Unit Labor Costs, International Competitiveness, and Exports

1

Unit Labor Costs, International Competitiveness, and Exports:

The Case of Senegal[*]

Ahmadou Aly MBAYE

Professeur Agrégé

Faculté des Sciences Economiques

et de Gestion (FASEG)

Université Cheikh Anta Diop de Dakar

BP 16448 - Dakar (Senegal)

Tel : (221) 835 27 26

Fax: (221) 824 43 90

Email:

and

Stephen GOLUB

Professor of Economics

Swarthmore College

Swarthmore PA 19081 (USA)

Tel: (1-610) 328-8103

Fax: (1-610) 328-7352

Email:

Final version, May 2002

To appear in Journal of African Economies, Vol 11, no. 2

Abstract:

Despite some favorable conditions and a number of policy reforms, Senegal’s participation in the global economy remains tenuous. This paper uses a Ricardian framework to study Senegal’s international competitiveness in manufacturing. Wages, productivity, and unit labor costs in Senegal are compared to those of other developing countries. Senegal’s labor productivity has grown much more slowly than in successful emerging economies. The 1994 devaluation of the CFA franc has dramatically improved Senegal’s international competitiveness but further improvements in competitiveness depend on productivity growth given the constraint of the fixed exchange rate. We find a significant effect of relative unit labor costs on exports, particularly of manufactured goods. Sustained export-led growth, however, requires additional structural reforms.

1

Senegal and the Global Economy

In the 1960s, Senegal, South Korea, Malaysia, and Mauritius all had roughly the same level of gross domestic product per capita. Despite some moderate recent growth, Senegal’s level of per capita GDP has stagnated or even declined over the last three decades. During the same period, the four East Asian «miracle» economies’ per capita GDP increased by a factor of about ten. A number of other countries such as Malaysia and Thailand in South-East Asia, Chile in South America, and Mauritius and Tunisia in Africa had impressive growth rates in the last twenty years or so.[1] (Figure 1)

In recent years, a near consensus has emerged on the positive effects of export growth and diversification on economic development[2]. Perhaps most convincingly, the remarkable success of a number of East and South-East Asia countries and a few others have all been at least partly based on integration into the global economy and rapid export growth, particularly of manufactured goods. (Figure 2).

There are a number of channels through which exports can foster growth in developing countries, in addition to the static gains from trade according to comparative advantage. First, in an environment of declining foreign aid, exports provide the foreign currency needed to finance imported inputs. Second, labor-intensive exports can contribute to reducing unemployment and thus poverty. Third, and perhaps even more importantly, exports can be a catalytic agent for development through the discipline imposed by competition in the international market, the economies of scale the world market affords, and the transfer of foreign technology and modern managerial techniques.[3]

Thus, in the last two decades, many developing countries have introduced economic policy reforms aimed at export promotion, although with varying results. In Africa in general, performance has remained quite disappointing (Collier and Gunning 1999, Ndulu and O’Connell 1999). As Collier (1997) argues forcefully, Africa has been unable to take advantage of globalization. Senegal is a case in point: since 1979 various programs of trade liberalization and export promotion have been implemented, with mixed results: a free trade zone which allows exporting firms to benefit from tax breaks; reduction of the fiscal deficit and stabilization of inflation below 5 percent; lower and simplified tariff barriers and elimination of almost all quotas on imports. Following the 1994 fifty percent devaluation of the CFA franc, which has been pegged to the French franc since Senegal’s independence in 1960, the growth rate of Senegal’s exports and output picked up, but they both remain well below the rates observed by the success stories in Asia and elsewhere.

Senegal has some advantages relative to other developing countries: political stability, geographic location propitious for access to the European and American markets, and a work force skilled in traditional crafts, and with a talent for and tradition of trading.[4] There was considerable optimism about Senegal’s prospects in the decades following independence.[5] It is true that Senegal is quite poorly endowed with natural resources, but this can be an additional impetus to industrial development. Sachs and Warner (1997) among others show that a high dependence on natural resources can be detrimental to industrial development and sustained growth. Countries like Taiwan and Mauritius are not well endowed in natural resources either.

