3082 Report No. 3082a-MAl VOL. 1 Malawi Growth and Structural Change A Basic Economic Report February 8, 1982 Eastern Africa Regional Office FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit = Kwacha (K) Exchange Rate US$ = K 1 K US$1 1965 1.4000 0.7143 1966 1.4000 0.7143 1967 1.3808 0.7242 1968 1.2000 0.8'333 1969 1.2000 0.8333 1970 1.2000 0.8333- 1971 1.2035 0.8309 1972 1.2396 0.8067 1973 1.2206 0.8193 1974 1.1888 0.8412 1975 1.1577 0.8638 1976 1.0953 0.9130 1977 1.1075 0.9029 1978 1.1851 0.8437 1979 1.2241 0.8169 1980 1.2314 0.8121 1981 (first 1.1743 0.8516 quarter) ABBREVIATIONS ADD - Agricultural Development Division ADMARC - Agricultural Development and Marketing Corporation ARD - Agricultural Research Department BIN - Brussels Nomenclattre BUE - lBlantyre .ater Board CCDC - Capitai City Devxelopment Corporation CDC - Coiur.onwcalth Developmient Corporation DAs - Duvelopn:ent Areas DDC - District Development Committees DEG - Deutsche Gesellschaft fur Wirtscaftliche ZusTnmaenarbeit DEVPOL - Statemnent of Development Policies, 1971-S0 EPAs - Ecological Planning Areas ESCOM - Electricity Supply Conmission of Malawi FMO - Nederlandse Financierings-Maatschappij voor Ontwikkelings- landen N.V. INDEBANK - Industrial Development Bank JCE - Junior Certificat Examination KFCTA - Kasungu Flue-Cured Tobacco Authority KRDP - Karonga Rural Development Project LLDP - Lilo.ngwe Lanid Development Project LRDP - Lilongwe Rural Development Project MANR - Ministry of Agriculture and Natural Resoucces MBC - Malawi Broadcasting Corpcration MBS - Malavi Book Service Y-CC - Malawi Correspondence College NtC - Mother-Child llealth Facilities ICE - Malawi Certificate of Education 1!C - Malawi Development Corporation 1!2C - Malawi Housing Corporation MR - Malawi Railvays MTIT - Ministry of Trade, Industry and Tourism MU - Management Unit NRDM - Nationial Rural Development Program IqSSA - National Sample Survey of Agriculture REC - Recurrent Expenditure Coefficient STA - Sipallholder Tea Authority SVADP - Shire Valley Agricultural Development Project IA. - Technical Assistants THA - Tradition2l Housing Areas TVS - Training and Visit Systeia IJLV - Ultra Low Volume (Sprayers) - aorld Development Report FISCAL YEAR April 1 - Mareh 30 FOR OFFICIAL USE ONLY Authorship This report is based on the findings of a mission that visited Malawi in June-July 1979. It has also benefited from two subsequent missions in August-September 1980 and January 1981 to appraise a struc- tural adjustment loan to the Government of Malawi. Members of the June-July 1979 mission were: William A. McCleary (Mission Chief) Gilbert Brown (Basic Needs) Peter Hansen (Public Finance) Kazuko Hashimoto (General Economist, Agriculture) Stephen Heyneman (Education) Richard LaCroix (Consultant, Agro-industry) Ben Lehbert (Industrial Economist) Katherine Sierra (Labor Economist) Robert Wesselman (Consultant, Agriculture Extension) Dennis Wood (Consultant, Agro-industry) Shirin Velji (Research Assistant) The members of the structural adjustment loan appraisal missions were: William A. McCleary (Mission Chief) John A. Edelman Kazuko Hashimoto Paul Murgatroyd (first mission only) This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. MALAWI GROWTH AND STRUCTURAL CHANGE A BASIC ECONOMIC REPORT Table of Contents Page No. Country Data ............................................... vi Summary and Conclusions .................................... viii I. BACKGROUND ................................................. I The Economic Setting ....................................... 1 Cultural and Political Aspects ............................. 3 Development Strategy ....................................... 4 Development Plan ........................................... 8 II. MACROECONOMIC PERFORMANCE: AN OVERVIEW .................... 10 Growth and Structure ....................................... 10 Capital Formation and Its Financing ........................ 14 Budgetary Performance ...................................... 17 External Trade and the Balance of Payments ................. 23 The Recent Economic Crisis ................................. 29 Employment, Wages and Labor Costs .......................... 31 III. ISSUES FOR THE EIGHTIES .................................... 46 Export Growth and Diversification .......................... 46 The Management of Public Resources ......................... 48 Population Growth .......................................... 50 Skilled Manpower Constraint ................................ 55 IV. AGRICULTURAL DEVELOPMENT ................................,. 59 The Role of Agriculture .................................... 59 The Smallholder Sector--Performance and Potential .... ...... 60 Estates--Structure, Performance and Potential .... .......... 72 Government Objectives, Policies and Institutions .... ....... 86 Emerging Issues and Constraints ............................ 94 Future Agricultural Strategy ............................... 96 V. THE DEVELOPMENT OF THE MANUFACTURING SECTOR .... ............ 103 Performance of Manufacturing ............................... 103 Structure and Characteristics of the Manufacturing Sector .................................. 105 Small-Scale Enterprise Sector .............................. 113 Institutional Framework .................................... 114 - ii - Page No. The Policy Framework ....................................... 119 Industrial Licensing System ................................ 120 Industrial Incentives in the Protective System .... ......... I'll Tax Incentives ............ ................................. 1'3 Price Policy . .............................................. 123 Evaluation of Industrial Policies .......................... 1 b4 Future Constraints and Possibilities ....................... 1.7 Future Prospects for Agro-Industrial Investments .... ....... 1".,0 VI. POPULATION: ITS GROWTH AND MOVEMENT ....................... 1'2 Population and Its Growth Rate ............................. 1:33 External Migration ......................................... 1'23 Internal MigrationL ......................................... 138 Age and Sex St:ruct:ure of the Population .................... 144 Mortality Stat:istics ....................................... 145 Fertility . ................................................. 15il Population Vit:al Rates ..................................... 15'6 Population Projections ..................................... 158 VII. THE DEVELOPMENT OF HUMAN RESOURCES ......................... 165 Introduction . ............................................... 165 Administration, Self-Help and Participation .... ............ 166 Education .................... 167 Health and Nutrition .................... 183 Evaluation of the Health Care System ....... ................ 185 Shelter Policy ............. 185 VIII. THE PERFORMANCE OF THE PUBLIC SECTOR ...................... 19L The Central Government Budget .............................. 19. Revenue Account Exlpenditure ................................ 191 Development Account Expenditures ........................... l9'i The Recurrent ]3xpenditures Implications of Investment ............ ............................. 191 Central Government Revenues ................................ 20'!' Public Enterpr:Lses ............ ............................. 21',! A Model of the Government Budget ........................... 21< IX. POLICIES AND PR"OSPECTS FOR THE EIGHTIES .................... 221 The Improvement: of Agricultural Productivity .... ........... 22i'^ The Development: of Manufacturing ........................... 23]. Population Policy . .......................................... 23t. Human Resources ................ I 237 The Public Sect:or ................ 23& Growth and Balance of Payments Prospects ..... .............. 241 Foreign Capital. Requirements .......... ..................... 247 - iii - LIST OF TABLES I. BACKGROUND II. MACROECONOMIC PERFORMANCE: AN OVERVIEW 1. Growth Rates for Aggregate and Per Capita Real GDP, GNY, and GDY 2. Sectoral Growth Rates, 1967-1980 3. Sectoral Shares in Real GDP, 1967, 1973, 1979, 1980 4. Shares of Investment and Savings in GDP 5. Shares of Domestic and Foreign Financing in Domestic Investment, 1967-80 6. Central Government Budget, Selected Years 1967/68-1980/81 7. Financing of Government Budgetary Deficits, 1967-80 8. Sectoral Shares in Development Account Expenditures 9. Balance of Payments Performance, 1965-80 10. Debt Service Burden 11. Real Growth Rates for Principal Exports 12. Real Growth Rates for Principal Imports 13. Labor Force and Employment Estimates 14. Growth of Wage Employment 15. Formal Sector Employment Elasticities, 1968-77 and 1977-79 16. Growth of Nominal Earnings, 1969-79 17. Growth in Labor Productivity, 1969-76 18. Labor Productivity and Costs, 1969-77 III. ISSUES FOR THE EIGHTIES 1. Malawi's External Terms of Trade 2. Effects of Population Growth on Government Social Expenditures 3. Modern Sector Employment Growth 1980-1990 4. Population Densities 5. Occupational Distribution of Non-Malawians and Vacancies, 1979 IV. AGRICULTURAL DEVELOPMENT 1. Indices of Aggregate Domestic Purchases by ADMARC, 1967-79 2. Real Crop Prices for Five Smallholder Commodities 3. Relationship between Gross Margins and Growth of Marketed Output, 1967-1979 4. Average Yields of Maize, LLDP 1977/78 5. Employment in Private Commercial Agriculture 6. Number of Tobacco Estates by Size in Acres 7. Malawi Tobacco Statistics--Flue-Cured Production and Average Price--1967-1978 8. Malawi Estate Tobacco Statistics--Burley Production and Average Price, 1967 to 1980 9. Profitability of Large Tobacco Estates in Malawi 10. Sensitivity Analysis of Tobacco Estates' Return on Shareholders' Equity in 1977 11. Made-Tea Production, 1967-78 12. Returns on Capital Employed and Net Assets in Malawi Tea Industry, 1973-78 - iv - 13. Sensitivity Analysis of Return on Shareholder Equity of Tea Estates 14. SUCOMA Profitability 15. Sensitivity Analysis of SUCOMA Profitability 16. Comparison of Export Parity and ADMARC Purchasing Prices for Maize and for Groundnuts at Various Locations, 1977 17. Comparison of Export Parity and ADMARC-s Purchasing Price for Rice at Various Locations, 1977 V. THE DEVELOPMENT OF THE MANUFACTURING SECTOR 1. Index of Manufacturing Output, 1970-80 2. Shares of Manufacturing Subsectors in Total Manufacturing Sale-s, Employment, and Permanent Capital Employed 3. Size Distr:ibution by Reporting Units by Average Number of Employees in Manufacturing, 1975 4. Inventories of Finished Goods and Inputs by Industrial Branch:, 1975 5. Selected Manufacturing Sector Indicators, 1975 6. Small-Scale Malawian Businessmen in the Manufacturing and Service Sectors 7. Malawi - Parastatal Holdings in Selected Major Industrial Firmis, 1977/78 8. Industrial Licenses for New Investment, 1967-78 9. Malawi - Estimated IRR and Potential Annual Foreign Exchange Earnings of Selected Industrial Projects VI. POPULATION: ITS GROWTH AND MOVEMENT 1. Malawi-s National and Regional Populations 2. Male-Female Sex Ratios, 1966, 1970, 1977 3. Characteristics of Regional Populations, 1966 and 1977 4. Relatives from Region Working Outside Malawi, 1966 5. Regional Migration 6. Characteristics of District Populations, 1966 and 1977 7. Intraregional and Inter-regional Migration, 1966 and 1977 8. The Growth of Urban Population 9. Distribution of Males and Females by Age Group, 1966 and 1977 10. Proportion ])ead of All Children Born Alive, Malawi and Selecte:. East African Countries 11. Proportion Dying before Age X 12. Proportion Dead Among Children Ever Born Alive 13. Expectancy of Life Remaining at Age 25 14. Expectancy of Life Remaining at Age 25, 1962-67 15. Life ExpectaLncy at Birth 16. National Fertility Estimates 17. Regional and. Urban-Rural Fertility Estimates, 1976-77 18. Regional Marriage Characteristics 19. Estimates of Vital Rates, 1977 20. Population Projects 1980-2010 21. Projected Population Growth Rates v 22. Population of Young Children, School Age Children, and Reproductive Age Mothers, 1980-2010 23. Working-Age Population VII. THE DEVELOPMENT OF HUMAN RESOURCES 1. Economic Rates of Return for Investment in Upper Secondary Education 2. Basic Health Units VIII. THE PERFORMANCE OF THE PUBLIC SECTOR 1. Financing of Central Government Total Expenditure 2. Revenue Account Expenditure by Function 3. Development Account Expenditure by Function 4. Estimated Recurrent Expenditure Coefficients 5. Actual and Predicted Recurrent Expenditure 6. Selected African Countries' Share and Structure of Revenue 7. Revenue Performance, 1967-78 8. Composition of Revenue 9. Recommended Revenue Measures 10. Public Enterprises Financial Performance 11. Contribution of Public Enterprises to Gross Domestic Savings and Investment 12. Composition of Development Account Expenditure 13. Government Budgetary Projections IX. POLICIES AND PROSPECTS FOR THE EIGHTIES 1. Growth and Composition of Exports, 1980-1990 2. Growth and Composition of Imports, 1980-1990 3. Summary National Accounts Projections, 1980-1990 4. Summary Balance of Payments Accounts, 1979-90 5. Foreign Capital Requirements, 1981-85 LIST OF CHARTS 1. Assumptions for Budgetary Projection MAP IBRD 15219 - vi - MALAWI Country Data Area Population (million) 94,276 km2 5.95 (mid-1980) 63.1 Population Characteristics (1970-75) Health (1974-78) Crude Birth Rate (per 1,000) 56 Population per physician 48,198 Crude Death Rate (per 1,000) 27 Population per hospital bed 546 Infant Mortality Rate (per 1,000 live births) 191 Distribution of Land Ownership % owned by top 10% of owners Income Distribution (1968/69) % owned by lowest 10% of owners % of private income, highest quintile 52.9 , lowest Access to Electricity quintile 5.7 % of population - urban - rural Access to Safe Water (1974-78) % of Population 33 - urban 70 Education (1974-78) - rural 29 Adult literacy rate % 25 Primary school enrollment % 62 Nutrition (1974-78) Calorie Availability as % of requirements 103 Per capita protein intake (grams/day) 59 CNP Per Capita in 1979: US$200-1 Gross National Product in 1980-/ Annual Rate of Growth (2, constant prices) US$ billion % 1970-75 1975-79 1979-80 GNP at market prices 1.49 100.0 7.7 5.5 0.6 Gross domestic investment 0.33 22.0 8.8 8.7 -29.0 Gross national savings 0.13 8.7 7.8 7.4 -29.5 Current account balance 0.20 13.4 Exports of goods, NFS 0.34 22.8 4.8 6.1 20.7 Imports of goods, NFS 0.51 34.2 4.6 0.8 -4.8 Output, Labor Force and Productivity in 1979 Value Added Labor Force V.A. per Worker US$ million % Thousands % US$ million % Agriculture 520.2 42.6 2,631 93.0 197.7 45.9 Industry 236.9 19.4 66 2.3 3,589.4 832.4 Services 463.2 38.0 133 4.7 3,482.7 807.7 Total/Average 1,220.3 100.0 2,830 100.0 431.2 100.0 Government Finance General Government Central Government K millions % of GDP K millions % of GDP 1980/81 1980/81 1975/76-1979/80 1980/81 2/ 1980/81 1975/76-1979/80 Current Receipts .. . .. 202.4 16.3 16.3 Current Expenditures . .. . 213.0 17.2 15.4 Current Surplus .. .. ,. -10.6 -0.9 0.9 Capital Expenditures .. .. .. 165.6 13.3 11.4 External Assistance .. .. .. 122.6 9.9 8.4 1/ Based on World Bank Atlas methodology and calculated at an average of 1977-79 prices and exchange rates. All other conversions to dollars in this table are at the average exchange rate prevailing during the period covered. 2/ Preliminary. not applicable not available - vii - Money, Credit and Prices 1970 1971 1972 1973 1974 1975 1976 1977 1978 .L979 1980 1/ -------------------------------- (K millions) ---------------------------------- Money and Quasi Money 43.5 48.6 54.9 72.4 99.3 103.7 98.0 122.7 133.2 144.2 177.9 Bank Credit to Public Sector -2.0 -4.4 2.2 -1.1 3.4 48.6 64.9 44.2 61.9 96.4 128.3 Bank Credit to Private Sector 26.4 35.1 35.6 33.0 49.4 56.1 76.6 87.7 122.2 170.8 182.4 Money and Quasi Money as % of GDP 16.3 14.5 15.3 18.0 20.3 18.3 15.0 15.9 15.6 13.7 14.3 General Price Index (1970 = 100) 100.0 108.2 112.1 117.8 135.9 157.0 163.8 170.7 185.2 206.1 243.9 Annual Percentage Changes in: General Price Index -- 8.2 3.6 5.1 15.4 15.5 4.3 4.2 8.5 11.3 18.3 Bank Credit to Public Sector -- -- -- -- -- 1,329.4 33.5 -31.9 40.0 55.7 33.1 Bank Credit to Private Sector -- 33.0 1.4 -7.3 49.7 13.6 36.5 14.5 39.3 39.8 6.8 Balance of Payments Merchandise Exports (Average 1977-80) 197, 1978 1979 1980 -/ US$ million % (US$ millions) Tobacco 114.0 50.0 Exports of Goods, f.o.b. 199.8 186.5 231.7 294.4 Tea 38.9 17.0 Imports of Goods, f.o.b. 183.3 263.0 311.3 341.2 Sugar 24.9 10.9 Non-factor services (net) -54.) -88.9 -121.2 -119.3 Groundnuts 11.5 5.0 Resource gap (deficit -) -37.2 -165.4 -200.8 -166.1 Cotton 2.7 1.2 Other 36.3 15.9 Factor Services (net) -25.5 --4.7 -42.6 -39.2 Total 228.2 100.0 Private Transfers (net) 5.5 5.9 -0.4 -0.9 Balance om Current Account -57.2 -164.2 -243.8 -206.2 Official Grants 19.9 38.8 39.2 50.0 External Debt (December 31, 1980) Net MLT Borrowing US$ million Disbursements 86.:3 111.5 144.8 203.2 Public Debt, incl. guaranteed 637.2 Amortizations 11.6 21.8 30.7 83.7 Non-guaranteed Private Debt .. Subtotal 74-7 89.7 114.1 119.5 Total 637.2 Transactions with IMF 8.2 5.7 32.3 31.3 Other Items, n.e.i. 12.3 11.9 46.2 14.7 Increase in reserves (-) -57.9 18.1 12.0 -9.3 Debt Service Ratio. 1980 1/ 2/ Gross Reserves 84.4 66.3 54.3 63.5 Public Debt, incL guaranteed 18.7 Petroleum Imports 28.4 36.1 54.9 .. Non-guaranteed Private Debt Petroleum Exports . . . . Total 18.7 Rate of Exchange US$1 K 0.9029 0.8438 0.8169 0.8121 IBRfD/IDA Lending (December 31, 1980) K 1 - US$ 1.107'i 1.1851 1.2241 1.2314 --US$ million- IBRD IDA Outstanding and Disbursed 25.52 130.52 Undisbursed 3.68 57.09 Outstanding incl. undisbursed 29.20 18'.61 1/ Preliminary. 2/ Ratio of actual debt service to exports of goods and non-factor services; debt service does nct include short-term or IMF charges. not applicable not available - viii - MALAWI GROWTH AND STRUCTURAL CHANGE A BASIC ECONOMIC REPORT Summary and Conclusions 1. This report takes the long view of Malawian economic development, looking back over the period since independence and forward over the next ten years or more. Its purpose is to examine the rate and structure of growth since indpendence, assess performance in light of the Government's development objectives, highlight the major emerging trends and issues, and suggest policy changes which are needed to improve future performance. Accordingly, this "Summary and Conclusions" is divided into five main sections: the first describes the major characteristics of the economy and the development strategy; the second assesses past macroeconomic perfor- mance; the third identifies the major trends and issues which will affect future performance; the fourth assesses past performance and emerging issues in four key areas--agriculture, manufacturing, population and human resources; and the last outlines the future development strategy and the required set of supporting policies and discusses the implications of a macroeconomic forecast for the next decade. Economic Characteristics and Development Strategy 2. At independence, Malawi was clearly the poorest of the three ter- ritories of the Central African Federation. Unlike Northern and Southern Rhodesia (Zambia and Zimbabwe), it possessed no substantial mineral re- sources and consequently had attracted little outside interest. Apart from the plantations of the southern region (mainly tea and tobacco), Malawi was largely a subsistence economy with non-monetary output accounting for almost one-half of gross domestic product. The limited infrastructure was concentrated in the relatively more prosperous south and road connections with the central and northern regions were poor. 3. From independence, it was clear that development must be agro- based. Moderately fertile soil and a favorable climate made the country suitable for a variety of food and cash crops. While population growth was rapid and population densities were already among the highest in Africa, open cultivable land was still available (especially in the north) and potential for increasing land productivity existed. Agricultural produc- tion derived from two subsectors--smallholder and estate agriculture. The smallholder sector accounted for almost 90 percent of agricultural produc- tion, met the country-s need for food (e.g., maize, beans and rice), pro- vided raw materials for domestic industries (cotton and tobacco), and created an export surplus amounting to almost one-half of Malawi-s merchan- dise exports. The estate sector, dominated by foreign-owned tea and tobacco plantations, accounted for over 40 percent of merchandise exports and about one-quarter of wage employment in 1964. - ix - 4. At independence, Malawi's reliance upon external capital and man- power was pronounced. Since domestic savings were virtually nil, most domestic capital formation was financed from abroad; government recurrent budget deficits were covered by UK grants-in-aid. Tea estates, manufactlir- ing and transport were dominated by British firms and commerce by As-,an traders. Because of neg:Lect of African education by the colonial admilii- stration, primary and secondary school enrollment ratios were low and 1:he quality of education poor; by 1964, only 33 Africans had university de- grees. Expatriates dominated the higher skill levels. In addition, Malawi's dependence upon external factors has been heightened by its laiid- locked position which makes it vulnerable to events in neighboring coun- tries and increases in transport costs. At times since independence, con- flicts within Mozambique, Mozambique's disputes with it neighbors, growing port congestion at Beira and Nacala, togetlher with rising fuel prices have combined to increase the costs and the uncertainty of Malawi's external trade. 