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“The only thing necessary for these diseases to the triumph is for good people and governments to do nothing.”

    


The Impact on Economic Growth in Africa of Rising Costs and Labor Productivity Losses Associated with HIV/AIDS

Malcolm F. McPherson

Deborah A. Hoover

Donald R. Snodgrass

CAER II Discussion Paper No. 79

August 2000

http://www.cid.harvard.edu/

The views and interpretations in these papers are those of the authors and should not be attributed to the Agency for International Development, the Harvard Institute for International Development, or CAER II subcontractors. We are grateful to Clive Gray of Harvard University and Orest Koropecky of USAID for helpful comments on our earlier drafts. We thank Seth Kirschenbaum for editorial assistance.

For information contact:
CAER II Project Office
Harvard Institute for International Development
14 Story Street
Cambridge, MA 02138
USA
Tel: (617) 495-9776
Fax: (617) 496-9951
Email:
caer@ksg.harvard.edu

Executive Summary

Conventional models explaining the impact of HIV/AIDS on economic growth typically present projections based on scenarios computed 'with AIDS' and 'without AIDS.' When the disease was in its early stages, that approach was a reasonable "first cut." However, with HIV/AIDS now an epidemic in many African countries, such comparisons are no longer valid. The impact of the disease cannot be treated as an 'exogenous' influence that can be 'tacked on' to models derived on the presumption that the work force is HIV-free. HIV/AIDS has become an 'endogenous' influence on most African countries that has adversely affected their potential for growth and development. In some cases, such as Zambia, Zimbabwe, and the region covering the former Zaire, the spread of HIV/AIDS may have already undermined their ability to recover economically.

This paper analyzes the impact of HIV/AIDS using a model of economic retrogression. Derived from reversing direction in an endogenous growth framework, the model provides a fresh perspective of the impact of HIV/AIDS on economic growth. Many analysts have now recognized that their best estimates of the effect of the epidemic have been systematically understated. What they have failed to fully account for is that the HIV/AIDS epidemic has been having a non-linear effect on economic growth. Our model incorporates this element by including the feedback to the rate of economic growth of declining savings and investment due to rising costs and falling productivity associated with HIV/AIDS.

The paper concludes with recommendations designed to assist the most seriously affected countries to begin looking beyond the HIV/AIDS epidemic. First, governments and donor agencies working in Africa should devise programs and responses that deal constructively with individuals who are HIV-positive. The challenge is to understand how large segments of the population, who know they will die prematurely, can be trained, managed, and motivated in ways that maintain (or, at least, do not undermine) productivity. Second, donor agencies and African governments need to devise broad-based programs of technical assistance specifically to stabilize the operations of the key social and economic organizations. Third, governments should work with employers to ensure that efforts to minimize the private costs of HIV/AIDS do not generate unacceptable social costs. Fourth, African governments need to rid themselves of all activities that do not contribute to the immediate tasks of promoting economic growth and development. The spread of HIV/AIDS has progressively undercut the capacity of African states. This requires a sharp scaling back of government activities. For their part, donors should ensure that the measures they promote, such as "comprehensive development frameworks," "poverty reduction and growth strategies," and "country strategies," do not place unsustainable demands on over-stretched and (often) dwindling state capacity. Finally, as a general matter, no African country can hope to recover economically (even if HIV/AIDS has not yet become a major problem) if the pattern of economic mismanagement and start-stop approach to economic reform continues. Such mismanagement and halting reform wastes resources and further undermines the capacity for growth and development.

Bios

Malcolm F. McPherson, formerly a Fellow of the Harvard Institute for International Development, is now a research fellow at the Belfer Center for Science and International Affairs, John F. Kennedy School of Government, Harvard University. He is senior advisor on the Equity and Growth through Economic Research (EAGER) Project and principal investigator for the study "Restarting and Sustaining Growth and Development in Africa." He holds a Ph.D. in Economics from Harvard University.

Deborah A. Hoover is an independent consultant who served as the Training Officer and Administrator on HIID's Macroeconomic Technical Assistance Project in the Ministry of Finance in Zambia. Ms. Hoover has undertaken extensive research on the problems of training under conditions of economic and social stress and of devising methods to motivate individuals who work on their own account and in large organizations.

Donald R. Snodgrass in an Institute Fellow emeritus of the Harvard Institute for International Development. Trained as a labor economist, he holds a Ph.D. from Yale University. He is the author of several books and numerous articles. With Malcolm Gillis, Dwight Perkins and Michael Roemer, he is the author of Economics of Development (Norton), which is currently being revised for its fifth edition.

