem. Columns 3 and 4 report analogous results with our real human capital per capita variable. In column 3, export growth, terms of trade, human capital and labour growth all have the expected signs and all

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are significant at 5%. Capital growth again turns out to be significant and SA1 has a negative sign. When we switch to SA2 in column 4, it is positive and significant at 1% and all of the other coefficients are significant at 5% or above, including investment. Hence expenditure on education per capita seems to perform better than aggregate expenditure on education. R¯2 is again 0.79 and autocorrelation does not appear to be a problem. Overall these are an interesting set of results. They suggest that population growth, investment, real export growth and human capital accumulation have all contributed positively to Mauritian growth over the last quarter of a century, whilst terms of trade movements have had an adverse effect. Structural adjustment also appears to have had a positive impact. However, there is little more we can say about that, given the methodology we have used. It is possible for example that its effect has operated through export growth or factor accumulation but one would need a much more sophisticated empirical framework to establish this. For our present purposes it is sufficient to conclude that the structural adjustment programmes analysed earlier in the chapter appear to have impacted favourably on growth.

4.5

SUMMARY AND CONCLUSIONS

In this chapter we have evaluated the impact of structural adjustment on the Mauritian economy. We began by reviewing the World Bank’s SAL programme, the rationale behind it and its implementation. We then examined in detail the characteristics of the Mauritian SALs.This was developed and implemented against the backcloth of fiscal imbalance and macroeconomic instability. It involved fairly radical restructuring in terms of the structure of incentives. Some restructuring of the sugar industry followed, accompanied by some further agricultural diversification. It also resulted in the introduction of further export promotion measures. To establish whether these had a positive impact on growth we estimated a model that included a structural adjustment dummy. That model generated a set of coefficient estimates which suggest that population growth, human capital accumulation and real export growth have all been important drivers of economic growth in Mauritius over the last quarter of a century. The results also suggest that structural adjustment has had a positive impact. Clearly the structural adjustment programmes which Mauritius underwent do not in themselves explain the country’s impressive

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growth record since that time. Other factors have clearly been influential. Nonetheless, this does appear to be a case of successful adjustment and one might ask why has the programme been successful here whilst unsuccessful in so many other Sub-Saharan African countries? This is due to a combination of factors. First, the preconditions were helpful. Successful stabilisation had occurred before the SAL. Second, it was a well designed adjustment programme that was appropriately sequenced. Third, a number of complementary circumstances were helpful. For example, inward investment to the textile and garments sector from the Far East, stimulated by the absence of MFA quotas, gave a boost to the EPZ at the right time. Finally, the human capital stock to support rapid diversification was available. In short, structural adjustment was most probably necessary, but certainly not sufficient for growth in Mauritius.

Note 1.

Surveys of the evidence can be found in Greenaway and Morrissey (1993), Rodrik (1994) and Krueger (1997).

References BEVAN, D., COLLIER, P. and GUNNING, J. (1992) ‘Trade Shocks in Developing Countries’ European Economic Review, vol. 37, 557–65. GREENAWAY, D. and LAMUSSE, R. (1999) ‘Private and Public Sector Responses to the 1972–75 Sugar Boom in Mauritius’, in P. Collier and J. Gunning (eds), Trade Shocks in Developing Countries, vol. 1, Africa (Oxford University Press), 207–22. GREENAWAY, D. and MILNER, C.R. (1986) ‘Estimating the Incidence of Protection Across Sectors: An Application to Mauritius’, Industry and Development, vol. 16, 1–22. GREENAWAY, D. and MILNER, C.R. (1988) ‘Trade in Differentiated Goods and the Shifting of Protection Across Sectors’, European Economic Review, vol. 32, 927–46. GREENAWAY, D. and MILNER, C.R. (1993) Trade and Industrial Policy in Developing Countries (London: Macmillan and New York: Michigan University Press). GREENAWAY, D., MORGAN, C.W. and WRIGHT, P.W. (1998) ‘Trade Reform, Adjustment and Growth: What Does the Evidence Tell Us?’, Economic Journal, vol. 108, pp. 1547–61. GREENAWAY, D. and MORRISSEY, W.O. (1993) ‘Timing and Sequencing Issues and Adjustment Lending’, Kyklos, vol. 46, 241–61. KRUEGER, A.O. (1997) ‘Trade Policy and Economic Development: How We Learn’, American Economic Review, vol. 87, 1–22.

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LEVINE, R. and RENELT, D. (1992) ‘A Sensitivity Analysis of Cross-Country Growth Regression’, American Economic Review, September, vol. 82, no. 4, 942–63. MEADE, J.E. (1961) ‘Report to the Government of Mauritius: The Economic and Social Structure of Mauritius’, Port-Louis, Government of Mauritius. MEADE, J.E. (1967) ‘Population Explosion, the Standard of Living and Social Conflict’, Economic Journal, vol. 77, no. 306. RODRIGUEZ, F. and RODRIK, D. (1999) ‘Trade Policy and Economic Growth: A Sceptic’s Guide to the Cross-National Evidence’, NBER Working Paper 7081, Cambridge, MA: NBER. WORLD BANK (1985) ‘Mauritius: Adjustment and Growth, Country Economic Memorandum’, Report 5533–MAS, Eastern and Southern Africa Region, Washington, DC.

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5 International Trade and Trade Policy Chris Milner

5.1

INTRODUCTION

Mauritius is a small, remote developing country; not the normal characteristics that one associates with successful economic performances based on export growth. There is considerable interest outside of Mauritius in countries that would like to emulate this success of the role of policy, in particular trade policy, in its development. There is also considerable interest in Mauritius itself in how the success story and export growth can be sustained in the face of changing domestic conditions (rising wages and incomes, changing relative endowments of labour, physical capital and human capital) and of changing external conditions. There are new competitive challenges and opportunities associated with the entry of new exporting nations, and there are changing trade policies and rules in Mauritius’ existing and potential export markets. The aim of this chapter is therefore twofold. On the one hand it seeks to assess the role of trade and trade policy in Mauritian development over the last few decades. On the other it investigates whether and how the trade strategy and policies need to be revised or changed in the light of changing domestic and international conditions. In doing so, it is able to draw upon a surprisingly large, existing literature. Trade policy is one of the most systematically researched areas of policy in Mauritius. The remainder of the chapter is organised as follows. In Section 5.2 some basic principles of commercial policy are reviewed as a basis for the later analysis. Section 5.3 sets out an assessment in broad terms of the role of trade in Mauritian development. This is followed in Section 5.4 by a review and analysis of Mauritian experience of structural adjustment and unilateral trade liberalisation. We turn in Section 5.5 to a consideration of the external trade policy environment and in Section 5.6 to the current and emerging issues in the formulation of the country’s trade strategy. Finally, Section 5.7 provides some summary conclusions. 79

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5.2 SOME PRINCIPLES FROM THE THEORY OF COMMERCIAL POLICY Normative aspects of the theory of trade policy focus on three broad considerations; namely efficiency, equity and revenue considerations. Let us briefly consider each of these in turn. Efficiency Considerations The fundamental postulate of commercial policy, as derived from neo-classical or H-O-S trade theory, is that for a small economy free trade is superior (in static and aggregate terms) to restricted trade, under first best conditions. There is no doubt that Mauritius is a small economy and is unable to influence the international terms of trade. The optimal import tariff and export subsidy is zero from the standpoint of allocative efficiency. Positive import tariffs can be expected in the case of Mauritius, ceteris paribus, to draw resources towards import-substitute activities (areas of apparent comparative disadvantage) and away from activities of comparative advantage and with export potential. Similarly export taxes would tend, ceteris paribus, to deter, in relative terms, activities of comparative advantage.1 Of course free trade may not be superior to restricted trade if first best conditions do not hold. Distortions or market imperfections may be more pervasive in small, developing countries than in developed market economies. Indeed the infant industry argument for import protection is often justified on grounds of capital and labour market distortions.2 But the case for intervention in general and the case for tariff intervention need to be separated. The principles of optimal intervention (Corden, 1974) require a ‘hierarchy of policies’ for each and every argument for intervention. The bi-product distortions associated with tariff intervention mean that some form of subsidy is invariably superior to a tariff, provided that the subsidy can be financed in a manner that is less distortionary than direct trade interventions. Some of the principles or postulates of commercial policy have been challenged by the strategic trade policy literature that has emerged out of the new trade theories which incorporate imperfectly competitive conditions (see Stegmann, 1996). None of the inter-country, rentsnatching arguments are relevant however to a small country like Mauritius. Invariably tariffs also remain a second best measure of intervention when the distortion arises from the imperfection in the

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domestic market structure. Despite the initial, intense interest in these new models, the economic professions’ subsequent response has in general been that the policy implications of ‘strategic trade policy’ analysis are not sufficiently robust to serve as a basis for real world policies.3 Tariffs therefore induce allocative inefficiencies. They are more effective in restricting imports than subsidies if the aim of government (for example for foreign exchange control purposes) is to restrict imports. Indeed on grounds of certainty and restrictiveness in the face of growing demand, quantitative import restrictions are likely to be more effective in restraining imports than tariffs. Many developing countries have used non-tariff interventions for this reason. The corollary of this, of course, is that on grounds of allocative efficiency quantitative import restrictions are inferior to tariffs. Equity Considerations The Paretian tradition in welfare economics places a premium on allocative efficiency considerations in defining optimality. There are, however, alternative traditions (for example the Pigovian) and approaches (for example the incorporation of social welfare functions of the Bergsten-Samuelson type into a Paretian framework) which would also evaluate the effects of interventions on the distribution of income. We might wish to consider, therefore, whether theory offers any advice about how interventions in the tradable goods sector will improve or worsen the distribution of income. A fundamental theorem of the H-O-S trade model is that import protection redistributes income from an economy’s abundant factor to its scarce factor. By raising the price of importables (which use the economy’s scarce factor relatively intensively) relative to the price of exportables (which use intensively the relatively abundant factor) tariff and quota protection raises the reward to the scarce factor. This theorem, the Stolper-Samuelson theorem, if applied to the typical, relatively labour abundant developing country would imply that import restrictions tend to redistribute income overall from labour to capital, and as a result from the poor to the rich in general. To the extent that the import-substitute and exportable sectors are segmented, tariffs and similar trade interventions are likely to redistribute in particular to owners of capital in the import-substitute (IS) sector. To the extent that the IS sector is concentrated in urban areas or run by a specific class or social grouping, then there may also be inequitable geographical or social redistributions.

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There are other important potentially inequitable redistributions associated with import protection. By raising the (relative) price of importables in the typical consumption basket, particularly where there is a single primary export there is a tendency to redistribute income from consumers in general to producers in the protected sector. In the case of tariff interventions the redistribution from consumers is towards producers and to the government in the form of tariff revenue. The government revenue may, but only may, be spent in a way that offsets in part the inequitable redistribution associated with import protection. Where import protection is achieved by quantitative import restrictions, then the redistribution from the consumer may be in favour of importers’ incomes rather than government revenue. Where restrictive import quotas are administered through the allocation of import licences, then quota rents accrue to the recipients of these licences. Given regulated and uncompetitive conditions in the import/commerce sectors, the creation of quota rents is unlikely to result in equitable or desirable redistribution in terms of personal, geographical or social class income distribution. Revenue Considerations All governments have a variety of reasons for collecting taxes. The possibility of welfare-raising interventions where there are distortions has been identified above. Similarly governments need to finance the provision of public goods. But on efficiency grounds standard welfare economics requires that taxation should also be non-distortionary, that is it should be lump-sum taxation which does not affect the marginal conditions for optimality. For administrative and/or equity reasons, lump-sum taxation is likely to be ruled out as a comprehensive means of taxation.We are faced then, as economists, with the need to evaluate second best interventions. This is the subject matter of the ‘optimal taxation’ literature. It is concerned with the raising of tax revenue through means that minimise the net loss of utility; netting marginal losses from induced allocative inefficiencies against marginal gains from redistribution. In the small country case aggregate consumption and production efficiency requires that the marginal rates of substitution in consumption between any two goods be the same for all consumers, and equal to the marginal rate of transformation in trade, given by world prices. Obviously this implies that there should be zero tariffs on both intermediate and final goods. The recommendation that emerges from optimal taxation prin-

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ciples, therefore, is that the second best solution is to satisfy revenue needs through optimal commodity consumption taxation. For instance a (common) tax on sales to final consumers of both domestically produced and imported goods avoids domestic production distortions, and minimises consumption distortions if optimally set across different commodities. Whether uniform or non-uniform rates across commodities are optimal depends on the structure of consumers’ preferences and on the specification of the social welfare function. The implications of this for trade policy are, in principle at least, quite straightforward. If trade taxes are currently used, welfare gains can be achieved by collecting at least the same revenue via alternative means. In practice of course (and in developing countries in particular) there may be administrative and other constraints on the use of higher-order means of revenue collection. The generally high fiscal dependence of developing countries on trade taxes (see Greenaway and Milner, 1991a) suggests that efficiency and equity issues are secondary to administrative feasibility and collection cost considerations. Considerable sophistication in administrative infrastructure and technical skill is required to operate income taxes or widely based sales taxes. Even when the requisite structures are in place these taxes may have limited applicability. The existence of large ‘subsistence’ sectors may mean that defining income is difficult. Moreover it may also mean that a significant proportion of output is distributed through informal markets. These characteristics result in collection cost to non-trade tax yield ratios being relatively higher in developing than developed countries, and in higher trade tax dependence than is desirable on standard efficiency grounds. We need shortly to consider how Mauritius’ trade policy regime matched up to these principles, and how these principles have affected the evolution of policies over time. Before we do this, it will be helpful first to see briefly how the pattern of the trade and structure of the economy has changed in the post-independence period.

5.3 THE ROLE OF TRADE IN MAURITIAN DEVELOPMENT There were marked improvements in public health in Mauritius after World War Two that raised the rate of population growth during the 1950s and generated pessimistic predictions about over-population

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and economic prospects (Meade, 1961 and 1967). Given that Mauritius is a small, relatively remote island, poorly endowed with natural resources,4 then a monocrop (sugar) economy, heavily dependent therefore on imported food stuffs, raw materials and capital goods, the prospects for raising the standard of living seemed limited. Contrast this potentially Malthusian view of the future with the state of Mauritius three decades later. By 1990, Mauritius was rapidly rising up the list of middle-income developing countries with a per capita income of $2,250, sustained rapid economic growth and growth of manufactured exports such that dependence on sugar exports had declined from nearly 100% (in 1960) to only about 30% of total exports. As we will see, trade and trade policy have played an extremely important role in the transformation of the economy.5 For an economy like Mauritius, relatively poorly endowed in 1960 with land and capital, rapid population and labour force growth required that production should become more labour-intensive. Given the absolute scarcity of land and limited international market opportunities for sugar, the policy focus at this time was on the need to diversify economic activity and establish some manufacturing activities. Further comparative advantage in manufacture should initially at least be based on the relative abundance and therefore relative cheapness of labour. Meade (1961) recognised that Mauritius must emulate (in approach if not scale) an economy such as Hong Kong; importing raw materials to be transformed into manufactured exports. But Meade himself and no doubt many policymakers in Mauritius at this time doubted the adequacy and acceptability of the market-based or liberal solution. There would be resistance from workers and trade unions to the downward pressure on wages if excess labour supply pressures persisted (despite or until increasing exports eliminated excess labour supply). Therein lay the policy dilemma. Free trade and liberal labour market policies in the presence of rapid population growth would foster efficient resource allocation and appropriate technologies, but it may have pushed wages to socially undesirable levels. Protectionist trade policies and interventionist labour market policies with administrative wage-setting on equity grounds would induce production biases, encourage inappropriate technologies and risk high un- or under employment. As it turned out the scale of the predicted population growth problem did not materialise. Improved public education and family planning provision combined with rising per-capita income slowed

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down population growth. But the growth in per-capita income was not exogenous or independent of policy, and the rapid development of Mauritius and its emergence as an ‘Indian Ocean tiger’ appears to have been strongly influenced by the style of economic management and by trade policies. The policy dilemma or choice that existed in the 1960s was initially responded to by an interventionist style of economic management and by protectionist/import-substituting trade policies. As we will see later, however, there has been a progressive shift over time towards more market-led and outward or exportoriented policies which given the associated rapid growth in exports and output certainly appears to point to the appropriateness of the liberal solution. But the legitimacy of this interpretation requires that we examine also whether the sequencing and pace of liberalisation were important for economic or political economy reasons and whether other, in particular external, factors were influential in Mauritius’ success. We will delay final judgement on these issues at this stage, and will return to it later once we have examined the evolution of trade policy in more detail. There is, however, a much greater consensus now than there was in the 1960s as to the appropriateness of a policy of openness to trade and foreign investment for small and poor developing countries such as Mauritius. The benefits of relatively neutral or unbiased trade regimes in order to achieve allocative efficiency or avoid the costs of rent seeking have been well documented (e.g. Bhagwati, 1988) and widely disseminated by agencies such as the World Bank. The recent revival of interest in growth theories has also drawn attention to the role of trade policy in affecting a country’s access to knowledge and ideas. Romer (1993) for example emphasises the importance of openness to foreign investment (in particular from Hong Kong) and the corresponding acquisition of ideas and entrepreneurial knowhow by Mauritius about running garment factories and about export market requirements. Further, as Ghatak and Milner (1997) conclude on the basis of time-series modelling of output growth, factor accumulation and openness, the initial trigger to industrialisation appears to have also induced ‘externality’ benefits; human capital accumulation and improvements in productivity in non-garment sectors. In short, the importance of trade and open policies to Mauritius has now been demonstrated to policymakers and policy analysts, and it is easier to advocate this development strategy now than in the circumstances of the 1950s and 1960s.

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5.4

‘UNILATERAL’ TRADE POLICY REFORM

There are a number of distinctive features of Mauritian experience of structural adjustment and trade liberalisation. These are gradualism, the existence of export incentives for non-traditional exports prior to direct import liberalisation and the significant role of foreign direct investment and foreign entrepreneurial skills in the export sector. Mauritius experienced a period of sustained stabilisation and exchange-rate adjustment starting in 1979 which was followed by a period of substantial import liberalisation between 1983 and 1987. This corresponds with the Structural Adjustment Lending (SAL) agreements in 1979, 1981 and 1983. However, attempts to reduce the trade regime bias against exports predate this episode of policy reform. Mauritius had operated an Export Processing Zone (EPZ) scheme since 1970. The presence of approximate (nominal) free trade status and favourable fiscal incentives for export firms meant that Mauritius had attracted foreign investment and know-how, from Hong Kong in particular, and acquired some (non-negligible) nontraditional export capacity by the beginning of the SAL programmes. (EPZ exports – mainly knitted textiles – already accounted for 24% of total exports by 1979). Similarly one might also extend the period of adjustment forward; the completion of tariff reductions not coming until the 1990s. The prestructural-adjustment trade policy regime in Mauritius is summarised in Table 5.1. It was typified by mixed and variable measures of import substitution, export-promotion assistance for manufactured goods and non-traditional agriculture, and export taxation of the traditional export (sugar). Note, however, that the importsubstituting period pre-dated the introduction of compensatory export incentives. To that extent the government favoured at the outset the interventionist/protectionist solution to the dilemma identified by James Meade. Perhaps by both accident and design the introduction of direct import-substituting measures in the non-traditional, manufacturing sectors in the 1960s merely intensified the existing anti-export bias generated by the sugar export tax.6 Import-Substitution Measures The Development Certificate Scheme was initiated in 1963. It was designed to encourage the establishment of import-substitute manufacturing industries in Mauritius. Incentives to companies with

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Chris Milner Table 5.1

Pre-trade liberalisation pattern of assistance to Mauritian industries

Sector Manufacturing Import-substituting • Large new activities (e.g. foodstuffs), assembly of colour televisions • Other Export-oriented • wholly (e.g. knitwear) • partially (e.g. furniture) Agriculture • Sugar – large growers • Sugar – small growers • Rice •

87

Other agriculture

Subjective Ranking of Main Form of Assistance Protection Levels

Development certificates scheme, tariff and import quota protection Import licensing and tariff protection

Assisted at a very high rate

Export Enterprise certificate scheme Tax rebate based on export growth

Assisted but at low rate

Tax of 23.625% on gross export receipts – Subsidised exchange rate and subsidy payments on rice –

Disadvantaged at low rates Severely disadvantaged Approximately zero rates Severely disadvantaged Approximately zero

Source: Dabee and Milner (1999).

Development Certificates (DCs) included a tax holiday on corporate profits, exemption for a period from income tax on dividends, advanced factories, investment finance at preferential rates, investment allowances and import duty relief (or exemption) on machinery, raw materials and semi-finished products. Protection from foreign competition was given through tariff and quota restrictions on imports. By 1980 about 150 companies with Development Certificates were in operation, employing a total of about eight thousand people; and concentrated on the food and beverages and engineering sectors. Both DC and non-DC firms received additional assistance/protection through tariff and non-tariff restrictions on imports.

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The Mauritian tariff schedule included general customs duty and fiscal duty. The (unweighted) average nominal rate of visible (fiscal and customs) duties was 55% in 1980. In addition a number of supplementary duties had also been applied after the mid-1970s to all imports, including an import surcharge (10%) and stamp duty (12%). In addition to import duties levied for general protective and revenue purposes, specific quota protection of up to 80% of the domestic market was offered on a discretionary basis to companies with DC status. Import licensing was also used in a less specific manner to provide protection for all local production in the manufacturing sector and non-traditional agricultural activity. It should be noted also that there was significant escalation in scheduled tariffs which was exaggerated further by the presence of quantitative restrictions generally on imports of final goods and the pervasive use of import duty exemptions on imports of intermediate goods and raw materials for DC firms and other firms on a discretionary basis. These factors contributed to producing very high and variable (within and across industries) effective rates of protection for import substitute activities (see Table 5.2).7 Export Promotion Measures The Export Processing Zone Act (1970) was intended to encourage the development of export-based manufacturing and a processing industry in Mauritius through local and overseas investment.8 The incentives offered at this time to companies under the Act included a tax holiday on corporate profits (longer than that available for DC firms), exemption from income tax for distributed dividends (again for a longer period than for DC firms), advanced factories, investment and export finance at preferential rates, investment allowances, import duty exemption on machinery, components, raw materials and semifinished products and no restrictions on ownership or repatriation of profits. These fiscal incentives combined with low wage costs were important factors in the development of the EPZ. A policy of centralised wage setting by the government gave implicit assurance to foreign investors of moderate wage increases and control of industrial unrest. External trade relations were also important to potential investors, as Mauritius was not subject to the Multifibre Arrangement (MFA) quota limits in the US and EU and the Lomé preferential trade arrangements provided Mauritius with a tariff preference for its exports to the EU.

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Table 5.2 Average rates of effective protection in the Mauritian manufacturing sector, 1980 and 1990 (per cent) Sector

1980

1990

Beverages and tobacco Textile yarn/fabrics Wearing apparel Leather products Footwear Wood products Furniture Paper products Printing/publishing Chemical products Rubber products Plastic products Non-metallic products Iron/steel Fabricated metal products Machinery (excluding electrical) Electrical machinery, etc. Transport equipment Optical goods, watches, etc.

123 77 99 269 158 191 130 131 75 38 125 89 77 154 156 62 179 23 266

182 11 4 8 88 38 241 57 7 21 144 59 48 73 48 3 181 4 9

Sources: Greenaway and Milner (1989) for 1980 rates; Dabee and Milner (1999) for 1990 rates.

At the start of the reform period about 130 firms were operating with EPZ status, employing about 24,000 people, with the vast bulk of the production in spinning, knitting and made-up garments. Thus, although there was a strong bias in the policy regime in favour of import-substitution activities (for domestic investors in particular), the EPZ sector was significantly larger than the DC sector in employment terms. In production terms the picture is less clear, since manufacturing as a whole accounted for 14.9% of GDP (at current and policydistorted factor cost) in 1979, while the EPZ sector contributed only 3.4% of GDP (with sugar processing accounting for 3.9%). Trade Liberalisation and the Structural Adjustment Experience During the period 1979–83 the emphasis was on macroeconomic stabilisation and exchange rate adjustment. During this period trade

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policy (in particular import duties) was used in a more restrictive manner, with stamp duty on imports progressively increased and an import surcharge applied in 1983. Trade liberalisation did not start therefore until after 1983. The initial period between 1983 and 1985 was concerned mainly with some liberalisation of foreign exchange and import licensing restrictions, and with the reform of the border taxation of imports. This latter element was rather more focused on simplification of the duty structure than on reduction of average rates of duty. Indeed, import surcharges were increased further in 1984 and 1985 for fiscal reasons. A planned consolidation of some duties, the reduction of the spread of rates and reduced exceptions (e.g. on intermediate imports) were aimed at reducing the spread and level of effective protection in import-substitute sectors (though little progress was made on this). The main phase of import liberalisation and reduction of protection for local firms came in the period 1985–87 with the progressive dismantling of quantitative import restrictions. (See also Dabee and Milner (1999) for a more detailed description of the timing, sequencing and extent of this trade liberalisation.) The post-reform estimates of effective protection (1990) are reported in Table 5.2. Average rates in some non-export industries remain absolutely high, with rates in excess of 100% in the case of beverages and tobacco, furniture, rubber products and electrical machinery. But, in general, significant declines in rates of effective protection relative to 1980 levels are identified. In five industries the fall is at least 100% points (wearing apparel, leather products, wood products, fabricated metal products and optical goods/watches), and there are six further industries where the fall is in excess of 50% points. Indeed the estimated rate of protection is higher in 1990 than 1980 in only four cases. Some of these reported changes in effective protection are also due to a shift in sales from the protected home market to exports. But this is consistent with the idea that there had been a genuine change in relative incentives, i.e. genuine liberalisation. (See also Milner and McKay (1996) on the measurement and dating of trade liberalisation in Mauritius.) The Effects and Sustainability of Reform The stabilisation episode of the early 1980s is captured by the importto-GDP ratio that fell from 0.57 in 1980 to 0.42 in 1983. After 1983 the ratio increased continuously until 1988, rising particularly quickly during the quantitative restriction (QR) liberalisation period between

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1986 and 1988. This growth may be accounted for in greater measure by the export-induced growth of intermediate and capital goods imports between 1982 and 1988. Note that the share of final consumer goods in total imports fell from 30.3% to 15.5% over this period. The share of exports (in particular manufactured/EPZ exports) in GDP also grew rapidly after 1983: from 0.44 to 0.61 in 1987. The expansion of exports may have been assisted (in part at least) by other external and non policy factors, and the resulting easing of the foreign exchange constraint facilitated the expansion of imports. Unfortunately we do not have a very satisfactory means of identifying the relevant counterfactual. A plausible interpretation of events, however is that trade liberalisation significantly altered relative incentives and this in turn was a major factor in the improvement in export performance. But why was trade liberalisation viewed as credible and therefore sustained in Mauritius? First, government kept economic agents informed about the reform process. For example, the rising level of foreign exchange reserves was frequently a news item in the media. Government was keen to advertise commitment to the reforms and demonstrate its performance in economic management. More important, however, government moved cautiously towards greater trade liberalisation. For example, even though a stand-by agreement and a SAL agreement were signed in 1979 and 1981 respectively, it was only over the period 1983–85 that reform of the trade regime was initiated. The World Bank was expecting a reform of the tariff structure to follow the removal of QRs. However, government argued that any further liberalisation would be unsustainable as the balance of payments and budget deficits would worsen. With the end of the structural adjustment programme in 1986, government had more leeway in negotiation with the World Bank, with the result that reform of the tariff structure was postponed for a few years. It was only in July 1994 that a major revision of the tariff structure was introduced. This gradual/cautious approach to reform helped to ensure that the reform was sustained, since it helped to maintain the credibility of the reforms. Impact of Trade Policy Reform It is shown above how the liberalisation episode in Mauritius was accompanied by a sharp growth in exports, in particular of manufactured exports from the EPZ sector. It would not be surprising to find

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that there were associated changes in the growth and structure of the economy. The stabilisation period of the reforms was identified earlier to be 1979–83. This was preceded by a period of deteriorating macroeconomic conditions. The growth rate fell steadily from 1977 up to 1980 (when negative growth and rising unemployment was experienced). With some success with stabilisation and also a recovery of sugar prices, there was a return to positive growth in 1981 and 1982. But it is not until after 1983 that there is sustained and accelerating growth in output and employment, with the period of QR liberalisation (1985–87) experiencing particularly high growth. It is also after 1983 that we can identify a significant increase in the share of manufacturing and EPZ activity in GDP; the share of both increasing in each year up to 1987. The declining share of construction in GDP up to 1987 suggests that increasing factor utilisation was the major source of growth up to this point. It is not surprising therefore that dramatic changes in output, trade and employment followed trade liberalisation. Agriculture’s share of employment remained fairly stable during the stabilisation period 1979–83, but fell steadily thereafter. Similarly manufacturing employment’s share remained relatively stable up to 1983, but rose sharply after this point. The growth in manufacturing employment closely coincides therefore with the start of the trade liberalisation period in 1983, with total manufacturing employment growing by over 25% between 1983 and 1984. Milner and Reed (1997) and Milner and Wright (1998) provide a more detailed analysis of the labour market effects of liberalisation. There are, however, two distinctive features of the growth in employment after 1983 that merit particular attention. One is the dominant role of one industry, namely clothing and textiles. Employment in this sector grew from about 20,000 in 1983 to over 80,000 in 1988. (Employment in other manufacturing activities rose from about 15,000 to just over 20,000 over the same period.) The second distinctive feature is the disproportionate growth in female employment in clothing and textiles in this period. The post-1983 experience of Mauritius is consistent therefore with trade liberalisation increasing the demand for labour (particularly female labour) in labour-intensive manufacturing (exportables) activity. Although there is some redistribution of labour from agriculture during the 1980s, and recorded unemployment fell to virtually full employment conditions by the late 1980s, the period also witnessed a large growth in the labour force associated with increased female participation.

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Declining unemployment and increasingly inflationary conditions in the first half of the 1970s resulted in sharply rising wages in most manufacturing sectors (especially non-EPZ) up to about 1978. During the stabilisation period (1979–83), the upward movement in real wages was sharply reversed. The post-stabilisation period is typified however by generally rising wages. In line with the predictions of trade theory the opening of trade increased the demand for and return to labour in Mauritius.

5.5

EXTERNAL TRADE POLICY RELATIONS

Mauritian trade performance and strategy has and continues to be fashioned by global and regional trade policy developments. In the case of some of these Mauritius has taken a very limited role in fashioning, e.g. the Uruguay Round of multilateral negotiations. Others have required a more active external commercial policy stance, e.g. membership of the Indian Ocean Commission and the regional PTA and negotiations under Lomé for preferential access to the EU market. Let us examine some of these ‘external’ trade policy issues in turn. The Uruguay Round, WTO and Mauritius The Uruguay Round multilateral trade negotiations were conducted under the auspices of GATT between 1986–94. They were complex and wide ranging, covering general market access, specific sectors, the GATT system and new issues. Market access agreements were secured on both tariff and non-tariff barriers. The central component in the former was a reduction in the average nominal tariffs of industrial countries of 38%. Deeper cuts were effected in higher tariffs, resulting in some further harmonisation of rates. In addition, tariffs were eliminated on trade in some eleven sectors. With respect to nontariff barriers (NTBs), commitments were made to proscribe the use of voluntary export restraints and similar NTBs. For the first time an agreement to liberalise industrial countries trade in temperate zone agricultural products was secured. This involves reductions in export subsidies, reductions in domestic support measures and tariffication of non-tariff barriers. A crucial outcome for Mauritius was the deliberations on textile and clothing and the commitment to phase out the Multifibre Arrangement

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(MFA); with trade in textiles and clothing being completely free of quota restrictions by 2005. Several negotiating groups focused on tightening the disciplines on the global trading system and arrangements for instance on subsidies have been revised; certain types of subsidy being proscribed in the latter case. Two vital systemic reforms were also the initiation of a Trade Policy Review Mechanism and the creation of the World Trade Organisation. The former confers on GATT an explicit audit function, thereby bringing greater transparency to individual country’s trade measures. The latter offers the opportunity for a more credible and secure agency at the heart of international commerce. Three new issues covered by the Uruguay Round were trade related investment measures (TRIMs), trade related intellectual property (TRIPs) and services. Agreements were reached on all three. As a result of the TRIMs agreement measures such as local content and trade balancing requirements were outlawed. For TRIPs, the general principles of national treatment and non-discrimination have been affirmed and a timetable set for all Contracting Parties to have in place appropriate mechanisms for protection of intellectual property. Finally, the General Agreement on Trade in Services (GATS) took an important first step in bringing disciplines to trade in services. As well as basic obligations of national treatment and non-discrimination being affirmed, a schedule is established for progressive liberalisation. Among the areas in the Uruguay Round agreement key from the standpoint of Mauritius are textiles and clothing, agriculture and services.9 Given the importance of the garment sector for both employment and exports, reform of the MFA is clearly central to Mauritius. On the one hand expansion of global trade in textiles and clothing will obviously benefit Mauritius. On the other, as trade is liberalised, the benefits from preferential access to the EU market will be eroded and the competitive threat from lower wage producers will become sharper. The net impact of the agricultural reforms is similarly complicated. Guaranteed prices of sugar exports may well fall as protection for European sugar producers falls, but the world price may rise. Tariff liberalisation will offer opportunities for increased exports of new agricultural exports. Indeed a general increase in world prices of agricultural products provided producers will have opportunities to diversify into non-sugar areas, while consumers may lose from higher food prices.

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At this point in time it is extremely difficult to evaluate the implications of the GATS. Mauritius does have a growing services sector and ambitions to develop as an offshore financial services centre. Mauritius will gain where it imports cheaper services, and can expand its exports if countries, in the region in particular, liberalise their markets. It is clear from this brief review of the Uruguay Round that Mauritius, as a small, very open economy, has very strong interest in the outcome and implementation of the agreements.There will be new competitive challenges arising from textile and agricultural liberalisation. There will also be new opportunities in these same areas. But the new opportunities associated with generally freer and greater international trade provide opportunities for diversification in non-textile manufacturing and non-sugar agriculture, and for reduced dependence of services exports on tourism. To this extent Mauritius should welcome a more disciplined, rules-based system of global trading; one that gives easier and more assured access to the markets of larger countries. Industrial Country and Regional Preferences Although Mauritius has substantially (albeit also cautiously and gradually) liberalised its own trade policies, it has had thus far an interest in preferential rather than multilateral liberalisation in industrial countries. Indeed some commentators (e.g. Stevens and Weston, 1984) and no doubt some Mauritian policymakers would place an emphasis on the existence of EU tariff preferences for Mauritian textile exports (combined with the absence MFA-quota constraints) as a major factor in the development of the EPZ sector. No doubt this preference, combined with EPZ incentives, played an important role in attracting and retaining foreign investment. But Mauritius was not the only country ‘endowed’ with access to the Lomé provisions and not the only one of ACP countries with comparable incentives. It should not also be overlooked that the EPZ success story post- rather than pre-dates structural adjustment and (unilateral) trade liberalisation in Mauritius. The simple reality is in any case that industrial country’s preferences will inevitably in the longer term become a minor factor in Mauritian export growth and diversification. There may be some temporary growth in the margin of preference in textiles and clothing and some agricultural and fishing products as higher tariffs are substituted for NTBs. But further tariff reduction will erode

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this, and in many manufacturing sectors there will soon be no scope for further erosion once tariffs are eliminated. Changing market access in the industrialised markets and regional development (including growth of the South African economy) may mean that greater consideration is given to the market opportunities within the region. Certainly regional economic growth and diversification can be expected to bring about greater opportunities for intraregional trade. But it is important to appreciate the relative sizes of the regional and global markets; the latter dwarfs the former. The process of regional economic integration has been slow thus far and is likely to remain so.10 There is not likely to be the same political and economic support nor underlying economic strength for regional integration as in the EU for example. All of the experience of regional and preferential trading schemes among developing countries points to major natural and policy-induced constraints on deepening integration and integration-induced growth. The complementarity of economic structures and reluctance to lower regional trade barriers have hampered all such arrangements. Improved access to the regional market that relies on preferences may be helpful in the shorter term, but greater competitiveness in the global market provides a more secure basis for both improved global and regional trade performance. 5.6

CURRENT AND FUTURE POLICY ISSUES

It is clear from the preceding discussion that international trade and trade policies remains high on the policy agenda in Mauritius. There are a number of obvious policy choices and issues that Mauritius currently faces or will face over the next decade. These relate to: •

• • •

•

the need to diversify exports both in terms of market destination and composition in both the agriculture and manufacturing sectors; the need to increase the integration of the EPZ and non-EPZ manufacturing sectors; the need to reduce the level of fiscal dependence on trade taxes; the need to shift from labour-intensive to more capital, especially human capital intensive, activities, including the development of the services sector; the need to comply with the new disciplines of the WTO and prepare for the post-Uruguay Round trade agenda.

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Export Performance and Diversification The prospect of falling guaranteed prices for Mauritius’ sugar exports has already prompted attempts at raising productivity in the sugar sector and at diversifying into other high-value crops, fruits and flowers. This will no doubt continue, though the smallness of the island is a major constraint on this being a significant source of growth and diversification in aggregate terms. As has already been witnessed, there are likely to be greater opportunities for export expansion in manufacturing. Over the last two decades, Mauritius has achieved considerable success in exporting manufactured products. It has built up a base of export-related skills, information and institutions. It has reduced dependence on foreign firms in the EPZ such that the majority of exports now come from domestically owned companies. Although wages have risen, exporters have managed to upgrade product quality, and some now have their own design and marketing capabilities. Heavy dependence on a few products and on the EU market increases vulnerability, however, to external conditions. Indeed Mauritius is very vulnerable, since over 80% of its manufactured exports come from one product group – clothing. This degree of dependence is higher than other garment-dependent exporters (such as Sri Lanka and Bangladesh) and has not declined over time. Compared to South Asian garment exporters, Mauritius is specialised in a different and generally higher quality, product range. However, this may not ensure continued export growth. The activity is open to easy new entry because of low capital and skill requirements, and is more ‘footloose’ than many other similar activities. One of the main reasons for locating in Mauritius, to circumvent MFA quotas and exploit EU market preferences, is set to disappear. A large and diverse textile industry may also be a source of competitive advantage for the garment industry in the large exporters such as China, Indonesia and India. These countries also have relatively large amounts of labour and low wages. The main competitive threat to the smaller garment exporters is obvious. Clearly the industry has to make a significant jump in quality and design capability to maintain an edge over such competitors. Mauritius’s export and industrial experience give it an opportunity to take the lead in the region in export activities. The East Asian NIEs, with similar initial bases of exporting have expanded their technology bases and product ranges. But this is likely to require changes in many

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supply-side policies affecting competitiveness11 and further changes in the incentive regime, including further changes in trade policies and institutions. Incentive Regime and EPZ Integration The trade policy reforms of the early 1980s have significantly lowered average levels of protection. These levels of protection are low compared with many developing countries but they are considerably higher than in industrialised countries and higher than in some of the newly industrialising countries in South East Asia. Protection rates in domestic markets for many industrial activities are still high and considerably in excess of the relative incentive to produce for the export market. The policy regime therefore continues either to act as an important source of anti-export bias or to protect activities of comparative disadvantage without export potential. High levels of protection also act as a deterrent to increased industrial linkages; export firms need to use competitive inputs (competitive that is in terms of price and quality). This is a deterrent to backward linkages. The mixture of continuing domestic protection and specialised EPZ/export oriented activities deters the integration of the EPZ into the rest of the economy and acts as a barrier to export diversification. Lowering of these barriers requires that protection of the local market be reduced; this will provide an incentive either for existing activities to seek export markets (and thereby encourage export diversification) or provide pressures for resources to be released to those activities with export potential. Given liberalisation of quantitative import restrictions and the use of a more flexible exchange rate policy in the 1980s, reform of tariff policy is the major instrument available for further lowering anti-export bias in the trade regime. This focus on the opportunity cost attached to import-substitution is particularly relevant in a fairly fully employed economy. Export promotion requires that relative incentives favour export activities over other activities, or at least do not disfavour export activities relative to import-substitute activities. In trying to provide incentives for all types of agricultural, industrial and service activities, the impact of incentives in Mauritius tend to be neutralised. The scope for giving greater nominal incentives to exports or export activities will be increasingly constrained by the UR Agreement on export subsidies and by the policing of the system by the WTO. In which case lowering the effective subsidisation of import-substitute activities via the

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tariff system will be the most efficient and effective means of strengthening the incentive to export. Trade Tax Reform and Fiscal Dependence A major constraint on the further liberalisation of imports called for above, besides the inevitable political resistance that would come from currently protected activities, is the current high fiscal dependence on trade taxes. Export duties on sugar are now a relatively small element in tax revenue (4.2% in 1992/3). Import duties are, however, the single largest source of tax revenue (over 45% in 1992/3), accounting for about 40% of central government’s total (tax and non-tax) revenue. Reform of import taxation requires considerable care if major fiscal depletion is to be avoided, and will require complementary reforms of non-trade taxes. A reform programme that lowers the incentive to import-substitute through import tax reform, without inducing substantial, direct fiscal depletion, can be designed. Effective rates of protection for import-substitute activities could be lowered in the shorter term by raising the operative import duties on imported intermediate inputs. This could be achieved by reducing tariff escalation in the customs schedule.12 Given that the demand for intermediate inputs is likely to be relatively inelastic raising tariffs on them should be revenue enhancing. Of course in the longer term the rates of duty on final, competing imports would need to be lowered if effective rates of protection in the domestic market are to be further lowered. This will not necessarily be revenue reducing. Indeed where duties are set for protective reasons then lowering tariffs is likely to increase imports sufficiently to result in fiscal-enhancement. But this cannot continue forever as tariffs progressively decline. Nonetheless a programme of first raising intermediate input duties, followed by the lowering of protective (final) duties, followed then by the progressive lowering of both final and intermediate duties could avoid fiscal-loss in the short-to-medium term, while creating an incentive to shift from fiscal dependence on trade taxes to dependence on non-trade taxes. This will require the reform and extension of domestic (indirect) taxes on goods and services, though it is to be anticipated that further growth of incomes will also increase the revenue-role of direct taxes on incomes and profits. Lowering of tariffs may, but only may, have adverse, short run

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effects on the balance of payments. Though it should be noted that these proposals include some raising of tariffs (on intermediates) in the short run. In any case in the longer term the balance of trade will be driven by macro- and other influences on the balance of (private and public) savings and investment. Prudent macroeconomic policies are vital therefore to the long run management of the balance of trade, while trade taxes are not as efficient as the exchange rate in dealing with short term problems. Development of Services Tourism already makes a significant contribution to foreign exchange earnings, but there is also scope for the further expansion of the services sector based on regional markets. There are genuine opportunities for the Mauritius Freeport, for example, to serve as a regional warehousing and distribution centre for exports to Eastern and Southern Africa. There are similar regional opportunities for banking and financial services linked to or independent of these trading activities. But in these types of activities it is non-price (e.g. quality of service, reliability, etc) as much as price factors that affect competitiveness. One major role of government in this regard is the maintenance of political and financial stability and confidence. Mauritius has had considerable success in the last two decades in creating such a favourable external image. But in the longer-term the development of higher value-added services that can sustain a relatively high wage economy must experience substantial human capital and technological development. Clearly, there are many institutions and a whole range of expenditure and policy measures that may require review to foster such development (see Lall and Wignaraja, 1997). It is in these areas (investments in skills and technology), rather than production of tradable goods, that externalities and potential market failures arise. Governments require therefore to be active in such areas, without hampering market-based development. WTO Membership and the Post-UR Agenda Membership of the WTO will automatically entail Mauritius accepting the disciplines and the implementation of the Uruguay Round agreements. The WTO will also have greater responsibility for implementing, monitoring and policing. It will continue as a forum for

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multilateral trade negotiations but it will also have to administer the strengthened disputes settlement procedures and the trade policy review mechanism (TPRM). Under TPRM, the trade policies and practices of all Contracting Parties are to be subject to periodic review; in the case of Mauritius this should be every six years. The objective is to improve adherence to GATT rules, disciplines and commitments, by increasing transparency and understanding. The assessment is carried out against the background of the development policies, objectives and conditions of the country under review. The reviews already undertaken (e.g. WTO, 1996) have been conducted on the basis of two reports; one presented by the Contracting Party under review and the other drawn up by the WTO Secretariat on its own responsibility. They constitute major documents, with detailed information on the development of the economy, the trade policy and foreign exchange regimes and trade policies and practices on an instrument-by-instrument and sector-bysector basis. The Government of Mauritius is now required to supply such information and be able to respond to the assessment made by this external agency. The information requirements and policy monitoring capacity of Governments in countries like Mauritius will need to expand as the UR agreements are phased in and the responsibility of the WTO extends to a wider range of services and areas such as intellectual property. Indeed the signs from the post UR discussions is that the coverage of areas of WTO jurisdiction will grow as the distinction between trade, industrial, competition, labour and environmental policies becomes more blurred.13 The technical capacity required of trade policymakers, trade promotion agencies and exporters relating to the international trading system and rules and the demand for international trade economists in Mauritius looks set to grow.

5.7

CONCLUSIONS

The theory of international trade and trade policy indicates that a small country like Mauritius should pursue open, outward-oriented trade policies; the optimal, first best, trade taxes are zero on allocative, equity and revenue-raising grounds. Faced with constraints on the use of other taxes and with rapid population growth, Mauritius did

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not set out at the start of the industrialisation process with a liberal trade policy regime. It feared the consequences for incomes of specialising in labour-intensive exports; given world prices for its exports combined with growth in the labour force holding or driving down real wages. As a result it started out on the industrialisation path with a relatively interventionist and inward-oriented or importsubstituting trade strategy. In the event population growth eased and the constraints of the small domestic market on industrial growth were recognised. The need to attract foreign investment and expand non-traditional exports was recognised with the creation of an EPZ. Although this redressed the anti-export bias in the trade regime somewhat, these mixed import-substituting and export-promoting measures must be viewed as part of an interventionist rather than market-oriented approach to policy formulation. Fiscal incentives, relatively cheap labour and the special market access opportunities for Mauritian exports to the EU were major factors in the initial development of clothing and textiles exports following the inward investment from Hong Kong. It was not the vibrancy or competitiveness of the economy as a whole that brought about the start of the export-led growth process. Although relatively stable politically, Mauritius was still at this stage a relatively regulated economy. The gradual shift from an interventionist to a market-led form of industrialisation came after the Structural Adjustment Lending programmes of the early 1980s. Perhaps some of the externatities or learning-by-doing benefits of early industrialisation and exporting were being reaped with a lag, but the immediacy and sustained nature of the export and growth response to trade and wider policy liberalisation after 1983 suggests there is a distinct and substantial trade policy effect to be allowed for in the case of Mauritius. As we have seen however the trade liberalisation was only partial and gradual, and this may have wider relevance for the design of reform programmes if they are to be credible and sustained. It also means that there is still further scope for moving towards a first best trade policy; one that reduces anti-export bias and trade tax dependence further and provides an incentive therefore to reduce the separation between EPZ and non-EPZ production. Faced with new competitive challenges in international markets and reduced advantages from preferential access to the industrial markets, Mauritius as a whole needs to be a zone that exports a wider range of manufactured goods and services.

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Notes 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

The Lerner symmetry theorem (Lerner, 1936) first formally identified the symmetry of an import and export tax in terms of relative price effects. Arguments for intervention in a developing country context are reviewed more extensively in Greenaway and Milner (1987). For a review of some of the empirical evidence on trade policy and imperfect competition see Milner (1996). Mineral resources or land space required for primary and secondary forms of economic activity. Of course, its location and climate is an endowment as far as activities such as tourism are concerned. See also Greenaway and Milner (1991b) for a more detailed assessment of the reasons for the failure of the Malthusian prognosis of economic prospects for Mauritius. Other than protectionist motives may have been important here since import taxes provided also further government revenue. See Greenaway and Milner (1993) for an explanation of the difference between nominal and effective measures of protection. In the case of Mauritius EPZ refers to a status or eligibility for incentives rather than a specific geographical location. For a fuller assessment of each and their implications for Mauritius and its trade policies, see Greenaway and Milner (1996). The Preferential Trade Area for Eastern and Southern African states came into force in 1982. For more detailed discussion of the type of measures and developments required to foster competitiveness see Lall and Wignaraja (1997). For details of the import tax regime (and of other trade policy measures) see WTO (1996). See Milner (1997) for a discussion of the nature and significance of this widening of the commercial policy agenda to a range of standards or ‘fair’ trade issues.

