"For Sierra Leone to be integrated into the world economy or be well positioned on the threshold of economic growth, exchange rate regime or price stability can no longer be conveniently ignored. Nations that did not take-off with globalization must now seize the opportunity to do so quickly or face inconceivable decline in national welfare as time progresses."
By Christopher Warburton, Ph.D.Econ.
Forms of money have evolved over the years and the changing forms have adapted to changing economic conditions and challenges. Today when we talk about “salary”, near-money, or things of “pecuniary” value, we are also alluding to concepts of ancient origin which were embedded in the barter system. Roman soldiers were paid with salt, sal (hence the word “salary”) and some ancient people preferred cattle, pecus, to salt (hence the word “pecuniary”).
To make money generally acceptable or attractive, the ancient Egyptians experimented with metal rings as early as 2500BC. At some point in time merchants began stamping gold bars with their imprints and the weights of the bars. The idea of imprints gained wide appeal, and when the Romans issued the silver denarius circa 150 BC, they were often stamped with the images of gods and goddesses, pictures of sacred objects or portraits of rulers. Today such imprints could best be associated with the idea of monetary nationalism. A modern controversy in some countries is whether or not the imprints or pictures are praise worthy or deserving of national or sacred recognition.
The modern monetary system has an intrinsic relation to international trade and the acceptability or viability of national currencies. Theoretical forms of contemporary money were popularized around the Mediterranean Sea where trading countries sought mutually acceptable forms of payments. In the 600s BC the government of the kingdom of Lydia in what is now western Turkey started to issue small kidney-bean-shaped pieces of money made of electrum (a mixture of gold and silver). Of course gold and silver have become veritable forms of money (commodity/multi-purpose, rather than fiat money).
Contemporary Monetary Challenges in Sierra Leone.
The general acceptability attribute of money is timeless and integral to the quality of any national currency. It is not just an ancient concept, and today the idea of having a uniquely Sierra Leonean international currency is seriously endangered and beyond redemption. There are obvious reasons for this predicament which is not only peculiar to Sierra Leone but most African countries for that matter. Why is it that the value or acceptability of the leone could not be elevated to that of the dollar, yen, euro, French franc, or British pound?
The lack of international monetary power could be closely linked to: the linking or pegging of the African currencies to American and European currencies at the dawn of independence; the loss of central bank autonomy over monetary policy shortly thereafter; loss of foreign reserves; unfavorable terms of trade; adverse foreign exchange regimes; seigniorage (the ability of governments to print money to finance purchases or make profit from printing money); the smallness of the Sierra Leonean economy; and extraordinary corruption which infected the economic fabric of the nation since the late 1960s. When the ultra modern phase of globalization started, most African economies were caught flat-footed and highly unprepared to take advantage of its welfare-enhancing virtue.
Between 1961 and today, the world economy has changed considerably with significant implications for a small [open] economy like Sierra Leone. In the words of Thomas Friedman and co The World is Flat. This is invariably their way of characterizing “globalization” which could be seen from a general economic perspective as economic integration or liberalization that is inclusive of geopolitical arrangements. How can the economies of the world be integrated? What role could geography or regional proximity play? What should be the uniting currency [if one is needed]? The craving for regional integration continues to be a response to some of these questions and globalization. The craving is becoming relentless and it is undoubtedly one of the indelible hallmarks of irreversible globalization. The most recent and advanced form of such an integration is the European Union (EU) which is an economic union or optimum currency area (OCA). A similar OCA could be found in the former French speaking colonies of Africa, colonies franÇaise d’Afrique (CFA).
The Americas have a free trade area, the North American Free Trade Agreement (NAFTA), and some are already courting the idea of a NAFTA evolution into an economic union. Some West African nations are belatedly now crafting their own economic union feverishly—the West African Monetary Zone (WAMZ) with ECOWAS as a spring board. It is hoped that a common currency, eco, would salvage the continued loss of trading position and monetary power in the international monetary system.
Who Needs an Optimum Currency Area (OCA)?
The theory of OCA dates back to the 1960s and is generally attributed to the Nobel aureate, Robert Mundell. It simply means that economic efficiency could be maximized if an entire [geographic] region shares a common currency.
The writing of Mundell coincided with a period when economic forces were coalescing around a second tidal wave of globalization between 1945 and 1980. This was a time when trade liberalization was influenced by a special type of specialization (manufacturing for the rich, and agriculture for the colonized or formerly colonized countries). It was also the Schumpeterian age of Creative Destruction when the creation of new products and new methods of production were supposed to destroy monopoly firms dedicated to old technology and products. During this phase most developing or underdeveloped economies did not participate in the growth of global manufacturing and services trade.
