Report No. 9352-TA Tanzan ia I > 4 . I.. Economic Report Towards Sustainable Development in the 1 990s (In 1wo Volumes) Volume l: Main Report June 11, 1991 Country Operations Division Southern Africa Department FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in ihe performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Unit - Shilling Average Fiscal Year Exchange Rates (July/June) (Tsh/US$) 1965/66 1966/67 1967/68 1968/69 1969170 1970171 1971/72 7.143 7.143 7.143 7.143 7.143 7.143 7.143 1972/73 1973/74 1974/75 1975!76 1976/77 1977/78 1978/7M 7.143 7.014 7.143 7.976 8.368 8.059 7.873 1979/X0 1980/81 1981182 1982/83 M9R3/84 1984'85 1985/86 8.221 8.207 8.647 9.762 12.645 17.8N7 18.646 1986/87 1987iXX 1988/89 1989/90 199(1191 51.163 82.286 119.424 173.505 201.801 Average Calenidar Year Exchange Rates (Tsh/US$) 1966 1967 1968 1969 19M7 1971 1972 7.143 7.143 7.143 7.143 7.143 7.143 7.143 1973 1974 1975 1976 1977 1978 1979 7.021 7.135 7.367 8.377 8.289 7.712 8.217 1980 1981 1982 1983 1984 1985 1986 8.197 8.284 9.283 11.143 15.292 17 '72 32.698 1987 1988 1989 1990 '. -e 1991 64.260 99.292 143.377 195.056 230.0 FOR OFMICIAL USE ONLY COUNTRY: Tanzania TITLE: Tanzania Economic Report - Towards Sustainable Development in the 1990s Vo'ume I: Main Report Volume II: Background Papers REGION: Africa SECTOR: Country Economic REPnI= TYPE CLASSIEICATION LANGUAGE 9352-TA ERA Official Use English DATE: June 11, 1991 ABSTRACT: This report analyzes the achievements of Tanzania's economic reform program since the mid-1980s and identifies constraints to continued economic recovery. Building on the directions set forth in the Government of Tanzania's Economic Recovery Program and Economic and Social Action Program, the report considers the key elements of a strategy for attaining sustainable economic growth and renewing social progress - reducing poverty - within Tanzania. Chapter I assesses the performance of the economy over three distinct policy regimes during the past two to three decades, thus providing a framework for evaluating, particularly, the results of change and growth over the past five years. Chapter 2 analyzes the period of reform frem the perspective of the impact on and welfare gained by a range of economic agents. Chapter 3 focuses on the impact of public sector performance on macroeconomic stability and discusses the financial and public sector reforms required to achieve greater macro stability. Chapters 4 and 5 analyze the impact of recent adjustment efforts and the agenda for further reform of the agriculture and industrial sectors, respectively. The requirements of parastatal reform are discussed, as are important infrastructure / real sector linkages. Chapter 6 assesses the stalled social progress of the past decade and suggests a strategy for restoring momentum toward social goals. Chapter 7 consolidates the report's analysis and recommendations. provide%s a framework for projections and argues that a deepening and a hastening of the relorm process is required if Tanzania is to achieve its longer term objectives for the economy. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. IAmnia commc bwirt Volume 1: Main Report Chapters Acknowledgement Executive Summary . . . . . . . . . . . . . . . . . . i 1. Perfbrmance of the Economy . . . . . . . . . . . . . . . 1 2. Impact of Reform on Key Economic Agent . . . . . . . . . . 17 3. Public Sector Performance and Macroeconomic Stability . . . . . . 31 4. The Agricultural Sector: Performance and Linkages . . . . . . . 59 5. Industry and Small-Scale Enterprise Development . . . . . . . . 89 6. Accelerating Social Progress . . . . . . . . . . . . . . .111 7. Sustainable Growth in the 1990s and Beyond: Scenarios and Conclusions . . . . . . . . . . . . . 131 Volume 1: Background Papers Papers 1. The Tanzanian Recovery, 1983-89 . . . . . . . . . . . . . . . 1 2. National Income Estimates in Tanzania: Methodological and Empirical Issues . . . . . . . . . . . . . 37 3. Private Sector Development in Tanzania Obstacles and Opportuities . . . . . . . . . . . . . . . . . . 99 4. Enhancing Aid Effectiveness in Tanzania . . . . . . . . . . . . 119 StatisticalAppendix . . . . . . . . . . . . . . . . . . 133 Bibliography ........ .......... . 143 ABBREVIATIONS AIDS Acquired Immune Deficiency Syndrome BIS Basic Industrial Strategy BOP balance of payments BOS Bureau of Statistics BOT Bank of Tanzania CCM Chama Cha Mapinduzi CDC Conmmonwealth Development Corporation CMS Central Medical Stores CPI consumer price index CRDB Cooperative and Rural Development Bank DRC domestic resource cost ERP Economic Recovery Program ERR economic rate of retum ESAP Economic and Social Action Program FIS formal sector industrial survey GDP gross domestic product GDY gross domestic income ICD Institute of Curriculum Development IFC International Finance Corporation IFS International Financial Statistics IMF International Monetary Fund KILIMO Ministry of Agriculture MDB Marketing Development Bureau MOP Ministry of Finance NBC National Bank of Commerce NDC National Development Corporation NGO non-governmental organization NMC National Milling Corporation ODA official development assistance OGL Open General License PEM protein energy malnutrition PER Public Expenditure Review PEs public enterprises PSAP Priority Social Action Program PSM public sector management QRs quantitative restrictions SAR Staff Appraisal Report SDR Special Drawing Right SGR strategic grain reserves SMEs small scale enterprise TAC Tanzania Audit Corporation TANU Tanzania African National Union TCMB Tanzania Coffee, Cotton or Cashew Marketing Board TDFL Tanzania Development Finance Co., Ltd. TIB Tanzania Investment Bank TOT terms of trade VAT value added tax VCRs value-ost ratios 1. This report was prepared and discussed on a collaborative basis with officials of idce Government of Tanzania. In particular, a team from the Planning Commission, headed by Solon.in Odunga (Director of Macroeconomic Planning), coordinated and contributed to the report's design and preparation. 2. We recognized from the outset the existing data weaknesses in many areas. Thus a World Bank and Central Bureau of Statistics team worked specifically on national accounts methodological and data issues. The objective went beyond more robust data analysis for this report; it also aimed towards a longer term institutional collaboration on methodological and data- gathering improvements. Furthermore, to complement published and unpublished data already available, during report preparation selected micro-surveys were carried out, and these data sources provide part of the basis for the analysis in the report. 3. This report focuses on a wide range of issues with significant intersectoral and macroeconomic implications to Tanzania's adjustment effort. The objective of examining these and other linkages has been to provide elements for a unified framework of analysis of the alternative strategic and policy choices for the future. No attempt has been made to present every issue exhaustively. Many topics which are central to development of Tanzania, such as a detailed sectoral analysis of transport, population, nutrition and health, women in development and public sector management, are not covered in detail here. Recent comprehensive reports are available in these areas, and where appropriate these are cross-referenced in the text. In addition, the government has identified a number of medium and long-term issues on which it is already undertaking or plans more detailed work than presented here. This collaborative effort is an input to that longer-term process. Thus, where appropriate, the report has attempted to identify additional areas for future study. 4. The report was prepared as a result of two main missions to Tanzania during late 1989, which were led by Daniel Kaufmann, and other subsequent work. The report's principal authors have been Daniel Kaufmann and Chris Hall (deputy mission leader), Southern Africa Country Operations Division. Other Government of Tanzania officials, World Bank staff and consultants who contributed to this report include Vargha Azad, Mboya Bagachwa, Benoit Blarel, David Cieslikowski, Paul Collier, Brian Cooksey, Peter Fallon, Roger Grawe, Jan Gunning, Mukwanason Hyuha, John Komba, Brian Levy, Robert Mabele, Rose Mang'enya, Darius Mans, Fidelis Mtatifikolo, Benno Ndulu, Ian Porter, Mataro Sabai, Roy Southworth, Brian Van Arkadie, Samuel Wangwe, and Michael Ward. Michael Walton commented extensively during the report's preparation. Valuable comments and suggestions were also received from Nisha Agrawal, Steen Jorgensen, Michael Mills, David Phillips, Enrique Rueda-Sabater, and Moina Varkie. Further assistance in putting the report together was gratefully received from Clara Amsel, Trini Angeles, Rita Attia, Anne Dronnier, Rosalie Ferraro, Huba Mannoro, Mary-Anne Mwakangale, Ligia Murphy, Norah Rusobya, Betty Sakaya, and Raj Stephen. S. The analysis and recommendations in the final version of this report reflect the many and valuable comments received during two sets of discussions with the govermment in March and May 1991. Extensive comments and suggestions from Joshua Doriye, Charles Kimei, JonasKipokola, Peniel Lyimo and Solomon Odunga have enhanced the quality of this collaborative report. TANZANI ECONOMIC RIEPIOT TOWARDS SUTSFAINABLE DEVELP2MENT IN THE 1990s Executive Summary I. Introduction 1. lhis report analyzes the achievements of Tanzania's economic reform program and identifies the constraints to continued economic recovery. Building on the directions set forth in the Economic Recovery Program and the Economic and Social Action Program, this report then comn:ers the key elements of a straeW for ataining sustainable growth and renewing social progress - reducing poverty - within Tanzania. 2. The effects on the Tanzania economy of inadequate policies and exten shocks during the late 1970s and early 1980s, combined with a weak productive structure, resulted in economic stnation and per capita income decline lasting almost a decade. Consequently, the substantial achievements since independence in building economic and social infrastucture not only could not be sustained, but were substantially eroded. However, an improvement in the performance of the Tanzanian economy has taken place since the mid-1980s. The government's economic restructuring program, as embodied by import liberalization measures begun in 1984 and the Economic Recovery Program (ERP), adopted in 1986 and expanded by the Economic and Social Action Program (ESAP) in 1989, has encompassed far-reaching reform measures across a broadening range of sectors and -licy instruments. Assisted by relatively good weather and additional aid inflows, Tanzania as a result has enjoyed five consecutive years of positive per capita GDP growth and improved welfare in sharp contrast to the preceding period. 