References BHAGWATI, J. (1988) ‘Export-Promoting Trade Strategy: Issues and Evidence’, World Bank Research Observer, 3, 22–58. CORDEN, W.M. (1974) Trade Policy and Economic Welfare. Oxford, Clarendon Press. DABEE, R. and MILNER, C.R. (1999) ‘Evaluating Trade Liberalisation in Mauritius’, in A. Oyejide et al. (eds), Trade Liberalisation and Regional Integration in Sub-Saharan Africa, vol. 2 (London, Macmillan). GHATAK, S. and MILNER, C.R. (1997) ‘The Role of Trade Policy and Growth Models: the Case of Mauritius’, mimeo. GREENAWAY, D. and MILNER, C.R. (1987) ‘Trade Theory and Less Developed Countries’, in N. Gemmell (ed.), Surveys in Development Economics (Oxford, Blackwell).

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GREENAWAY, D. and MILNER, C.R. (1989) ‘Nominal and Effective Tariffs in a Small Industrialising Economy: the Case of Mauritius’, Applied Economics, 21, 995–1009. GREENAWAY, D. and MILNER, C.R. (1991a) ‘Fiscal Dependence on Trade Taxes and Trade Policy Reform’, Journal of Development Studies, 27, 95–132. GREENAWAY, D. and MILNER, C.R. (1991b) ‘Did Mauritius Really Provide a Case Study in Malthusian Economics?’, Journal of International Development, 3, 325–38. GREENAWAY, D. and MILNER, C.R. (1993) Trade and Industrial Policy in Developing Countries (London, Macmillan). GREENAWAY, D. and MILNER, C.R. (1996) ‘The Uruguay Round: Its Impact and Implications for Mauritius’, Report to the Commonwealth Secretariat (Commonwealth Secretariat). LALL, S. and WIGNARAJA, G. (1997) ‘Mauritius: Dynamic Export Competitiveness’, report for Ministry of Finance, Government of Mauritius (Commonwealth Secretariat). LERNER, A. (1936) ‘The Symmetry Between Import and Export Taxes’, Economica, 3, 306–13. MEADE, J.E. (1961) ‘Mauritius: a Case Study in Malthusian Economics’, Economic Journal, 71, 521–34. MEADE, J.E. (1967) ‘Population Explosion, the Standard of Living and Social Conflict’, Economic Journal, 77, 233–55. MILNER, C.R. (1996) ‘Analysis of Welfare Effects of Commercial Policy’, in D. Greenaway (ed.), Current Issues in International Trade (London, Macmillan). MILNER, C.R. (1997) ‘New Standard Issues and the WTO’, Australian Economic Review, 30, 90–7. MILNER, C.R. and MCKAY, A. (1996) ‘Real Exchange Rate Measures of Trade Liberalisation: Some Evidence for Mauritius’, Journal of African Economies, 5, 61–91. MILNER, C.R. and REED, G. (1997) ‘Trade Liberalisation in Mauritius: Efficiency Gains and Labour Market Effects’, in L. Petterson (ed.), PostApartheid Southern Africa: Economic Challenges and Policies for the Future (London, Routledge). MILNER, C.R. and WRIGHT, P.W. (1998) ‘Modelling Labour Market Adjustment to Trade Liberalisation in an Industrialising Economy, Economic Journal, 108, 509–28. ROMER, P.M. (1993) ‘Two Strategies for Economic Development: Using Ideas and Producing Ideas’, Proceedings of the World Bank Annual Conference on Development Economics (Washington, World Bank). STEGMANN, K. (1996) ‘Strategic Trade Policy’, in D. Greenaway (ed.), Current Issues in International Trade (London, Macmillan). STEVENS, C. and WESTON, A. (1984) ‘Trade Diversification: Has Lomé Helped?’, in C. Stevens (ed.), EEC and the Third World: A Survey (London, Hodder and Stoughton). WTO (1996) Trade Policy Review: Mauritius 1995 (World Trade Organisation).

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6 The Export Processing Zone1 Ramesh Durbarry

6.1

INTRODUCTION

The economy of Mauritius has passed through several distinct phases and, in the process, has successfully diversified from a monocrop culture highly dependent on the export of sugar into manufactured exports and tourism. Its development path has been shaped by its location and resource endowments and many factors have contributed to its success. They include strong demand for the output of the two fast growing sectors – the export processing zone (EPZ) and the tourist industry – and the continuation of the sugar quota arrangement with the European Union (EU). Furthermore, Mauritius offers a favourable business environment, with strong incentives provided by the government for the growth sectors, and prudent demand management. Mauritius has maintained an average real growth rate of 5.8 per cent over the period 1970–97. Its GDP per head, in current prices, has risen remarkably from US$270 in 1970 to US$3,640 in 1997. The availability of labour, the dynamism and pragmatism of the Mauritian entrepreneurs and generally favourable external conditions have added to its success. This chapter assesses the economic impact of the EPZ, which is said to be the ‘engine’ of growth over the last decades. The country is known to have switched from the ‘sugar era’ to a ‘textile era’. The first phase of industrialisation has been successful and the country is consolidating and diversifying its base to enter into the second phase of industrialisation. The chapter is organised as follows: the following section outlines the concept of the EPZ, section 6.3 depicts the development and structure of the EPZ and how the sector has fared. Section 6.4 assesses the macroeconomic contribution of the EPZ on the economy. The penultimate section outlines some of the strengths and weaknesses of the EPZ and section 6.5 considers future prospects and concludes. 105

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106 6.2

The Export Processing Zone THE CONCEPT OF THE EXPORT PROCESSING ZONE

Explosive population growth, particularly in LDCs after World War Two, has contributed substantially to unemployment. LDC governments have come to realise the problems of focusing almost exclusively on import substitution, which has been highly capital intensive, providing little employment opportunities. It has been reckoned that manufacturing expansion would offer a solution. What one writer refers to as an increasingly conventional wisdom involves the growth of labour-intensive export oriented industries as a possible panacea for labour-surplus developing countries (Ranis, 1972). Exportoriented policies require that firms compete with, or are part of, other international producers. Governments must liberalise many aspects of their economy, such as the tariff and quota regimes and availability of foreign currency, in order to give exports a competitive advantage. Some of the countries which adopted export-oriented policies early on have experienced very rapid economic growth and have been labelled Newly Industrialising Countries (NICs). South Korea, Taiwan, Hong Kong, and Singapore are good examples of NICs. In the late 1960s many less developed countries (LDCs) began to create EPZs as a means of launching their export-oriented industrialisation. Lacking sufficient domestic capital, entrepreneurship, managerial skills and the capacity to build an industrial infrastructure nation-wide, many LDC governments chose to establish the EPZ enclave. The concept of the EPZ emanates from Ireland, a pioneer in the field, which established the Shannon Export Free Zone in 1959 because of the decline in the use of Shannon airport. The government declared the airport area as a free zone and actively sought to attract manufacturers. The reasoning behind this rather innovative approach was that the firms would help to replace the jobs lost as a result of the airport’s decline. This would provide new employment opportunities and through the export by air of industrial products with a high value added would give a new lease of life both to the airport and the national airline. Subsequent events proved the validity of this approach. In 1960, its first year of operation, the Shannon free trade zone saw the creation of 440 new industrial jobs, and by 1975 was employing over 3,800 people.As for the airport itself, the total number of employees rose from 1,250 in 1960 to 2,200 in 1975. Ireland’s initial success with this innovative structure encouraged many LDCs to create EPZs, and their number grew rapidly. Ireland’s

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experience was buttressed with a fundamental change in the theory of economic development. Considering the success of the Shannon experiment, which was beyond expectations, UNIDO and other international agencies undertook a series of studies, which tended to support the setting up of EPZs as an important tool in the industrialisation process. By 1986, there were 145 EPZs established in 47 developing countries and some additional 110 zones were planned or under construction. Matthew (1992) states that ‘EPZs are either geographically defined, economically extra-territorial areas or they are functional statuses in which enterprises produce almost exclusively for export. Special fiscal incentives, publicly subsidised infrastructure provisions, duty-free imports of inputs, and unlimited repatriation of profits are usual features offered to attract foreign (and when possible domestic) entrepreneurs to operate in the industrial enclave.’ The main objectives of EPZs, identified by UNCTAD (1983), are: (a) (b) (c) (d) (e)

generating foreign exchange earnings, creating employment, attracting foreign capital and advanced technology, acquiring and upgrading labour and management skills, and creating linkages between EPZ industries and the domestic economy.

The concept of the EPZ seemed very attractive and Mauritius was eager to embark on such a scheme after the import substitution programme failed, with unemployment rising. The following section depicts how the Mauritian EPZ was initiated and how it fared.

6.3 THE DEVELOPMENT AND STRUCTURE OF MANUFACTURING In the famous publication widely known as the Meade Report (Meade et al., 1961), attention was drawn to the dangers that unchecked population growth then posed to Mauritius. The report made it clear that the sugar industry would not be able to generate additional jobs and it reckoned that the sugar industry would provide ‘any substantial volume of increased employment for only a strictly limited, if appreciable, labour force. It is, therefore, to the institution and expansion of

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manufactures that one must turn to seek productive employment for substantial numbers’ (p. 25). At that time, industrial expansion had many problems. In addition to a small domestic market, the country was poor in raw materials, financial institutions were limited and Mauritian businessmen had little or no experience of manufacturing industries. The authors pointed out that some countries such as the United Kingdom, Japan, Jamaica, and Hong Kong had flourishing manufactures based on the import of raw materials which were transformed into manufactures for the domestic market or for export. They also depicted cases in which countries with very limited domestic markets ultimately enjoyed economies of large-scale production by producing for the export market. But instead of planning to embark on an export oriented strategy, the government reacted by introducing, in 1963, a series of incentives and concessions under the Development Certificates (DC) Scheme to encourage import-substitution industries. By the late 1960s, around 70 new industrial enterprises oriented almost entirely to the local market had gone into production. Almost all were locally privately owned, although they relied to a varying extent on foreign technology and know-how. The products manufactured were very diverse – for example, beer, margarine, pickles, soap, paint, edible oil, cosmetic and rolled steel. By the late 1960s, as Bheenick and Schapiro (1989) stated, the opportunities for import substitution began to dry up due to the size of the domestic market and the high rate of effective protection which prevented local firms from competing on the export market. Although this development had the advantage of initiating some industrial activity of a new type (away from agriculture), it became clear that the levels of employment and economic growth that could be generated by an import-substitution strategy in a small economy were limited and insufficient. Per capita income had stagnated during the 1960s and the establishment of DC industries had led to the creation of no more than 1,200 jobs between 1964 and 1968. After achieving independence in March 1968, the new Mauritian government was faced with major challenges. It was then decided to take into account Meade’s proposal about export-led strategy. The Establishment of the Export Processing Zone Before the creation of the EPZ, the government sent a team to study the operation of free zones in countries such as Hong Kong, Jamaica,

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Puerto Rico, Singapore and Taiwan, where manufacturing was export oriented. Based on the team’s report, the government announced its intention in July 1970 to create the Mauritian EPZ. The idea was to attract foreign investors and encourage joint enterprises with local investors by offering a series of incentive packages such as tax holidays, free repatriation of profits, tariff exemptions on imports of equipment, machinery and raw materials, among others (a summary of the incentives provided is listed in Appendix 6A). At that time, it was estimated that about 20 per cent of the labour force was more or less wholly unemployed and that, in the face of the rapidly expanding labour force, even the prevailing modest levels of income (about US$200 per capita) could only be maintained by selling on the world market goods that could be produced more cheaply in Mauritius than elsewhere. The new orientation of the government was therefore to encourage the manufacture or assembly for export of those products in which labour costs were a significant proportion of the value added. Its main concern was to provide jobs for the many (skilled) unemployed in the hope that the establishment of labourintensive activities would reduce unemployment level. Female workers dominate employment in the EPZ (Figure 6.1). The major reason for this is that female workers are paid lower wages than male workers. Keeping wage rates low in the export sector was also necessary for the government to attract foreign investors. The overall picture that emerges since the creation of the EPZ is a success story that has attracted the attention of many countries, institutions and researchers. To get a sense of how the EPZ has fared over the past two decades in particular, it is useful to divide the ups and downs into some phases. The phases described are in relation to the level of employment in the EPZ sector, which was the very motive of its creation. Figure 6.1 illustrates the number of distinct movements during the period 1970–99. Phase I: The EPZ Take-off, 1970–77 After the EPZ legislation was passed, investment, employment, and export expanded considerably. The local business community invested also, benefiting greatly from the sugar boom (a record sugar crop of 718,000 tons in 1973 and a remarkable surge in sugar prices from 1970 to 1974 of over twentyfold). The balance of payments situation improved considerably from a surplus of Rs94 million in 1970 to Rs365 million in 1974.This helped the EPZ enterprises to benefit from

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The Export Processing Zone

110 100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000

98

96

94

19

19

92

19

90

19

88

Male

19

86

19

84

EPZ (Total)

19

82

19

80

19

19

78

76

19

74

19

72

19

19

19

70

0

Female

Figure 6.1 Employment in the EPZ, 1970–99

the availability of foreign exchange for the importation of raw materials, machinery, and equipment. The result was an impressive number of new units added each year until 1977 when there was a total of 86 firms employing 17,474 workers (see Figure 6.2). During this initial phase it was observed that a perhaps unexpected feature was the predominantly high female labour force participation rate, around 80 per cent (see Figure 6.1). Phase II: EPZ Stagnation, 1978–82 This phase was marked by a deceleration in EPZ expansion. The momentum created in the earlier phase was lost. In general the number of units operating continued to increase but at a much slower pace. During this period, nearly one-third of existing firms shut down; with the highest number of closures in one year being 15 in 1978. The EPZ had borne the brunt of the recession in the industrialised countries (which were the main importers of EPZ products) and of their increasingly protectionist policies. Furthermore, on the domestic front, the expansionary fiscal policy the government pursued in the wake of the boom conditions of the mid-1970s raised wages faster than productivity, leading to higher unit labour costs and pricing some

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700 600 500 400 300 200 100

Total No. of Firms

Figure 6.2

New

97

95

19

93

19

91

19

19

89 19

87 19

85 19

83 19

81

79

19

77

19

75

19

73

19

19

19

71

0

Closures

Evolution of EPZ firms, 1971–98

EPZ products out of world markets. The manufacturing sector was adversely affected by work stoppages and slowdown by workers in the port and transport industries, which resulted in a sudden rise in real labour costs and reduced competitiveness of EPZ products. The volume of investment declined (from Rs62 million in 1979 to Rs38 million in 1982), the growth rate of exports and employment decelerated. A rising real exchange rate and large wage hikes tended to reduce considerably Mauritius’ international competitiveness. Also, with the approach of the general election in 1982, the political climate deteriorated and potential investors were reluctant to invest in the EPZ. In response to the economic and financial crisis which the government faced in the late 1970s, a series of stabilisation and structural adjustment policies were undertaken under the auspices of the International Monetary Fund and the World Bank. The programme was based primarily on export-orientated manufacturing to create the preconditions for export-led growth, on the consolidation of the sugar industry and expansion of the tourist industry. Trade and exchange rate regimes were liberalised gradually, credit expansion was restricted, and institutions were reformed so as to lay a solid foundation upon which the country would subsequently be able to build. The EPZ was ready to enter a new phase.

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Phase III: The EPZ Crusade, 1983–88 With a newly elected government, the year 1983 marked a turning point in the political and economic structure of the economy. A new set of institutions and incentives were put in place to maintain the viability and inherent attractiveness of the EPZ (see Appendix 6B for the list of revised incentives). The ‘textile era’ was yet to start. Unemployment was at its peak level, around 22 per cent.An international campaign was launched to attract foreign investors from Europe and Southeast Asia. In 1984, the Mauritius Export Development and Investment Authority (MEDIA) was established as a corporate body with executive and advisory functions. MEDIA’s principal objectives were (i) to promote the export of goods and services from Mauritius, (ii) to engage in investment promotion activities designed to promote Mauritius as an attractive base for the establishment of manufacturing industries and services with special emphasis on those that are export oriented, (iii) to develop and operate industrial sites and estates, and (iv) to plan, implement, and review programmes to develop export and investment in export oriented manufacturing. The availability of cheap, literate and skilled labour, fiscal and financial incentives and infrastructural facilities all led to a massive flow of foreign direct investment (FDI). In fact, FDI increasing substantially from Rs19 million in 1983 to Rs68 million in 1984 and it maintained an upward trend until 1989 (see Table 6.1). Phase IV: EPZ Consolidation, 1989–91 In the fourth phase, 1989–91, the growth of firms was severely constrained. In fact, the highest number of closures was recorded in 1989, 107 of operating firms, thereby causing a substantial decrease in the total number of firms for the first time. This was due to the wage compensation awarded at end 1988 in the public and private sectors. Pressure for higher wages was also building up in the EPZ sector, leading to swelling costs, hence reducing competitiveness. Employment fell from 89,080 in 1988 to 88,650 in 1989. One of the characteristics of the EPZ is its heavy concentration on textile activities (as shown in Table 6.2). In fact initially textile activities accounted for around 90 per cent of EPZ employment and 75 per cent of the firms were in this category. Recognising the danger of being dependent on textile (and garment), the authorities intensified the programme of diversification and consolidation in the 1990s. Progress in this area has been noted,

Source: CSO.

114.2

9.9 90.9 2.3 0.5 0.3 2.0 8.3

France Hong Kong UK Germany Taiwan Singapore Other

Total

1985

Countries

Table 6.1

73.4

4.3 23.9 3.1 3.5 1.4 – 37.2

1986

189.3

7.6 10.3 6.5 0.5 12.6 0.4 151.4

1987

235.00

13.2 120.0 12.4 1.8 1.8 1.0 85.8

1988

298.5

31.9 19.4 28.7 49.7 13.3 5.3 150.2

1989

270.3

58.0 54.6 7.2 3.8 62.7 – 84.0

1990

129.8

17.5 11.2 24.0 – – – 77.1

1991

203.2

22.6 29.0 11.2 1.3 0.5 14.0 124.6

1992

91.9

9.9 37.7 – 0.4 – – 43.9

1993

Foreign direct investment in the EPZ by main countries of origin, 1985–94 (Rs million)

60.2

2.1 3.7 2.7 10.0 – 5.6 36.1

1994

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113

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The Export Processing Zone

114 Table 6.2

Number of firms and employment in the textile* and non-textile sectors Number of Firms

Employment

Year

Textile

Non-textile

Textile

Non-textile

1982 1987 1990 1995 1998 1999

65 387 371 275 272 282

53 144 197 206 214 226

20,421 80,716 80,498 70,141 77,921 80,118

3,055 7,189 9,408 10,466 9,981 10,334

* ‘Textile’ includes textile yarn and fabrics and wearing apparel. Note: Figures for 1998 and 1999 are for September. 1999 figures are provisional. Sources: Ministry of Industry and Industrial Technology; and CSO.

the number of non-textile firms has since then increased as has the employment level in this sector (see Table 6.2). The main products in the diversification programme include leather goods, footwear, jewellery and related articles, flowers, watches and clocks, optical goods. Results for the 1990s indicate a recovery in EPZ performance, including a strengthening of the textile sector and progress in diversification. Phase V: EPZ Slowdown and Reorientation, 1992–99 Initially in this phase EPZ showed some signs of slowing down but with some reorientation EPZ is back again on course. As Figure 6.1 depicts, in 1992 the employment level fell, as has the number of firms. The number of EPZ establishments fell from 558 units to 481 in 1995 and rose to 508 in 1999. Consequently, employment in the EPZ after reaching a peak of 91,000 in December 1991 dropped to 80,466 in 1992 but has recently shown an improvement, with the number of employed in the sector rising to 90,452. There are a couple of reasons explaining these recent changes. First, there was general election in 1991 and some firms and potential investors were reluctant to invest until some stability was perceived. Second, due to rising nominal

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wages labour unit cost has risen considerably. Third, closely related to the second, firms have started to relocate their units in neighbouring countries such as Madagascar and Mozambique where labour is cheaper. Also, foreign direct investment in the EPZ sector has declined substantially during this period. Foreign investors have started to delocalise their activities to other low cost producing countries. All these slowed the performance in the EPZ sector in the first half of the 1990s. But with a change in government in 1995 after the general election where the Labour Party came to power, investors from the East were given incentives to invest in a range of products other than textile such as electronics and computer software. Also by that time, the Mauritian Stock Exchange had become well established and the proper functioning of the offshore banking facilities no doubt created a sound business environment. With the inflation rate remaining at single digit during the period 1995–99, real wages were constant. Although there has been some slight increase in unit labour cost (by 3.7 per cent for the period 1997 to 1998), labour productivity rose by 5 per cent for the same period, explaining the increase in the level of employment and the number of firms.

6.4 THE MACROECONOMIC EFFECTS OF THE MAURITIAN EPZ Mauritius has been hailed an economic miracle by many observers. Its growth rate has been remarkable over the last decade thanks to some key sectors. The Mauritian experience with export-led industrialisation has been widely acclaimed. The EPZ can be said to be the engine of growth and it has made a great impact on the country’s economic position. In this section we assess the impact of the EPZ on employment and look at its contribution to GDP, exports and foreign exchange earnings. Employment Effects Figure 6.3 shows the trend in employment for some key sectors in the economy during the period 1973–98. There is no doubt that since the establishment of the EPZ, employment in agriculture (dominated by the sugar industry, once the main employer) has fallen both in

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The Export Processing Zone

116 100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000

97 19

95 19

93

91

19

89

EPZ

19

87

19

85

Agriculture

19

19

83 19

81 19

79 19

77

75

19

19

19

73

0

Tourism

Figure 6.3 Employment in agriculture, tourism and the EPZ, 1973–98

absolute and relative terms. Around 18 per cent of the labour force are employed in the EPZ. Although female workers dominate labour employment in this sector, the proportion of male workers has been rising. Many factors account for this change. First, as the economy is reaching full employment (in 1991 the unemployment rate was 2.7 per cent), demand for more workers has been rising. Second, with increasing pressures on wage rates (especially in the 1990s), employees were more keen to employ male workers. Overall, the average daily earnings in the EPZ have trebled in the space of ten years (from Rs52 in 1989 to Rs151 in 1999). Table 6.3 shows the average daily earnings during the period 1989–99 in EPZ and non-EPZ activities. The EPZ sector has not only created employment opportunities but also over time has attracted labour from the agricultural sector. As from 1985 it has become the main sector in terms of employment, absorbing a significant portion of the labour force. The withdrawal of labour from agriculture has had some important consequences. First, it has led to an increase in the nominal wage rate in the sugar sector due to a shortage of labour. As a result the sugar industry has been forced to resort to mechanisation. Second, prices of agricultural products have also risen due to increased costs of production.

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Ramesh Durbarry Table 6.3

117

Average daily earnings in EPZ by industrial group, 1989–99 (Rs) 1989

1996

1997

1998

1999

EPZ

52

125

137

146

151

Of which: Textile Wearing Apparel Wood and Furniture Jewellery and related articles Other

55 49 58 96 56

165 119 148 186 140

176 134 162 150 163

194 143 223 137 145

191 149 223 133 133

Non-EPZ

72

108

89

98

119

Source: CSO.

Contribution to GDP The rapid growth of the Mauritian economy has been the result of a number of interacting economic, political and social factors, though the relative importance of each cannot be easily quantified. It is widely accepted that the EPZ has contributed enormously to the rapid growth. Until the rapid growth of manufactured export during the 1980s, sugar was the main sector contributing significantly to the GDP and was the main source of income and export earnings. In fact in 1976 sugar accounted 23 per cent of total GDP and 73 per cent of exports earnings, but since the 1980s the contribution of sugar to GDP has relatively fallen as depicted in Figure 6.4. On the other hand, the EPZ, which accounted for only 2.6 per cent of GDP in 1976, had its share increasing to about 13 per cent in 1990 and it remained around this figure in 1998. This shows the relative importance of the EPZ sector in the Mauritian economy. The value added of the EPZ sector has not stopped increasing since its establishment and it is worth noting that it was only after 1987 that its value added was higher than that of sugar – the mainstay of the economy for more than one and a half centuries. Within the EPZ sector, if it is segmented into different groups such as textile yarn and fabrics, wearing apparel, jewellery, watches, clocks and optical goods, the sector which contributes most to the total value added of the manufacturing sector is the wearing apparel sector. The value added generated by that sector was Rs191.8 millions in 1980 (59.7 per cent

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118 1980 Sugar 8% Other Agriculture 4%

Other 5% Government Services 13%

EPZ 4% Other Manufacturing 12%

Financing, Insurance and Business Services 18%

Electricity, Gas and Water 3%

Transport and Communication 11% Hotels and Restaurants 2%

Construction 8% Wholesale and Retail Trade 12%

1998 Other Agriculture 3% Government and others 13% Financial, Real Estate and Business Services 16%

Transport and Communication 12% Restaurants and Hotels 5%

Sugar 6% Manufacturing 11%

EPZ 13% Electricity, Gas and Water 2% Construction 6% Wholesale and Retail trade 13%

Figure 6.4 Sectoral distribution of GDP 1980 and 1998

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of total EPZ value added). Its contribution kept increasing in the following years to reach a peak level of 79.6 per cent of EPZ value added in 1987. Since then its contribution has declined and stabilised at around 60 per cent. The next most important sector is textile yarn and fabrics. In fact, in the early 1980s this sector’s value added was around 20 per cent of total EPZ value added, but due to the expansion of other sectors such as watches, clocks, optical goods, and jewellery, its share dropped to around 10 per cent in the 1990s. These sectors, especially watches, clocks and optical goods, have registered a good performance over the past few years. Exports Exports have become an important element in the industrialisation of developing countries due to the failure of production for the domestic market through import substitution. Mauritius is no exception. Traditionally sugar was the only main export item, accounting for 90 per cent of exports. With the development of the EPZ, the manufacturing sector now accounts for the bulk of exports, surpassing even the sugar sector which once dominated exports (see Table 6.4). Exports of textile and wearing apparel are essentially directed to the EU and the US markets, as illustrated in Table 6.5. The EU has been the privileged market since the creation of the EPZ in 1970. The ACP-EEC agreements signed in 1975 guaranteeing free access of Mauritian exports to the European markets have greatly helped towards the growth of the EPZ. At the same time, Mauritius was shielded by the Multifibre Agreement (MFA) against Asian countries, where the costs of production were also low. Hence the EPZ did not

Table 6.4

Sugar exports and EPZ exports, 1980–97 (Rs million)

Total Exports Sugar EPZ EPZ Imports Net EPZ Exports Source: CSO.

1980

1990

1995

1996

1997

3,491 2,272 894 658 236

18,086 5,219 11,474 7,348 4,126

27,326 6,326 18,267 10,856 7,411

32,349 8,347 21,001 12,077 8,893

33,402 7,294 23,049 13,880 9,169

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120 Table 6.5

Direction of EPZ exports, 1980–97 (Rs million) 1980

1990

1994

1995

1996

1997

European Union France Germany United Kingdom Italy Others

758 220 121 222 – 195

8,714 3,780 1,456 1,914 670 894

11,028 4,652 1,342 2,541 908 1,585

12,663 5,208 1,445 3,412 1,015 1,583

15,113 5,762 1,607 4,234 1,141 2,369

16,303 5,670 1,631 5,344 1,153 2,505

Non-European Union USA Hong Kong Switzerland Others

137 102 1 1 33

2,760 2,024 52 139 545

5,505 4,198 165 261 881

5,604 3,860 152 322 1,270

5,888 3,787 160 344 1,597

6,746 4,353 98 355 1,940

Total

895

11,474

16,533

18,267

21,001

23,049

Source: CSO.

Table 6.6

Textile Non-textile

EPZ exports of textile and non-textile products, 1982–97 (Rs million)

1982

1990

1991

1992

1993

1994

1995

1996

1997

966 269

9,540 10,441 10,945 13,393 13,578 14,815 17,634 19,451 1,902 2,022 2,136 2,528 2,955 3,450 3,367 3,598

Source: Bank of Mauritius and CSO.

have to undergo intense competition. On the other hand, the penetration into the US markets through the Generalised System of Preferences reduced the reliance on the EU market. The degree of concentration in textile and wearing apparel is quite significant also in terms of exports (Table 6.6). In fact, together they account for around 80 per cent of EPZ exports. Knitted pullovers, Tshirts and men’s woven shirts and trousers are the leading export items. Mauritius is ranked third among exporters of fabric made of woollen apparel in the world. The Mauritian government is aware of such dependence on the textile products and significant improvements in the non-textile sectors have already been envisaged.

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Ramesh Durbarry Table 6.7

EPZ Sugar

121

Net foreign exchange earnings of EPZ and sugar sectors, 1975–97 (Rs million)

1975

1983

1988

1989

1990

1995

1996

1997

6 1,258

461 2,194

2,285 3,646

1,555 4,010

4,053 4,175

7,411 6,326

8,892 8,347

9,152 7,294

Source: CSO.

The rapid development of the EPZ, especially since the 1980s, operating on imported raw materials and having a low local value added (which was as low as 20 per cent in the initial stage and around 35 per cent in the mid-1980s), generated a large volume of imports and exports. The share of this sector in international trade, which was negligible in 1970, had reached 50 per cent in 1990s. In other words, the direct impact of the development of the EPZ has been doubling the volume of trade of the country. In 1997, total EPZ exports and imports as a proportion of GDP stood at around 50 per cent, which is quite significant and impressive for a small island economy. Foreign Exchange Earnings Increasing foreign exchange is one of the primary goals of countries establishing EPZs. When we assess the performance of Mauritius, it offers a mixed picture. Although EPZ exports account for around 60–75 per cent of total exports, net EPZ exports to EPZ exports hardly ever reached over 30 per cent in the period 1970–89. This is because the EPZ sector is heavily concentrated in textiles where the import content is quite significant. As mentioned earlier, the diversification programme set in the 1990s shows some progress. It is observed that it is only in the 1990s that net EPZ exports to export figures were above 40 per cent. Comparing net foreign exchange earnings of the EPZ sector with the sugar sector (Table 6.7) a positive picture emerges. In the beginning net foreign exchange earnings in the EPZ was quite low (only Rs6 million compared to Rs1,258 million from the sugar sector in 1975) but with time progress has been made.The sugar sector, which was once the only sector bringing foreign exchange, has now been overtaken by the EPZ. There is no doubt that the EPZ sector has helped to alleviate the trading account of the economy (see Yin et al., 1992).

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6.5 STRENGTHS AND WEAKNESSES OF THE MAURITIAN EPZ Strengths The Mauritian EPZ has completed three decades of existence and without doubt has marked the buoyant economic activities of the economy. There was a blend of exogenous and endogenous factors that marked the ‘textile era’. Among the exogenous factors, in the early 1980s, were the over-valuation of the US dollar and its subsequent depreciation. This was combined with falling oil prices and lower debt servicing, which considerably eased off the foreign exchange problem. With the recovery on the international scene, demand in both European and American markets expanded sharply after 1984. Following the stabilisation programme of the early 1980s, the devaluation of the Mauritian rupee helped Mauritian exports to become more competitive. During the same period the appreciation of the Taiwanese dollar led to some Taiwanese firms being less competitive and at the same time encouraged prospective Taiwanese investors to turn to Mauritius as a base of operation. Another factor that played in favour of Mauritius was political uncertainty in some potential competitor countries. For instance, the political situation in Hong Kong attracted many businessmen to Mauritius in search of a safe haven for their capital and manufacturing operations. These entrepreneurs not only brought capital, but also know-how and a marketing network with them. A series of endogenous factors have strengthened the dynamism in the EPZ, such as sound government policies and judicious economic management. The stabilisation and structural adjustment programmes pursued in the late 1970s and early 1980s improved the competitiveness of the EPZ. The creation of MEDIA had a major impact in attracting foreign investors and providing assistance in promoting, planning and implementing programmes to develop exports and investment. MEDIA’s emphasis on diversifying the market and on the product mix has also been successful and efforts in this area are still being pursued. Another factor is the favourable business climate with a good combination of a stable government. Many EPZ firms have perceived that their success was due to low corporate tax, cheap and adaptable labour, satisfactory labour productivity, and free repatriation of divi-

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dends. The generous fiscal and monetary incentives through various schemes are also one of the endogenous factors. Weaknesses The success of the Mauritian economy stems from a formidable combination of factors working together to produce impressive results, as outlined above, but it must be recognised that the EPZ, as the engine of growth, is not without its limitations. For instance, the economy is vulnerable to exogenous shocks. Its reliance on foreign sources of supply of raw materials and on a few markets for the end products is an issue pre-occupying both the public and private sectors. The overwhelming dependence on textile and wearing apparel sector is source of concern, although efforts are being made to diversify production. The success of Mauritius is fraught with the danger of just transforming an economy based on one product to an economy based on two products. Although the quality of the administrative support service has been enhanced, there is still substantial room for improvement and modernisation. The need to further cut down on red tape, bureaucratic excesses and reduction in the overall complexity of government procedures deserves attention. Since 1987 a new problem has been emerging: skill shortages. This is an unusual phenomenon for a country traditionally used to grapple with the problem of surplus labour. The shortages of machine maintenance technicians, middle management and production managers are particularly acute. Difficulties of skill shortages were complicated within a year with those of a shortage of unskilled labour. One consequence is an increasing upward pressure on wage rates without corresponding increase in productivity. The tightening of the labour market has serious implications in terms of education, manpower training investment and social behaviour within the industrial sector. The nature and extent of linkages between industrial activities in the EPZ and those outside the EPZ are another key issue affecting the ultimate success of the EPZ. Matthew (1992) argues that linkages with the domestic economy are poor. Linkages with the domestic economy are limited and constrained. While forward linkages face impediments, backward linkages have not been fully exploited. High prices and scarcity of local inputs are probably responsible. The absence of such linkages makes the EPZ appear like a separate entity.

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This, of course, is not a welcome development. The EPZ must be integrated into the domestic economic structure.

6.6

FUTURE PROSPECTS AND CONCLUSION

It is clear that Mauritius depends heavily on the EU and US markets and is mainly concentrated in textile and wearing apparel. The diversification programmes undertaken have produced some positive results and are certainly moving in the right direction. New market avenues are being exploited and we need to be patient so as obtain any conclusive result. The existence of EPZ over the last three decades has provided lessons for Mauritian authorities, making them aware of the benefits and dangers in industrialising. This strategy provides an example to countries intending to consolidate or set up EPZs. In the light of Mauritius’ success, it might be tempting to conclude that the EPZ concept offers a straightforward policy instrument for diversification, export growth, and development. However, the case of Mauritius is an exceptional one where many factors have been playing major roles. It has been observed that most of the LDCs establishing EPZs have suffered from political uncertainties and civil unrest and complicated and poorly designed investment laws. Others have inefficient zone management, delays in processing and clearing imports and exports, poor location, inadequate infrastructure, unreliable transport services, lack of indigenous subcontracting capacity, overvalued exchange rates, expensive labour and productivity difficulties. Thus, in making decisions, policymakers should consider the major elements that were important in the success of Mauritius: the internal conditions, the external conditions, the package of incentives and the nature of the governments. In retrospect, the EPZ has made very good use of Mauritian resources in terms of its contribution to GDP, exports, foreign exchange generation, employment, and the spur provided to industrial initiative and activity in the economy. The EPZ has, since its creation in 1970, strongly marked the socio-economic structure of the country. In fact, it has performed in three decades what the sugar did in one and a half centuries. As the economy is almost at full employment, firms have already felt labour shortages. This is now resulting in an upward pressure on wages. With little improvement in labour productivity, labourintensive firms are likely to face lower returns. With increases in wage

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bills, it is an opportunity to adopt new labour-saving technologies. Up to now very little has been done to stimulate resources to move from labour-intensive and low-skill-intensive activities to high technology, skill-intensive vanguard industries. Labour-intensive industries could be exported to neighbouring countries like Madagascar. Mauritius will benefit from this policy through dividends, interest and profits repatriated. The picture that one gets since the establishment of the EPZ is that it has changed not only the country’s economic but social development. It is reckoned that Mauritius’ geographical location will continue to hinder attempts to reach export destinations on time. Delays and high costs associated with distance and infrequent shipping services have seriously handicapped the expansion of exports. Improvements in the port infrastructure have substantially curtailed vessel waiting times, but the textile and wearing apparel industries are still exposed to shipping problems, resulting from tight schedules between the receipt of orders and the requested time of delivery. Shipment by air is an ideal solution, but its costs can easily put Mauritian exporters at a disadvantage compared with low-cost producers. Hence, the distance factor puts Mauritius at an unfair disadvantage vis-à-vis its competitors. The intensive penetration and dependence of EPZ products on the EU and the US markets constitute a serious threat as global trade liberalisation increases. The philosophy of the World Trade Organisation is to cater for expansion and liberalisation of international trade and placing it on a secure basis, thereby contributing to the economic growth, development and welfare of the world’s population. It acts both as a code of rules and as a forum in which countries can discuss solutions to their trade problems and negotiate the reduction of various trade restrictions and distortions. Hence, the expiration of the preferential treatment enjoyed under the Lomé Convention will represent a direct threat because actually Mauritius is protected against other competitors who have to pay an import duty of a little over 10 per cent on goods entering the EU. The phasing out of the MFA by 2005 is also a major threat for Mauritius. The MFA has, since 1982, been a blessing in disguise. Mauritius owes the success of its industrial development largely to the conclusion of the third MFA session that further restricted the import into developed markets of textile products from developing countries. This motivated the Asian tigers, especially Hong Kong, to seek refuge in countries enjoying unrestricted and preferential access to the

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developed markets. Hence the influx of Hong Kong and Taiwanese investors in Mauritius. Furthermore, the MFA helped curtail competition on textile products in favour of Mauritius as quantitative restrictions on its direct competitors namely, India, Pakistan, Sri Lanka, Bangladesh, gave Mauritius sufficient field for manoeuvre vis-à-vis potential buyers. The MFA is being phased out in stages. At every stage, Mauritius will be faced with an increasing trade deficit if the same level of productivity, quality of products and costs of production are maintained. On top of that, competition from other textile exporting countries, especially India, Pakistan, Sri Lanka, Vietnam and the Republic of China, where the cost of production is generally low mainly due to cheap labour, will almost be impossible unless appropriate measures are initiated to remedy the situation. The future will also depend on how the government deals with two key challenges. On the domestic front, inflation needs to be further slowed down and wage-setting policies liberalised (e.g. wage adjustments linked to productivity growth, including measures to promote the movement of labour from lower to higher productivity sectors). On the international scene, Mauritius needs to be prepared to face cutthroat competition. The authorities will have to continuously refine the package of EPZ incentives as they have recently done with tax harmonisation. Additional measures are required for vocational training, the opening of the domestic market, diversification into new industries and integration of the EPZ with the economy. Progress in these areas will help to transform the EPZ’s labour-intensive, low technology production base to a more capital-intensive, high technology, skill-intensive one and to maintain the status of Mauritius as globally competitive.

APPENDIX 6A The following incentives, advantages and facilities were offered in the beginning to EPZ enterprises: 1.

Complete exemption from payment of import duty on capital goods (i.e., machinery, equipment, and spare parts). 2. Complete exemption from payment of import and excise duty on raw materials, components, and semi-finished goods (except spirits, tobacco, and petroleum products). 3. Corporate income tax holiday for a minimum of 10 years and a maximum of 20 years depending on the merits of each case. 4. Exemption from the payment of income tax on dividends for five years.

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Free repatriation of capital and remittance abroad of profits and dividends to companies with an approved status. Electric power at preferential rates. Loans at preferential rates (from commercial banks) for the importation of raw materials. Provision of reinforced factory buildings for use by industrialists. Loans up to 50 per cent of total building cost for a ten-year period. Favourable labour legislation to help export industries meet their export objectives. Export finance at preferential rates of interest from commercial banks. Exemption from the payment of crane and other harbour handling dues chargeable by the government on imported content of export products. Exemption from payment of registration fees on land and buildings purchased by new industrial enterprises. Leases at preferential rates of land in the vicinity of certain housing estates. The issue of permanent residence permits to promoters and shareholders as warranted by the size of their interest. Completion within 24 hours of customs inspection of incoming or outgoing commodities. Priority, wherever possible, in the allocation of investment capital by the Development Bank of Mauritius. The services of the Government Foreign Trade Unit made available to facilitate access to foreign markets and provide market information to exporters. Government contribution to the cost of approved trade missions, trade fairs and collective advertising. Direct negotiation by the government with shipping lines and airlines for favourable terms of freight. Exemption from income tax on profits earned from foreign investments in Mauritius if these are not transferred but re-invested in Mauritius. Immediate issue of import licenses for machinery and semi-finished materials and of export licenses for the finished products. Guarantee against nationalisation. Equitable settlement of disputes assured by the government’s adherence to the Convention on the Settlement of Disputes administered under the auspices of the International Bank for Reconstruction and Development.

Source: Government of Mauritius (1973).

APPENDIX 6B Summary of Revised Incentives for Export Industries in the MEPZ in 1983* 1. Income Tax Relief (i) Industries operating in EPZ automatically enjoy a 100 per cent corporate tax exemption during the first ten years. From the eleventh to the

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The Export Processing Zone fifteenth year, a 50 per cent exemption is available and from the sixteenth to the twentieth a 25 per cent exemption. Within the first ten-year period dividends are wholly exempted from income tax for a period of five consecutive years, beginning from the first dividend year.

2. Other Incentives (i) Capital goods, raw materials, components and semi-finished products used by export industries are admitted into Mauritius free of customs and other duties. (ii) Profits re-invested in new manufacturing enterprises in Mauritius, instead of being transferred abroad, enjoy partial exemption from income tax. (iii) Foreign technicians are granted a global exemption on an initial sum of Rs15,000 on their salaries, inclusive of fringe benefits, plus a further relief of 30 per cent on the balance. 3. Other Facilities (i) Guarantee against nationalisation. (ii) Profits and dividends may be freely repatriated. Likewise for capital actually invested, excluding capital appreciation that is subjected to the normal rate of stamp duty. (iii) Shares are freely transferable. (iv) Priority, wherever possible, in the allocation of investment capital by the Development Bank of Mauritius. (v) Loans are available from commercial banks at preferential rates. (vi) Export bills are discounted by commercial banks at preferential rates. (vii) Protection against double taxation, for instance, where tax laws prevent investors from benefiting from tax incentives in host countries, the government is prepared to conclude agreements with ‘tax sparing’ provisions. (viii) Export firms benefit from freight rebates from major shipping companies plying between Mauritius and Europe. (ix) The government provides valuable assistance for participation in trade missions and trade fairs so as to facilitate the marketing of the products to be exported. * This summary appears in A Guide for Foreign Investors (Joint Committee for the Promotion of Industry, 1983).

Note 1.

Much of the material from this chapter is drawn from my MSc dissertation, ‘The Economic Impact of the Export Processing Zone in Mauritius’, 1994, University of Nottingham.

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References BANK OF MAURITIUS, Annual Report, various issues, Mauritius. BHEENICK, R. and SCHAPIRO, M.O. (1989) ‘Mauritius: A Case Study of the Export Processing Zone’, in Successful Development in Africa: Case Studies of Projects and Policies, EDI Development Case Studies Series, Analytical case studies No. 1 (Washington, DC, World Bank). CENTRAL STATISTICAL OFFICE, Annual Digests of Statistics, various issues, Mauritius. CENTRAL STATISTICAL OFFICE, Bi-Annual Survey of Employment and Earnings, various issues, Mauritius. CENTRAL STATISTICAL OFFICE (1990) Digest of Demographic Statistics, Mauritius. CENTRAL STATISTICAL OFFICE, Economic Indicators, various issues, Mauritius. CENTRAL STATISTICAL OFFICE (1973–98) Digest of Industrial Statistics, Mauritius. DURBARRY, R. (1994) ‘The Economic Impact of the Export Processing Zone in Mauritius’. MSc Dissertation, University of Nottingham. GOVERNMENT OF MAURITIUS (1973) Mauritius – Export Processing Zones, Ministry of Commerce and Industry, Port-Louis. MATTHEW, W.R. (1992) Export Processing Zones in Jamaica and Mauritius: Evolution of an Export-Oriented Development Model (Washington, DC, World Bank). MEADE, J.E. et al. (1961) The Economic and Social Structure of Mauritius (London: Methuen). RANIS, G. (1972) The Gap Between Rich and Poor Nations (London: Macmillan). UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT (UNCTAD) (1983) Export Processing Zones in Developing Countries. Implications for Trade and Industrialisation Policies (TD/B/C.2/211, Geneva, UNCTAD). WORLD BANK (1989) Mauritius: Managing Success (Washington, DC, World Bank). WORLD BANK (1992) Mauritius: Expanding Horizons (Washington, DC, World Bank). YIN, P., YEUNG, D.H., KOWLESSUR, D. and CHUNG, M. (1992) L’île Maurice et sa Zone Franche, la Deuxième Phase de Développement (Mauritius: 5-PLUS/T- Printers).

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7 Tax Policy Oliver Morrissey

7.1

INTRODUCTION

Accepting a need for government, and hence for some level of public expenditure, the requirement to raise revenue follows. Essentially, a government has three sources of domestic revenue: taxation, non-tax revenues (such as charges, licence fees) and domestic borrowing. These are supplemented by two basic sources of external financing, aid grants and borrowing (some of which may be at concessional rates). It is a general feature of development that for countries with very low levels of income, public expenditure needs tend to be high relative to domestic revenue raising capacity (the savings rate is low and the tax base is small whereas expenditure needs for investment and social services are high); foreign financing, especially aid, accounts for a large part of the public budget. As a country grows, the tax base and potential for domestic borrowing expand, and the need for external financing should fall. In this chapter, we will restrict attention to the tax revenue raised in Mauritius (aspects of public expenditure are addressed in Chapter 8). The process of raising taxes has effects on the economy, some of which are undesirable. For example, tariffs increase the price of imports, which can increase production costs, and generates the economic inefficiencies associated with protectionist policies; taxes on exports reduce the incentives to exporters, who are usually the principal source of foreign exchange earnings; taxes in general distort prices and can thus generate allocative inefficiency. Low income countries are typically heavily reliant on taxes on trade, which account for more than a third of government revenue for low income countries but less than five per cent in industrial countries (Greenaway and Milner, 1991), thus the potential for distortionary effects are great. Economic theory can inform us on the potential distortionary effects of alternative taxes, thus we can comment on the preferred tax structure given the trade-off between the need to raise revenue and the desire to minimise distortions. 130

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The last two decades have seen considerable and often dramatic tax reform. Among the developed economies, ‘the tax reform movement has been almost universal’ with the aim of reducing the tax share of national income, and in particular reducing individual income tax rates (Pechman, 1988: 13). In developing countries, tax reforms have been an important component of adjustment programmes. About 50 per cent of all adjustment loans agreed between 1979 and 1989 included conditions relating to ‘fiscal reforms as part of absorption reduction policies’ and more than 50 per cent of all such loans included conditions relating to both trade and ‘rationalisation of government finances’ which had tax reform elements (Webb and Shariff, 1992: 71). Mauritius is no exception, and the economic reforms introduced since 1980 have had important implications for the tax system. There are at least two reasons for considering the effects of adjustment policies on tax revenues. First, tax reforms play a complicated part in adjustment packages. On the one hand, tax reductions are advocated to remove price distortions.This is especially true in respect of rationalisation of tariffs (reducing both the number of tariff rates and their levels) which is a basic component of trade liberalisation. On the other hand, governments are asked to reduce the budget deficit; while public spending cuts are recommended to meet this objective; these are often difficult to achieve. Consequently, a fall in tax revenues can increase the deficit and undermine the adjustment programme (Greenaway and Morrissey, 1993). Second, and not unrelated, an implicit objective of tax rationalisation is to increase tax revenue, based on the assumptions that: i) lower tax rates in a more simple system will increase compliance and revenue; and ii) a simple tax system is less of a constraint on growth so the tax base is widened, leading to greater revenue. We will address these issues in respect of Mauritius. The structure of this chapter is as follows. Section 7.2 provides a general discussion of the desirable criteria for a tax system, which will be used to inform our later discussion of taxation in Mauritius. Section 7.3 presents a brief overview of the tax structure in Mauritius as compared with other developing countries. We address the evolution and composition of the Mauritian tax system in Section 7.4; following an overview of trends in composition of tax revenue attention turns to the distortionary effects of taxes, equity and distributional implications. Section 7.5 concludes by considering issues of tax reform, elaborating on points raised in the previous section, and

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the implications for increasing the revenue-generating potential of the tax base.