Introduction

At a public lecture at Harvard University in 1999, Dr. Peter Piot, Director of UNAIDS, made an interesting comment. He noted that despite having worked on HIV/AIDS for most of the last two decades, he continues to be surprised by the inaccuracy of predictions about the course of the epidemic, including those that he, himself, has made.1 Dr. Piot singled out the extent to which the economic and social impacts of the disease have been understated.

Our paper builds on this point. We argue that, with respect to the economic impact of HIV/AIDS in Sub-Saharan Africa (henceforth Africa), the dynamics of the disease have been widely misperceived. Important economic thresholds have been crossed as the epidemic has intensified. There are at least three reasons for these misperceptions.

One. The conceptual model commonly used to trace the dynamic effects of HIV/AIDS on economic growth is seriously flawed. The most common projection models are linear in growth rates.2 Emerging evidence suggests that they should be curvilinear with growth rates declining at an increasing rate as the epidemic intensifies.3

Two. The main official responses to the epidemic so far have been focused on prevention and cure. Generally overlooked have been the tasks of training, managing, motivating, and otherwise constructively engaging the large numbers of people who are HIV-positive and whose productive lives are being prematurely shortened.4 Because of this bias, maintaining labor productivity has become increasingly difficult. We argue that without a special effort to raise (or maintain) the productivity of those who are HIV-positive, economic growth cannot be maintained let alone increased.

Three. The full implications for economic recovery and subsequent growth and development of the loss of skills and erosion of institutions across Africa remain largely unrecognized.5 With the exception of Botswana (where the prevalence of HIV/AIDS is high) and Mauritius (where it is not) all other African countries (including South Africa) have been engaged in efforts to reverse years of economic stagnation and decline. Though some analysts had claimed that Africa was "on the move,"6 economic reform was eluding most African countries even before HIV/AIDS began decimating their work forces and eroding the performance of their major organizations. Indeed, a case can be made that the cumulative losses due to HIV/AIDS are preventing recovery in some countries. For countries, such as Zambia, Zimbabwe, Uganda, and Malawi where a high proportion of the adult population is HIV-positive,7 barriers to reform and future growth may already exist that are not fully understood.8

The paper is organized as follows. Section 2 provides background material on the issues being examined. Section 3 sketches a conceptual approach for examining the dynamic impact of HIV/AIDS on economic growth. The model is derived from theoretical work on economic retrogression that involves "running in reverse" an endogenous growth model. The spread of HIV/AIDS reduces national savings and investment. The ensuing (endogenous) reduction in the growth of productive capacity systematically undermines economic growth and development. Section 4 indicates how such a model might be tested. The final section has concluding comments.

The paper has three annexes. Annex A, by Deborah Hoover, is a review of the literature of work place responses to HIV/AIDS in Southern Africa. Annex B, by Donald Snodgrass, examines the influence of HIV/AIDS on labor productivity. Annex C, by Malcolm McPherson and Tzvetana Rakovski, reports econometric evidence using Zambian data on the non-linear growth effect due to the intensification for the HIV/AIDS epidemic. As such it offers a test of the theoretical approach developed in the text.

Background to the Study

The literature on HIV/AIDS is truly enormous.9 Two aspects of that literature concern us here, namely the economic impact of HIV/AIDS in Africa10 and the implications of HIV/AIDS for public policy.11

Analyses of the costs of HIV/AIDS have focused primarily on the impact on the labor force, the family, the education system, and national economies. A major area of emphasis has been the rising costs due to the progressive debilitation and loss of workers. These studies highlight other negative effects including: the impact on organizations (public and private) associated with the added cost of training replacement workers, higher wage bills as additional staff are retained to compensate for absenteeism and worker debility, the costs incurred when work schedules are disrupted, the increase in employer provided health and medical costs, and the unanticipated depletion of pension and insurance funds.12 The early literature suggested that these costs were small. More recent contributions are showing that these costs are rising rapidly. The implication is that both the rate of economic growth and the prospects for future growth have been compromised.13

Since the losses from HIV/AIDS are cumulative and data on the effects of the impact of the epidemic are unreliable (see Annex A), the overall impact of HIV/AIDS on the labor force has been subject to considerable uncertainty.14 As noted in the discussion below, an important source of that uncertainty has arisen because analysts have tended to ignore critical aspects of the underlying dynamics when calculating the costs of HIV/AIDS. A major focus in the literature has been work place prevention. Far less attention has been given to the types of behavioral, social, and structural changes needed within the work place to prevent productivity and growth from falling.15

This has occurred despite important efforts to identify and advertise "best practices" for dealing with HIV/AIDS.16 As Annex A shows, such practices have not been widely used. The reality is that, for many organizations and enterprises (and one might argue most of the countries of Southern Africa), the epidemic has elicited few constructive responses let alone the adoption of "best practices." Indeed, a major gap in the research (and practice) has been how to deal with a large and growing number of workers who know (or suspect) that their lives are being dramatically foreshortened.