3. In the first years of reform, the most successfiu adjustment measures have been in areas of economic liberalization, where demands on Tanzania's limited institutional and administrative capacity have been relieved by the reforms - e.g., in the substantial real exchange rate movement, external trade liberalization, domesuc trade deconfinement and price decontrol, and at present the Tanzanian economy largely relies on market signals for pricing and allocative decisions. In a continuing effort to improve the prospects for the Tanzanian economy, the government has, in addition, broadened its reform program to include comprehensive restructuring programs in agricultural marketing (e.g., by liberalizing marketing arrangements, reforming the cooperative system), in infrastructure (e.g., by beginning the implementation of the integrated roads program), and most recendy the financial sector (e.g., by allowing entry to new banks, granting autonomy to and initiating restructring of existing banking institutions). In addition, the government has taken some initial steps in public and parastatal reform (e.g., through public enterprise restructuring) and in the social sectors (e.g., by incorporating social concerns fully into the reform program). 4. While many conditions for further recovery are present, there are several factors of significance that continue to hinder economic response in Tanzania - and could even halt it. As discussed in this report, deepening the reform process and wherever possible accelerating the pace of implementation will be crucial if Tanzania is to consolidate gains made to date, sustain - II - growth and development and achieve poverty reduction. In particular, it will be crucial to address successfully the objectives of: * achieving macroeconomic stability: In the past excessive credit requirements of agriculturai parastatals and cooperatives have been readily met by directed credit from the government-controlled, non-competitive banking sector; this contributed to continuing high inflation, crowded out other borrowers from the financial system, and effectively bankrupted the financial sector. In addidon to agricultur marketing inefficiencies and continuing transport and processing constraints, these contributed as well to Tanzania's precarious balance of payments situation. * spreading the benefits of reform more widely: during the reform period agricultural output and picasants' living standards have risen substantially - due in large part to increased availability of goods and inputs In rural areas, the result in large part of trade liberalization. However, the benefits of the past exchange rate devaluation, which should have reached farmers through substantially greater real price increases, have largely been taxed away by an inefficient export crop marketing system. Raising production further will thus depend on implementing further reforms of the agricultural marketing system and addressing critical longer-term productivity concerns. * Iundertaking public enterprise reform: the govermnent recognizes that it does not have the financial or manpower resources required for new investment or to manage public enterprises adequately. Thus to reduce budgetary costs and improve efficiency in the industrial sector and throughout the economy the government needs to adopt a comprehensive program of parastata reform and actively pursue private participation and outright sale of government-owned enterprises. * rehabilitating and maintaining infrastructure: the lack of adequate infrastructure impedes economic growth. As one of the government's core responsibilities it will be important to improve Tanzania's basic infrastructure in roads, railways, ports, telecommunications, power and water so that it contributes to improved economic and social prospects. In this context it will be important for government to consider how best to ensure delivery of these services in the future. * improving social servicedelivery systems: longterm sustainabilityrequires building indigenous capacity, raising labor productivity and augmenting poverty reduction efforts. This calls for budgetary restructuring, improved financing arrangements, and the development of alternative systems for service delivery and management. * raising productivity of the public sector: results will require greater budgetary emphasis on government's core responsibilities (e.g., infrastructure, social services, agricultural services); raising civil service productivity and capacity; reducing the drain on public resources from parastatals; and raising the efficiency of tax and revenue policies to promote greater domestic resource mobilization. S. This report first analyzes the impact of the reform program to date. It points to (i) the common features underlying the achievements of the past five years of reform, (ii) the common denominator in the areas of remaining constraints to continued recovery, accelerated growth and social progress, and (iii) the key linkages between the sectoral and macroeconomic determinants of performance in the Tanzania economy. Building on the directions set forth by government in the ERP and ESAP, this report then considers the key elements of a strategy for ataining sustainable growth and a renewal of social progress. H. Determinants of growthb In TaMnn 6. As set forth in Chapter 1, external factors, such as terms of trade losses, the war with Uganda and variable weather conditions, whdle important in explaining economic performance in some years, cannot alone fully explain the persistence and extent of the economic decline in the late 1970s and early 1980s, the development of a parallel market economy in Tanzania or, later on, the economic recovery from the mid-1980s onwards. Rather, the evidence suggests the centrality of policy-related factors in determining Tanzania's economic performance. The exchange rate, trade and pricing regimes have been significant determinants of growth performance, mostly via the efficiency by which in-vestments, imports and other resources have been allocated in different periods. 7. Donors share with the government the responsibility for many of the policy mistakes and disappointing economic outcomes of the past two decades. With the benefit of hindsight it appears that external assistance in earlier years supported inappropriate policies and programs. Economic growth in Tanzania could have been substantially higher if aid programs had been designed appropriately and implemented more effectively. The statistical evidence suggests that in contrast to the past, aid levels have been more effective in determining economic performance during the years of the ERP - a period of increasingly market-based allocative mechanisms and aid channeled to support recurrent imports rather than large expansions in installed capacity. mH. How have key economic agents fared sinc rform bgn? B. The improved policy framework in Tanzania has contributed to economic growth rates exceeding 4 percent per annum for almost 5 years-an impressive achievement in the aggregate, particularly given weak institutions and debilitated infrastructure. An analysis of sector and micro-level performance of economic agents (peasants, workers and firms), within the limitations of the data, confirms that not all agents have shared similarly in the achievements of the ERP. As expanded upon in Chapters 2, 4 and 5, this conclusion points to further actions in the policy agenda related to those three categories of agents. 9. The peas . Since 1985, agricultural production has increased by approximately 5 percent per year. Per capita food consumption in rural areas has risen substantially since the ERP began, a, has availability of non-food consumer goods. Peasants have thus consumed a much improved commodity basket, in contrast with the large decline in peasants' living standards experienced during the 1977-1984 period. However, prices received by producers for agricultural output have overall not risen in real terms since reform began, and farmers' real cash incomes have only slightly increased during this period. Thus, the large peasant supply response and their improvement in welfare have not resulted from price change. Rather, it appears that improved production and welfare gains have in large measure been the outcome of the much improved availability of consumer goods and inputs in rural areas, in turn the result of import - iv - and domestic food crop marketing trade liberalization. These, aided by good weather, have led to large increases in production and marketed volumes. 10. The break from past trends in the peasants' living standards has thus been significant. But it could have been more impressive, if it were not for the increasing level of implicit taxation imposed on farmers by the export crop marketing institutions (Cdiapter 4). While farmers received nominal price increases during this period, the large exchange rate movements of recent years were not fully passed on to peasants through equivalent real price increases. 11. Farmers now face an improved marketing situation for food crops and non- traditional exports, the result of liberalized marketing of these crops. In turn, production has increased. By contrast, output production of traditional export crops - which are central to rural incomes and to Tanzania's overall export effort - has not grown significantly. Pardy, this could be due to the required time lag between new investment, which may be taking place, and output response. In addition, until very recently marketing of traditional export crops remained monopolistic and agricultural marketing efficiency deteriorated severely. Throughout the decade official exports of traditional agricultural products performed poorly: by 1990 they were 22 percent below their 1981 level in current dollar terms, and the value of these exports continued to fall even after 1986. By contrast, official estimates of liberalized non-traditional exports, show these exports to have risen by almost 30 percent in value over the same time period. 12. The urban worker. Per capita food consumption by the urban population has increased significantly since 1984 as greater production qnd liberalized foodgrain marketing has brought greater supply to urban areas. Non-food consumption has also increased significantly in the urban areas since the mid-1980s, the outcome of external trade liberalization, additional aid and increased industrial production. As real cash incomes grew in urban areas, and the availability of goods improved markedly throughout the country, overall urban consumption improved significantly - in sharp contrast to the years of stagnation and empty shelves in the early 1980s. 13. Not all urban inhabitants have fared equally well, however. Those engaged in trading, construction and the informal sector appear to have done (relatively) better than others. Also, those with preferential access to the banking sector and those involved in extra-income activities hate contidnued to benefit as the volume of resources available in the economy has increased markedly. In contrast, young, unskilled, underemployed workers, as well as public sector employees with little access to non-salary income, have benefitted much less. More broadly, a'l u-ban inhabitants (as well as their rural counterparts) have continued to face inadequate delivery of social services - e.g., primary health care, basic education and training. 