5. Because cf its resource endowments and the small size of Its domestic market, Malawi has opted for an outward-looking, export-oriented development strategy based upon agriculture. The Government has opted for a two-pronged approach to agricultural development, involving smallholders and estates. For the smallholder sector, the Government has undertaken a number of rural development projects designed to increase productivity and augment cash incomes through the sale of surpluses in urban areas and ex- port markets. More recently, concerned that intensive and costly capital investments in agriculture could not be extended to the entire country quickly enough, the Government developed the National Rural Development Program (NRDP) aimed at covering the entire agricultural sector within 20 years but with less intenasive staffing and infrastructure. Under NRDPP, emphasis is given to increasing the productivity of land already under cul-- tivation through the provision of agricultural services (most particularly extension, input supply, marketing and credit). The role of the estate sector in the development strategy has been to provide rural employme n: opportunities and generate foreign exchange earnings through the exports oif tobacco, tea and sugar. 6. Malawi's emphasis on an export-oriented, agro-based strategy has influenced its policies toward manufacturing, price and wage policy, the roles of domestic and. foreign investment, and investments in the social sectors. Since the GDvernment viewed the development of manufacturing as complementary to agriculture, care has been taken to avoid the creation zf inefficient firms. Tariffs in general have been low and quantitative ra- strictions on imports (for protective or other purposes) have been largeLy avoided. Price and wage restraint have played important roles in restraLl- ing inflation, maintaining international competitiveness, providing inceni- tives for employment creation, and moderating the rural-urban gap. While flows of foreign capital and expertise have been encouraged (e.g., through moderate taxes, unrestricted repatriation of dividends and profits), Malawianization of capital has been fostered through easily available leaseholds for estates, restraints on Asian traders, and the creatiorn - x - of public (and quasi-public) enterprises (e.g., MDC, Press and ADMARC). These enterprises have made substantial loan and equity investments in ag- riculture, industry, transport, construction, etc. Because of the Govern- ment emphasis on growth, it has favored investments in agriculture, trans- port, power, etc; relatively small amounts have been invested in have gone into the social sectors (education, health, etc.). Past Performance Growth and Capital Formation 7. In spite of its limited resources, Malawi's achievements have been impressive. Aggregate and per capita incomes have grown rapidly. Between 1967 and 1979, real GDP grew at an annual average rate of 5.5 per- cent per annum and per capita income at about 3 percent (since 1970, real GDP growth has averaged 7 percent). Over the same period, the GDP deflator rose at a rate of 8.2 percent per annum, lower than the rate of inflation in the developed countries. Growth has been widespread, exceeding 5 per- cent per annum in all sectors (except subsistence agriculture). Despite this performance Malawi remains one of the poorest countries in the world; 1979 per capita GNP was US$200. 8. Domestic capital formation and its financing have been character- ized by increasing domestic savings and investment as shares of GDP, grow- ing contribution of domestic savings to the finance of investment, and a falling contribution of the share of investment financed from external sources. At independence, investment constituted only 8.6 percent of GDP and domestic savings were virtually nil. By 1979, the share of investment in GDP had risen to 29 percent. The domestic resource mobilization effort has been even more impressive. Domestic savings rose to 17 percent of GDP by 1979, increasing the share of investment financed from domestic sources to about 60 percent. Over this period, all sectors--the central govern- ment, public enterprises, and especially the private sector--made signifi- cant contributions to the savings effort. While the share of domestic in- vestment financed from abroad has fallen, the size of foreign capital in- flows has still increased substantially: owing mainly to government mobi- lization of foreign assistance, but with increasing contributions for pri- vate and public enterprise ventures, net long-term capital flows grew almost twentyfold between 1964-66 and 1977-79. Public Sector Performance 9. Over much of the period since independence, the Government s bud- getary performance has been satisfactory. Dependence on UK grants to cover recurrent deficits was eliminated by 1972/73, and small recurrent surpluses in most years thereafter have made modest contributions to financing devel- opment expenditures. Up through 1976/77, government expenditures and reve- nues increased roughly in line with GDP; while deficits grew larger, they still did not exceed 8-9 percent of GDP and resort to borrowing from the domestic banking system remained modest. During the four succeeding budget years, expenditure growth outstripped revenue expansion (mainly due to capital outlays for railway extension, a new airport, and government build- - xi - ings including defense, but due to recurrent outlays for debt service and security as well). As a consequence, deficits have increased sharply (averaging 13 percent of GDP during 1979/80 and 1980/81), resulting in increased borrowing from the banking system, and more acute balance of pay- ments pressures. 10. While government revenues have increased somewhat faster than GDP since independence, there is still room for improvement in revenue perfor- mance, Revenues, as a share of GDP, are below those of many African coun- tries. Moreover, since most of the revenue system (except for irncome taxes) is inherently inelastic, revenue performance has depended upon ad hoc introduction of new taxes, adjustments of rates, etc. With the cnset of domestic and international inflation, revenues from specific excises and import duties and from charges for government services have not kept pace with price increases. Much needs to be done, therefore, to improve the re- sponsiveness of revenues to changes in output and prices. 11. Shortages of recurrent funds for operating and maintaining exrist- ing capital investments is becoming an increasingly difficult problem in Malawi. Suggestions of possible underfunding arise from the more rapid ex- pansion of government development than recurrent expenditures and from the declining share of the economic and social sectors in recurrent expenditure (despite their consistent 80-90 percent share in government investme!nt). In a joint study by the Malawian Government and World Bank, the recurrent expenditure implications of a large number of types of projects in agricul- ture, education, health, road construction, water supply and buildings have been quantified. Applying the results of the study to the actual invest- ments undertaken by Government during 1970-77 shows that underfurnd:ing (centered in agriculture, roads, and buildings) amounted to about 7 percent of 1978/79 recurrent expenditures. 12. Until recently, the performance of public enterprises as a group was quite satisfactory, especially when compared with that in other LDCs. As a group they were liquid, soundly capitalized, profitable and financed a substantial proportion of their own investment programs. Viewing perfor- mance in the aggregate, however, overlooks the very large contributions made by ADMARC and the rather mixed performance of the remaining enter- prises. ADMARC has been more profitable, more liquid, better capitalized and growing more rapidly than the others. While the remaining public enterprises as a group have been marginally profitable, performance varies: some have been consistently profitable (e.g., ESCOM, MHC); some consis- tently unprofitable (e.g., Air Malawi) and others more variable year--to- year performances (e.g., Malawi Railways, CCDC). Moreover, mainly as t:he result of increasing costs combined with relatively inflexible output prices, the financial position of most public enterprises deteriorated sharply during 1979-81. This deterioration has led to the sector s increased difficulties in covering its debt service and to its increased reliance on borrowing from the domestic banking system; in addition, the postponement of substantial amounts of public enterprise debt service U'as a major factor in the worsening of the Government-s budgetary position during 1980/81 and 1981/82. - xii - Trade and the Balance of Payments 13. Balance of payments performance over the period has been charac- terized by growing current account deficits, resulting partly from increas- ing deficits in merchandise trade and, more importantly, from a severe deterioration on non-factor and factor services account. During 1965-79, export volume grew at 6.8 percent (9 percent per annum 1965-73, and 3.9 percent per annum thereafter). This satisfactory overall performance, however, was the product of moderate to rapid growth of all estate crops (averaging 13.6 percent per annum) and smallholder growth that has only averaged 1.7 percent per annum. Moreover, the sharp decline in export per- formance since 1973 is the result of stagnation in smallholder exports. Since 1965, import volumes have tended to rise more slowly than real GDP, partly due to an absolute decline in the volume of consumer goods imports and partly to relatively slow growth in intermediate and capital goods volumes. 14. This pattern of export and import expansion, combined with the absence of any pronounced trend in Malawi's external terms of trade through the mid-1970s, produced a mild upward trend in deficits in merchandise trade, with the deficits actually declining as a share of GDP. As the result of the sharp fall in Malawi's external terms of trade during 1978-80 (the consequence of falling tobacco and tea prices combined with sharply rising import costs especially for fuels, fertilizer and transport), trade deficits have expanded sharply, both absolutely and as a share of GDP. Of greater significance to the growing current account deficits have been the increasing outflows on service and non-factor service, the former a product of higher debt service payments and the latter from rising charges for transport. The combined deficit on factor and non-factor services account in 1978-80 accounted for two-thirds of the total deficit on goods and services account. 15. While current account deficits have been trending upwards, through 1977 they averaged only 7-8 percent of GDP; net capital inflows were generally more than sufficient to cover the deficits allowing a build- up of official reserve holdings in most years. With the severe (35 per- cent) decline in the terms of trade since 1977 and the continuing deterio- ration on services account, current account deficits have expanded sharply, averaging 12 percent of GDP 1978-80. Part of these deficits were covered by foreign capital inflows (and increased use of IMF resources). In con- trast to past experience, however, whereby the bulk of Malawi's capital inflows were grants and soft loans, over one-third of the 1978-80 capital flows were on commercial terms. Such commercial borrowing will have a pro- nounced effect on future debt service. While Malawi's debt service ratios were only 7 percent in 1977 and 12 percent in 1979, they reached 19 percent in 1980 and are expected to average over 20 percent per annum over the next 3-4 years. Because the 1978-80 capital inflows were not sufficient to cover the current account deficits, Malawi has also experienced a sharp fall in foreign exchange reserves; between the ends of 1977 and 1980, net official reserves fell from MK 37 million to minus MK 33 million. - xiii - Employment and Earnings 16. Malawi's rapid growth has made a significant contribution in pro- viding employment for a growing labor force. Since 1968, formal sector wage employment expanded at over 8 percent per annum. The largest coatri- bution to employment generation came from estate agriculture: employment there grew at over 11 percent per annum and represented over 50 perce,at of the new jobs created over the period. The industrial and service sect:ors expanded at less rapid but still respectable rates of 6.3 and 6.0 percent per annum, respectively. The high employment elasticities (e.g., employ- ment growth relative t:o growth of real value added) registered in all sectors (especially in agriculture, manufacturing) suggest a labor-inten- sive pattern of development, consistent with the government po]icy objectives. Despite this impressive performance, it is important to recog- nize that formal sector wage employment is relatively small: witlhL its growth absorbing slightly less than one-quarter of the new entrants tD the labor force over the period, the formal sector's share in total emplo ilent grew from 8 to 12 percent, the remainder being absorbed in mainly su.E,is- tence agriculture but also in the rural and urban informal sectors. 17. Owing to government wage reviews and the absence of institutLicnal forces which tend to raise wages regardless of market conditions, the rate of wage increase has been significantly less than that in many other African countries. Over the period 1969-79, average nominal earnings g;rew at about an average rate of about 4 percent; while average earnings grcwth in several sectors exceeded 5 percent per annum (e.g., agriculture, manu- facturing, trade), in no sector did growth keep up with the rise in con- sumer prices and on average real earnings fell by about one-third ove17 the period. There are several indications, however, that the fall in average real earnings overstates the decline in worker's real wages (or income). Average nominal earnings vary over time not only because of changes in wage rates but also because of changes in the skill, race and sex mix o:!i the labor force. Malawi has been very successful in generating employmert at the low end of the wage scale: over half the jobs created in the pr>vate and public sectors between 1969 and the mid-1970s were at earning l1!vels below the 1969 level, a factor which would have exerted considerable drag on increases in average earnings in succeeding years. Moreover, whil4z the average earnings of govrernment employees failed to keep pace with iinfla- tion, it can be shown that the real incomes of civil servants at virtilally all levels actually increased between the late 1960s and 1978; the slow rise in average nominal earnings in government has, thus, been the rl'sult of a rapid expansion of employment at the low end of the salary s.i:-ale. Lastly, data suggest that smallholder output rose somewhat faster than smallholder population. Therefore, it cannot be said that the conti:rLuing rapid migration to urban areas was the result of deteriorating condill:ins in agriculture forcing people into the cities to accept low-income obs, even at declining real wages. - xiv - Emerging Development Issues 18. Despite Malawi's impressive achievements since independence, the Government will have to address a number of key developmental issues if the rapid improvement in income and welfare is to be maintained in the coming decade and beyond: (a) the need to accelerate and diversify exports; (b) the need to maintain and improve agricultural and industrial policies to cope with more rapid expansion of population and the labor force; (c) the need to improve the management of public sector re- resources; and (d) the need to reduce the skilled manpower constraint. 19. The expansion of estate agriculture has been the major force in the growth of exports since indepedence. Over the period smallholder ex- ports have grown slowly and, since 1973, have actually been falling. Given the prospects for Malawi's external terms of trade and for relatively slower growth of estate exports, increased diversification efforts are necessary if the slow expansion of foreign exchange is not to be a major constraint to growth during the 1980s. Compared with the relatively poor 1979 year, World Bank commodity price forecasts show that Malawi's external terms of trade will only improve by 7 percent by 1985 and 8 percent by 1990. Moreover, owing to various constraints, the expansion of the tradi- tional estate crops (tobacco, tea, sugar) is more likely to average 3-4 percent per annum during the 1980s (as compared with 13.6 percent per annum 1967-79). Improved export growth will depend upon the diversification of estates into new crops (e.g., livestock and dairy, groundnuts and irrigated wheat) and, more importantly, the encouragement of traditional major small- holder crops (e.g., groundnuts, cotton) and new or minor products (e.g., guar beans, oil-bearing seeds, fish) through improvements in agricultural services and price incentives. 20. The continued rapid growth of population is probably the single largest obstacle to an improvement in incomes ar-d welfare of the majority of Malawians. It augments pressures on Malawi's scarce land resources and increases the need to improve the productivity of land. It diverts public resources from improving the amount of economic and social services pro- vided per capita. While population grew at 2.9 percent per annum between the censuses of 1966 and 1977, with constant fertility and the likely decline in mortality, growth would accelerate to 3.4 percent per annum by 1990 and, within 20 years, to 3.7 percent per annum, tripling Malawi's pop- ulation to 17 million by the year 2010. Such growth would lead to popula- tion densities higher than those now prevailing in any African country or in many Asian countries currently thought of as densely populated (e.g., India, Pakistan, Thailand). Moreover, while the past rapid expansion of formal sector employment has only been able to provide jobs for a fraction - xv - of new entrants to the labor force, the labor absorption problem will become even more acute in the future. With projected formal sector employ- ment growing at about 5 percent per annum, 80-90 percent of new labor force entrants will have to find work in subsistence agriculture and in the rural and urban informal sectors during 1980-90. The implications for agricul- tural and industrial policy are clear. Since the rural work force is likely to be growing at about 3.5 percent per annum, agricultural output must grow at at least that rate and at about 5-6 percent per annum to provide a 2 percent per annum growth in per capita incomes. The required increases in production and employment would have to be achieved through (a) techniques which increase land productivity and the demand for labor (e.g., use of hybrids, fertilizers); (b) augmentation of the supply of Jand through irrigation, soil conservation, etc.; and (c) higher value, more labor-intensive crops. While industry is likely to play a secondary role to estate and smal]holdier employment generation, industrial policies will still be important. The encouragement of inefficient industries shouLd be avoided since their growth would be constrained by the small size of Malawi's market and. sirice their production discourages agricultural eKpan- sion (through underpricing inputs or overpricing outputs). More3ver, policies which affect the relative prices of capital and labor shou:d be carefully monitored; for example, low (real) interest rates, low taoriffs and/or rapid depreciation rates for capital goods, and high minimum wages should be avoided. 