Under conditions of high AIDS prevalence, as in Africa, conventional approaches to training, managing, organizing, and motivating workers need to be fundamentally re-thought.17 There is little to suggest that HIV-positive trainees or workers should respond (or can be expected to respond) in the same way as those with a "normal" life expectancy. Moreover, the prospect of large losses of skilled workers from HIV/AIDS makes the value of long-term degree-based training problematic. One question that has not been answered is whether donor agencies are prepared to continue supporting long-term training in the face of rising attrition rates?

For employers, a key issue is the type of (cost-effective) incentives they can devise to induce HIV-positive workers to maintain their productivity. Faced with high and rising incidence of HIV/AIDS, no one should be surprised that employers (alone and collectively) are taking measures (often draconian) to contain their costs.18

One of the purposes of the review in Annex A is to show how organizations and businesses have sought to maintain productivity (and profitability) when significant numbers of workers will become debilitated and die. Such measures include the "externalization" of costs, the use of expatriate labor, and forced retirement of infected workers. These measures often reflect attempts by employers to shift the costs of HIV/AIDS onto the infected worker's family or onto society at large. Such practices will undoubtedly continue. Nonetheless, it should be recognized that employers are constrained in their ability to shift these costs. Some employers can succeed in the short-run. But, as the HIV/AIDS epidemic intensifies, the macroeconomic effects of these rising costs will feedback to affect the employers' output, sales, taxes, or access to social services.19

Cost shifting is a defensive strategy. What has not been widely considered is how to take a more constructive approach. Such an approach will emerge as managers begin to grapple with the following questions. How they can continue managing their operations effectively and efficiently when the incidence of HIV/AIDS is high and rising? This matter becomes increasingly complicated when the managers themselves are HIV-positive or suspect that they are. What institutional or organizational changes (to goals, workflow, or operational procedures) will enable productivity to be maintained? What actions will help counteract the lack of motivation, low morale, and counterproductive behavior (pilfering, absenteeism, asset stripping) that progressively encumbers an organization as more staff become debilitated and die? Finally, what measures can be taken now so that, when countries eventually begin to move beyond the HIV/AIDS epidemic, the damage to personal and social relations and economic growth is not irreparable?

The above questions have a common theme. They relate to the organizational, social, and economic dynamics of situations where a large (and increasing) number of productive lives are being dramatically shortened. This, we argue, is the context in which the impact of HIV/AIDS on economic growth (and development) has to be understood.

That context is missing from most analyses of the effect of HIV/AIDS on economic growth. The most common approach has been for analysts to provide a model of what they believe is the present structure of an economy. Then, based on their best estimates of trends in the incidence of HIV/AIDS, they derive alternative growth paths reflecting situations 'with' and 'without' HIV/AIDS. Kambou, Devarajan and Over, in one of the earliest examples of this approach, studied the impact of HIV/AIDS in Cameroon.20 Using a Computable General Equilibrium (CGE) model, they derived two sets of projections. The first was a base case that abstracted from the effects of HIV/AIDS. The second allows for those effects. They did that by reducing the supply of labor by an estimate of what the losses to HIV/AIDS were expected to be over the projection period.

The results derived by Kambou, Devarajan and Over (and those of other studies cited below) underscore Dr. Piot's observation noted earlier. Subsequent evidence has shown that their projections grossly understated the effect of the epidemic on Cameroon and, by extension, other African countries.

There are several reasons for this, but two stand out. First, Kambou et al. could not have foreseen that new, virulent sub-types of the disease would emerge.21 Second, using a CGE model to derive the alternative scenarios, 'with' and 'without' AIDS, is inappropriate. As the HIV/AIDS epidemic has intensified, economies have experienced substantial structural change.22 This does not get adequately reflected in CGE models (or other fixed coefficient models) upon which the 'with AIDS' scenario was based.23 Kambou et al. (and other analysts who have followed their lead) did not modify their basic model to reflect these changes.24

When their research was undertaken (1990), such an approach could be defended as a "rough first cut." At that time, the spread of HIV/AIDS was just beginning to accelerate. What cannot be defended, however, was the continued use of such comparative scenarios. This point, however, has not been widely appreciated. For example, the Sunday Times in South Africa reported that in mid-1997 the impact of the HIV/AIDS epidemic in 2005 would be to reduce overall growth rates of the economy by 1 percent per annum.25 This projection has startling implications. It means that, with more than 20 percent of the adult population infected with HIV and likely to die within five years, the impact on South Africa's economic growth is expected to be incidental. Clearly, something is amiss.