14. The firm. Average industrial production has increased by over 5 percent per year since 1985, the year when capacity utilization and production volumes reached their lowest levels. As the analysis in the report indicates, a restructuring and reallocation of resources is also underway. According to a limited survey carried out for this report, efficient formal sector enterprises appear to have increased production by an estimated 20 percent since 1985, while output of inefficient enterprises has declined. Expanding firms are utilizing a much lower share - v - of foreign exchange than contracting enterprises, suggesting an incipient shift towards higher domestic resource utilization. However, a large segment of the industrial sector, comprised mostly of large-scale and import-intensive parastatals, has not yet streamlined their operations. 15. In contrast to the limited restructuring of larger-scale entetprises, the smaller scale sector is undergoing a dramatic change. Multiple smaller scale production and trading activities have emerged since the mid-1980s. A three-fold increase in such activities has been 'wsthmated since then. The positive response of the Tanzanian entrepreiteur to the more market-oriented policy environment, in spite of the serious remaining constraints faced by the entrepreneurs (e.g., inadequate financial services and infrastructure, continuing regulatory obstacles), is Indicative of this sector's dynamism and the enormous potential for future expansion. 16. The aggregate contribution of farmers, urban workers, and entrepreneurs has led to an official GDP growth rate averaging over 4 F.. 'ent per annum since the ERP started. This has result-' in positive consumption per capita growth - in sharp contrast to the declines of the early 198&y Factoring in the expansion of the informal economy - whose share in overall GDP is estimated to be around 30 percent and growing - actual GDP growth (and its level) is higher than the official figures suggest. 1' In many respects, urban and rural inhabitants appear to be better off now than five years ago, although the overwhelming majority of the population, with an average income per capita estimated at less than US$220 per year, is still very poor, remains at great risk from malnutrition and other health problems, and faces inadequate access to education, health and other social services. IV. Achievements and Constraints during the ERP: The "Intitutional Gammon ?enominatQr. 17. The changes in the positions of the various economic agents reflect both the achievements and limitations of the ERP. In particular, successful implementation of the reform program has primarily taken place in areas where the demands on Tanzania's limited institutional and administrative capacities have been relieved by the reforms themselves, rather than the reforms placing additional demands on the existing irnstitutional framework. Notable examples of institutional constraint-relieving reforms have been import liberalization through own-fuided imports and the Open General License Facility (OGL), foodgrain marketing liberalization, distribution deconfinement of virtually all consumer goods and inputs, price decontrol, and a more realistic exchange rate regime. In turn, these reforms have been associated with (i) the significant increase in foodcrop production and per capita consumption, (ii) the ongoiog reallocation of resources within industry; and (iii) the emergence of many new informal and small-scale activities. Common to all these developments, and to the relaxation of institutional constraints, has been the much-improved environment in which the private sector can operate in agriculture, industry and services. lt COne mud exereso caution when using GDP per capita estimates. The World Bank calculates per capita incomes using atlas mwodology - they are based on orTicially repored GDP, exchange mtes and price deflatous. Inm estimates using purchasing power panty estimations would show elaively higher incomes in Tanzania than the official figures. See 'National Income Estimatw in Taraania", backgrund paper number 2 in Volumo 2 of this report for further discussion of national incon accounting methodology used in Tanzania and Chapter 6 which presents international comparisons of econonu. and social indicators using PPP. * VI - 18. The government h s been courageous in undertaking these politically difficult measures. Once political consensus has been reached, implementation of these "institution- relieving" reforms has been relatively straightforward. In contrast, the areas where full implementation of reform has not yet taken place - and on which government plans to focus in the coming months and years - are those areas where the institutional demands imposed by the required reforms are high. For example, the non-ompetitive agricultural export marketing system has been pardy responsible for lower-than-expected agricultural export growth. Toe government has now embarked on further marketing liberalization (i.e., allowing competition in marketing by deconfining marketing for the traditional export crops), but in addition major institutional changes are required, since export marketing boards and the cooperative system need to be restructured institutionally and financially. The role of the marketing boards is already being reduced. In addition to financial restructuring, cooperatives will also be based on voluntary participation, implying that farmers will be free to market goods through alternative channels. 19. Other examples of reform measures that will continue to tax Tanzania's institutional capacity are in the financial, government, parastatal and social sectors. In the case of the social sectors, the slow response to the ERP has been directly related to institutional and budgetary constraints. In Adition to the social and productivity-enhau iing effects of a reformed incentive structure, social progress and poverty reduction will depend on: (i) extending and creating greater participatory (community-taed schemes) and private sector channels for serv5ce delivery and management - improving effectiveness in delivery and relieving public sector capacity constraints; (ii) promoting public sector management reform, including allocating additional puolwc ex iii-uifes w socal W- uwf essewiw la puwS Gnu Suppunlvo uuatuctre; and (iii) implementing this strategy will require an improved capacity in government plan and implement targeted interventions - including improving self-financing of social services (i.e., through cost recovery and other resource mobilization). Local government must figure prominently in this approach as social service delivery primarily takes place at this level of government. V. AIM$ng Mro_cnomic, S__tl: Conslidating Fiscal Accounts. 20. As discussed ia Chapter 3, the excessive credit requirem..ts of agricultural parastatals, cooperatives and some public industrial enterprises, have been met without adequatc economic or financial review and have not been fully repaid by the borrowers. The state-controlled banking sector, however, has continued providing credit to many large borrowers (as in the case of agriculture) as alternative marketing channels have not existed. As a result, the consolidated fiscal deficit of the public sector (the goverment deficit plus financial sector financing of quasi- fiscal expenditures) has been very high over the ERP period - even though fiscal targets for the government budget alonb have generally been met or even surpassed over the period of reform. The consolidated deficit has been a critical factor in explaining the money supply growth of about 30 percent per annum over the first four years of the ERP. This contributed to the persistent monetary imbalances and relative macro-instability: until recently, the inflation rate has been about 30 percent per annum. Inflation, in turn, necessitated larger and politically-painful nominal exchange rate devaluations. During 1990, the official inflation estimates fell to just below 20 percent for the first time in over a decade. However, in the first quarter of 1991, following a year of decline, inflation rose again to an annual average of 27 percent, due in part to poorer weatier conditions and the effects of the Gulf crisis. - vii - 21. In addition to having become an impediment to macroeconomic stability, the performance of the financial sector has had an increasingly adverse impact on resource allocation throughout the real economy. As the price of foreign exchange has come closer to a market- determined rate, and has been allocated increasingly through non-administrative mechanisms, domestic liquidity has become a binding constraint. Credit by the fnancial institutions has been allocated primarily to large parastatals, particularly to marketing insdtutions, often on subsidized terms (through preferential interest rates, grace periods, inadequate repayment enforcement, increasing arrears, etc.). Credit to other potentially more efficient borrowers has therefore been severely constrained, and total supply response has been less than it could have been. The government has recognized that future economic growth and development will require financial sector reform and has taken the steps to begin this process by issuing a policy statement and enacting legislation establishing the objective of competition within the sector, allowing market entry for private banks and instituting conmnercial banking principles. VI. Public Sector Management: The Need for Institution-Intensive Reforms 22. A productive economy requires an efficient public sector. The task over the coming years will be to significantly improve productivity of this sector. Accomplishing this will require institutionally-intensive measures. Critical is the restructuring of public expenditures - determining priorities within a constrained resource picture, allocating expenditure toward core activities to provide basic physical and social infrastructure and services to the population, streamlining parastatal financing, broadening the tax base, and improving revenue collection efficiency. Such restructuring would have to be accompanied by programs to address the institutional and management weaknesses which have been compounded by the deteriorating structure of compensation. Monthly salaries in the public sector represent one-fifth of their real levels of the late 1970s and on average are insufficient to feed and provide for an average household. As a result, workers morale and discipline at all levels have suffered and many civil servants are forced to divert considerable official time to private venture activities. Absenteeism is therefore high, and civil service productivity is low. 23. Inadequate compensation has also lowered Tanzania's ability to meet its social objectives, as approximately half of Tanzania's civil service are teachers and health workers. Continued productivity decline of these professionals and other workers in response to inadequate and often very late pay, as well as inadequate funds and distribution channels for complementary inputs, will continue to constrain Tanzania's social prospects. 