This paper is part of a longer-term research project that seeks to identify the sources of Senegal’s weak integration in the global economy. Here we focus on macroeconomic cost competitiveness. In other work, we are examining this problem from a more microeconomic perspective, with case studies of selected industries (Golub and Mbaye 2000).

We begin with an overview of Senegal’s trading pattern and trade policies, followed by a theoretical framework for analysis of international competitiveness. In our empirical work, we will first attempt to assess the absolute productivity and cost of Senegalese labor in relation to other countries, particular the successful emerging economies. We will then use a trade-weighted relative unit labor cost indicator in a time series analysis of Senegalese exports.[6]

II – Overview of Senegal’s International Trade

Senegal’s exports are characterized by slow growth and lack of diversification. This is largely rooted in the policies of import substitution, adopted in the first two decades following Senegal’s independence in 1960. Since 1979, however, a series of reforms, liberalizing trade and promoting exports, have been undertaken in the context of various structural adjustment packages. These reforms have had limited success. The financial and economic recovery plan of 1980-85 and the medium- and long-term structural adjustment program (PAMLT) of 1985-1992 included various measures to liberalize the economy but did not modify the fixed parity of the CFA franc to the French franc, given Senegal’s membership in the West African Franc Zone. Only with the devaluation of the CFA franc in 1994 did export growth pick up. The devaluation was shortly followed in 1994-95 by the most far-reaching structural adjustments to date, with the World Bank PASCO program of trade, labor market, and other reforms. Even after 1994, however, export growth and diversification have been insufficient to fuel sustained growth. The growth rate of export volume jumped to 8.2 percent in 1994-95, much improved over the 2.5 per cent rate in 1960-1979, but then fell back to just 3 percent in 1996-98. In comparison, world export volume grew 8.7 per cent in 1994-95 and 6.7 percent in 1996-98 so most of the slowdown in Senegalese export growth cannot be attributed to the disruptions associated with the Asian crisis.[7]

II- 1- A weak and poorly diversified export sector[8]

Senegal’s most important exports are currently:

--groundnuts and their derivatives (oil, oilcake, and edible peanuts)

--fishing and fish products

--phosphates and their derivatives (fertilizer, phosphoric acid)

--tourism.

These four industries accounted for about 80 percent of exports in the 1990s. Overall growth has been sluggish (Figure 2). Labor-intensive manufactured goods are largely absent despite the abundance of underemployed labor earning subsistence incomes in agriculture and in the urban informal sector. In fact the textile and clothing industries have contracted sharply since the 1970s. Here we briefly summarize some of the issues arising in our case studies of the groundnut, fishing and textile-clothing industries. (Golub and Mbaye 2000)

Groundnuts. From the colonial era until the middle of the 1970s, groundnuts were the mainstay of the Senegalese economy; the sector’s contribution to GDP was about 20 percent, and it accounted for more than 70 percent of employment. Most exports are in the form of unrefined oil and oil cake. A government parastatal, the SONACOS, has until recently controlled all stages of production and marketing. Towards the end of the 1970s, a steady decline set in. Senegal’s world market share of peanut oil exports declined from 23% to 14% between 1961-65 and 1986-1988, while that of Asian countries increased from 8% to 32%. The causes of this weak performance can be classified into two categories: exogenous shocks and government policies. The main exogenous shocks have been the decline of rainfall since the 1970s and the fall in demand for peanut oil in European markets, partly connected to fears about aflotoxin, a carcinogen in peanuts. But government policies seem to have been even more important, notably the inefficiency and corruption of the SONACOS financing and distribution of seed grains, and collection and processing of output. The SONACOS oil processing facilities operate at very low capacity and hence high unit cost, but they have not been consolidated for political reasons. Two attempts to privatize the SONACOS have failed due to the unattractive conditions specified by the government. Nonetheless the role of the private sector, both formal and informal, has expanded at the margin in recent years. Informal traders as well as the firm NOVASEN are purchasing, distributing, and processing a larger share of the crop although the SONACOS still plays a dominant role.

