Copyright (c) 2012 Morgan D

Aid and Reforms
Has donor financial support to Kenya given the donor community the leverage to strongly influence the shaping of Kenya's economic and social policies? Certainly Kenya has received massive amounts of aid over a sustained period of time--more than US$15 billion between 1970 and 1996. This substantial flow of financial and technical assistance has given donors leverage, but much less than the aggregate numbers might suggest. One important reason is that the amount of money that the donors disburse, through grants and loans, is greater than the amount of money that the government actually receives. If aid flows into the country outside the government budget, or the government has less control over the use of the funds provided to it, the government is presumably less influenced by aid in these cases.

However, as noted above, these agreements were not always implemented. Sometimes the probability of successful implementation was low from the outset. Other times the lenders or donors may have aligned themselves with well-intentioned technocrats who wished to achieve the results contracted for but lacked the political support to do so. It is our view, therefore, that donor aid can have an influence on the form of agreement reached and on the agreed timetable for implementation, but whether implementation is carried out depends in the end much more on domestic political and economic factors than on donor money . If aid has had only limited impact on the implementation of reforms, is it possible that a large volume of aid could make it easier for a government to ride out a crisis without undertaking needed reforms? It is probable that the heavy infusion of budget support Kenya received during the 1980s helped the government to finance the budgetary cost of an overstaffed civil service and inefficient public enterprises, thus enabling the government to defer reforms in these areas until the 1990s. Finally, can the threat or actuality of an aid cut-off induce a government to restart a reform effort that has stalled or gone into reverse? In such circumstances the pressure of debt obligations on past ODA or commercial loans would presumably give added leverage to the donor/creditor community to induce a return to the reform program.

The Investment Equation
Government investment and imports are negatively related to private investment while aid loans and the 1974 shift dummy have a significant positive correlation with private investment. These results suggest that government investment crowds out private investment. Some possible reasons for this include the fact that it is likely that public investment competes for available resources with private sector, or could be producing output that substitutes for rather than complements private investment. In addition, there is a possibility that deficit financing, which has been a common feature of Kenya's fiscal management since the mid 1970s, leads to crowding out of private investment via its pressure on interest rates. This is consistent with the finding that aid loans have a negative association with income but a positive association with private investment (as they relax the deficit financing constraint).

The negative correlation between imports and private investment is somewhat surprising because one would expect the opposite effect. A possible explanation for this is that certain components of imports could be competing with domestic production. Excessive protection of domestic industries for nearly three decades of independence created uncompetitive industries and therefore when foreign trade was liberalised, most of the domestic firms were ill prepared for the ensuing external competition. It is also possible that imports of consumables are increasing which could be growth-inhibiting.

Foreign aid loans are positively related to private investment. Because aid loans go to the government, it can be argued that these loans finance government expenditures that have a direct beneficial effect on private investment, such as transport and communication systems and other infrastructure, but do not require domestic financing (through domestic borrowing or taxes). The negative correlation between public and private investment suggests that it is the (domestic) financing of public investment that has a crowding-out effect. Foreign resources ease the government budget constraint and reduce the need for government to borrow from the domestic credit market, in turn releasing funds to the private sector. Similarly, reduction of government domestic borrowing due to availability of external aid alleviates pressure on domestic interest rates.

A surprising finding comes from the significant positive relationship between private investment and the long term effect of the shift dummy. A possible interpretation of the positive effect of the shift dummy is that the share of private investment in output was lower before the oil shock and higher after the shock. It can be argued that in 1973/4 prices of crude oil quadrupled thereby creating excess liquidity in oil exporting countries which in turn made it possible for government and private firms to borrow cheaply from these countries. From this viewpoint, it is possible that after the initial shock, private investment rose because cheap credit was available from the oil producing counties. Another conjecture is that given that Kenya supplies most of the East and Central African region with imported oil, which it refines and then re-exports to surrounding countries, the country benefited from higher oil prices on account of these re-exports.

Policy Implications

Private investment has been a consistently strong determinant of growth both in the short- and long- run. The implication here is that in order to stimulate and sustain economic growth in Kenya, policy makers need to pay closer attention to factors that determine private investment. Government investment has also exhibited strong positive effect on growth. Nonetheless, it can be made more effective by re-directing it towards economic infrastructure. Furthermore, the issue of efficiency needs to be considered to ensure public investment is made more productive. The policy recommendation therefore is for the government to improve the productivity of its investment so as to generate positive returns and enhance its complementary role to private sector. It should also institute measures that stimulate and support private investment such as mobilization of domestic savings and creation of a stable macroeconomic environment.

Foreign aid in the form of loans can play a vital role in promoting growth directly or indirectly through private investment. It can be made even more productive if used to finance productive activities such as export promotion, infrastructure development, and domestic resource mobilization. This means that Kenya needs to have concerted efforts in improving foreign direct investments by for example making it easier for a foreign investor to trade in Kenya. Kenya could also diversify in the area of international trade and target new partners like China who need to feed its 1.3 billion populations and have only 7% arable land. Regional integration will help open borders for more business opportunities for Kenyans and East Africans alike. The government should also start looking for bond markets in new areas like the Middle East or China who we can engage as partners and not as donors to support our private investment.