24. As the Public Expenditure Review (PER, 1989) and this report point out, medium- term budgetary planning and restructuring and revenue enhancement have begun, but much more remains to be done. Initial steps taken recently include increased allocations of public resources directed toward rehabilitation and maintenance and incipient development of alternative (private sector) delivery systems. Despite the importance the government attaches to the social sectors, the priority attached to those sectors as evidenced by budgetary allocations has been mixed. The objective for the future should be to focus a greater share of the government's limited financial and manpower resources on these key sectors. 25. Correcting the problems in public sector management will be capacity-intensive and require decisive action over a considerable period of time. It will also require government to - viii - continue to redefine the role of the public sector in the economy in response to a realistic assessment of comparative advantage and resource capacities. Government should also consider which public services are necessary and which could better be provided through private sector delivery systems or other alternatives. As government has already recognized, hard decisions of reducing the size of the public sector will have to be taken, and some actions have been initiated. VII. PgMatatas: Restructuring a Larg_e Setor of the Economy 26. Parastaal restructuring is a major item on the future agenda for Tanzania because of the need to reduce budgetary costs and improve efficiency in the agricultural and industrial sectors. To date, Tanzania has relied primarily on changes to the overall macroeconomic framework to stimulate restructuring. Recently, however, the government has initiated some parastatal- and subsector-specific restructuring to counter sectoral inefficiencies and persistent financial losses. In the case of NMC for example, a major restructuring, including sale of assets, has already taken place. In the case of the leather subsector, the government has decided to seek joint venture partners in the subsector's enterprises. 27. Restructuring an expanded array of subsectors and enterprises needs to proceed. However, the step-wise, subsector or firm-specific approach presently being followed in Tanzania cannot encompass the many systemic problems affecting parastatals as a whole. Thus the future strategy of government should include adopting a comprehensive program of parastatal-wide reforms aimed at: (i) eliminating budgetary subsidies; (ii) ensuring parastatal autonomy and accountability through the adoption of performance contracts; (iii) increasing the commercial orientation of the enterprises; and (iv) allowing competitive pressure through further reforms in trade, regulatory and industrial policies, easing entry of new firms and competition in all sectors. Furthermore, the government recognizes that it does not have the financial or manpower resources which would be required for new investment, to put all state enterprises on a sound footing or to manage public enterprises adequately. Consequently, Tanzania's parastatal reform program now includes the possible outright sale of public enterprises - an option which needs to be actively followed up on without regard to whether the enterprises are presently loss-making or profitable. In addition, the parastatal restructuring program will need to facilitate the exit and liquidation of non-viable concerns. VIII. Balance of Payments and Institutional F-ctors 28. A variety of factors has influenced the critical condition of the balance of payments (BOP) experienced after the mid-1980s - including, inter alia, continued infrastructure and processing bottlenecks, declining export (coffee) prices, and increase in the price of oil. Yet the 'institutional' factor appears to be critical in this area of macro-performance as well. The poor performance of the cooperative unions, marketing boards, and transport parastatals (e.g., railways), and in some cases their parent ministries, have contributed to crop procurement and processing inefficiencies. They have also reduced the pass-through to the farmer of higher prices resulting from exchange rate changes and have constrained access to inputs. The result has been lower production and exports of traditional export crops than would otherwise have been the case. - ix - 29. Exchange rate policy has had a greater impact on non-traditional exports than on the traditional exports, since the marketing system for the former has been liberalized further, providing higher incentives to the producers. However, even for non-traditional exports growth could have been more significant if exporters had faced a more appropriate real exchange rate. Notwithstanding the very dramatic realignment of the nominal and real exchange rate over the ERR period, the real level of the exchange rate had not yet reached an appropriate level by early 1991. Since May 1991, however, further devaluation in real terms have taken place. Maintaining an appropriate real exchange rate level through complementary fiscal and monetary policy, combined with continued flexibility in exchange rate management, will be very important in enhancing balance of payments viability. 30. Import use efficiency has improved substantially since the mid-1980s. However, it is likely to continue below potential as long as subsidies are still provided to importers. Donor assistance allocated to particular recipients or tied to particular procurement arrangements contributes to this situation. Tanzania's low creditworthiness has also meant that the country at times has had to pay very high prices for its imports, and on occasion has had to secure its imports through tied deals. IX. Sustainable Growth In the 1990s and Beyond: Deepening and Accelerating Reformr- An Agenda for the Future 31. Continued efforts to resolve the critical sectoral and institutional constraints afflicting the Tanzania economy are essential if Tanzania is to attain sustainable and equitable growth within a stable macroeconomic framework. Resolution of these constraints requires, foremost, an effort to create an efficient, well-functioning economy, through: (i) implementation of the government's plans for financial sector reform, (ii) further agricultural marketing liberalization, and (iii) further parastatal restructuring. These are key elements of a strategy to promote a more dynamic private sector, and reflect the limitations on public sector resources and capability. They will need to be supported by other policy and institutional reforms. Public expenditure and investment restructuring and civil service reform to continue to rebuild and enlarge infrastructure, capacity-enhancing actions through education and training, and targeting particular groups (e.g., the poor, women) with specific poverty alleviation interventions are equally important. 32. In setting priorities for the future reform effort, this report distinguishes between (1) measures which are constraint-relieving in terms of their institutional demands, and could be expected to be taken in the near term, and (2) measures which are capacity-intensive in terms of their institutional demands. In this latter category, institutional reforms should be begun now, but may take longer to effect, or to see the full results of, as they will place great demands on Tanzania's implementation capacity (Matrix 1 at the end of this Executive Summary summarizes these actions). Both sets of measures are essential to the overall program of structural reform, and neither would be effective without the other. Some of these actions are already in the process of implementation or decisions have already been taken. 33. Constraint-relieving actions would encompass, inter alia, measures to attain and maintain an appropriate exchange rate system; reform agricultural export marketing by deconfining marketing for all crops; continue liberalization in industry and services by further deconfinement and decontrol of prices and allowing freedom of market entry by domestic and - x - forelgn investors; eliminate parastatal subsidies; close non-viable public enterprises; allow competition in the financial sector between domestic and foreign-owned banks; and allow the private sector and other agents a greater role in service provision. The institutionally demanding (capacity-intensive) reforms identified include restructuring and strengthening of financial sector Institutions and their clients, including the cooperatives; parastatal restructuring and public sector management reform. 34. An important objective of the report's agenda for policy and institutional reform is to promote unification of the parallel and official economies in Tanzania. Unification is Important to reduce inefficiencies associated with rent-seeking, encourage greater resources to flow through the official economy and increase the government's ability to manase the Tanzanian economy through indirect measures. An incentive-led unification of these markets requires an integrated approach, including continued flexibility of exchange rate management (reflecting an appropriate premium between the parallel and official markets, underlying movements in the trade account) supported by prudent monetary and fiscal policies. Equally important to bring more economic agents into the official economy are trade, regulatory and financial sector reforms. The response of economic agents will unavoidably be gradual as confidence builds, but government can certainly influence the pace of parallel and official economy unification through the speed and breadth of overall reform implementation. 35. Since the beginning of economic reform five years ago, the economic growth and higher per capita consumption attest to the capacity of Tanzania's economic agents to respond to economic incentives. Given Tanzania's economic potential and the evident supply response capacity of farmers, firms and workers, there is little reason to doubt that with suitable incentives, an improved institutional and infrastructural framework, the population would benefit from sustained economic advancement over the coming years. 