7.2

CRITERIA FOR TAXATION

Normative tax theory rests on a number of guiding criteria for taxation. These typically emanate from Adam Smith’s canons of taxation, which can be succinctly stated as ‘equity, certainty, convenience of payment and economy of collection’ (Ruane and O’Toole, 1995: 128). Issues of equity in taxation are addressed in detail in the first sub-section below. The latter three canons refer to efficiency of tax collection, and are discussed together in the third sub-section. When economists talk of tax efficiency, however, they are not usually concerned with collection but with the effect taxes have on relative prices and hence on economic behaviour. Of particular relevance are the distortionary effects caused by taxes at different rates on goods and services, especially, for a developing country like Mauritius, on importables versus exportables. Our discussion of tax efficiency in the second sub-section relates to effects on relative prices. Before considering these criteria in detail, some terminology requires clarification. One of the most common distinctions is that between direct and indirect taxes. From the perspective of the economy, taxes are a deduction from national income. Some taxes are directly levied on (or deducted from) income: personal income taxes, taxes on unearned income (such as rents, interest and dividends), capital gains and inheritance taxes, and corporate income (profits) tax; taxes on property and wealth, on the basis that these are accumulated income. In all of these cases the tax base, the monetary value to which the rate of tax is applied, is some measure of income. Other taxes are, in one way or another, levied on some measure of expenditure and, as income is needed so as to spend, these are indirectly on income. Such indirect taxes include: those on domestic sales of goods and services, including value added tax (VAT), excises and sales taxes, which may be ad valorem (a percentage of value) or specific (a fixed amount per some unit volume); trade taxes, on exports and tariffs on imports. One of the most basic concepts is that of the tax base, the monetary value of the activity or asset on which the tax is levied. In the aggregate, national income (GNP) is the total base (although wealth represents taxable assets) thus richer countries have the potential to

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raise more tax revenue, although this in itself says nothing about revenue as a percentage of income. From the perspective of raising taxes the important point is the extent to which the economy is monetised: it is easiest to levy taxes on recorded monetary transactions or on revenue-generating assets. In practice, one is concerned with the base for specific taxes, and governments will tend to levy taxes where the base is largest (this is not always the case: often landowners possess the largest tax base in poor countries but are powerful enough to resist taxation). In low income countries, subsistence agriculture and informal sector activities account for a large share of national income; many transactions, including labour, are not officially monetised (cash may change hands, but few records exist). Consequently, the tax base is small, especially for domestic sales and income; this has important implications for the structure of tax systems in developing countries (see 7.3 below).As economies develop, the share of recorded income and transactions increases, as does the tax base. Thus, the total tax/GNP ratio tends to increase as national income increases. Tax liability is the amount that must be paid (statutorily) by a taxpayer, given by the tax rate times the tax base. Typically, some of the tax base will be exempted: income tax is not normally charged until income exceeds some given level (taxable income equals total income minus the threshold, which may vary, for example if married earners get a different allowance to unmarried earners), or traders are only liable to sales tax if turnover exceeds a given threshold; certain goods, such as staple food, may not be subject to sales tax; or certain imports, such as medicines, may be exempt from tariffs. Often there may also be exceptions, which generally apply when particular taxpayers, such as charities as importers, or when specific goods purchased by specific taxpayers (such as raw materials imported to produce exports) are exempted. Furthermore, tax rates may differ. In the case of direct taxes, or indirect taxes on assets, tax rates often increase as the tax base increases; for example, the tax rate is zero on income below the threshold, at a basic rate on the band of income from the threshold up to some given level, and at higher rates on higher income bands. In the case of indirect taxes on goods and services, the rate may vary depending on the good in question; for example, there are often numerous tariff rates for different types of imports. The greater the multiplicity of exemptions, exceptions and/or rates, the more difficult it is to identify tax liability (which can reduce collection efficiency, as argued below).

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Most people dislike paying tax, as it reduces their real income, so they may try to reduce their liability, or not pay taxes. Tax avoidance is legal and refers to altering one’s financial affairs, such as sources of income, so as to reduce liability; for example if the income from one form of savings is taxed at a lower rate than that on another, a person may alter their investment portfolio and reduce liability. Avoidance also includes availing of, or lobbying for, exemptions and exceptions. Tax evasion, however, is illegal and refers to not paying taxes for which one is liable, for example smuggling to evade tariffs or not declaring income. Governments will wish to minimise evasion, as it is a leakage from revenue, and will expend resources to detect it. They should also wish to minimise avoidance, which implies keeping the number of exemptions, exceptions and rates to a minimum. Equipped with these terms, we can now address the range of tax criteria. Principles of Tax Equity Equity is traditionally interpreted as implying two conditions: those of similar means should pay a similar amount of tax (horizontal equity), and those of dissimilar means should pay comparably dissimilar amounts (vertical equity). There are two common approaches to defining (dis)similarity of means (see Musgrave and Musgrave, 1980: 239–50). The first of these is ‘ability to pay’, conventionally interpreted as income: taxpayers with the same income (in principle, regardless of source) should pay the same amount of tax. The second approach is ‘benefit’; people should pay tax in proportion to the benefit they derive from public expenditure. In practice, as income is easier to measure than benefit, the former approach is most often used. In principle, horizontal equity for income tax is easy to achieve, by taxing individuals with the same income at the same rate. This begs two questions in practice: what factors render individuals dissimilar and how does one measure income. The standard resolution to the former is to give a married person (as the sole earner) a higher allowance than a single person, and frequently there is an allowance for children; in this way allowances are used to adjust for a taxpayer’s characteristics to render them similar. The resolution to the second problem is more complicated in practice: all sources of income should be treated the same, but usually earned income (remuneration for labour) is taxed at a different rate to unearned income (reward for saving; and alternative forms of investment are often taxed at

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different rates). The rationale is to encourage (specific types of) saving (see Kay and King, 1990: 79–88). Vertical equity is a more contentious issue as dissimilar treatment requires judgement on redistribution and on what equality, and inequality, is to mean (for a comprehensive discussion see Musgrave and Musgrave, 1980: 250–54). Most countries accept some degree of progressivity so that those on higher incomes pay proportionally more tax. The simplest justification for this is to assume diminishing marginal utility of income, so that an additional Rs1 of income confers less utility to somebody on Rs50,000 than to somebody earning Rs10,000. The ability to pay principle is interpreted as how much utility from income a person is willing to sacrifice to gain the benefit (utility) from public goods provision; if each person sacrifices the same amount of utility, diminishing marginal utility of income implies a progressive income tax. The degree of progressivity can be measured as the ratio of the marginal tax rate (MTR) to the average tax rate (ATR), which is an approximation of the elasticity of the tax function (etb), the proportional change in tax revenue (t) relative to the proportional change in the tax base (b), i.e. etb = (dt/t)/(db/b) = (dt/db)/(t/b) = MTR/ATR. A tax is progressive if etb > 1, proportional if etb = 1 and regressive otherwise. Sometimes it can be useful to consider tax buoyancy (ety), the responsiveness of tax revenue to a change in income (y), defined as ety = (etb)(eby), where eby measures the responsiveness of the tax base to a change in income. Income tax buoyancy depends on progressivity and eby, which will be affected by evasion, avoidance and whether allowances and tax bands are adjusted to keep pace with income growth. For example, if wages increase in line with prices and the income tax structure is indexed to inflation then eby = 1 unless reduced by evasion/avoidance; ignoring evasion/avoidance, if wages rise faster than inflation then eby > 1 (income tax buoyancy arising in this way is termed fiscal drag). A similar argument extends to the buoyancy of Sales taxes, where eby depends primarily on the marginal propensity to consume the taxed goods (in general, high marginal propensity to save implies eby < 1). Insofar as simplicity in a tax system reduces evasion/avoidance it is desirable in promoting buoyancy. Nath (1995) presents estimates to suggest that the overall buoyancy of tax revenue in Mauritius has fallen slightly from 1.18 in 1979–86 to 0.98 in 1987–94. This decline is due principally to reductions in import and export taxes and a significant decline in Sales tax buoyancy (from 2.5 to 1.2 respectively). It is significant that in the later period

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(1987–94) income tax, corporation tax and property taxes all became buoyant (with values slightly above unity). This suggests evolution of the tax structure, from dependence on indirect taxes on trade (which are very distortionary) to greater dependence on, and increased buoyancy of, direct taxes. The introduction of VAT to replace Sales tax in 1998 should increase the overall buoyancy of the tax system (so that in the late 1990s it is probably just above unity). Indirect taxes are not devoid of equity implications. It is often argued that as staple food represents a very large part of a poor person’s expenditure, but a very small part of a rich person’s spending, a tax on food is regressive in that it represents a greater burden on poorer people; in many countries staple food is exempted from tax. More commonly, luxury items are often subject to high rates of tax as they are bought only by those on relatively high incomes. When we consider equity in the Mauritian tax system in 7.4 below, attention will be focused on income tax. Taxation and Economic Efficiency When economists talk of tax efficiency, they are usually concerned with the effect taxes have on relative prices and hence on economic behaviour. Thus, income taxes reduce the net payment for labour therefore reduce the (opportunity) cost of leisure; once tax rates go beyond some level, the incentive to choose extra work diminishes and people may choose leisure; empirical evidence suggests that this disincentive effect is not, however, great (Atkinson and Stiglitz, 1980: 48–57). Of greater relevance are the distortionary effects caused by taxes at different rates on goods and services. We will confine our discussion of efficiency below to effects on relative goods prices. Standard discussion of economic efficiency of taxes begins with the Ramsey Rule: tax rates should be inversely related to the elasticity of demand for the taxed good. If demand is highly price elastic, a tax (price increase) will reduce demand by a greater than proportional amount, hence tax revenue will be low; a tax on goods with very inelastic demand (such as petrol or tobacco) will generate considerable revenue as sales will not decline in proportion to the price increase. There are two general exceptions to this rule. First, distributional considerations may imply a desire for differential tax rates; for example, as noted above, one may desire a lower tax rate on staple foods than on luxuries. Second, consumption of certain goods may generate

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externalities; for example, cars generate pollution so one may tax cars and/or petrol at a higher rate to account for this external cost. There have been many ‘extensions’ to the basic rule through the literature on optimum taxation, generating a number of conclusions regarding criteria for efficiency (Coady, 1997: 25–26): • •

• •

Lump-sum taxes, which do not affect relative prices, should be used if possible; this implies an efficiency case for land taxes; Indirect taxes should be based on final consumption and designed in line with the Ramsey Rule accounting for equity and externality considerations where appropriate; Tariffs should be at the same rate as taxes on corresponding domestically produced goods Taxes on intermediate inputs, whether tariffs or domestic indirect taxes, should be avoided unless the relevant final consumption good cannot be taxed, or there are distributional or externality justifications.

Efficiency of Tax Collection Three of Smith’s canons refer broadly to tax administration. Certainty requires that taxpayers and tax collectors can easily determine tax liability, which depends on how simple and visible a tax is. A tax is visible when the amount paid can be seen by the taxpayer at the time of payment. For example, most State sales taxes in the US are visible as the tax rate and amount paid are printed on the receipt provided by a shopkeeper; most income taxpayers in the UK have tax deducted by their employers under the pay-as-you-earn (PAYE) scheme, and the amount paid is printed on the pay slip. A simple tax is one with very few exemptions, exceptions and rates, so that taxpayers and collectors can easily determine liability. A sales tax at a uniform rate on all goods (as in many US states), or a poll tax of a fixed amount on all adults, are both simple; income taxes with few allowances/thresholds and few rate bands (such as the UK), or taxes on goods with few exemptions and only one rate (e.g. VAT in most European countries) are relatively simple; but direct taxes with multiple allowances and exceptions (such as US Federal income tax, or most capital gains taxes) or indirect taxes with numerous rates and exemptions (such as tariff schedules in many developing countries) are complex, and generally less visible. Simplicity, which applies to taxpayers and collectors, and visibility,

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which relates more to taxpayers, interact to determine certainty, and thereby influence collection efficiency. For example, State sales taxes in the US are simple and visible; VAT in the UK is relatively simple (in determining liability, although accounting can be complex) but is not visible (there are effectively three rates, counting zero for exempted goods, and the amount paid by consumers is not printed on receipts). On the other hand, the Federal income tax in the US is relatively complex but not immediately visible (despite self-assessment, final liability can take time to be determined), whereas the UK income tax, at least the PAYE which applies to the majority of taxpayers, is relatively simple and visible. The greater overall simplicity in the UK suggests greater collection efficiency. The issue of visibility can have important implications for the political economy of taxes: if governments want to increase revenue without generating taxpayer opposition, they have an incentive to increase the less visible taxes, perhaps even while reducing (by less) the more visible taxes (Morrissey and Steinmo, 1987, provide evidence for this in the UK). Finally, we should note that greater certainty reduces the opportunity for evasion or avoidance. Thus, we can posit many strong arguments for tax simplicity (including economic efficiency, as there are few rates); visibility is desirable for taxpayer certainty, but there are political reasons why governments may favour less visibility. Convenience refers simply to the method of payment: for example, it is more convenient to have tax deducted at source than to have to go in person to the tax office; it is a less important issue than certainty or collection costs. Economy of collection requires that the costs of collection (to which one should add compliance costs incurred by taxpayers in determining liability and making payment) should be low relative to revenue collected; in general, simple taxes will have lower collection costs. We will use simplicity as an indicator of the efficiency of tax collection. To summarise, we can identify four guiding criteria for a ‘good’ tax system: i)

Efficiency: taxes should distort individual choice, usually represented by prices, as little as possible; ii) Equity: some degree of progressivity, or at least the avoidance of regressivity (when the poor pay proportionally more), is desirable for social justice; iii) Simplicity: taxes should be easily understood by the taxpayer, with as few rates and exemptions as feasible; iv) Cost: taxes should be relatively easy to administer and pay, so

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that compliance costs (incurred by taxpayers in meeting their liability) and collection costs (including detection of evasion) are very low relative to revenue.

7.3 STRUCTURE OF TAXATION IN DEVELOPING COUNTRIES A particular feature of taxation in developing countries is, as detailed in Greenaway and Milner (1991: 101), a relatively heavy dependence on taxes on international trade: using averages over 1976–82 for a sample of 69 countries, trade taxes globally accounted for five percent of government revenue; this figure was less than two per cent for industrial countries (97 per cent of these trade taxes being on imports) but 17 per cent for non-oil developing countries (78 per cent on imports). Dependence ranged from 34 per cent of tax revenue on average for low income countries, to 22 per cent for lower middle income, down to ten per cent for upper middle income countries; 17 countries were classified as high dependence, with trade taxes averaging 43 per cent of total tax revenue (Greenaway and Milner, 1991: 103). This represents an inherent problem for low income countries: the low tax base leads to trade tax dependence; high tariffs increase the price of importables and export taxes reduce the return on exportables, inducing inefficiency in domestic production. Burgess and Stern (1993) demonstrate that there is a positive correlation between per capita income and the tax/GDP ratio; this is unsurprising, as income is a good indicator of the size of the tax base. Furthermore, there is a clear structural change as income increases. In low income countries, much of the economy is relatively unmonetised (agriculture and the informal sector) and official employment is relatively low, hence most revenue is raised from taxes on official transactions (trade, and to a lesser extent domestic sales). In higher income economies, the monetised sector is much larger and a wider range of taxable activities exist; tariff reductions on manufactures negotiated under successive rounds of the GATT have resulted in trade taxes being a very small share of tax revenue in industrial countries, where the major sources of tax revenue are income (including social security). Table 7.1 provides evidence of how tax structure changes as income rises, and compares Mauritius to patterns in various (income) groups of countries. The general tendency for income taxes to provide a greater source of revenue in higher income countries is apparent;

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140 Table 7.1

Tax structure in Mauritius compared to regional averages as % Tax Revenue

Industrial Developing Latin America Asia Africa Mauritius

GNP Per Capita

Tax/GDP %

Income %

Trade %

Indirect %

$13,477 $1,241 $1,581 $743 $621 $1,631

31.2 18.1 18.2 14.8 19.5 21.3

35.8 28.9 24.2 27.4 32.3 11.6

2.8 29.4 21.3 35.0 35.6 60.5

29.3 30.4 36.5 34.8 25.8 22.0

Notes: All figures are regional averages of three-year averages (the three years closest to 1987; for Mauritius 1986–88). The sample has 21 industrial countries and 82 developing countries; 23 in Latin America (Western Hemisphere), 16 in Asia and 31 in Africa. Income taxes include individual and corporate; indirect taxes include excises, sales, VAT, etc. Tax shares do not sum to 100 per cent as Social Security, Wealth and property taxes are excluded. Sources: Figures for Mauritius calculated from Government Finance Statistics Yearbook 1994 (IMF); other figures from Burgess and Stern (1993, tables 4 and 5), who use Government Finance Statistics Yearbook 1989 (IMF).

Africa is something of an outlier, and the figure for Industrial countries is understated by the exclusion of social security taxes (although liability depends on income, these are conventionally treated as social insurance payments and employers contribute so they are distinguished from income tax). The tendency of trade taxes to diminish in importance as income rises is more evident, whereas there is no evident pattern for indirect taxes. Mauritius is very heavily dependent on trade taxes whatever comparison is used: regionally, it is part of Africa but is markedly more dependent on trade taxes than the region; in terms of per capita GNP, Mauritius is comparable to Latin America but is almost three times as dependent on trade taxes.

7.4

THE TAX SYSTEM IN MAURITIUS

Mauritius avails of a wide range of taxes; to sketch the composition, we will take fiscal year 1990/91, when total tax revenue was some nine

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Oliver Morrissey Table 7.2

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Composition of tax structure in Mauritius as % Tax Revenue

1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96*

Tax/GDP %

Income %

Indirect %

Trade %

(tariffs) %

20.4 20.4 21.0 22.5 23.3 23.1 23.6 22.1 21.5 n.a. n.a. n.a.

13.35 10.13 12.02 12.76 14.73 16.03 15.37 16.83 14.31 13.12 16.30 17.17

23.58 22.15 22.06 21.69 23.79 23.85 25.20 27.54 28.49 29.41 31.30 32.30

57.82 62.26 60.36 58.91 55.06 53.06 51.80 49.19 50.01 50.51 44.98 42.64

(45.46) (49.14) (47.62) (47.84) (45.89) (48.19) (47.06) (44.72) (45.78) (47.00) (44.98) (42.64)

* provisonal. n.a. not available. Notes: Income taxes include individual and corporate; indirect taxes include excises, sales, VAT, etc; trade taxes are tariffs and export taxes. Tax shares do not sum to 100 per cent as Social Security, Wealth and property taxes are excluded. Sources: Tax/GDP ratio calculated from Government Finance Statistics Yearbook 1994 (IMF); other figures from CSO, various years.

billion rupees, as an example (data from CSO, 1992). Income taxes contributed about 15 per cent of total tax revenue, in the rough proportion 60 : 40 between corporate and individuals, while social security contributions and payroll taxes added about another five per cent. Domestic taxes on goods and services contributed about a quarter of revenue, in rough proportions 40 : 40 : 10 : 10 between excise duties, sales taxes, taxes on gambling and on hotel bills. Consistent with the evidence presented above, trade taxes contributed 52 per cent of tax revenue; 90 per cent of trade tax revenue is from tariffs (and export taxes were abolished from 1994/95). The only other major tax is that on property, which contributes just less than seven per cent of total tax revenue. Non-tax revenues were worth some Rs450m (equivalent to five per cent of tax revenue), and came mostly from property income, fees, charges and non-industrial services. Table 7.2 shows the composition of tax revenue by major categories over 1983/84 to 1995/96. A number of general trends are apparent.

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First, and perhaps foremost, Mauritius is becoming progressively less reliant on trade taxes, which have declined as a share of tax revenue from about 60 per cent throughout most of the 1980s, to 50 per cent in the early 1990s and tending towards 40 per cent in the late 1990s. About half of this decline is attributable to the reduction and then abolition of export taxes, but tariffs’ contribution to revenue also seems to be declining. This dependence on trade taxes implies relatively high levels of effective protection and has adversely affected resource allocation (protection in Mauritius has been addressed elsewhere in this volume). Such trade taxes increase the degree of economic inefficiency in the tax system. Although nominal tax revenue almost quadrupled between 1985 and 1995, real tax revenue, as indicated by the tax/GDP ratio, rose only slightly from 20 to about 22 per cent (there is an one-off fall in tax revenue in 1994/95, apparently associated with the abolition of export taxes). This is consistent with rising national income, and arguably the aggregate tax take is about right. We would anticipate the broad tendency of income taxes as a share of revenue to increase, as revealed in Table 7.2, to continue and even to become more pronounced. One objective of tax policy in Mauritius should be to ‘replace’ tariff revenues with income taxes (although the intention in the Budget statement of 9 June 1997 was to expand domestic tax revenue through the introduction of VAT rather than by income taxes). Domestic taxes on goods and services are becoming an increasingly important source of revenue, from just over a fifth of tax revenue in the early 1980s to almost one third by the late 1990s. This trend is likely to continue under the VAT. Part of this increase may reflect replacing tariffs with sales taxes, which would generally imply a reduction in economic inefficiencies associated with the tax system. The basic personal income tax allowance in 1995/96 was Rs40,000, with a further Rs20,000 allowance for a dependent spouse, Rs10,000 for a dependent child under 18 (and over 18 if attending full time education or training; Rs30,000 if at university), plus specific deductions associated with pensions, assurance, medical insurance and certain investments; agricultural income, especially in the sugar sector, received special relief. By 1997/98 the basic allowance had been increased 12.5 per cent, that for a dependent spouse 25 per cent, and for a dependent child under 18 by 20 per cent; clearly, the income tax system shifted relatively in favour of families as against single persons (the relief for those attending tertiary education also increased by 25

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Oliver Morrissey Table 7.3

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Illustrative income tax burdens Single

Married

1995/96 Gross Income [1] Allowances [2] Taxable Income [3] Tax paid [4] ATR [4]/[1]

Rs100,000 Rs40,000 Rs60,000 Rs10,250 10.25%

Rs100,000 Rs70,000 Rs30,000 Rs3,000 3.0%

1997/98 I: Constant income Gross Income [1] Allowances [2] Taxable Income [3] Tax paid [4] ATR [4]/[1]

Rs100,000 Rs45,000 Rs55,000 Rs8,750 8.75%

Rs100,000 Rs82,000 Rs18,000 Rs1,200 1.2%

1997/98 II: Incomes and allowances rise at same rate Gross Income [1] Rs112,500 Allowances [2] Rs45,000 Taxable Income [3] Rs67,500 Tax paid [4] Rs12,500 ATR [4]/[1] 11.11%

Rs112,500 Rs82,000 Rs30,500 Rs3,150 2.8%

1997/98 III: Incomes increase faster than allowances Gross Income [1] Rs150,000 Allowances [2] Rs45,000 Taxable Income [3] Rs105,000 Tax paid [4] Rs23,750 ATR [4]/[1] 15.8%

Rs150,000 Rs82,000 Rs68,000 Rs12,650 8.4%

Source: Author’s calculations from rates and allowances given in text.

per cent or more). The tax rates and bands were not altered over this period, remaining at: five per cent on the first Rs15,000 taxable income, 15 per cent on the next Rs20,000, 25 per cent on the next Rs20,000 and 30 per cent on the remainder. We can use these figures to illustrate specific features of the income tax system. The calculations in Table 7.3 refer to the cases of two taxpayers, one single (S) and the other (M) with a dependent spouse and one child under 18, both earning Rs100,000 (gross income) in 1995/96.The ATR, tax paid relative to gross income, is 10.25% for S and 3.0% for M; these average rates are low, but some 80 per cent of taxpayers had incomes above Rs100,000 in 1994/95 so our example cases are low

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income. We then consider the situation of these taxpayers in 1997/98 under three scenarios. First, we assume nominal incomes remain constant, to demonstrate the effect of changing allowances only: the ATR on S falls by less that a fifth to 8.75 per cent whereas that on M more than halves to 1.2 per cent. This illustrates the fact that increasing allowances is of relatively greater benefit to those on lower incomes. Second, we assume the basic allowance was indexed to inflation and incomes increase at that rate (12.5 per cent), to demonstrate the effect of not indexing tax bands: the ATR on S rises by about a tenth to 11.1 per cent whereas that on M is still lower than initially at 2.8 per cent. This illustrates the trade-off between allowances and tax bands on the ATR: for S the tax rate increases as the fixed tax bands dominate the indexed allowance; for M the large increases in dependent allowances, and thus low taxable income relative to gross income, more than offset the effect of fixed tax bands – although the amount of tax paid actually rises, it is a lower proportion of the increased income. Third, we allow incomes to increase by 50 per cent to illustrate the buoyancy associated with fiscal drag: the ATR on S is 15.8 per cent, about a 50 per cent increase on the initial position, while the ATR on M is 8.4 per cent, almost a 300 per cent increase on the initial rate. This illustrates the potential severity of fiscal drag (when allowances and tax bands are not increased in line with earnings) and how it induces tax buoyancy. Taking the case of M: gross income rose 50 per cent, but taxable income increased by 227 per cent (implying eby is approximately 4.5), and tax revenue rose 280 per cent (implying etb is approximately 1.2); ety is therefore some 5.6. An income tax system is unlikely to ever exhibit such buoyancy, unless there is no indexation and incomes are increasing rapidly (which could occur during hyperinflation but would encourage evasion), but it should be clear that it is easy to have ety > 1 for income tax. Table 7.4 provides some data on the progressivity of the individual income tax system, for 1992/93 compared with 1994/95 (for illustrative purposes). Three points are worth making. First, the overall ATR (on the tax base of gross income) falls slightly to just above seven per cent, implying ety < 1 (allowances and bands probably increased by more than income did). The changes to the income tax structure outlined above suggest that the ATR will have increased, perhaps to eight per cent by 1997/98. Second, for both years there are anomalies in that the apparent ATR is relatively high for those earning Rs20–40,000; in 1994/95 there is almost certainly some misallocation to the Rs100–250,000 range from adjacent ranges (the pattern for 1992/93 is

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Oliver Morrissey Table 7.4 1992/93 Gross Income Range (Rs ’000s) <20 20–30 30–40 40–50 50–100 100–250 250–500 >500 Total 1994/95 Gross Income Range (Rs ’000s) <20 20–30 30–40 40–50 50–100 100–250 250–500 >500 Total

145

Progressivity of income tax, 1992/93 and 1994/95

Gross Income

Tax Paid

Average Tax Rate

5.2 9.8 69.0 184.9 2,060.0 3,063.1 854.7 790.6 7,037.3

0.1 0.3 1.7 4.0 69.4 215.5 116.8 136.3 544.1

1.92 3.06 2.46 2.16 3.37 7.04 13.67 17.24 7.73

Gross Income

Tax Paid

Average Tax Rate

0.6 0.6 0.8 108.6 2,320.1 388.5 1,225.1 1,051.5 8,595.8

0 0.1 0.1 0.3 38.3 235.1 155.0 187.6 616.5

0.00 16.67 12.50 0.28 1.65 60.51 12.65 17.84 7.17

Source: Derived from table 6.1 in Digest of Public Finance Statistics 1992–1996, Port Louis, Mauritius: Central Statistics Office.

what one would expect and is similar to the unreported patterns for 1991/92 and 1993/94). Third, there is a discernible level of progressivity: given a MTR of 30 per cent, then progressivity in 1992/93 is roughly 3.9 and in 1994/95 is almost 4.2. All of this implies potential buoyancy in income tax: as incomes rise, tax revenue should rise at least proportionally. There is apparent scope for income to provide an increasingly important source of revenue. Given the four criteria for a ‘desirable’ tax system listed at the end of 7.2, how should one evaluate Mauritius? The income tax appears equitable, in that it is progressive, and relatively simple; the principal anomaly lies in the special treatment of agricultural incomes, espe-

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cially those in the sugar sector. If agriculture has special needs, from the perspective of the tax system it would be preferable to address these through direct income support measures rather than through income tax allowances and exceptions. The introduction of VAT to replace Sales tax will have transitional costs but should ultimately lead to a more efficient (economically and in terms of collection) and buoyant taxation of domestic goods and services. Further moves to reduce and rationalise tariffs are essential to promote simplicity, economic and collection efficiency; the elimination of taxes on exports removes one major distortion. Overall, the changes to the tax system are moving it towards a more desirable structure, but there is much yet to be done.

7.5

TAX REFORM AND FUTURE PROSPECTS

Greenaway and Milner (1991) are particularly concerned with the effect of trade reform (liberalisation) on tax revenues and identify a number of conditions under which reform is likely to be revenue increasing. First, if initially tariffs are excessive, such that they discourage potential imports in being prohibitive or, more commonly, in offering high returns to smuggling and evasion; this is unlikely to be a major factor in Mauritius in the 1990s. Second, if there is scope to convert QRs to tariffs; this avenue has been utilised by Mauritius in the 1980s. Third, if simplification leads to greater transparency and reduces exemptions so that collection efficiency rises; given the importance of tariffs, this offers scope for Mauritius to increase revenue and simplify the tax system. The actual reforms implemented in Mauritius in the early 1980s were not great. Duty exemptions and average tariff rates were reduced, but import surcharges were imposed in 1984–85. Many quantitative restrictions were removed in 1985; exemptions to export taxes were increased and duty drawback scheme expanded in the early 1980s. The implicit import tax (tariff revenue as a share of import value) rose from 17.6 per cent in 1980 to a maximum of 25.5 per cent in 1983 then fell back to 18.7 per cent by 1986. The implicit tax on exports rose from eight per cent in 1980 to a peak of 12.7 per cent in 1981, then fell steadily to five per cent in 1986. The trade tax/GDP ratio rose from 13.1 per cent in 1980 to peak at 14.9 per cent in 1983 and 1984 and then fell to 11.2 per cent in 1986 (Greenaway and Milner, 1991: 118–19). Overall, the effect of trade reforms in reducing

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average tariffs has been very gradual; reliance on trade taxes has been significantly reduced in the 1990s, especially following the abolition of export taxes. Introduction of VAT The general argument for VAT, to replace sales tax and other domestic consumption taxes, is that it would be revenue enhancing (assuming a relatively high rate). The potential benefits are threefold. First, there is flexibility in setting the rate, and hence scope for generating increased revenue, while an integrated VAT avoids the tax cascading of the existing system (e.g. taxes on intermediates are compounded by taxes on final goods; sales taxes are levied on imports which have already attracted tariffs). Second, it is expected that once VAT is established and traders became used to the good accounting practices required evasion would decline due to the self-policing nature of VAT. To distinguish between the value of purchased inputs (i.e. the VATinclusive cost) and that of output, so that effectively VAT is only levied on value added, traders and manufacturers have to keep records of purchases and transactions. Thus, VAT would encourage proper record keeping and recording of inputs on which the tax has been paid. In this way it can be self-policing. Third, as the practice of keeping proper records spreads the tax base for VAT will grow and revenue will increase; ultimately, VAT will have a wider coverage than sales tax and can generate more revenue (it has relatively high tax elasticity and buoyancy). The major problems with VAT are that it is administratively difficult to implement and often no obvious improvement on the existing system. First, even a simple VAT, where only manufacturers are the liable tax units, will be a more complex version of the sales tax but applying also to inputs. Second, a VAT will impose much higher collection and compliance costs than the existing system, largely because of the detailed recording and monitoring required. Third, and related to the first two, the tax administrators will face costs and difficulties in introducing a VAT system smoothly and efficiently. To the extent that the existing system of keeping records is ‘limited’ any VAT system would be difficult and costly, in both time and training, to introduce. Finally, the complexity of records required could encourage evasion, especially for traders whose turnover is near the exemption threshold, rather than discouraging it. In general, VAT may be a desirable tax but it does involve high implementation costs.

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Prospects for Tax Revenue Tax revenue in Mauritius has largely kept pace with economic growth, increasing only slightly as a share of GDP in the 1980s. There is no generally agreed ‘proper’ size of government but a tax/GDP ratio of some 25 per cent would be reasonable for an economy such as Mauritius, which implies that the government would wish to speed up slightly its domestic revenue mobilisation. Simultaneously, dependence on tariffs should be progressively reduced. Consequently, buoyant sources of tax revenue are required: this is offered by VAT, but is unlikely to be realised until about 2000, when the transition period for introducing VAT is over and the system is functioning. In the immediate future, income tax offers a buoyant source of tax revenue. The potential buoyancy of income tax has not been realised during the early 1990s, but should become apparent as the decade comes to a close. The tendency to increase allowances by at least the rate of inflation benefits those on lower incomes, whereas the tendency not to consistently index the tax bands implies some fiscal drag, especially for those with relatively higher incomes. Earnings growth in the economy, and of course employment growth, offer the most promising source of increased income tax revenue. Furthermore, as employment in the non-agricultural sector expands, the anomalies in income tax revenue caused by the special treatment of agricultural incomes will be of lesser importance. With the anticipated strengthening of the income tax base and buoyancy, and the long-term potential benefits from VAT, prospects for an improved tax system are strong. The likely improvements are twofold. First, as tariffs are successively reduced and rationalised, and VAT leads to a uniform domestic sales tax with wide coverage, the price distortions associated with the tax system will be reduced; hence economic efficiency will increase. These changes also offer the prospect of a more simple tax system, at least regarding trade and indirect taxes, hence greater collection efficiency. Second, the inherent buoyancy of VAT and income tax imply an increased revenue-generating potential of the tax system, and the additional revenue will be obtained in a less distortionary manner. In sum, the prospects are good if appropriate reforms are followed: rationalising tariffs, retaining a relatively simple income tax structure and keeping VAT rates relatively low but uniform with wide coverage.

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References ATKINSON, A. and J. STIGLITZ (1980) Lectures on Public Economics (New York, McGraw Hill). BURGESS, R. and N. STERN (1993) ‘Taxation and Development’, Journal of Economic Literature, xxxi (2), 762–830. COADY, D. (1997) ‘Fiscal Reform in Developing Countries’, in Chandra K. Patel (ed.), Fiscal Reforms in the Least Developed Countries (Cheltenham: Edward Elgar). CSO (1992) Digest of Public Finance Statistics 1988–1992 (Port Louis: Central Statistics Office, Ministry of Economic Planning and Development, Mauritius). GREENAWAY, D. and C. MILNER (1991) ‘Fiscal Dependence on Trade Taxes and Trade Policy Reform’, Journal of Development Studies, 27, 2, 95–132. GREENAWAY, D. and MORRISSEY, W.O. (1993) ‘Structural Adjustment and Liberalisation in Developing Countries’. Kyklos, vol 46, 241–61. KAY, J. and M. KING (1990) The British Tax System, 5th edn (Oxford: Oxford University Press). MORRISSEY, O. and S. STEINMO (1987) ‘The Influence of Party Competition on Post-War UK Tax Rates’, Policy and Politics, 15 (4), 195–206. MUSGRAVE, R. and P. MUSGRAVE (1980) Public Finance in Theory and Practice, 3rd edn (New York, McGraw Hill International Student Edition). NATH, S. (1995) ‘Fiscal Policy and Economic Development in Mauritius’, mimeo, Department of Economics, University of Mauritius. PECHMAN, J. (1988) ‘Introduction’ in J. Pechman (ed.), World Tax Reform: A Progress Report (Washington, DC: The Brookings Institution). RUANE, F. and F. O’TOOLE (1995) ‘Taxation Measures and Policy’, in J. O’Hagan (ed.), The Economy of Ireland (London: Macmillan). WEBB, S. and K. SHARIFF (1992) ‘Designing and Implementing Adjustment Programs’, in V. Corbo, S. Fischer and S. Webb (eds), Adjustment Lending Revisited: Policies to Restore Growth (Washington, DC: The World Bank).

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8 Government Expenditure and Economic Development Shyam Nath

8.1

INTRODUCTION

Prior to the initiation of structural transformation in the early 1980s, Mauritius was confronted with severe financial bottlenecks, namely, lack of development finance and balance of payments pressures that undermined economic performance. The pace of economic growth was stimulated through increased emphasis on the export-oriented manufacturing sector, which emerged in the 1970s. Export-led growth, which showed up significantly after 1982, helped Mauritius to increase its per capita income from US$1,000 in 1982 to more than US$3,000 in recent years putting it in the category of an upper middle income country. With relatively stable population, the growth of per capita income was accelerated. Further, it attained near full employment by 1990 with, on an average, five per cent annual real income growth. These developments converted a mono-crop economy into a newly industrialising one in which the role of the state policy was considerable. This chapter looks at the major trends in government expenditure and their implications for economic development in Mauritius. An analysis of expenditure policy should ideally include the public sector as a whole, as significant economic activities are undertaken by the public sector enterprises as well. Therefore, we discuss here the consolidated central government. As governments operate through the revenue and expenditure accounts of the budget, an analysis of both these accounts along with budgetary imbalances would constitute the subject matter. The structure of the chapter is as follows. In the next section, we discuss the main objectives of expenditure policy and its role in economic development. The third section tests certain hypotheses pertaining to the growth of government expenditure in Mauritius through 150

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the various phases of economic performance including the periods of sugar booms and structural adjustment. It also includes an analysis of the composition of government expenditure. The financing pattern of government expenditures will be taken up for discussion in the subsequent section, with a view to highlighting the domestic and foreign financing of government expenditure vis-à-vis the role of tax policy. Section five will consider the implications of the growth of government expenditure and of the pattern of financing. This section also includes an empirical examination of the performance of the expenditure policy. The final section summarises the basic issues and discusses some of the policy options.

8.2

OBJECTIVES OF EXPENDITURE POLICY

Musgrave (1959) classified the objectives of fiscal policy into three categories: efficient allocation of resources, equitable distribution of income and wealth and stabilisation of economic activities. Whereas the first two objectives assume significance both in developed countries and less developed countries (LDCs), the stabilisation objective is accorded higher priority in developed country fiscal policies. In LDCs, stabilisation policies are designed more as a necessary condition for growth, which is the foremost objective. (For a good discussion of these issues, see Chelliah, 1960.) The three distinct components of government budgets, namely, expenditure, taxation and borrowing constitute the important tools for achieving fiscal policy goals. All societies – from those organised under laissez-faire to those under socialism – essentially require a public sector simply because even under best conditions, the market mechanism cannot perform all economic activities desired by households. This is particularly true because the issues involved in the provision of public goods are different from private goods in the sense that in the case of public goods, consumption is non-rival and exclusion of consumers may not be possible or desirable. Such goods are called pure public goods. For instance, national defence is available to all; one person’s use of this good does not reduce the benefits available to others. Moreover, it is either impossible or prohibitively costly to exclude anyone from the benefits once the good is supplied. Such a good would have to be provided by government, as market failure is total. For other public goods, the characteristics of non-rival consumption and non-exclusion are present but are less pronounced. Therefore,

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markets can function but only in an inefficient way. Primary health care, primary education, police protection, low-income housing and safe drinking water are some examples. In these cases, it would be noted that although it may be possible to exclude some from consumption, it would, however, not be desirable, as it would entail health and social implications. Access to safe drinking water, for instance, if denied may cause health hazards (negative externalities) and consequent budgetary implications to control them. Similarly, the provision of primary education entails considerable positive externalities. Primary education and health, though not pure public goods, are chosen for public provision through the budgetary process on the ground of their merit. Hence they are called merit goods. Expenditure policy aims at allocating resources to the provision of public goods, which helps the division of total resources of an economy between the provision of public goods and private goods. The appropriate role of the public sector would thus depend on the technical grounds to provide public goods. Extension of the public sector beyond that would largely depend on ideological and political considerations. While governments exist with the explicit objective of meeting the public good needs of society, macroeconomic objectives of growth, income distribution and stabilisation have been considered equally important.

8.3

GROWTH OF GOVERNMENT EXPENDITURE

Alternative Approaches The significance of government has witnessed considerable change over time, consequent upon changing economic philosophy towards the role of government. While classical economics minimised the role of government, the significance of government was maximum under the Keynesian movement. Neoclassicals believed in the free play of market forces and this has also shaped the economic philosophy of the World Bank and the International Monetary Fund (IMF). Their preference is a small government with market friendly fiscal policy. New growth theory propounded by Romer (1986) and Lucas (1988) has again revived the role of government in the context of economic development of LDCs. In these economies, the role of the state has assumed special significance in the context of physical infrastructure, human capital, and institutions highly needed for development.

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A look at the profile of economic philosophy towards government would suggest a significantly changing role of government. Moreover, government size would also respond to the nature of economies, market or socialist. However, most countries – both developed and developing – seem to have assigned greater than the technically required role to the public sector. International Comparisons World development indicators show that total government spending as a per cent of GDP, a measure of size of government, has varied from 14.4 per cent in some low income countries to more than 50 per cent in industrial countries (Table 8.1). In fact, there is no trend as regards government size along the constitutional status of different countries. A higher ratio may be expected in federal countries. But the expenditure levels in countries such as Australia, India, the United States and Canada do not confirm this trend. Countries with strong central governments among developing countries like Korea and Singapore have not shown substantially higher expenditure to GDP ratios. However, one trend, which is confirmed is that government size is positively associated with level of economic development. In Mauritius, this ratio is stabilised around 25 per cent during the last two decades – which is comparable with expenditure levels in developing countries. Empirical Evidence on Trends It has been postulated in the literature that the share of the public sector grows more rapidly than the community output. This is known as Wagner’s Law. It requires that the income elasticity of public goods is greater than unity. Further, studies of government expenditure growth have revealed a certain historical pattern in which periods of social upheavals were associated with abrupt upward shifts in the government expenditure to GDP ratio. This pattern has been explained in terms of the displacement effect hypothesis, advanced in a study of long term public expenditure growth in the UK by Peacock and Wiseman (1961). Although the expenditure level generally subsided after the upheavals, it came to rest at a level appreciably above the one prevailing before the disturbance. In essence, the hypothesis emphasises the role of social disturbances in changing tax payers’ perceptions of tolerable tax burdens.

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Government Expenditure and Economic Development Table 8.1

Country

Government size: international comparisons Government expenditure as a proportion of GDP 1978

1985

1992

Developing Kenya Ghana Pakistan Philippines Peru Chile Mauritius Singapore Malaysia Korea South Africa Indonesia India

28.1 20.7 22.4 14.7 20.8 32.4 33.5 22.2 29.5 18.1 27.7 20.5 17.6

28.0 14.0 23.9 14.0 17.4 30.7 28.0 35.9 32.7 18.1 30.6 21.6 22.4

27.0 17.0 26.4 19.1 14.4 21.7 26.1 20.2 28.1 18.7 n.a. 19.2 20.4

Industrial United Kingdom Australia France united States Luxembourg Sweden Canada Netherlands

37.5 28.9 38.3 22.1 46.7 44.8 21.5 51.3

40.5 30.5 45.2 25.3 46.9 49.7 24.6 55.9

41.2 27.7 45.1 24.6 52.2 45.8 n.a. 53.1

n.a. not available. Source: IMF, International Financial Statistics Yearbook, various issues.

A number of studies have attempted to test the empirical validity of Wagner’s postulation; results are supportive but rather weak in developing countries. (See Henrekson, 1993 for a good discussion.) A test for Wagner’s Law is normally conducted by estimating the elasticity of government expenditure with respect to GDP.A value of elasticity greater than one would support Wagner’s Law. This elasticity, however, should not be very high for Mauritius because the role of the public sector may be limited in an economic system, which is open and market-oriented.1 The economy has been in fact growing at a rapid rate more because of private sector growth and external factors, such as foreign domestic investment and the protected export

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0,30 0,25

0,15 0,10 0,05 0,00 19 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 95

Ratio

0,20

GEX/GDP

Figure 8.1

TAX/GDP

Trends in tax and expenditure shares in GDP, 1968–95

markets. The objectives of government policies have been to maintain government expenditure and deficits at a level that does not crowd out the productive sectors of the economy. It can be observed in Table 8.1 that the share of government spending in GDP declined from 33.5 per cent in 1978 to 26.1 per cent in 1992, which is dramatic in the group of countries included. This means that the response of government expenditure to GDP growth is very low. As for the displacement effect as a source of government expenditure growth, it would need empirical verification. Although the sugar boom of the early 1970s hardly matches the social upheavals earlier in the century, the sudden growth of expenditure to GDP ratio during the 1970s and the early 1980s may fall into a pattern that might, for analytical purposes, conform to the displacement effect hypothesis. However, while government expenditures rose rapidly, the share of tax revenue in GDP did not rise significantly (see Figure 8.1). The latter indeed followed the previous pattern. Thus, one can presume that the growth of government expenditure was policy induced and could not be attributed to factors representing abrupt shifts. Further, it would be evident that expenditure as a proportion of GDP declined

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Government Expenditure and Economic Development Table 8.2

Growth of government expenditure*

Current expenditure

Capital expenditure

Total expenditure

1975

668.9 (79.7)

171.2 (20.3)

840.1 (100.0)

1980

1,971.9 (83.2)

398.0 (16.8)

2,369.9 (100.0)

1985

3,626.4 (85.8)

602.8 (14.2)

4,229.2 (100.0)

1990

7,384.0 (83.2)

1,495.9 (16.8)

8,879.9 (100.0)

1994

11,549.7 (80.9)

2,721.7 (19.1)

14,271.4 (100.0)

1995

13,011.2 (82.0)

2,856.6 (18.0)

15,867.6 (100.0)

* Rs million – current prices. Figures in brackets indicate percentages of total government expenditure. Source: IMF, Government Finance Statistics Yearbook, various issues.

after 1980. This was primarily due to the implementation of the structural adjustment policies during the 1979–86 period. Growth and Composition of Expenditure Total government expenditure consists of recurrent and capital expenditures. Recurrent expenditures comprise wages and salaries, spending on health and education, social security, and welfare. These are in the nature of ‘consumption and social’ expenditure. Capital expenditure, on the other hand, comprises the spending on capital projects, more particularly infrastructure development. A simple look at the data, reported in Table 8.2, shows that there has been a many-fold increase in aggregate, recurrent and capital spending. Recurrent expenditure has continued to occupy more than 80 per cent of total expenditure, which has constrained the growth of capital expenditure. This trend should have an adverse effect on the government’s role in infrastructure development. A further analysis would reveal that ‘consumption and social expen-

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Shyam Nath Table 8.3

157

Economic classification of consolidated general government expenditure (percentages)

Categories

1987

1990

1993

1994

1995

Education* Health* Social Security and Welfare* Other social* Fuel and energy** Agriculture, Forestry and Hunting** Mining and Mineral** Transport and Communication** Other economic services** Other expenditures

12.3 7.5 13.8 3.3 0.07 8.5 1.4 10.5 2.6 39.6

14.2 8.6 13 6.5 0.05 7.3 0.6 3.62 4.8 40.9

14.9 16.1 9.4 9.2 16.1 16.6 7.9 8.6 0.02 0.04 5.9 5.75 0.55 0.5 5.5 6.6 3.6 2 35.8 34.5

17 8.8 16.5 8.8 0.05 6.1 0.7 4.5 2.1 35.1

* Social services. ** Economic services. Source: IMF, Government Finance Statistics Yearbook, various issues.

diture’, which formed as high as 86 per cent of total expenditure in 1985, witnessed a declining trend in recent years. One may be tempted to conclude that there is a marginal increase in government capital investment. However, a closer look at the economic classification of the budget would indicate that social categories have attracted higher expenditures relative to economic categories (Table 8.3). Social security and welfare attracted greater attention – 13.8 per cent in 1987 and 16.5 per cent in 1995. Other important categories are education and health in the social group as well as transport and communication, and agriculture, forestry and hunting on the economic side. Health expenditure has gained in relation to transport and communication after 1990. From the above description, two policy implications emerge. First, government has tended to retire from economic sectors. There are sectors, such as transport and communication, which have developed more as off-budget government activities, that is, in the operations of parastatal corporations. The second conclusion is that government has grown more as a welfare state in terms of expenditure on social security, education and health. The growth and social welfare implications of these developments would indeed be revealing. Before undertaking an analysis of the implications emerging from

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the preceding analysis, however, it would be instructive to examine the pattern of financing government expenditure as well because the different modes of financing would entails considerable economic and social effects, independent of the trends in government expenditure. We examine these issues in the next section.