The latest wave of globalization witnessed the emergence of some developing economies like China and India making inroads into the global market system while poverty was on the rise in other areas of the world. The poverty stricken areas, including Sierra Leone, failed to make that breakthrough into the global market system. This global market system is now occasionally defined as the era of outsourcing, insourcing, offshoring and unbelievable technological progress for which the old ways of doing business have irretrievable lost their innocence and demoded forms of production or economic transactions are no longer efficient. National currencies of the poverty stricken African countries have become undesirable not only beyond their national frontiers, but also endogenously as de facto dollarization makes it difficult to have a perspective of money in circulation. A stylized fact is that economic integration promises to assuage the escalating fears of hyperinflation and precipitous devaluation.
Regional integration as a manifestation of globalization works well under certain structural preconditions and warnings. If the goal is clearly to take advantage of globalization to foster the much needed and overdue economic investment and growth, why not dollarize a small [open] economy if a West African Monetary Zone (WAMZ) is elusive and precarious? Sometime ago I expressed reservation about the willingness of political leaders to do so. But if the love with economic union is sincere, there seems to be a propensity to retreat from monetary nationalism and seigniorage; suggesting that political leaders are beginning to realize that the time is ripe for a more credible monetary policy.
The Pitfalls of OCA.
Viable economic unions such as the US, EU, and [to some extent] the CFA zone have benefited from integration because of hard work and propitious preconditions that have worked in their favor. These preconditions may variously include all or some of the following: (i) a somewhat reconcilable culture or civilization; (ii) adequate safety net to deal with endogenous or exogenous asymmetric macroeconomic shocks/disturbances associated with articles of trade or terms of trade, inflation, interest rates; natural disasters, and political instability; (iii) high factor mobility; (iv) low debt to gross domestic product (GDP) ratio; (v) a well functioning independent supranational institution to co-ordinate regional monetary policy (regional central bank); and (vi) a sustainable foreign exchange regime.
How is the eco coming along for Sierra Leone?
The Heads of State of Ghana, Guinea, Liberia, Nigeria, the Gambia, and Sierra Leone met in 2000 to sign the Accra Declaration. It was in many ways a demonstration of resolve to establish a WAMZ. The institutional frame work for a West African Central Bank (WACB) and a West African Monetary Institute (WAMI) was also laid out. The bank is supposed to have supranational authority for regional monetary policy and WAMI is mandated, inter alia, to monitor convergence benchmarks.
It is far from surprising that there are “teething” problems, but these problems may well portend looming and lasting problems beyond incipience or oblique implementation. The severest of these problems are asymmetric shocks when unemployment and business conditions fluctuate in the member countries differently.
The belated awareness of the need for economic union, and its probable anachronism, may well result in unfair criticisms. The Europeans started theirs in 1957 with the Treaty of Rome, and it was not until 2002 that the euro became a distinct reality, although it is still having problems that may be residual. The CFA franc in Africa was established in the 1940s with the help of the French who were originally more interested in a policy of assimilation in Africa.
Political and economic data on WAMZ countries show that with the exception of debt, corruption, and GDP (not national income per head), less convergence and more divergence is evident and imminent. Pertinent long-run issues are already defining and shaping divergence. These include: national deficit, which might have a lot to do with fiscal discipline or institutional fitness (corruption); revenue; and the general price level or inflation.
Variations in terms of trade (the ratio of export price index to import price index) and factor mobility (immigration), are also serious challenges to convergence because of less synchronization of economic performance. In the late 1990s WAMZ countries ambitiously set convergence goals: a ceiling on central bank finance of budget deficits (10% of previous year’s tax revenue); maintenance of single digit inflation; and a restriction of the budget deficit to GDP ratio of no more than 3%.
With the exception of debt, GDP, and corruption, for which convergence is taking place, sensitive economic indicators indicate divergence. There are large differences/variances among the WAMZ members. For example, the standard deviations (SDs) for the key economic indicators that could cause asymmetric shocks (exports, imports, inflation, and revenue) are considerably high in 2006. Using World Bank data, I calculate SDs for both exports and imports of goods and services as a percentage of GDP to be above 500.
Data on unemployment for the WAMZ countries are generally unreliable or unavailable. Yet unemployment is a key macroeconomic variable that will be impacted by disturbances. Will unemployed Sierra Leoneans freely migrate from Sierra Leone to Nigeria, Guinea, or Liberia in search of jobs if there is a severe recession in Sierra Leone that is not regionally pervasive? Will they be welcomed with open arms? I am not so sure. Evidence shows that political instability and the nervousness associated with contagious unrest have encouraged neighboring countries to rapidly close their borders when there is turmoil in Sierra Leone.