21. To assure a steady expansion of public services commensurate with the development needs of the economy, improvement in budgetary and public enterprise management will be necessary. Through expenditure restrainr: and new revenue measures, the Government has reduced its net borrowing fronl the banking system implied in its 1981/82 budget to zero. Over time, fu:-ther measures will have to be taken on the expenditure and revenue sLdes. Because of continuing revenue constraints, the rapid buildup of investrients in sectors with heavy recurrent funding requirements (e.g., agricul:ure, education, health) more careful planning is required to avoid a growing underfunding problem. 'The Government/World Bank study of recurrent expend- iture requirements of investment should be extended further to checlb the accuracy of the sectoral recurrent expenditures coefficients, test 1:heir sensitivity to disaggregation, determine the lag pattern between in-Test- ments and requirements. Moreover, to determine the possibilities for economies, the levels of government services should be carefully examined-- e.g., intensity of extension services, student-teacher ratios (particui.arly at the secondary and un:iversity levels), the quality of civil service u1ous- ing. Lastly recurrent expenditure implications of the Government's ini7est- ment program should be 1hen projected. Future success in improving re' enue performance will depend upon measures which improve the elasticity ol: the system as well as on periodic ad hoc adjustments. Included in the fLrmer category are: e.g., changing from specific to ad valorem import and e:cise duties; reductions of exemptions under the income tax; changing the base for personal and company income taxes from the previous to the prlsent year. Included in the latter are, for example, more frequent adjustments in charges for government services, fees, licenses, house and ground rents; periodic adjustments in specific rate taxes; increased taxes on luxuries. - xvi - During 1980 and 1981, the Government has taken numerous steps to improve the financial position of public enterprises including significant tariff increases for several, closing inefficient and unprofitable activities and the creation of a Department of Statutory Bodies (in the Office of the President and Cabinet) which will provide policy and medium-term planning advice to public enterprises. Taken together these measures have improved the short-term outlook for many public enterprises. However, to maintain and improve upon these gains, continual adjustments to changing circum- stances will have to be made. 22. Because of the small stock of educated manpower inherited at in- dependence and the relative priority the Government attached to investments in economic rather than the social sectors, skilled manpower remains an im- portant constraint to development. Although primary and secondary enroll- ment have risen quite rapidly since independence, government expenditures on education are a lower share of total expenditures than in most African countries and secondary school enrollment is lower than that in all but five sub-Saharan African countries. The Basic Economic Mission-s analysis of the earnings and employment patterns of secondary school leavers (from the Government's 1976 Tracer Study) and the recurrent and capital costs of education shows that the social and private returns to investment in upper secondary education lie in the ranges 14-21 and 31-50 percent, respec- tively, suggesting that additional investment is highly desirable both from the nation's and the individual's point of view. Such conclusions are cor- roborated by analysis of the Government-s 1979 manpower survey which shows a continuing high dependency on expatriates and high rates of vacancy in most higher skill categories (e.g., managers, engineers, scientists, doctors and dentists, veterinarians, secondary schoolteachers, farm machin- ery operators). Projecting the demand and supply of labor with two year-s secondary schooling and above (based on the likely expansion of the economy and the Government's program for educational expansion) shows a continuing imbalance for the 1980-90 period implying a continuing dependence on expatriates, a lowering of job qualifications, some slowing of growth due to manpower constraints or a combination of the three. These findings suggest that a more rapid expansion of secondary enrollments than the 5-6 percent growth the Government is currently planning would be appropriate. To ease budgetary constraints, the following should be considered: (a) measures to reduce costs (e.g., increasing student-teacher ratios at the secondary and university levels, a shift of greater amounts of boarding costs to students); and (b) raising tuitions to improve cost recovery at the secondary and university levels. Sectoral Performance, Issues and Strategies Performance and Potential of the Agricultural Sector 23. MalawiTs agriculture output derives from two subsectors--estates and smallholders. Over the last 10-15 years, the estate sector (flue-cured and burley tobacco, tea and sugar) has been relatively more dynamic, its output rising at over 15 percent per annum, its share in exports rising from about one-third to two-thirds, and its employment generation account- - xvii - ing for over one-ha'Lf of the new formal sector jobs. Because of data limi- tations, it is not possible to measure smallholder output performance with accuracy. Available evidence, however, suggests that smallholder output growth fell from an average rate of about 5 percent per annum during the 1950s and 1960s to about a 3.2 percent per annum rate 1967-79.1 ''hree reasons have been given for the decline in smallholder growth: (a) the decline in smallholder price incentives (as evidenced by the large increase in the marketing board's profits); (b) the rapid expansion of estates through alienation of customary land; and (c) the reduced availabilitly of consumer goods in rural areas that is purported to have followed the Malaw- ianization of trade. While it is clear that price incentives offered smallholders have not been favorable and that the growth of land knder estates has been rapid (over 10 percent per annum since the late 1960si, it is not possible to quantify their impacts on smallholder growth. 24. Agricultural pricing has undoubtedly been an important factor in smallholder performance over the past decade. Numerous studies have ;hown that Malawian smalLholders are price responsive. Moreover, the highest smallholder growth rates over the past decade were registered in crops with the highest returns per manday (e.g., rice and tobacco) and the lowest in those with the lowest returns (e.g., cotton, groundnuts). While agr:.cul- tural prices are supposedly set to balance the interests of smallholders and ADMARC, it is c[Lear that balance has not been achieved. ADMARC's trad- ing activities have been highly profitable and smallholders have received only a small share of the earnings realized on such important crops as cotton, groundnuts, and tobacco. On balance, ADMARC's prices have t-axed the producers of cotton, groundnuts and tobacco (paying them less thay the equivalent of export parity) while subsidizing the production of maiz4i and rice.2 25. While the! est:ate sector will continue to be a source of growing output, foreign exchange earnings and employment, its expansion will bho lEstimates of smallholder growth must always be qualified. Sul:sis- tence production is usually estimated by the rate of population growth: and marketed production by the volume of sales to ADMARC. Such estimates fail to capture actual production or the substantial informal domestic and for- eign trade in agricultur^al product. 2Because of high transport costs and the resulting large differel::tial between import and export parity for maize, there is clear economic jt.sti- fication for some subsidy in the maize price (relative to export parity) to reduce the probability of imports. Ideally maize price policy would be aimed at ensuring a production level slightly in excess of domestic con- sumption in normal years at a producer price equal to or slightly i.bove export parity (the excess being added to stocks and/or exported to ni.arby countries). - xviii - significantly slower than in the past. Government restraint on further ex- pansion of estates means that competition with smallholders for scarce land will be reduced. The future growth of estate production will come mainly through yield improvements accompanied by increased utilization of existing estate land and a moderate expansion of estate land area. Tobacco expan- sion will be constrained by the need for restructuring in the wake of the present financial crisis, the likelihood of tight credit conditions (espe- cially in the short- to medium-term), the shortage of experienced managers, and growing shortages for fuelwood for curing (in view of more favorable world price prospects and the use of air-curing the prospects for burley are better than those for flue-cured). On balance, estate tobacco is likely to grow at an average rate of 4-5 percent per annum during the 1980s (compared with a rate of 17 percent per annum during 1967-80). While potential exists for substantial improvements in tea, the prospect of a downward trend in world real tea prices and the limited availability of suitable land will constrain future growth. The growth of tea production is unlikely to exceed the potential for yield increases--i.e., 2-4 percent per annum. While Malawi will shortly reach full capacity production from the two existing sugar estates, the potential for additional sugar produc- tion is there. World prices are projected to be favorable and several sites appear to be suitable. However, the economic feasibility of further investments remains to be demonstrated, and therefore the timing and magni- tude such investments is unclear. 26. Improved smallholder performance is the key element in the devel- opment strategy for the 1980s. Faster smallholder growth is needed to pro- vide a surplus for the diversification of exports, to generate employment for workers not absorbed by the expansion of the modern sector, and to pro- vide the inputs for (as well as buy the product of) agro-based and other industries. Given estimates of labor force growth as well as likely em- ployment generation in the modern sector, smallholder expansion of at least 4 percent per annum would be necessary and 5-6 percent per annum to bring about a significant increase in sectoral per capita incomes. Such rates are high relative to estimated smallholder growth for the 1970s (3.2 per- cent per annum) but not out of line with the 5 percent rate estimated for the 1950s and 1960s. The agricultural strategy issues involve the future roles of smallholders and estates, the provision of public services for augmenting the productivity of land, and the adequacy of price incentives and marketing services. 27. Future smallholder strategy must address the need to maintain self-sufficiency in basic foodstuffs (especially maize), generate export surpluses and improve rural incomes. Whereas past growth resulted from the expansion of cultivated areas, land shortages will force increasing atten- tion to measures which improve yields (e.g., fertilizers and pesticides, better crop rotation, irrigation, soil conservation). To maintain maize self-sufficiency while holding present land under maize constant (thus allowing other land to be used for export crops) would require increases in national average maize yields of 40 percent by the end of the decade. While such an increase is large, the required yield is substantially less than is currently being achieved in large projects in Malawi through the use of improved varieties and fertilizers. Since farmers outside the main project areas have not shifted into new varieties, success in improving maize yields over the next decade will depend upon the rate of implementa- tion of NRDP, the development by research and extension of crop packages - xix - responsive to farmers needs, and the development of hybrids with suitable taste and storage characteristics. 28. Groundnuts and cotton offer the most promising prospects for rapid increases in production and exports. Both have been exported irn far greater quantities than at present and, owing to poor husbandry for ground- nuts and insufficient insecticide applications for cotton, the potertial for substantial yield improvements is there. Setting and maintaining appropriate price incentives is essential to yield improvements for both crops. While the expansion of dark-fired tobacco is likely to be con- strained by fuelwood' shortages, smallholder production of burley, with ade- quate extension supervision, appears technically feasible. With small- holders moving into burley, further alienation of customary land for burley estates would be less necessary. Since ADMARC buying prices for rice exceed export parity, exports involve a loss to Malawi and, given present and projected prices, continuation of rice exports at present volumes is not economic. WhiLe some types of rice fetch premium prices in South African markets, the production of irrigated rice for a single overseas market appears costly and risky; development efforts should be direct:ed toward production of rainfed rice for self-sufficiency. 29. Prospectsl also exist for the diversification of smallholder mnd estate production beyond the present major crops. The most promis:ing smallholder prospects include many products that are key inputs into poten- tial agro-industria:L projects--e.g., oil-bearing seeds and beans (e.g., cotton, sunflower, and sesame seeds and soya beans), pulses, cassava, guar beans, honey and beeswax, livestock and dairying, fish and coffee. The Government has commissioned studies of the possibilities for estate diver- sification; at present the most promising prospects appear to be macademia nuts, coffee, manipintar groundnuts, tea seed, maize, cotton and soya beans. A study has also been commissioned to examine the potential for the expansion of irrigation to increase land productivity. While firm state- ments would be premature at this stage, the crops with the greatest po:en- tial for irrigated development appear to be: wheat, beans, coffee, cot:an, groundnuts and fruit:s and vegetables. The Government expects estates to play a major role in any expansion of irrigation. 30. The Government, in its 1981/82-1985/86 investment program, is committed to increasing the share devoted to agriculture, forestry and livestock. The National Rural Development Program (NRDP), the cornersl:one of the agricultural development effort, is directed toward improving pro- ductivity on land already under cultivation through the extension of !ov- ernment services (e.g., extension, markets, credit). In view of the filAel- wood problem and the need to conserve forest resources, NRDP also now in- cludes an afforestation program. Aimed at improving agricultural servl.ces for the entire country by the end of a 20-year period, NRDP's general goals and implementation appear reasonable. The main problem areas lie in stafE- ing, standards, planning, expenditure priorities, and improvements in extension and research. While current manpower shortages are being met through training and upgrading of existing staff, competing demands from estates and agro-busineSses for the anticipated increased output irom - xx - agricultural schools may lead to chronic shortages and necessitate some re- phasing of NRDP. In addition, given Malawi's financial constraints, pre- sent extension ratios, housing standards, etc. raise serious questions about the speed with which NRDP can be extended. The scheduled government review of standards is, therefore, to be welcomed. Further, the establish- ment of priorities for the implementation of NRDP would be facilitated through the preparation of indicative plans for the country's eight agri- cultural regions. 31. Current extension organization and methods are in general well suited to Malawi's stage of development. Extension workers are well trained and disciplined and the group method has proven an effective means for communicating practices to farmers. Some adjustments, however, could prove beneficial. Where the use of upgraded extension workers is espe- cially heavy, the quality of services might be improved through the use of the more disciplined and programmed use of the "training-and-visit" system now employed in other countries. In addition, extension needs to encourage more farmer participation to discover why particular crop packages are not being adopted and, through cooperation with research, develop appropriate remedies. Necessary improvements in research include the need to reduce vacancies and the redirection of research efforts toward responding to farmers- problems, studying mixed cropping, and developing high-yield maize varieties with appropriate taste and storage qualities. 32. Improvements in price incentives and in marketing services will play an important role in stimulating smallholder output. While an inter- ministerial price advisory committee was established in 1978, price deci- sions have been made ad hoc with respect to particular crops and have not appeared to reflect relationships between crops or an overall strategy to encourage smallholder production. Recently the Government has announced its intention to improve incentives for smallholders through annual price reviews. For these reviews, it has adopted a methodology which takes ac- count of export parity prices, grower's crop margins and ADMARC's revenues and costs and attempts to balance the interest of all three parties--pro- ducers, consumers and ADMARC. The adoption of this methodology represents an important step forward but more needs to be learned about intercrop sub- stitution in response to price changes if it is to be an effective guide to pricing decisions. Scope for increasing producer incentives can also be obtained by improving ADMARC's efficiency. ADMARC has generally been con- sidered an efficient marketing institution, but government officials are becoming increasingly concerned that its costs may be higher than necessary due to losses from improper handling and storage and excessive transport costs (arising from the location of storage facilities and from nationally uniform producer prices). An FAQ study will examine ADMARC's practices and make recommendations for improvement. Performance and Potential of Manufacturing 33. Between independence and 1980, the manufacturing sector expanded at an annual average rate of 9.6 percent, increasing its share in GDP from 9 to 12 percent. Growth in output has been nearly matched by that in em- ployment, indicating a fairly labor-intensive pattern of development. The resource base for manufacturing has been predominantly agricultural, mainly food and beverages, clothing and footwear for domestic consumption and - xxi - tobacco, tea and sugar processing for export. With the exception of tobacco, tea and sugar, manufacturing has contributed little to the expan- sion of Malawi's exports. 34. Since other industrial branches (e.g., metalworking, capital goods, chemicals) require a level of technical skills or market size which Malawi is unlikely t:o reach for many years, future manufacturing expansion will continue to be based on the country's agricultural, forestry and live- stock resources. The prospects for expansion look excellent. A consul- tant-s study has identified a large number of promising projects in oilseed extraction, honey and 'beeswax, dairying and livestock, fisheries, fuel alcohol from molasses; charcoal; sawmilling and particle board/plywood pro- duction; macadamia nuts, guar beans, coffee and rubber processing. Many of these projects link with efforts to diversify the estate and smallholder sectors. Tentatively, the study calculates the rates of return on the var- ious investments at between 10 and 36 percent; it also estimates that the net foreign exchange earnings for the export-oriented projects would total MK 9-15 million per year (1980 prices) and from the import substitution projects MK 14-21 million per year, the total (net) gains being the equiva- lent of about 10-15 percent of 1980 merchandise exports. 