8.4

FINANCING OF GOVERNMENT EXPENDITURE

One of the principal challenges to government expenditure growth is the management of public finances, which has gained greater importance because of the need for controlled expansion of the public sector. In traditional public finance, government first determines its expenditure in the light of economic and social objectives and then attempts are made to locate sources of funds to meet the proposed expenditures. This is unlike private expenditure where available resources may be generally known beforehand. In modern public finance, this distinction is not quite well established and fiscal constraints have greatly influenced government spending decisions in many developing countries (Dudley and Montamarquette, 1992). We assume, for the present analysis, that these decisions are largely dependent on the politicians’ perception of social and economic needs of a country and taxpayers’ perception of emerging benefits from government spending. Taxes account for the bulk of the revenue sources on the recurrent account of the budget. Other sources are non-tax revenues and grants. Borrowing, however, is undertaken principally to meet the excess of aggregate expenditure over current revenues and grants and is, therefore, an important instrument for financing budgetary deficits. In modern public finance stemming principally from the writings of Keynes, budget deficits have assumed special significance as a fiscal instrument, which accords borrowing a more important role in financing government spending. Borrowing includes bond finance (issue of government bonds to raise resources from the public and from financial institutions, that is, market borrowing), loans from the central bank and external loans. Any decision to produce a deficit budget would thus amount to using tax and borrowing as either substitutes or complements. (For relevant discussion and empirical results on this issue, see Nath and Sobhee, 1995.) We discuss in this section the growth of budgetary deficits, the pattern of deficit financing and emerging policy issues.

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Shyam Nath Table 8.4 Fiscal Year

159

Trends in budgetary deficits (Rs million)

Revenue Deficit

Budgetary Deficit

Primary Deficit*

1980–81

-362.1

-1,293.2 (13.7)

-831.8

1985–86

-357.2

639 (3.7)

+1,708.2

1990–91

+501.5

-703.6 (1.6)

+1,129.4

1991–92

+275.0

-1,231.0 (2.6)

+580

1992–93

+700.8

-1,031 (1.9)

+484

1993–94

-200.6

-1,458 (2.4)

+359.7

1994–95

-1,469.1

-2,427 (3.7)

-266.1

1995–96 (RE)

-3,120.0

-4,349.0 (6.0)

-1,890.9

- deficit. + surplus. * Budgetary deficits excluding interest payments. RE: Revised estimates. Figures in brackets are percentage of GDP. Source: Bank of Mauritius, Annual Report, various issues.

Budgetary Deficits and Modes of Financing There are various methods of computing the budget deficit, depending on the objectives that an analyst has in mind (Blejer and Cheasty, 1991). Further, the measurement of deficit can be attempted in nominal or real terms (see Chelliah, 1973; Barro, 1984). However, governmental accounting practices report calculations of current account, capital account and overall deficits. A revenue deficit refers to the gap between total current expenditure and total current revenue (tax and non-tax revenues) and grants. The overall deficit refers to the gap between aggregate expenditure (disbursements: revenue plus capital) and aggregate revenue receipts (on current and capital accounts). It is important to note that excepting a few years, there were deficits on the recurrent account (Table 8.4). This trend can be

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Table 8.5

Trends in financing of aggregate spending (percentages) Deficit Finance

1981 1985 1990 1993 1994 1995

Tax Finance

Central Bank

Commercial Banks

Public Borrowing

External Borrowing

61.0 74.7 91.3 90.6 85.8 63.0

20.0 -8.3 -11.3 -16.4 9.1 -5.0

-4.7 0.7 13.2 26 1.9 12

4.5 4.1 1.7 -7.1 -9.0 9.7

23.9 16.9 -1.9 -2.6 -0.7 13.5

Note: Negative figures indicate repayments. Source: IMF, Government Finance Statistics Yearbook, various issues.

explained in terms of substitution between different sources of funds, particularly tax and loans (Table 8.5). The share of total taxes, which constituted about 90 per cent of total resources raised to finance total expenditure, declined to 63 per cent in 1995. The reduced reliance on tax finance is seen in the enhanced borrowing both external and internal, which are important instruments of deficit financing. The government has systematically borrowed in the money market to tap the excess liquidity. Further, in recent years, the government has also raised loans in the external market to meet the financing requirements of infrastructural projects. Thus, the existence of overall deficits after 1981 are due to deficits on both the accounts, and loan financing has been resorted to not only meet the capital needs of developmental programmes but also for government consumption expenditure. It can be observed that overall deficits have constituted less than three per cent of GDP till 1993–94, which cannot be considered a high figure. But deficits have increased to more than five per cent of GDP in 1995–96 and have tended to increase in recent years. It is also customary to analyse budgetary deficits by excluding interest payments, which gives primary deficits. According to our calculations, it is disheartening to note that the previous primary surpluses have been converted into deficits in recent years (Table 8.4). This trend in primary deficits would have a telling effect on the stabilisation objective.

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161

PERFORMANCE OF EXPENDITURE POLICY

The growth of aggregate expenditure would have significant linkages for budget deficits, balance of payments, economic growth, income distribution, and employment. An empirical assessment of the impact of expenditure policy would, however, be severely constrained because of the simultaneous operation of different economic and social policies in the economy. Any examination of the economic effects of government expenditure would need a general equilibrium framework. Nevertheless, some insight can be derived from simple partial equilibrium analysis. Growing government expenditures unaccompanied by higher tax revenues would produce overall budgetary deficits. To examine the link between government expenditure and budgetary deficits in Mauritius, we regressed the budget deficit as a proportion of GDP (DEF) on per capita GDP, expenditure (TG) and tax revenue (TAX).2 DEF = 53.2 + 1.24 TG - 0.985 TAX - 0.057048 GDP (t) (1.107) (13.9) (-9.77) (-2.65)

¯ 2 = 0.89 R

F = 69.7

DW = 1.7227

From the above results, the relative efficacy of tax and expenditure policies in controlling deficits can be compared. We find that expenditure reduction would prove to be more deficit reducing. Thus, there is a need to cut government current expenditure, which will also release resources for investment purposes. This will also reduce the reliance on taxes, which can have disincentive effects. This result in fact confirms the typical structural adjustment approach whereby spending cuts are found more efficient in curbing the growth of budgetary deficits. Government expenditures particularly on education and infrastructure would contribute to economic growth by complementing the private production initiative. Government expenditure on education, health and social services would significantly contribute to improving the quality of human capital. Social expenditures and taxes, such as pensions and personal income tax are likely to reduce inequality. It is, however, contended that these taxes are distortionary because they interfere with work and investment decisions, having an adverse impact on growth. Indirect taxes, government consumption expenditure, particularly on wages and salaries, borrowing from the central bank and from commercial banks may destabilise prices.

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Theory and evidence are inconclusive in explaining the consequence of the expansion of government spending on economic growth. There does not seem to be a strong relationship between the ideology underlying the public sector and economic performance. Moreover, economic theory does not provide a fully developed methodology that incorporates government spending in standard growth models. Nevertheless, two principal channels can be identified through which government activity may influence economic performance. First, government spending, particularly investment, may provide goods that enter directly into private sector production; examples include education and infrastructure. Second, government spending may correct for any market failure and provide essential public goods. Available empirical evidence, however, does not reveal any strong relationship between government spending and economic growth in developing countries. (For a good survey of empirical studies, see Lindauer and Velenchik, 1992.) Regressions with government spending as one of the arguments have not found a significant impact on the growth rate of the economy. However, attempts to explain the impact of government expenditure on growth have been better captured by dividing aggregate expenditure into productive and unproductive. Devarajan and others (1993) found that governments in developing countries have been misallocating public expenditure in favour of capital expenditure at the expense of current expenditure. These results show that productive capital expenditure, when used in excess, could become unproductive. Nevertheless, results based on tests of the crowding out hypothesis have invariably established a significant positive relationship between private and public investment. (For interesting results on the productivity of government expenditure, see Aschauer, 1989, and Sturn and Hann, 1995.)

8.6

CONCLUSION AND POLICY IMPLICATIONS

The aim of the expenditure policy is to allocate resources for the provision of public goods, which helps the division of total resources of an economy between the public and private sectors. Thus, the appropriate role of the public sector should depend on the technical grounds to provide public goods. The extension of the public sector beyond the provision of public goods would largely depend on

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ideological and political considerations. While governments exist with the above explicit objective, macroeconomic objectives of growth, income distribution and stabilisation have been considered equally important. In an open economy like Mauritius where structural adjustment and liberalisation policies constitute the core of the development strategy, it is not surprising that the share of government expenditure in GDP has fallen. The government has tended to retire from economic sectors. There are sectors, such as transport and communication, which have developed more as off-budget government activities, that is, in the operations of parastatal corporations. Further, the government has grown more as a welfare state by raising the expenditure on social security, education, and health. The potential link between expenditure and budgetary deficits has major policy ramifications. The deficit-raising potential of expenditure outweighs the negative impact of taxation. If the country has to choose between expenditure reduction and taxation as a measure to reduce the budgetary deficits, the expenditure route seems to be more promising. The tax route should have very limited avenues as it would be creating more disincentives for investment. There is a need to adopt consistent policy changes in the public expenditure mix. It may be important to note that recurrent expenditures produce a stimulating impact on imports, which add to the current account deficits. The size of the capital budgets should increase further, provided selective domestic and external borrowings are encouraged to finance the emerging capital needs of infrastructure development. These measures should be accompanied by a mechanism to monitor overall fiscal discipline using the inflation rate as a regulator. However, it should be emphasised that the efficacy of government expenditure in general and capital expenditure in particular should be examined in relation to the growth of the private sector. It is worth noting that government interventions in various forms seem to have crowded out investment in the private sector. Given the crowding out possibilities, a more pragmatic approach towards government budgets would improve our understanding of macroeconomic implications of expenditure growth. The objective should be to further reduce the role of government as an economic enterprise. The success of the public expenditure policy has been firmly established on the social welfare front in terms of improvement in employment and income distribution. We have seen that both exports and

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164

capital expenditures have increased income inequality. But exports have increased employment. Given the fact that employment is an important means of reducing income inequality, the objectives of expenditure policy can be oriented towards creating a favourable climate for exports. Further, the social orientation of budgets as well would need to be promoted as a second line of defence for correcting social imbalances. The role of government is indeed vital in education and health both on grounds of human capital formation and quality of life.

Notes 1.

2.

Expenditure elasticity was estimated for Mauritius by regressing government expenditure on GDP in double log form for the period 1968–93. A value of 0.97 was obtained, which does not confirm Wagner’s Law. We have employed the standard regression approach to assess the impact of expenditure on various macro- and micro-variables. We performed the tests for stationarity and co-integration in time series data for about 25 years, but these tests did not support any long-term relationship between them. However, recognising that small sample properties of these tests are not known we have relied upon OLS estimates.

References ASCHAUER D.A. (1989) ‘Is Public Expenditure Productive?’, Journal of Monetary Economics, 23, 177–200. BARRO R.J. (1984) Macroeconomics (London: McGraw-Hill). BLEJER M. and CHEASTY A. (1991) ‘The Measurement of Fiscal Deficits: Analytical and Methodological Issues’, Journal of Economic Literature, 29, 1644–78. CHELLIAH R.J. (1960) Fiscal Policy in Underdeveloped Countries (London: McGraw-Hill). CHELLIAH R.J. (1973) ‘Significance of Alternative Concepts of Budget Deficit’, IMF Staff Papers, 20, 3. DEVARAJAN S., SWAROOP V. and ZOU H. (1993) ‘The Composition of Public Expenditure and Economic Growth’, Journal of Monetary Economics, 37, 2, 3313–44. DUDLEY L. and MONTAMARQUETTE C. (1992) ‘Is Public Spending Determined by Voter Choice or Fiscal Capacity?’, Review of Economics and Statistics, 74, 3, 522–29. FRY M.J. (1997) ‘In Favour of Financial Liberalisation’, Economic Journal, 107, 754–70.

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HENREKSON M. (1993) ‘Wagner’s Law-Spurious Relationship?’, Public Finance/Finances Publiques, 48, 2, 406–16. LINDAUER D.L. and VALENCHIK A.D. (1992) ‘Government Spending in Developing Countries’, The World Bank Research Observer, 7, 1, 59–78. LUCAS R.E. (1988) ‘On the Mechanics of Economic Development’, Journal of Monetary Economics, 22, 1, 3–42. MUSGRAVE R.A. (1959) The Theory of Public Finance – A Study in Public Economy (London: McGraw-Hill). NATH S. and SOBHEE S.K. (1995) ‘Foreign Aid and Public Fiscal Behaviour: a Case Study of Mauritius’, paper presented at the World Econometric Congress held at Keio University, Tokyo, August 22–29. PEACOCK A.T. and WISEMAN J. (1961) The Growth of Public Expenditure in the United Kingdom (Princeton: Princeton University Press). ROMER P.M. (1986) ‘Increasing Returns and Long-Run Growth’, Journal of Political Economy, 95, 5, 1002–37. STURN J.E. and DE HANN J. (1995) ‘Is Public Expenditure Really Productive?’, Economic Modelling, 12, 1, 60–72.

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9 Agriculture and Sugar Wyn Morgan

9.1

INTRODUCTION

Given fertile soils and a climate that is conducive to good growing conditions, it is not surprising to find that Mauritius is a large producer of agricultural products. What is remarkable, though, is the manner in which just one crop – sugar – dominates the output of this sector to such an extent that in many respects Mauritius is a monoculture economy relying very heavily on the production and export of sugar. The undiversified nature of agricultural production implies that the export revenues generated by the sector are highly susceptible to fluctuations in the world price of sugar creating large potential problems for the macroeconomic stability and growth of the economy. Given the occasional occurrence of freak weather such as cyclones, this is an important issue for producers and the economy as a whole. While sugar output overshadows all other agricultural products, it is not large enough to ensure that Mauritius becomes a dominant or large economy in the world market. Thus, as it is a price taker, it has to accept the price that the world market generates, although as a signatory to the Sugar Protocol of the Lomé Agreement, Mauritius is afforded some insulation from the worst of these effects. This chapter will highlight the role of agriculture in general, and sugar in particular, within the Mauritian economy. In doing so it will provide not only an outline of the specific features of this one market but it will also show the workings of world sugar policies and how these have affected the allocation of resources in the sugar sector around the world. The implications for future production should these policies change are significant and must be addressed with some urgency by countries such as Mauritius which rely heavily on the export revenues that sugar generates. In Section 9.2 an overview is presented of the agricultural sector in Mauritius and in particular it highlights the dominance of sugar in the sector’s total output. Section 9.3 then continues with the idea of a near 166

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Wyn Morgan

167

monoculture production structure by exploring the way in which reliance on one crop to generate export revenues can leave a country exposed to world price volatility and hence macroeconomic uncertainty and instability. Section 9.4 examines the world sugar market and the policies that dominate it while section 9.5 provides a prospective view of the sugar industry in particular and the implications for the Mauritian economy in general. A concluding discussion is offered in section 9.6. 9.2

AGRICULTURE AND THE MAURITIAN ECONOMY

The natural advantages afforded to Mauritius by its climate and geographical location mean that it is a fertile and productive island leading to a dominance of economic activity by agriculture. However, its tropical climate also brings the threat of tropical storms and cyclones that can be devastating to agricultural production. The impact of agriculture on the Mauritian economy is evidenced by an examination of some summary statistics. As Table 9.1 shows, the share of agriculture in GDP has been declining since the mid 1980s, which perhaps reflects recent policy emphasis on diversification towards manufacturing. Indeed, what is striking is the apparent success of this process of structural adjustment at moving Mauritius away from what was essentially an ossified monoculture framework to a more diversified and flexible economic structure. Figure 9.1 gives an indication of the declining participation rate in agriculture. The numbers of workers employed by the sector have declined from about 80,000 in 1972 to roughly 60,000 in 1997. At the same time, there have been large increases in employment in the other two sectors, most notably in the tertiary (tourism) sector. These figures

Table 9.1

Agriculture Secondary Tertiary

Sectoral share of GDP in Mauritius (%)

1976

1980

1985

1986

1987

1988

1989

1990

1997

23 – –

12.4 25.9 61.8

15.3 29.2 55.5

15.3 31.6 53.2

14.6 32.5 52.9

13.2 32.5 54.2

12.5 32.3 55.2

12.3 32.3 55.4

8.9 31.9 60

Source: CSO quoted in World Bank (1992) and at http://ncb.intnet.mu/cso/fragrticu.htm.

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168

Agriculture and Sugar

250.0

200.0

150.0

100.0

50.0 1972

1983 Primary

Secondary

1990

1997

Tertiary

Figure 9.1 Employment in Mauritius (000s) Source: CSO Mauritius web page http://ncb.intnet.mu/cso/fragricu.htm

serve to emphasise the move away from the land to the more dynamic, younger sectors of the economy as highlighted in Chapters 4 and 5 of this book. The concentration of resources in the agricultural sector over time has entailed a high level of production. Table 9.2 gives some raw indices of production (as well as adjusting them on a per capita basis) since 1985. It is apparent from the data that food and agricultural production have generally been quite stable although they do implicitly show the impact that weather changes might have on production as well. While not shown in this table, freak weather, such as the cyclones of 1975 and 1980 or the extremely good growing conditions of 1973 and 1974, all impact greatly on output and move it away from the relatively stable average. The small population of Mauritius in relation to output means that there is surplus which is available for export. Table 9.3 shows the contribution that agricultural exports make to total Mauritian export revenues. In 1995, for example, agriculture contributed some 27 per cent of revenues, which consisted almost entirely of sugar exports and to a much lesser extent, fish and fish products. The proportion accounted for by agriculture has declined since the 1980s and even since 1990 when approximately 32 per cent of export revenues were generated by the agricultural sector.

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Wyn Morgan Table 9.2

169

Indices of agricultural production in Mauritius

Agricultural Output Index

On per capita basis

Food Output Index

On per capita basis

98.7 105.3 106.4 98.8 96.5 101.1 102.4 106.8 105.3 100.4 100.1 103.7

102.8 108.7 109.1 100.6 97.4 101.2 101.4 104.7 102.0 96.1 94.7 97.1

96.2 103.3 105.4 97.5 96.3 101.3 102.4 107.1 105.3 101.0 102.1 107.3

100.1 106.6 108.0 99.2 97.2 101.3 101.4 105 102.1 96.7 96.6 100.4

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

Source: FAO Yearbook (various): 1989–91 = 100.

Table 9.3

Manufacturing Exports Imports Agriculture Exports Imports

Mauritian trade (100,000 US$)

1990

1991

1992

1993

1994

1995

11,724 16,093

11,968 15,605

12,956 16,170

13,105 17,282

13,260 18,970

15,370 19,590

3,792 2,046

3,646 2,069

4,017 2,265

3,673 2,326

3,669 2,739

4,149 3,102

Source: FAO Yearbook (various).

With specific reference to the sugar sector, Table 9.4 gives recent trade volumes and values for both imports and exports although it is only the latter that is of direct relevance here. Indeed, when comparing Table 9.3 with Table 9.4, it becomes apparent that the revenues generated by sugar exports constitute almost the entire agricultural sector export revenues. Any analysis of Mauritian agriculture is necessarily going to focus most heavily on the sugar sector, but there are many other outputs

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Table 9.4

Mauritian sugar trade

Exports

1993 1994 1995

Imports

Volume (100 mt)

Value (10,000 US$)

Volume (100 mt)

Value (10,000 US$)

5,351.6 5,187.8 5,238.9

33,063 32,150 36,689

1 – 202.1

1 – 910

Source: FAO Yearbook (1997).

that the sector produces primarily for domestic consumption. In terms of land area given to sugar production, some 76,000 hectares were planted in 1996, producing some 560,000 metric tonnes suggesting an average yield of 73.7 tonnes per hectare (FAO, 1997). In contrast to this, roots and tubers, pulses, coconuts and tea constitute only some 10,000 hectares; vegetables and melons however are more prevalent with approximately 56,000 hectares being planted in 1996. The yield of these crops is quite low and thus production is used to meet domestic demand only and no surpluses exist for export. Production of livestock in 1996 was limited to 34,000 head of cattle, 12,000 pigs, 95,000 goats, 7,000 sheep and 3,000 chickens. In the same year, milk production stood at 25,000 tonnes, egg output amounted to 5,000 tonnes and hay production was 3,000 tonnes. All of these products were consumed almost exclusively in the domestic economy with a growing proportion being accounted for by the tourist sector (FAO Yearbook, various years). In summary, the Mauritian agricultural sector has traditionally dominated the domestic economy both in terms of employment and export revenue generation. Such a situation was the result of the production and export of sugar that dominates the agricultural sector. In recent years, employment in agriculture has declined as the Mauritian economy has adjusted its output mix to encourage greater manufacturing output. However, the role of sugar as a major earner of export revenue has not diminished although its contribution to the island’s revenues has been variable due to the unusual crop years of the mid 1970s (booms) and then 1975 and 1980, where cyclones hit production badly. As the international policy environment alters, the Mauritian economy may be further exposed to greater price and

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revenue risk and thus may face difficulties in pursuing structural adjustment. The rest of this chapter, therefore, will focus solely on the sugar market and the implications of relying on it as an export revenue earner for Mauritius.

9.3

MONOCULTURE AND ITS PROBLEMS

The reliance on the production of sugar to generate the bulk of export revenues in Mauritius would not be a problem if there were a guarantee that the output and the level of demand could be known with certainty each season. If such a case existed, then prices would be known with certainty and hence revenues could be determined with very little risk. Obviously, this is a very naive view of the world, particularly when considering a soft commodity like sugar, the production of which is highly dependent on an uncontrollable factor, the weather. Consequently, reliance on the sales of sugar abroad places the Mauritian economy in a potentially vulnerable state since if prices were to plunge then revenues would plunge and the government could face a budget crisis if it treated the slump as permanent. In turn, many of the plans for developing manufacturing and the island’s infrastructure would be imperilled and hence growth would be restricted if not reversed. Thus, in very simple terms, over-reliance on one commodity, particularly a ‘soft’ one, may expose the producing nation to significant price and income risk. The movement of primary commodity prices can be viewed as important in both the long- and short-run. In the long run, it is argued that the terms of trade for primary commodities are declining although this is not universally agreed. The implication of this is that export revenues buy fewer and fewer manufactured imports, even if prices of primaries remain the same, which has significant implications for growth. In the short-run, volatility of prices can have a huge impact on revenue generation and hence on government revenues. For example, the volatility of sugar prices has increased greatly in the 1980s, with prices ranging between 2.5 and 41 cents/lb in that time. The effects of volatility are most keenly felt in less developed countries (LDCs) even though developed market economies (DMEs) are large producers, and dominant consumers, of primary commodities. Many LDCs rely heavily on one or two commodities for export revenue generation such as Uganda with coffee, Nigeria with oil and

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Mauritius with sugar (Sapsford and Morgan, 1994, p. 1). Reliance on the export of one or two commodities to generate earnings is risky if prices are prone to be volatile. The low income and price elasticities of demand for primary commodities in DMEs and the volatility of supply, particularly of soft commodities, create the possibility for prices to fluctuate wildly from one season to the next. The problems this can create for what Radetzki (1990) called a ‘monoeconomy’ may be quite severe. Maizels (1994) illustrates how volatility has increased since the Second World War and especially in the late 1980s and early 1990s. Table 9.5 gives the volatility of prices for several widely traded primary commodities and it is apparent that it is not insignificant. Such swings in prices create uncertainty of price for producers which inhibits rational planning and investment in the technology needed to improve output and product quality. The prices of manufactured goods have tended to be less volatile over the same period, partly due to the greater certainty in supply (not weather affected) and also due to a greater price and income elasticity demand for such products. Such volatility is not generally welcomed by either producers or consumers of primary products. Consumers, in general the DMEs, fear that potentially high commodity prices will feed into higher production costs of manufactured goods that use commodities as inputs. This in turn may result in higher final good prices and the response of workers to seeing their real wages fall might be to press for higher wages. The potential for inflation to then spiral is a real one and may require monetary and fiscal policy adjustments to deal with it. A good illustration of this came with the oil price shocks of the 1970s where heavy dependency on oil meant that demand was very price inelastic. Companies using oil as an input had to raise prices to cover soaring Table 9.5

Price range of selected commodities (1982–92) Min

Sugar Coffee Cocoa Copper

2.5 60 49 58

Max (cents/lb) 41 303 147 159

Source: UNCTAD (1993) derived from Maizels (1994).

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costs that created wage pressure from labour and resulted in much higher levels of inflation in the DMEs. While the opposite may also be true – falling commodity prices might ease inflationary pressures (as seen in the mid-1990s) – the uncertainty of which state will materialise is of great concern to DME policymakers. Similarly, exporters of primary commodities will be concerned about volatility. Export revenues are crucial for growth, especially in LDCs, so price falls, which will cut earnings and will be harmful to the producing nation. The response of both parties to the high degree of uncertainty was to seek ways of limiting the effects that it may have on their economies. Policy options included international action, such as the establishment of International Commodity Agreements which aimed to control supply to the market, or providing compensatory finance to the LDCs to cover shortfalls in export revenues arising from lower world commodity prices. Schemes here included the IMF’s compensatory scheme and the EU’s STABEX. Domestic policy measures have tended to focus on devising parastatal marketing boards that have the remit, based on being non-profit maximising, to shelter domestic producers from world price shocks. However, the boards are often highly expensive to operate and can be open to corruption and great inefficiencies. Unsurprisingly, for those countries that rely heavily on commodity exports, the degree of volatility exhibited by commodity prices and the failure of policy to provide an adequate response to it is of major macroeconomic concern. If, in turn, the country is a monoeconomy, then the problems are even greater and have a more fundamental impact on the particular macroeconomy. Radetzki (1990) shows (p. 159) that an economy which relies heavily on one commodity for trade faces three key problems: first, how much revenue should be raised from the export sector, second what rate of tax should be applied that will ensure high revenue flows but not strangle the sector and finally, how will the economy cope if there are shocks to the export market? In general, most LDC governments have seen themselves as the main actors for the promotion of economic growth and have sought to increase public expenditure to finance investment. Increased expenditure has to be met by increased revenues unless the economy is to move into serious debt problems. Thus, it is rational policy on the part of the government to tax the sectors that are high earners and these are usually export revenue generating sectors. The problems that this

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causes, however, become apparent when public expenditure begins to grow more rapidly than the export sector or when the earnings from the export sector are shocked by changes in world prices. Indeed, it is this last point which is crucial for developing nations. There is not only a risk of earnings collapsing if prices fall but there is also a danger of ‘Dutch’ disease effects of the price of the commodity booms (see Bevan, Collier and Gunning, 1993). Clear examples of where this has occurred are for coffee in Kenya, copper in Zambia and oil in Nigeria. The response of the government and the private sector to such price shocks is a major determining factor in whether the boom can be seen as a useful windfall in aiding growth rather than a permanent change in income for the country. In the section on sugar markets below, evidence is presented which explores the Mauritius response to the price boom in sugar in the 1970s. Blake et al. (1995) examine the Mauritian economy using a computable general equilibrium (CGE) framework based on two- and three-sectors models of the economy. The main aim of their work was to demonstrate what the effects of a price shock for sugar might be on the trade and non-trade sectors in the two-sector model and to what extent a rise in the price of all exports might have in the threesector model. Special reference in each case is made to the export processing zone (EPZ), an initiative which aimed to boost exports of non-traditional goods as part of the structural adjustment programme (see Chapter 4). Their results suggest that a shock in the two-sector case generates rapid over-heating of the domestic economy and non-tradable prices while in the three-sector model, the traditional (sugar) sector expands at the expense of a shrinking EPZ while factor prices and nontradable prices increase. The main driving force behind this is the increase in unit costs which can be borne by the profitable booming sugar sector but can’t be absorbed by the tightening of margins in the EPZ and so factors move out of the EPZ and into the sugar sector. Thus, the private sector response in this type of model suggests that factors will respond to price shocks by moving to the booming sector although the speed of adjustment depends on the type and quality of the factor as well as its importance in the production process. Having outlined some of the pertinent issues in commodity markets in general, the focus will now switch towards the sugar market in particular, with specific reference to Mauritius.

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175

THE WORLD SUGAR MARKET

Mauritius and World Sugar Prices Figure 9.2 shows the movement of world sugar prices from 1950 to 1992 which, even from a casual glance, suggests that prices have been less than stable. World prices rose sharply in the mid-1970s. A decline in 1975 was followed in 1979 by a further sharp increase only for prices to fall again in 1981. The major 1972–75 shock came from both demand and supply factors (Greenaway and Lamusse, 1994). On the demand side, prices of many commodities had been stimulated by the strong industrial sector demand in DMEs in that same period and some re-stocking occurred in 1974/5, which maintained upward price pressure. Perhaps more significantly for the sugar market, there were concomitant supply side effects. In particular, Cuba had a very poor harvest reducing world supplies sharply and thus forced Russia, the main purchaser of Cuba’s supplies, to buy on the world market, which pushed prices upwards. The influence that the Russian buying had on the world market price is not an indication of the size of Russian

500 400 300 200 100

Figure 9.2 World sugar prices, 1950–92 Source: reproduced with the permission of Elsevier Science from World Development, vol. 22(11), 1994 (Morgan et al. ‘Price Instability and Commodity . . .’ , fig. 3)

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

1968

1966

1964

1962

1960

1958

1956

1954

1952

0 1950

(1990 = 100)

Real sugar price index

600

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consumption, although it is considerable, but more a reflection that the world market for sugar is essentially a residual market. Most of the world’s sugar production is sold on to consumers through agreed deals and contracts, particularly via the sugar protocol of the Lomé Agreement. Given these movements in world prices, how have the government and producers in Mauritius responded to them? Greenaway and Lamusse (1994) examined the effects the 1972–75 boom had on Mauritius, the reasoning for focusing on this particular period being that its effects were so dramatic. Mauritius was heavily dependent upon sugar at that time (80 per cent of exports) and the government gained 10 per cent of its revenues from the sector. Sugar generated 30 per cent of GDP and 40 per cent of employment thus highlighting the monoeconomy nature of the island at that time. Greenaway and Lamusse suggest that the shock had a present value effect of some 6 per cent of GDP. Greenaway and Lamusse (1994) suggest that the sugar boom provides a clear example of a significant but temporary shock to the economy. Other factors, such as the influence of the Export Processing Zone and the oil price hike can be discounted as being negligible (p. 3). Not surprisingly, there was a huge windfall effect on incomes in the sugar sector which Greenaway and Lamusse calculated the gains in the peak year to range between 19.5 per cent and 25 per cent of GDP. To convert this into permanent income terms, a discount rate of 8 per cent was applied giving a gain between 3.25 per cent and 6 per cent of GDP, still a very significant shock. Private sector savings also responded to the boom with the result that the savings ratio increased over the period above trend, highlighting the fact that agents perceived the boom to be temporary rather than permanent. The ratio of private sector investment to GDP showed a significant change in the mid-1970s but lagged the changes in the income and savings of the private sector. This suggests that investors were seeking ways to prolong the effects of the boom and thus stretched investment to try and achieve this aim. The interesting feature, though, is that the increased investment was not simply a ‘plough back’ into the sugar sector, but was more a spread across other sectors such as construction for tourism. In general terms, therefore, it could be stated that the sugar boom in the 1970s had the effect of raising private sector incomes but also generated higher savings and investment, the latter two features suggesting that agents believed the shock to be temporary. How then

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did the public sector respond, given that the type of response was crucial to the short-run and long run effects of the boom? Greenaway and Lamusse suggest that the government, like the private sector, believed the boom to be temporary and indeed resisted pressure to join calls for re-negotiation of the Lomé agreement or to switch sugar from guaranteed contracts to world market sales to take account of higher prices. As a major source of government revenues, the sugar sector provided a boom for government coffers in the mid-1970s, with sugar tax revenues rising to 17 per cent of GDP in 1974, compared to an average of around 8 per cent normally. However, it was not simply a question of fiscal drag that raised these revenues: the government imposed a special levy on individuals of 15 per cent and corporate taxes were augmented by a special 10 per cent surcharge. Further, exports were taxed on a sliding scale of 6 to 9 per cent rather than the flat-rate 6 per cent as previously occurred. In effect, the government was seeking to absorb some part of the windfall, again suggesting their belief that the boom was temporary. The government not only increased revenues but also increased its expenditures. Most of the increase went on current rather than capital expenditure, with particular increases in rice and flour subsidies and public sector emoluments via pensions and wages increases. The latter features resulted in an increase in recurrent expenditure and created problems for the economy in the late 1970s. The final aspect of the response of the Mauritian economy is that of the policy regime. Up to and including the sugar boom of the mid1970s the main trade policy had been protection via high nominal tariffs and hidden tariffs existed also, as well as the tax on sugar exports. Financial and exchange controls were extensive and, when coupled with the anti-export bias of the trade regime, it is not surprising that the sugar boom led to a boom in the construction industry as there were few alternative areas for investment. Greenaway and Lamusse posit that there was no boom-induced policy response and that if anything trade policy become more restrictive after the boom. However, the financial commitments made by the government put the economy under severe strain in the post-boom years with the result that Mauritius had to turn to the IMF and World Bank for help (see Chapter 4 for a discussion of structural adjustment). Indeed, it was the treatment of revenue increases as permanent by the government that led directly to this crisis. In this regard, Mauritius was not dissimilar to other boom economies.

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In conclusion, the boom in sugar prices was significant for Mauritius. The private sector appeared to have estimated correctly that this was a temporary phenomenon and while initially it appeared that the government thought the same, subsequent expenditure changes belied this as they implied a belief in a permanent change in national incomes. This mixed response is in some senses in line with findings from other countries that experienced commodity booms (Bevan, Collier and Gunning, 1993). While this gives an indication of the Mauritian response to a shock in the world price of sugar, it has ignored a key element of that market and that is the policy environment. It is important to understand the context in which producing nations operate, although as Greenaway and Lamusse suggest, the impact of policies in the mid-1970s was of negligible importance in determining the response of the Mauritian economy. However, for other countries this might not be the case and certainly the boom of the 1980s had little impact on Mauritius precisely because of the guaranteed market effects of the Lomé Agreement. World Sugar Policies The recognition of this residual nature of the world sugar market allows for a clearer understanding of why, for example, the 1980 sugar price rise had little impact on many producer nations. Most were signatory nations to the Lomé Agreement and as such received guaranteed prices for their output. In 1980, the guaranteed price lay below the world price and while this entailed producers missing a windfall gain, it did mean that they had some certainty of revenue flows not only in this year but in other less extreme price years. The lower revenues in 1980 were also exacerbated by the damage caused by cyclones that devastated the sugar crop. Most producer nations are signatories to the sugar protocol of the Lomé Agreement which is a formal ‘contract’ between some of the world’s major consuming nations (the EU) and the producing nations of the ACP countries (African, Caribbean and Pacific). In 1997, there were 70 ACP members whose populations, when combined with those of the 15 EU countries, comprised 17 per cent of the world’s population. In effect, it is the ‘largest and most comprehensive development partnership outside the UN’ (EU Commission, 1996, p. 14). In essence, the main aim of the agreement is to provide a formal mechanism by which the richer countries aid

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the development process in the developing countries either directly through aid or indirectly through trade agreements and trade promotion. Particular emphasis is laid on remedying the problem of export revenue instability in commodity and mineral markets. Explicitly Article 186 of the agreement states: With the aim of remedying the harmful effects of the instability of export earnings and to help the ACP States overcome one of the main obstacles to the stability, profitability and sustained growth of their economies, to support their development efforts . . . a system shall be operated to guarantee the stabilisation of export earnings derived from the ACP States’ exports to the Community or other destinations. (p. 52) The original Agreements were drawn up on the basis of European links with former colonies but as the EU (then EC) developed, a more formal system was devised. This was instigated in the early 1970s and culminated in the Lomé 1 Agreement of 1975. Since then, there have been another three Agreements, the latest (IV) being signed in Mauritius in November 1995. The aims have essentially remained the same but periodic adjustments have been undertaken to ensure that compromises between the two parties can be achieved. Central to the operation of Lomé are two key instruments of policy. First is that exports from the ACP countries are not subject to tariffs when arriving as imports in the EU. In addition to this preferential treatment, there exists for some commodities a guaranteed export market in the EU. This policy, which is central to the sugar protocol section of the Agreement, usually operates by allowing exporters specific quotas on the amount they can export each year. The second instrument is that of financing to help shortfalls in the export earnings of specific commodities. Known as STABEX, this system has been in operation since 1975 and differs from the IMF’s Compensatory Financing Facility (CFF) in that it does not try to stabilise the entire export earnings of an economy and it includes greater emphasis on redistribution of funds once they are paid.1 In essence, the STABEX is an ex post system of funding such that if an ACP country has a shortfall in its export earnings for a key commodity (defined in terms of proportion of exports) then it can apply to the EU for STABEX funds. These are then paid out in a series of regular instalments in the next year when, of course, export earnings may be back to a more normal level.

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This safety net policy applies to all the commodities and all countries covered in the Lomé Agreement. As the Agreement been amended over time, both the number of commodities and number of countries have risen making the potential scope of Agreement quite significant.

9.5

the has the the

FUTURE PROSPECTS

The previous sections have given a clear indication of the extent to which Mauritius relies on the production of sugar to generate both exports and income. Given the vagaries of world commodity markets and the high degree of price volatility it made good economic sense for the Mauritian government to sign-up to the Sugar Protocol of the Lomé Agreement, a move whose sagacity was evidenced by the impact of the 1980/1 sugar price shock which hardly affected the island due to the insulating effects of Lomé. However, it is apparent that trading and price agreements such as Lomé are now coming under increasing pressure from the WTO (formerly GATT) to undergo reform and perhaps in the long-term be scrapped altogether. The general tenet of the Lomé Agreement is to define trade flows by document and institutional direction as opposed to letting the market through comparative advantage decide what should be exported and to where. As such, the Agreement runs counter to the WTO’s stated aims and beliefs and is therefore vulnerable to pressure for change. Further pressures are beginning to be exerted within the EU as countries seek ways in which to reduce their contributions to the EU’s budget. A simple way of achieving this is to reduce expenditure out of the budget. While this is generally unpopular with domestic voters if they perceive that they are losing out, it is much easier and less politically sensitive to reduce spending overseas where the recipients are not voters. Consequently, a reduction in overseas expenditure would be a relatively ‘soft’ target for governments to aim for, especially when the cut can be said to be in line with pressure for policy reform emanating from the WTO. The outlook for the Lomé Agreement would, on the face of it, appear to be very poor although it has to be remembered that a new agreement was signed as recently as 1995 with an extended coverage of countries which does not suggest immediate cessation of the policy is to occur. The inertia inherent in policy reform in an area as sensi-

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tive to former colonial powers in Europe is perhaps understandable and may over-ride the seemingly more urgent concerns of the more dispassionate WTO. Indeed, it is perhaps easier for the EU to argue the case for supporting LDCs via trade agreements than it is for the WTO to make its case for scrapping them. Overall, though, there is likely to be some form of evolution in the Lomé Agreement in the near future which will have potentially major implications for the signatory nations, especially the LDC producers. The impact of policy change will be most keenly felt by those nations which are most vulnerable to world market shocks and these are generally the monoeconomies such as Mauritius. The reduction of help, either through reducing guaranteed markets or through smaller compensatory payments, could lead to financial hardship for such countries – export revenues fall, government receipts fall and the terms of trade moves against the country making the exchange rate fall and thus increasing the opportunity cost of importation. Unsurprisingly, this is a situation that many countries, not just the monoeconomies, wish to avoid and they need to seek ways of at least lessening the impact of policy reform. Put very simply, the easiest way to avoid a macroeconomic dislocation is to diversify into the production of other goods. However, this is not an easy task as has been shown earlier in this book (Chapters 4, 5 and 6) and thus while the logic and acceptability of diversification is a policy response, it is not always the one chosen. Mauritius has long realised that if it is to grow and develop it has to diversify away from sugar production. This does not mean to imply that sugar would no longer be important to the island, far from it, as the industry would still be a significant producer of export revenues and thus still highly important to the economy.What is implied instead is that other sectors of the economy should be developed so that at the margin any shocks to the sugar sector can be dealt with more readily. Thus, the switch into greater textile and clothing production has not only generated new investment and employment for the island but it has also provided a significant and growing buffer for export revenue shocks that may arise in the sugar sector. Further, it also helps to reduce reliance on imports of some manufactured products. There is an argument in some monoeconomies that resources could be switched within the agricultural sector itself rather than into other sectors entirely. In some countries this may be possible but in the case of Mauritius there would appear to be little scope for such a policy. As Section 9.1 of this chapter showed, there is little production of

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other crops that could be raised significantly beyond meeting domestic requirements. Indeed, many of the crops, vegetables and livestock could not be exported due to the lack of neighbouring markets and the prohibitive nature of the transport costs that would be applicable if markets further afield were sought. The only possible exception to this is the fish sector which shows some signs, such as the scale of production, that suggest it might be expanded into a greater export earner for the island. It is apparent, therefore, that Mauritius is perhaps pursuing the most sensible strategy it can in trying to diversify away from the reliance on sugar. There is, however, a strong need to ensure that the sugar sector does not get neglected in this search for new opportunities elsewhere in the economy. Investment needs to be maintained and the quality of the product has to be ensured at the very least and if at all possible it should be enhanced. The sector needs to maintain its export markets where possible (given the current Lomé links) and promote its image as a provider of high quality and competitively priced sugar. These targets require sensible investment and management strategies and it is crucial that these are in place if the sector is to continue to provide the bulk, if not all, of the export revenue flows for the island.

9.6

CONCLUSIONS

Mauritius is a small island but has the great natural advantage of fertile soils and a climate conducive to growing crops. This combination of features has been ideal for the establishment and development of a significant sugar production sector. Historically, this sector has always dominated not only the agriculture sector but the island’s entire economic life, forming the major part of its output value, export revenues and hence income generation. This reliance on sugar production, however, leaves the economy open to the potential for instability generated by shocks on the world market. This chapter has shown that commodity markets are inherently unstable and that producers who sell on to them face price and income uncertainty. Despite attempts at market management to try and reduce the effects of instability, most commodity markets, including sugar, have remained volatile in terms of price. Exposure to this volatility is magnified many times when the producer nation relies on the sales of only one or two products for its export revenues – the case of Mauritius with sugar in the past. Price and income shocks that can

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arise through no fault of the producer, as they are too small to affect world market prices, result in macroeconomic problems as government revenues fall, terms of trade alter and exchange rates depreciate. These are not the conditions on which governments would like to try and encourage increased growth. Mauritius’ response to one particular price shock, the boom of the mid-1970s, suggested that the outcome could be hugely damaging, even though in this case prices had risen and not fallen. The private sector appeared to have acted as though the boom were temporary whereas the government, despite initial moves to the contrary, acted as though the boom were permanent and created fiscal problems for the island which were highly damaging to growth. To try to offset the potential for such crises to arise, a policy of diversification is often advocated although the structural adjustment that this requires can be quite massive. However, the ability of an economy to spread its risk across several sectors of production rather than over one or two, suggests that shocks in one sector will have less of a destabilising effect than would otherwise be the case. In Mauritius, this has been proved by the move into textile and clothing manufacturing as an alternative source of export revenues to sugar. It is interesting to note that the performance of the Mauritian economy has greatly improved since the explicit policy of structural adjustment has occurred. It is also apparent that the policy will need to be maintained if the island is not to suffer from the reform of the Lomé Agreement that is being suggested at present. While it acts as a safety net for sugar exports and hence sugar prices/incomes, it may be the case that these features will diminish in years to come. If that were to be the case, then the Mauritian government must look at ways of limiting the impact of the policy change by continuing to support diversification into other sectors.

Note 1.

For a full and informative discussion of the STABEX and other compensatory schemes, see Herrmann, Burger and Smit (1993).

References BEVAN, D.L., COLLIER, P. and GUNNING, J.W. (1993) ‘Trade Shocks in Developing Countries’, European Economic Review, 37, 557–65.

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BLAKE, A., MILNER, C., REED, G. and WESTAWAY, T. (1995) ‘Trade Shocks and Model Dimensionality: a CGE Analysis for Mauritius’, CREDIT Working Paper (95/11), University of Nottingham, Department of Economics. EUROPEAN COMMISSION (1996) ‘Lomé IV Conventions as Revised by the Agreement Signed in Mauritius on 4th November 1995’, The Courier, no. 155, January/February. FAO (various years) Trade Yearbooks, Rome. FAO (various years) Production Yearbook, Rome. GREENAWAY, D. and LAMUSSE, R. (1994) ‘Private Sector Responses to the 1972–75 Sugar Boom in Mauritius’, paper presented to a workshop on Temporary Trade Shocks,Tinbergen Institute,Amsterdam, September 1993. HERRMANN, R., BURGER, K. and SMIT, H.P. (1993) International Commodity Policy: a Quantitative Analysis (London: Routledge). MAIZELS, A. (1994) ‘Commodity Market Trends and Instabilities: Policy Options for Developing Countries’, UNCTAD Review. RADETZKI, M. (1990) A Guide to Primary Commodities in the World Economy (Oxford: Blackwell). SAPSFORD, D. and MORGAN, C.W. (1994) The Economics of Primary Commodities: Models, Analysis and Policy (Aldershot: Edward Elgar). UNITED NATIONS (various years) Yearbook of National Accounts Statistics (New York). WORLD BANK (1992) Mauritius: Expanding Horizons, World Bank Country Study (Washington, DC).

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10 Evolution of the Financial System K. Junglee

10.1

INTRODUCTION

Financial development has been assigned a strategic importance in economic development. This is based on the theoretical underpinning that a developed financial system would lead to gains in financial resource mobilisation and allocation and thus contribute to economic growth. Financial sector reforms are ubiquitous in many less developed countries (LDCs) as interest rate determination, domestic credit controls, exchange controls, high reserve requirements, segmented financial markets, underdeveloped capital and money markets have been targets of reform. While some countries have instituted reforms at their own initiative, others have acted under the policy advice of international institutions like the World Bank and the International Monetary Fund (IMF). Financial system development has become a key ingredient in the economic stabilisation and adjustment programmes prescribed by these institutions. In Mauritius, financial system development has loomed large in the economic agenda even before the economy embarked upon a structural adjustment programme. However, a conscious policy to develop the financial system began in the late 1980s. And there has also been a shift in financial policy in the 1990s so as to develop the financial system not only to serve other sectors of the economy, but to transform Mauritius into a regional financial centre with the sector becoming the ‘fourth pillar’ of economic development after sugar, tourism and the Export Processing Zone (EPZ). This chapter analyses the major changes that have taken place in the financial system since the early 1970s. It is organised as follows: Section 10.2 raises some issues relating to financial system development and economic growth. Section 10.3 discusses the changes in financial and monetary policy regimes. Section 10.4 identifies financial 185

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sector interventions and institutional changes in the financial system. Section 10.5 examines the degree of financial development since 1970 and finally the concluding remarks and policy implications are given in Section 10.6.