Will economic adversity result in a similar response? Will the effects of a deficit in a large-member economy be exported to other members? In the absence of a monetary tool, will the Sierra Leone government have enough social safety net e.g. transfer payments or unemployment compensation to tide a recession? These questions are just the type of issues to be addressed with the sacrifice of monetary autonomy.
In 2006 the annual percentage of inflation in Sierra Leone, using the GDP deflator (nominal to real GDP ratio), is 1151; in Guinea, 239; Gambia, 393; Liberia, 3995; Nigeria, 800 and Ghana, 1249. With the exception of Guinea, the present value of debt is considerably high for the rest of the members. In current US dollars, the debt of Sierra Leone is 7.9 billion; Liberia, 7.4; Gambia, 7.8; Ghana, 4.7; Guinea, 2.8; and Nigeria 5.8. Unlike the rest of the members, Guinea has the lowest debt-to-GDP ratio (0.44). It is ironic, and probably unfortunate that unlike the other members, Sierra Leone and Liberia spent a huge percentage of GDP on their military in 2006.
In Sierra Leone, 32% of GDP was spent on the military; Liberia spent 96% of GDP; Nigeria, 16%; Guinea, 18%; Gambia, 14%; and Ghana, 12%. The Sierra Leonean and Liberian data may partly be attributed to war and post war reconstruction. There is however a tendency for African countries to spend a huge percentage of their GDP on military and war equipments during peace time so that non-democratic regimes can stay in power indefinitely; a disposition which is very much unlike their wealthier counterparts with democratic and relatively stable political institutions.
Using the nonparametric Chi Square test of World Bank data between 2001 and 2005, I evaluate the relationship between: time and changes in exports; time and changes in imports; and time and inflation. My estimates indicate that there has been no significant relationship between time and changes in exports, or time and changes in imports for the WAMZ members.
That is evidence of a statistical steady state for key economic variables in the past five years. However, there has been a substantial and significant relationship between time and change in annual inflation [at the 5% level of significance and 20 degrees of freedom]. The Chi Square test statistic for the annual change in inflation is 158.68; a significantly phenomenal amount relative to the critical value of 31.4. This means that contrary to the ambitious WAMZ agenda in 2000, inflation has significantly increased for the WAMZ countries over time. It is doubtful or unclear whether or not this trend is likely to be altered in the near future. A commitment to credible price stability can never be more urgent.
As a political proxy, corruption indicates convergence. There is consequently convergence on the most undesirable variable i.e. convergence for the wrong reason. According to the 2006 Transparency International results, corruption in Sierra Leone and Nigeria converged to a 2.2 index on a scale of 1 to 10, where 1 is exceedingly corrupt and 10 is least corrupt. Liberia scored 2.2 in 2005 (since 2006 score is unavailable). Guinea scored 1.9 and the scores for Gambia and Ghana were 2.5 and 3.2 respectively. If monetary policy is subsequently transferred to a regional central bank, assuming the bank is autonomous and supranational, then member nations will be left with autonomous fiscal policy. A successful synthesis of corruption and fiscal policy is highly destabilizing. A large economy that can successfully synthesize fiscal policy and corruption will definitely wreak a destabilizing havoc on economic integration. This scenario is unlikely in a dollarized economy.
De facto Dollarization: To Dollarize or not to Dollarize?
Dollarization occurs when residents of a foreign country use the US dollar or an international currency alongside or instead of the local currency. Partial dollarization occurs when foreigners hold dollar denominated bank deposits to protect them against hyperinflation of their domestic currencies. Most Sierra Leoneans will rather hold international currencies at home or in questionable places for expeditious access when inflation becomes intolerable. Full dollarization will mean the complete elimination of the leone and its replacement with the US dollar or an international currency.
Full dollarization is not common because of the symbolism some countries attach to national currency. This symbolism is becoming increasingly controversial. The EU has accommodated some measure of national symbolism and such a sentiment could be tolerated by an economic union in the making. Yet for Africa, the idea of seigniorage to finance run away deficits or earn profits via an inflation tax might be a significant deterrent to dollarizing local economies or implementing an economic union.
As far as Sierra Leone is concerned, some of the major drawbacks of failed monetary policy are already evident and cannot readily be made worse. De facto dollarization, seigniorage, hyperinflation, and the elusive underground economy make it impractical to conduct an effective monetary policy. Compounding these drawbacks is the central bank’s loss of monetary autonomy, which became more pronounced in the 1980s when the bank was reconstituted into an efficient infrastructure to finance government debts and the Ponzi schemes of notorious tycoons.