35. While high transport costs will continue to act as a disincentive for exports and as "protectibn" for import substitution, the poteni:ial still exists for exporting manufactured goods to distant markets (e.g., Europe) and, given increasing political stability, to nearby countries. In penetrating the latter markets, Malawi's relatively low production costs give it an advantage in producing low value:weight products, undercutling the high transport costs from outside the region; examples would be aglri- cultural implements, simple agricultural machinery, and processed foods (e.g., flour, maize meal). Malawi-s ability to enter the markets of many neighboring countries in the short- to medium-term will continue to be con- strained by their protectionist trade regimes and foreign exchange rat'on- ing systems. Nearby countries (mainly Zambia and Zimbabwe) are substantial importers of numerous products in which Malawi possesses potential for ex- pansion--e.g., vegetable oils and fats, dairy products and eggs, textiLe yarns and fabric, f-Lsh, confectionary groundnuts, fruits and vegetables, and crude rubber. 36. The policies necessary to support the output and employment ob- jectives of the manufacturing sector include improving incomes policies, strengthening major development institutions, and maintaining incentives which do not discourage agricultural growth. Formal and informal price controls, covering much of manufacturing, have led to the financial deter:L- oration of numerous firms and now constitute the most serious impediment to investment. The Government should give serious consideration to a drast.'- cally reducting the number of goods subject to control to a few essentials to low-income groups (e.g., maize meal) or vital to the national econormy (e.g., fertilizers) and to improving procedures for reviewing price change requests for such products. - xxi i - 37. While the Malawi Development Corporation and Press Holdings (together with other institutions such as INDEBANK) are expected to play a major role in developing agro-based industries, neither is at present in a position to undertake substantial new investments. The financial positions of both have declined as a result of falling profitability of their subsi- diaries, organization and management difficulties, and unfavorable medium- term debt profiles. The position of MDC is more tractable; it has closed down several of its unprofitable subsidiaries, employed consultants to make recommendations and, together with the Treasury and the Department of Sta- tutory Bodies, is undertaking a review of its financial position to deter- mine needs for refinancing and new equity injections. Press has closed un- profitable subsidiaries, trimmed its labor force, suspended dividends, and employed international consultants to make further recommendations about reorganization and financial restructuring (the consultant's report is expected by the end of 1981). While such steps are important and, properly implemented, will improve Press' profitability, Press' unfavorable debt profile means that financial restructuring will at some point be necessary. 38. Since the future development of manufacturing will be agro-based, care will have to be exercised that incentives for industry do not discour- age agriculture. In general Malawi's past development has been free of such problems. While special protection and exclusive domestic production privileges have been granted in a limited number of cases, tariff rates are quite mild and quantitative restrictions on imports have been largely avoided. However, it is worth pointing out that even relatively mild tariffs (especially when combined with low agricultural producer prices) are a disincentive to agricultural production. In addition, the present tariff system--with higher rates on consumer goods than on intermediate and capital goods rebates on certain inputs used in the production of domestic- ally used goods and drawbacks on all imported materials used in manufac- tured exports--is biased in favor of consumption goods and in favor of pro- duction using imported inputs. The Government may wish to review this structure of incentives to determine whether it is consistent with national objectives. Population Policy 39. Malawi's outstanding demographic characteristics are its high rates of total fertility and mortality (the latter the result of high in- fant and child mortality rates). The total fertility rate (about 7.75) is among the highest in the world. The causes of the infant and child mortal- ity rates--high even by the standards of low-income LDCs and other sub- Saharan countries--are as yet unclear and merit serious and prompt study. Since mortality can be expected to decline with improvements in incomes, health, education, etc., population growth will depend importantly upon fertility behavior. With constant fertility, population growth will accel- erate to 3.6 percent per annum by the year 2000 and the population in the year 2010 would total 17 million. With a mild reduction in fertility (to 6.9, 1990-95; and 4.8, 2005-2010), population growth would drop to 2.6 percent around 2000 and the 2010 population to 14 million. With a drastic - xxiii - (if somewhat unrealistic) fall in total fertility to 3 by 1990, population growth would fall to 1.4 percent per annum by the turn of the century and 2010 population would tot:al 9 million. Thus, it is evident that fertility reductions can have significant effects on the size and growth of poptla- tion and consequently on the numbers demanding government services a-nd employment. 40. However, the Government's approach to controlling population growth is passive. ]:t a:Llows the distribution of birth control devices by hospitals and clinics, but will do nothing to provide active support for birth control. Therefore, the reductions in fertility from natural socio- economic causes are likely to be slow. Marriage is early, large numbers of children are desired to provide labor services and old age assistance, and high fertility rates are needed to assure the desired number of surviving children. Given the very low level of per capita income, the continuillg rural character of Malawian society, and the likely slow progress In extending education t:o women (especially above the secondary level), rapid declines in fertility from natural causes are unlikely. 41. Given the slow and uncertain effects of socioeconomic variables on fertility reduction, government efforts to reinforce and accelerate thiLs process would be highly desirable. Action would required on both the sup- ply and demand side. On the one hand, emphasis would be placed on building up existing health facilities (including the under-five clinics), training health personnel in delivering family planning services and increasing the numbers of health personnel. Action on the demand side is needed at two levels: (a) the provision of information on the effects of large families, the desirability of spacing births to improve child health and control family size, and the methods for limiting family size involving the use of mass media, health units and the adult and formal education systems; anid (b) direct action oni socioeconomic variables affecting attitudes toward fertility (e.g., efforts to improve child health, improvements in the edui- cation of women). Since lead times are long in improving facilities, training personnel, and changing attitudes toward family size, it :is important that a start on family planning programs be made as soon as pos- sible. Human Resources 42. The links between investment in the social sectors and econa,mic growth in developing countries is becoming increasingly more clear. More education leads to increased earnings and greater farm productivity; iDI- provements in health (including nutrition and water/sanitation) raise labor productivity and so forth. Despite financial constraints, Malawi has madle considerable progress in the provision of social services. Since indepen- dence, primary school enrollments have more than doubled and secondlary school enrollments increased almost fourfold. The coverage of health care has been expanded through the growth in facilities and through preventive programs such as the under-five clinics, immunization, nutrition educati:n, etc. Over 70 percent of the urban population has access to safe water through piped systems; in 1977, over 30 percent of the rural population haLd access to safe water through gravity-fed piped systems, shallow wells and boreholes and this number was expected to have reached 50 percent by 19B(). As a consequence, compared with other sub-Saharan African countries, - xxiv - Malawi performs as well or better than its income-predicted level in many areas--e.g., primary school enrollments, female enrollments, adult liter- acy, access to safe water. 43. One of the major reasons for this performance has been the strong degree of local participation and self-help. Major infrastructure invest- ments (e.g., secondary schools, universities, central hospitals) are under- taken by the Central Government. Self-help district development committees (DDCs--established in 1966) are responsible for initiating all smaller- scale projects such as primary schools, health clinics, teacher and health worker housing, wells and gravity-fed piped water systems. The DDCs are broadly based advisory and decisionmaking bodies which gather ideas from village and area action committees and act as coordinators between the local level and the Central Government. While responsible for the comple- tion of projects, the DDCs must rely on other units of local and central government for construction plans, specialized equipment, etc. An impor- tant element of these projects is the self-help labor provided by the proj- ect beneficiaries. Self-help projects have attracted substantial external support from donor governments and volunteer agencies. 44. Despite progress in the social sectors, considerable problems re- main. Primary and secondary school enrollments remain low and increased efforts are needed to expand them. Moreover, there are large regional in- equalities in education services. Enrollment ratios are highest in the north, lower in central and lowest in the southern region; student-teacher ratios again favor the north. While it has been government policy to reduce inequality, progress has been very slow. In addition, the quality of educational facilities at the primary level is in need of improvement; many schools lack books, maps, desks, etc. and the quality of school con- struction, in many instances, is low. These factors, together with the ill-health of many students, appear to be having pronounced effects on the amounts learned. Therefore, the recent decision of the Central Government to provide primary school textbooks and assistance for self-help construc- tion is welcome. While the use of medical and prenatal facilities has clearly been expanding, the continuing high incidence of communicable diseases (e.g., malaria, measles) and high infant/child mortality rates suggests that further improvements are warranted. Although mother-and- child health, immunization, and vector controls have been attracting greater attention, most government health resources continue to be directed toward traditional health facilities. Shortages of staff at all levels continues to be a serious constraint on the expansion of health care. Lastly, the lack of a health plan makes it difficult to establish project priorities or to assess present and future staff requirements. 45. The budget constraints on the expansion of social services makes it essential for the Government to reassess policies towards standards of services and toward cost recovery. Such factors as student/teacher ratios, staff housing, and the quality of facilities should be carefully re- examined to determine where economies can be affected without significant losses in the quality of services provided. In education, secondary and university tuition fees cover but a small fraction of recurrent and capital - xxv - costs. At a minimum, tuitions ought to be raised at the same rate as costs. Better, since access is severely limited and the private returns have been shown to be very high, the Government should consider more siz- able increases to ration access and provide finance. To protect the needy student, subsidized loans or scholarships could be offered. Similarly, in health, the Government should consider expanding charges to a wider range of services, with exemptions for the truly needy. In water, the system of charges is more varied. In Blantyre and Lilongwe, the system has been self-supporting, covearing operating and capital costs; here, the policyi of periodic price increases to compensate for rising costs should be conl:in- ued. Moreover, these principles should be extended to other urban areas, which have operated at a small collective deficit. Because of low mainte- nance costs and the large amounts of self-help labor involved, the policy of providing free rural water seems justified. Should maintenance costs increase significantly, however, a system of charges should be considered. Policies and Prospects for the Eighties 46. During 1979 ancd 1980, Malawi experienced a severe economic crisis characterized by slower growth, increased government budgetary defic:its, deteriorating financLal positions for many private and public enterprises and growing balance of payments pressures. Falling prices for tobacco and tea accompanied by rapid increases in import prices (especially for fuqls, fertilizers and transport) have led to terms of trade which have aver<.ged 25 percent less than those of the mid-1970s. These problems were exacer- bated by declines in several smallholder crops due to weather and peric,dic traffic disruptions on the Beira and Nacala raillines. Squeezed between rising costs and relatively ppor product prices, many tobacco estates, private and public enterprises have experienced deteriorating cash f1ows and difficultires meeting their debt service obligations. The expansior of government expenditures outstripped the growth in revenues, leading to larger budgetary deficits and increased borrowing from the domestic banlking system. Increased balance of payments current account deficits have leen financed, in additiorn to normal aid sources, mainly by borrowing on comr.er- cial terms drawdowns in foreign exchange reserves and the use of 114F resources. Faced with growing internal and external imbalances, thle Government has initiated a number of demand management measures, leading 1:o a standby arrangemenl: with the IMF. The Government-s fiscal and financial austerity program has consisted of restraint on expenditure expansion, measures to raise revenues (e.g., increases in excises and import dutiei;) and increases in interest rates. On the supply side, the Government has also taken important steps to improve prospects for export and import sub- stitution including price incentive measures, increased budgetary alloca- tions for the development of smallholder agriculture, and institutional reforms. These demand and supply side measures have improved the prospects for recovery and set the stage for more rapid long-term growth. 47. The strategy for the decade of the eighties places increasing emphasis on the development of agriculture, agro-based industries and huilman resources as the most: promising avenue for sustained growth in the face of poor prospects for the external terms of trade, the near exhaustion of Uil- - xxvi - cultivated arable land and a growing manpower constraint. The Government's increasing emphasis on agriculture and human resources (as evidenced in their increasing shares in the 1981/82-1985/86 investment program, for example) is entirely appropriate. The development of agriculture and re- lated agro-businesses builds upon Malawi's comparative advantage, offers the best prospects for increasing exports and efficient import substitu- tion, and provides the most promise of productive employment for a rapidly growing labor force. The increased emphasis on human resources is comple- mentary to agro-based development. The expansion of literacy, increases in numbers of middle level manpower and improvements in health will, for example, facilitate the adoption of new technology by smallholders, the training of skilled agricultural and industrial workers, and increases in labor productivity. 48. The required supporting policies have been described in previous sections and need only be summarized here. In addition to increased bud- getary allocations for agriculture and the social sectors, they include: for agriculture--improvements in price incentives, marketing services, and extension and research efforts, and the preparation of indicative plans for the eight agriculture regions; for industry--improved price incentives, strengthening key institutions (e.g., MDC, Press) and the maintenance of a trade regime that minimizes disincentives for agricultural expansion. 49. Malawi will be under tight balance of payments constraints during the 1980s. While traditional smallholder exports and "other exports" (con- sisting of new or heretofore relatively minor smallholder and estate prod- ucts and agro-industrial products) can be expected to grow more rapidly, they will not compensate for slower growth of traditional estate exports (tobacco, tea, sugar) or the relatively small projected improvement in the external terms of trade. Moreover, competing claims on foreign exchange earnings will continue to be heavy: there is little prospect for improve- ments in ocean freight rates or in the ports or rail lines through Mozam- bique and debt service, arising from large amounts of commercial borrowing in the late 1970s, will be heavy in the early 1980s. In addition, to improve Malawi's external creditworthiness for borrowing modest amounts of its capital requirements on commercial terms and to encourage foreign investors to provide direct foreign investment to support agro-industrial (and other) enterprises, restoration of foreign exchange reserves to more prudent levels will be an important part of the Government's balance of payments strategy. The above claims severely constrain the use of foreign exchange for expanding imports. 50. Given such constraints, growth during the 1980s will be slower than in the past. With the cutback in tobacco acreages and the poor pros- pect for any improvement in the terms of trade, growth during 1981 and 1982 will be particularly slow. After that--as the terms of trade improve, the tobacco industry begins to recover and efforts to stimulate diversification begin to accumulate--growth should begin to accelerate. Real GDP growth is expected to average 4.6 percent per annum during 1980-85 and 5.8 percent per annum during 1985-90 (the 5.2 percent average for the decade falling substantially short of the 6.8 percent average for 1970-79). - xxvii - 51. Malawi's capital requirements for 1981-85 will be substantial. The gross foreign capital inflows required to cover projected current aLc- count deficits, make amortization payments, and allow a buildup of foreign exchange reserves (toward the equivalent of three months of imports) amount to US$1.8 billion or US$360 million per year. Since the Government of Malawi has been successful in attracting grant assistance, approximately one-third is projected to be on a grant basis. The remainder is broken down as follows: bilateral/multilateral borrowing (44 percent), direct foreign investment (5 percent), and commercial borrowing (18 percent). On this basis, Malawi-s debt service ratio would rise from 19 percent in 1980, peak at 25 percent in 1982, and gradually taper off to 16 percent in 1985, and 13 percent in 1990. 52. The Governments budget will also be under tight constraints liar- ing the 1980s, especially during the period up to 1985. On the one hlrLd, owing to the need to build up foreign exchange holdings and allow domestic credit to flow to the private sector to support economic recovery, govern- ment borrowing from the domestic banking system must be held to a minimum. On the other hand, heavy recurrent expenditure requirements arising from investments in agriculture and the social sectors and increasing lebt service payments (especially in the early to mid-1980s) will lead to needs to expand recurrent expenditures. Reconciliation of these opposing needs is possible (without resorting to underfunding recurrent operations) through a modest improvement in tax effort, restraints on other (non- project related) recurrent expenditures (e.g., for administration and defense, grants and subsidies), and restraint on the expansion of deveLop- ment expenditures. 