36. The lessons from the recent experience of Tanzania, coupled with the identification of key constraints that are beginning to be addressed, provide room for cautious optimism. 'rhe projections contained in Chapter 7 suggest that the reform strategy oudined here would have a positive economic impact. Over the coming two decades, Tanzania could continue to achieve economic growth between 4 and 5 percent per annum and per capita consumption growth of between 1 and 2 percent per year. Such growth would particularly reflect strong agricultural production and export response to the further liberalization of agricultural export marketing, institutional reform and improved infrastructure. Continued strong performance in the informal sector and small scale industry would be an important contributor. More efficient allocation of imported and domestic resources within medium and larger scale enterprises would also promote private investment and greater output and export growth in that sector. Export performance, though vibrant, would remain substantially less than total import requirements, the result of the much smaller base of the former. This means that the balance of payments would improve but would remain difficult for the foreseeable future. The role of donors and their response to the intensification of economic reform would remain crucial for Tanzania's external viability. Donors would need to maintain if not increase real aid levels. Both fast-disbursing balance of payments support, particularly in the short to medium term, and well-targeted project aid would be required. In addition, donor commitment to untied import support to the OGL system will be essential if market unification is to succeed. - xi 37. The public sector restructuring program would have a positive social impact in alleviating poverty and ill-health, and result in an increased ability to invest in its people's health and education. Specifically, relatively greater emphasis and allocation of more financial and human resources toward the social sectors would assist Tanzania to better address the critical health threats now facing the country, such as the continuing problems of malnutrition, of malaria and other long-standing diseases, and the new challenges posed by AIDS. 38. There are some costs and risks to the strategy set forth here. In large part, economic and social costs normally associated with stabilization we4e borne during the years of stagnation and deprivation and during the period preceding the ERP when prices for most consumers already reflected scarcity value. In the future, however, the reform will result in transitional costs, largely the expected outcome of civil service retrenchment and lay-offs from parastatals. Government and donors will need to devise programs to ameliorate these costs (such as compensatory and retraining mechanisms, etc.) as an integral part of public and parastatal reforn. 39. There may also be political risks to reform, though Tanzania has shown preparedness to take them on. In the cooperative sector, for example, the government has taken difficult decisions, declaring that cooperative membership wIll in the future be based on voluntary associatlon and individual societies and unions wIll have to maintain their own viability. In April 1991 the government enacted the necessary legislation to effect these changes. When fully implemented these reforms will result in full liberalization of marketing to allow multiple private channels and in the restructring of cooperatives and removal of political and administrative interference. The government has also announced that private domestic and foreign banks wIll be allowed to operate in Tanzania and enacted necessary legislation. 40. Key questions addressed by the report are whether the growth seen during the initial years of the ERP can be sustained and whether social progress can be achieved by maintaining or only incrementally extending the existing liberalization measures. The report concludes that this incremental approach would be unlikely to be sufficient. Rather, the ongoing reform program needs to be deepened and the pace of decision-making and implementation accelerated to better ensure achievement of sustainable and equitable development over the longer term. 41. There are a number of reasons why a reform program which is not broadened and deepened would most likely be unviable. First, recent growth performance has greatly been the outcome of one-time gains due to trade liberalization which led to the increased availability of goods. Now that liberalization in many sectors has substantially taken place, fewer additional welfare gains and supply response can be expected from this source alone. Second, sustained growth is unlikely to take place if macroeconomic balance were to remain elusive - if reform were not undertaken in agricultural marketing, fiancial, public and parastatal sectors - and if public infrastructure (e.g., transport and social services) were not improved. Third, there would be clear limits to the replicability of donor aid funding increases in the future, as aid even at present levels is contingent on continued progress on economic reform. Finally, many gains during the ERP were due to increases in underutilized capacity. In the future, many activities, particularly in industry, will face effective capacity constraints as a result of their expansion in output and their high level of obsolescence and disrepair. Thus, although reallocadon of recurrent inputs can still result in supply response for a number of years, efficient new investment - xii - wUi be critical to determining growth performance in Tanzanian economy. As the public sector lacks both the resources and the comparative advantage to undertake the required investment economy-wide, attaining acceptable levels of efficient investment wIll require an enabling policy and regulatory environment conducive to private sector investment from domestic and foreign sources. In addition, public sector investments will be required in economic infrastructure, particularly where the private sector is unlikely to enter. A restructured public sector and budgetary framework would be necessary to facilitate the implementation of key public investments in physical infrastructure, basic health and education, and to address poverty issues. X. The Role of Donor Assistance 42. The report emphasizes that donors have a major role to play in assisting the government with the major reforms required. Maintaining and even increasing somewhat the already high levels of assistance will be important in the coming years to support Tanzania's policy reform and restructuring program. The effectiveness of this assistance also needs to be improved further. Increased collaboration and improved coordination of donor assistance, including some concentration of donor assistance according to sector and expertise will be important, and the report suggests a number of means of instituting this (see Chapter 7). In particular, the report suggests that collaborative work programs among government and donors be developed, that analytical reports and other work be discussed more widely and that donors base decisions concerning involvement and financing on this joint work. 43. With regard to resource requirements of Tanzania over the coming years, the report stresses that continued high levels of import support will be critical. The report also recommends that donors firther shift assistance currently tied to specific enterprises or activities to support for the OGL. In the context of the Special Program of Assistance, donors with funds tied to source should also work to untie assistance, and all donors should strive to eliminate the earmarking of counterpart funds. Both these actions will contribute to increase the scope for effective economic management in Tanzania. Conventional project assistance will also be very important, but the government and donors will need to review very carefully the preparation and design of such projects to ensure that an appropriate overall policy framework is in place and the projects take fill account of the need to make use and strengthen local capacities and institutions. Xl. Dynamism and Growth through Private Sector DeeloMent 44. The country's strategy for productivity improvement, economic development and social progress over the coming years must have as a central component the realization of the potential dynamism of the private sector. The analysis of Tanzanian economic agents attests to the substantial unrealized potential for dynamism and growth through private sector development. There is ample evidence that the vast majority of Tanzanians respond significantly, through increased production and exports, to the environment of appropriate economic incentives. These, coupled with improved public institutions and infrastructure would fuel economic growth for the coming years. 45. The agents for dynamism and growth are diverse. Peasant farmers, due to their numbers, are central to the process of securing extensive indigenous participation in economic growth and establishing a strong income base in rural areas. Tbis group has raised production - xlii as a consequence, inter alia, of improved availability of Incentive goods, inputs and the overall economic liberalization which Tanzania has undertaken to date and should respond similarly to the incentives, marketing and support system reforms which government has planned and which are outlined in this report. Larger-scale ventures have recently begun to produce and market non- traditional crops: there are many agriculture-based entrepreneurs who, in the incentive environment of the early 1980s (especially the exchange regime), could not have succeeded, but who now export large quantities, employ a substantial and growing work force and who are diversifying their activities, a process which should be encouraged. Small sector industrial and service sector activities, including informal sector participants, will continue to contribute significantly to growth. There are also larger industrial groups, who have begun to develop different types of enterprises. All these agerts are expected to respond to the reform of incentives and regulations, removal of excessive regulation and improved physical and financial infrastructure. 46. The emphasis on the dynamic entrepreneurship potential of the private sector has implications for the role of government and donors. Complementary to the requirement of establishing the right environment of incentives, institutions and infrastructure, the success of this will require the accelerated investment in Tanzania's human resources, men, women, and children. Investments in education, health and nutrition will underpin the achievement of sustained and equitable growth in the longer term. xiv i]l*§ X.