10.2 FINANCIAL SYSTEM DEVELOPMENT AND ECONOMIC GROWTH The relationship between financial sector development and economic growth has led to a substantial amount of theoretical and empirical research subsequent to the pioneering works of McKinnon (1973) and Shaw (1973) and the accumulated experiences of various LDCs with financial reforms. Instead of a systematic review of the literature, an attempt will be made in this section to raise some issues relating to financial system development, which can help us to understand the changes in the Mauritian financial system. The theoretical underpinning of the relationship between financial intermediation and economic development can be traced back to Schumpeter (1911) and more recently, to McKinnon and Shaw. Subsequently, many researchers including Kapur (1976), Galbis (1977), Fry (1978, 1980 and 1995) and Mathieson (1980) have extended the literature. The endogenous growth literature has also emerged to explain the relationship between financial intermediation and economic growth. Important contributions include Greenwood and Jovanovic (1990), Bencivenga and Smith (1991), King and Levine (1993). On the other hand, another a group of researchers belonging to the neo-structuralist School has also taken position against financial liberalisation. Schumpeter emphasised the importance of the services of financial intermediaries for innovation and economic development. Goldsmith (1955 and 1968) and Patrick (1966) highlighted the contribution of the financial system to economic development basing their works on the case studies of newly advanced countries. Financial intermediation can lead to many benefits, including better financial resource mobilisation and allocation, lower costs of transactions, and better risk management. A related issue is the form of financial intermediation and the choice between decentralised financial intermediaries such as banks or centralised markets such as the stock exchange. Gurley and Shaw (1960) state that the form of financial intermediation is a function of

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the stage of development a country itself. They identify three distinct stages. In the first, there is only outside money and the absence of financial intermediaries constraining economic growth. In the second, financial intermediaries play a more important role. And finally, as the economy matures, there is a proliferation of financial instruments with the increasing importance of financial markets and emergence of ‘securitisation’ and ‘financial disintermediation’. Another issue is that of interest rate determination and interest rate policies in LDCs. McKinnon and Shaw develop a theoretical model of financial development and argue that financial systems in LDCs are ‘financially repressed’ and this has a negative impact on economic growth. ‘Financial repression’ refers to a situation when government intervenes in the financial system to impose measures such as interest rate ceilings, high reserve requirements and directed credit policies in the context of high inflation. The essential elements of the McKinnon-Shaw model are illustrated in Figure 10.1. When the real rate of interest is fixed below the equilibrium real rate R*, actual investment is limited to I1, and saving to S1. An increase in the real interest rate towards the equilibrium rate would increase both investment and savings and help promote economic growth. McKinnon and Shaw advocated financial liberalisation and development as growth-enhancing policies. A number of researchers extended the McKinnon-Shaw models of financial development taking into account fundamental issues like financial liberalisation as part of economic stabilisation pro-

Real Interest Rate Saving

R* R Investment I1 = S1

Figure 10.1

Real interest rate determination

Saving and Investment

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grammes. Recently the endogenous growth models have attempted to formalise the relationship between the financial system and economic growth. Bencivenga and Smith (1991) show that the existence of financial intermediaries led to higher growth rates. Greenwood and Jovanovic (1990) stress the role of financial intermediaries in the collection and analysis of information and in providing better advice to investors. On the other hand, the issue of whether financial liberalisation would lead to an increase in the supply of credit to firms led to a theoretical debate. The neo-structuralists emphasise the existence of informal markets that are not subject to reserve requirements. An increase in the real deposit rate would shift money from the informal markets and reduce the supply of credit to firms. Moreover, the interest rate on curb market loans would increase lending rate leading to a cost-push increase in prices and a decline in output (Van Wijnbergen, 1982 and 1983; Taylor, 1983; Buffie, 1984; Lim, 1987; Morisset, 1993). The failure of some of the financial liberalisation programmes implemented in the late 1970s and early 1980s in some LDCs has led to a reassessment of interest rate policies and financial liberalisation strategies (McKinnon, 1986). Subsequently, a number of new theoretical issues came into focus relating to institutional impediments, asymmetric information, macroeconomic stability, timing and sequencing of financial liberalisation, regulation and economic growth. These are discussed below. The structure of the financial sector influences interest rate liberalisation policy. There are many distortions in the financial markets of LDCs such as narrow capital markets; high transaction costs due to managerial inefficiency and controlled interest rates. Moreover, there are generally fewer financial institutions. This can lead to a situation of monopoly or implicit collusion in the financial sector. Some lenders may act as monopolists in relation to a pool of potential borrowers who are attached to them through a long-term customer relationship (Stiglitz, 1994). Courakis (1984) also analyses the effects of repressive policies in a monopolistic setting and compares them with a perfectly competitive banking industry. He finds that the effects of financial repression on deposit saving mobilisation depends critically on market structure. The issue of incomplete information and moral hazard in the financial system is taken up by McKinnon (1986) who assesses the failures of liberalisation programmes in Latin America and revises his early

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position on interest rate liberalisation. He suggests that ‘the government should probably impose a ceiling on a standard loan and deposit rate of interest’ to overcome the problem of banks’ moral hazard. Stiglitz and Weiss (1981) show that there are limits to which interest rates can be raised due to imperfect or asymmetric information between lenders and borrowers. The market-clearing interest rate is neither optimal nor efficient as compared with the credit-rationing level where the bank profits are at a maximum level and risky borrowers are rationed out. Macroeconomic stability is important to consider when analysing the failures of financial liberalisation programmes. McKinnon (1973) emphasised the importance of stable macroeconomic and financial conditions for the success of interest rate liberalisation. Hanson and Neal (1985) state that ‘the success of financial liberalisation programmes depends on appropriate domestic fiscal, monetary, exchange rate, commercial and trade policies’. The sequencing of financial liberalisation is another issue especially for the success of interest rate liberalisation. Villanueva and Mirakhor (1990) suggest a sequencing based on the model that highlights the impact of macroeconomic instability, imperfect information and moral hazard on financial liberalisation, as illustrated in Table 10.1. Turtelboom (1991) discusses how macroeconomic instability, oligopolistic financial markets, absence of developed capital markets, sequencing of financial liberalisation programmes and asymmetric availability of information can explain the increase in spread between lending and deposit rates and the inflexible pattern of interest rates during the transition to a market-based financial system. He analyses the case of five African countries undertaking interest rate liberalisation policies. Finally, there is the direction of causation between financial development and economic growth. Patrick (1966) argues that a positive association is insufficient in establishing causality. McKinnon (1986) also raises the same issue: Is finance a leading sector in economic development or does it simply follow growth in real output which is generated elsewhere? Demetriades and Hussein (1996) find little evidence that finance is a leading sector in the process of economic development. Most evidence seems to favour the view that the relationship between financial development and economic growth is bi-directional. Hence, the debate over the contribution of financial development to economic growth remains an unsettled issue on both theoretical and empirical grounds.

Liberalise interest rates

Step 2

Liberalise interest rates

Stabilise economy and maintain supervision; begin gradual interest rate liberalisation

UM/AS

Liberalise interest rates

Maintain economic stability and boost supervision; while enhancing supervision, temporarily regulate interest rates

SM/IS

Maintain economic stability and supervision; can liberalise interest rates simultaneously

SM/AS

Note: UM denotes unstable macroeconomy; SM stable macroeconomy; IS inadequate bank supervision; and AS adequate bank supervision. Source: Villanueva and Mirakhor (1990).

Stabilise economy and strengthen supervision while regulating interest rates

UM/IS

Country Initial Conditions

Suggested sequencing of macroeconomic and financial sector policies

Step 1

Policy Sequencing

Table 10.1

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FINANCIAL AND MONETARY POLICY REGIMES

There have been numerous financial and monetary policy shifts in the economy since the early 1970s. They provide insights into the flexible approach pursued by policymakers to move from one regime to another in order to serve the economy in its transformation from a monocrop economy in the 1970s to a newly industrialising economy in the 1980s. Moreover, in the 1990s a substantial shift in financial policy is taking place with the objective of establishing Mauritius as a financial services centre and subsequently, a number of developments have been taking place in the financial system. First of all, financial and monetary policies remain one aspect of overall economic policy and should not be regarded as independent, because their objectives are part of the overall economic objectives. It is important to distinguish between the functional and institutional aspects of monetary policy. The functional aspect refers to the management of financial resources in the economy in line with the objectives of monetary policy and the institutional aspect concerns the development of the organisational structure to promote the financialisation of savings and promotion of financial intermediation. In Mauritius, the primary objectives of monetary policy have been the maintenance of price stability, attainment of economic growth and a strong balance of payments position. The subsidiary objectives are the development of the financial system and its regulation to maintain public confidence. During the early 1970s, the objective of financial policy continued to be the establishment of a minimum financial infrastructure to promote monetisation and financial intermediation. An expansionary monetary policy was implemented to promote investment and economic growth in line with the objectives of the Development Plan 1971–75.The threat of rising inflationary pressures due to favourable balance of payments and rising aggregate demand called for a change in monetary policy in 1973. A ‘restrained credit expansion’ policy was adopted, based on both a short-term view and a secular view. The long-run view aimed at increasing the legitimate credit needs of an expanding economy while in the short-run; a control was imposed on the rate and direction of credit expansion. Given the degree of financial development and structural bottlenecks in the real sector, such a policy of long run neutral money or achieving ‘maximum feasible output and price stability’ was justified. When a policy is conducted with a view to long-run price stability at maximum feasible

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output, the other goals of macroeconomic policy are more easily attained. The ‘restrained credit expansion’ policy was reinforced in the late 1970s to redress macroeconomic imbalances in economy. The high level of budget deficits coupled with adverse international developments led to a financial crisis and to the adoption of a structural adjustment programme. Since then, a more flexible approach towards monetary policy has been observed in line with the overall objective of economic liberalisation. Financial liberalisation has become a priority for reaping the full benefits of economic liberalisation. An array of financial reforms has been implemented in order to transform our financial system into a flexible and market-based one. The sequencing of financial reforms is given in Table 10.2.

10.4 FINANCIAL SECTOR INTERVENTIONS AND INSTITUTIONAL CHANGES Policymakers have intervened intensively in the economy to liberalise and develop the financial system, which has changed remarkably from Table 10.2

Sequence of financial reforms, 1988–96

July 1988

Liberalisation of interest rates

July 1991

Issue of Bank of Mauritius Bills

November 1991

Auctioning of Bills

July 1992

Abolition of ceilings on credit to priority sectors

July 1993

Abolition of credit ceilings on non-priority sectors Imposition of a credit-deposit ratio

February 1994

Setting up of a secondary market cell at Bank of Mauritius

21 June 1994

Bank Rate linked with average Treasury Bill rate of preceding 12 weeks plus a margin

July 1994

Suspension of Exchange Control Act Establishment of an interbank foreign exchange market

July 1995

Bank rate linked with weighted average of the latest Treasury Bill auction rate

July 1996

Abolition of credit-deposit ratio

Source: Bank of Mauritius, Annual Report, various issues.

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a highly regulated to a more market-based one. Although a number of imperfections are still present in the financial system today, policymakers have been addressing different issues relating to financial development as discussed below. Instruments of Monetary Policy The choice of monetary policy in LDCs is constrained by the degree of financial sophistication, stage of economic development and political system. Khatkhate (1972) argues that an early stage of economic development, increasing the stock of money becomes imperative to promote the shift from fixed assets to financial assets. Thus, the direct regulation of credit and interest rates become the main instruments of monetary policy. At a later stage, it becomes important to develop the financial system and prepare the groundwork for shifting from direct control mechanisms to indirect-market based techniques such as open market operations and moral suasion. In Mauritius, it is important to distinguish between the two approaches towards monetary policy implementation: the system of ceilings or direct control that started in the early 1970s and the recently adopted indirect market–based techniques. Direct Control Mechanism Until the early 1990s, the central bank intervened heavily in the pricing and allocation of loanable funds. Reserve requirements, credit ceilings and administered interest rates have been the main instruments of monetary policy. Commercial banks were required to maintain reserve ratios consisting of cash in their vault or deposits at the Bank of Mauritius and non-cash liquid assets such as Treasury Bills, Bank of Mauritius Bills and Government Securities maturing within seven years. In addition to influencing the credit creation capacity of commercial banks, the maintenance of cash and non-cash liquid asset ratios was for prudential control. Table 10.3 shows changes in the reserve ratios since 1969. The total reserve ratio has increased from 5 per cent in 1969 to 33 per cent in 1988. But since July 1996, in line with the objective of deregulation, the ratio has been declining to 28 per cent in 1996 and finally, to 6 per cent as from July 1997. This is an indication of a reduction in implicit taxation on financial intermediation and a shift away from a ‘financially repressed’ economy.

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Table 10.3

Years

Changes in reserve ratios, 1969–97

Cash Ratio %

Liquid Asset Ratio %

Total Reserve Ratio %

5 8 12 12 12 12 10 8 6

– – – 13 18 20 23 20 0

5 8 12 25 30 32 33 28 6

1969–72 1973–74 1975–77 1978 1979–82 1983–87 1988 1996 1997

Source: Bank of Mauritius, Annual Report, various issues.

Credit Ceilings Credit ceilings have been another powerful tool of monetary policy introduced in 1973. It was restricted to the trade sector in 1973, and between 1974 and 1992; it was applied to the whole of the private sector. In addition to the overall credit ceilings on banks, a sub-ceiling was also imposed on the non-priority sectors. The system of quantitatively controlling the availability and direction of credit has helped to attain the objective of price stability and sustain economic growth by ensuring the flow of financial resources to the priority sectors of the economy. Moreover, with the selective credit policies, the share of credit to the non-priority sectors which was limited to a maximum of 25 per cent since July 1984 has been further reduced to 18 per cent. Credit ceilings on the priority sectors were lifted in July 1992 and virtually abolished as from July 1993. This indicates a major institutional change in the financial system and a move towards liberalisation.

Interest Rate Policy Shifts In the absence of a developed financial system, the direct regulation of interest rates became another instrument of monetary policy. Interest rate ceilings were imposed on lending and deposit rates of commercial banks. In addition, commercial banks have been pegging their

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interest rates to Treasury Bill rates and the Bank Rate fixed by the Bank of Mauritius. Given a period of high inflation and fixed interest rates, the financial system was repressed with negative real interest rates till the early 1980s. A more flexible approach was adopted as deposit rates were increased to provide a positive real return on savings. Moreover in line with the monetary policy objective of ‘restrained credit expansion’, interest rate subsidies have been granted to the priority sectors of the economy. By the early 1980s, there was a move to liberalise the interest rates with the lifting of interest rate ceilings until finally in June 1988, interest rates were fully liberalised.

Shift in Monetary Policy Implementation As financial reforms were carried out an alternative approach towards monetary policy implementation became imperative. By the early 1990s there was a shift from a direct control mechanism with reserve requirements, credit ceilings and fixed interest rates to indirect market based techniques such as open market operations and moral suasion. The development of a bill market became a major objective for the Bank of Mauritius. Treasury Bills were auctioned from November 1991 and the Bank of Mauritius also introduced the Bank of Mauritius Bills on tender. In order to further develop the bill market, a Secondary Bill Cell was set up as from February 1994. And as from July 1995, Bank rate has been linked to the latest average bill rate to move closer to market-determined interest rates.

Macroeconomic Stability A stable macroeconomic environment is a prerequisite for successful financial reform as indicated in section 10.2. In addition to adopting a gradual approach towards financial liberalisation, policymakers have pursued macroeconomic policies geared at containing inflationary pressures, promoting growth and achieving a balance of payments position. Given the continued surplus in the balance of payments and high real growth rates since 1985, the maintenance of price stability remains a primary objective. Various measures were introduced to increase savings, mop up excess liquidity in the economy and maintain fiscal discipline.

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Financial Institutions The establishment of a wide range of financial institutions constitutes a first step towards building up the financial infrastructure in the economy. In Mauritius, policymakers have intervened intensively in the financial system in order to fill the gap by promoting a variety of financial institutions in the banking, non-banking and contractual savings sectors. The Tables 10A.1 and 10A.2 in the Appendix highlight the rapid changes in the banking and non-banking sectors since the early 1970s. Commercial banks have been the most important depository institutions and main providers of loanable funds to the public and private sector. They dominate the financial sector by holding more than 70 per cent of all assets. The main feature of our banking system is that there are few banks with a heavy concentration of banking activity in two of them, namely, the State Commercial Bank (SCB) and the Mauritius Commercial Bank (MCB). Policymakers have had to address issues relating to the oligopolistic nature of the market and diversification of the financial system. Regulation and supervision were vital to maintain public confidence and financial stability. First, policymakers have initiated reforms to instil competition in the financial system. Back in 1970, the SCB was established to promote competition (see World Bank, 1992). Moreover, a number of financial institutions belonging to the contractual savings industry, non-banking sector emerged to offer a variety of services to economic agents and also to compete with banks. These include the Mauritius Housing Corporation specialising in the provision of housing loans, the Development Bank of Mauritius (DBM) providing industrial loans, the Mauritius Leasing Company (MLC), the State Investment Corporation (SIC), the Post Office Savings Bank, Investment Trusts, Unit Trusts and Pension Funds. A number of financial institutions have been set up in the 1980s to broaden the financial system. Moreover, institutions like SIC, DBM, MLC have been privatised to provide them with more autonomy to deal on the Stock Exchange and compete with banks. Recently, other financial institutions have been allowed to apply for depository licences to carry out depository transactions, thus increasing competition. At present, there is intense competition among financial institutions for deposits as well as the supply of credit.

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Another institutional change has been the setting-up of an offshore banking sector since 1988. This strategy is in line with the objective of diversifying the economy and transforming Mauritius into a regional financial centre. Competition between domestic and offshore banks exists as the residency requirement has been relaxed to allow offshore banks to lend to both residents and non-residents in foreign currencies. The number of offshore banks is seven at present with total assets of US$790 million (June 1996). Although it is argued that there may be a tendency for collusion in the banking sector, excess liquidity has led to an increase in competition. The interest rates paid on deposits and loans may be inflexible but banks are using non-price competition to raise their market share. On the other hand, in order to increase efficiency, automation is taking place rapidly and the automatic payment system is in the pipeline.

Development of Financial Markets and Instruments The expansion of the financial market and the diversification of financial instruments have been another objective of policymakers. By the early 1970s, the Bank of Mauritius had already instituted a market for government stocks and Treasury Bills. Over time, these markets have grown in importance. They are an investment outlet for financial institutions and individuals. Nowadays, in order to reduce distortions in the financial market, a segmented market for government borrowing is being abolished. In line with interest rate liberalisation, government is required to borrow at the market rate of interest. The Stock Exchange of Mauritius was formalised in 1989 and has added a new dimension to the financial system. The transactions held on the stock exchange have been increasing considerably as indicated by the number of companies listed, market capitalisation and shares traded, as shown in Table 10.4. Recently, foreign investors have also participated in this market following fiscal incentives such as total exemption of capital gains tax and suspension of exchange control. Other developments on the stock exchange are the setting up of a central depository system, and the emergence of a bond market. As far as financial instruments are concerned, there is a wide choice at the disposal of investors due to the emergence of financial

236.97

n.a.

50.27 28 122.81

42 8.74 154.17 -17.06

81 6.97 171.23 56.03 39.27

20 6 81.24 -8 4.48 26 3.15

Jan– Dec 1991

14 8 88.51 521 3.55 479 2.21

n.a.

4.52 115.2

1.22

0.61

6 6 14.26

Jan– Dec 1990

92.45 84 1,256.54

109 15.54 183.18 29.01

22 2 177.43 118 10.48 134 6.60

Jan– Dec 1992

126.56 37 484.06

126 31.01 302.63 119.45

30 8 691.63 290 37.34 256 14.91

Jan– Dec 1993

404.96 220 1,469.79

91 52.31 473.67 171.04

35 5 1,519.49 120 50.64 36 28.54

Jan– Dec 1994

Stock market performance, 1989–97

167.28 -28 305.30

20 49.15 353.46 9.02

-3 4.09 344.44 -129.23 232.39 -43 1,396.05

45 4 1,601.69 31 92.00 55 33.38

Jan– Dec 1996

41 6 1,220.49 -20 59.38 17 27.82

Jan– Dec 1995

n.a. not available. * debenture issues only. Note: The figures for Market Capitalisation and SEMDEX are for the last session of the year. Source: Stock Exchange Commission.

Over the Counter Market Turnover (Rs million) Yearly rate of increase (%) Capital raised on the primary market (Rs million)*

Official Market No. of listed companies New listing Turnover (Rs million) Yearly rate of increase (%) Shares traded (million) Yearly rate of increase (%) Market Capitalisation (Rs billion) Yearly rate of increase (%) % of GDP (Market prices) Evolution of the SEMDEX Yearly increase (points)

Jul– Dec 1989

Table 10.4

176.18 5.3 650.00

4 46.33 367.31 3.9

53.91 58 34.68

45 0 1,366.12

Jan– Aug 1997

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institutions like National Mutual Fund Ltd, National Investment Trust, Country Funds, Mauritius Leasing Company and an increasing number of bonds issued by the Bank of Mauritius. On the other hand, since the early 1990s policymakers are also developing the money market (bill market) to be used as an instrument for monetary management. Moreover, an interbank foreign exchange market in US dollars has been established in July 1994 following the suspension of exchange control. The development of financial markets is a major institutional change in the financial system.

Regulatory Framework The main legislation for the financial system includes the Bank of Mauritius Act 1966, the Banking Act 1988, the Insurance Act 1987, the Stock Exchange Act 1988 and the Mauritius Offshore Business Activities Act 1992. The Bank of Mauritius Act 1966 makes a number of provisions that allow the Bank of Mauritius to develop a strong financial system. The Banking Act 1988 was passed to replace the 1971 Act in order (a) to handle a more complicated and global banking business and (b) to be in line with the international norms of regulation and supervision. The 1988 Act also provides the legal framework for the creation and operations of offshore banks in Mauritius. The Bank of Mauritius supervises and regulates the activities of commercial banks in Mauritius as stipulated in the Banking Act 1988. The Insurance Act 1987 replaces the 1966 Act and takes into account the modernisation of the financial system. The main objective of the Act is to instil public confidence by protecting policyholders from bankruptcy of insurance companies. Another important Act, the Stock Exchange Act 1988, makes provisions for the creation of investment institutions, investment clubs, and a listing committee. Additional amendments were made in 1994 to allow foreigners to invest on the stock exchange. The Mauritius Offshore Business Activities Authority (MOBAA) Act regulates and supervises the conduct of non-banking offshore activities.

10.5

EXTENT OF FINANCIAL DEVELOPMENT

Given the importance of the banking sector, we can first look at financial deepening which is measured by ratios of monetary

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aggregates to GNP and by the availability of total credit in the economy. The ratio of M2/GNP has increased from 0.437 to 0.721 in 1996. However, the ratio of M1/GNP has decreased, indicating the portfolio shift within the financial system. The ratio of domestic credit to GNP has increased significantly. This indicates that the financial system has developed to respond to the credit needs of the economy. The establishment of a stock market as well as the development of other financial markets have also been used as measures of financial development. The ratios in Table 10.4 indicate expansion of the stock market and hence, financial system development. A recent development on the stock exchange is the emergence of the debenture market, which has facilitated a shift from bank borrowing by companies to direct borrowing from the public. Other indicators can also be used to assess the extent of financial system development over time. They include the shift in the portfolio of savers, liberalisation of interest rates, growth of the financial markets (money markets), emergence of financial institutions and internationalisation of the financial system. With the increase in the number of financial institutions especially, in the 1980s, both short term and long term financial instruments have proliferated. A shift from financial intermediation to financial disintermediation is taking place in the financial system with the increasing public issue of debentures. Portfolio shifts are taking place among the investors following the broadening of the financial system. The secondary bill market has also developed following the introduction of the Bank of Mauritius Bills and their issue on tender. But the value of transactions is still relatively low and this is a major obstacle in the development of the bill market as a tool of monetary management. In order to broaden the secondary bill trading and to develop an efficient secondary market for bills, the Bank of Mauritius decided to sell bills to the public through brokers in addition to the normal sales effected through the Secondary Market Cell (SMC). The amount of bills transacted outside the SMC dropped from Rs728.7 million in 1994–95 to Rs200 million in 1995–96.As the financial system develops, such a market for short term loans is expected to play an important role. Another indicator of financial development is the flexibility in interest rates following liberalisation. Although the Bank Rate has been pegged to the weighted average yield of Treasury Bills, lending and

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deposit rates have been quite inflexible in the financial system. The spread between lending and deposit rates has also in fact been recently rising, notwithstanding the abolition of credit ceilings and reduction in reserve ratios. Finally, given the financial policy shift since the early 1990s to develop the financial services sector in Mauritius and transform Mauritius into a regional financial centre, the contribution of financial services sector to economic growth could be used as an indicator of financial system development. The contribution of financial services to GDP has gradually increased to 5.5 per cent and is expected to rise further as the financial system develops.

10.6

CONCLUSION AND POLICY IMPLICATIONS

In this chapter the substantial changes which occurred in the financial system over recent decades have been discussed. These changes have been mostly policy-induced; as shown by the array of financial interventions and institutional changes that have taken place since the late 1980s. Policymakers have addressed a number of issues relating to financial system development including the promotion of financial institutions, increasing competition in the financial system, interest rate liberalisation, development of financial markets, and the promotion of an appropriate regulatory framework. They have also shifted from one monetary regime to another with a view to developing the financial system and achieving the objectives of economic policy. Their flexibility and prudential approach towards financial liberalisation has been emphasised. Consequently, some degree of financial development has been achieved. The contribution of financial development to economic growth is difficult to assess due to various theoretical and empirical problems. However, it may be argued that the financial sector interventions in the economy have helped to sustain high real growth rates in the economy since the mid-1980s. Financial deepening has been substantial and the saving-investment gap has been reduced following higher saving rates in the economy. The financial services sector continues to develop and with the modernisation of the financial system, the growth prospects for this sector are apparent. Although the financial system has undergone remarkable changes, there are still a few factors impeding further development which

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policymakers have to address. These include heavy concentration in the banking system, a thin capital and money market, the threat of rising inflationary pressures and of macroeconomic instability. The development of the financial system is a long term process and policymakers should continue to maintain the appropriate macroeconomic conditions and institutional framework for its continued successful expansion.

APPENDIX 10A Table 10A.1 Year 1. 2. 3.

4. 5. 6. 7. 8. 9. 10. 11.

Evolution of commercial banks, 1970–96 1970

Number of commercial 8 banks Locally incorporated 3 Number of branches 32 Savings deposits 57,379 accounts (no.) Time deposits 2,962 accounts (no.) Total assets 303.9 (Rs million) Total credit to private 218.9 sector (Rs million) Total credit to govt. 17.9 (Rs million) Total deposits 230 (Rs million) Foreign assets 30.1 (Rs million) Cheques clearance 2,552 (average daily) Number of inhabitants 25,171 per branch Assets of offshore banks na (US$ million)

1980

1990

1996

12

13

11

8 108 393,172

8 122 892,593

6 148 1,143,222

39,144

94,907

97,564

3,322.9

24,330.2

63,617.0

1,966.9

11,889.8

32,054.0

675.5

7,074.7

13,622.0

9,583

49,331.0

2,715.5 90.0

1,668.9

4,408.7

7,474

12,982

17,880

8,684

8,398

7,630

35

790

na

na: not applicable. Source: Bank of Mauritius, Annual Report, various issues.

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203

Performance of selected financial institutions, 1970–95 (Rs million) 1970

1980

Mauritius Development Bank (1964*) Total assets 58.4 388.7 Total loans 38.3 271.5 Mauritius Housing Corporation (1968*) Total outstanding 31.9 219 loans Post Office Savings Bank (1951*) Total saving 11.4 39.1 deposits Number of savings 92,200 171,645 accounts

1985

1990

615.4 514.2

1,480.8 1,042.0

3,563.4 1,004.2

247.9

500

1,214.9

80.2 230,576

81.1 213,416

The Mauritius Co-operative Central Bank Ltd (1948*) Assets 13.2 111.5 210.5 Total Loans 7.2 78.7 154.9 Sugar Insurance Fund Board (1936*) Total Assets na 380.1 Total Loans/ na 368.1 Deposits

1995

220.6 185

25.0 196,823

1,062.9 655.6

2,139.0 1,379.5

959.7 878.2

914.9 702.8

* Year of establishment. na: not available. Source: CSO, Annual Digests of Statistics, various issues.

References BENCIVENGA, V.R. and SMITH, B.D. (1991) ‘Financial Intermediation and Endogenous Growth’, Review of Economic Studies, 58, 195–209. BUFFIE, E.F. (1984) ‘Financial Repression, the New Structuralists, and Stabilization Policy in Semi-Industrialized Economics’, Journal of Development Economics, 14, 305–22. CAPRIO Jr, G., ATIYAS, I. and HANSON, J.A. (1994) (eds) Financial Reform: Theory and Experience (Cambridge: Cambridge University Press). COURAKIS,A.S. (1984) ‘Constraints on Bank Choices and Financial Repression in Less Developed Countries’, Oxford Bulletin of Economics and Statistics, 46, 341–70. DEMETRIADES, P. and HUSSEIN, A.K. (1996) ‘Does Financial Development Cause Economic Growth? Time Series Evidence from 16 Countries?’, Journal of Development Economics, 51, 387–411.

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DEMETRIADES, P. and LUINTEL, K.B. (1994) Financial Repression, Financial Deepening and Economic Growth: Evidence from India (Department of Economics, Keele University). FRY, M.J. (1978) ‘Money and Capital or Financial Deepening in Economic Development?’, Journal of Money, Credit and Banking, 10, 464–75. FRY, M.J. (1980) ‘Saving, Investment, Growth and the Cost of Financial Repression’, World Development, 8, 317–27. FRY, M.J. (1995) Money, Interest and Banking in Economic Development (London: Johns Hopkins University Press). GALBIS, V. (1977) ‘Financial Intermediation and Economic Growth in LessDeveloped Countries: A Theoretical Approach’, Journal of Development Studies, 13, 58–72. GOLDSMITH, R. (1955) ‘Financial Structure and Economic Growth in Advanced Countries’, in Abromovitz, M. (ed.), Capital Formation and Economic Growth (Princeton: Princeton University Press). GOLDSMITH, R. (1968) Financial Institutions (New York: Random House). GREENWOOD, J. and JOVANOVIC, B. (1990) ‘Financial Development, Growth, and the Distribution of Income’, Journal of Political Economy, 98, 1076–107. GURLEY, J.G. and SHAW, E.S. (1960) Money in a Theory of Finance (Washington, DC: Brookings Institution). HANSON, J. and NEAL, C.R. (1985) Interest Rate Policies in Selected Developing Countries (Washington, DC: International Monetary Fund). KAPUR, B.K. (1976) Alternative Stabilization Policies for Less-Developed Economies, PhD thesis, Stanford University. KHATKHATE, D. (1972) ‘Analytic Basis of the Working of Monetary Policy in Less Developed Countries’, IMF Staff Papers. KING, R.G. and LEVINE, R. (1993) ‘Finance and Growth: Schumpeter Might Be Right’, Quarterly Journal of Economics, 108, 717–37. LIM, J. (1987) ‘The New Structuralist Critique of the Monetarist Theory of Inflation: The Case of Philippines’, Journal of Development Economics, 25, 45–61. MATHIESON, D.J. (1980) ‘Financial Reform and Stabilization Policy in a Developing Economy’, Journal of Development Economics, 7, 359–95. McKINNON, R.I. (1973) Money and Capital in Economic Development (Washington, DC: Brookings Institution). McKINNON, R.I. (1986) Financial Liberalization in Retrospect: Interest Rate Policies in LDCs, Center for Economic Policy Research, Stanford, Publication No. 74. MORRISET, J. (1993) ‘Does Financial Liberalisation Really Improve Private Investment in Developing Countries?’, Journal of Development Economics, vol. 40, 133–50. PATRICK, H.T. (1966) ‘Financial Development and Economic Growth in Underdeveloped Countries’, Economic Development and Cultural Change, 14, 2, 174–89. SHAW, E.S. (1973) Financial Deepening in Economic Development (New York: Oxford University Press). SCHUMPETER, J.A. (1911) The Theory of Economic Development (Cambridge, MA: Harvard University Press).

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STIGLITZ, J.E. (1994) ‘The Role of the State in Financial Markets’, in Bruno, M. and Pleskovic, B. (eds), Proceedings of the World Bank Annual Bank Conference on Development Economics 1993 (Washington, DC: World Bank). STIGLITZ, J.E. and WEISS, J. (1981) ‘Credit Rationing in Markets with Imperfect Information’, American Economic Review, 71, 393–410. TAYLOR, L. (1983) Structuralist Macroeconomics: Applicable Models for the Third World (New York: Basic Books). TURTELBOOM, B. (1991) Interest Rate Liberalisation: Some Lessons from Africa, IMF working paper WP/91/121 (Washington, DC: International Monetary Fund). VAN WIJNBERGEN, S. (1982) ‘Stagflationary Effects of Monetary Stabilization Policies: A Quantitative Analysis of South Korea’, Journal of Development Economics, 10, 133–69. VAN WIJNBERGEN, S. (1983) ‘Interest Rate Management in LDCs’, Journal of Monetary Economics, 12, 433–52. VILLANUEVA, D.P. and MIRAKHOR, A. (1990) ‘Strategies for Financial Reforms: Interest Rate Policies, Stabilization, and Bank Supervison in Developing Countries’, International Monetary Fund Staff Papers, 37, 509–36. WORLD BANK (1992) Mauritius Financial Sector Review (Washington, DC: World Bank). WORLD BANK (1993) The East Asian Miracle (Oxford: Oxford University Press).

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11 Labour Market Adjustment Chris Milner and Peter Wright

11.1

INTRODUCTION

There is relatively little evidence available about the effects of trade-induced shifts in the composition of demand on inter-industry employment and wage levels in developing countries. Analyses1 of the factor content of imports and exports suggest that a shift from import substitution (IS) to export promotion (EP) policies will typically, in the case of a developing country, expand the more labour-intensive industries, increase labour demand overall and drive up real wages in the long run. But trade liberalisation and increased foreign competition may not only affect the composition of the tradable goods sector (i.e. the distribution between importables and exportables), they may also affect both the efficiency with which all firms use factors (including labour) and the distribution of output within a sector between more and less efficient firms. Thus the net long-run effects of trade liberalisation on employment will depend upon the balance of structural and efficiency effects, which cannot be identified from analyses of the composition of trade alone. Further we must also recognise that the short- and long-run effects of trade liberalisation on employment and wages may diverge; the divergence depending on the degree of factor mobility and the competitiveness of labour markets. The aim of this chapter is to model labour market adjustment to trade liberalisation in an industrialising country. It will do so using panel data evidence for Mauritius, an economy that has undergone significant trade liberalisation and transformation during the 1980s. Indeed Mauritius is viewed simultaneously as a successful liberaliser and an economy with extensive government intervention in the labour market. It provides a valuable test base for investigating labour market adjustment to trade liberalisation. Although its success in liberalising and developing non-traditional exports may be viewed as 206

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‘atypical’ for developing countries, especially in the Africa region, there are many features of this economy and of the pre-reform policy regime that make it appropriate for this purpose. A major advantage is that it has implemented a sustained and credible trade policy reform and there is now sufficient information relating to labour market conditions under both its pre- and post-liberalisation experience. The rest of the paper is organised as follows. In Section 11.1 we investigate the theoretical short- and long-run labour market responses to trade liberalisation in the absence and presence of labour market rigidities. We turn then to the specific experience of Mauritius. Section 11.2 provides a brief description of the nature and timing of trade liberalisation in Mauritius and of labour market developments in Mauritius during this period. In Section 11.3 the specific framework used to model and test the effects of trade liberalisation on sectoral labour demand and wages is set out. The results of the empirical modelling are reported in Section 11.4. Finally the implications of the results and summary conclusions of the work are given in Sections 11.5 and 11.6.

11.2

LABOUR MARKET ADJUSTMENT IN THEORY

Adjustments in sectoral employment and wages following trade liberalisation have been examined in the context of trade models inter alia by Mussa (1978) and Neary (1978). These specific-factors models typically allow for short-run capital-specificity, labour mobility between sectors and inelastic aggregate factor supply.2 The literature has also compared outcomes in the presence of policy-induced labour market rigidities with the efficient, competitive labour market outcome. Edwards (1988), investigates labour market adjustment for a small, two factor (capital (K) and labour (L)) economy that produces three goods (exportables (X), importables (M) and non-tradeables (N)). Production functions have conventional properties, the ranking of factor intensities is assumed to be (K/L)M > (K/L)N > (K/L)X, there is incomplete specialisation and factor supplies are fixed. Equilibrium in this type of model means that world prices of exportables and importables (plus tariffs) determine factor rewards, which in turn determine the price of non-tradeables (under competition).3 The adjustment of employment and wages in the long and short run are investigated with and without wage rigidities. We summarise some of the main findings of Edwards in Table 11.1.

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208 Table 11.1

Sectoral employment and wage changes following trade liberalisation in traditional trade models1 Without Wage Rigidities

Employment Change Exportables Importables Non-tradeables Wage Change3 Exportables Importables Non-tradeables 1. 2.

3.

With Wage Rigidities2

Short-run

Long-run

Short-run

Long-run

≠ Ø ?

≠ Ø ?

≠ Ø ?

≠ Ø ≠

Ø Ø Ø

≠ ≠ ≠

Ø ≠ Ø

? ≠ ?

Adapted from Edwards (1988) Table 1. Arrows indicate the direction of change and ? denotes ambiguity. The case of minimum wages is considered here and in the text. Note also that we take the case of sector-specific rather than economy-wide measures. Although Mauritius has fairly comprehensive minimum wage legislation, the legislation is not viewed as being binding in all sectors, and therefore we assume that a binding minimum wage applied only in the importables sector. Defined as the nominal wage rate relative to the price of nontradeables.

Long-Run Effects The long-run effects of the fall in the relative price of importables following liberalisation4 in this type of model are in line with those predicted by the Stolper-Samuelson theorem; where exportables are relatively labour-intensive tariff reduction increases demand for the economy’s abundant factor, driving wages higher (and the return to capital lower). The within-tradeables shift in production and employment is unambiguously towards exportables and away from importables, given the rise in the relative price of exportables. In the case of non-tradeables there are opposing influences on long-run employment. On the one hand production of non-tradeables can be expected to be higher given the assumed pattern of factor intensities as demand grows (due to switching from tradeables and any positive income effects of tariff reduction), but on the other hand production of nontradeables will (as in all sectors) be more capital-intensive following the rise in wages.

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Short-Run Effects With capital sector-specific, the direct link between the price of tradeables and factor rewards is broken. As a result the price of nontradeables will be determined by both demand and supply factors. If non-tradeables are a gross substitute in consumption and production with tradeables and the substitution effect of a tariff change dominates the income effect, then the price of non-tradeables will fall relative to exportables but will rise relative to that of importables following liberalisation. In which case production and employment must increase in the exportables sector, while output and employment adjustments in non-tradeables are ambiguous and depend on the pattern of substitution between tradeables and non-tradeables. By contrast the fall in the relative price of importables combined with capital-specificity reduces production, labour-intensity of production and employment. Wages in the Edwards models are defined in relative terms, i.e. relative to the numeraire, the price of exportables. In the short-run the above changes in the relative prices of tradeables and non-tradeables following import liberalisation mean that wages have risen relative to the domestic price of importables, but fallen relative to the price of exportables and non-tradeables.5 Thus the real wage effects in the short run may strictly be viewed as ambiguous, depending on the relative importance of importables, exportables and non-tradeables in the local consumption basket. In order to eliminate this ambiguity, however, we define the real wage effects in Table 11.1 in terms of nontradeables. This is convenient for the present purpose, since the later empirical work uses the consumer price index to proxy non-tradeable prices. Wage Rigidities We consider the case where there is a sector-specific source of wage rigidity, e.g. from minimum wages that constrain only particular sectors. We assume here that the binding minimum wage applies only in the importables sector and is effective prior to the trade liberalisation6 in which case there is an initial equilibrium level of unemployment. Note also therefore that wage and employment changes described in Table 11.1 relate to deviations from different (pre-reform) equilibria. The reduction in the relative price of importables shifts the demand for labour in this sector downwards in the short-run (i.e. with capital

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immobile across sectors); employment falling therefore at the constant (money) wage in that sector. The changes in the unconstrained sectors (exportables and non-tradeables) following trade liberalisation will be qualitatively similar to those in the absence of any wage rigidities. The rise in the price in the uncovered sector relative to importables increases the demand for labour in these sectors, but with the capital stock fixed wages are forced down relative to exportables and non-tradeables prices. Employment in exportables unambiguously rises, but in the case of non-tradeables there are conflicting pressures. The wage decline tends to increase employment (i.e. cause movement down the labour demand function), but the fall in price in non-tradeables induced by import liberalisation also shifts this sector’s labour demand function down; employment in non-tradeables being lower or higher depending on the relative magnitude of these two influences. In the longer term, capital will tend to be drawn away from importables into the exportables and non-tradeable sectors. The long-run equilibrium will be characterised therefore by higher employment and higher wages than in the short run in these uncovered sectors. Whether the long-run level of relative wages is higher than their pretrade liberalisation level, given their short-term decline, is however ambiguous. By definition (binding minimum) money wages in the importables sector will remain constant following import liberalisation. Since the price of exportables is taken as constant (exogenously set by world prices) then wages relative to this price also remain constant in the short- and long-run following liberalisation. But the price of nontradeables is driven down in the current framework by import liberalisation and the real wage of importables (expressed relative to the price of non-tradeables) is shown, therefore, as rising in the short- and long run in Table 11.1. The above analysis is conducted in the context of a relatively simple, low dimension model. It does however capture a number of the broad features that are typical of many developing country economies, including Mauritius. But some complications in the interpretation of the later empirical analysis should be anticipated, given for instance the presence in practice of the non-homogeneity of sectors and factors and given also that liberalisation and trade changes may have competitive and efficiency effects in product markets which affect employment levels. Further it should be recognised that the assumption of fixed factor supplies is likely to be restrictive. We abstract here from

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capital rental effects, but the predicted, short-run wage effects will be sensitive to the scope for increasing capital stocks through foreign direct investment. Similarly the employment response of the importables sector will be fashioned by the extent to which increased demand for exportables following liberalisation can be satisfied by drawing labour from a pool of unemployed labour or of non-participating labour. In Mauritius, as in many developing countries, expansion of certain exportables may encourage increased female participation. This elasticity in aggregate labour supply may affect both the magnitude and direction of sectoral wage and employment responses.

11.3 TRADE LIBERALISATION AND LABOUR MARKET DEVELOPMENTS IN MAURITIUS We seek now to test the above model of labour market adjustment to trade liberalisation in the context of a specific, small and industrialising economy. Mauritius provides a useful case study and accords quite closely with the Edward’s model. It has a relatively undiversified economic structure with homogeneous and clearly identifiable tradable and non-tradable sectors. The low dimensionality of the Edwards model is more acceptable in this context than in larger, more diversified developing countries. Factor mobility characteristics and the relatively low levels of the measured unemployment are also in line with the assumptions set out in Section 11.2.7 Further Mauritius has undertaken a significant and discernible trade liberalisation, one that has been associated with substantial structural adjustment to the economy. Given that Mauritius has not experienced political instability and other sources of shock during the trade liberalisation period, the analysis is not open to the obvious criticism that structural adjustment has been contemporaneous with a number of other significant influences besides trade liberalisation. Finally it should be noted that the range and quality of trade and labour market data for Mauritius compares favourably with many developing countries. The pre-structural adjustment trade policy regime in Mauritius was typified by mixed and variable measures of import substitution (IS), export promotion (EP) assistance for manufactured goods within the Export Processing Zone (EPZ)8 sector and for non-traditional agriculture, and export taxation of the traditional export (sugar).9 For present purposes it is sufficient to note that, despite the mixed measures of IS and EP, there was overall a strong pro-importables bias

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to the trade regime, including within the manufacturing sector. Despite this bias in the trade regime in favour of IS activities, the EPZ sector (mainly relatively labour intensive textiles and clothing) was significantly larger than the importables manufacturing sector in employment terms.10 At the start of the 1980s some 130 firms were operating with EPZ status, employing about 24,000 people and with the vast bulk of the production being in spinning, knitting and madeup garments. In production terms the picture is less clear since manufacturing as a whole accounted for 14.9 per cent of GDP (at current and policy-distorted factor cost) in 1979, but the EPZ sector only accounted for 3.4 per cent of GDP. Trade Liberalisation During the period 1979–83 the emphasis was on macroeconomic stabilisation and exchange rate adjustment. Indeed during this period trade policy (in particular import duties) was used in a more restrictive manner; with stamp duty on imports progressively increased and an import surcharge applied in 1983. Trade liberalisation did not start therefore until after 1983. The initial period of trade liberalisation between 1983 and 1985 was concerned mainly with some liberalisation of foreign exchange and of import licensing restrictions. Indeed import duty surcharges were increased further in 1984 and 1985 for fiscal reasons. The main phase of import liberalisation and reduction of protection for local firms came in the period 1985–87 with the progressive dismantling of quantitative import restrictions. Some guidance as to the extent and time of the trade liberalisation can be gained from several indicators. Average rates of effective protection remained quite high in some non-export industries in 1990, but in general there were significant declines in rates of effective protection relative to 1980 levels (see Dabee and Milner, 1994). This type of indicator of trade liberalisation gives limited guidance however to the precise timing of the liberalisation. Milner and McKay (1996) however report information on the movement in real exchange rates that indicates a rise in the price of exportables after 1983 and a fall in the price of importables after 1984. This dating of trade liberalisation is supported also by the information on the changes in trade volumes.11 In the stabilisation episode of the early 1980s the import-to-GDP ratio recorded a fall from 0.57 in 1980 to 0.42 in 1983. After 1983 the ratio rose continuously up to 1988, rising particularly quickly during the QR liberalisation period between 1986 and 1988. The share of exports

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(in particular manufactured/EPZ exports) in GDP also grew rapidly after 1983: from 0.44 to 0.61 in 1987. Labour Market Developments Mauritius evolved over the post-war period an extensive set of legal and institutional arrangements for the exercise of governmental influence over the determination of wages and working conditions. Trade union activity and collective bargaining are protected, but subject to elaborate conciliation and dispute settlement procedures, including provision for compulsory arbitration. The National Remuneration Board (NRB) sets both a general minimum wage level and detailed minimum wage scales, and other working conditions, for various industrial and occupational groupings covering most of the blue-collar employees in the private sector. As a major employer, the government exercises both a direct and indirect influence in the labour market through employment policy decisions and periodic salary revisions. Despite the pervasiveness of interventions in the form of NRB remuneration orders, the qualitative evidence would seem to indicate that NRB remuneration orders have not been important in determining the structure of relative wages across the economy as a whole. Certainly the influence of these interventions has been of lesser importance in exportables and has also tended to decline over time as labour market conditions tightened. The changes in the level and the structure of manufacturing employment in Mauritius over the last two decades are shown in Figure 11.1. We can identify three phases or episodes in terms of overall employment change; growth up to the mid-1970s, stagnation between 1977 and 1983, and rapid growth after 1983. Within manufacturing there are two major distinctive features of the post-1983 growth. One is the dominant role of the exportables sector, especially clothing and textiles, in that growth. The second distinctive feature is the disproportionate growth in female employment in clothing and textiles in this post-1983 period. After 1983 and 1988 Mauritius experienced a sharply and constantly increasing demand for labour (in particular female labour) from the manufacturing, exportables sector (see Figure 11.2). The levels of employment in the nonexportables sector remained relatively stable however throughout the stabilisation period (1979–83) and the initial liberalisation phase (1983–85). Indeed, after 1985 employment in importables increased somewhat. This absence of employment reduction effects in the

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214

Employment

200,000

100,000

0 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Importables

Figure 11.1 1968–90

Exportables

Importables and exportables employment within manufacturing,

100,000

Employment

80,000 60,000 40,000 20,000 0 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992

Males

Figure 11.2 1972–92

Females

Male and female employment in exportable manufactures,

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importables sector was due in part at least to the ability of exportables to grow through increases in female participation. The effect of changing domestic and external demand conditions on real wages is illustrated by Figure 11.3. Declining unemployment and increasingly inflationary conditions in the first half of the 1970s resulted in sharply rising wages in most manufacturing industries (especially non-EPZ) up to about 1978. During the stabilisation period (1979–83) the upward movement in real wages was sharply reversed. The post-stabilisation period (i.e. after 1983) is typified by rising real wages in all manufacturing sectors. Average wages in the exportables (EPZ), especially clothing and textiles, sectors display less volatility than the non-exportables sectors throughout the period, and are consistently lower than in non-exportables manufacturing. This feature is captured by Figure 11.4, which plots wage rates in the nonexportables sectors relative to exportables real wages. There is apparently some further convergence of real wages after 1983; i.e. a rise in the relative wage in exportables, but this is, interestingly, less marked than in some earlier periods. But for a decline in 1985 of wages in exportables, there is no difference in the short- and long-run responses of wages.