53. The amount and terms of aid will be important to Malawi's perEcr- mance during this decade. The real volume of aid should grow and the terms become somewhat soft:er. The expansion of aid 1980-90 projected hern is quite modest. The 1.0.7 percent per annum growth in aid (in nominal teens) implied in the forecast is less than the 11.7 percent growth called in the "high case" in the World Bank's World Development Report 1981.3 A mocre rapid expansion would allow a greater acceleration of development expemldi- tures and hence more rapid growth. Moreover, in view of the fact -hat Malawi's budget and balaLnce of payments will be under particularly serere constraints during the next two or three years, a temporary shift in empha- sis from project to program assistance would be desirable. The projected trend toward somewhat softer loan terms is an important part of the budget and balance of payments scenarios. The trend, together with governrient policies which moderate the size of budget deficits and current account deficits (relative to GDP), would allow Malawi to undertake modest amounts of borrowing on commercial terms while still reducing the share that debt service absorbs out of recurrent budget expenditures or export earnings 3The "high case" assumes the DAC countries maintain net disbursements of development assistance at levels equivalent to 0.37 percent of their combined GNP throughout t-he decade 1980-90. See World Bank, World Deve'op- ment Report 1981 (Washington, D.C.: August 1981), pp. 12-13. MALAWI GROWTH AND STRUCTURAL CHANGE A BASIC ECONOMIC REPORT I. BACKGROUND The Economic Setting 1.01 When Malawi gained political independence, it was clearly the poorest of the three territories of the Central African Federation.1 Unlike Northern and Southern Rhodesia (Zambia and Zimbabwe), it did not possess any substantial mineral resources. While low-grade coal and baux- ite deposits were known to exist, it was not--and has not been to this day--economically feasible to exploit them. Some mines and quarries sup- plied local building materials, including inputs to the cement industry. Because of the lack of mineral resources, it had, unlike its partners, attracted little outside interest. Apart from the plantations of the southern region (mainly tea and tobacco), Malawi was largely a subsistence economy with non-monetary output accounting for almost one-half of gross domestic product. Whatever infrastructure there was, was concentrated in the south; the poorer central and northern regions were poorly connected by road with the more prosperous south. 1.02 It was evident from the outset that Malawi's development must be based on agriculture. The soil was moderately fertile and the climate-- with fairly reliable rainfall--made the country suitable for a variety of foodcrops and tropical cash crops such as tea, tobacco, sugar and cotton. While population growth was rapid and densities were already among the highest in Africa, there was still potentially cultivable open land--espe- cially in the north--and considerable potential for increasing the produc- tivity of land. In 1964, agriculture accounted for 55 percent of GDP and occupied over 90 percent of the resident labor force; agricultural produc- tion derived from two subsectors, smallholder agriculture and estate agri- culture. The smallholder sector accounted for nearly 90 percent of all agricultural production and met the country's demand for food staples (maize, beans, groundnuts, sweet potatoes and rice), provided raw materials for domestic industries (cotton and tobacco), and created an exportable surplus amounting to nearly one-half of merchandise exports (groundnuts, lIn 1965, GNP per capita in the three countries was: Malawi--US$60; Zambia--US$250; and Zimbabwe--US$220. Comparable figures for 1979 (at 1979 prices and exchange rates) were: Malawi--US$200; Zambia--US$510; and Zimbabwe--US$470. - 2 - cotton, tobacco). The estate sector was dominated by foreign-owned tea and tobacco plantations, producing almost entirely for export. Estates pro- duced about 43 percent of merchandise exports and provided roughly nre- quarter of wage employmeat in 1964. 1.03 At independence, Malawi's reliance on external capital and nan- power was pronounced. Virtually all of the tea estates were owned by British companies. Manufacturing and transport were dominated by Bri:ish firms and commerce by Asian traders. Because of the scant resource base, domestic savings were almost non-existent and virtually all of the domestic capital formation was financed from foreign sources. Domestic governrnent revenue was insufficient to cover the operating expenses of the small ad- ministration, and re!current budget deficits were covered by UK grants--in- aid. 1.04 In addition, Malawi was heavily dependent upon expatriate exper- tise. Education--particularly for Africans--had been badly neglected by the colonial administration; education was a relatively small part of the government expenditures and the amount spent per white student was over one hundred times that spent on. an African student. While mission schools taught literacy and religion, their emphasis was on elementary vocational skills thought to be practical for the native population (e.g., smithery, carpentry and rules of crop production); such education, in many instances, appears to have had 'Litt:Le lasting effect on literacy. Secondary education began in 1940, but prior to 1962, only four secondary schools existed "two constructed with government funds and two with church funds). By the time of independence, the seven-year primary school program was catering to Less than half the relevant population, many schools only offered two or tliree grades and physical facilities in many instances were woefully inadequate. Total secondary school enrollment was about 4,000 students, about 1 percent of the relevant population, and vocational and technical schools enro.led less than 1,000 students. Only 33 Africans had completed a university edu- cation. Under these circumstances, a continued dependence upon expatr:Late expertise was hardly surprising. Expatriates were concentrated in the higher skill levels: they constituted over 80 percent of secondary school- teachers, over 50 percent of higher-level positions in Government and over 90 percent of all positions requiring university degrees. 1.05 Because of the landlocked position of the country and becausr! of the need to open up the underdeveloped northern and central regions, trans- portation has captured a large share of government attention since indepen- dence. For the bulk of transport of its foreign trade, Malawi has relied on railroad routes, through Mozambique to the port of Beira (and aiter 1970, a route to the port of Nacala); in addition, until the time of the Mozambican-Rhodesian border closure (1976), substantial railroad traffic existed through Mozambique with both Southern Rhodesia and South Afr:.ca. Moreover, with Rhodesia'S Unilateral Declaration of Independence (1965) and later with the closing of the Zambian-Rhodesian border (1973), a small but growing proportion o:l Zambia's external trade has transited Malawi en route to Mozambican ports. Malawi's landlocked position has put it at the mlrcy of forces over which it has little control. At times, conflict wi:hin Mozambique, Mozambique's disputes with its neighbors, and growing conges- tion within the ports of Beira and Nacala have delayed or severed external traffic; together with accelerating fuel price increases since 1973, these factors have led to a rapid expansion in costs of Malawi's external trade. On the domestic side, in order to provide for a growing volume of agricul- tural produce in all regions of the country, as well as for political and security requirements, an expansion of the internal transportation network was clearly called for. Attention was focused on the main north-south arteries with the construction of roads linking Lilongwe with Blantyre and Zomba in the south and Mzimba and Mzuzu in the north, and with the con- struction of the lakeshore road. In addition, feeder roads were started to facilitate the marketing of agricultural crops. Cultural and Political Aspects 1.06 Malawi enjoys a considerable degree of ethnic and linguistic uni- formity. While ethnic and regional differences do exist, they have not been a disruptive element within society. Of the nine major total group- ings, the Chewa predominate in the central region and the Nyanja (closely related to the Chewa) in the south. The Tumbuka are the predominant tribe in the north. The other tribes consist of the Ngoni in the south and north, Tonga and Ngonde in the north, and the Yao, Lomwa and Sena in the south. Over three-quarters of the population speak and/or understand Chichewa, the language of the Chewa and Nyanja and, since 1968, the nation- al language of Malawi.2 Malawi's tribes are sufficiently alike in culture and social organization to permit relatively easy interaction, including intermarriage, mixing in agricultural settlements, and mixed groupings for political purposes. Unlike many other African countries, the need for tri- bal representation and for tribal balance has not been a major considera- tion for the appointment of cabinet ministers and other high government officials. 1.07 Since independence in 1964, Dr. H. Kamuzu Banda has led Malawi with a firm hand. His power derives from his unique qualities of leader- ship as well as from his control over the structure of government and over the sole political party, the Malawi Congress Party. The President has the power to appoint and dismiss cabinet ministers and all civil servants (in- cluding military officers) and selects members of parliament from a list submitted by the Party in each district. In accordance with the constitu- tions of the state and party, the goals of the Government and the Malawi Congress Party are the economic and cultural development of Malawi for the benefit of its citizens. All citizens are expected to participate in the development effort, a concept in full accord with the traditional African concept of the communal village society. Dr. Banda has also strongly en- couraged private enterprise and foreign investment. 2English, a legacy of the colonial past, is the language of government and commerce. Along with Chichewa, it is used as a medium of instruction in the schools and by the mass media. -4- Development Strategy 1.08 Malawi has opted for an outward-looking, export-oriented growth strategy based upon agriculture. The dependence upon agriculture was dic- tated by resource endowments: fertile land and labor were relatively abun- dant while mineral resources, capital and skills were in short supply. The emphasis on exports was dictated by the desire for rapid growth. Given the country's limited productive capacity, possibilities existed for the -rapid penetration of worldl markets with little risk of depressing prices. On the other hand, given t;he small size of the domestic market (a population of 5.7 million and a per capita income of US$200 in 1979), a strategy of autarky would have quickly exhausted the possibilities for efficient import substitution and constr-ained the expansion of industries to the rate of growth of the domestic market. Malawi's choice of an export-oriented, agro-based strategy has strongly influenced its policies toward the agri- cultural and manufacturing sectors, toward prices and wages, and toward the roles of domestic and foreign investment. The emphasis upon production has also had important implications for investments in the social sectors. 1.09 For agricultural development, the Government has opted for a two-pronged approach, involving the smallholder and estate sectors. In the traditional sector, it has undertaken a number of rural development -:roj- ects designed to raise agricultural productivity and to increase cas'h in- comes through the sale of surpluses to the growing urban areas and through the introduction of export crops. Past public investments have been of two types: (a) a more general approach involving a gradual improvement in ex- tension, land husbandry, and farmer training throughout the countr,y and supported by small, low-cost rural development projects and by special activities such as ox training, dairy improvements and tea development; and (b) more expensive and management-intensive integrated development programs in four areas (Lilongwe, Shire Valley, Karonga, and Lakeshore). The i'our comprehensive projects all involve the provision of infrastructure, land improvement and conservation measures and are concentrated in the more densely populated areas covering about 20 percent of Malawi's population. Since three out of the four are outside the southern region, they also con- tributed toward the Government's goal of more balanced regional develop- ment. By the mid-1970s, it became increasingly clear that such inte1Sive and costly capital investments could not be replicated in the rest oJ.' the country within a reasonable length of time. Rethinking the Government's strategy led to the National Rural Development Program (NRDP, initiate(d in 1978), the basic thrust of which was to provide agricultural services more extensively to a larger segment of the population by concentrating re- sources on the more immediately productive areas. Under NRDP, cultivation of new land is discouraged and emphasis given to increasing smallholder productivity through the provision of agricultural inputs and serzices (most particularly extension, input supply, marketing, and credit). NRDP aimed to extend and consolidate various rural development programs over the entire country within 20 years but with less intensive staffing and i-nfra- structure than past projects. 1.10 The rolE of the estate sector has been to generate foreigl ex- change earnings through sales of tobacco, tea, and sugar and to create rural employment opportunities. Since the sector has been largely left in private hands (except for public enterprise participation in sugar and in some tobacco estates), the Government has attempted to provide a favorable investment climate. The most important incentives have been the ability to sell products at export parity, inexpensive and readily available leases on land (especially for tobacco), and low wages. 1.11 In the Government's overall strategy, the role of manufacturing has been to create domestic value added and employment. The sector's ex- pansion is closely linked to the expansion of agriculture, both on the sup- ply and on the demand side. The growth of agriculture would increase the supply of products for further processing (e.g., maize milling, textiles, and oilseeds as well as tea and tobacco); at the same time, it would also lead to an increase in demand for agricultural inputs (e.g., implements, seeds, fertilizers) and for consumer goods. This view of the complementary roles of agriculture and manufacturing has strongly influenced Malawi's in- dustrial policy which is aimed at fostering the growth of firms which are competitive at international prices. While, in some instances, moderate amounts of protection have been granted to provide some market security and firms have been granted exclusive domestic production rights for limited periods of time,3 by and large, tariffs are quite low and quantitative re- strictions have been largely avoided. In general, policy has been directed at preventing the establishment of firms which would only be profitable if their inputs were severely underpriced or their outputs severely overpriced by comparison with international prices; both would tend to reduce farmers' real incomes thus discouraging agricultural development, the former by pay- ing farmers too little for their products and the latter by forcing farmers to pay too much for inputs or for consumer goods. By the same logic, gov- ernment policy has discouraged the establishment of capital-intensive industries; such investments would create little domestic value added or employment and would require too much protection in order to be financially viable. 1.12 Incomes policies--in the form of controls on both prices and wages--have played an important role in restraining the domestic rate of inflation and the rate of increase of wages and labor costs thus maintain- ing Malawi's international competitiveness, providing incentives for the introduction of labor-intensive methods and controlling the rural-urban in- come gap and hence the rate of internal migration. Over the past decade, a system of formal and informal price controls has evolved for most domesti- cally manufactured goods.4 With the increased inflationary pressures that began in the late 1970s, the price control system has begun to create ser- ious disincentives for producers. Incomes policies have also been imple- mented through government review of all private sector/parastatal employer applications for wage increases in excess of five percent to determine 3For details, see Chapter V. 4For a more complete description and analysis of the price control system, see Chapter V. - 6 - the likely effects on output prices, on capital-labor substitution and on the ability of the firm to attract necessary semi-skilled and skilled labor.5 In part, incomes policies have also been implemented by restrain- ing the behavior of those institutions which have a tendency to raise 'aages regardless of demand and supply conditions. While trade unions do exist in Malawi, they. have not played an important role in wage negotiat-'ons; Government has not acted as a wage leader but has set civil service ,ala- ries (usually with a considerable lag) so as to maintain competitiveness with the private sector. As a consequence of incomes policies, wage in- creases in Malawi have been quite moderate as compared with those in ,other African countries and as compared with the prices of imported consumer and capital goods. Moderate wage expansion, coupled with growing labor produc- tivity in most sectors of the economy, have helped to keep Malawian goods competitive in international trade; wage moderation has also kept the demand for labor high and meant that the rapid economic growth MalawL has experienced since independence has been accompanied by a rapid expansion of employment opportunities. 1.13 Regarding local participation in enterprise, the Government'! ap- proach has been highly pragmatic, a middle road between the desire tc in- crease indigenous participati6n in enterprise and the evident need for for- eign capital. The Government has successfully steered this middle road. Incentives for investment include moderate levels of taxation,6 relatitvely low wages, exchange rate stability and the absence of restrictions on the repatriation of dividends and interest. Such incentives, together with the dynamic performance of the economy, have been sufficient to stimulate a rapid expansion of domestic investment and to obtain a growing net capital inflow for private and public enterprise ventures. On the other hand, Malawian ownership of capital assets in agriculture, trade, and industry has increased appreciably. The Government bought out a number of pr:ivate estates in the cent:ral region for resettlement by Malawians; it has also made it relatively easy for Malawian enterprises to obtain leases on cus- tomary land and the number of tobacco estates has expanded rapidly. In 1969, the licenses of Asian rural shopkeepers were not renewed and by 1972 their activities had been restricted by law to urban areas. The Import: and Export Corporation (a wholly-owned subsidiary of the Malawi Development Corporation) was established in wholesale trade to assist in the tranLsfer of rural stores to African ownership by supplying essential, mass-con: umed items; it also was to give preference to foreign suppliers who would con- sider setting up subsidiaries in Malawi once a market had been establi:hed. 5Malawi's wage review procedures and its wage and employment ixpe- rience are summarized irl Chapter II. 6While Malawi offers no tax holidays and taxes company income at a 45 percent rate, it does offer a rather generous level of depreciation wlite- offs, initial investment allowances, a system of rebates of import dities on some inputs, and drawbacks on duties on inputs in the production of man- ufactured goods that: are exported. See Chapter V for a more complete das- cription and assessment. - 7 - The usual range of utilities is under public ownership--railways (which were nationalized in 1966), electricity, telecommunications. Most signi- ficant, however, has been the rise of a group of public and quasi-public institutions which have made loans and equity investments and, in some in- stances, provided the management expertise for a wide range of activities in agriculture and industry; these organizations include the Malawi Devel- opment Corporation (MDC), Industrial Development Bank (INDEBANK), Agricul- tural Development and Marketing Corporation (ADMARC), and Press (Holdings) Ltd.7 Today, the ownership and operational control of industrial enter- prises is heavily concentrated in these parastatals and a few large foreign controlled firms. In addition, MDC, Press and ADMARC combine to own major- ity shares in Malawi's two commercial banks. The four enterprises strongly influence the operations of the important industrial firms and most major investment decisions--even those of companies with majority foreign owner- ship. Parastatals are particularly dominant in mainline products of agro- industries, which they own either wholly or jointly with foreign compa- nies. Wholly-owned subsidiaries produce maize meal, flour, edible oil, fish, bread, coffee, canned fruits and vegetables, milk, rice, fertili- zers. Foreign firms are major partners in the production of beer (Carls- burg), textiles (David Whitehead and Sons) and vegetable oils and chemicals (Lever Brothers). 