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IN PRAISE OF IDLENESS: Further reflections on knowledge, capital and growth

Why is society, even those countries in which more capital could not possibly appreciably improve standards of living, still obsessed with hard work, thrift and accumulation of capital? Why are Africa’s leaders forever trooping to the West and East, fawning, groveling and whoring for capital? By DAVID NDII

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In Praise of Idleness: Further Reflections on Knowledge, capital and growth
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“Modern technic has made it possible to diminish enormously the amount of labor necessary to produce the necessaries of life for every one. Let us take an illustration. Suppose that at a given moment a certain number of people are engaged in the manufacture of pins. They make as many pins as the world needs, working (say) eight hours a day. Someone makes an invention by which the same number of men can make twice as many pins as before. But the world does not need twice as many pins: pins are already so cheap that hardly any more will be bought at a lower price. In a sensible world everybody concerned in the manufacture of pins would take to working four hours instead of eight, and everything else would go on as before. But in the actual world this would be thought demoralizing. The men still work eight hours, there are too many pins, some employers go bankrupt, and half the men previously concerned in making pins are thrown out of work. There is, in the end, just as much leisure as on the other plan, but half the men are totally idle while half are still overworked. In this way it is insured that the unavoidable leisure shall cause misery all round instead of being a universal source of happiness. Can anything more insane be imagined?”

Bertrand Russell In Praise of Idleness

 

In economics, we are concerned primarily with three things, productivity, efficiency and welfare. Productivity is simply output per unit of input. We measure productivity in terms of output per worker. Economic efficiency is a question of optimality, that is, whether the resources have been put to the best possible use. Economics is in fact known as the study of resource allocation. Welfare is a question of whether the way production and distribution are organized is good for society. We can summarize the three questions: are we good at it, are we doing it right, and what good does it do. In short, it boils down to purpose. What is it all in aid of? This is Russell’s beef with the industrious society. To what end?

In economics, we are concerned primarily with three things, productivity, efficiency and welfare.

Ms Agronomy and Mr. Capital are two young farmers. Both have inherited fifty acres of land on which their parents practice traditional farming, growing maize, beans, yams and livestock. Mr. Capital is an ambitious guy. He studied finance. He wants to modernize and mechanize.   Business plan, bank loan, buys tractors, harrows and ploughs and puts the whole 50 acres under maize. He is able to double his yield to 20 bags an acre. Next year he leases another 50 acres. Soon he is farming 500 acres. He has a fleet of tractors, sprayers, irrigation system, a combine harvester grain driers, silo—the works. He is producing 30 bags per acre.

Ms Agronomy went to agricultural college. She has small plots set aside on her farm where she experiments with different agronomic techniques such as zero-till farming, crop rotation, inter-cropping, organic farming, mulching and so on. She is still farming her fifty acres. For ease of analysis we translate all her different products into “maize equivalent.” Her production also works out to the equivalent of 30 bags of maize per acre.

Ms Agronomy and Mr. Capital’s economic accounts are summarized in the table below. Although both obtain the same yield, 30 bags per acre, Mr. Capital’s operation is evidently much more productive. Its total output translates to 750 bags per worker, two and a half times more than Ms Agronomy’s 300 bags per worker. It is not difficult to see how this difference has come about. Mr. Capital’s workers have more tools to work with, Sh. 3 million per worker against Ms Agronomy’s Sh. 600,000 per worker—five times as much. They are also working more land, 25 acres worker compared to 10 acres per worker in Ms Agronomy’s operation, obviously because they are mechanized.

Table 1

Table 1

But capital is not free. In economics we think of the cost of capital in terms of depreciation, wear and tear if you like, which is the rate of its consumption. Because Mr. Capital has all manner of equipment that need spare parts and replacement that Ms Agronomy does not have, his consumption of capital will be higher. Let us put it at 20 percent and Ms Agronomy’s at 15 percent. This translates to a capital costs of KSh. 600,000 and Sh. 90,000 per worker respectively.

To complete the accounts, we need cost of land and other inputs (fertilizers, diesel, electricity etc) which we call intermediate inputs in economic accounting jargon. The land rent is assumed at 500 per acre, Ms Agronomy has 10 acres per worker and Mr. Capital has 25, which works out to Sh. 6,000 and 24,000 per worker respectively. For intermediate inputs Mr. Capital uses more inputs including diesel, electricity fertilizer pesticides and so on. We assume that his input costs work out to Sh.80 per bag and Ms Agronomy’s are half as much, which adds up to Sh. 37,500 and Sh.6,000 per worker respectively. The price of maize is Sh. 1000 a bag.