Fishing. The artisanal (informal pirogue) sector is booming but industrial fishing, particularly on-shore processing, is experiencing grave difficulties, notwithstanding Senegal’s coastal region being one of the richest of the world in terms of fish stocks. The problems of the tuna-processing industry are particularly acute and symptomatic of the difficulties of Senegalese industry. There are only three firms of moderate capacity, down from seven in 1960, and even these three firms face chronic problems of excess capacity and have been intermittently closed in recent years. Senegalese canned tuna has steadily lost market share in Europe to East Asian tuna despite exemption from import duties of 24 % that the Asian countries must pay. Senegalese tuna processors have high costs even relative to those in Abidjan, and have accordingly seen a further erosion of market share, as tuna boats operating off West Africa tend to prefer to unload their catch in Abidjan, all else equal. Other large on-shore industrial fish-processing enterprises are also facing severe difficulties. The problems of the fishing industry are numerous: dwindling stocks of some species due to over-fishing and pollution, problems of conforming to international norms of hygiene, insufficient capital investment in boats and processing facilities, confrontational labor relations and poor management in some cases.

Textiles-Clothing. Towards the end of the colonial era and in the decades following independence, Senegal developed a sizable but inefficient import-substituting textile industry. Extremely high protection and pervasive government intervention characterized this industry, as for most manufacturing. The textile industry nearly collapsed in the 1980s under the twin pressures of smuggling and trade liberalization. The formal clothing industry has all but disappeared, with only the booming informal sector remaining. The 1994 devaluation had a short-run positive effect on this sector, but mostly for the relatively capital-intensive sub-sectors (weaving and spinning) rather than the labor-intensive apparel sub-sector. To this date there is little or no foreign outsourcing of clothing production in Senegal by global manufacturers such as occurs in Asia, Latin America, and North Africa. Senegal exports some raw cotton but little else, and the textile industry as a whole incurs a large trade deficit. Exports of clothing are almost nonexistent, while imports of used and new clothes (some of which continue to be smuggled despite the devaluation and trade liberalization) constitute a large part of domestic consumption.

International competition in the clothing industry is fierce. Nonetheless, several studies indicate that Senegal has some key advantages: a decline in labor costs thanks to the devaluation of 1994, a location close to Europe and the USA, highly skilled producers in the informal sector (weavers from the Casamance, tailors who custom make beautiful clothes for relatively well-off local consumers). The possibility of sub-contracting from countries like Morocco where labor costs have risen relative to Senegal, could help jump-start production. Unfortunately, Golub and Mbaye (2000) show that there remain grave institutional impediments to progress: the lack of training of personnel and management, unreliable and expensive infrastructure, especially transport and electricity, lack of access to credit, and costly and cumbersome customs and investment procedures, often associated with corruption.

In each of these industries, the formal sector faces grave difficulties while the informal sector is booming. Despite endowments and location suggesting potential comparative advantage in these industries, Senegal has severe competitiveness problems, particularly vis-a-vis Asian producers. Our interviews as well as other studies show that there are a number of general features of the business environment in Senegal that contribute to low productivity, high unit costs or uncertainty, all of which discourage investment in formal industry: lack of transparency and corruption, infrastructure deficiencies, lack of access to credit, inadequate training, and confrontational labor relations.

It is also important to note that much of Senegal’s exports such as groundnut oil, fish products, and phosphate products are not readily classified as either manufactured goods or primary products. For the most part, they are lightly processed primary products. Certainly, they are mostly not homogeneous primary products for which the law of one price is likely to hold closely. For example, for fresh and processed fish, prices depend on the species, freshness, extent of processing, etc. Product differentiation also characterizes some goods where Senegal has a potential comparative advantage such as clothing and Afro-centric products. Thus, models assuming homogeneous tradable goods are not likely to be appropriate for Senegal.