1.14 Because of its growth orientation the Government has directed the bulk of public expenditures toward the productive sectors (mainly agricul- ture) or toward supportive sectors (mainly transportation but also communi- cations and power) and, as a consequence, spent relatively smaller amounts on the social sectors (education, health and housing). The Government's serious financial constraint dictated a conservative approach to the social sectors. The Government was acutely aware that social sector investments tend to generate relatively large claims for recurrent expenditures in future years and that the experience of other countries had shown that it was relatively difficult to satisfy the public's demand for social services (especially if, as is usually the case, they are heavily subsidized). Since independence, the primary concern of the Central Government has been the expansion of secondary education to meet the country's evident manpower requirements; emphasis was also given to post-secondary education through the establishment of the University of Malawi and to the introduction of formal and informal agricultural education (through the introduction of agriculture into secondary and primary curricula, through the training of technical workers, and through the creation of rural training centers for farmers). The expansion at the secondary and post-secondary levels has been impressive: secondary school enrollments have increased almost four- fold since independence8 and university enrollment tripled between 1966 and 1978. This, in turn has led to a sizable increase in Malawian parti- 7For a more complete description of the nature of these enterprises and their activities, see Chapter V. 8However, recently secondary school enrollment growth has been slower, averaging only 3.6 percent per annum 1972-79. - 8 - cipation in the middlle and top levels of the private sector and civil ser- vice, including secondary schoolteaching where the percentage of expa- triates has dropped from 80 to 24 percent during the past 15 years, None- theless, the secondary school enrollment ratio is still only 4 percent--low even by African standards--and the stock of technical and managerial man- power is still limited. Manpower thus remains a serious constraint on development. 1.15 On the other hand, primary education has absorbed relatively little central government investment. While after independence the Central Government took control over curriculum, teacher standards and teacher al- locations, the level of primary school fees, and the payment of primary schoolteacher salaries, it left the construction/maintenance and equipping of primary schools to be handled from local government finances and self- help programs. Actilvities at the primary school level since independence have been impressive: new classrooms have been constructed on an unprece- dented scale, enrollments have more than doubled raising the enrollment ratio from 40 to 56 percent, and the rate of efficient progression from one grade to the next has q[uadrupled. Nonetheless, there is growing concern about primary education: the enrollment ratio is still low and the quality of education--as is visible in the quality of the facilities and the avail- ability of teaching materials and as can be demonstrated about the amounts learned--is less than is probably appropriate. In addition, primary schoolteacher qualifications are low and the student/teacher ratios lhave been rising.9 Development Plan 1.16 Since independence, the Government has been guided by econo::mic development plans. However, owing to the scarcity of technical experliise and the inadequacy of the statistical base, early plans were little riore than lists of projecls for the Government's development budget. Plans did not take the long view of the development process; they provided neither an analysis of the country's development problems, nor comprehensive econcmic forecasts, nor a systematic quantitative and qualitative review of aggre- gate or sectoral development strategies. Many of the deficiencies of tie early plans were remedied by the Statement of Development Policies 1971-;30 (DEVPOL) which set cut the Government's basic priorities for developrie;at and provided a framework for long-term development planning. DE5iPOL spelled out Malawi's overall development strategy, provided projections of major macroeconomic variables and sectoral output, elucidated the strate- gies and policies for each of the major sectors, and presented indicative investment requirements (by government and public enterprises) for thie sectors. DEVPOL was not a development plan in the usual sense of the word. It was a statement of intent (but with supporting policies and investment strategies) and its projections were not so much targets z1s illustrations of prospects and the likely course of growth. DEVPOL has 9For a further discussion and appraisal of Malawi's education systern, see Chapter VII, paras. 7.07-7.32. - 9 - been implemented through a three-year rolling public sector investment pro- gram under which each ministry was allocated investment expenditure tar- gets. These three-year estimates were revised annually to take into account changing internal and external circumstances and included in the Government's development budget which is subject to legislative approval. 1.17 The main objectives of DEVPOL may be summarized as follows: (a) more rapid economic growth (8 percent per annum, with determined national efforts was considered a realistic possibility); (b) an increase in agricultural productivity to improve rural living standards, provide employment opportunities and earn foreign exchange; (c) a better balance in economic development between the three regions by the siting of rural development projects, by road building in the central and northern regions, and by the re- location of the capital from Zomba in the south to Lilongwe in the central region; (d) an increase in local participation both in semi-skilled and skilled employment and in the ownership of enterprise; and (e) elimination of dependence on foreign finance to cover gov- ernment recurrent budget expenditures. 1.18 As the coming chapters will show, many but not all of these goals have been achieved. The rate of economic expansion during the 1970s has been 7 percent per annum, a very respectable record even if below the goal of the plan. The foreign finance of the recurrent budget was elminated by 1972/73 and, in most succeeding years, modest recurrent surpluses have helped to finance development expenditures. The capital has in fact been relocated. Malawian participation in the ownership of enterprise has been greatly expanded. Performance on the remaining plan objectives has been mixed. While agricultural expansion has been rapid, generating employment and foreign exchange earnings, growth has been largely concentrated in the estate sector production of tobacco, tea and sugar; smallholder growth has been more uneven (with maize, rice and tobacco expanding, for example, and cotton falling) and on balance probably not much more rapid than population growth. Moreover, while government investment in agriculture, transporta- tion and the relocation of the capital has created a better balance in development and industry has been expanding in the Lilongwe area, the majority of industry is still located in the southern region, most particu- larly in the Blantyre area. Lastly, as already pointed out in paras. 1.12 and 1.13, despite the expansion of the educational system and the increased localization of employment in all sectors (except government), the develop- ment of skills remains a problem. Expatriates still constitute 3-5 percent of the labor force in most sectors (and a still larger share of top level professional and management positions) and shortages of skilled manpower are an important constraint to economic development. - 10 - II. MACROECONOMIC PERFORMANCE: AN OVERVIEW Growth and Structure 2.01 Over the period 1967-79, aggregate and per capita real, incomes grew rapidly (table 1). Real GDP grew at an average rate of 5.5 percent per annum, with growth aLccelerating during the last 9 years of the 12-year period. Over' the same period, the GDP deflator rose at an annual rate of 8.2 percent per annum, a very respectable performance when compared with the increases in the GDP deflators of the industrialized countries (8.8 percent per annum) or in prices of exported manufactures from the developed countries (10 percent per annum).1 Since net factor incomes did not change much in real terms between the end years, the growth in GNP was equal to that in GIDP; however, during the time when the remittances of migrant workers and interest earnings from increasing foreign exchange holdings were expanding rapidly (e.g., 1967-73), GNP growth exceeded GDP growth; in the succeeding period (1973-79) when migrant remittances and foreign exchange reserves were falling and servicing on external debt grow- ing more rapidly, the expansion of GNP has fallen below that in GDP. 2.02 Because of changes in Malawi's external terms of trade, real do- mestic income (GDY) has shown. a somewhat different pattern of growth than that in GDP. Since K4alawi's terms of trade have deteriorated some 14 er- cent over the 1967-79 period, the real growth in GDY has not kept pace with that in GDP. While Malawi's terms of trade were improving (e.g, 1967-73), real GDY growth was faster than real GDP growth; owing entirely to a sliarp decline in the terms of trade that began in 1977, Malawi's 1979 terms, of trade were lower than in 1973, and the growth in real income fell short: of the growth in real product for that period. lThe former is a weighted average GDP deflator for the industrialized countries while the latter is the World Bank's "international price index" which is a US dollar index of industrialized countries' exports to the developing countries. Both are reported in IBRD, Price Prospects for Major Primary Commodities, Report No. 814/80 (Washington, D.C.: January 1980). - 11 - Table 1: GROWTH RATES FOR AGGREGATE AND PER CAPITA REAL GDP, GNP, AND GDY 1967-70 1970-79 1967-73 1973-79 1967-79 1979-80 b/ GDP 1.4 6.8 4.7 6.2 5.5 0.2 GNP 1.8 6.7 5.4 5.6 5.5 0.8 GDY a/ 2.9 6.0 4.9 5.6 5.2 -1.9 GDP per capita -1.4 3.9 1.8 3.3 2.5 -2.4 GNP per capita -1.1 3.8 2.4 2.7 2.5 -1.7 GDY a/ per capita -0.0 3.1 1.9 2.7 2.3 -4.4 a/ Gross domestic income (GDY) is real GDP corrected for changes in the external terms of trade. b/ Preliminary. Source: Derived from Statistical Appendix, tables 1.04, 2.02, 2.03, and 2.04. 2.03 Growth rates in GDP, GNP, and GDY, however, have all exceeded population growth (about 2.9 percent per annum) by a comfortable margin, leading to per capita income growth of over 2.5 percent per annum for the period, with higher rates being recorded for the period after 1970. 2.04 There is reason to believe that average growth rates for 1967-79 somewhat understate the long-term growth rate of the economy, which most observers feel is in the 6-7 percent per annum range. This understatement is due to the poor performance of the economy during 1967-70 when output in agriculture, transport and community services all declined, leading-- because of interconnections with industry, construction and finance--to re- latively sluggish performance in other sectors as well (table 2).2 Aside from occasional lapses--usually due to bad weather--growth in other periods before or since 1967-70 has been considerably more rapid. Since 1970, GDP has grown at an average rate of 6.8 percent per annum, and even after the oil crisis of 1973 at 6.2 percent per annum (table 2). For 1970-79, growth in all sectors (except in subsistence production and community and social services) exceeded 6 percent per annum. 2Another reason for believing that the growth rate is understated is that subsistence growth is undoubtedly understated. While government statisticians have generally estimated subsistence growth as equal to population growth, actual expansion was probably higher. - 12 - Table 2: SECTORAL GROWTH RATES, 1967-1980 (percent per annum) 1967-70 1970-79 1967-73 1973-79 1967-79 1979-83 a/ Agriculture, Forestry, Fishing Monetary 0.2 7.2 3.7 7.2 5.4 -0.7 Subsistence b/ -1.9 3.7 1.9 2.7 2.3 -1.0 Total -1.3 4.9 2.4 4.2 3.3 -0.9 Manufacturing 4.2 6.5 5.1 6.7 6.3 3.9 Construction 5.7 8.3 6.9 8.3 7.6 -6.5 Electricity and Water 7.7 9.0 8.6 8.7 8.7 10.5 Wholesale and Retail Trade 10.0 9.8 13.4 6.4 9.9 1.2 Transport, Storage and Communication -6.9 9.9 5.4 5.5 5.5 2.5 Financial Services and Real Estate 5.8 15.0 13.0 12.2 12.7 4.4 Community, Social and Personal Services -0.5 5.7 1.1 7.3 4.1 0.3 Total GDP 1.4 6.8 4.7 6.2 5.5 0.2 Monetary 4.0 8.6 6.9 7.9 7.4 0.6 Subsistence -2.3 3.3 1.3 2.7 2.0 -0.7 a/ Preliminary. b/ See footnote, para. 2.04. Source: Statistical Appendix, table 2.02. 2.05 Because growth in Malawi has been widespread, structural shifts have not been pronounced (table 3). The largest shift has been the delicline in agriculture's share in GDP from 51 to 39 percent between 1967-79; since monetary output in agriculture has more or less kept pace with GDP,I, this decline has been due entirely to the relatively slow growth of subsi:!tence production. The shares of other sectors remained roughly constant ::,r in- creased marginally, wilth the largest increases occuring in trade (frcm 7.2 to 11.8 percent) and in financial services (from 3.0 to 6.7 percent). - 13 - Table 3: SECTORAL SHARES IN REAL GDP, 1967, 1973, 1979, 1980 1967 1973 1979 1980 b/ Agriculture, Forestry and Fishing Monetary 14.7 13.9 14.6 14.5 Subsistence 36.4 31.0 25.2 24.9 Total 51.1 44.9 39.8 39.4 Manufacturing 10.9 11.2 11.5 12.0. Construction 4.0 4.5 5.1 4.8 Electricity and Water 0.9 1.2 1.3 1.5 Wholesale and Retail Trade 7.2 11.7 11.8 11.9 Transport, Storage and Communication 4.9 5.1 4.9 5.0 Financial Services and Real Estate 3.0 4.8 6.7 6.9 Community, Social and Personal Services 13.0 10.5 11.1 11.1 Other a/ 4.9 6.2 7.6 7.3 Total GDP 100.0 100.0 100.0 100.0 Monetary 57.4 65.1 71.5 71.8 Subsistence 42.6 34.9 28.5 28.2 a/ Net indirect taxes. b/ Preliminary. Source: Statistical Appendix, table 2.02. - 14 - Capital Formation and Its Financing 2.06 Capital formation and its financing have been characterized by several dominant trends: (a) increases in domestic savings and investment as shares of GDP; (b) a growing contribution of domestic savings to the financing of investment; and (c) a concomittant decline in the share of in- vestment financed by foreign capital (the latter inspite of substantial in- creases in the level of foreign capital inflows). Taken together, these trends constitute a very impressive achievement. At independence, the situtation looked bleak. Investment was only 8.6 percent of GDP and it was apparent that large investments in economic and social infrastructurez would be required. Domestic savings were virtually nil (0.3 percent of GDP) and most capital formation was financed from foreign sources. Governmeint sav- ings were negative and recurrent budget deficits had to be financed by grants from the United Kingdom. Since then, the picture has changed dramatically. Table 4: SHARES OF INVESTMENT AND SAVINGS IN GDP (percentages) 1967-69 1970-73 1974-76 1977-79 1980 b/ Gross Domestic Investment, of which: 16.3 23.1 22.6 30.2 21.7 Gross Fixed Capital Formation a/ (16.1) (20.9) (22.6) (26.1) (21.7) Gross Domestic Savings 4.2 12.2 11.3 17.7 10.9 Resource Gap 12.1 10.9 11.2 12.6 10.8 a/ The difference between gross domestic investment and gross fixed capital formation is due to changes in stocks. b/ Preliminary. Source: Derived from Statistical Appendix, tables 2.01, 2.03 and 2.04. 2.07 Between 1967 and 1979, gross domestic investment (in f>urrent prices) grew at an average annual rate of 22 percent per annum, risinag as a share of GDP from 16 to 29 percent (table 4). The incremental c<.pital- - 15 - output ratio (ICOR)3 implied by this performance is 3.9; estimated ratios of similar magnitudes are obtained for subperiods within this period, implying that the ratio has been quite stable over time. While a ratio of this magnitude would not be considered low by comparison with some other fast-growing LDCs (e.g., Botswana, Ivory Coast, South Korea, Taiwan and Thailand), it is considerably lower than those of many nearby African countries--e.g., Kenya, Tanzania, Zambia, Zaire. Capital formation by all sectors increased roughly in line with the increase in total investment (table 5). The share of the Central Government in the total rose somewhat over the period while those of local government and the private sector mar- ginally declined; the share of public enterprises remained quite stable. 2.08 The domestic resource mobilization effort has been even more im- pressive; savings have risen faster than investment so that an increasing share of capital formation has been financed from domestic sources. During 1967-69 gross national savings (GNS)4 were sufficient to cover only 7.5 percent of domestic investment (table 5). GNS was sufficient to cover 48.8 percent of investment in the following period (1970-73) and marginally higher amounts thereafter. This improvement in performance resulted from large increases in savings in most sectors (except local government), most particularly by the Central Government and private sectors. In the early years, government savings were negative, a condition which continued until 1971. By holding the lid on the expansion of recurrent expenditures while revenues grew, the Government was able gradually to turn the recurrent deficit to surplus, increasing its contribution to total domestic savings and to the financing of its own capital expenditures. Over the last six years of the period, more than one-quarter of central government investment was financed by government savings. Similarly, private savings have also risen rapidly, raising the sector's share in total savings and its financ- ing of its sectoral investment program; during 1977-79, private sector sav- ings were over 90 percent of private sector investment. By contrast, pub- lic enterprises have not performed so well; over the period, their savings have increased less rapidly, reducing their share in total domestic sav- ings; nonetheless, public enterprises have generally been able to self- finance about 60 percent or more of their own investment programs. 3The ICOR is the change in the capital stock divided by the change in income (both in constant prices) and provides an estimate of the amount of investment necessary to generate one additional unit of income. For investment, figures for gross fixed capital formation were used (i.e., depreciation and changes in stocks were ignored). 