5,000

Real wage

4,000

3,000

2,000

1,000

0 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Exportables

Importables

Figure 11.3 Average real wage rates in manufacturing exportables and importables, 1968–90

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216 3.5

Relative wage

3.0 2.5 2.0 1.5 1.0 .5

1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Exportables

Importables

Figure 11.4 Average real wage of importables relative to that in exportables, manufacturing sector 1968–90

11.4

MODELLING AND TESTING FRAMEWORK

The two main approaches that have traditionally been used to investigate the employment effects of increased trade are the factor content of trade and the accounting decomposition methods. In addition there are a number of studies that use regression techniques to examine the determinants of revealed comparative advantage. Studies that use regression techniques to look directly at employment determination within LDCs are however scarce and of the existing econometric studies that directly examine the impact of trade on labour market outcomes, the majority are based on US data.Abowd (1987), for example, examines the impact of import competition on collectively bargained wage and employment outcomes in the United States, with Abowd and Lemieux (1990) and Caves (1990) providing a comparison with Canada. Denny and Machin (1991) and Konings and Vandenbussche (1995), using firm-level data for the UK, also examine the impact of increased foreign competition on wages and employment. Turning first to employment, the econometric analysis within this paper is conducted within the framework of a fairly simple static profit-maximising model of firm behaviour. We begin by assuming a Cobb-Douglas production function of the form:

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Qi = AgKaiLbi

(1)

where: Q = real output K = capital stock L = units of labour utilised and where a, b represent the factor share coefficients and g allows for factors changing the efficiency of the production process. A profitmaximising firm will employ labour and capital at such levels that the marginal revenue product of labour equals the wage (w) and the marginal revenue product of capital equals the user cost (c). Solving this system simultaneously to eliminate capital from the expression for firm output allows us to obtain the following expression: a

Ê aLi w ˆ b Qi = A ◊ L Ë b c¯ i g

(2)

Taking logarithms and rearranging equation (2) allows us to derive the firm’s, and therefore the industry’s, derived demand for labour as: ln Li = q0 + q1 ln(w/c) + q2 ln Qi

(3)

where: q0 = -(g ln A + a ln a - a ln b) / (a + b) q1 = -a / (a + b) q2 = 1 / (a + b) This equation will form the basis of estimations conducted in this chapter. Since the data set which will be used has both a cross-sectional and time series element, the estimating equation for the panel of industries in our study is of the form:12 ln Lit = li + dt + q1 ln Wit + q2 ln Qit + q3Xit + uit

(4)

where: Lit = total employment in industry i in time t Wit = average real wage in industry i in time t Qit = real output in industry i in time t Xi = variables which affect the efficiency of the production function li = industry specific effect dt = time specific effect

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Wages may be determined by a large number of factors such as efficiency wage considerations, union bargaining and insider-outsider effects. In the empirical labour economics literature it is now reasonably standard to summarise these effects by estimating a wage equation of the form: ln Wit = li + dt + b1Xit + b2 ln Qit + b3 ln Lit + b4 ln Wi,t-1 + uit

(5)

where: Wit, Qit and Lit are as above and Xit = exogenous variables In the above framework, X denotes a vector of variables that may either be internal or external to the individual firms engaged in the wage-setting process. For the purpose of our study, the key influences in this context are taken to be the extent of foreign competition (and the moderating influence on the ability of firms to pay large wage increases) and the degree of employee market power. These effects are captured respectively by the addition of trade-share and sex ratio (male/female employment) terms to the wage equation. In the former case we are assuming that the lowering of import barriers and increased competition on the domestic market will be reflected in increased import volumes or import penetration of the domestic market. Similarly growth in export shares results in greater exposure of production in a particular sector to international competition.13 In the latter case the rationale for proxying market power in this manner is that, where unionisation is present, it is male dominated.14 The malefemale ratio may also affect wages if there is discrimination in the labour market or if different social factors operate in the wage-setting processes in female-dominated firms. Lagged wages are included to reflect the persistence in wages. The estimation of the effects of trade liberalisation on sectoral employment and wages is conducted in the following way. First, employment and wage functions are estimated separately for exportables and importables for the whole sample period. From these we are able to report short- and long-run employment and wage elasticities. These provide a basis for identifying the direction and magnitude of direct and indirect effects of the inferred output-changes associated with trade liberalisation. Further by examining the stability of the estimated employment and wage functions, we can consider if and how any structural breaks contemporaneous with trade liberalisation

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affected short- and long-run elasticities or induced any efficiency effects. Finally, we investigate how changes in trade effects, additional to output effects, influence the demand for labour and wages by directly including trade terms in some of the equations. Results are presented both for import and export penetration ratios and the level of real imports and exports. The rationale for these terms is that an increase in the openness of the economy may induce either efficiency effects in the case of labour demand or discipline effects in the case of wage determination.

Data and Estimation The dataset that is used in this study has been assembled using a diversity of sources in order to allow the construction of an integrated database of industrial, labour market and trade statistics. Thus we have a panel of 25 manufacturing industries (corresponding approximately to a three digit ISIC level of aggregation) from 1968 to 1991.15 Industries are classified as importables or exportables on the basis of information about market orientation and the policy regime. Since we have information both cross-sectionally and through time the modelling of employment and wages adopts panel estimation techniques. For the purposes of estimation, equations 4 and 5 are differenced so as to transform out the fixed effects, and dynamic labour demand and wage equation are implemented. However, since the differencing will induce a bias in the coefficient on the lagged dependent variable, an instrumental variable approach must be adopted. The one used in the following estimation is the generalised method of moments technique of Arellano and Bond (1991). This technique uses lags of the endogenous variables dated t - 2 and earlier as instruments, but is efficient in the sense that it expands the instrument set as the panel progresses and the number of potential lags increases. In the case of the employment equation the real wages and output are also treated as endogenous variables and suitably instrumented. Because the use of (t - 2) instruments requires that no second order serial correlation exists, test statistics are calculated and presented in the tables. The validity of the instrument set is checked using a Sargan test based on the correlation between the instruments and the residuals from the model.

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220 11.5

THE RESULTS

Employment Equations The estimated employment equations for the full sample from 1971–91 (restricted by the lag structure) are given in Table 11.2, columns 1–3. In column 1 we report a pooled regression which allows for time effects, while in column 2 there is allowance for both time and industry specific effects.The estimated coefficients (sign and magnitude) are consistent across both specifications, are generally highly significant,16 Table 11.2

Employment equations for Mauritian industry 1

2

3

4

5

6

constant

0.07 (0.045)

0.06 (0.045)

-0.01 (0.043)

-0.06 (0.051)

-0.08 (0.050)

-0.08 (0.048)

D ln Emplt-1

0.69 (0.032)

0.57 (0.026)

0.62 (0.034)

0.64 (0.085)

0.54 (0.088)

0.46 (0.096)

D ln Wagest

-0.45 (0.055)

-0.46 (0.097)

-0.50 (0.057)

-0.52 (0.129)

-0.50 (0.126)

-0.51 (0.120)

D ln Wagest-1

0.43 (0.057)

0.35 (0.076)

0.41 (0.045)

0.43 (0.138)

0.43 (0.134)

0.38 (0.127)

D ln Wagest-2

-0.08 (0.042)

-0.08 (0.039)

0.01 (0.040)

-0.07 (0.079)

-0.08 (0.083)

-0.08 (0.080)

D ln Outputt

0.49 (0.038)

0.49 (0.086)

0.50 (0.043)

0.54 (0.101)

0.53 (0.098)

0.56 (0.091)

D ln Outputt-1

-0.24 (0.041)

-0.13 (0.071)

-0.20 (0.014)

-0.25 (0.111)

-0.16 (0.108)

-0.10 (0.108)

D ln imppt

-0.07 (0.034)

D ln exp pt

0.05 (0.055)

D ln rimpt

-0.07 (0.031)

D ln r expt

0.04 (0.030)

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Chris Milner and Peter Wright Table 11.2 1

2

221

(Continued) 3

exportablest

0.04 (0.014)

exp. D ln Emplt

-0.22 (0.156)

exp. D ln Wagest

0.12 (0.233)

exp. D ln Wagest-1

-0.30 (0.253)

exp. D ln Waget-2

0.07 (0.205)

exp. D ln Outputt

-0.31 (0.135)

exp. D ln Outputt-1

-0.18 (0.145)

4

5

6

ind. dummies

no

yes

no

no

no

no

time dummies

yes

yes

yes

yes

yes

yes

Sargan Test (P-Value)

0.09

0.02

0.14

0.35

0.53

0.60

Second Order

0.192

-0.202

-0.091

0.114

0.401

0.345

Instruments

gmm2

gmm2

gmm2

gmm2

gmm2

gmm2

Period

1972–91 1972–91 1972–91 1981–92 1981–92 1981–92

and are in line with priors. Increases in industry output increase the demand for labour, whereas increases in average wage rates cause a fall in employment ceteris paribus. It may also be seen that employment exhibits persistence as the change of employment depends significantly on its lagged value. Thus, as would be expected theoretically, the long-run responses will be greater than the short-run responses. For the present purpose of modelling dynamic adjustment it is particularly useful to distinguish empirically between short- and long run

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222

responses. However, it must be acknowledged that the particular estimation procedure used here relies for proof of consistency on slope homogeneity. See Pesaran, Smith and Im (1996) for a discussion of this problem. The relative shortness of the time span of the present data set deters, however, the use of alternative modelling approaches. Table 11.3, columns 1–3, similarly presents the results for the estimated wage equation for the period 1972–91. As with the employment Table 11.3

Wage equations for Mauritian industry

1

2

3

4

5

6

constant

0.03 (0.036)

0.05 (0.036)

0.034 (0.036)

-0.14 (0.043)

-0.14 (0.042)

-0.15 (0.042)

D ln Wagest-1

0.37 (0.044)

0.29 (0.049)

0.33 (0.053)

0.28 (0.102)

0.20 (0.104)

0.23 (0.101)

D ln Emplt

-0.36 (0.042)

-0.39 (0.044)

-0.38 (0.048)

-0.30 (0.082)

-0.26 (0.084)

-0.31 (0.086)

D ln Emplt-1

0.11 (0.049)

0.09 (0.050)

0.13 (0.053)

0.14 (0.083)

0.14 (0.079)

0.11 (0.078)

D ln Emplt-2

0.09 (0.030)

0.07 (0.033)

0.09 (0.031)

-0.02 (0.018)

-0.03 (0.018)

-0.03 (0.019)

D ln Outputt

0.29 (0.037)

0.27 (0.039)

0.30 (0.044)

0.30 (0.084)

0.30 (0.080)

0.27 (0.087)

D ln Outputt-1

-0.08 (0.036)

-0.07 (0.038)

-0.11 (0.042)

-0.10 (0.089)

-0.09 (0.087)

-0.06 (0.050)

D % female

0.01 (0.024)

0.02 (0.024)

0.02 (0.026)

-0.06 (0.051)

-0.04 (0.051)

-0.06 (0.050)

D % femalet-1

-0.04 (0.022)

-0.03 (0.023)

-0.04 (0.023)

-0.02 (0.043)

-0.04 (0.042)

-0.021 (0.042)

D ln imppt

0.03 (0.028)

D ln exp pt

0.09 (0.040)

D ln rimpt

-0.01 (0.026)

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223 Table 11.3 1

2

(Continued) 3

4

5

D ln r expt

6 0.05 (0.023)

exportablest

0.01 (0.013)

exp. D ln Wagest-1

-0.13 (0.218)

exp. D ln Emplt

0.25 (0.188)

exp. D ln Emplt-1

-0.18 (0.208)

exp. D ln Emplt-2

-0.05 (0.159)

exp. D ln Outputt

-0.33 (0.137)

exp. D ln Outputt-1

0.24 (0.154)

exp. D % female

0.21 (0.118)

exp. D % femalet-1

-0.09 (0.116)

ind. dummies

no

yes

no

no

no

no

time dummies

yes

yes

yes

yes

yes

yes

Sargan Test (P-Value)

0.05

0.06

0.01

0.76

0.70

0.73

Second Order

0.656

0.394

0.705

-0.142

-0.270

-0.075

Instruments

gmm2

gmm2

gmm2

gmm2

gmm2

gmm2

Period

1972–91 1972–91 1972–91 1981–92 1981–92 1981–92

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equations, the estimated coefficients (size and magnitude) are consistent across specifications, with the equations having a high degree of explanatory power. The estimated coefficients are also generally in line with theoretical priors. Increases in output cause wages to rise as firms take on more labour to meet their production needs, though expansions in employment independent of increased output generally cause wages to fall. Turning to the percentage of the labour force which is female; it can be seen that the contemporaneous effect of an increase in female workers is to raise wages (this effect is statistically insignificant however). The effect of increased female employment last period is however to significantly decrease wage levels. A possible explanation for this is that, as has been stated previously, much of the expansion of the EPZ has involved the rapid integration of women into what is a persistently tight labour market. This causes a weak positive association between contemporaneous female employment and wage levels. This effect is however largely transitory and for the reasons detailed earlier (lack of union organisation and discriminatory labour practice) female dominated industries pay less than other sectors, ceteris paribus. As discussed in the previous section, an important element in the theoretical model is that there will be differing wage and employment responses between import competing and export competing sectors. Thus, in column 3 of tables 11.2 and 11.3, intercept and interaction dummies are included to allow employment and wage responses to vary between the two sectors. These equations allow us not only to distinguish between the short run and the long run, but also allow us to distinguish between the ceteris paribus responses of importables and exportables. Such information therefore allows us to contrast the differing wage and employment responses of the importables and exportable sectors to trade reforms. For example, the model of Edwards (1988) suggests that the impact of tariff reductions would serve to reduce the price of importables relative to that of exportables, and lead to a switch of production in favour of exportables. Such a reform will have output, wage and employment implications for the economy being considered and these may now be traced through for Mauritius using the relationships that we have estimated. Since the initial shift in production will have both employment and wage effects, the implied change in employment in each sector [i = x,m] is given by: d ln N i d ln N i d ln N i d ln Wi = + ◊ d ln Qi d ln Qi d ln Wi d ln Qi

(6)

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where: Ni = employment in sector i Qi = real output in sector i Wi = real wage rates in sector i and the corresponding change in wages by: d ln Wi d ln Wi d ln Wi d ln N i = + ◊ d ln Qi d ln Qi d ln N i d ln Qi

(7)

The results of this analysis are presented in Table 11.4. Three sets of responses are calculated. The impact effects are the contemporaneous, current-year, responses. The short-run effects are the responses taking into account contemporaneous and lagged responses and the long-run effects take into account the full adjustment process. Looking first at the estimated responses for exportables, it may be seen that these correspond to those predicted theoretically in Table 11.1. Exportables employment growth rises both in the short run and the long run as resources are re-allocated from the importables sector. In contrast, wage growth fall in the short run and rise in the long run. This is due to the very low responsiveness of exportables wages to output in the short run, which implies that wage changes are dominated by increases in employment, which serve to drive wages down. In the long run the output effects, which serve to increase wages, become increasingly dominant. Turning now to the wage and employment responses of importables, the estimated results imply that wages and employment growth move together both in the short run and the long run. This is in Table 11.4

Simulated total response coefficients for sectoral employment and wages following an output shock*

Employment Change Exportables Importables Wage Change Exportables Importables

Impact

Short-run

Long-run

0.20 0.35

0.15 0.28

0.24 0.72

-0.05 0.11

0.08 0.14

0.08 0.09

* Where shock is a rise in output on exportables and a fall in output on importables.

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contrast with the predictions of theory, employment growth being predicted to fall in the short and the long run, but wages only to rise in the long run. A possible reason for the divergence of theory and practice is that the Edward’s model is premised on the basis of a fixed supply of labour. Exportable employment could therefore only rise if importable employment fell. However, as we have seen, the supply of labour increased dramatically in Mauritius as women entered into the labour market. This allowed employment in importables to be maintained (even slightly increase) as the exportable sector expanded. This factor is probably crucial in explaining how Mauritius was able to undergo such a dramatic structural change without a lengthy adjustment process and accompanying unemployment. In addition the dynamic impact of trade liberalisation on output growth, which allows importables and exportables to expand together, albeit at differing rates is ignored. Other Effects of Trade There are other indications that the simple model of trade as expounded by Edwards is not sufficient to explain the experience of Mauritius, and other modifications must be made to the basic model. For example the stability of the employment functions reported in Table 11.3 was investigated using Wald tests.17 From this testing procedure we identify three points in time where significant changes in the relationship (relative to the pre-break point) occur. These are in 1979, 1983 and 1987. Interestingly these correspond with the start of the stabilisation period (1979), the start of the liberalisation era (1983) and the end of the QR (import) liberalisation (1987). All of the breaks correspond to an increasing responsiveness of employment to output and wages changes in the long run. This might plausibly be explained by a change in the behaviour of exporters corresponding to growing confidence in sustainable growth of output associated with the liberalisation. Thus the impact of liberalisation is more fundamental than simply a reallocation of resources between sectors. Finally we investigate the effects of introducing trade variables directly into our wage and employment equations, but for the restricted time period 1981–91 due to a lack of suitable trade data. Columns 4 of Tables 11.2 and 11.3 report a basic dynamic specification of employment and wages for the restricted period, while in columns 5 and 6 import/export penetration (impp/expp) or aggregate real trade values (rimp and rexp) are also included. Turning to employment, the coefficients on the non-trade variables

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are consistent with the short- and long-run response coefficients discussed earlier. In neither specification is the coefficient on the export variable significantly different from zero, i.e. there is no independent trade effect that is not captured by the output variables. This is not surprising given the concentration of exports on a small number of industries and the dominance of exports in output in those cases. By contrast there is evidence of a significant import effect: greater import penetration or real imports lowering, ceteris paribus, the level of labour demand.We might view this as evidence of a disciplinary effect, with greater competition from imports inducing greater efficiency and reducing labour demand. In contrast to the employment equations, the influence of trade on wages comes about primarily via the export variable. This may reflect increased wages that are paid temporarily to workers as the EPZ sector expands and sucks in more labour under relatively full employment conditions. There is, however, no evidence of a disciplinary effect of increased imports.

11.6

CONCLUSIONS

This paper seeks to develop a framework for testing empirically a model of labour market response to trade policy reform. The specificfactors model of labour market adjustment utilised in this paper predicts that there may be differential responses between importables and exportables sectors, between the short-run and the long-run and between situations where there are and are not labour market distortions. In order to test for these differential responses we estimate dynamic models of employment and wages using panel data estimation techniques, which allow us to distinguish between sectoral responses and which provides short- and long-run response coefficients. These equations are estimated for an industrialising economy, namely Mauritius, which underwent extensive trade liberalisation and extensive labour market adjustment during the period of the analysis. For this case we find only partial support for the theoretical model. The estimated responses of employment and wages in the exportable sector are in line with the model’s predictions; employment and wages increasing in the long run in response to trade liberalisation, but some evidence of downward pressure on wages in the very short run. In the case of the importables sector output contraction is predicted by the estimated model to reduce employment and wages. In actual fact employment and wages have expanded in this sector following liber-

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alisation, and have been accompanied by general expansion of the economy and of labour supply. These latter two influences are captured by the empirics, but not by the theoretical model. The model provides, therefore, a useful analytical framework for linking labour market adjustment to trade reform, and for investigating the dependence of the adjustment process on the conditions relating to factor supply, factor mobility and sectoral rigidities assumed. Many of these conditions are similar across industrialising economies and as such the present results are of wider relevance. However, allowance also needs to be given to country specific circumstances when modelling a particular trade liberalisation.

APPENDIX 11A i)

Industry Divisions (3 digit ISIC classification)

Industry Food products Beverages Tobacco Textiles Wearing apparel except footwear Leather products Footwear except rubber or plastic Wood products except furniture Furniture except metal Paper and paper products Printing and publishing Industrial chemicals Other chemicals Rubber products Plastic products Pottery, china and earthenware Glass and glass products Other non-metallic mineral products Iron and steel Fabricated metal products Machinery except electrical Machinery electrical Transport equipment Scientific and other professional equipment Other manufacturing

ISIC code 311 313 314 321 322 323 324 331 332 341 342 351 352 355 356 361 362 369 371 381 382 383 384 385 390

Classified (x = exportable, m = importable) m m m m x x m m m m m m m m m m m m m m m m m m x

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Chris Milner and Peter Wright ii)

Sample Details

Full Sample Time Period Number of Industries Total number of observations

1968–91 25 543

Restricted Sample Time Period Number of Industries Total number of observations

1979–91 9 117

iii) –

229

Sources of Data Bi-Annual Digest of Statistics, Central Statistical Office, Mauritius Ministry of Economic Planning and Development. Quarterly External Trade Statistics, Central Statistical Office, Mauritius Ministry of Economic Planning and Development. National Accounts of Mauritius, Central Statistical Office, Mauritius Ministry of Economic Planning and Development. Bi-annual Survey of Employment and Earnings in Large Establishments, March. UNIDO Industrial Statistics.

– – – –

Notes 1. 2.

3. 4.

5. 6.

See Wood (1994) for a review of this evidence. In the context of a trade liberalisation which draws labour into relatively low skilled exportables there are likely to be few skills barriers to mobility. The degree of geographical mobility will be fashioned by factors such as country size and quality of infrastructure. Total output of and factor use by non-tradeables is demanddetermined, with the remaining factors being used in tradeables production in a traditional H-O manner. In fact Edwards (1988) investigates a fall in the price of importables induced by a change in the world price, i.e. a terms of trade change, but he points out that this is almost equivalent to an import tariff change that results in a change of the same magnitude in the domestic price of imports. The exogenous shock generates, however, a higher income effect than the trade policy change. The overall increase in the demand for labour, given the shift in production from importables to exportables, is with fixed capital stocks and therefore implies a falling marginal product of labour in the short run. Edwards (1988) also investigates the effects of economy-wide wage rigidities arising from minimum wages. There are likely to be significant differences between the two cases.

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230 7. 8.

9. 10.

11.

12. 13. 14.

15. 16. 17.

In particular high levels of labour utilisation are not characteristics of a ‘labour-surplus’ economy where one might anticipate very high elasticities of sectoral labour supply. There is no special geographical zone on the island. Rather EPZ firms have a specific legal status. The government has encouraged the dispersal of establishments, with designated factories and sites being bounded. For a detailed description of trade policy during this period see Greenaway and Milner (1989) or Dabee and Milner (1994). Textiles and clothing are typically viewed as relatively labour intensive in both developed and developing countries. The measured ranking of factor intensities in Mauritius of importables, non-tradeables and (nontraditional) exports is in fact in line with the Edward’s model (see Blake, Milner, Reed and Westaway, 1995). Of course issues of counterfactuals and causality arise. The expansion of exports may have been assisted (in part at least) by other external and non policy factors, with the resulting easing of the foreign exchange constraint facilitating the expansion of imports. Assuming perfect capital markets, the user cost of capital will only vary over time, so that in estimation its variation will be captured by time dummies. There is a long tradition of proxying the effects of foreign competition with actual trade volumes or shares in the literature on growth, exports and trade liberalisation (see Edwards, 1993). In the case of Mauritius the proliferation of small and localised membership means that standard measures of labour market power based on unionisation are inappropriate. Social influences on wage determination are better proxied by the sex ratio. Details of the data sources used are included in Appendix 11A. Robust standard errors were calculated in the case of column 1 results and confirm the reported results. Detailed results not reported here are available from the authors.

References ABOWD, J.M. (1987) ‘The Effects of International Competition on Collective Bargaining Agreements in the United States’, Princeton University, unpublished. ABOWD, J.M. and LEMIEUX, T. (1990) ‘The Effects of International Competition on Collective Bargaining Outcomes: a Comparison of the United States and Canada’, NBER Working Paper 3352. ARELLANO, M. and BOND, S. (1991) ‘Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations’, Review of Economic Studies, vol. 58, 277–97. BLAKE, A., MILNER, C.R., REED, G.V. and WESTAWAY, A.J. (1995) ‘Trade Shocks and Model Dimensionality: a CGE Analysis for Mauritius’, CREDIT Research Paper 95/11.

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CAVES, R.E. (1990) ‘Adjustment to International Competition: Short Run Relations of Prices, Trade Flows and Inputs in Canadian Manufacturing Industry’, Economic Council of Canada. DABEE, R. and MILNER, C.R. (1994) ‘Evaluating Trade Liberalisation in Mauritius’, Paper presented at the AERC workshop in Harare, March. DENNY, K. and MACHIN, S. (1991) ‘The Effects of Import Competition on Wages and Employment’, mimeo, Institute for Fiscal Studies. EDWARDS, S. (1988) ‘Terms of Trade, Tariffs and Labour Market Adjustment in Developing Countries’, World Bank Economic Review, vol. 2, 165–85. EDWARDS, S. (1993) ‘Openness, Trade Liberalisation and Growth in Developing Countries’, Journal of Economic Literature, vol. 31, 1358–98. GREENAWAY, D. and MILNER, C.R. (1989) ‘Nominal and Effective Tariffs in a Small Industrialising Economy: the Case of Mauritius’, Applied Economics, vol. 21, 995–1010. KONINGS, J. and VANDENBUSSCHE, H. (1995) ‘The Effect of Foreign Competition on UK Employment and Wages: Evidence from Firm-Level Panel Data’, Weltwirtschaftliches Archiv, vol. 131, 655–71. MILNER, C.R. and MCKAY, A. (1996) ‘Real Exchange Rate Measures of Trade Liberalisation: some Evidence for Mauritius’, Journal of African Economies, vol. 5, 61–91. MUSSA, M.L. (1978) ‘Dynamic Adjustment in the Heckscher–Ohlin– Samelson Model’, Journal of Political Economy, vol. 82, 1191–1203. NEARY, P. (1978) ‘Short-Run Capital Specificity and the Pure Theory of International Trade’, Economic Journal, vol. 88, 448–510. PESARAN, H.M. SMITH, R.P. and IM K.S. (1996) ‘Dynamic Linear Models for Heterogeneous Panels’, in the Economemcs or Panel Data, ed. L. Mat´yás and P. Sevestre, ch. 8, pp. 145–95. Kluwer Academic Publishers, Dcrdrecht, The Netherlands. WOOD, A. (1994) North-South Trade, Employment and Inequality (Oxford: Clarendon Press).

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12 Local Government Finance Shyam Nath

12.1

INTRODUCTION

The assignment of tax-expenditure responsibility at the local level has gone significantly farther in developed than in developing countries. However, recent global political and economic changes have substantially raised the prospects for decentralisation in developing countries. Structural adjustment policies initiated during the 1980s and the recent wave of liberalisation have contributed to the declining role of top heavy central government. In this process, local authorities have been considered as an instrument of democratisation of service institutions and systems compatible with market outcomes. Donor pressure has been the most significant catalyst for the increasing importance of local government. Donors are in fact increasingly making loans with conditionalities requiring local participation (World Bank, 1991; UNDP, 1992). These developments have also encouraged World Bank and IMF economists, in particular, to assess the potential gains and dangers of fiscal decentralisation. (See, for example, recent contributions by Prud’homme, 1995 and Tanzi, 1995.) Although there has been increased recognition of the important role that can be played by local government in recent years, this emphasis may be displaced in very small countries due to the lack of meaningful spatial variations in local service needs. We can argue that the decentralised provision of local goods and services should depend on the level of economic development, geographical area and population size of a country. A very small country can probably satisfy only the economic development criterion to improve the prospects for decentralisation. This chapter employs standard economic principles to evaluate the role of local government in providing and financing locality based services in Mauritius. The plan of the chapter is as follows: Section 12.2 232

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examines the rationale of local governments in providing locality specific services with particular reference to very small countries. The extent of fiscal decentralisation and revenue and expenditure patterns of municipal councils are examined in sections 12.3 and 12.4 respectively. Trends in local finances are analysed in section 12.5, which also includes the grant system and an evaluation of local property tax revenue performance.An attempt is made to discuss local government response to grants from central government in terms of local resourceraising efforts in section 12.6. The next section examines the basic issues for undertaking a reform of local public finance with particular reference to revitalisation of local property tax and the grants regime. Concluding remarks are contained in the final section.

12.2 THE RATIONALE FOR LOCAL GOVERNMENTS IN VERY SMALL COUNTRIES There are economic and non economic arguments for creating local level authorities. The economic argument is based on the idea of the geographical area over which the benefits of public goods can be distributed. If the benefit area of a public good is the entire nation, it is called a national public good. National defence is an example. On the other hand, benefit areas can be very small for such goods as primary education and garbage disposal.Thus, local governments exist because benefit areas differ from one public good to another and they are small for certain public goods. Theoretically speaking, it would be wise to take for granted that local services should be provided by a local government (Oates, 1972). Conventional literature on fiscal assignment suggests that a government’s distribution and stabilisation functions should be greater relative to its allocative functions, the higher it is in the federal hierarchy (see, for example, Musgrave, 1959, pp. 179–83). For those allocative functions for which local governments are most suited, the distribution of functions will depend on how large or small the jurisdiction benefiting from those functions is. Nevertheless, the question as to whether it is more efficient when a local function is performed by a local government or not has various dimensions. Citizens’ choices between local and central government would depend upon whether uniform or non uniform local services and taxation are desirable. Even though the benefits of local goods are limited to a locality and there is a case for local government provision, there may be a national

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concern to reduce inter-locality differences in local services. The latter approach would support fiscal centralisation. While discussing the desirability of local governments in very small countries, there is an important dimension that may assume special significance in the Mauritian context. Efficiency of provision has two dimensions-allocative and production efficiency. Allocative efficiency means gains in the sense of providing citizens the kind of services they want. In the literature, it is known as Samuelsonian efficiency. Production efficiency or cost effectiveness means that average costs of different local services are lower when provided by a local government. When benefit areas are very small, there is great likelihood that the latter condition will not be satisfied. One of the ways to address this situation is to create an intermediate tier in the structure on the ground of technical economies of scale. Examples are single purpose water boards, metropolitan transport authorities and school districts. These can be autonomous or under central control. This method of creating a new tier is known as functional decentralisation. The advantages of functional decentralisation may be substantial in resource constrained developing countries. In Mauritius, such parastatal bodies are present for water supply and electricity generation and distribution. The issues underlying the provision of municipal services are quite different, however. The channel for supplying these services would probably depend more on citizens’ preferences. If it can be taken that allocative efficiency effects of local provision will be greater than economies of scale effects, then it would support local provision. Thus, the choice between fiscal and functional decentralisation may depend on factors other than technical efficiency gain.

Economic Development With economic development, fiscal decentralisation should increase as the demand for local services systematically responds to urbanisation and income growth (Martin and Lewis, 1956; Kee, 1977; Bahl and Nath, 1986). Given the fact that income is the main determinant of a voter’s preferences for services provided by the public sector (Meltzer and Richard, 1981), income induced preferences would also reflect on the choice of governments at different levels to provide locality based services. Moreover, when income increases are accom-

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panied by inequality in the early phases of development (Kutnets’ hypothesis), the preference for central government may increase on the ground that central tax and expenditure policies are supposedly more redistributive (Musgrave and Musgrave, 1989). Export-led growth in Mauritius has helped increase per capita income from US$1,000 in 1982 to more than US$3,000 in 1995, and has improved income distribution as well (the Gini coefficient has fallen from 0.43 to 0.33 during the 1983–95 period (MEPD, 1996)). Furthermore, the various indicators of disparities in wages have shown definite signs of improvement during the period of economic transformation. During the period 1980–92, intersectoral disparities in wages fell from 0.42 to 0.25 and within manufacturing disparities in wages decreased from 0.27 to 0.22 (Nath, 1995).These factors may contribute to the contention that even in a very small country, citizen-voter preferences would favour local governments for the provision of local goods and services. Trade Openness Kee (1977) found more decentralisation in countries that have more open economies. But since his sample consisted of developed countries only, its worldwide validity is somewhat mitigated. According to Krugman (1994), a closed economy, whether developed or not, will favour metropolitan concentration. This can be explained by the fact that firms will be willing to be established near markets and sources of intermediate inputs so that people flock to the metropolis lured by work prospects and access to services offered. However, if the economy is open to international trade, the typical firm will sell much of its output to the world market and perhaps get much of its intermediate inputs from that market as well. Thus, the proximity to the main market becomes less crucial and this will engender smaller big cities. Mauritius is highly dependent on trade both for exports and imports: about 50 per cent of GDP. This trade openness has caused greater dispersal of population and economic activities. It may seem that in a country where population is not concentrated in a few areas, smaller scattered jurisdictions are desirable. But the dispersal of population over a very small geographical area may favour a single homogeneous jurisdiction covering the entire population. There may not therefore be a need to create several levels of government and a local

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function can be performed by central government or a parastatal body under central government. Political Factors Besides country size and economic factors, the political system of a country may play an important role in determining government structures. Bahl and Linn (1992), however, found little difference in measures of expenditure and revenue mix between a federal and nonfederal structure. What is more pertinent is the autonomy of local governments, which is higher in a federal structure. The degree of fiscal autonomy is usually determined by such factors as the level at which regulatory and administrative power is exercised, the formal constitutional and statutory relationships between the local government and higher levels of government, and the political culture prevailing in the country (Wolman, 1982).Although local governments may not be very strong in centralised systems, they would still occupy an important place in the service delivery system, depending on tradition and political philosophy. Empirical Evidence Empirical evidence on the suitability of local level authorities in very small countries is scarce. In a recent paper, the relative efficiency of local and central governments in providing local services has been compared in Mauritius (Nath, 1998). It was postulated that citizen-voters’ preferences for one layer of government against another are reflected in property values in a locality. Further, both local and central public officials maximise property values in a locality. The actual functioning of selected municipal councils was compared with a hypothetical central government performing the same functions. Although most of the services were underprovided in either regime, it has been shown that local governments are in no way less efficient than central government in providing local public goods and services. It has also been noted in this exercise that citizens do not make much difference between central and local taxes as long as the funds are spent on locality based services. These results can be interpreted to mean that there does not seem to be any evidence against fiscal decentralisation, despite the small size of the country both in terms of geographical size and population.

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12.3 TRENDS IN FISCAL DECENTRALISATION IN MAURITIUS Although the structure of local government may seem to be highly decentralised, the degree of fiscal decentralisation is quite low. For example, local government expenditure as a proportion of GNP averaged 1.2 per cent over the last ten years. We present a taxonomy of local government functions in Table 12.1 and compare it with functions that are generally allocated to urban local bodies in representative developing nations. It should be noted that the derivation of this representative urban government, based on an ‘average’ practice, is quite tentative in view of the wide variation in the scope of local government responsibility (see Bahl and Linn, 1992). We compare the city of Port Louis with the above ‘average’ practice because other municipalities are much smaller. Expenditure decentralisation in Mauritius, as represented by the municipal council of Port Louis – the biggest city council, falls short of the ‘average’ practice in terms of the allocation of functions. This also proves that the other municipalities would deviate considerably from the ‘average practice’. Thus, the degree of decentralisation seems to be quite low. It is also confirmed by the low level of expenditure decentralisation; the ratio of local government expenditure is about 5 per cent of general government (central plus local) expenditure (Table 12.2). One should also note that local government own revenues constitute only a little over 2 per cent of general government revenue. Besides small fees, the most important source is local property tax. Therefore, the big gap between expenditures and revenues is filled by the central grants. The greater the significance of grants, the lower would be the degree of fiscal decentralisation. This is because grants are generally used by central governments to impose central preferences in providing local goods and services and thereby impinging on local autonomy and preferences. This argument, however, may not apply to a very small country where spatial differences in citizen-voter preferences for local public services may not be significant. The significance of grants in local finance stems from the fact that the reasons for decentralising expenditures are much stronger than the reasons for taxes. This is despite the fact that the theory of financial responsibility would suggest that both spending and taxing powers should be decentralised so that the spending units also share the unpleasant task of raising revenues. The key point is that the

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238 Table 12.1

Functions of local government in Mauritius

Port Louis

‘Average’ Practice in Local Councils

General Urban Services Refuse Collection Parks and Recreation Markets and Abattoirs Cemeteries Fire Protection Police

✓ ✓ 1 ✓ ✓ ✗

✓ ✓ ✓ ✓ ✓ ✗

Public Utilities Water Supply Sewerage and Drainage Electricity Telephone

✗ 2 ✗ ✗

✓ ✓ ✗ ✗

Transportation Highways and Roads Street Lighting Bus Service

3 ✓ ✗

✓ ✓ ✓

Social Services Primary Education Primary Health Social Welfare Housing

✗ ✗ ✗ 4

✓ ✓ ✗ ✓

Functions

✓ Yes. ✗ No. Notes: 1. Abattoirs are now under the control of the central government. 2. Sewerage and drainage were formerly under the responsibility of the municipal council of Port Louis. Responsibility of the sewerage system (only) now is under the control of the central government. 3. Only roads are under municipal control. 4. Housing estates locally known as ‘cités’ were formerly erected by the municipal council of Port Louis. Today the council’s function is only to maintain such housing estates and not to build any more of them. All housing projects are nowadays undertaken by the National Housing Development Corporation which is partly funded by the central government.

advantages of expenditure decentralisation lie in economic efficiency gain in the sense of providing the services in the light of preferences of taxpaying citizens. On the other hand, revenue decentralisation would be founded on the principle of benefit taxation, that is, whether

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Table 12.2 Trends in fiscal decentralisation (% of general government expenditure and revenue)

1986/87 1991/92 1994/95

Local Government Expenditure*

Local Government Own Revenue

4.3 4.9 4.9

1.4 1.8 2.1

* including grant financed local expenditure. Source: CSO, Annual Digest of Public Finance Statistics, various issues.

benefits are localised over small jurisdictions and identifiable taxpayers. Further, centralisation considerations are based on economies of scale; cost advantages may be significant for centralised spending and taxing activities. Thus, generally speaking, the assignment of expenditure and tax functions would result in financial gaps at the local level, which would have to be filled by grants. But the adverse effect of grants on local autonomy can be minimised by making grants more formula-based and transparent. The smallness of a country may in fact help improve transparency because of lack of meaningful variations in service needs across localities.

12.4

EXPENDITURE AND REVENUE FUNCTIONS

Expenditure Heads Local governments in Mauritius are responsible for a wide range of public services. Since Mauritius has a unitary system of intergovernmental arrangements, the functions of local authorities are not defined in the Constitution. At present these locality level authorities derive their powers from the Local Government Act, 1989. According to this Act, municipal and district councils have both compulsory and discretionary powers while the few functions of village councils are generally of a nondiscretionary nature. The bulk of the services provided by municipal and district councils are obligatory ones and are set out in the following functional classification:

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(i) Health and Sanitation • collection and disposal of waste • construction and maintenance of lavatories and baths in the public places • erection and maintenance of cemeteries and cremation grounds • measures for ensuring food hygiene especially in markets (ii) Environment • control of pollution • caretaking of beds and banks of lakes and water flows • maintenance of parks and gardens • works of afforestation, terracing, tree planting and tree removal (iii) Education • nurseries and kindergartens • public libraries (iv) Entertainment and Recreational • provision of such sports and recreational amenities as sports grounds, swimming pools, art galleries, theatres and exhibition halls and other places for public entertainment • sponsoring of activities related to the promotion of sports and culture (v) Traffic Control and Road Infrastructure • construction, maintenance and lighting of public roads • erection of pavement, drains and bridges • construction of bus shelters, traffic centres and public squares • allocation of parking for private cars (vi) Trade • building up of places of public auction • control of premises used for trading, industrial, professional and other purposes of a related nature (vii) Housing • construction of residential buildings • managing, maintaining and improving housing estates (viii) Miscellaneous • town planning schemes • the issue of building permits

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Beyond their m]andatory functions, municipal and district councils also have certain powers such as the improvement and control of public roads and the opening of markets and fairs. They may also, subject to the approval of the Minister for Local Government, carry out any undertaking that promotes the welfare of the inhabitants of their administration area. There are also certain functions that only municipal councils are allowed to perform such as disposal of nightsoil and electrification of public or private buildings. Moreover, there are only two municipal theatres in the island, one in Port Louis and the other one in Beau Bassin/Rose Hill. As a result, functions related to the maintenance and improvement of the theatres can only be performed by the municipalities of these two regions. Finally, the municipal council of Port Louis is the sole authority to run a fire brigade. The functions of village councils are mostly obligatory and pertain to the organisation of sports, cultural, leisure and other welfare activities. In the educational realm, they have to run pre-primary and sewing classes. With respect to health and sanitation, they have obligatory functions to maintain burial and cremation places and to perform any public works that would promote sanitation in the village and the well being of its inhabitants. However, according to Dukhira (1994) the delivery of such services is increasingly being undertaken by the district councils because of the lack of resources and administrative skills at the village level.

Revenue Categories Property Tax The property tax is levied on the net annual rental value of property the value of which exceeds Rs1,750. According to the Local Government Act 1989, these values should be readjusted within five-year periods. The fact that municipal councils can now decide upon the rates to be imposed on different properties is an indication that some degree of decentralisation has taken place in revenue terms. In fact, as argued earlier, the power to set taxes promotes fiscal autonomy and accountability. Nevertheless, the municipal councils are not given unbridled discretion over the property rate; elements of central control are still present. For instance, the taxable value of the property is assessed by the central government. Exemption

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of certain properties from the tax is also sanctioned by the central government. Tenant Tax The tenant tax is imposed as a percentage of monthly rent payable by the tenant. Just as in the case of property taxes, the municipal councils are also free to impose different tax rates within their community. So far, however, only the municipal council of Curepipe has made use of this privilege with its tax ranging from 15 to 30 per cent. The other councils have up to now made use of single tax rates: 15 per cent for the municipal councils of Port Louis and Beau Bassin/Rose Hill and 10 per cent for the municipal councils of Quatre Bornes and Vacoas/Phoenix. Trade Licence During the last five years, revenue from trade licences as a percentage of total revenue has averaged 8 per cent for municipal councils and 15 per cent for district councils. This higher percentage for district councils can be explained by the fact that district councils are not empowered to raise property tax and tenant tax so that they are compelled to fully exploit trade licences as a revenue base. Since certain commercial activities require the use of some locally provided services, for example, trash collection, road usage, the trade licence may be interpreted as payment for benefit received and is therefore consistent with the basic principles behind decentralisation. Other Incomes Apart from the main sources from which local authorities can derive revenue, there are other minor income sources that municipal and district councils are allowed to use so as to supplement their own revenue. They consist of building and development permits, entertainment duty, market stall fees, bus tolls, rents on housing estates and cemetery fees. Although none of these revenue sources contributes much to revenues, they jointly weigh quite heavily on the overall financial structure of Mauritian local authorities. For instance, during the last five years, the ‘other income’ component of local finance accounted for 16 per cent of total revenue for municipalities and 6 per cent for district councils, the difference being explained by the fact that urban authorities earn higher income from markets stalls, bus stands, and sale of commercial space.

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Borrowings In Mauritius, the ability of local authorities to contract loans is restricted to borrowing for the purchase of land or for the erection of buildings or for the carrying out of any activity or works the cost of which should be spread over a number of years [Local Government Act 1989, Section 116(1) (c)]. Further restrictions are also applied to local government borrowings in respect of the size of the loan. Thus, Section 116 of the Act precludes a council’s total debt from being more than the revenue of the six immediate past years. Such strict control of local borrowing prevents councils from swelling the public deficit and leading to macroeconomic problems. Bahl and Linn (1992) noted that there is no theoretical objection against local borrowing but that prior to enjoying this privilege, subnational governments should generate a capacity for loan repayment and should also establish a proper loan management system. These two conditions are however absent in developing countries, including Mauritius, so that central approval of local loan taking is essential.

12.5

TRENDS IN URBAN–LOCAL FINANCES

Comparable data are not available for rural local governments, hence the present analysis is carried out only for urban local governments, that is, municipalities. Table 12.3 reports the composition of municipal expenditures. All the expenditure categories have grown over time. Given the fact that inflation was moderate during the period of analysis, real expenditures generally have also shown similar trends. Except for Port Louis, all municipalities have spent more on sanitation than on public welfare and with minor exceptions, road maintenance has attracted much higher expenditure than streetlighting. These trends conform with local government’s role in other countries. The significance of expenditure under the heading ‘public finance’ has increased enormously in all municipalities. This shows the growth of wages and salaries in local public administration. Overall, Port Louis spends most, followed by Curepipe, Beau Bassin/Rose Hill, Vacoas/Phoenix and Quatre Bornes. Per capita expenditure can be taken to be an indicator of local service level when inter-jurisdictional cost differences in providing local services by local-level authorities

Source: Final accounts of municipal councils.

6.4 3.8 20.7 12.7 6.9 3.9 74.4 140.8 52.8

2.1 4.1 5.8 2.3 3.7 15.2 33.2 71.3 26.5

1985/86

1985/86

1994/95

Curepipe

Beau Bassin/ Rose Hill

5.0 10.7 14.2 8.6 33.9 42.6 115.0 140.8 81.6

1994/95 0.9 1.1 3.5 1.4 3.6 8.2 18.7 71.3 26.2

1985/86 4.9 4.8 13.4 7.6 19.7 26.3 76.7 140.8 54.4

1994/95

Quatre Bornes

Expenditure trends (Rs million)

1.4 1.0 2.3 1.1 2.1 8.3 16.2 71.3 22.2

1985/86

4.8 5.1 12.6 5.1 13.4 55.2 96.2 140.8 68.3

1994/95

Vacoas/Phoenix

3.0 8.0 8.0 8.0 12.0 27.0 66.0 71.3 92.0

1985/86

Port Louis

11.5 18.6 27.8 33.3 54.4 80.4 226.0 140.8 160.5

1994/95

244

Public lighting 2.5 Roads 1.0 Maintenance 6.5 Public welfare 2.8 Public finance 7.3 Others 9.6 Total expenditure 29.7 CPI 71.3 Real expenditure 41.6

Function

Table 12.3

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Shyam Nath Table 12.4

1985–86 1986–87 1987–88 1988–89 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95

245

Per capita expenditure of towns (rupees)

Port Louis

Beau Bassin/ Rose Hill

Quatre Bornes

Vacoas/ Phoenix

Curepipe

481.1 525.5 583.0 823.6 918.9 1,070.7 1,107.9 1,151.5 1,334.4 1,553.9

323.6 373.2 505.3 627.3 736.1 757.6 792.0 780.0 977.5 1,009.1

289.9 341.3 432.2 521.7 627.2 650.3 713.6 739.5 906.1 1,043.5

297.6 348.5 406.6 429.5 513.2 446.6 798.2 807.5 963.2 1,020.8

525.5 700.5 934.7 1,002.7 968.9 1,054.2 1,195.7 1,310.3 1,457.3 1,501.1

Source: Final accounts of municipal councils.

are minimal. This is very plausible in Mauritius because the same technology is available to all municipalities. Table 12.4 shows that per capita municipal expenditure both in terms of level and trends are comparable, except in Port Louis and Curepipe municipalities. The figures are higher for the latter as they have undertaken more capital projects to participate in commercial activities that are financed by loans. On the revenue side, there are three important sources, namely, central grants, property tax and tenant tax (Table 12.5). Property tax is assessed on net annual market value of real property exceeding Rs1,750 per annum. The base of property tax is assessed by the Central Valuation Board. Municipalities can use differential tax rates on annual value slabs. Tenant tax is levied on occupiers of private premises of a non-residential nature, that is, properties used to carry out trade, business and commercial professions. Tenant tax is imposed as a percentage of monthly rent paid. A single rate of 10 per cent is used in Quatre Bornes and Vacoas/Phoenix, and 15 per cent in Port Louis and Rose Hill/Beau Bassin. Only Curepipe municipality charged differential tax rates between 15 and 20 per cent. Property tax however, has declined as a proportion of total revenue in all localities except Rose Hill/Beau Bassin. But it has dropped drastically in Vacoas/Phoenix from 22.2 to 8 per cent. Tenant tax, however, has continued to grow in fiscal significance particularly in Port Louis.