Projection errors like these would be significantly less consequential if officials and the general public across Africa were more forthcoming about the extent of the epidemic. Indeed, with very few exceptions, the official and private response has been denial.26 Events, however, may be changing that. During the last week of May 2000, viewers of. Cable News Network around the world saw Thabo Mbeki, President of South Africa, at the time on a visit to the United States, attempting to justify his reluctance to face the reality of HIV/AIDS in his country.27 Whether Mbeki has come to grips with the problems South Africa is facing or not, others have. The theme of the Durban conference in July 2000 was "breaking the silence." Mbeki gave a keynote speech. His predecessor, Nelson Mandela, whose tenure was notable for its absence of any serious effort to confront the issue, has at last noted that history will judge harshly those who sit idly by. History so far has shown that until mid-2000, both Mandela and Mbeki ducked the issue. In the interim, South Africa (and Southern Africa in general) has borne a terrible cost. Millions of people have died and millions more will die because of their leaders' silence and/or ambivalence.28 Their inaction or, at best, lukewarm response has killed large numbers of their own citizens.29

Unfortunately, there is nothing new about denial and limited recollections of (traumatic) events. History has many examples of societies and groups that exhibit such behavior. Wars and organized mayhem have been particularly fertile periods for generating selective social amnesia. Yet, in most cases, the denial relates to events. By contrast, the HIV epidemic is a process. Rather than dulling its impact, denial allows the epidemic to intensify.30

Scholars and practitioners dealing with HIV/AIDS on a day-to-day basis understand the folly of denial. Yet, there are many reasons why it has persisted. For example, as noted in Annex A, governments were reluctant to openly deal with HIV/AIDS because officials argued it would adversely affect tourism and foreign investment. Others have boxed themselves in by years of silence or cant. African journalists, for example, who failed to write candidly about the disease, and leaders who avoided the issue, face a dilemma. President Chiluba of Zambia provides an example. Though the conference was held in Lusaka, Chiluba failed to attend the "International Conference on AIDS and Sexually Transmitted Diseases in Africa" in September 1999. From his inauguration as president until the time of that conference, more than 500,000 Zambian children have become AIDS orphans.31 Attending the conference risked advertising his lack of attention to the toll HIV/AIDS has had and was having on the citizens whose welfare he had sworn to protect. Though his absence from the conference received little attention in Zambia (where observers understood it was consistent with his past behavior), the foreign press took note.32

Donor agencies, too, have been caught in a web of denial. Although they generously support work by health ministries on prevention and treatment of HIV/AIDS, most donor agencies have failed to scale back their "development" agendas in line with the erosion of skills and institutional capacity in Africa as a result of HIV/AIDS. For example, both the World Bank and the International Monetary Fund have proceeded with their sector investment programs, comprehensive development frameworks, poverty reduction and growth strategies, as though the capacities of African governments remained unimpaired.33 This directly contradicts the message the World Bank conveyed in its 1999 study Confronting AIDS. That study made referred to the World Development Report of 1997 where it was suggested that developing countries should ensure their development programs were consistent with "State capacity."34

African countries themselves have compounded these problems. Though they lack the relevant capacity to implement the donor-driven agendas, their key policy makers continue to accede to the various World Bank, IMF (and other donor) "initiatives." The (predictable) result has been that most donor-supported adjustment programs are pre-programmed to fail.35

The above examples could be multiplied as the material in Annex A shows. The implication is that our basic conceptual models for dealing with the impact of HIV/AIDS are flawed. Understanding the social and behavioral dimensions of the HIV/AIDS requires that we correct these flaws. The model presented below is one option for doing that.

A Conceptual Framework

A Model of Retrogression

The basic framework adopted here for thinking about the dynamic impact of HIV/AIDS on economic growth draws on models of economic retrogression. These models were developed in the early 1990s36 to examine the effects of rising levels of corruption and inefficiency on the growth paths of developing countries. The objective was to explain why a large number of countries in Africa had been exhibiting "patterns of growth" that did not conform to the (so-called) "normal" time paths derived by Kuznets and Chenery and his colleagues.37 Economic regression became so pronounced in some countries (such as Zambia, Tanzania, and Senegal) that the relative contribution to GDP of agriculture had risen over time.38

Few of the plausible explanations for retrogression of this nature were 'exogenous.' (Drought "might" be seen as an exception.)39 To capture these effects, the principal features of a regressing economy were modeled by reversing the direction of an endogenous growth model. Corruption, measured as an increase in the unlawful "diversion" of public resources, reduced the investible surplus. As corruption intensified, public confidence declined. There was an increase in capital flight (and other defensive actions by asset holders). This led to further reductions in investment. That, in turn, reduced the growth rate of income and lowered savings and investment even further. The model also incorporated a "backlash" feature that hinged on the reactions of groups most seriously affected by resource diversion. The same effect is produced in outside agents, e.g., donor organizations began forcing the governments they were supporting to observe principles of 'good governance.' This helped boost investor confidence, raising the rate of investment and helping spur income growth. Such a diversion/backlash mechanism generated a wide range of time paths for retrogression and recovery.