4Gross national savings are equal to domestic savings plus net factor income. Since the latter have usually been negative in Malawi, domestic savings most often exceeds national savings. - 16 - Table 5: SHARES OF DOMESTIC AND FOREIGN FINANCING IN DOMESTIC INVESTMENT, 1967-80 (percentage contributions to gross domestic investment) 1967-69 1970-73 1974-76 1977-79 1980 b/ Gross Domestic Investment, of which: 100.0 100.0 100.0 100.0 100.0 Central Government 28.8 25.0 38.6 31.6 a,/ f.nL. Local Government 2.1 2.9 4.1 1.4 a/ n.a. Public Enterprises 18.5 22.8 18.8 19.1 a! n.a. Private Sector 50.7 49.3 38.5 48.0 n.a. Financed by: Gross National Savings, which equals: 7.5 48.8 50.9 50.9 38.3 Gross Domestic Savings, of which: 25.8 52.7 50.2 58.4 50.0 Central Government -18.3 3.1 10.0 8.3 a! n.a. Local Government 1.4 0.5 0.8 0.4 a/ n.a. Public Enterprises ) 42.7 12.9 16.9 10.8 a/ n.a. Private Sector ) 36.0 22.6 45.1 a! n.a.. Less: Net Factor Incomes -18.3 -3.9 0.7 -7.5 -11.7 Net Foreign Financing, of which: 92.5 51.2 49.1 49.2 61.7 Net Capital Inflow 49.5 47.8 28.6 40.3 44.7 Net Foreign Transfers 45.0 15.2 12.4 12.2 19.8 Net Change in Official Reserves (decrease = +) -2.0 -11.8 8.1 -3.3 -2.8 Memorandum Items (sectoral savings: investment ratios) Central Government Savings/ Central Government Investment -63.5 12.6 26.0 26.2 a/ n.a. Local Government Savings/ Local Government Investment 69.6 17.2 18.4 27.3 ax n.a. Public Enterprise Savings/ Public Enterprise Investment ) 56.7 89.9 56.5 a/' n.a,, Private Sector Savings/ ) 61.7 Private Sector Investment ) 73.1 58.7 93.9 a/ n.a. a/ 1977-1978 only. b/ Preliminary. Source: Statistical Appendix, tables 2.04 and 2.05 and mission estimates. - 17 - 2.09 The rising contribution of domestic finance to total investment necessarily implies a declining share for foreign finance (table 5).5 While annual average amounts of net foreign finance have increased almost fourfold over the period 1967-79, the foreign contribution to domestic cap- ital formation has declined from 93 to 50 percent. The major characteris- tics of foreign financing have been that: (a) the share provided from private and public capital inflows has increased while that provided by net transfers has declined; (b) the annual levels of net transfers declined as the United Kingdom withdrew its recurrent budget support, but have again begun to increase (starting in 1976) as the Government has been successful in mobilizing new sources of assistance on a grant basis; and (c) the con- tribution of changes in official reserves in financing capital formation has on balance been negative as Government policy has been to increase re- serves to maintain a prudent level of cover as imports increased. Budgetary Performance 2.10 At independence, Malawi's budgetary position was clearly con- strained. While there was a clear need for expanding government services--for projects to increase the productivity of smallholder agricul- ture, for transport links to unify the country and open up internal and ex- ternal markets, and for social services to develop labor skills and in- crease the well-being of the population, the possible bases for domestic resource mobilization were not obvious. Malawi possessed no mineral sector that could be readily taxed, its modern sector was relatively underdevel- oped and subsistence sectors generated a large proportion of GDP. The cen- tral government budget, therefore, was heavily dependent upon foreign sup- port. Ordinary revenues were not sufficient to cover revenue account ex- penditures,6 balance being achieved through yearly grants-in-aid from the United Kingdom. Development account expenditures were virtually entirely financed by domestic and external borrowing, with foreign resources provid- ing over 70 percent of total financing. To reduce dependence on foreign finance while providing adequate financing for an expanding level of gov- 5Net foreign finance consists of net (private and public) capital flows, net (private and public) transfers and changes in official reserve holdings. 6The central government budget contains two accounts: revenue account and development account. Expenditures in the revenue account are mainly of a recurrent nature--civil service salaries, purchases of goods and ser- vices, grants (to local government and other public bodies) and debt ser- vice, but also include some capital items--durable goods used for normal government operations (e.g., vehicles, typewriters), defense equipment, and equity investments in international organizations. Development account consists mainly of two types of capital expenditure--gross fixed capital formation and capital transfers (equity investments in or loans to public enterprises and local government); it also includes some recurrent expendi- tures in the form of wages and goods and sevices that foreign donors have agreed to finance during the period of project implementation. - 18 - ernment services, the Government sought to raise greater tax revenues; in DEVPOL this goal was explicitly stated as raising the share of tax revenues in GDP from 11 to 16 percent by 1980.7 In the process, dependence on for- eign grants for revenue account balance was to be eliminated by 1973, with modest surpluses thereafter to contribute to financing development expendi- tures. While the elimination of dependence on foreign grants for revenue account balance was achieved on schedule and the revenue account has -een in surplus in succeeding years (except for 1980/81), a number of impor:ant public finance issues remain unresolved: the size of the Goverrment's tax (and other revenue) effort, the adequacy of funding of recurrent expenidi- tures and, in recent years, the rapid expansion of budgetary deficits. 2.11 Over the period 1967/68 to 1979/80, government revenue increased at an average annual rate of 16 percent, somewhat faster than the growth in nominal GDP (table 6). During this time, tax revenues grew at 18.7 percent per annum while non-tax revenues expanded at 11.5 percent per annum rate. As a consequence, the former increased its share in GDP from about 8 to 13 percent, while the share of the latter fell from 6 to 4 percent. This tax performance was due to the elasticity of the direct tax system (especially the company income tax) and most particularly to the introduction in 1970 of the surtax (a fcrm of sales tax on imports and domestically produced goods); the shares of d irect taxation and the surtax in total governnaent revenue have expanded sharply during the 12-year period. On the oi her hand, the performance of import duties and excise taxes has been less ;at- isfactory, the shares of both in total revenue having fallen. Import duties have expanded relatively slowly and have fallen consistently as a percentage of the va:Lue of imports, owing in part to the specific nature of some duties (such as those on fuel) and in part to the increasing share in imports of intermediate and capital goods which are taxed at low or duity- free rates. Moreover, while the expansion of excise tax revenues has been faster than that of import duties, these taxes are also inelastic iith respect to their tax base, owing to the specific rates at which they are levied. Thus there is some cause for concern about revenue performance in Malawi. Total revenues, as a share of GDP, are below those of many African countries (e.g., Kenya, Tanzania, and Sudan and especially the mineral pro- ducing countries--Zambia, Zaire, and Liberia); and tax revenues are st:ill considerably short of the Government's goal of 16 percent of GDP for 1l:I80. Moreover, as will be seen below, revenues have lagged behind government ex- penditures, most particularly in recent years, leading to growing concern about the adequacy oi funding for recurrent and development expenditures. 7Statement of Development Policies, 1971-80. Table 61 CENTRAL COVEtRtHENT BUDGET, SELECTED YARS 1967/68-1980181 i (HK sition) J. 1967/68 1970/71 1973/74 1976/77 1977/78 1978/79 1979/80 1980/81 Eipendtturea 8v Government Accounts 49 0 82.1 92.0 149.5 184.9 253.9 300.9 378.6 Revenue Account 38.9 46.9 61.7 93.6 108.3 140.4 173.0 213.0 Development Account 10.1 35.2 30.3 55.9 76.6 113.5 127.9. 165.6 By Economtc Claesificatloa 49.0 82.1 92.0 149.5 184.9 253.9 300.9 378.6 Consumption 28.4 .31.6 38.9 60.4 72.1 99.0 n.-. n.e. Grants and Subsidies 6.5 8.8 11.4 14.9 11.5 15.5 n.a. n.e. Interest 2.5 S.1 3.5 8.7 10.9 14.3 n.a. n.a. Amortization 1.5 1.7 7.0 7.0 6.4 6.0 n.a. n.a. Capital Transfers 1.9 15.8 6.4 11.7 15.5 33.9 n.A. n.e. Capitol Formation 8.2 19.1 24.8 46.8 68.5 85.2 n.a. n.e. Revenues 30.4 43.9 63.1 94.3 115.7 147.8 186.9 202.4 Tax Revenue 18.6 41.6 70.5 87.3 119.1 1T62. Otther Revenue 12.4 17.4 21.5 23.8 28.4 28.7 45.8 39.6 Overall Deficiti -18.6 -38.2 -28.9 -55.2 -69.2 -106.1 -114.0 _176.2 Flnancing 18.6 38.2 28.9 55.2 69.2 106.1 114.0 176.2 Domestic Borrowing 5.0 6.3 4.0 16.0 14.3 31.0 53.6 External Borrowing 5.9 31.9 21.0 28.2 47.2 66.7 48.4 61.3 External Grants 8.5 4.6 3.7 9.4 16.0 / 19.1 34.6 61.3 Other (- i lncreaee in Government balaes) 1.7 -3.3 -2.1 13.6 -10.0 6.0 M ;-; 1967-69 1970-73 1974-76 1977-78 1979.80 \ Total Expenditures/GDP 25.8 24.9 24.5 27.0 29.7 Revenues/CDP 15.9 15.7 15.4 16.2 17.0 Tax Revenue/GDP 9.3 10.3 10.9 12.7 13.3 Other Revenue/GDp 6.6 )5.5 4.5 3.5 3.7 Overall Deficit/GDP 9.9 9.2 9.1 10.8 12.7 Revenue Account/Total Expenditures 74.4 63.6 60.2 56!7 56.8 Development Account/Total Expenditures 25.6 36.4 39.8 43.3 43.2 Total Revenue/Total Expenditures 61.6 63.1 62.8 60.1 57.3 Government Consumptions// Total Expenditures 53.5 42.4 39.6 39.0 n.a. Capital Fotmetion/Total Expenditures 20.1 23.1 35.5 35.0 n.a et Wages plus goode and services on revenue and development account. b/ The yeare refered to here are government fiscal years whicih run from April 1 througil Harch.1 lhence 1967 refers to the budget year which spans 1967/68 and 1980 to that which spans iv8U7a1 Similarly, the heading 1979-80 covers the two budget yeare 1979/80 and 1980/1 and so forth. Source: Statistical Ap''.nd!7, tables 7.01 and 7.08N - 20 - 2.12 Between 1967/68 and 1979/80 government expenditures in current prices grew at an annual average rate of 16.2 percent, with revenue account expenditures growing at 13.3 percent and development account expenditures at 23.4 percent (table 6). Up through 1976/77, expenditure growth was more moderate, roughly in line with the expansion of total governmerit reve- nues and GDP. While budgetary deficits grew larger, their share in GDP averaged a steady 9 percent. Over the next three budget years, expendi- tures have doubled, with revenue account expanding by 84 percent and devel- opment account by 129 percent. Most of the increase in development expend- itures during these three years was accounted for by transport (railway construction, roads and the airport), government buildings including the new capital city, and defense facilities; the sharp increases in expendi- tures on agriculture, education, health and water registered in 1978/79 and 1979/80 were considerably smaller in size. With these developments, the share of government expenditures and budgetary deficits in GDP increased-- the former from 25 to 29 percent and the latter from 9 to 11 percent; by 1980/81, expenditures had reached 30 percent and the budgetary deficit 14 percent as a share of GDP (table 6). With the acceleration in growth of government expenditures and increased budgetary deficits, balance of pay- ments pressures began to accelerate, partly owing to excess aggregate demand and partly to the large import content of government expenditures. Larger balance of payments current account deficits have been accompanied by increased resort to external borrowing on commercial terms and drawdowns of foreign exchange reserves (para. 2.20). 2.13 Shifts in the composition of finance for budgetary deficits have been pronounced. On balance over the period 1967/68 through 1980/31, ex- ternal loans and grants have financed 70-85 percent of the budget deficit with domestic borrow:ing covering the remainder (table 7). The shares of foreign loans and grants have fluctuated significantly. As Malawi's eLepen- dence upon UK grants to cover recurrent deficits declined, the share of grants fell sharply and reliance on foreign borrowing increased. Mc3t for- eign borrowing was on soft terms, with the United Kingdom and International Development Association as the largest contributors. In recent years, grants have again become an important part of aid to Malawi. P rEvious loans from the UK, Germany, Canada, and Denmark have been conveiited to grants and a growing portion of new assistance is on a grant basis (table 7). From 1967 through about 1975, government reliance on domestic bcrrow- ing was modest: on balance, government borrowing tended to be abou: 15-20 percent of the deficit and the equivalent of about 2 percent of GDP, With the subsequent period's tendency toward larger budget deficits has zcme an increased dependence upon domestic borrowing: such borrowing relail.ive to the size of the deficit or to GDP has grown sharply (table 7). - 21 - Table 7: FINANCING OF GOVERNMENT BUDGETARY DEFICITS, 1967-80 (percentages) 1967-69 1970-73 1974-76 1977-78 1979-80 Share in the Budgetary Deficit External Borrowing 44.3 74.4 57.6 65.0 37.8 External Grants 33.1 9.0 13.9 20.0 33.0 Domestic Borrowing 22.5 16.5 28.5 15.0 29.0 Share in GDP Overall Deficit 9.9 9.2 9.1 10.8 12.7 External Borrowing 4.4 6.8 5.2 7.0 4.8 External Grants 3.3 0.8 1.3 2.2 4.2 Domestic Borrowing 2.2 1.5 2.6 1.6 3.7 Source: Statistical Appendix, table 7.01. 2.14 Owing to the limited resources of domestic non-monetary financial institutions, much of increased government borrowing was financed through the banking system. With the government borrowing more heavily and with loans to the public and private enterprise sectors also accelerating, domestic credit expansion has been more rapid and the pressure on foreign exchange reserves more pronounced. Whereas between 1967 and 1973, total bank net domestic credit and credit extended to Government grew by 7.2 per- cent and 24.9 percent per annum (the former more slowly than the expansion in nominal GDP), over the succeeding 7 years the growth rates have been 38 percent and 33 percent per annum, respectively (Statistical Appendix, table 8.01). While relatively mild expansion in net credit extended to Government was accompanied by a buildup of foreign exchange reserves, the period following 1973 has been one of generally declining reserves (para. 2.20). 2.15 The composition of development account expenditure during the past decade has been quite consistent with the investment objectives laid out in DEVPOL concentrating on the development of smallholder agriculture and on the development of the transport network while limiting the expan- sion of social sector investments. During 1970/71-1979/80, actual invest- ments have exceeded DEVPOL's expectations in agriculture and transport while falling short in the social sectors (table 8). Investment in the - 22 - T'able 8: SECTORAL SHARES IN DEVELOPMENT ACCOUNT EXPENDITURES (percentages) Actual DEVPOL 1970/71-1979/80 Economic 72 74 Agriculture 19 20 Transportation 30 40 Other 23 14 Social 15 9 EduceLtion 5 5 Healt:h 5 2 Housing 4 2 Admini s tration (inc].uding New Capital) 13 17 Source: Statement of Development Policies, 1971-80, p. 111 and Statistical Appendix, table 7.06. economic sectors has consistently accounted for about three-quarters of development account expenditure. Transportation has dominated this cate- gory, particularly in recent years reaching 50 percent of total i:.xpendi- tures, due to the continued expansion of the primary road network,, exten- sion of the railway to Lilongwe and to the Zambian border and the c4::,nstruc- tion of the Lilongwe International Airport. Agriculture has bien the second largest seactor, accounting for over 25 percent of total expo:Mditure until the mid-1970s when its share began to fall. Investment in aimini- strative infrastructure absorbed the third largest share in the deve..lDpment account, reaching as much as 20 percent in the mid-1970s, owing to l:he con- struction of the new capital at Lilongwe and again in the late 1970; due to a buildup in def'ense expenditures. Giving way to these claims, e!:xpendi- tures on the social sectors (except for education) fell short of ]!::EVPOL's sectoral share objectives, 9 versus 15 percent. The above investments ln infrastructure--especially those for railways, airport and capita.l city, were all in line with the development objectives of DEVPOL and were an important part oit investment in the 1970s; they were, however, ess..ntially one-shot investments which will not be repeated during the 1980s. While transport will continue to be of high priority, agriculture and the social, - 23 - sectors are likely to receive increasing attention. These, however, are the sectors with relatively high recurrent costs per unit of investment and hence will--in the absence of greater mobilization of domestic revenues or of external resources--contribute to greater budgetary strain in the future. 2.16 Several characteristics of the expansion of revenue account ex- penditures strongly suggest possible underfunding of recurrent expendi- tures: (a) the fall of the share of revenue account expenditures in total government expenditures from 74 to 57 percent between 1967-69 and 1979-80 (table 6); (b) the decline in share of government consumption in total gov- ernment expenditures from 54 to 39 percent between 1967-69 and 1977-78 and the corresponding rise of government capital formation from 20 to 35 per- cent (table 6);8 and (c) the falling shares of economic and social ser- vices in revenue account expenditure (and rising shares of administration and debt service) despite the fact that economic and social sectors have accounted for over 85 percent of government development account expendi- tures during the 1970s (see Statistical Appendix, table 7.04). While quan- tification of the amount of underfunding of recurrent expenditure will be provided in Chapter VIII, the three examples given above strongly suggest that the pattern of government expenditure expansion has led to shortfalls in adequate funding for some government operations. External Trade and the Balance of Payments 2.17 The balance of payments for the period 1965-79 has been charac- terized by growing current account deficits, partly as a result of greater trade deficits but more importantly because of a severe deterioration on non-factor and factor services accounts. Over the period, export volumes grew at an annual average rate of about 6.8 percent per annum (about 9 per- cent per annum 1965-73 and 3.9 percent per annum thereafter); on the other hand real imports grew at a 5.5 percent per annum rate (6.8 percent for 1965-73 and 3.7 percent per annum thereafter; tables 11 and 12). Between 1965 and the mid-1970s, this pattern of real export and import growth com- bined with the absence of any clear upward or downward trend in the exter- nal terms of trade limited the increases in the size of trade deficits; the trend in such deficits was mildly upward but, relative to GDP, deficits actually fell from about 7 percent in the mid-1960s to about 4 percent in the mid-1970s. Since the mid-1970s, and especially during 1978-80, Malawi's external terms of trade have fallen sharply: as a result of fall- ing tobacco and tea prices and rising import costs (due mainly to fuels, fertilizers and transport costs), the terms of trade fell some 35 percent from the 1977 peak reaching levels in 1979 and 1980 some 23 and 28 percent below the average for 1974-76 (see Chapter III, table 1). As a conse- quence, trade deficits have averaged MK 56 million for the years 1978-80, a sharp increase over the average deficits of previous years and a share in total GDP equivalent to those higher levels of the early 1970s (table 9). 8This exercise involves ignoring debt service, grants and subsidy items on revenue account and government loans and equity investments for public enterprise on development account. It also involves combining the consumption items and the capital items on both accounts. teOIS 9, BALANCE Of FAYHMNTS PERFORMANCE, 1965-80 (sK illiton and percentage sharas In GDP) Share in Share in Share tn Share in Share tn [965-67 CDP (M) 1967-69 CDP (7) 1970-713 GDP () 1974-77 CDP (M) 19'78-80 CDP (.) Exports. f.o.b. 103.5 1712 124 4 8.2 .S3.4 18.6 ,,1., 22.3 585.8 -B.6 Imports, f.o.b. 145.2 24.1 168.2 24.5 332.1 24.4 651.1,- 26.3 753.3 24.0 Trade balance -41.7 -6.9 -43.7 -6.4 -78.7 -5.8 -99.8 -4.0 -167.5 -5.3 Mon-Factor Servtcoo (not) -28.5 -4.7 -39.1 -5.7 -70.2 -5.2 -125.3 -5.0 -270.9 -8.6 Factor Service. (net) -17.7 -2.9 -20.5 -3.0 -12.2 -0.9 -20 ; -0.8 -70.6 -2.2 Balance on Goods end Servico Account -87.8 -14.5 -103.3 -15.0 -161.1 -11.8 -245. 9 -9.9 -509.0 -16.2 Private Transfers (net) 4.2 0.7 5.0 0.7 10.1 0.7 1. 7 0.8 4.0 0.1 Government Transfers (net) 59.0 9.8 '45.i 6.6 37.8 2.8 52.5 2.1 125.0 4.0 Cuirent Account Balance -24.6 *4.1 -53.1 -7.7 -113.2 -8.3 -174.5 -7.0 .380.0 -12.1 Private Long-Term Cap. (net) 8.4 1.4 19.3 2.8 25.7 1.9 47.6 1.9 29.8 0.9 Public Enterprise Long-Term Cap. (not) 2.7; 0.4 3.0 0.4 12.8 0.9. 