It might just be a worthwhile idea to outsource monetary policy to much more resourceful architects in order to restore credibility, attract foreign investment, and attain stable prices with relatively lower interest rate. The ultimate aim of monetary policy is in fact stable prices and reasonably low interest rate. A dollarized Sierra Leonean economy could easily tie the interest and inflation rates in Sierra Leone to that of the US [if the US dollar is preferred]. Low interest rate might not be such a bad idea for investment and debt repayments after all.
These are not qualities that are immediately guaranteed by a Third World economic union which has to peg or float its currency anyway and may well succumb to adverse devaluations. For example, the CFA Franc suffered major devaluations in 1960 and 1994 in the face of major external shocks and poor growth performance. The sacrifice of monetary autonomy makes fiscal challenge under an economic union or a dollarized economy largely unchanged. The success of outsourced monetary policy is therefore highly contingent on principled or disciplined fiscal policy and a well functioning banking system without a national central bank.
In this golden age of globalization, in lieu of commodity money (preferably gold), foreign businesses, foreigners, and even local residents will willingly accept dollars or international currencies either to conduct business or hedge against hyperinflation at an annual rate of over 1000%. Nations in financial crisis equally pursue dollars or international currencies avidly to restore confidence and price stability. Development is no longer exogenous to the forces of globalization of which an acceptable international currency is a critical component. It is probably apparent by now that corruption and adverse foreign exchange arrangements or regimes have not augured well for the Sierra Leonean economy. It is high noon for a vigorous implementation of policies leading to price stability if growth is desirable for a small [open] economy on the fringe of globalization.
The Daunting Homework of Sequencing
Social planners must therefore take up the daunting dollarization homework on what to do in order to successfully restore monetary and financial credibility to the nation. Dollarization is sensible for a small economy with hyperinflation but it might not need to be an automatic panacea. Policy sequencing must therefore be given serious thought. The literature on exchange rate and financial reforms is both eclectic and controversial. Economists like to find the silver bullet which is not always easily obtainable but hidden somewhere. I will however synthesize the most pertinent and sensible ones which are vital to obtaining exchange rate reform and financial sanity:
(i)The national debt is clearly a problem. The present value of debt (largely the result of unwise spending, trade adversities, corruption, and seigniorage) is more than twice the GDP of the country. Bringing the national debt down to acceptable level of GDP has to be a priority. The IMF reports that over the past 30 years, 60 percent of sovereign debt crises occurred when debt levels in the year preceding the crisis had been higher than 39 percent of GDP. Moreover, a 50 percent probability of being in a debt crisis is associated with a debt-to-GDP ratio of 80 percent. The debt-to-GDP ratio for Sierra Leone in 2006 was over 200%. There is need to negotiate long-term structural debt. High levels of debt pose servicing and default problems in the absence of seigniorage. The government will need to secure social consensus on spending and raise revenue through negotiations of credit lines so that it will not have to fund a new crisis.
(ii) No lender of last resort. Because monetary autonomy is sacrificed or will be sacrificed, depository institutions will not find a lender of last resort at home. Stringent bank supervision and adequate risk management strategies are indispensable precursors, although they may well be concomitants. A weak banking structure imposes negative externalities in the form of liquidity problems, stifled production, and inadequate investment-hence unemployment. Effective laws for equal credit opportunities and sensible regulation of domestic and international bank mergers must be in place. International mergers have the potential of increasing market capitalization, banking assets, and access to credit, but economists are normally suspicious of monopolies (there must be well defined conditions for mergers).
(iii) Labor market and wage flexibility. “Fine-tuning” is the language economists use
when monetary and fiscal policies are available to a nation to address downturns
or inflationary situations. In situations of recessions expansionary monetary
policy (lower interest rate or increased money supply/credit expansion) could
be utilized [so could expansionary fiscal policy, tax cuts or more government
spending]. With economic integration or dollarization, conventional monetary
policy is unavailable. Fiscal policy is then the limited instrument available.
Anecdotal analyses have not clearly indicated whether dollarization will speed up
or slow down labor market reform; but the impact of dollarization on the labor
market cannot be disregarded by any social planner.
A safety net must clearly be articulated to address the probable unemployment situation. Laws affecting trade
union activity, wage indexation, and employment insurance must be well formulated in response to careful and well thought out simulations.
For Sierra Leone to be integrated into the world economy or be well positioned on the threshold of economic growth, exchange rate regime or price stability can no longer be conveniently ignored. Nations that did not take-off with globalization must now seize the opportunity to do so quickly or face inconceivable decline in national welfare as time progresses.
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