~I itxaa ii ] Jiiiiitii !M i]f li -d ljIo I ^~ IIIII:ih { X *11 11t ixJ } {ll{Elf~iI 1:1| 1 iE 1 I3S & [Wi*1 Y~~11 I Sectorl Constraint-Relieving Capacift-lntensive Action Government Objective Action Nearterm Mediumterm Initiatives B. Public sector (cont). Docide on objecfives and t lish rdiable database on Reduce staffing kvels in line Somc work ongoing to actions to reform civil serv civil senvic, contl addtios with mview of fiutions and develop reliable systems for B. civil service reform - to to the payrol and ratch role of govenment aDd MOniorig and co Ming rove incenves for civl sent and payron budgeary constraints payroll. Stus ongoing to productiviy and imromve review alnafi for morale within the civil Improwe incenives / Provide compenaon I Compensation scm. serie wompen tn ih substal rtaining schems for civil rmo-firme agreed over real pay incrmas sewn affeced by staff whieb decisiom on reduction measure implmenttion of staff Remove already-identified reductionn will be taken. ovrgaffng Monetize allowances and benefits and itegate into salry 4 C. tax poliy and mplmaent simplified tax Refonn customs sevice Develop and implement tax Maximum tax rates adminiration reform - to system with the objecive of thrugh higher remuneration, credit system as prelude to substaialy reduced. Tax improve efficiency of tax achievng a low, wntary sales rewards Sor uncovermg fraud, VAT Commiseo prering final systm and mpowc tax rate with a limited number etc. report. administrtion of emisable goods liminae abitrariness and Reduce tariff and make more instie equal and trnsparet uniform t tatmt for an small/large, publc/private Eliminat disctionary taxhaiff axemion xvii II< t'! .1ii ] I t1 i ~1.111 il j}Mt tE ffo E 4 *S 1 fl ttZ ]tZ ]it{S ii] l 10 i 1 { ti t]]1]E Sector/ Constain-Relieving pacity-ntensive Action Goverment Objective Action Near-term Medium-term Initiadves V. Ao& m saLiber deconfnca cops Develop mechaisms for Res nional ld uw Prinip of multi_cml - to wfwvo iia ~ at an levels fuSncing agriul polcy and gon maretng accepwd. oonsrait and stengte p-d Legislton to fm agrcu umis to Remove g_vcrnwnentatd Reorient and rehablite cooperatives movamt prmote ingtrm prin replace wah Refonn soops to make thnm research and etenion nacted. Markting b productivity inditve prices for an cops gmso. voluntary sevces ad dvelop restrUt iniliated. associ s akemative delve st, nclding priva sectr Downsizresn alvoe makding boards Coniu to mn~ementmao infuct rhbbiltion Plowa Sectorl Constraint-Relieving Capaity-Intensive Action Govemnmen Objective Action Near-term Medium-term Inidatives VI. P ag nd Eliminate aDl budgety Clssify all PEs iwto Reform corpot legal and Publi: antpri nurial refonn subsidies to commercial non- strategic/non-strategic, regulatory syem to ams resuctrig has begun - to prmote greater, more strategic PEs (subject to commenial entry, opeation and exit of Wih lcer industry efficient prductin interim financing non-commecial, firms - and to dal beter whereby joint vents are finanial discine, arrangemnts) including short- viable/non-viable with enforcenent of contract, bein sough Decisionm effioiet rsourco uili}zation term bridging loans and bankrptcy, liquida made in principle that and macro stabiy longer-ern leding from Initiat retuctuing - taeoves similar arangemn would Treas including physical, finacial be sought for al other non- and ownership (partial or full Develop ategis and plns strategic ntpcs. Eliminate p)- of for improving efficiency of Decision made to shift non- import suppot, shifting all commecial, viable entcpris remaining PEs (e.g., commcial p _aras to those resource to the OGL perfomnce ontr, budget. Define respecive roles, introducing perflor based Shift granting of credit for responsibilities, autonomy of incentive schemes) cotpart funds payment to line ministries, finance financa system minisy, boards of dectos, Reform land allocaion, _ Inagenum o _ocpacy an devlopent Abolish SCOPO and SCOPO- (zoniW reguWi hlk contol over PE$ Develop effective system for -1f PBS Cbl or shift non-commecial parstta to thd budget Refom licening and Cle J liqie nonviable rgsation procedu Rationae Natiol bnement Act inaentives and widen ope of sector Sectorl Constraint-Relieving Capacity-Intensive Action Govenmment Objective Action Near-term Medium-term Initatives Vll. Social sector refbrn - Encowurage private sector and Decenbtrm responsibility for Restucture expendue Effots made to encouwagc encourage more effective NGO participation in delivery supply decisions to allocation system to community and NGO delivery systans of priority systems implementing units to use consolidate miniseial par in servic social services locally-gencrated funds (user responsibilities and refect deivery. Decisions tak Deconfine medical and chargs) for local needs overaU decentralization to resuctue cerarl educational supplies and objectives medical supply system. personnel Restrm central supply delivery systems Better integrate capal and Ensure adequate expenditures recurrent expenditures to in core programs Ensure social setors establish uniform sectoral integrated with overall civil expenditure progams that can service refonn mobilize donor/ NGO/community support CHAlEEM I Performance of the Eoonomy 1.1 IntroductIon. The 1980s have been characterized as a "lost decade' for Africa. Whatever the merits of such a characterization for the continent as a whole, the reality for Tanzania has been much more complex. Performance of the economy has differed dramatically in different time periods and in the various policy and sectors of the economy. 1.2 Following rapid growth during the mid-1960s and early 1970s, the Tanzanian economy began to slow down in the mid-to-late-1970s. Two major oil price increases, fluctuating international prices for traditional export commodities, variable weather conditions, the break-up of the East African Community and the war with Uganda imposed a number of significant external shocks during that decade. Inadequate policy response to these shocks, coupled with the institutional and productive structure of key sectors of the economy - agriculture and industry in particular, whose structural and policy weaknesses and overall fragility became exposed by the external imbalances - magnified and lengthened the severe economic decline that set in after 1978. 1.3 By 1982 the economy was in a serious crisis, per capita GDP was declining at about 3 percent per annum and the impress ve gains achieved in the preceding decade on education and health were being eroded. Faced with the deepening crisis, and in the aftermath of initial attempts to implement partial polir; aqjustments in the early 1980s, the government embarked on a comprehensive reform progrsi; in the mid-1980s. The positive response to the trade liberalization program of 1984 pare.d the way for a broad package of structural adjustment measures initiated in 1986 under tht. Economic Recovery Program (ERP). The first phase of the gradual adjustment path implemented by the government lasted until late 1989, when the authorities unveiled the second phase * the recovery program, the Economic and Social Action Program (ESAP), which has broadenes: m*ve scope of the reform effort. 1.4 How did the economy pert: 'm during the 1980s? In what ways do incentives, institutions and structural characteristics st he Tanzanian economy interact? What are the key lessons for government policy and donor asistance for their roles in the economy for the coming decade which emerge from this analysis? What ate the prospects for Tanzania's sustainable development? These ambitious questions frame the analysis and structure of this report. An important objective in preparing this report has been to complement the government's own policy papers and studies, for instance the ESAP. Our aim has not been to provide definitive and complete answers to each question, but rather to provide tools and elements for analysis, discussion and debate on the issues confronting the economy today and to outline strategic options for deepening the reform process in the future. A. The Economy since Independence: Economic erformance Under Varlous mes 1.5 At independence in 1961, Tanzania was one of the poorest countries in the world. Largely dependent on subsistence agriculture, the country had a very small industrial base and a limited number of educated and trained personnel. The direction of economic policy in the first - 2 - six years thereafter relied largely on market forces, stressing the objectives of per-capita income growth and national self-sufficiency in skilled manpower, and viewing foreign investment as the major instrument of industrial develcpment. The policy regime for trade and capital movement was largely non-restrictive, and economic policy was essentially neutral - was not biased for or against any particular sector. 1.6 Tanzania's economic history since the mid-1960s, however, has been fundamentally influenced by three major policy events: (i) the Arusha Declaration in 1967, (ii) adoption of the Basic Industrial Strategy in 1976, and (iii) initiation of reform as signified by the 1984 expansion of the own-funds import scheme and, particularly, adoption of the Economic Recovery Program in 1986. Three distinct policy regimes have followed from the implementation of these declarations and policies. While economic performance itself must be viewed as a transition between these regimes, this analytic framework is useful for evaluating that performance, the difficulties facing the Tanzania economy, the consequences of the changes which have taken place over the past half decade - which is the time period of primary focus of this report - and for considering future prospects. 1.7 Growth and increasing controls: mid-1260s to mid-170s. The period from the mid-1960s to the mid-1970s, which represents the first regime, was one of a growing though also an increasingly controlled economy. The Arusha Declaration of 1967, the policy action which signalled the beginning of this regime, called explicitly for the establishment of a socialist society, with greater emphasis on rural development, self-reliance in development efforts, and the development of a more universal education system. A leading role was given to the state, especially in the reform and creation of appropriate institutions. This led to the nationalization of major commercial and financial institutions and some private agricultural estates, the creation of numerous parastatal bodies, and the initiation of a concerted program of collectivization of peasant agriculture, including the formation of communal villages. 1.8 During this period, an increasing proportion of Tanzania's resources began to be directed toward developing the pub'1. enterprise sector, particularly with the objective of industrialization based on import substitution and creation of heavy industry. The Tanzania government also attached substantial priority to providing resources to the social and human resource sectors during this period as well. Indeed considerable gains were made in providing such services - particularly in access to education, literacy, infant survival, access to safe water and health care in general. In fact, access to education and adult literacy rates were among the highest in all of Africa, and donor assistance increased rapidly over the period as many donors identified strongly with the goverment's strategy. 