14.7 0.8 54.5 1.7 Government Long-Term Cap. (net) 11.6 1.9 33.0 4.8 79.3 5.8 : 176.1 7.1 218.8 7.0 Total Lonp-Term Cap. (net) 22.7 3.8 ,55.3 8.1 117.7 8.6 243.4 9.8 303.1 9.6 Short-Term Cop. & Errors & Omiesionu 9.5 1.6 0.0 0.0 32.6 2.4 -41.2 -1.9 59.3 1.9 Net Movements in Official Resrves - Increase) -7.7 '-1.3 -2.2 -0.3 -37.2 -2.7 -21.2 -0.9 17.6 0.6 Sources Statistical Appendix, table 9.01. - 25 - 2.18 Of greater significance to the growing current account deficits, especially during the last 3-4 years, is the growing deficit on services account arising from the decline in worker remittances, greater debt ser- vice payments, and increasing transport costs for imported merchandise. Up through 1975, increases in migrant remittances exceeded increases in out- flows from capital services (interest, dividends, etc.) reducing the net outflows and finally generating surpluses on factor services account; dur- ing both 1974 and 1975 migrant remittances reached MK 30 million, making them Malawi's second leading foreign exchange earner behind tobacco. Following the Government's suspension of migrant recruiting within Malawi in 1974, existing contracts were allowed to lapse and remittances fell sharply in 1976 and 1977. The recovery of remittances in subsequent years has been more than offset by the increase in capital service payments and there has been a growing net outflow on factor service account since 1975. Of even greater significance in the growing negative balance on services has been increased transport costs, arising from rapid increases in sea and air freight charges since 1973, the closure of the Zimbabwe-Mozambique bor- der in 1976, intermittent fighting in Mozambique delaying or severing tran- sit, and increasing congestion in the ports of Beira and Nacala. Rising fuel costs, growing theft, uncertainty of transit and delays in port clear- ance have increased the share of freight and insurance charges from the equivalent of 16 percent of the value of imports, f.o.b. in 1973 to 28 per- cent in 1978-80. In 1979 and 1980, net non-factor services averaged a negative MK 97 million, accounting for over 70 percent of the total current account deficits for those two years, a far larger contribution than the negative trade balances. 2.19 Thus, the growing current account deficits observed over the per- iod are the result of a deteriorating trade balance and an even greater decline on net services account. Current account deficits have increased from an annual average of MK 8 million per annum during 1965-67 to over MK 125 million per annum during 1978-80, or from amounts equivalent to 4 per- cent of GDP to levels of over 12 percent of GDP (during the 3 years 1978-80, these deficits were 12, 15, and 9 percent of GDP, respectively). 2.20 Up through the end of 1977, net capital flows were generally more than sufficient to cover current account deficits, allowing a buildup in official reserve holdings. Owing mainly to government mobilization of for- eign assistance, but with increasing contributions for private and public enterprise ventures, net long-term capital flows have increased from MK 23 million during 1965-67 to MK 303 million during 1978-80 (table 9). While net flows to the private sector have increased almost fourfold and those to public enterprises twentyfold nearly 75 percent of the increase has been due to multilateral and bilateral assistance combined with some commercial lending to Government. While the bulk of increased capital flows has been on relatively soft-term loans to Government, significant amounts of borrow- ing by Government and public enterprises during 1978-80 (totalling an esti- mated US$195 million of new commitments) have been on commercial terms. The excess of net capital inflows over current account deficits has led to a buildup in gross official reserve holdings; such holdings increased from - 26 - MK 18 million at the end of 1965 to MK 59 million by the end of 1980. How- ever, such a comparison of end points mnasks important movements within the period. Of the 9 years following 1965, reserves increased in 7, reaching a total of MK 69 mil]lion by the end of 1974; since then reserves have trended downwards, falling in 4 of the 7 succeeding years, from an equivalent of 4.5 months of import cover to 1.7 months of cover.9 2.21 Between the ends of 1965 and 1980, Malawi's public and publicly guaranteed disbursed debt increased from US$64 million to US$637 mrillion (Statistical ApperLdix, table 10.02). Of the debt outstanding at the end of 1980, about two-thirds was owed to multilateral and bilateral agencies. Malawi's two most important creditors, the United Kingdom and the World Bank Group, held about 13 and 24 percent of the outstanding debt, reSpec- tively. Because of the heavy preponderance of multilateral and bilateral debt, the terms of lending to Malawi have been relatively soft--low inter- est charges combined with long grace and repayment periods. Up through 1977, average loan terms were in the range of 2 percent interest, 7-8 years grace and repayment periods of 30-40 years (Statistical Appendix, table 10.04). During 1978-80, over one-third of new loan commitments have been on commercial terms, leading to a hardening of average loan terms. Over those three years, average terms have been approximately: interest, 5.5 percent; grace, 6 years; maturity, 25 years. The combination of increased external borrowing plus harder loan terms has led to rising debt service. While Malawi's deb: service has been quite low, the burden has been rising and, because of recent commercial borrowing, is likely to continue increas- ing in the early 1980s. Table 10 shows the accelerating increments intl debt servicing beginnirng around 1973, building up to larger increases in 1978-80. The increased debt burden will undoubtedly continue in the early 1980s as projected debt service payments for that period from loans already committed by the end of 1979 are three to four times greater tha-i the levels of 1978 and 1979. 9Because of the buildup in liabilities owed to international agencies (mainly the IMF), the decline in net official reserve ho]Ldings is nore dramatic, from MK 68 million to minus MK 33 million between the ends of 1974 and 1980. - 27 - Table 10: DEBT SERVICE BURDEN (MK million and percentages) 1968 1970 1973 1976 1977 1978 1979 1980 Debt Service (MK million) a/ 3.3 4.8 9.0 13.2 11.5 22.7 27.4 51.7 Exports of Goods and Non-Factor Services (MK million) 49.0 60.5 100.6 185.6 218.4 187.4 217.8 277.1 Debt Service Ratio 6.8 8.0 9.0 7.1 5.2 12.1 12.6 18.7 a/ Interest and amortization payments on public and publicly guaranteed debt. Source: Derived from Statistical Appendix, tables 2.03 and 10.02. 2.22 While overall export expansion has been satisfactory, the pattern of export growth has led to a greater concentration of exports in a few crops and to a growing share contributed by estates as compared with small- holders. This pattern is the result of moderate to rapid growth in all im- portant estate crops and a more mixed performance of expansion and decline among various smallholder crops. As shown in table 11, total exports grew at an average rate of 6.8 percent per annum over the period 1965-79, with estate growth averaging 13.6 percent per annum and smallholders 1.7 per- cent. Since 1973, however, the overall rate of growth of exports has declined sharply because of stagnation in the main smallholder exports (with declines in rice, cotton, and groundnuts offsetting the continued ex- pansion of tobacco) and the decline of "other exports." The share of exports produced by smallholders declined from about one-half to under 25 percent over the 15-year period while the proportion produced by estates was increasing from 37 to 66 percent. Moreover, crop concentration signi- ficantly increased. Whereas in 1965 tobacco (estate and smallholder) was the top foreign exchange earner (at 36 percent of total exports) and the top three crops (tobacco, tea, groundnuts) accounted for 74 percent of for- eign exchange earning, by 1979 the top three (tobacco, tea and sugar) accounted for 82 percent with tobacco alone contributing 55 percent. The growing concentration of exports exposes Malawi to increased risk from fluctuations in international prices. - 28 - Table 11: REAL GROWTH RATES FOR PRINCIPAL EXPORTS (percent per annum) 1965-70 1970-79 1973-79 1965-79 1'379-80 a/ Estate Exports 10.0 15.7 13.1 13.6 18.2 Tobacco 15.0 18.8 18.1 17.4 21.8 Burley (5.1) (14.8) (16.7) (11.2) (28.8) Flue-Cured (28.5) (21.2) (18.8) (23.7) (17.8) Tea 6.0 6.5 2.0 6.3 -2.9 Sugar - 53.8 26.1 - 41.5 Principal Smallholder Exports 0.1 2.6 -0.1 1.7 --14.4 Tobacco -5.6 10.6 8.6 4.6 --47.3 Groundnuts 3.6 -5.4 -10.9 -2.3 65.0 Cotton 5.1 -14.8 -9.2 -8.2 71.4 Rice 20.6 10.7 -11.2 14.1 85.0 Other Exports 16.5 -7.1 -11.7 0.7 55.2 Total Exports 8.1 6.1 3.9 6.8 15.1 a/ Preliminary. Source: Derived from Statistical Appendix, table 9.12. 2.23 Over the period 1965-79, the volume of total imports tended to grow somewhat morea slowly than real GDP, a tendency that has becoma more pronounced since 1970 (table 12). Partly, this is a consequence of declin- ing volumes of imported consumer durables and non-durables, but par-ly it is also due to the sharp decline in the growth rate for intermedial:e and capital goods (both absolutely and relatively to real GDP growth) since 1970. Over the 15-year period, the share of consumer goods in total im- ports have fallen from about one-third to 15 percent while the shar-es of intermediate and capital goods have risen commensurately--from 44 to 52 percent and from 22 to 33 percent, respectively. Also noteworthy :is the slow rate of expansion of petroleum imports since 1973 (1.9 percer.t per annum); since the modern sector has been growing vigorously since t:hen, such slow growth appears to be the product of the Government's pol::.cy of taxing fuel heavily and passing the full cost of fuel import plu3s tax through to the fiLnal consumer. Despite the slow growth of pet:-cleum volumes, the share of petroleum in the value of total imports has expanded: while petrol's sha:re was about 8 percent in 1973, it had reached 11 percent in 1978 and an estimated 15 percent in 1980. -29 - Table 12: REAL GROWTH RATES FOR PRINCIPAL IMPORTS (percent per annum) 1965-70 1970-79 1973-79 1965-79 1979-80 a/ Consumer Goods -0.9 -0.4 -0.6 -0.6 -8.0 Intermediate Goods 9.3 5.1 4.2 6.6 -9.8 (Petroleum) - 3.5 1.9 - 0.2 Capital Goods 14.6 5.8 5.3 8.9 4.0 Total Imports, c.i.f. 7.6 4.3 3.7 5.5 -3.8 a/ Preliminary. Source: Derived from Statistical Appendix, table 9.14. The Recent Economic Crisis 2.24 During 1979 and 1980, Malawi has experienced a severe economic crisis characterized by slower growth, increased government budgetary deficits, deteriorating financial positions for many private and public en- terprises and growing balance of payments pressures. In 1979 and 1980, the external terms of trade were three-quarters or less of the average for the mid-1970s. Falling prices for tobacco and tea were accompanied by rapid increases in import costs, most notably for fuels, fertilizers and trans- port. These problems were exacerbated by a decline in several smallholders crops due to weather--most notably a shortfall in maize which necessitated imports--and periodic traffic disruptions on the Beira and Nacala lines. During the 1979/80 season, the auction prices for flue-cured tobacco fell by 36 percent as compared with the previous season. Numerous tobacco estates have been running at losses and relying to an increasing extent on bank credit to sustain operations; it has been estimated that flue-cured tobacco acreage will be reduced by 25 percent for the 1980/81 growing season through voluntary cutbacks, credit restraints and bankruptcies. Squeezed between rising costs and fixed prices for their products, many major private and public enterprises are experiencing deteriorating cash flows and having difficulties meeting their debt service obligations.10 Some public enterprises have sought and received relief through non-payment 10For a more complete description of the difficulties of individual public enterprises during 1979 and 1980, see Chapter VIII. - 30 - of debt service obLigations to the Government. Because of the accumulation of bad debts by tobacco estates and other private firms, the financial position of the two commercial banks has deteriorated. 2.25 As a comsequence, real GDP growth slowed to 5.1 percent in 1979 and to 0.2 percent: in 1980. Taking account of the deterioration iin the terms of trade, real gross domestic income fell 2 percent. On a per capita basis, the declines in real GDP and GDY were 2.3 and 4.4 percent, respec- tively. The deterioration in production performance in 1980 pervaded all sectors of the economy except utilities (table 2): real output declined in agriculture and ccnstruction and growth rates fell sharply in manufactur- ing, transport and community and social services. As already outlined above (paras. 2.12, 2.17 and 2.20), budgetary and balance of payments per- formance have worsened during 1979 and 1980. The trend toward more rapid expansion of governlment expenditures has continued, with budgetary deficits reaching 13 percent of GDP (as compared with historical averages of 9 per- cent) and with increased reliance on domestic borrowing from the banking system. Owing to weakening in the trade account and the non-factor ser- vices account, current account deficits in the balance of payments reached 15 and 9 percent of GD? in 1979 and 1980, respectively (compared with his- torical levels of 7-8 percent). In addition to normal aid sources, these current account deficits have been financed by borrowing on commercial terms, drawdowns in foreign exchange reserves and the use of IMF resources. 2.26 Faced with growing internal and external imbalances, the Govern- ment in 1979 initiated a number of short-term demand management measures leading to a two and one-half year standby arrangement with the IMF cover- ing the period through December 31, 1981. The transport dislocati::n, at the end of 1979, however, led to replacement of this arrangement with a new two-year standby arrangement covering the period April 1, 1980, through March 31, 1982 (drawing on the second through fourth credit tranches and the supplementary financing facility for US$64.8 million equivalent) The Government's fisca:L and financial austerity program consisted of restraints on the expansion of revenue and development account expenditures, meLsures to increase revenues (e.g., increases in excises, in import duties, and in the duty on imported petrol), and increases in interest rates. The IMF performance criteria for the standby include ceilings on total donestic credit, credit extended to Goverrnment, and external borrowing of 1-12 year's maturity. - 31 - Employment, Wages and Labor Costsll 2.27 According to mission estimates,12 Malawi's total labor force grew from 2.06 million in 1968 to 2.66 million by 1977 or at the same rate as total population (2.9 percent per annum), adding about 66,400 persons per year to the labor force (table 13). While the rate of growth of formal sector wage employment has been substantial (8.3 percent per annum), it has provided only some 16,100 jobs a year leaving a residual 50,300 to be ab- sorbed by the smallholder sector, the informal sector, the ranks of the migrant worker abroad, and among the unemployed. llThis section is based upon IBRD, Malawi--Employment Aspects of Development (Washington, D.C.: Report No. 3463-MAI, May 8, 1981) authored by Katherine Sierra. 12The labor force estimates use the 1966 and 1977 censuses and urban/rural, male/female labor force participation rates as contained in NSO, Malawi, Labour Force Survey, Feasibility Report (October 1977). Since the labor force estimates are based on an assumption of constant participa- tion rates, they are necessarily crude. Participation rates would tend to change due to changes in age distribution, urbanization, availability of paid employment, literacy, and school enrollment ratios. All of these fac- tors have been changing in Malawi, but it has not been possible to sort out their influences on participation rates. - 32 - Table 13: LABOR FORCE AND EMPLOYMENT ESTIMATES Percent '000 Persons of Total 1968 1977 1968 1977 Total Labor Force 2,059.9 2,657.3 100 100 Rural 1,976.0 2,480.9 96 93 Urban 83.9 176.4 4 7 Total Formal Sector Employment a/ 164.6 309.0 7 12 Agriculture, Forestry, Fishing 44.2 155.1 2 6 of which: private 40.8 132.8 2 5 government 3.4 22.3 - 1 Industry 34.5 59.8 2 2 Services 55.9 94.1 3 4 Residual: Subsistence Agri- 1,895.4 2,348.3 92 88 culture, Rural and Urban Informal Sectors and Unemployed a/ The 1977 employment figures cover all firms regardless of the size of establishment; prior to 1977, only firms with 20 or more employees were counted. To ensure comparability of the 1968 and 1977 figures, the 1968 figures were adjusted upwards to account for an estimated 30,000 workers in firms with less than 20 employees (an estimate provided by NSO). Source: Mission estimates. 2.28 Despite rapid expansion, formal sector jobs employed only about 12 percent of the 1977 labor force as compared with 8 percent ir. 1968 (table 13). Most of the remainder is in subsistence agriculture, allhough some would be found in the rural and urban informal sectors or among the unemployed. In 1977, about one-half of wage employment was provid'ed by agriculture, fishing and forestry; employment in this sector--whiclh con- sists mainly of agricultural estates--grew at about 11 percent per annum over the 9-year period. The growth of wage employment in the industrial and service sectors has been less rapid at 6.3 and 6.0 percent per annum, respectively. 2.29 By 1979, somne 369,000 persons were engaged in formal secto, wage employment. Of these, about 80 percent were employed by the private ,ector - 33 - or statutory bodies. Agriculture accounted for 50 percent of all formal sector employment, with tea and tobacco estate workers amounting to three- quarters of this figure (and the remainder being employed by the sugar estates, forestry and fishing industries, or as government agricultural employees, mainly in extension and other technical work). 2.30 Through wage policies (as well as through investments tailored to Malawi's factor and resource endownments), the Government has actively sought to create a favorable environment for the expansion of employment. The results show that it has succeeded. Formal sector wage employment grew at an average rate of 8.3 percent per annum 1968-77 (table 14), a very re- spectable rate when compared with the growth rates of total real GDP or GDP generated in the monetary sectors. Employment opportunities expanded most rapidly between 1968 and 1973; following that, employment expansion slowed to a still satisfactory 7.6 percent average rate. Private sector employ- ment (including statutory bodies) has grown at a much faster rate than that of government, a tendency that has become more pronounced after 1973 as government employment expansion slowed to 1.2 percent per annum. The increasing share of private sector in total employment is the result of the Government's explicit policy of encouraging the private sector to take the lead in economic development. The expansion of employment opportunities has been most marked in agriculture, with wage employment growing by about 11 percent per annum 1968-77. Agriculture and financial services, are the only sectors whose growth rates were higher than average and as a conse- quence, their shares in total employment increased over the period. Despite the impressive employment growth recorded in all other sectors, their shares in total employment declined. Between 1977-79, led by agri- culture, utilities, construction and transport, employment growth again accelerated reaching 9.3 percent per annum. - 34 - Table 14: GROWTH OF WAGE EMPLOYMENT (percent per annum) 1968-7ka1 1973-7-7/ 1968-7' c 1977_7 i!/ Agricuiture, Forescry7 and 9 Fishing 11.5 10.8 b/- 11.3 b/ 9.2 Manufacturing, Xining and Quarrying c-/ 8.3 4.5 6.5 3.S Electrict.t7 and 'ater 14.1 -0.9 .7.2 11.8 Building and Constr-uction 6.6 1.4 4.3 27.1 Wholesale/Rtecil raAe, a Hotels and Sstaurancs 14.4 -0.L 7.7 8.7' Transport, Storat;e and Commuaicat4cnS 49 10.8 7.5 11.7 Financ
Группа Всемирного банка · Pre-2003 Economic or Sector Report
Malawi - Growth and structural change : a basic economic report (Vol. 1 of 2) : Main report
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