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How Should Uganda Grow? Faculty Research Working Paper Series

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How Should Uganda Grow? Faculty Research Working Paper Series How Should Uganda Grow? Faculty Research Working Paper Series Ricardo Hausmann Harvard Kennedy School and Center for International Development (CID), Harvard University Brad Cunningham CID, Harvard University John Matovu CID, Harvard University Rosie Osire CID, Harvard University Kelly Wyett CID, Harvard University February 2014 RWP14-004 Visit the HKS Faculty Research Working Paper Series at: http://web.hks.harvard.edu/publications The views expressed in the HKS Faculty Research Working Paper Series are those of the author(s) and do not necessarily reflect those of the John F. Kennedy School of Government or of Harvard University. Faculty Research Working Papers have not undergone formal review and approval. Such papers are included in this series to elicit feedback and to encourage debate on important public policy challenges. Copyright belongs to the author(s). Papers may be downloaded for personal use only. www.hks.harvard.edu How should Uganda grow? Ricardo Hausmann, Brad Cunningham, John Matovu, Rosie Osire and Kelly Wyett CID Working Paper No. 275 January 2014 Copyright 2014 Hausmann, Ricardo; Cunningham, Brad; Matovu, John; Osire, Rosie; Wyett, Kelly; and the President and Fellows of Harvard College Working Papers Center for International Development at Harvard University CONTENTS ABSTRACT.................................................................................................................................... 3 1. INTRODUCTION ................................................................................................................. 4 GROWTH STORY .......................................................................................................................... 4 GROWTH CHALLENGES ............................................................................................................... 4 2. BACKGROUND ON ECONOMIC COMPLEXITY AND THE PRODUCT SPACE 10 ECONOMIC COMPLEXITY ........................................................................................................... 10 THE PRODUCT SPACE ................................................................................................................ 12 3. THE ECONOMIC COMPLEXITY AND DIVERSITY OF UGANDA ........................ 16 4. AVENUES FOR DIVERSIFICATION............................................................................. 19 EFFICIENCY FRONTIER ............................................................................................................... 19 STRATEGIES ............................................................................................................................... 21 5. ISSUES AND POLICY PRESCRIPTIONS ..................................................................... 25 CURRENTLY IDENTIFIED CONSTRAINTS .................................................................................... 25 INSTITUTIONAL WEAKNESSES FOR IDENTIFYING AND ADDRESSING CONSTRAINTS ................ 26 A NEW APPROACH TO INDUSTRIAL POLICY .............................................................................. 27 PRINCIPLES FOR ENGAGING IN INDUSTRIAL POLICY ................................................................. 30 OIL ON THE HORIZON, A POTENTIAL RESOURCE CURSE ........................................................... 30 POLICIES FOR PREVENTING A RESOURCE CURSE ...................................................................... 32 6. FINAL REMARKS ............................................................................................................. 33 REFERENCES ............................................................................................................................ 35 TECHNICAL APPENDIX I: OIL REVENUE MANAGEMENT RULE .............................. 37 TECHNICAL APPENDIX II: ECONOMIC COMPLEXITY, DISTANCE, OPPORTUNITY VALUE AND OPPORTUNITY GAIN ...................................................................................... 38 MEASURING ECONOMIC COMPLEXITY ...................................................................................... 38 DISTANCE, OPPORTUNITY VALUE AND OPPORTUNITY GAIN ................................................... 39 ----------------------------------------------------------------------------------------------------------- This working paper is an output from a joint project with the Effective State and Inclusive Development Research Centre which is funded by the UK Aid from the UK Department for International Development (DFID) for the benefit of developing countries. However, the views expressed and information contained in this paper are not necessarily those of, or endorsed by, DFID, which can accept no responsibility for such views or information or for any reliance placed on them. 2 ABSTRACT Income per capita in Uganda has doubled in the last 20 years. This remarkable performance has been buoyed by significant aid flows and large external imbalances. Economic growth has been concentrated in non-tradable activities leading to growing external imbalances and a growing gap between rural and urban incomes. Future growth will depend on achieving sufficient export dynamism. In addition, growth faces a number of other challenges: low urbanization rate, rapid rural population growth and high dependency ratios. However, both the dependency ratio and fertility rates have begun to decline recently. Rural areas are also severely overcrowded with low-productivity subsistence agriculture as a pervasive form of production. Commercial agriculture has great possibilities to increase output, but as the sector improves its access to capital, inputs and technology it will shed jobs rather than create them. These challenges combined tell us that future growth in Uganda will require a rapid rate of export growth and economic diversification. The country faces the prospect of an oil boom of uncertain size and timing. It could represent an important stepping stone to achieve external sustainability, expanded income and infrastructure and a greater internal market. However, as with all oil booms, the challenges include avoiding the Dutch disease, managing the inevitable volatility in oil incomes and avoiding inefficient specialization in oil. Policies that set targets for the non-oil deficit could help manage some of these effects, but a conscious strategy to diversify would still be needed. The best strategy is therefore to use the additional oil revenue and accompanying investments to promote a diversification strategy that is sustainable. To determine how to encourage such a transformation, we draw on a new line of research that demonstrates how development seldom implies producing more of the same. Instead, as countries grow, they tend to move into new industries, while they also increase productivity in existing sectors. In this report, we analyze what those new industries might be for Uganda. To do so, we first look to those products which balance the desire to increase the diversification and complexity of production, while not over-stretching existing capabilities. These include mostly agricultural inputs, such as agrochemicals and food processing. In addition, Uganda should concurrently develop more complex industries, such as construction materials, that are reasonably within reach of current capabilities and will be in great demand in the context of an oil boom. Here, the fact that Uganda is landlocked and faces high import costs will provide natural protection to the expanding demand in Uganda and neighboring countries. We conclude with a discussion of the government policies that will support Uganda in developing new tradable industries. 3 1. INTRODUCTION Growth Story Income per capita in Uganda has doubled Figure 1: GDP per capita in the last 20 years (Figure 1). Much of this growth was a rebound to past levels of economic activity and the resumption of trade following two decades of extreme political instability and an asset-destroying civil war. Some was due to large-scale donor-financed rehabilitation and some can be attributed to the increase in international coffee prices in the early 1990s. Source: WDI During this period, Uganda also followed a comprehensive stabilization, rehabilitation and reform program. Rehabilitation allowed rural people to profitably work their land and open up new land for cultivation, and it allowed businesses to re-open their operations. Market liberalization allowed farmers and firms to make better choices on how much of what to produce, and with which inputs. Privatization removed inefficient state provision of products and services (World Bank, 2007). These reforms accelerated, and then sustained, Uganda’s growth. Indeed, most post- conflict rebounds typically run their course within six years (Collier and Hoeffler, 2001). Also, most growth episodes, however started, tend to expire within eight years or so, because they run-up against some new binding constraints (Hausmann et al, 2005). In contrast, Uganda’s growth spurt is still running, for more than twice as long as would be regarded as average. More recently growth has decelerated owing to various internal and external factors like the recent global recession. Growth Challenges Despite Uganda’s remarkable economic growth over the last few decades, continued growth will need to address challenges from the restructuring of economic activity. High but declining dependency ratio - Uganda has one of the highest dependency ratios (ratio of non-working age population to working age population) in the world (Figure 2). The dependency ratio increased during
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