The above framework can be readily adapted for examining the dynamic impact of HIV/AIDS on economic growth. The rising prevalence of HIV/AIDS lowers worker efficiency, raises costs, and reduces individual savings and firms' profits. Individuals who are HIV-positive increase their consumption, in part to combat the effects of the disease and, in part, because the prospect of a premature death raises the opportunity cost of time.40 These changes lower the supply of investible resources, at both the individual and national levels, and reduce the efficiency with which the existing stock of productive assets is used. Those effects, in turn, lower the rate of growth of per capita incomes, setting off a further cycle of declining savings and investment.

One could imagine that such a process might have a "floor" that provides the basis for economic recovery if measures were devised to prevent the overall efficiency of the labor force from declining. Several mechanisms might suffice. One would be to lower the rate of infection of workers through reductions in the costs of combating HIV/AIDS.41 Another would be to manage, train, and motivate workers who are HIV-positive in ways that maintain (and even improve) their productivity.42 A third would be to use external resources (foreign aid and technical assistance) to compensate for the decline in the local supply of investible resources and loss of domestic skills.

A major problem with these measures is that, to be effective, they all require additional resources. This places many African countries, where HIV/AIDS is widespread, in a bind. To prevent further retrogression due to HIV/AIDS, they need additional resources. The resources, however, are not available because saving and investment have fallen as a result of the HIV/AIDS epidemic.

HIV/AIDS and Retrogression

The above description broadly summarizes our conceptual framework linking the effects of the spread of HIV/AIDS to economic growth. When an individual becomes HIV-positive, his/her productivity declines, medical expenses and other costs rise, and economic behavior changes (if for no other reason than economic horizons shorten).

The principal building blocks of this framework include:

    • The theory of endogenous growth
    • Falling rates of savings and investment
    • Rising opportunity costs of time for those who are HIV-positive
    • Declining labor productivity
    • Progressive loss of skills and the increasing erosion of the effectiveness of key (social and economic) organizations

Each of these points is discussed in turn.

Endogenous Growth: Theories of endogenous growth derive their inspiration from a number of sources.43 The principal idea is that increasing returns to scale (resulting largely from the accumulation of knowledge) boosts the rates of savings and investment. The higher rate of investment leads to an acceleration of the rate of economic growth. There are several "knowledge-based" explanations that are used to support this theory. These include "learning-by-doing", 44 "induced innovation", 45 the effects of rising population, 46 and "learning-by-trading."47 In many African countries, particularly those that have had poor economic performance over extended periods, there is also the prospect of "learning-by-reforming," most notably during the transition period.48

Whether the resulting growth path involves a "permanent" acceleration of the rate of growth or cycles in the rate of growth (e.g., as in the so-called "new economy") is still subject to debate. The essence of endogenous growth is that there are "spread" effects that raise efficiency more generally in the economy. Adam Smith captured this idea when he described the advantages of the 'division of labor' that was earlier stimulated by the 'expansion of the market.'49 The efficiencies resulting from specialization and the division of labor lowered costs thereby further expanding the market. In more recent times, Gunnar Myrdal described this as a process of "cumulative causation."50 The basic idea is that existing economic activities benefit from the fact that improving efficiency in other enterprises help to lower their costs. The overall effect is for all enterprises whose costs are falling to take action to expand their output. This sets off another round of spillover effects.

These insights help explain why endogenous growth is such a useful framework for understanding the micro- and macro-economic effects of HIV/AIDS. The reduction in savings and loss of efficiency associated with the spread of the disease is akin to "running Adam Smith in reverse." As an increasing number of workers become debilitated and drop out of the labor force, many of the advantages of specialization and the division of labor are lost. Moreover, the loss of labor is a direct reduction of the nation's productive capacity.

Falling Savings and Investment: The basic problem with attempts to tease out an independent influence for the impact of HIV/AIDS is that the economic performance of many African countries had deteriorated even before HIV/AIDS began to spread.51 For most African countries, the decline began with the oil and food "shocks" of the mid-1970s. Because of limited internal adjustment and frequent policy reversals, African countries were already heavily in debt and in precarious financial circumstances by the early 1980s. The HIV/AIDS epidemic compounded their problems. The difficulties were evident in adverse trends in key macroeconomic data. The following tables show that for most countries real income was declining, rates of investment and savings were falling, foreign aid flows rose rapidly, and there was a sharp increase in the debt burden. The data in the table covers the period 1970 to 1998 for SSA excluding South Africa and Nigeria.52

The data show that average real per capita income was lower in the 1990s than in the 1970s. Savings rates have declined over time. Investment has fallen by less than savings but only because of a major increase in foreign aid and foreign borrowing. The size and duration of these external flows has been unprecedented. No region of the world has received such extensive support for so long. Yet, even these large and persistent resource flows have been unable to maintain investment at levels that will raise national income on a sustained basis.53 The severity of the economic stress has compromised recovery efforts. The spread of HIV/AIDS has further aggravated the situation.