II-2- Trade Reforms with Meager Results

Senegal has had few direct barriers to exports, with the exception of some export taxes on groundnuts and gold which were eliminated in 1985. Instead, the impediments to exports arose from the general anti-export bias of the import-substitution regime. Weak export performance has continued in spite of a number of reforms instituted since the 1970s, aimed at trade liberalization and export promotion.[9]

Senegal instituted one of the first free trade zones in Africa in 1974 in order to encourage assembly and processing of manufactured goods for export, as well as related service activities. Firms that secured free-trade status benefited from total exemption of corporate income taxes and other direct taxes. Their imports of capital goods and intermediate inputs entered free of duty.

In addition, the tax code was reformed to create a more favorable environment for exports. A number of taxes were eliminated as early as 1979 (including the taxe statistique, the taxe intérieure, and the taxe forfaitaire). With the New Industry Policy of 1986, a uniform customs duty of 15 percent was instituted, and the variable customs duty rates (droit fiscal) were shifted down as follows: d.f. réduit unchanged at 10%, d.f. normal lowered from 40 from 30%, d.f. supérieur lowered from 50 to 35% and d.f. spécial lowered from 75 to 65%. By 1988, the uniform customs duty rate was further reduced to 10 percent and almost all import quotas were eliminated. Nonetheless, the following year, the basic customs duty rate was raised back to 15%, and some products were shifted to a higher droit fiscal rate (taux supérieur) from the reduced rate (taux réduit). Concurrently, preferential exemptions of taxes and import duties were extended to firms outside the free trade zone to increase their competitiveness. In particular, temporary duty-free admission of imports was permitted for firms processing imported inputs, as long as 80 percent of their production is re-exported.

On the institutional level, as early as 1981 the government created l’Agence Sénégalaise d’Assurance et de Crédit à l’exportation (ASACE), which insures Senegalese exports against political and commercial risks. In addition, the Centre Sénégalais du Commerce Extérieur (CICES) was established in 1986, to help exporting firms participate in commercial fairs and missions abroad. Finally an export subsidy was instituted, equal to 10% of the value of exports from 1980 to 1983, rising to 15% of export value in 1983-86, and starting in 1986, 25% of value added. This subsidy was eliminated in 1991, however, when it became clear that it was not significantly contributing to export diversification, despite the ever-rising fiscal burden it entailed.

In 1994, the CFA franc was devalued 50 percent and a number of accompanying measures to liberalize labor and product were enacted.[10] The extent of implementation of these structural reforms was erratic, however. (Berg, 1997)

Recently, in January 1999, the common external tariff (TEC) of the West African Economic and Monetary Union (UEMOA), has been put in place. The TEC has considerably reduced and simplified the system of import taxation of the member countries, including Senegal. Prior to the TEC Senegal’s tariffs and other import duties could cumulate to about 70%. Now, the ceiling is in principle 22% (20 percent customs duties, 1% statistical tax and 1% prélèvement communautaire de solidarité. This higher rate is limited to final consumer goods; for socially essential goods, the tax rate is zero, for necessities, it is 5%, and for intermediate inputs it is 10%. Nonetheless the application of the TEC has been accompanied by offsetting measures such as the taxe dégressive de protection (TDP) and the taxe conjonturelle à l’exportation (TCI). The TDP only concerns industrial and agro-industrial products, and is supposed to cushion temporarily (for four years) the impact of reduced protection. The TDP has a “reduced rate” of 10 percent for those products suffering a cut in the effective rate of protection of 25 to 50%, and a higher 20% rate for those products having even larger reduced effective protection. The TCI is applied in cases of foreign dumping or when the UEMOA commission judges that there has been an important decline in the world price of the product in question. Also, it seems that the timbre fiscal and other small taxes are still applied.