1.9 Even with the rapid consolidation of control over major aspects of the economy and the major institutional changes, real GDP grew at just under 5 percent per annum between 1966- 73 (Table 1.1), and gross investment rose to above 20 percent of GDP. These siggregates concealed, however, the emerging structural weaknesses within the economy. These weaknesses included declining productivity of investment in industry and agriculture, declining export volumes, dwindling domestic savings, parastatal inefficiencies, and an overly ambitious public expenditure program which could not be maintained. These reflected as well a policy environment which was biased against agriculture through, inter alia, increasingly excessive levels -3- of protection for import-substituting industries. Over time, these weaknesses had deleterious consequences for the Tanzanian econrmy. Ible 1.1: TANZANIA: Growth of Sected Maclndkators - 1966-1989 eet) Regme IRegBng 2 Rogime 3 Annual Growth 196675 1976-80 1981483 1984-85 1986-90 GDP I/ 4.7 2.0 0.5 2.7 4.5 GDY per capita ! 1.5 -4.7 -1.6 0.9 0.2 Exports t/ -6.8 -5.7 -8.1 -2.4 10.2 Imports i 0.6 2.1 -7.0 -11.3 1.3 Current Account Deficit b/ 35.6 62.5 -12.9 0.9 23.0 Terms of Trade (rate of change) 3.9 -S.7 -1.0 3.8 -7.9 Domeatic Inflation (rate) 12.1 16.5 29.4 33.2 25.0 Gross Dom. Inv. / GDP (avg) 20.7 24.7 18.4 15.5 21.1 Nat'l Savings / GDP (avg) 15.5 15.6 11.4 8.6 -0.2 Source: Tanzania National Accounts, mission estimates Notes: _/ In constant terms yr In current terms 1.10 In particular, following two decades of impressive growth, the volume of agricultural exports stagnated in the mid-to-late 1970s. Moreover, although a centerpiece of Tanzanian policy at this time was self-reliance in generating domestic financial resources for development, very litie was accomplished in this regard. Domestic savings reached a peak of 18 percen. of GDP in 1970, but dropped to less than 10 percent by the mid-1970s (Graph 1.1). During this period, private savings were dampened due to the uncertain climate for private investment; parastatal savings did not keep pace with the increased investment in that sector; and government savings declined as a result of an explosive increase in government consumption expenditures. Tanzania's external accounts reflected this widening gap between investment and savings: current account deficits were already growing significantly in the late 1960s and early 1970s as the real exchange rate appreciated, exports declined and imports increased. By the early 1970s, the trade deficit reached 67 percent of GDP, in contrast to the balanced trade situation in the late 1960s. By this time the share of total capital formation financed by foreign savings - - essentially foreign aid - had risen to over one-half of the total - up from one-third during 1973 and less than 10 percent during the latter half of the l960s. However, in many cases the returns to these investments were very low because of the inadequate macroeconomic policy environment, including policies such as cost-plus pricing, and exogenous shocks, and also due to failures in project design and implementation. 1.11 In 1974 Tanzania experienced its first serious economic crisis, the immediate cause of which was a combination of two years of drought and the first oil shock. During 1974 and -4 - 1975 Tanzania's current account deficits averaged 14 percent of GDP, and international reserves fell by nearly 70 percent. The government was able to moderate the immediate adverse impact of the resulting Imbalances by restraining public sector wages, tightening import and capital account restrictions and mobilizing large inflows of concessionary fiacing. In addition, the government delayed the full introduction of its basic industrial strategy (BIS), which had been announced in 1974, with the result that the government was able to weather the iunmediate poor resource problems for a short period of time. Graph 1.1 Tanzania - Investment and Savings 1967-1989 30 p n 10 t o 0 D- - I f G -10 0- D -20 1967 1970 1975 1980 1985 1989 Year - Savings / GDP - Investment J GDP 1.12 Economic decline: the mid-1970s to the beginning of reform. Pressures on external accounts eased considerably in 1976 and 1977 with the recovery of domestic food production and the arrival of the coffee boom. Fiscal pressures eased as well, given that the govermnent chose to tax away most of the windfall in export proceeds. In this relatively favorable external and fiscal climate, in 1976 the government initiated full implementation of its third five year development plan and the BIS. It is this event which inaugurated the second regime, which went on to encompass the period until the mid-1980s. 1.13 While the Arusha Declaration changed the pattern of ownership of industry and reversed, in principle, dependence on foreign investment for industrial development, by the mid- 1970s it had not yet directly affected the structure of industrial production. Thus the BIS was significant because it attempted to implement government's objectives of restructuring economic output and eliminating external dependence. Industry was seen as the principal agent of structural transformation and self-reliance, and thus the import-substituting manufacturing sector was to have priority over other productive sectors. .5 - 1.14 In 1978, in the aftermath of the coffee boom and with donor advice and support, the government initially relaxed somewhat its stringent import controls. However, about the same time the country's terms of trade began to decline due to the collapse of the coffee boom. The import liberalization without complementary exchange rate management and appropriate fiscal and monetary policies resulted in a large and increasing balance of payments deficit. Later in 1978 the country was hit with the second oil price increase and with the war with Uganda. These events raised the current account deficit to above 15 percent of GDP. In contrast to the earlier crisis, when Tanzania managed to maintain per capita consumption through increased inflows of external capital, adjustment to the economic shocks of 1978 and 1979 required substantial cutbacks in both consumption and investment. In addition, the 1979 Uganda war resulted in a further dramatic fiscal deterioration: the fiscal deficit rose from 10 percent of GDP in 1977/78 to nearly 20 percent in 1979/80. Inflation doubled between 1978 and 1980, to about 30 percent per annum, a level at which it remained throughout the 1980s. Domestic savings continued to fall. Concessional financing was sought and increased to a level equal to about 75 percent of exports, but this was not sufficient to achieve external balance. Tanzania thus resorted to external borrowings on harder terms, which led to a steep rise in debt service, reserve drawdown and, later, increases in arrears. In spite of expansive monetary and fiscal policies, exchange rate policy was passive, involving maintenance of a constant rate against the SDR, which was sustained by an elaborate system of import licensing and foreign exchange allocation, and price controls; the associated policy of confinement was reintroduced and tightened. These controls fell particularly heavily on intermediate goods and actually drove down capacity utilization in manufacturing at the precise time when government and donor priorities were supposed to be focussed on increasing manufacturing capacity. Together with the direct compression of consumer imports, this produced a severe shock to the supply of goods. 1.15 By the early 1980s the import contraction was particularly severe because exports continued to fall, commnercial lendirg dried up and aid flows declined. The latter occurred as donors had become concerned about the low returns to aid-financed investments and had realized that maintaining high levels of external support only allowed the government to sustain inappropriate macroeconomic policies. Consequently, total external assistance (excluding technical assistance) declined from US$ 470 million in 1981 to US$ 300 million in 1985. As a result, goods and inputs which were available were often allocated according to non-market mechanisms, and prices deviated from market determination even more. The acute shortages of basic consumer goods from the official market - particularly in the rural areas - a reduction in real producer prices and increasing overvaluation of the exchange rate accelerated the decline in export volumes during the early 1980s (see Table 1.1). Investment growth took place until the early 1980s, though at that time it began to fall. The productivity of investment, however, continued its steady decline initiated during the 1970s. Over the 8-year period from 1975 to 1983, official figures report that Tanzania's per capita income fell by 3-4 percent. Certainly, as discussed in more detail in Chapter 2, there are some indications that the actual drop in living standards was as large as 40-50 percent. Per capita income did not begin to rise again until 1986. 1.16 During this time there emerged a parallel economy, involving both legal and extra- legal operations and transactions, in addition to the formal one, in order to cope with the shortages and the administrative rationing which were taking place. Overall, accounting for the domestic and external trade components, the parallel economy is now estimated to have reached -6 - 30 percent of GDP and b not captured In the official national accounts.1' in effect, the emergence and past growth of the parallel economy was the result of the government's policy tesponse to the various external crises - the imposition of greater external and internal controls while having a passive exchange rate policy - as well as the philosophical stance supportive of greater reliance on direct rather than indirect measures to achieve economic goals. Tbis policy envkonment was charaterized by (i) official controls - regulating production, instituting an extensive system of licensing, raising Import, sales and excise taxes to prohibitive levels, and attempting to control economic 'sabotage' by statute and (ii) official marketing arrangements - setting adminirteed prices and confining marketing and distribution through single channels. At the same time Tanzania infrastructure was deteriorating, as were the marketing arrangements, thus encouraging producers to seek their own marketing ovatets outside the official systems. Finally, there emerged shortages of basic goods and services - which required that households acquire even basic necessities through informal channels. 