0.4 (1.3)

18.8 (63.3)

4.1 29.8 71.3 41.6

Tenant tax

Grants

Others Total CPI Real

10.8 97.5 140.8 69.2

57 (58.5)

2.1 (2.2)

27.6 28.3

4.6 33.2 71.3 46.6

20.6 (62.0)

0.2 (0.6)

7.8 (23.5)

48.0 135.6 140.8 97.7

66.9 (60.0)

3.7 (3.2)

17 (12.5)

1994/95

0 18.7 71.3 26.2

13.3 (71.1)

1.7 (9.1)

3.7 (19.8)

1985/86

0 76.7 140.8 54.4

44.2 (57.6)

19.0 (24.8)

13.5 (17.6)

1994/95

Quatre Bornes

Figures between brackets refer to percentages of total revenues. Source: Final accounts of municipal councils.

6.5 (21.5)

1985/86

1985/86

1994/95

Curepipe

Beau Bassin/ Rose Hill

Revenue trends (Rs million)

2.4 16.2 71.3 22.7

10.0 (61.7)

0.2 (1.2)

3.6 (22.2)

1985/86

26.7 96.2 140.8 68.3

60.8 (63.0)

0.8 (0.3)

7.9 (8)

1994/95

Vacoas/Phoenix

8.1 66.0 71.3 92.6

43.0 (65.2)

1.8 (2.7)

13.1 (19.8)

1985/86

Port Louis

42.4 226.0 140.8 160.5

122.4 (54.2)

23.3 (10.7)

37.9 (16.8)

1994/95

246

Property tax

Source

Table 12.5

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The proportion of grants in total revenue is high; it ranged between 54 and 71 per cent during the period of study. It is important to note that even grants witnessed a relative decline in fiscal significance in all the municipalities. This shows that other ad hoc sources of finance, such as license fees have appeared on the revenue scene.

12.6

PERFORMANCE OF LOCAL PROPERTY TAX

Despite the fact that property taxes are the mainstay of local finances, their revenue record is not very encouraging. Moreover, they are also not considered efficient and equitable because of associated tax distortions. For instance, the rate of return on investment in construction activities may be reduced and this may have a dampening impact. Furthermore, disparate property tax assessments introduce both horizontal and vertical inequities. On the whole, this tax is one of the most unpopular of taxes in the world. We concentrate here on the buoyancy of property tax, which depends on the growth of the tax base and on changes in the tax rate. The relative significance of property tax varies from locality to locality and its fiscal signifi-cance has declined in some municipal councils. The determinants of property tax yield can be analysed in terms of changes in the tax base and tax rates as well as collection efficiency. The base is the value of land and of structures on it and is called assessed value. It is determined in the light of estimated market value. The latter would depend on the level of various services provided by local govern-ment in particular and on the achievements of central government policies measured by economic growth (GDP growth rate). It is obvious that the success of this source of revenue will depend on the quality of administration in capturing market trends for assessment purposes. Rate changes may not be popular because of taxpayer resistance and political consequences. Tax rate changes have generally resulted when upgradation of property assessments does not come by easily. Collection efficiency is another important source of revenue growth. Tax collection is not automatic. When rates are applied to base, tax demand is generated. On the basis of tax demand, tax bills are issued to property owners and occupiers. In many cases, property owners go to court and taxes remain unpaid. Thus, there is no guarantee that tax demand is equal to tax collection in a year. It is quite common to find growing tax arrears.

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Given the tax administration as described above, the determinants of property tax yield can be written as PT/MV = f(PT/PTD, PTD/PV, PV/MV, MV/GDP) where PT = property tax collection; PTD = property tax demand; PV = property assessed value; MV = market value; GDP = gross domestic product, and MV/GDP = 1, that is, economic growth trends are adequately reflected in market values of properties. This isolates three determinants of tax performance, namely collection efficiency (PT/PTD), rate changes for given assessed value (PTD/PV), and assessment efficiency (PV/MV). Information on market values of taxable properties is not available. For the present exercise, the trend in market value is measured by real estate component of GDP. Further, in the absence of data on property tax demand, we calculate (PTD/PV) directly. This will measure tax collection response to growing assessments. Similarly, (PV/MV) measures assessed value response to growth of real estate value/GDP. These calculations are made for only two municipal councils; namely Port Louis and Quatre Bornes for which relevant data are available. The results of this exercise are reported in Table 12.6. Three important conclusions emerge. First, assessments have lagged behind market value of assessed properties, which is approximated by trends in the value added in real estate and GDP. Secondly, property tax revenue growth is considerably higher than the growth of assessed value of properties in both the municipalities. This shows that local governments have relied more on rate changes and collection efficiency. Finally, property tax collection has not kept pace with the growth of GDP, which means that it is not a buoyant source of revenue.

12.7

GRANTS AND LOCAL EXPENDITURE

The use of intergovernmental transfers or grants has become a prominent feature of modern fiscal federalism. Grants may also be used to enforce the grantor’s preferences. These may be necessary for services regarded as merit goods by the grantor and a feeling that localities will produce too little if allowed to choose service levels themselves. Examples of such services are primary health and education. Lastly, grants may be necessary to reduce disparities in tax rates and variations in standards of service. Without equalisation grants, some

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Shyam Nath Table 12.6

Indicators of tax performance (Rs million)

Assessed Property Value

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 Growth rate (%)

249

Property Tax Revenue

PL

QB

PL

QB

Real Estate Value Added

GDP

205.4 208.3 211.9 217.0 221.3 231.7 242.8 260.5 299.4 308.4

62.6 64.2 70.8 69.0 72.1 83.1 97.0 102.4 102.3 103.7

13.2 13.4 13.8 19.2 19.9 21.0 34.0 37.9 41.1 43.8

4.4 4.6 4.9 6.7 8.3 8.5 11.8 12.1 12.3 13.5

1,030 1,093 1,533 1,417 1,303 1,270 1,681 2,506 2,422 2,409

19,700 24,222 28,683 33,274 39,275 44,316 49,633 56,493 63,106 68,728

4.6

5.9

11.5

13.5

13.3

14.8

PL Port Louis. QB Quatre Bornes. Source: Compiled from accounts of municipal councils and CSO, National Accounts Statistics, 1996.

localities would be able to offer more attractive fiscal packages than others causing horizontal inequity among residents in different localities and stimulating migration that involves cost to the society. The Grant System In Mauritius, central transfers come in the form of general grants. These are paid according to a formula prescribing different rates for municipalities and district councils for the various grant elements (Table 12.7). The total amount of funds payable is decided by the central government following the examination of particulars provided by local authorities in respect of estimated revenue and expenditure for the next financial year, and such details as population, length of tarred roads, and total direct revenue raised. Comparison of the new grant structure with the previous grant system indicates that since the Local Government Act 1989, the annual revision of the grant formula has aimed at reducing the disparity between municipalities and district councils. In fact, while the grant formula for urban authorities has on the whole remained the same, the basic grant and citizen welfare

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Local Government Finance Table 12.7

The grant system

Grant Elements

Municipalities

District Councils

A: Basic grant

Rs80 per capita

Rs70 per capita

B: Citizen welfare grant

Rs80 per capita

Rs70 per capita

C: Living environment protection grant

Rs70 per metre of tarred road

Rs30 per metre of tarred road

D: Special grant: Port Louis Curepipe Black River

50% of (A + B + C) 30% of (A + B + C) 15% of (A + B + C)

E: Revenue raising incentive grant

45% of revenue received during the year

65% of the revenue received the year

Source: Data obtained from the Ministry of Local Government.

grants for district councils have both increased from Rs45 per capita to Rs70 per capita. Though it is often assumed that local autonomy, local accountability and fiscal discipline will be reduced with any growth in the proportion of central transfers, these grants may still invigorate the decentralisation process by allowing local authorities to perform functions they would otherwise be unable to afford. Moreover, the last element of the present grant structure is based on a measure of tax effort (that is revenue raised) to stimulate local resource mobilisation. If there is a positive response to this incentive, the revenue raising capacities of local authorities can be enhanced. This can also result in improved service delivery since local authorities will become more accountable towards their locality. In the long run, therefore, more revenue and spending powers may be assigned. It can therefore be asserted that the present grant system favours a decentralised regime since it consists of more general rather than specific grants. The grants programme for local governments is, therefore, a combination of specific purpose, lump sum and matching grants. Lump sum grants do not impose restrictions on use whereas such restrictions are mandatory for other categories of grants. Similarly, matching grants are tied to projects and also require a certain matching proportion in terms of additional local resources.

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Expenditure Stimulation One interesting aspect of grants is that they can stimulate or dampen local revenue effort. Expenditure stimulation will entail additional resource mobilisation by local governments. On the other hand, grants may be used to give tax relief to citizens and this is likely to dampen local expenditure. Local governments generally treat lump sum transfers as a general increase in revenue (the income effect) and there is a possibility that they use them for giving tax relief to citizen-voters thereby reducing local tax effort. But other types of grants should reduce the local tax price of aided projects through the substitution effect and are likely to stimulate local spending. To demonstrate local fiscal response to grants, let us assume a community with the following preference function: U = U(X, G) where X denotes private goods and non-local public goods provided by other governments, and G represents local public goods. In Figure 12.1, X2G3 is the budget line. At equilibrium E, the community’s consumption of X is at X*, and its consumption of G is G*, for X2-X* local taxes. Availability of grants (GR) equal to EB would either shift the budget constraint upwards or tilt it to the right. Thus if a general purpose grant is given, budget constraint shifts to X1 G5. But in the case of a special purpose project grant, budget line will tilt which is given by X2G6. To analyse tax effort implications, let us consider three outcomes that are indicated by equilibrium points A, B and C on the new budget lines. Point B denotes that local expenditure rises from G* to G2, keeping local taxes at X2-X*. The entire amount of grant is spent on local goods and services. In other words, dG = dGR. There is no tax relief to citizens and no additional resource mobilisation either. Any attempt to target relief to taxpayers would be indicated by obtaining equilibrium on the left of point B on the budget line. For instance, at point A which shows that dG < dGR. Local expenditure increases from G* to G1which is less than EB. This indicates the dampening effect. Taxpayers enjoy tax relief because they now pay taxes only X2-X3. This will enable them to spend more on ‘all other goods’. As regards the stimulating effects of grants, this is given by points on the right of B. Let the community’s equilibrium shift from E to C. Local expenditure increase to G4 where G*-G4 is greater than the amount of grant, EB (dG > dGR). This increase in local expenditure

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252 All other goods X1

X2 A

X3

B

X*

E

C

X4

0

G*

G1

G2

G3 G4

G5

G6

Local goods

Figure 12.1

Impact of grants

is financed by additional taxes. Citizens now pay total tax equal to X2-X4. To assess the extent of expenditure stimulation of grants, the standard methodology used in the literature is to estimate expenditure elasticity with respect to grants. A value exceeding unity is used as an indicator of expenditure stimulation (Gramlich, 1977). We have calculated the growth rates of municipal expenditures and grants to form a rough idea of expenditure stimulation due to grants. The results are shown in Table 12.8. It is found that the growth rate of local expenditure in the two municipalities for which data are available is higher than that of grants.This produces some evidence of expenditure stimulation of grants; that is, grants at least do not depress local tax effort. Expenditure response to grants is encouraging, but their response to income growth is sluggish. A lower expenditure growth can be interpreted as an indicator of inadequate expansion of local services to

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Shyam Nath Table 12.8

253

Local expenditure and grants (Rs million) Expenditure

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 Growth rate (%)

Grants

PL

QB

PL

QB

GDP

46.2 51.0 56.3 56.4 60.2 65.9 79.7 108.2 125.9 138.1 154.3 164.5 180.6 211.2 243.0

11.6 12.4 14.0 14.1 17.0 18.7 23.2 31.2 34.9 35.1 43.3 49.8 55.6 60.3 67.6

34.0 38.3 41.2 38.5 43.0 50.0 63.5 88.6 92.8 91.5 98.1 103.0 104.0 122.0 131.0

10.0 11.3 12.9 11.9 13.3 15.0 20.7 25.6 27.5 28.9 32.2 33.5 40.2 42.2 45.1

10,209 11,725 12,763 14,360 16,618 19,700 24,222 28,683 33,274 39,275 44,316 49,633 56,493 63,106 68,728

12.7

13.6

10.6

11.5

14.5

PL Port Louis. QB Quatre Bornes. Source: As for Table 12.6.

meet the fast growing demand for urban services consequent upon income growth. 12.8

REFORM OF LOCAL PUBLIC FINANCE

There is no dearth of literature on the poor performance of local government on the revenue raising front (Bahl and Linn, 1992). What is, however, important is to relate current service levels to some normative level in order to determine the gap in service levels. It has been argued that the expenditure requirements of a locality would grow at least in proportion to a locality’s personal incomes (Bahl and Schroeder, 1983). This assumption may not be implausible as it is in line with Wagner’s Law. In fact, the demand for local public services has considerably increased due to rapid economic and social transformation after 1982. However, local expenditure growth, an indicator of growth of local services, has been sluggish.

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This would not only make a case for revitalisation of local taxes but also necessitates redesigning the grants system. In particular, property tax lacks buoyancy; that is, it is highly income inelastic. Even though the Local Government Act, 1989 has given more autonomy in setting property tax rates; local authorities have been generally reluctant to use them. Frequent rate changes may have political implications. But rate changes alone may not yield desired revenue results unless the tax base, that is, rateable values of taxable properties determined by the Central Valuation Board, reflect market trends. In the absence of frequent revaluations even under a centralised valuation regime, rateable values do not exhibit an upward trend. There is a need to streamline property tax rates and base management with a view to imparting upward flexibility in the revenue base of local authorities. Rateable values of properties have lagged behind market values in many LDCs, mainly due to assessment problems (for a good discussion of these issues, see Bahl and Linn, 1992). In Mauritius, the last valuation was completed in 1950. The best way to deal with the problems of continuous assessment is to use standardised values. Standardisation proposals have taken three forms. The first is area-based standardisation of tax payment. ORG (1979) and Ramakrishna (1980) have suggested moving away from rental value and relating property tax to plinth area. Surcharges and ‘extras’ may be added according to location, type of construction, nature of use, and age of building. Each of these could be divided into a few categories and a tax value attached to each. In the second approach, the rental or market value per unit of area is fixed. The third approach is to fix per head tax amounts. Poll taxes are simple and transparent, but do not offer a system in which tax liability is related to ownership or use of property. Hence, for a property related standardisation exercise, it would be better to consider one of the first two alternatives. To render property tax revenue income elastic, rates would need to show an upward trend. The inflation rate may be used for indexation purposes. Standard tax payments or values, once fixed, may be made to rise every two or three years by the inflation rate. Where tourist business properties are concerned, a different approach is required. In fact, the property tax has been shown to be a better instrument for taxing international tourists (see Nath, 1993). The existing system levies a tax on hotel and restaurant bills in which hotel rents occupy a major share.These rents, however, may not reflect market trends because of extensive group tour discounts and excess

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supply of accommodation. In practice the revenue from this tax has lagged behind the growth of tourist arrivals and tourist expenditure, whereas increased tourist travel has raised the social costs to the host country. In this situation, a property tax provides a mechanism to impart buoyancy in tourist taxes and also acts as a Pigovian tax that relates the tourist’s tax liability to the social costs to the host country. There would be a need to index standardised rates to reflect market trends. The indexation formula could be worked out by combining factors, such as trends in tourist arrivals, tourist expenditure in the host country, and host government general expenditure. The first two factors represent demand for tourist accommodation and other facilities and the latter is intended to capture the growing cost of maintaining tourist destinations. Finally, in the case of grant reform, it is pertinent to note that population based grants do not capture rapidly growing expenditure needs of local governments. Rapid income growth has substantially contributed to the demand for local services. Therefore a grants programmes should reflect this trend: one way of incorporating income trends in grants is to link them to trends in central government finances. It is possible to redesign the existing grant structure by combining the existing population and road infrastructure criteria with central taxes. The best way to do this would be to introduce a system of shared taxes. As an experiment, 3 to 5 per cent of central tax revenue may be earmarked for local governments. Shared tax strategy would fit very well in a very small country context to take advantage of scale economies in tax revenue administration.

12.9

CONCLUDING REMARKS

This chapter raises important issues about the desirability of local governments in a very small country like Mauritius. Our analysis of trends in fiscal decentralisation shows that the financial operations of local authorities are not extensive. However, rapid economic and political development has created a favourable climate for community level governments. Furthermore, there seems to be some evidence in favour of fiscal decentralisation in Mauritius, despite its smallness. Whereas the demand for local public services has considerably increased, local government’s fiscal response has been relatively sluggish.There may be a need to revitalise the local financial resource base to meet the fast growing resource crunch. The property tax will have

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Local Government Finance

to find its place and for this, a complete overhauling of property tax administration may be needed. To overcome the problem of frequent assessment of properties for tax purposes, the area approach and standardised rates can be used. To render property tax yield more elastic, the standard rates can be linked to inflation. It is also desirable to consider a separate tax on properties devoted to tourist business. For this purpose, there may be a need to redefine the municipal limits, as most tourist business is concentrated in non-urban coastal areas. This would further require inter-locality political and administrative cooperation. Much of the desired cooperation can be achieved by redesigning the existing grant mechanism. It has to be recognised that population based grants have lacked elasticity whereas service needs have accelerated. It is, however, heartening to note that these grants have generated a positive impact on the local tax effort. Nevertheless, there may be a need to redesign the intergovernmental financial transfer mechanism. When population increases slowly but income changes are significant, financial transfers should be related to income growth. Given that citizens may not discriminate between local and central provision of local services, a case can be made to institute a tax sharing device whereby local authorities also derive their revenue from more elastic central taxes.

References BAHL R.W. and LINN J.F. (1992) Urban Public Finance in Developing Countries (Oxford: Oxford University Press). BAHL R.W. and NATH S. (1986) ‘Public Expenditure Decentralisation in Developing Countries’, Environment and Planning Series C: Government and Policy, 4, 405–18. BAHL R.W. and SCHROEDER L. (1983) ‘The Real Property Tax’, in R. Bahl and B. Miller (eds), Local Government Finance in the Third World, A Case Study of Philippines (New York: Praeger). DUKHIRA C.G. (1994) Grassroot Democracy for National Development (Mauritius: Edition de l’Océan Indien). GRAMLICH E.M. (1977) ‘Intergovernment Grants: an Empirical Review of Literature’, in W.E. Oates (ed.), The Political Economy of Fiscal Federalism (Lexington, MA, Cambridge University Press). KEE W.S. (1977) ‘Fiscal Decentralisation and Economic Development’, Public Finance Quarterly, 5, 79–98. KING D. (1992) Local Government Economics in Theory and Practice (London: Routledge). KRUGMAN P. (1994) ‘The Role of Increasing Returns and Transport Costs’, in Proceedings of the Annual Conference on Development Economics (Washington, DC: The World Bank).

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MARTIN A. and LEWIS W.A. (1956) ‘The Patterns of Public Revenue and Expenditure’, Manchester School of Economic and Social Studies, 24, 203–44. MELTZER A.H. and RICHARD S.F. (1981) ‘A Rational Theory of the Size of Government’, Journal of Political Economy, 89, 914–27. MEPD (1996) Economic Indicators (Mauritius: Ministry of Economic Planning and Development). MUSGRAVE R.A. (1959) The Theory of Public Finance (New York: McGraw-Hill). MUSGRAVE R.A. and MUSGRAVE P.B. (1989) Public Finance in Theory and Practice (Singapore: McGraw-Hill). NATH S. (1993) ‘Taxing International Tourist Population’, Seventh Annual Conference of the European Society for Population Economics, Demographic Research Institute, Budapest. NATH S. (1995) ‘Urbanisation and Employment Structure Change in African Economies: An Analysis of Policy Options with Special Reference to Mauritius’, United Nations University, Helsinki, processed. NATH S. (1998) ‘A Model of Local Fiscal Choice’, paper presented at 54th Congress of International Institute of Public Finance, Cordoba, Argentina. NATH S. and PUROHIT B.C. (1995) ‘A Model of Local Fiscal Choice’ Public Finance, 47, 93–107. OATES W.E. (1972) Fiscal Federalism (New York: Harcourt Brace Jovanovich). ORG (1979) ‘Property Tax System in Madras Urban Agglomeration. A Review of Existing Systems and Proposed Rationalisation’, Operation Research Group, Madras, processed. PADDISON R. (1988) ‘The British Reform in International Context’, in N. Barley and R. Paddison (eds), Reform of Local Government Finance in Britain (London: Routledge). PRUD’HOMME R. (1995) ‘The Dangers of Decentralisation’, The World Bank Research Observer, 10, 201–20. RAMAKRISHNA G.V. (1980) ‘Municipal Property Tax: A New Approach’, Nagarlok Urban Affairs Quarterly. SAMUELSON P.A. (1954) ‘The Pure Theory of Public Expenditure’, Review of Economics and Statistics, 36, 387–9. TANZI V. (1995) ‘Fiscal Federalism and Decentralisation’, in M. Bruno and B. Pleskovic (eds), Proceedings of the Annual World Bank Conference on Development Economics (Washington, DC: World Bank). UNDP (1992) The Urban Environment in Developing Countries (New York: UN). WOLMAN H. (1982) ‘Local Autonomy and International Finance in Britain and the United States’ in R. Rose and E. Page (eds), Fiscal Stress in Cities (New York: Cambridge University Press). WORLD BANK (1991) Urban Policy and Economic Development: An Agenda for the 1990s (Washington, DC: World Bank).

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13 Population and Demographics Malati Pochun

13.1

INTRODUCTION

The population dynamics of a country is the study of changes over a certain time period, in size, character and distribution of its population, with a view to explaining the changing population situations, the processes and agencies which cause such changes, and analysing anticipated consequences of probable future changes. In analysing the causes and effects of changes in these basic facts, the three primary demographic variables that produce them will need to be emphasised, namely birth, death and migration. This chapter aims at explaining past and recent demographic tendencies in the Island of Mauritius (hereafter referred to simply as Mauritius, to which all the data in this chapter relate). It will examine the socio-economic significance of these population trends and of future expectations in size, composition, density and distribution, the focus being on the ageing of population and its socio-economic implications. The chapter is divided into seven sections, the first being the introduction. Section 13.2 considers trends in population growth from 1846 to 1998, covering both the demographic revolution of the postwar years and the demographic transition which followed it. Section 13.3 examines trends, patterns and determinants of fertility and mortality. International migration is very briefly reviewed in Section 13.4. Section 13.5 analyses changes in composition, structure and distribution of the population, and their impact on both the working age population and dependency ratios. Section 13.6 highlights population projections and the future outlook for the period 1996–2036, including the ageing of population and its socio-economic impact. Lastly, discussion and policy implications are presented in Section 13.7. 258

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TRENDS IN POPULATION GROWTH, 1846–1998 Immigration and Population Growth, 1846–1944

Census records for Mauritius, which date back to the middle of nineteenth century, show that before 1881 population growth in Mauritius was almost completely dependent on immigration, large numbers of indentured labourers being brought from India. During this period although the birth rate was high, the death rate was also high, and sometimes even higher than the birth rate, partly due to the malaria epidemic of 1867–69. Thus the exceptionally high population growth between 1851 and 1881, when the population doubled, can be almost entirely attributed to immigration. After 1881, when immigration of Indian labourers had practically been completed and the population growth depended mostly on migration of other people during the remainder of the nineteenth century, and on natural increase, the population rose only very gradually from one census enumeration to the next. In fact, the average annual rate of increase amounted to less than half of one per cent per annum during each inter-censal interval from 1881 to 1944 (Table 13.1). Although the fertility rates during the first two decades of this century were high, the rate of population growth remained low due to unfavourable mortality conditions which were such that very often the death rates in a year exceeded the birth rates (Table 13A.1, Appendix).There was thus little change in population size inspite of some net immigration in the first decade. Since 1910 immigration made no significant contribution to population growth, till almost the sixties. The period 1921–44 was characterised by considerable fluctuations in both birth rates and death rates with alternating periods of prosperity, improved health conditions and depression years. The population growth rate in this period was somewhat higher, although still less than half per cent. 13.2.2 Demographic Transition of Mauritius and Population Growth, 1945–98 The dramatic developments after the Second World War however, ushered Mauritius into an entirely new era of demographic trends. Between the censuses of 1944 and 1952, the annual rate of population growth shot up to an average of 2.26 per cent. The successful control of infectious diseases and the eradication of malaria led to a sharp fall

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260 Table 13.1

Population growth in intercensal periods, 1846–1990 Population

Census Year 1846 1851 1861 1871 1881 1891 1901 1911 1921 1931 1944 1952 1962 1972 1983 1990

Both Sexes

Male

Female

Average Intercensal Increase

158,462 180,823 310,050 316,042 359,874 370,588 371,023 368,791 376,485 393,238 419,185 501,415 681,619 826,199 966,863 1,022,456

104,598 119,341 202,961 193,575 208,655 206,038 199,552 194,095 194,108 200,609 210,326 252,032 342,306 413,580 481,368 510,676

53,864 61,482 107,089 122,467 151,219 164,550 171,471 174,696 182,377 192,629 208,859 249,383 339,313 412,619 485,495 511,780

– 22,361 129,227 5,992 43,832 10,714 435 -2,232 7,694 16,753 25,947 82,230 180,204 144,580 140,664 55,593

Annual Rate of Increase %

Density per km2

– 2.55 5.87 0.19 1.31 0.29 0.01 -0.06 0.21 0.44 0.49 2.26 3.12 1.94 1.44 0.80

85 97 166 169 193 199 199 198 202 211 225 269 366 443 518 548

Source: CSO, Digest of Statistics, various issues.

of 32 per cent in the death rate in a single year from 29.5 in 1946 to 20.1 in 1947. This rapid decline in mortality was also accompanied by an unprecedented rise in fertility and in 1950 the birth rate reached the highest ever level of 49.7. The rate of population growth reached a peak of 3.12 per cent during the following 1952–62 intercensal period. Rapidly falling mortality from very high levels was the main agent of growth. Changes in mortality were mostly brought about by advances in medical science, and in fact occurred at a time when the standard of living of the people was declining. This demographic revolution was very sudden and the rate of increase of Mauritian population became one of the highest in the world. Moreover, Mauritius, a small island with a strictly limited amount of land and natural resources (the total area is 1865 square kilometres) and with a population density approaching 400 persons per square kilometre, being dependent at that time only on agriculture, faced the grim prospect of a population explosion. The population had grown by over 60 percent from 419 thousand in 1944 to 682 thousand in 1962 and was projected to reach three million by the end of the century if fertility rates remained at the same high level and the mortality rate declined further as a result of the progress of medicine and of public health.

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The government was greatly concerned by the increase in the population and international attention was focused on the population problem in Mauritius. The country faced high unemployment and deterioration of social welfare. Government policy thus aimed at lowering the rate of fertility through family planning services as recommended by Titmuss and Abel-Smith (1968), through measures to improve the status of women, and by changing the minimum legal age of marriage for females from 15 to 18 years. Other measures which were expected to lower the high population growth rate were health education, communication and information programmes, improvement in educational attainment, increases in employment and improvement in income distribution. The above measures resulted in widespread adoption of family planning and an increased desire for smaller families. The Mauritius Family Planning Association which started operating in 1957 also had its share in popularising the use of family planning methods. The period of high fertility and low mortality did not continue for long. Population growth rates declined to 1.94 per cent between 1962 and 1972, 1.44 per cent between 1972 and 1983 and further to 0.80 per cent between 1983 and 1990. This decline in growth rates was mainly due to a spectacular drop in fertility rates during the period 1962 and 1973. The rate of fertility decline between 1965 and 1973 is considered as a rate unequalled for any population of substantial size. Fertility rates since then followed a generally downward trend to reach a point below replacement level in 1985. Mauritius had thus gone through a demographic transition in a little over four decades and this must seem like a miracle, looking back at the post-war years. Since 1987 there had been some reversal in the declining trend in fertility. However, since 1993 fertility started declining once again and the crude birth rate reached a record low in 1998. The death rate, on the other hand, has been almost stable. The population of 1,022 thousand according to 1990 census was far from the projections of 1960s of near three million. In 1998 the population was 1,124 thousand.

13.3 TRENDS, PATTERNS AND DETERMINANTS OF FERTILITY AND MORTALITY The records of vital statistics, like censuses, go back a long way in Mauritius. At least for the period from 1871 onwards, these data are considered to be of a sufficiently satisfactory quality to provide a

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general picture of the components of population change. The trend in the crude birth rates and death rates throughout has been characterised by large annual fluctuations and in the present century also by pronounced cyclical fluctuations. After a relatively good decade during the 1870s, when the crude death rate was about 29, mortality conditions seem to have gradually worsened and reached a very high level of 38 during the first decade of the present century. Although there was some improvement in the decade, the influenza epidemic of 1919 led to an exceptionally heavy toll of deaths. The period from 1916 to the mid-1920s was a relatively prosperous one for the sugar industry and successful campaigns against malaria and hookworm led to a significant decline in the death rate. However, a deterioration in the economic situation quickly led to a reversal to the familiar pattern of high mortality. By the late 1920s employment and wages had fallen whereas by early 1930s death rates became higher than birth rates. Undernourishment seems to have been an important factor in rising mortality, and malaria and hookworm once again became prominent when campaigns against them were mostly abandoned. Although, with an improvement in economic conditions in the early 1940s mortality levels declined to those of 1920s, health conditions seemed to be far from satisfactory. Life expectancy at birth over the 1942–46 period was 32 for males and 34 for females (Table 13.2). Only

Table 13.2

Life-expectancy by sex at specified ages, 1942–92 Male Age (in years)

Female Age (in years)

Period

0

60

65

80

0

60

65

80

1942–46 1951–53 1961–63 1971–73 1982–84 1984–86 1986–88 1988–90 1990–92

32.25 49.79 58.66 60.68 64.38 64.45 64.74 65.01 66.15

8.11 11.78 13.24 13.33 13.65 13.69 14.19 14.11 14.97

6.71 8.75 10.67 10.63 10.81 11.00 11.47 11.31 12.22

3.98 4.29 4.91 4.79 4.20 4.97 5.25 4.94 5.98

33.83 52.29 61.86 65.31 71.23 71.88 72.22 72.96 73.91

10.57 14.59 15.82 17.01 17.66 18.23 18.53 18.71 19.45

8.59 11.71 12.57 13.46 14.03 14.75 15.04 15.19 15.77

4.61 5.33 5.46 5.71 5.23 7.17 6.99 6.96 7.73

Source: UN, Demographic Year Book of Statistics, various issues.

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after the end of the Second World War was there a major breakthrough in the control of mortality when with the use of new modern methods of insecticide spraying, malaria was completely eradicated within a matter of a few years. Titmuss and Abel-Smith have attributed most of the dramatic decline of 32 per cent in mortality between 1946 and 1947 to the eradication of malaria mainly due to the use of insecticides. However, Frederiksen (1969) indicates that the spraying campaign was started only in 1949. He also argues that the per capita production of sugar rose sharply as mortality declined and the inverse relationship between the mortality rate and the standard of living suggested that reductions in mortality were still dependent on improvements in the standard of living. Improvements in health services mattered only as a part of general improvements in living standards. Since 1947 the downward trend in mortality continued, interrupted only by occasional fluctuations. From 20 in 1947, the death rate was halved in 1961 and has remained at slightly lower than 7 since 1981. The life expectancy at birth rose to 59 for males and 62 for females in 1961–63, and was 66 and 74 in 1990–92 for males and females respectively. Since 1871, the birth rate also displayed considerable fluctuations from year to year, but the five-yearly averages showed a marked stability up to the second decade of this century (Table 13A.1, Appendix). Over this entire period of 50 years the birth rate was around 36 to 37. From the 1920s there appeared to be a tendency for the birth rate to rise with favourable economic conditions and to fall during periods of economic hardship. Thus during the early 1920s the rate reached a level near 40, but fell as low as 26 during the depression of the early 1930s. Such fluctuations are indeed surprising when one considers that this was a period when family planning measures were perhaps unheard of. However, the census statistics on marital status seem to suggest that the reduction of the birth rate during the depression years was also partly due to a large-scale postponement of marriages, as indicated in Table 13.3. Throughout the latter 1930s and till the early 1940s the birth rate remained at the low level of 32 to 33. The low rate during the latter part of the period was also partly due to the absence of a significant number of men recruited for the Pioneer Corps. Similarly, the subsequent sharp rise of 33 per cent in the birth rate in 1944 could be associated with the recruitment of draftees and the dependency grant provided to their wives.

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264 Table 13.3

Percentage of females married* by age group, 1931–90 censuses

Age Group

1931

1944

1952

1962

1972

1983

1990

15–19 20–24 25–29 30–34 35–39 40–44 45–49

30.7 62.8 74.9 76.4 75.0 68.1 63.3

35.9 65.4 74.4 76.1 74.0 67.9 61.6

39.9 72.3 82.9 83.8 81.8 76.5 69.0

27.8 68.2 83.1 85.3 83.9 78.5 71.1

12.4 49.7 76.0 83.6 84.2 80.0 74.4

10.5 47.9 70.8 76.8 79.1 78.9 75.0

10.8 49.3 72.3 79.4 79.0 75.9 73.8

* Legally, religiously and consensually. Source: CSO, Census Report, various issues.

After the end of the war there was another marked increase in the rate when the birth rate approached an all time record of 50 in 1950. This peak rate was partly due to the catching-up of marriages and births postponed during the war. Although the birth rate fell from this peak level it was still above the pre-war levels till around the mid 1960s. This continuing high fertility, combined with the spectacular declines in mortality, gave rise to an unprecedented period of population expansion in Mauritius. Some explanations for the rise in the birth rate include a higher marriage rate, relatively prosperous conditions in the sugar industry, and the improvements in the health of the population leading to more pregnancies and more live-born children. The fertility trend turned downward only about 20 years after the dramatic downturn in the death rate. From the post-war peak of 50 in 1950, the birth rate declined to 30.6 in 1967. Between 1962 to 1967 Mauritius experienced over 20 per cent decline in the birth rate. According to Frederiksen, a reduction in mortality was a precursor of, and perhaps a prerequisite for, a reduction in fertility in the course of demographic transition of Mauritius as in the case of many other countries. Thus, Mauritius experienced a population explosion, that is, a transitory phenomenon. The sharp increase in the rate of population growth quickly called for both individual and collective decision making. A lower mortality and a higher probability of survival of children motivated parents towards a reduction in fertility. This was in turn assured by the spread of the family planning measures. It is there-

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fore to be noted that during the course of the demographic transition of Mauritius, a reduction in mortality at first caused a population explosion which in turn brought about a reduction in fertility, so as to restore a new balance between mortality and fertility. The reduction in mortality itself seems to be largely due to improvement in economic conditions. The decline in fertility which occurred since the late 1960s has been attributed to family planning programmes, rise in women’s age at marriage due to higher levels of education, and increased employment opportunities for them leading to a strong desire for smaller families. The Total Fertility Rate (TFR) declined from nearly six children per woman in 1962 to 3.4 in 1972. A second rapid decline in fertility occurred between the two censuses of 1972 and 1983 and fertility reached replacement level by 1985 (Table 13.4). This latter decline was attributed to a combination of factors, such as, later marriage, delayed child bearing, increased spacing between births and early stopping of child bearing. The contraceptive prevalence rate which was negligible in the early 1960s rose to 80 per cent in 1985. The mean age at first marriage of women rose from 19.9 years in 1962 to 23.7 in 1983. In 1986 both the birthrate and the TFR reached the lowest recorded levels of 18.3 and 1.94 respectively, after which a reversal in the downward trend was observed. Since 1993 fertility has been declining once Table 13.4

1962 1967 1972 1977 1983 1985 1986 1989 1992 1993 1995 1997

Fertility rates 1962–97, selected years TFR*

GRR*

NRR*

5.86 4.45 3.42 3.04 2.23 1.97 1.94 2.21 2.36 2.31 2.13 2.03

2.90 2.24 1.67 1.49 1.10 0.96 0.94 1.07 1.16 1.16 1.06 1.00

2.51 1.94 1.49 1.33 1.05 0.92 0.90 1.03 1.12 1.12 1.02 0.96

* See Glossary for definitions. Source: CSO, Digest of Statistics, various issues.

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again as mentioned earlier, although the TFR has not yet reached the record low level of 1986. The contraceptive prevalence rate fell to 75 per cent in 1991 and the mean age at marriage did not show much further increase since 1983. This phenomenon seems to be due to some ‘catching up’ of marriages and births during the period of economic prosperity.

13.4

INTERNATIONAL MIGRATION

Mauritius has a multiracial and multicultural population consisting of descendants of immigrants from Europe, Africa, Madagascar, India and China. Those from Africa, Madagascar and India were especially brought to work in the sugarcane fields. As seen earlier, during the nineteenth century, immigration was the main cause of population growth. By 1920, however, immigration was almost negligible and made no significant contribution to population growth until the sixties. Since then, there has been some emigration which seems to be mainly due to the high population growth of the earlier decades and the consequent high unemployment rates. After independence in 1968, uncertainties about socio-economic conditions might also have contributed to an increase in emigration, as shown in Table 13.5. There have been wide fluctuations in the emigration in response to the changing economic conditions, namely, the sugar boom of the mid-1970s, followed

Table 13.5

1956–60 1961–65 1966–70 1971–75 1976–80 1981–85 1986–90 1991–94

Official long-term emigrants* by sex, 1956–94 (annual average) Both Sexes

Male

Female

150 968 2,313 1,806 338 1,336 2,128 1,053

110 563 1,096 763 111 880 1,084 537

40 405 1,217 1,043 227 456 1,044 516

* Persons obtaining permits to migrate to other countries. Source: CSO, Digest of Statistics, various issues.

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by rising unemployment till the mid-1980s. The current decline in emigration seems to be partly due to the rapid economic development of Mauritius.

13.5 CHANGES IN CHARACTERISTICS AND DISTRIBUTION OF POPULATION Mortality, fertility and migration form the movement of a population, while its structure consists of various characteristics, for example demographic characteristics such as age, sex, marital status, urban/ rural distribution. The movement and structure of a population are interdependent. Thus, the age and sex distribution of a population affects birth rates, death rates, migration, marriage rates as well as the gross national product, educational facilities needed. Whilst changes in mortality, fertility and migration, in turn produce changes in the age and sex distribution. It is therefore important to analyse the changes that have taken place in the sex and age composition of the population and their possible consequences.

13.5.1

Trends in Gender Composition, 1846–1997

The sex ratio is the universal demographic measure of sex distribution (hereafter referred to as gender ratio). It is defined as the number of males per 100 females. Throughout the world the gender ratio at birth is consistently about 105. The predominance of males in the younger ages declines with increasing age due to differential mortality until a balance is reached. After that, the proportion of females gradually rises with increasing age. In countries where females receive inferior treatment, the death rate may be higher among females, and the gender ratio can be higher than 105 at adult ages. High gender ratios can also result from differential immigration of males to newly settled, hazardous areas. Gender ratios below 90 or above 115 are regarded as out of balance. As seen earlier, during the last century, population growth of Mauritius was mainly due to immigration. Thus, during the first half of the last century, the gender ratio was close to 200, or, extraordinarily high due to a predominance of males among immigrants. However, as Table 13.6 shows, there has been a continuous declining trend in the gender ratio since 1851.

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Table 13.6

Census Year 1846 1851 1861 1871 1881 1891 1901 1911 1921 1931 1944 1952 1962 1972 1983 1990

Gender ratio as enumerated at each census, 1846–1990 Gender Ratio (Males/100 Females) 194.2 194.1 189.5 158.1 138.0 125.2 116.4 111.1 106.4 104.1 100.7 101.1 100.9 100.2 99.1 99.9

Source: CSO, Census Report, various issues.

After 1880 immigration slowed down and practically came to an end by 1910. By the turn of the century the gender ratio thus became more responsive to changes in demographic factors such as the gender ratio at birth, level of fertility and differential mortality. During the first few decades of this century the ratio was still relatively high as a result of a high gender ratio at birth, and also due to higher female mortality, particularly at ages between 1 and 34 years. This latter situation might be an indication of a preference for a male child and consequent inferior treatment of a female child, coupled with reproductive health problems during the peak child-bearing ages. Subsequently, however, improvements in mortality were much faster for females than for males. In fact, the male mortality rate worsened at certain adult ages. The gender ratio thus gradually evolved in favour of females. In 1983 census, for the first time, the number of females exceeded males, and the gender ratio was below 100. Since then the gender ratio has remained around 100. The gender ratio varies widely by age (Table 13.7). Both in 1990 and 1997 the gender ratio generally rose with age till around the age of 30–39, after which it declined sharply. The preponderance of

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269

Gender ratio by selected age groups, 1990 and 1997 Gender Ratio (Males/100 Females)

Age (in Years)

1990

1997

0 1–14 15–39 40–59 60–64 65–69 70–74 75–79 80–84 85+

101.8 102.4 103.6 96.5 91.6 87.1 78.4 64.4 48.7 31.3

100.8 103.1 104.5 98.2 88.2 82.0 77.2 66.3 56.9 36.1

99.8

100.0

All Ages

Source: CSO, Digest of Statistics, various issues.

females with the rising age is a reflection of the differential mortality in favour of females. Thus, at age 80–84, the number of women was around double the number of men and at 85 years and over, the number of women is nearly three times that of men. Although women thus comprise a very large majority of elderly persons of 80 years and over, much improvement can be observed in the gender ratio in 1997 as compared with 1990. 13.5.2

The Changing Age Structure of the Population, 1931–96

Table 13.8 shows the age distribution divided into four rough categories: those too young to work (although some may actually be working), young working age, old working age, and those 65 years and over and retired. The changing patterns in age structure at each census since 1931 reflect very clearly the fluctuations which have occurred in the birth rates since 1920. The proportion of persons in the under 15 group rose steadily from 1944 to reach a peak of over 45 per cent in 1962 due mainly to the rise in the birth rate in the years after World War Two. Although fertility had fallen to a relatively low point just prior to the 1931

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270 Table 13.8

Age structure of the population by occupational characteristics, 1931–96 (percentages)

Age and Occupational Characteristics

1931

1944

1952

1962

1972

1983

1990

1996

Under 15 – Pre work group

38.4

35.1

40.2

45.3

40.1

32.1

29.3

26.9

15–44 – Young working age group

–

48.1

44.0

39.1

42.8

49.8

51.4

51.5

45–64 – Old working age group

–

13.8

12.6

12.4

13.3

13.5

13.9

15.5

58.7

61.9

56.6

51.5

56.1

63.3

65.3

67.0

2.9

3.0

3.2

3.2

3.8

4.5

5.4

6.1

15–64 – Total working age group 65 and over – Retired

Sources: Titmuss and Abel-Smith, 1968; CSO, Census Report; and Digest of Demographic Statistics, various issues.

census, the large cohort of children born during the early 1920s caused the total percentage under age 15 to be higher at this census than in 1944 when the cohorts born during the depression years formed part of this age group. Thereafter, with rising fertility, the proportion of children in the population continued to increase till the beginning of fertility decline in the late sixties, and the population of Mauritius had a young age structure throughout this period. Although fertility declined rapidly by 1972, the young structure persisted till the large cohorts born during the baby boom period passed through this age group. Only as from 1983 onwards a large decline occurred in the proportion under 15. The median age of the population consequently increased from 17.1 years in 1962 to 22.3 years in 1983. The median age rose further to 25.4 years in 1990 and 27.8 years in 1996. The persons in the too-young-to-work and retired groups represent the dependency burden on the working age group and constitute a drain on national productivity. People in the two intermediate categories contribute the bulk of the gross national product. The decrease in the proportion of children in the population has therefore been favourable to Mauritius, as the share of the working age group 15–64

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years, on which the economy depends, increased from 51.5 per cent in 1962 to 67 per cent or two-thirds of the population in 1996. In fact, the young working age group (15–44 years) now constitutes nearly 52 per cent of the population. On the other hand, till 1962 a very small proportion of the population – only about 3 per cent – was 65 years of age and over. Since 1962 this proportion started rising to reach six per cent in 1996. Thus Mauritius has gradually changed from a young age structure to a slightly ageing one, although the typical old age structure of industrialized countries with more than 10 per cent of the population above 65 years old is still decades away. Ageing of population will be discussed further in the Section 13.6.

13.5.3

The Dependency Ratio

The dependency ratio compares the proportion of the population in the nonproductive ages with those of working age. As mentioned earlier, the working age is generally taken as the age group 15–64 years. In Mauritius, for pension purposes the working age is considered as 15–59 years, but the dependency ratio is calculated by using the age group 15–64 years. The number of persons under 15 years together with those aged 65 and over per 1,000 adults aged 15 to 64 provides an index of ageinduced economic drain on manpower resources. As a result of the changes in the age structure of the population, the dependency ratio in Mauritius rose sharply since 1944 to reach a peak of 942 in 1962. Thereafter, the dependency ratio declined continuously and was only 489 in 1996, as indicated in Table 13.9. These reductions in the dependency ratio have resulted from large reductions in the child dependency ratio. Such reductions implied declining percentage expenditures on existing facilities for education and the possibility of providing increased facilities such as the free secondary education since 1977 and free tertiary education in the late 1980s. The elderly dependency ratio has been in fact increasing ever since 1944. The dependency ratios, after disaggregation by gender, show that throughout 1962 to 1996 the overall dependency ratios are consistently higher for women than for men. Although the large difference between male and female ratios in 1962 narrowed sharply in 1972 and 1983, this difference seems to be rising once again since 1990 (Table 13A.2, Appendix). On the whole, however there has been about

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Table 13.9

Dependency ratio, 1931–96

1931

1944

1952

1962

1972

1983

1990

1996

Child dependency ratio Elderly dependency ratio

654

567

710

880

715

507

449

399

50

49

57

62

68

71

83

89

Total dependency ratio

704

616

767

942

783

578

532

489

Sources: CSO, Census Report; and Digest of Demographic Statistics, various issues.

48 per cent decline in the dependency ratios for both males and females over the period 1962–96. When the dependency ratios are considered by both age group and gender it is observed that since 1972 female child dependency ratios are, in fact, smaller than those for males. The elderly dependency ratios are consistently larger for females than for males.

13.6 PROJECTIONS OF POPULATION AND FUTURE OUTLOOK, 1996–2036 13.6.1

Projected Population Growth

According to the CSO’s medium variant projections, from 1996 to 2036, the population of Mauritius is expected to grow with a declining annual rate from 0.90 between 1996–2001 to 0.11 between 2031–36. As a result, during each of these four decades the population will rise by 9, 7, 5 and 2 per cent respectively, to reach 1,371 thousand in 2036 from around 1,100 in 1996 (Table 13.10). Projection of the population at selected age groups shows that the child population will decline by about 46 thousand during this period, amounting to a reduction of 16 per cent. On the other hand, the working age population (15–64 years) would increase by 150 thousand from the current 738 thousand, an increase of 20 per cent. Lastly, both the number of pensioners (60+) and elderly persons (65+) would more than treble between 1996–2036 (Table 13.11).