In this regard, it is useful to recall Harry Johnson's characterization of economic development as a "generalized process of capital accumulation" where capital is broadly defined to include physical and human capital as well as institutions and organizations.54

Sub-Saharan Africa: Selected Macroeconomic Indicators, 1970-1998

Year

GDP per capita (1995 USD)

Gross Dom. Invest. (share of GDP) (%)

Gross Dom. Savings (share of GDP) (%)

Net ODA (all donors)(bill. USD)

Net ODA (all donors)share of GDP (%)

Total External Debt (ratio to GDP (%))

1970

612.0

17.3

21.1

1.1

1.6

..

1971

634.0

18.0

20.2

1.2

1.8

14.7

1972

623.3

16.8

22.2

1.3

1.7

15.0

1973

642.2

19.1

25.2

1.6

1.7

15.2

1974

681.8

21.0

28.1

2.4

1.9

14.5

1975

670.3

22.6

23.4

3.3

2.3

15.6

1976

669.5

23.6

25.5

3.1

1.9

16.2

1977

649.6

20.6

26.4

3.6

2.1

21.1

1978

641.0

20.4

24.1

4.9

2.6

24.8

1979

644.7

18.4

25.5

6.3

2.7

24.0

avg. 70s

646.8

19.8

24.2

2.9

2.0

17.9 *

1980

660.9

20.2

28.5

7.4

2.5

22.9

1981

671.7

22.8

23.2

7.3

2.5

26.4

1982

648.0

19.8

21.1

7.5

2.8

31.5

1983

617.3

16.2

20.5

7.3

2.9

37.1

1984

623.0

15.5

21.0

7.6

3.3

41.4

1985

601.6

13.8

21.2

8.5

4.1

54.2

1986

595.4

14.6

20.9

10.5

4.6

56.2

1987

591.8

14.6

20.5

12.1

4.8

58.6

1988

599.2

16.5

19.2

13.7

5.2

56.9

1989

599.0

15.8

19.4

14.5

5.4

58.3

avg. 80s

620.8

17.0

21.5

9.6

3.8

44.4

1990

587.2

14.2

17.9

17.3

5.8

59.7

1991

573.5

17.0

18.2

17.0

5.6

60.6

1992

550.2

14.7

13.0

18.3

5.8

60.0

1993

542.6

16.2

14.5

16.8

5.5

65.5

1994

541.5

17.5

16.5

18.2

6.3

78.1

1995

548.5

18.5

16.2

17.9

5.6

73.6

1996

558.8

17.7

17.7

15.7

4.7

69.5

1997

561.9

17.4

16.4

14.2

4.1

63.6

1998

558.2

17.8

14.8

..

..

54.5

avg. 90s

558.0

16.8

16.1

16.9 *

5.4 *

65.0

Notes: * - Average for the years with observations

Source: World Bank Africa 2000 CD-ROM Database

 

Sub-Saharan Africa excl. South Africa and Nigeria: Selected Macroeconomic Indicators, 1970-1998

Year

GDP per capita (1995 USD)

Gross Dom. Invest. (share of GDP) (%)

Gross Dom. Savings (share of GDP) (%)

Net ODA (all donors)(bill. USD)

Net ODA (all donors)share of GDP (%)

Total External Debt (ratio to GDP (%))

1970

334.6

15.0

24.9

0.9

3.4

..