1.17 In brief, the Tanzanian economy of the late 1970s and early 1980s had the following features: (i) stagnant and declining output; (ii) passive exchange rate management in the face of large fiscal and external imbalances; (iii) declining exports and reduced import capacity; (iv) continued dependence on traditional exports for foreign exchange; (v) demands on foreign exchange resources for the expansion of government and for investments in the import- substituting manufacturing sector; (vi) quantitative restrictions on all categories of imports, implemented through direct government allocation of foreign exchange, increased government control over external and internal trade and distribution, and de facto rationing of most traded goods; (vii) widespread domestic price controls on traded and non-traded goods; and (viii) a growing parallel market for exports, imports and other rationed goods. 1.18 This was also a time when many early successes in providing basic education and health services began to be eroded. Central goverment expenditure priorities were shifted away from these sectors, and these manpower-intensive sectors suffered as well from the general decline in public sector salaries and productivity. Responsibility for delivering these services began to be shifted more and more to local government, which did not have the financial capacities or other resources required for effective delivery. Social service physical facilities were also hampered by lack of maintenance and the overall deterioration in Tanzania's infrastructure. 1.19 Partial liberalization: the begInning of reform to the present. By the early-to- mid-1980s it was evident that recovery from the economic decline which had set in from 1979 could only come about with changes in economic management and the policy framework affecting economic incentives. During the early years of the 1980s, the government had initiated a number of attempts at policy reform (including small devaluations and producer price increases), but these were not accompanied by a consistent policy enviroment, fell short of the adjustment required, and failed to achieve their objectives. 1.20 The transition to the third regime - the primary focus of this report - began in 1983/84 with the inauguration of the own funds import scheme and of other measures in the 1it m BWhwa, 1989. -7- budget to reduce subsidies and institute greater cost sharing. Tle own funds scheme was considerably widened drring 1984. Aimed at alleviating the severe shortages of goods available within the economy, this critical policy reform eased significandy the import compression of the early 1980s and provided a major impetus for resumption of economic activity. This action was followed in June 1986 when the government launched the Economic Recovery Program (ERP), which is the umbrella program under which the reforms since that time have been undertaken. The ERP had as its primary objectives raising the rate of output growth, reducing inflation and restoring external balance. The main features of the ERP at that time included actions to (i) reduce overvaluation of the exchange rate; (ii) put in place a supportive macroeconomic framework of appropriate fiscal and monetary policies; (iii) improve the incentives for agricultural production; (iv) reform the government's trade policies. With the launching of the ERP, donor assistance (excluding technical assistance) increased significantly from $490 million in 1985 to $ 850 million in 1989, with around $ 400 million of that amount provided in the form of balance of payments assistance to support the process of policy reform and to ease the balance of payments constraint on economic activity. 1.21 The cornerstone of ERP policy change to date has been the adjustment of the exchange rate as this is central to the process of unification of markets and removal of the rationing which had become prevalent in the Tanzanian economy. As can clearly be seen in Graph 1.2, beginning in the late 1970s, the Tanzania shUlling's real exchange ratet' appreciated significantly through 1985. In early 1986 the government began to adjust the nominal exchange rate, and since that time the observed real exchange rate has depreciated significantly: moving from an index of 2.07 in 1985 to 0.33 in 1990 (Graph 1.2), a depreciation of over 80 percent. The extent of adjustment to date can also be gauged by observing the ratio of the parallel to the official exchange rate. The parallel:official ratio reached a peak of 9:1 by the end of 1985 and has dropped to about 1.5: I by end-1990. 1.22 Although government has begun the process of liberalization and reduced some controls over the economy, the parallel economy continues to thrive even under this new regime. While the parallel premium has fbllen from previous levels, it still remains at 50 percent, and thus exchanget rate incentives continue to favor at least to some extent remaining outside the official economy. In addition, continued administrative allocation of foreign exchange, the continuing need for regulatory reform and improvements to the enabling environment with respect to private sector development, continuing inadequate public sector service provision, aid an evident low level of confidence in the ability of government to enforce rules and regulations have encouraged the institutionalization of the parallel economy. Certainly, unifying Tanzania's dual economy will be a gradual process over the medium to longer-term. 1.23 Under this third regime the economy has seen a gradual liberalizadon of economic policies and a resulting economic recovery which arrested and reversed the per capita income declines of previous years. Both GDP per capita and trade volumes began to rebound in 1986 2/u IP fom nominal change fas and aluive price comparisons of a bast of curnencies ropenting Taania's major tmding pner. This calculation does not speak to the ism of an anord exchange mm as it does not take other faton (e.g., stmuiul shifts in the economy, productivity declines, eto.) intoaccount. ebaw isl 1980 - 1. -8 - after reaching their lowest points in 1985. Real GDP growth averaged about 4 percent from 1986 through 1990, with even higher growth evident in the burgeoning infornal sector (which may not even be fully reflected in the official aggregate figures). The most notable source of growth, however, has been the agricultural sector, where overall production increased between 4 and 5 percent in both 1987 and 1988. This has particularly reflected sustained increases in foodgrain production and the production of non-traditional export crops, though also includes improvement in some traditional export crops. Graph 1.2 Real Exchange Rate and Parallel Premium R 1966-1990 0~~~~~~~~~~~~~~~~~~~~~0 a~~~~~~~~~~~~~~~~~~~~ I P E 2.5 500 9 a 1.5 - 300 200 1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 0.5- 9 __ _ _ __ _ _ __ _ _ __-_ __ _ _ _ ___-__ _ _ __ _ _ __ _ _ __ _ _ _ o 1966 1970 1975 1980 1985 1990 ) I Year - Observed RER Parallel premium Rise In iTndOX represents appreciation. Rils in ,,remia: greater divergence betw prrallel and otficial exch rate. B. Performance of the economy since the mid-1980s 1.24 With regard to performance since the initiation of reform, in addition to policy change, the economy has been affected by four favorable txternal shocks, two of which were The nature of the changes in he economy requieS the analya to have an appmpriate storal disagegation. In paticular, ine there was a series of lre devaluations, those past of the economy which sood to benefit (manufactunng and agricultural eports)the sectos producing itenationaly trdable goods- need to be distinguished from the rest of the economy. Given a prgram of substan trmde liberalizaon, those tradable activdit which had benefitted from protection (bradly capured by manufacturing) noed to be distinguished from those which had not (i.e., expost agriculture). The changes in activities which produce output not readily tadable intemationally, namely fooderop agriculture, public admstraion and services ar also import to distinguish. Finally, large changes in both public end private invesment are identified through puehas of capital goods and distinguished between those which a tradable and those which ar nontradable. The lter is captured by constnaction. -9 temporary and two of which are likely to be longer-lasting. First, there was a temporary improvement in terms of trade due to the coffee boom in 1986. In addition, in response to the own-funded imports scheme there appears to have been some repatriation of capital which had previously fled the country. Of a longer-lasting nature has been the drop by two-thirds in the real price of petroleum and products experienced since 1982 - notwithstanding the high oil prices during the latter half of 1990 due to the Gulf crisis. Finally, as a result of the policy reforms, donor aid has increased significantly from around US$300 million per annum (excluding technical assistance) during the early to mid 1980s to over US$800 million each year in the late 1980s (plus additional debt relief). 1.25 The combination of these external shocks and the policy changes implemented since 1984 largely account for the observed changes in economic performance over the past half- decade. As shown by Table 1.2, since 1983 there has been a modest increase in per capita GDP, reversing the rapid decline from 1976 to 1983. The declining trend in GDP from 1976 to 1983 (and the acceleration in the decline itself experienced in the early 19l0s) suggests that in the absence of policy changes the economic stagnation would have continued - and most likely the decline would have acceleratedY Consequently, the subsequent improvement must be seen as even more impressive than the aggregate GDP growth indicates. I4 See for instance, Bevan, et al., 1987. During the eady 1980s farmers rewted to inadequate incentives and shodtges by educing the prduction of expoit crops, which affected the amount of foreign exchango available for impos and which fujther reduced the availability of consumer goods and inputs in ruml ameas. Hence a (downwani) multiplier effec was at play. - 10- TAkLb lb. s Pasonaa of Enomy da ofOtl O ut39540 (395 a 100) 37S 39w 11984 198 l986 t987 low 39o two ODPSI 108.3 100 103.4 106.1 109.3 113.5 318.2 123.4 128.9 GDPper copl 111.0 100 300.6 100.4 100.6 101.6 103.0 104.6 106.4 Expobkl 1380.3 100 104.6 106.3 101.3 105.6 104.3 113.9 .a.z Mn_luft v.baedad &I 133.7 300 102.7 98.7 94.7 98.7 104.0 109.6 116.7 Publicmduselalatlm iw.g 66.1 300 100.2 102.1 91.0 91.5 94.4 n.a. aLL Capil goods: Trad gi 103.6 100 164.3 221.0 200.0 192.9 168.9 a.. A.. Non-Tndedg/ 161.0 100 120.2 109.5 128.4 131.3 137.0 U.N. ns. Nooktauablas: AgIubae(aMLf 91.2 too 104.0 110.3 116.6 121.7 127.2 132.9 140.2 s9vic Etc. EJ 95.0 1oo 103.0 104.6 112.7 116.7 121.5 125.8 133.2 GDP per capit excMliag public admlmadom 119.4 100 101.2 101.3 104.0 105.3 106.9 n.. L.m I Bwewursi of Swtm, unblimed da. k' Fnn FP