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Malati Pochun Table 13.10

Projected population by sex and growth rate, 1996–2036

Population in Thousands Both Sexes

Male

Female

Growth Rate (% p.a.)

1,099 1,149 1,195 1,237 1,278 1,315 1,344 1,363 1,371

550 575 597 617 636 653 666 674 676

549 575 599 621 642 662 678 689 695

0.90 0.79 0.69 0.65 0.57 0.44 0.28 0.11

1996 2001 2006 2011 2016 2021 2026 2031 2036

273

Gender Ratio (Males/100 Females)

Density per km2

100.2 100.0 99.7 99.4 99.1 98.6 98.2 97.8 97.3

589 616 641 663 685 705 721 731 735

Source: CSO, Digest of Demographic Statistics, 1996.

13.6.2 Assumptions Underlying the Medium Variant Population Projections, 1996–2036 The projections are based on the following assumptions in respect of fertility, mortality and migration. The base for all projections is the estimated 1996 resident population by sex and age. Fertility The assumption for future fertility is that the Total Fertility Rate (TFR) will decline continuously from 2.24 in 1991and 1996 to reach 1.85 in 2006 and 2036. Mortality With the level of development attained by the country and with a policy aimed at promoting healthy life styles, life expectancy at birth is expected to improve further. Sex and age specific survival ratios will improve from current levels. The implied life expectancies at birth are shown in Table 13A.3 in the Appendix. Migration (average annual net migration) It is assumed that the net external movement of about 1,700 between 1996–2001 will decline rapidly in the following decades and thereafter net migration will be nil, as shown in Table 13A.4 in the Appendix.

294.6 709.0 738.1 95.1 66.0

1098.7

0–14 15–59 15–64 60+ 65+

All Ages

1149.3

294.6 750.2 781.6 104.5 73.1

2001

1195.3

285.9 791.0 828.5 118.4 81.0

2006

1237.5

286.8 822.4 876.3 146.3 92.4

2011

1278.2

260.7 853.3 900.9 182.2 116.6

2016

1314.9

259.2 833.0 908.1 222.7 147.6

2021

1344.4

258.9 818.2 903.9 267.3 181.7

2026

1363.5

255.1 814.2 891.2 294.2 217.2

2031

Projections of the resident population at selected ages, 1996–2036 (in thousands)

Source: CSO, Digest of Demographic Statistics, 1996.

1996

Age

Table 13.11

1371.2

248.3 811.3 888.2 311.6 234.7

2036

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275

The Projections of Gender Ratio, 1996–2036

Between 1996 and 2036 the gender ratio will decline from 100.2 to 97.3 because of more favourable mortality and higher increases in life expectancy of females. Thus between 1996 and 2006, the female population will increase by 26.6 per cent as compared to 22.9 per cent increase for males, implying a preponderance of females among the population.

13.6.4

The Changing Age Patterns of the Population, 1996–2036

The long-term trend of the population age distribution is one of growing older. At present the population of Mauritius is passing through a transition phase with an intermediate age structure and median of 27.8 years in 1996. However, gradually the population will evolve into a typical old age structure generally characterized by a median age of over 30 years, a child population (0–14 years) of about 20 per cent, and an elderly population (65 years and over) of 10 per cent or more. Although by 2016 Mauritius would thus show signs of population ageing, the typical old age structure of the industrialized countries will be reached in less than 40 years from now as can be seen from Table 13.12.

Table 13.12

Projections of the resident population at selected ages, 1996–2036 (Percentages)

Age (Years)

1996

2001

2006

2011

2016

2021

2026

2031

2036

0–4 0–14 15–59 15–64 60+ 65+

9.4 26.8 64.5 67.2 8.7 6.0

8.3 25.6 65.3 68.0 9.1 6.4

7.4 23.9 66.2 69.3 9.9 6.8

6.9 21.7 66.5 70.8 11.8 7.5

6.8 20.4 65.3 70.5 14.3 9.1

6.6 19.7 63.4 69.1 16.9 11.2

6.4 19.3 60.8 67.2 19.9 13.5

6.1 18.7 59.7 65.4 21.6 15.9

5.9 18.1 59.2 64.8 22.7 17.1

Median age

27.8

29.4

31.1

33.0

34.9

36.1

37.4

38.6

39.9

Source: CSO, Digest of Demographic Statistics, 1996.

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276 13.6.5

Population and Demographics Ageing of the Working Age Population, 1996–2036

The working age population (15–64 years) will also be ageing over the next 40 years. The younger age components 15–24 years and 25–34 years would each decline steadily from around 27 per cent to around 20 per cent between 1996 and 2036 while the proportion of those aged 45–64 would rise from 23 per cent to 39 per cent during the same period, as shown in Table 13.13. 13.6.6 Changes in the Size and Composition of the Dependency Ratio, 1996–2036 As a result of the changes in the age structure of the population, the child dependency ratio will decline from nearly 400 in 1996 to 279 in 2036 (Table 13.14). The elderly dependency ratio will rise slowly at first till 2011, after which it will increase at an accelerated rate and more than double by 2036. The overall dependency ratio will thus reach a record low of 412 in 2011, and then rise sharply to reach 543 in 2036. The overall dependency ratio will, however, continue to be favourable for the Mauritian population throughout this period. 13.6.7

Socio-Economic Significance of Ageing Population

It is to be noted that the most important causal factor in the ageing of population of Mauritius is the decline in fertility since the mid1960s. Mortality decline or increases in life expectancy accelerated population growth with respect to all age groups and not merely those of elderly. On the other hand, a relative slowing down of population growth in the younger age groups resulted from a decline in the birth rate. Once the fertility reached replacement levels, any further declines in mortality would have an important impact on ageing of population. Thus, in the future, declining mortality could be the principal cause of ageing. Ageing is considered an expensive luxury, as a vast majority of older people will be consumers, and not producers. They will expect adequate pensions and will also make heavy demands on medical services with some of them needing expensive nursing care. At the same time, the number of people who will be working and who will be paying for the pensions will remain almost the same. Thus, each worker will have a heavier burden to bear. The rising percentages of both pensioners and elderly will need to be emphasised in overall socio-economic

781.6 (100.0)

25.5 23.3 24.3 17.6 9.2

2001

828.5 (100.0)

22.4 23.7 22.9 19.4 11.5

2006

399 89 488

Child dependency ratio (under 15) Elderly dependency ratio (65+)

Total dependency ratio

900.9 (100.0)

21.8 20.4 21.5 20.2 16.1

2016

908.1 (100.0)

20.1 21.6 21.2 18.9 18.2

2021

474

376 98

2001

443

345 98

2006

412

306 106

2011

418

289 129

2016

19.2 21.6 20.1 20.6 18.4

2026

903.9 (100.0)

447

285 162

2021

Projections of the dependency ratio, 1996–2036

Source: CSO, Digest of Demographic Statistics, 1996.

1996

Dependency Ratio

Table 13.14

876.3 (100.0)

22.5 22.3 20.3 20.7 14.1

2011

488

287 201

2026

529

286 243

2031

891.2 (100.0)

19.3 20.4 21.7 20.9 17.7

2031

Projections of the age structure of working age population, 1996–2036 (percentages)

Source: CSO, Digest of Demographic Statistics, 1996.

738.1 (100.0)

27.5 26.5 22.9 14.5 8.6

15–24 25–34 35–44 45–54 55–64

Total 15–64 (thousands)

1996

Age (Years)

Table 13.13

543

279 264

2036

888.2 (100.0)

19.5 19.5 21.8 19.8 19.4

2036

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planning of manpower, and allocation of financial resources so as to ensure income security as well as health care to elderly dependants. The ageing of population would also lead to important changes in patterns of consumption, including higher demands for medical and health care products, investments, and care of elderly persons, especially in the context of nuclear families and rising percentages of working women. Table 13.15 highlights the consequences of the ageing population on the National Pension Fund. The projections of population by occupational characteristics between 1996–2036 show that the percentage of persons of pension age and over rises sharply from 9 to 23 whereas the percentage of persons in the age group 15–59 years rises slowly till 2011 and then declines gradually to 59 in 2036. The absolute number of persons of pension age and over is expected to almost double during the 20-year period from 1996 to 2016 and then rise further by over 70 per cent in the years 2016–36. The number of persons aged 15–59 years will rise by about 18 per cent between 1996 to 2016 and then decline slightly over the next 20 years. This would lead to large increases in the estimated future expenditure on basic non-contributory pensions payable to all people over pension age. Also, the combination of the rise in number of persons over pension age and the continuing maturity of the contributory pension scheme implies very sharp increases in future expenditures on contributory pensions. The comparison between the numbers at working ages (15–59 years) and those over pension age is a major factor determining the relative size of contribution income and benefit expenditure. With a steady decline in the former and a sharp rise in the latter as seen earlier, it is clear that from 1996 there will be a continuous decline in pensioner support ratio. Thus, in 1996 there were 7.4 persons of working age to support one pensioner, whereas this ratio will be halved by 2021, and will fall further to reach 2.6 by 2036. This situation could be a cause for concern since it has serious economic and social implications for the country. Table 13.16 shows the estimated income and expenditure of the National Pensions Fund. The balance in fund at end of year, which will rise from nearly Rs6 billion in 1994–95 to around Rs8 billion in 2009–10, will decline sharply to a mere Rs160 million in 2029–30. This is mainly due to the fact that the contributions from employers and employees which far exceed the contributory pensions till 2009–10, thereafter increasingly fall short of the contributory pensions so that

294.6 (26.8) 709.0 (64.5) 95.1 (8.7) 1,098.7 (100.0) 7.4

1996 294.6 (25.6) 750.2 (65.3) 104.5 (9.1) 1,149.3 (100.0) 7.2

2001 285.9 (23.9) 791.0 (66.2) 118.4 (9.9) 1,195.3 (100.0) 6.7

2006 268.8 (21.7) 822.4 (66.5) 146.3 (11.8) 1,237.5 (100.0) 5.6

2011 260.7 (20.4) 835.3 (65.3) 182.2 (14.3) 1,278.2 (100.0) 4.6

2016 259.2 (19.7) 833.0 (63.4) 222.7 (16.9) 1,314.9 (100.0) 3.7

2021 258.9 (19.3) 818.2 (60.8) 267.3 (19.9) 1,344.4 (100.0) 3.1

2026

255.1 (18.7) 814.2 (59.7) 294.2 (21.6) 1,363.5 (100.0) 2.8

2031

Projections of population by occupational character and the pensioner support ratio 1996–2036 (in thousands)

* As defined for pension purpose. Note: figures between brackets refer to percentages. Source: CSO, Digest of Demographic Statistics, 1996.

Pensioner support ratio

Children under 15 *Working age 15–59 Pension age and over 60+ All ages

Ages

Table 13.15

248.3 (18.1) 811.3 (59.2) 311.6 (22.7) 1,371.2 (100.0) 2.6

2036

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279

5,830

259 6,940

198

1,514

235 32 59

1,188

1,712

1,193 519

1999–00

7,660

108

1,777

341 37 68

1,331

1,885

1,333 552

2004–05

7,170

-190

-26 7,790

2,567

651 34 92

1,790

2,377

1,792 585

2014–15

2,118

482 40 78

1,518

2,092

1,520 572

2009–10

5,690

-368

3,048

823 31 106

2,088

2,680

2,090 590

2019–20

3,310

-547

3,521

984 31 120

2,386

2,974

2,387 587

2024–25

160

-686

3,892

1,111 30 130

2,621

3,206

2,662 584

2029–30

All estimates are expressed in terms of 1992–93 benefit rates. Government grant meets the cost of basic pensions and the cost of meeting the guaranteed minimum level of contributory retirement pension. 3. Basic pension includes bonus of one month’s pension, except for 1989–90 when bonus was half a month’s pension. Source: CSO, Digest of Demographic Statistics, 1996.

1. 2.

Balance in fund at end of year

342

Excess of income over expenditure

1,285

155 26 51

49 19 46 1,006

1,053

1,544

1,062 482

1994–95

892

1,348

901 447

1989–90

Estimated future income and expenditure of the National Pensions Fund1 (Rs million)

Total expenditure

Expenditure Non-contributory (basic) pensions3 Contributory pensions Other payments Administration

Total income

Income Government grant2 Contributions from employers and employees

Table 13.16

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in 2029–30 the contributions from employers and employees would form only 52 per cent of the contributory pensions. The ageing of the working age population 15–64 years, on the other hand, could have serious repercussions in matters such as health and productivity of the labour force. The training and skill updating of the ageing labour force, especially in the context of the technology revolution, the competitivity and globalisation of the post-GATT era would need to be emphasised.

13.7

DISCUSSION AND POLICY IMPLICATIONS

During the nineteenth century immigration was the main cause of population growth in Mauritius. The population then stood around 370 thousand. Till 1920 there was little change in population size in spite of net immigration. The population growth during the 1921–44 period also was very low – less than 0.5 per cent – due to high fluctuations in both birth and death rates, and the population in 1944 was 419 thousand. These demographic trends changed dramatically after the Second World War and the annual population growth rate shot up to an all-time record level of 3.12 per cent by 1962, due both to a rapid decline in mortality and an unprecedented rise in fertility. This sudden demographic revolution in Mauritius, a small island with a very limited amount of land and natural resources, pushed the population density to almost 400 persons per square kilometre. Mauritius, dependent at that time only on agriculture, was almost on the brink of a population explosion and consequent socio-economic disaster. The population had grown by over 60 per cent from 419 thousand in 1944 to 682 thousand in 1962 and was projected to reach three million by the end of the century if fertility rates remained at the same high level and the mortality rate declined further. However, in the following two decades, there was a spectacular decline in the fertility rate, unequalled in the world, and the fertility reached a point below replacement level in 1985. The population in 1998 was 1,124 thousand, far below the projection of near three million. Mauritius had thus completed the demographic transition in a little over four decades and averted the projected population crisis. Projections till 2036, assuming a further decline in both the fertility rate and the population growth rate, some improvement in the mortality, and net migration gradually declining to zero, indicate that the population would rise from 1,099 thousand in 1996 to 1,371 thousand

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in 2036 – an increase of 272 thousand – representing an increase of 25 per cent in 40 years. The population density per square kilometre would rise from the present 589 to 735 in 2036. Over the four decades 1996–2036, the increase in the population size would be 96 thousand, 83 thousand, 66 thousand and 27 thousand respectively. This would imply a sharp increase in the number of households and the consequent rise in the demand for land for residential purposes, housing loans and high-rise apartments. At the same time the demand for agricultural commodities like vegetables and fruits would also rise, while per capita availability of arable land will decline. This points to the urgent need to intensify agricultural production for local consumption by the use of modern technology. Other expected changes are increases in demand for imports of consumer goods, energy and water supply and other infrastructures and services. Consequently, it would be equally important to expand exports. The gender ratio which was extraordinarily high till the 1920s due to the predominance of males among immigrants, gradually evolved in favour of females and in the 1983 census, for the first time, the gender ratio was below 100 and then fluctuated around 100 till 1998. The projections, however, show that the gender ratio will decline once again consistently to reach 95 in 2036 as a result of the more favourable mortality for females. This would imply a predominance of females among the population, which would be especially significant at older ages. It is thus clear an appropriate gender policy planning will be urgently needed. It would be especially necessary to increase and facilitate women’s access to secondary and tertiary education, as well as to, vocational education and training and skill updating. There may also be an increase in the number of women-headed households and women living alone, especially at older ages, which would necessitate women to be economically independent. As a result of demographic transition, the population dynamics of Mauritius has changed from a young age structure to a slightly ageing one. Population projections till 2036, however, show that the ageing process will accelerate especially after 2016 and by 2036 Mauritius will have a typical old age structure with a median age of 40 years. Thus, while the percentage of child population (under 15 years) would gradually decline, the pensioners (60 years and over) will form nearly 23 per cent of the population and elderly persons (65 years and over) slightly over 17 per cent.With other conditions being same, the smaller child population (both in absolute and percentage terms) would require a smaller share of government expenditures on primary and

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secondary education, school construction and equipment, books and other related expenditures. This also implies increased savings that could be allocated to productive investment. Other expected changes would be a decline in the demand for baby food, clothing and toys and other similar products. The decrease in the proportion of the under 15 group in the population between 1962 and 1996 noted earlier has also been favourable to Mauritius in other ways. The share of the working age group 15–64 who contribute the bulk of the gross national product rose as a consequence during the same period. Although the proportion of under 15 in the population would continue to decline till 2036, the share of the working age group 15–64 would rise further only till 2011. In the remaining 25 years this percentage would decline as a consequence of the rising proportion of the elderly population, 65 years and over. At the same time, an increase of around 80,000 between 1996 and 2006 and a further increase of over 40,000 in the following decade in the population aged 15–59 years would mean that new employment creation would be particularly very important till 2016. In the absence of such growth in employment, Mauritius would once again face massive unemployment similar to that of the early 1980s. The population in this age group is expected to gradually decline by 2036. With the changing age structure of the population, the dependency ratio declined from a peak of 942 in 1962 to reach 489 in 1996 and would be only 412 in 2011 due to the large reductions in the child dependency ratio. Although the dependency ratio will rise to 543 by 2036, as a result of a sharp rise in the elderly dependency ratio, it will still be favourable for the country throughout this period. It is to be noted, however, that the actual dependency ratios could be much higher, as many people do not work at 15 years and retire much earlier than 60 years. It is also observed that the female dependency ratios have been consistently larger than those for males due to the higher elderly dependency ratios for females. With the decline in gender ratios and improvements in female mortality till 2036, this trend could be expected to continue. As seen earlier, the gender ratio by age for the year 1996 declined consistently with age from 91 at the age 55–59 to 56 and 35 respectively at the ages 80–84 and 85 and over. Women thus comprised a very large majority of the oldest population of 80 years and over. On the other hand, the working age population (15–64 years) would also be ageing, as the proportion of those aged 45–64 among the working age population would rise from 23 per cent in 1996

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284 Table 13.17

Percentage of people aged over 60, selected countries, 1990 and 2030

Country

1990

2030

OECD countries Latin America and Caribbean Asia China Sub-Saharan Africa Mauritius

18 7 7 9 5 8 (1993)

31 16 16 22 6 23 (2033)

Source: World Bank, 1994.

to 39 per cent in 2036. Similar demographic changes of longer lives and fewer births will require most countries of the world (except most of Africa) over the next 30 or 40 years to think seriously about alternative ways of paying for and looking after older people, as implied by Table 13.7. Of all the consequences of the ageing of population in Mauritius, the most certain and serious one seems to be that on the social security and National Pension Fund (NPF) as the pensioners in 2036 and onwards are already born. Some of the solutions proposed by Battersby (1993) for consolidating the NPF over the long term include an increase in the contribution rate, reductions in the pensions, and an extension of the retirement age from the present 60 years to 65 or 67 years. The latter is perhaps the most effective way of increasing the labour supply since it would both increase revenue from taxes and social security contributions and reduce the expenditure on pensions. The solution is likely to be viable if unemployment is not high and the workers expecting to be pensioners do not object to waiting a little longer for their benefits. Some other solutions being considered in different countries are: •

•

Raising fertility rates with a view to spreading the cost of looking after the old, especially in the rich countries. This would increase the ratio of working people to retired ones. For example, in Sweden, where the ageing process is very advanced, the birth rate is rising to the replacement level. Immigration is considered as another way of achieving the same purpose. The huge numbers required can, however, lead to political and social problems.

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•

285

Increased contributions from the young workers, reduced benefits or a combination of the two is another way of cutting the pensions and health care costs. Private sector pension schemes may be another response to the ageing problem.

The extent to which these recommendations are adopted may, however, have to be determined in the light of their social dimensions. To conclude, the demographic facts are inescapable because the people concerned are already born. The same baby boomers born after 1945 who had threatened population explosion in the 1960s are now set to create another demographic crisis in the 2030s. The demographic time-bomb is thus a reality. What remains to be seen is whether it will be possible to defuse it before it explodes.

APPENDIX 13A Table 13A.1

Period 1901–05 1906–10 1911–15 1916–20 1921–25 1926–30 1931–35 1936–40 1941–45 1946–50 1951–55 1956–60 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971

Crude birth and death rates, rate of natural increase and infant mortality rates, 1901–98

Crude Birth Rate

Crude Death Rate

Rate of Natural Increase

Infant Mortality Rate

36.5 35.8 38.3 35.1 39.1 35.2 31.3 33.1 36.0 44.7 44.3 40.7 39.4 38.5 40.2 38.4 35.7 35.6 30.6 31.2 27.4 26.8 25.5

37.6 37.4 34.7 38.6 31.0 28.8 29.8 27.1 28.5 20.8 14.7 11.6 9.8 9.3 9.6 8.6 8.6 8.9 8.5 9.1 8.1 7.8 7.7

-1.1 -1.6 3.4 -3.5 8.1 6.4 1.5 6.0 7.5 23.9 29.6 29.1 29.6 29.2 30.6 29.8 27.1 26.7 22.1 22.1 19.3 19.0 17.8

169.6 169.2 155.6 167.0 141.8 140.9 140.3 155.6 154.31 119.62 81.3 68.2 62.0 60.1 59.3 56.7 64.1 64.2 70.5 69.1 70.4 57.0 51.7

TME13 6/20/2001 9:44 AM Page 286

Table 13A.1

286 Period

(Continued)

Crude Birth Rate

Crude Death Rate

Rate of Natural Increase

24.8 22.4 26.8 24.8 25.3 25.5 26.7 27.2 26.6 24.9 22.1 20.6 19.6 18.8 18.3 19.1 19.9 20.6 21.3 20.7 21.1 20.4 19.5 18.2 18.2 17.4 16.7

7.9 7.7 7.3 8.0 7.8 7.8 7.1 7.2 7.1 6.7 6.6 6.5 6.6 6.8 6.7 6.6 6.6 6.8 6.7 6.6 6.5 6.8 6.7 6.7 6.8 7.0 6.8

16.9 14.7 19.5 16.8 17.5 17.7 19.6 20.0 19.5 18.2 15.5 14.1 13.0 12.0 11.6 12.5 13.3 13.8 14.6 14.1 14.6 13.6 12.8 11.5 11.4 10.4 9.9

1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Infant Mortality Rate 63.8 63.3 45.6 48.7 40.4 45.0 33.9 32.9 32.3 33.6 29.4 25.6 23.1 23.8 26.3 24.2 22.0 21.6 19.9 18.1 18.4 19.6 18.0 19.6 22.2 20.3 19.4

Source: CSO, Digest of Statistics, various issues. Table 13A.2

Dependency ratio by gender, 1962–96

1962

1972

1983

1990

1996

Male

Female

Male

Female

Male

Female

Male

Female

Male

Female

872

889

717

711

512

502

451

447

402

397

Elderly dependency ratio

46

79

54

78

60

84

70

96

74

105

Total dependency ratio

918

968

771

789

572

586

521

543

476

501

Child dependency ratio

Source: Computed from CSO, Census Report and Digest of Statistics, various issues.

TME13 6/20/2001 9:44 AM Page 287

Malati Pochun Table 13A.3

287

Implied life expectancies at birth by sex, 1991–2036

Period

Male

Female

1991–96 1996–2001 2001–06 2006–11 2011–16 2016–21 2021–26 2026–31 2031–36

66.38 67.89 69.33 70.59 71.67 72.57 73.22 73.67 74.00

73.93 74.97 76.01 76.89 77.62 78.17 78.66 78.99 79.29

Source: CSO, Digest of Demographic Statistics, 1996.

Table 13A.4

Net migration by sex, 1996–2036

1996–2001

2001–06

2006–11

2011–36

Male Female

-600 -1,100

-300 -500

-100 -200

nil nil

Both Sexes

-1,700

-800

-300

nil

Source: CSO, Digest of Demographic Statistics, 1996.

GLOSSARY Gender Ratio: The number of males to every 100 females. Crude Birth Rate: The number of live births in a year per 1,000 mid-year population. Crude Death Rate: The number of deaths in a year per 1,000 mid-year population. Natural Increase: The excess of births over deaths. Infant Mortality Rate: The number of infant deaths in a year per 1,000 live births during the year. Net External Migration: The difference between international departures and arrivals of residents. Total Fertility Rate: The average number of children born to an average woman assuming that she survives to the end of her child-bearing age and is subjected to a fixed schedule of age-specific fertility rates.

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288

Population and Demographics

Gross Reproduction Rate: The average number of daughters born to an average woman assuming that she survives to the end of her child-bearing age and is subjected to a fixed schedule of age-specific fertility rates. Net Reproduction Rate: The extent to which the average woman will replace herself, assuming a fixed schedule of age-specific mortality rates to prevail through her reproductive span of life. Singulate Mean Age at Marriage: Estimate of the mean number of years lived by a cohort of men or women before their first marriage. Child Dependency Ratio: Ratio of the child population (under 15 years) to the population of intermediate age (15–64 years). Elderly Dependency Ratio: Ratio of the elderly population (65 years and over) to the population of intermediate age (15–64 years).

References BATTERSBY E.I. (1993) Mauritius National Pensions Fund, An Acturial Review as at July 1990 (Mauritius: Ministry of Social Security). Central Statistical Office, Digest of Demographic Statistics, various issues (Mauritius: Ministry of Economic Planning and Development). Central Statistical Office, Digest of Statistics, various issues (Mauritius: Ministry of Economic Planning and Development). Central Statistical Office, Census Report, 1944 to 1990 (Mauritius: Ministry of Economic Planning and Development). FREDERIKSEN H. (1969) ‘Feedback in Economic and Demographic Transition’, in P. Reining and I. Tinker (eds), Population: Dynamics, Ethics and Policy (Washington, DC: American Association for the Advancement of Science). GREENAWAY D. and MILNER C. (1991) ‘Did Mauritius Really Provide a “Case Study in Malthusian Economics”?’, Journal of International Development, 3, 4, 325–38. MEADE J.E. (1961) ‘Mauritius: a Case Study in Malthusian Economics’, Economic Journal, 71, 521–34. MEADE J.E. (1967) ‘Population Explosion, the Standard of Living and Social Conflict’, Economic Journal, 77, 233–35. MEADE J.E. et al. (1968) The Economic and Social Structure of Mauritius (London: Frank Cass). Ministry of Economic Planning and Development (1994) National Population Report (Mauritius: Ministry of Economic Planning and Development). POCHUN M. (1981) ‘Population, Labour Force and Employment in Mauritius’, University of Mauritius Journal. THOMLINSON R. (1965) Population Dynamics (New York: Random House). TITMUSS R.M. and ABEL-SMITH B. (1968) Social Policies and Population Growth in Mauritius (London: Frank Cass). UNITED NATIONS, Demographic Year Book, various issues (New York: United Nations). WORLD BANK (1993) Averting the Old Age Crisis (Washington, DC: World Bank).

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Index Abel–Smith, B. 261–2 Abowd, J.M. 216 ACP countries 178–9 ACP countries 39, 95 ACP–EEC agreements 119 Africa 140, 207, 266, 284 Sub-Saharan Africa 45, 77, 100 Aggregate Monetary Resources (AMR) 21–2, 30 Aghevli, B.B. 45 Agriculture 6, 26, 63, 71, 87–8, 94, 116, 133, 139, 146, 157, 166–84, 260, 281–2 Allocative (Samuelsonian) efficiency 234 Alter, R.G. 1 Amin, S. 13 Anti-export bias 5, 86, 98, 102, 177 Arellano, M. 219 Aschauer, D.A. 162 Atkinson, A. 136 Australia 49, 153, 154 Automatic payment system 197 Bagasse 70 Bahl, R.W. 234, 236–7, 243, 253–4 Bahrain 49 Balance of payments 3, 7, 23–4, 27–8, 34–5, 46–7, 54–5, 91, 100, 109, 150, 161, 191, 195 Balance of payments deficits 2, 18–19, 35, 68 Balance of trade deficit 14, 16, 29, 35 Bangladesh 97, 126 Bank of Mauritius 1, 3, 21–2, 30–1, 35, 42, 46, 54, 127–8, 159, 192–5, 197, 199–200 Bank of Mauritius Act 199 Banking 3, 8, 23, 30–1, 35–6, 41–2, 55, 161, 186, 188, 196

Barro, R.J. 159 Battersby, E.I. 284 Bencivenga, V.R. 186, 188 Bergsten–Samuelson social welfare function 81 Bevan, D. 67, 174, 178 Bhaduri, A. 13, 36 Bhagwati, J. 85 Bheenick, R. 108 Birth rates 258–87 Blake, A. 174, 230 Blejer, M. 159 Bond, S. 219 Borrell, B. 39 Budgetary deficit 18, 159–63, 192 Buffie, E.F. 188 Bundoo, S. 1, 49 Burger, K. 183 Burgess, R. 139–40 Burn, N. 42 Canada 153–4, 216 Capital 4 capital expenditure 26–7 capital markets 8 capital stock growth rate 73–4 Caves, R.E. 216 Central Housing Authority (CHA) 27, 73 Central Water Authority (CWA) 27 Cheasty, A. 159 Chelliah, R.J. 151, 159 Chile 154 China 97, 126, 266 Chung, M. 121 Coady, D. 137 Cobb–Douglas production function 216 Collier, P. 67, 174, 178 Company Act 70 Computable general equilibrium (CGE) 174

289

TMEINDEX 6/20/2001 9:56 AM Page 290

290

Index

Consumer price index (CPI) 18, 29, 37, 61 Corden, W.M. 45, 80 Courakis, A.S. 188 Credit ceilings 8, 193–5, 201 CSO 24, 48, 51–2, 113–14, 117, 119–20, 141, 167–8, 239, 249, 260, 264–6, 268–70, 272–5, 277, 279, 286 Cuba 175 Dabee, B. 1–10, 45–61, 87–90, 212, 230 Deer farming 71 De Hann, J. 162 Demetriades, P. 189 Denny, K. 216 Dependency ratio 271–2, 276–7 Destabilisation phase 2, 19, 37 Devaluation 18–19, 23, 28–9, 31, 36–7, 45–8, 51, 53, 57, 122 Devarajan, S. 162 Development Bank of Mauritius 196 Development Certificate Tax 86–7 Development Certificates 87–9, 108 Development Plan 191 Development Works Corporation (DWC) 73 Displacement effect hypothesis 153, 155 Distribution of income 17 Domestic credit 22, 30–1 Dommen, E. 12 Dudley, L. 158 Dukhira, C.G. 241 Duncan, R.C. 39 Durbarry, R. 5, 105–29 Dutch disease 174 Economic crisis 7, 11 Economic growth 14, 19, 23, 27, 29, 34, 84, 96, 108, 117, 125, 150, 161–2, 166, 173, 185–91, 194, 201 Economic recovery 11, 19 Education 41, 72, 74, 76, 84, 123, 152, 156–7, 161–4, 233, 238, 240, 248, 261, 271, 283 Edwards, S. 207–9, 211, 224, 226, 229

Emigration 266–7, 273 Employment 8, 13–16, 27, 29, 33–4, 93, 106–7, 112–16, 124, 148, 150, 161–4, 167, 170, 176, 206–31, 261–2 EU 2, 28, 32, 39–40, 60, 72, 88, 93–7, 102, 105, 112, 119–20, 122, 124–5, 173, 178–81 Exchange rate 17–18, 27, 29, 37, 45–53, 56–7, 60, 69, 89, 98, 111, 189, 212 exchange rate policy 3, 27–8, 63 exchange rate stability 3 effective exchange rate (EER) 51–3 real effective exchange rate (REER) 51–3, 61 Exogenous shocks 66, 123 Exports 4–6, 12–16, 27–31, 45–7, 51, 54, 57, 60, 67–8, 73–6, 82, 88, 91, 95, 100, 112, 119, 121, 124–5, 130, 164, 167, 169–72, 182, 206–31, 235, 282 Export Credit Guarantee and Insurance Scheme 71 export duty 5, 26, 68, 70, 80, 86, 99, 130, 135, 147 export earnings 17, 23, 31, 117, 166–7, 173–4, 179, 181–2 export growth 79 Export Processing Zone (EPZ) 1–5, 25–6, 32–4, 37, 40, 48, 51, 54, 57–9, 67–8, 71–2, 77, 86, 89, 91–3, 95–8, 102–3, 105–28, 174, 176, 185, 211–13, 215, 224, 227, 230 Export Processing Zone EPZ Act (1970) 88 export promotion (EP) 206, 211 Female employment 211–15, 218, 222–4 Fiji 60 Financial repression 7–8, 187, 193 development 7, 8, 185–203 intermediaries 187 liberalisation 186–9, 192 services 33, 36–7

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Index Fiscal decentralisation 8, 232–56 fiscal centralisation 234 fiscal deficits 15–16 Fishing 71 Flour 37, 68, 177 Food and beverages 58, 87, 167 Foreign direct investment (FDI) 3, 38, 55, 59, 71, 86, 112, 211 Foreign exchange 14–15, 27–9, 46, 50, 52–3, 55–6, 59–60, 91, 101, 110, 115, 121–2, 124 foreign exchange reserves 56–7 foreign exchange, liberalisation of 1, 59, 90 France 29, 48–9, 71, 113, 120, 154 Frederickson, H. 262, 264 Free port 1, 36, 100 Free trade 80, 84, 86 Fry, M.J. 186 Functional decentralisation 234 Galbis, V. 186 GATT agreement 39, 93–4, 101, 139, 180, 281 GDP 7, 14–15, 18, 24, 30, 32–8, 42, 55, 66–9, 89–92, 105, 115, 117, 121, 124, 139, 141–2, 148, 153–5, 159–61, 163–4, 167, 176–7, 198, 201, 212–13, 235, 247–8 GDP growth rate 1, 6, 15, 19, 67 Gender ratio 267–9, 275, 282 General Agreement on Trade in Services (GATS) 94–5 Germany 49, 71, 113, 120 Ghana 66, 154 Ghatak, S. 45, 85 Gini coefficient 235 GNP growth rate 73, 132–3, 140, 200, 237, 267, 270, 283 Goldsmith, R. 186 Gooroochurn, N. 3, 62–77 Government expenditure 6, 8, 15, 19, 21, 23, 26, 32, 34, 42, 74, 150–65, 177, 282 austerity programme 34 borrowing 21, 26, 151, 158, 160, 197 control 14, 17

291

monopolisation of financial resources 23 policy 19–20, 23, 27, 30, 35, 110, 261 revenue 7, 20, 23, 34, 67, 82, 130–49, 151, 183, 243 role 152–3, 156, 232 Gramlich, E.M. 252 Grants 248–55 Greenaway, D. 1–10, 62–78, 83, 89, 103, 130–1, 139, 146, 175–8, 230 Greenwood 186, 188 Gross Domestic Fixed Capital Formation (GDFCF) 24, 26 Gross National Savings (GNS) 24 Gulhati, R. 32 Gunning, J. 67, 174, 178 Gurley, J.G. 186 Hanson, J. 189 Health care 152, 156–7, 163–4, 238, 248, 259–64, 276–8 Hein, P. 1, 12 Henrekson, M. 154 Herrmann, R. 183 Hong Kong 36, 60, 84–6, 106, 108, 113, 120, 122, 125–6 H–O–S trade model 81 Human capital growth rate 73 Hussein, A.K. 189 Im, K.S. 222 IMF 7, 19, 30–2, 34, 47, 52, 55, 62–3, 67–9, 111, 141, 152, 154, 156–7, 160, 177, 179, 185, 232 Compensatory Financing Facility (CFF) 179 Standby Loan 68 Immigration 9, 259, 266–8, 281 Import substitution (IS) 4, 5, 206, 211–12 Imports 3, 14–18, 27, 35, 46–59, 68, 81–2, 109, 121, 130, 133, 135, 169–71, 235 Import–substitute sector 81 India 49, 97, 126, 153–4, 259, 266 Indian Ocean Commission 93 Indonesia 97, 154

TMEINDEX 6/20/2001 9:56 AM Page 292

Index

292

Industrial Coordination Unit (ICU) 71 Infectious diseases 9, 259 Inflation 2, 11, 15, 17–18, 22–3, 33, 37, 50, 67–9, 115, 144, 163, 172–3, 187, 195, 215, 243, 254 Insurance 3, 33, 36, 41, 54–5 Insurance Act 199 Interest rates 7–8, 15, 30, 187–90, 193–5 International Commodity Agreements 173 International trade 4, 12–13, 17, 79, 96, 125, 139, 235 Ireland 106 Italy 120 Jamaica 108 Japan 48–9, 108 Jayaram, T.K. 60 Jovanovic, B. 186, 188 Junglee, K. 7, 8, 185–205 Kapur, B.K. 186 Kay, J. 135 Kearney, R.C. 1 Kee, W.S. 234–5 Kenya 154, 174 Keynes 152, 158 Khatkhate, D. 193 King, M. 135 King, R.G. 186 King, D. 254 Konings, J. 216 Korea 66, 153–4 Kowlessur, D. 121 Krueger, A.O. 77 Krugman, P. 235 Kutnets’ hypothesis Kuwait 49

235

Labour 4, 12–14, 30, 40, 70, 73, 84, 105, 107, 109, 115–16, 122–3, 173 labour growth rate 73–5 labour intensive industries 125 labour market adjustment 8, 34, 206–31 labour market reform 63 Labour Party 115

Laissez–faire 151 Lall, S. 100, 103 Lamusse, R. 2, 11–43, 67, 175–8 Land Development Tax 70 Land Transfer Tax 70 Latin America 140 Legislative Assembly 68 Lemieux, T. 216 Lerner symmetry theorem 103 Levine, R. 73, 186 Lewis, W.A. 234 Lim, J. 188 Lindauer, D.L. 162 Linn, J.F. 236–7, 243, 253–4 Local Government Act (1989) 239, 241–2, 249, 254 Local government authorities 8–9, 12, 18, 233–56 Lomé Convention 7, 39–40, 88, 93, 95, 125, 166, 176–83 Sugar Protocol 7, 39, 166, 178, 180 Long-Term Perspective Study for Mauritius 41 Lucas, R.E. 152 Luxembourg 154 Machin, S. 216 Macroeconomic policy 2, 11, 14–16, 18, 60 stability/instability 7, 67, 76, 212 Madagascar 115, 125, 266 Maizels, A. 172 Malawi 66 Malaysia 154 Managed float 50 Manufacturing 89–90, 92, 95, 97, 102, 105, 108–9, 111–14, 117–19, 168, 171–2, 181, 211–13 Martin, A. 234 Mathieson, D.J. 186 Matthew, W.R. 107, 123 Mauritian Stock Exchange 115, 196–7, 200 Mauritius Commercial Bank 196 Mauritius Export Development Investment Authority (MEDIA) 71, 112, 122

TMEINDEX 6/20/2001 9:56 AM Page 293

Index Mauritius Family Planning Association 261 Mauritius Housing Corporation 196, 203, 238 Mauritius Leasing Company 196, 199 Mauritius Offshore Business Activities Authority Act 199 Mauritius Sugar Industry Research Institute (MSIRI) 70 McKay, A. 61, 90, 212 McKinnon, R.I. 186–9 Meade, J.E. 14, 62, 84, 86 Meade Report 107, 108 Meltzer, A.H. 234 MEPD 16, 235 MEPD 32 Merit goods 6, 152, 248 Mexico 66 Milner, C.R. 1, 4–5, 8, 61, 63, 68, 71, 79–104, 130, 139, 146, 206–31 Mini state 11–13, 38 Minimum wage 208, 210, 213 Ministry of Economic Planning and Development 1 Mirakhor, A. 189–90 Monetary policy 30, 31, 47, 64, 193, 195 Money supply 30–1, 63 Monocrop economy 1, 14, 62, 67, 84, 105, 150, 166–7, 171–3, 176, 181, 191 Montamarquette, C. 158 Montiel, P.M. 45 Morgan, C.W. 6–7, 66, 166–84 Morisset, J. 188 Morrissey, O. 5–6, 77, 130–49 Mortality rates 9, 258–87 Mozambique 115 Mukherji, A. 13, 36 Multifibre Agreement 2, 5, 40, 77, 88, 93–7, 119, 125–6 Multilateral trade negotiations 5, 101 Musgrave, A. 151 Musgrave, P.B. 235 Musgrave, R. 134–5, 233, 235 Mussa, M.L. 207

293

Nallari, R. 32 Nath, S. 6, 8–9, 135, 150–65, 232–56 National Remuneration Board (NRB) 213 Neal, C.R. 189 Neary, P. 207 Netherlands 154 New growth theory 73 Newly Industrialising Countries (NICs) 106 Nigeria 66, 171, 174 Nobel Laureate 62 Non-repressed financial markets 15 Non-tariff barriers (NTB) 93, 95 O’Toole, F. 132 Oates, W.E. 233 Offshore banking 1, 12, 115, 197, 199 Offshore services 3, 5, 12, 33, 41, 60, 95 ORG 254 Paddison, R. 254 Pakistan 126, 154 Parastatal enterprises 15, 27, 34, 42, 73, 157, 163, 173, 234, 236 Paretian tradition 81 Patrick, H.T. 186, 189 Peacock, A.T. 153 Pechman, J. 130 Pensions 278–85 Peru 154 Pesaran, H.M. 222 Philippines 66, 154 Pigovian tradition 81 Planters Service Centre 70 Pochun, M. 9, 258–88 Pollution 240 Population dynamics 9, 258–88 Portfolio investment 3, 59 Preferential Trade Area (PTA) 93, 103 Price shock 7, 67–8, 172–8, 181–3 Price stability 7, 37, 172 Private Consumption Expenditure (PCE) 24 Private goods 151

TMEINDEX 6/20/2001 9:56 AM Page 294

Index

294 Production efficiency 234 Prud’homme, R. 232 Public goods 6, 151–2, 162, 233 Public sector accounts deficit 18, 23, 26, 28, 34–5 borrowing 21 enterprises 150, 153 investment 25–6 Public Sector Investment Programme 27 reform 63–4 role 154 services 15, 27 wages 7 Puerto Rico 109 Quantitative restriction Quota rents 82

90–2

Radetzki, M. 172–3 Ramakrishna, G.V. 254 Ramsey Rule 136–7 Ranis, G. 106 Reed, G. 92, 230 Renelt, D. 73 Reserve requirements 8, 193 Resource gap 14, 19 Restrained credit expansion policy 191–2, 195 Restricted trade 80, 82 Restrictive wage policy 23, 69 Rice 37, 68, 87, 177 Richard, S.F. 234 Rodrik, D. 77 Romer, P.M. 1, 73, 85, 152 Ruane, F. 132 Russia 175–6 Sales Tax 23 Sapsford, D. 172 Sargan test 219, 223 Schapiro, M.O. 108 Schroeder, L. 253 Schumpeter, J.A. 186 SDR 3, 28, 42, 48, 50–1, 53–4, 68 Secondary Market Cell 200 Seigniorage revenue 15 Selwyn, P. 13

Sengupta, R. 13, 36 Shannon Export Free Zone 106–7 Shariff, K. 131 Shaw, E.S. 186–7 Singapore 36, 106, 109, 113, 153–4 Skill shortages 123 Smit, H.P. 183 Smith, Adam 132, 137 Smith, B.D. 186, 188 Smith, R.P. 222 Sobhee, S.K. 158 Social services 26, 130 South Africa 48–9, 96, 154 South Korea 106 Special Drawing Right (SDR) 47 Sri Lanka 97, 126 STABEX 173, 179, 183 Stabilisation Loans (SL) 62, 67 Stabilisation programmes 3, 26–7, 68–9, 73 State Commercial Bank 196 State Investment Corporation 196 Stegmann, K. 80 Steinmo, S. 138 Sterling peg 46–7, 50 Stern, N. 139–40 Stevens, C. 95 Stiglitz, J. 136, 188, 189 Stock Exchange Act 199 Stolper–Samuelson theorem 81, 208 Structural adjustment lending (SAL) 3–4, 11, 31, 62–2, 65–9, 72–7, 86, 91, 102, 131 Structural adjustment programme (SAP) 2–4, 11, 19, 23, 30, 34, 45, 53, 58, 62–3, 66, 74, 76, 91, 111, 122, 131, 151, 156, 163, 167, 171, 174, 183, 192, 211, 232 Structural investment and growth 3 Sturn, J.E. 162 Sugar industry 2, 5–7, 20, 25–8, 32, 37–40, 46, 58, 67–76, 84, 86–9, 92, 94, 97, 99, 105, 107, 111, 115–19, 121, 124, 142, 146, 166–84, 211, 262, 264, 266 Bumper crops, sugar boom 25–6, 50, 55, 74, 109, 151, 155, 170, 174, 176–8, 183, 266

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Index Swaroop, V. 162 Sweden 154 Switzerland 120 Taiwan 106, 109, 113, 122, 126 Tanzi, V. 232 Taxation average tax rate (ATR) 135, 144 benefit taxation 238 company tax 25 direct and indirect taxes 132, 136–7, 140 horizontal and vertical equity (tax) 134–5 import tax 6, 34, 37, 58–9, 88, 126, 146–7, 212 income tax 6, 25, 83, 87, 126–8, 133–48 marginal tax rate (MTR) 135, 145 optimal taxation 82 Pigovian tax 255 poll tax 254 property tax 8, 136, 141, 233, 237, 241–2, 245–8, 254–6 tax avoidance 12, 134–5, 147 tax efficiency 132, 138, 248 tax policy 5–6, 35, 130–49, 151, 161, 232–56 tax reform 131 tenant tax 8, 242, 245 trade taxes 5, 23, 83, 99–100, 130, 139, 141–2 Value Added Tax (VAT) 6, 132, 136, 138, 140–2, 146–8 Taylor, L. 188 Tea Development Authority (TDA) 27, 73 Telecommunications 41 Terms of trade 4, 18, 28–9, 45, 67, 73–6, 80, 171 Textiles 2, 5, 37–41, 77, 85–9, 92–7, 105, 112, 114, 117, 119–26, 181, 183, 212–15, 230 Thailand 66 Titmuss, R.M. 261–2 Total Fertility Rate (TFR) 265–6, 273

295

Tourism 1, 3, 6, 12, 25, 32–3, 36, 46, 48, 55, 57–9, 69, 72, 95, 100, 105, 111, 167, 170, 176, 254–6 Trade gap 19 Trade liberalisation 1, 5, 8, 29, 38–40, 60, 79, 86, 89–92, 95, 102, 125, 131, 146, 163, 206–31 Trade licence 242 Trade policy 4–5, 63–4, 79–85, 93, 96, 98, 101–2, 207, 212, 227 Trade Policy Review Mechanism 94, 101 Trade Related Intellectual Property (TRIPs) 94 Trade Related Investment Measures (TRIMs) 94 Turtleboom, B. 189 Uganda 171 UK 29, 46, 48–9, 71, 108, 113, 120, 137–8, 153–4, 216 UNCTAD 107, 172 UNDP 232 Unemployment 4, 17, 27, 34, 70, 84, 92–3, 106–9, 112, 215, 261, 266–7, 283–4 underemployment 4, 17, 84 UNIDO 107 Uruguay Round Agreement 5, 93–6, 98, 100–1 US 29, 40, 42, 48–9, 60, 72, 88, 119–20, 122, 124–5, 137–8, 153–4 Utility pricing 63 Van Wijnbergen, S. 188 Vandenbussche, H. 216 Velenchik, A.D. 162 Vietnam 126 Villanueva, D.P. 189–90 Wagner’s Law 153–4, 164, 253 Wald test 226 Webb, S. 131 Weiss, J. 189 Westaway, T. 230 Weston, A. 95 Wignaraja, G. 100, 103 Wiseman, J. 153

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296 Wolman, H. 236 Wood, A. 229 World Bank 7, 15–16, 25–6, 29, 31–2, 34, 42, 62–4, 66, 68–9, 76, 85, 91, 111, 152, 167, 177, 185, 232 World Trade Organisation 7, 94, 96, 98, 100–1, 125, 180–1 World War Two 83, 106, 172, 259, 263, 269, 281

Index Wright, P.W. 31

1, 8, 66, 92, 206–

Yeung, D.H. 121 Yiheyis, Z. 45 Yin, P. 121 Yotopoulos, P.A. 45 Zambia 174 Zou, H. 162