1971

344.7

15.7

22.3

1.1

3.6

25.3

1972

347.6

16.1

23.7

1.2

3.7

25.9

1973

349.5

16.9

25.2

1.5

3.8

26.6

1974

363.5

19.4

26.9

2.4

4.9

28.1

1975

362.6

20.2

23.0

3.2

5.6

29.8

1976

372.3

19.9

25.5

3.1

4.8

32.1

1977

370.0

19.5

24.5

3.6

5.0

38.4

1978

367.1

19.1

22.1

4.9

6.0

42.6

1979

366.2

17.6

20.5

6.3

6.6

42.7

avg. 70s

357.8

17.9

23.9

2.8

4.7

32.4 *

1980

357.4

18.1

20.4

7.4

6.5

45.4

1981

362.0

18.8

18.6

7.3

6.3

50.7

1982

359.8

17.7

19.4

7.5

6.7

57.4

1983

353.4

15.3

19.2

7.2

6.9

64.0

1984

348.7

14.2

20.7

7.5

6.8

67.2

1985

346.9

14.7

20.8

8.5

7.3

78.7

1986

349.4

15.2

20.6

10.4

7.7

75.8

1987

347.0

15.4

19.2

12.0

8.4

82.6

1988

349.2

16.7

16.5

13.6

9.1

80.5

1989

348.3

15.3

15.9

14.2

9.5

84.4

avg. 80s

352.2

16.1

19.1

9.6

7.5

68.7

1990

341.5

16.0

15.0

17.0

11.0

91.7

1991

336.4

20.1

16.6

16.7

10.8

96.7

1992

322.7

15.7

7.0

18.0

12.5

109.2

1993

316.3

17.3

10.1

16.3

11.4

120.8

1994

314.1

19.3

14.3

17.7

14.3

135.4

1995

322.6

19.3

12.6

17.3

12.5

126.0

1996

330.9

20.2

13.3

15.1

10.0

113.5

1997

335.5

19.6

14.4

13.5

8.6

105.4

1998

338.3

19.3

13.3

..

..

..

avg. 90s

328.7

18.5

13.0

16.5 *

11.4 *

112.4 *

Notes: * - Average for the years with observations

Source: World Bank Africa 2000 CD-ROM Database

Much of what African countries have experienced over the last two decades, as a result of economic decline and the spread of HIV/AIDS, can be seen as a generalized process where capital (as defined above) has been decumulating. Since income is the return on wealth and wealth is the capitalized value of income, the reduction in the stock of (all types of) capital has led to lower rates of income growth (with declines in numerous instances), lower savings and (despite large amounts of foreign aid) lower investment.

Another factor that has endogenously lowered savings and investment has been the general loss of confidence among (local and foreign) investors in Africa. The process whereby that has happened can be understood in terms of the theories of irreversibility and options values. Investment is defined as an action that involves a certain present outlay in the expectation of a future return. All investment is characterized by some sunk costs, or "irreversibility." Those costs may be reflected in the purchase of specialized equipment, the time taken to conceive of and develop the investment project, or the opportunity cost of alternative investments passed over once the decision to pursue a particular course of action is taken. These costs, by definition, cannot be retrieved should the investment be liquidated. Investors expect, however, that future returns from the investment will amortize these sunk costs.

The prospect of irreversible costs adds to the uncertainty. It also raises the question of the value of alternative options. These "option values" exist because all investors have alternatives, the most obvious of which is to do nothing, i.e., decide to wait. But, like all investment, "waiting" has an opportunity cost as well. When there is growing uncertainty, as has been the case in African countries where growth has been so low, the costs of waiting are more likely to be small relative to the potential costs associated with irreversibility. For many potential investors in African countries, especially those with connections to international financial markets, the alternative activities may be lucrative, low risk and highly attractive.

Taken together, the notions of irreversibility and options values are crucial considerations when both locals and foreigners contemplate investing in African countries. Investors are more likely to wait when they have information indicating that the spread of HIV/AIDS will affect adversely the cost structure of any investment they are contemplating. Under these circumstances, waiting provides time to reassess and re-evaluate their options. Having a low-risk, secure (foreign) alternative investment reduces the urgency of committing their resources.55 The outcome has been devastating in terms of stimulating new activity across Africa. As the perceived costs of dealing with the spread of HIV/AIDS rises, the rate of investment tends to decline. This has reinforced the decline in the supply of investible resources, already under pressure through falling productivity due to the spread of HIV/AIDS.

Rising Opportunity Cost of Time: One microeconomic mechanism that has reinforced the decline in savings has been the diminished incentive for those who are HIV-positive to save. Although many people who are HIV-positive also have lower incomes from which to save, especially as they become increasingly debilitated, the two effects need to be analyzed separately. The prospect of a premature death raises the opportunity cost of time. There is now a wealth of research, dating back to Irving Fisher, tracing the systematic changes that occur in the ratio of consumption to saving as patterns of time preference change.56 For risk averse individuals, the standard result is that time preference is inversely proportional to the length of the decision horizon. The relevant decision horizon for people with HIV/AIDS shortens dramatically. As noted in Annex B, it is normally five to seven years from the diagnosis of HIV to the onset of AIDS. Death comes within one or two years after that.

A similar response can be derived from the 'life-cycle' model of savings.57 The underlying theory recognizes that there is a systematic shift in the relationship between a worker's earning potential and the pattern of family formation over his/her life cycle. Early in a person's working life, income streams and resource demands are rising. With the expectation of a "normal" life span of work, the person has the capacity to finance his/her consumption and asset accumulation goals based on the expectation of higher income flows later in his/her productive life. The spread of HIV/AIDS, however, has sharply reduced what individuals can "normally expect" from their (truncated) life span of earnings. Once an individual is HIV-positive, his/her consumption rises while at the same time his/her potential future earnings stream is cut. Thus, when viewed in terms of the 'life-cycle' model, we would expect to see a major reduction in individual savings. To the extent that the individual has accumulated wealth during his/her working life, there will be dissaving.58

Much the same result can be derived from the notion of 'overlapping generations.' The typical approach is to assume two generations - one generation produces, the other consumes. (The effect is the same as a continuous two-part 'life-cycle'.) In this formulation, accumulation and growth occurs because the output (or income) produced by the generation of producers exceeds the output absorbed (or expenditure) of the generation of consumers. With the spread of HIV/AIDS, this balance between production and consumption shifts in ways that reduce this inter-generational surplus, thereby reducing accumulation. This effect is reinforced as the dependency ratio (the ratio of workers to persons under 15 years of age) shifts. A major feature of the HIV/AIDS epidemic has been the sharp rise in the number of orphans.59 The implication is that the extent to which the generations overlap has undergone a serious, systematic, and adverse change. The net outcome is to reduce the capacity of economies with a high prevalence of HIV/AIDS to save and invest, and ultimately to accumulate and grow.

Declining Labor Productivity: Factors that reduce the rate of investment lower labor productivity by reducing the level and/or rate of growth of physical capital with which labor is combined to generate output and income. From the usual conditions attached to production functions (positive productivity of all factors, diminishing marginal productivity of individual factors), a decline in capital per worker reduces output per worker (all other things being equal). Further reductions in productivity occur when workers are demoralized and distracted.

Apart from those who are in complete denial, individuals with HIV recognize that they face a premature death and a shortened decision horizon. Under normal circumstances, individuals facing rising opportunity costs of time would invest in labor saving capital and technology. This option is often unachievable for those who are HIV-positive due to higher costs they incur for (formal or traditional) medical services. Thus, while the spread of HIV/AIDS induces the need for higher rates of investment to help maintain worker productivity, it erodes the means by which such investment can be financed.

If finance could be arranged (for example, through the efficient use of foreign assistance), the strategic use of new technology would allow countries to compensate for the loss of labor due to HIV/AIDS. The obvious drawback to such a strategy is that it takes resources to acquire new technologies and skilled personnel to operate them. Though a drawback, this should not be an insurmountable problem, particularly if attention is given to devising goal-oriented practical training.60

A further element reducing labor productivity is the reduction in real effective demand associated with the decline in real per capita income. As already noted, real incomes across Africa were declining well before the onset of the HIV/AIDS epidemic.61 Adding HIV/AIDS to the equation has reinforced the decline. This has occurred through a mechanism described by Adam Smith over two centuries ago. But, while Smith described the benefits (to output, productivity, and growth) of expanding the "extent of the market," the circumstances in Africa have been equivalent to running the mechanism he described in reverse. The decline in real effective demand raises the unit costs of all domestic activities. For African countries where infrastructure is poorly developed, one obvious change is an increase in transport and distribution costs as a proportion of total costs. The relevance of this point becomes increasingly evident when one distinguishes, as T.W. Schultz did, between the economic and the physical supplies of land.62 The latter is the land base of a country or region. The former is the land area that, for given technology and market conditions, yields a positive net rent. Declining real effective demand reduces the net rent from all economic activities and by extension reduces the productivity of all factors including the labor that contributes to these activities. The outcome is contraction in the economic supply of land. Furthermore, since land is an important component of wealth in African countries, the declining economic supply of land reduces the value of wealth. This leads to a further contraction in real effective demand, further lowering the productivity of associated factors of production.

Other factors contribute to the decline in labor productivity. The theory of efficiency wages is based on the recognition that, because of fixed costs of employment (hiring, training, settling-in), firms will have an incentive to pay above-market wages in order to keep their employees. A further aspect of the theory is that firms will pay workers above-market wages because of the direct link between wages and worker productivity.63 Annex A reviews what employers have been doing in Southern Africa through training and reorganization of work schedules to maintain productivity. Annex B explains the incentives employers have to providing training.64

In these matters, one can readily imagine that both these processes work in reverse as the HIV/AIDS epidemic intensifies. Because of increasing debility and absenteeism, the marginal value product of workers who are HIV-positive is less than the wage being paid by the employer. Faced with this situation, firms have an incentive to reduce employment and/or take steps to reduce labor costs. Doing this, however, reduces the incomes of all their employees whether they are HIV-positive or not.65 To the extent that the efficiency theory of wages holds, overall efficiency declines.

The severity of the economic decline in Africa, however, has resulted in some practices that tend to contradict the efficiency theory of wages. There is mounting evidence that