What more do they tell us?

Although Mr. Capital’s operation has higher output per worker, Miss Agronomy’s operation has a labour surplus of Sh.196,500 against Mr. Capital’s Sh. 88,500 per worker, that is Sh.108,500 more. The labour surplus is what is available for consumption. If Miss Agronomy were to farm Mr. Capital’s land, she would create 50 jobs, two and half times more than Mr. Capital, and generate afford the society Sh. 5.4 million more consumption. With the same financing her operation would employ five times more workers (100 compared to 20) and six times the labour surplus (Sh.10.8 million compared to Sh.1.77 million) OF Mr. Capital’s operation, but it would require twice as much land—and that would be a problem wouldn’t it. As this columnist has remonstrated for the better part of three decades, if society entrusts landlords with the allocation of its resources, it ought not be befuddled that they seek to maximize rents

Mr. Capital’s workers produce Sh. 450,000 more, but the capital stock consumes more than the additional output. In economics we say that Mr. Capital’s operation has over-accumulated capital or if you want to be esoteric, it is “dynamically inefficient.” The idea that economy can over-accumulate capital runs counter to conventional wisdom, which maintains that consumption is bad, and investment is good. A particularly irksome variant of this conventional wisdom maintains that the more government spends on “development” by which we mean brick and mortar stuff, and the less is spends on recurrent, especially the wage bill, the better.

Suppose an economy starts out with a GDP per capita of $1000 and no physical capital stock. You can think of this as a pastoralist economy where the GDP is simply the value of each pastoralist’s annual off-take— for example, that each family sells four steers per person at $250 each. GDP is also equal to consumption.

Now, this economy decides to develop by “adding value” —feedlots, abattoirs, meat processing plants the works. It also needs infrastructure— electricity for the cold rooms, water etc. To finance this, it needs to save and invest. The table shows how the economy would evolve under four different investment rates 10, 20, 30 and 40 percent, and the associated economic growth rate, output (GDP per capita), the capital stock (obtained by depreciating investment at 20 percent per year), and consumption per person. At a 10 percent investment rate, GDP per person grows by one percent per year.

Ten years on, the GDP is just about 10 percent higher – the economy has accumulated $460 of capital stock per person – but people are still consuming $6 less than before development started. The elderly who die during this period would have been better off without development. They will have to be satisfied with bequeathing their children a better future—hopefully. At an investment rate of 20 percent, the economy would be breaking even after ten years, with consumption $75 higher than in year zero. Thirty percent investment rate consumption rises by another $12. But at 40 percent investment, the per capita consumption in year ten is $62 less than at an investment rate of 30 percent. What’s driving this?

[An] economy decides to develop by “adding value”…At a 10 percent investment rate, GDP per person grows by one percent per year. Ten years on, the GDP is just about 10 percent higher…but people are still consuming $6 less than before development started. But at 40 percent investment, the per capita consumption in year ten is $62 less than at an investment rate of 30 percent. The elderly who die during this period would have been better off without development…What’s driving this?

Mathematically, it is the relationship between the investment rate and the growth rate. A 10 percent investment rate increases growth by 1 percent. From 10 to 20 percent it increases by two percentage points. The increase declines to 1.5 percentage points between 20 percent and 30 percent, and to one percentage point between 30 and 40 percent investment rate. This is not a sleight of hand. It reflects two things. First the returns to capital decreases with the amount of capital—the law of diminishing returns. Secondly the more capital an economy accumulates the more resources are consumed by maintaining and replacing it. In the 40 percent investment scenario the replacement cost of capital amounts to a good 30 percent of GDP— three quarters of the 40 percent investment rate is simply maintaining the level of capital stock.

This economy has violated the Golden Rule saving rate. The Golden Rule saving rate is the rate of capital accumulation required to maintain a stable rate of consumption growth. It is called the golden rule because it requires each generation to do what it would have other generations do. Save too little, the capital stock declines and the next generation’s consumption will fall. Saving too much deprives the current generation only to burden future ones with maintaining a bigger capital stock than they need. The Golden Rule saving rate for this economy is somewhere between 30 and 40 percent. The economy ought to shed some capital. The question is, what will it shut down? No capitalist will volunteer to close down their plant for the good of the country. Since none will, recessions come every so often and sorts them out.

Table 2

Table 2

It should also be evident that capital on its own cannot deliver the kind of growth in prosperity that we observe in reality. I gather that my smartphone has millions of times more computing power than the Apollo Guidance Computer (AGC) aboard the spacecraft that took Man to the moon. The AGC was the first computer to use integrated circuits (ICs), the now ubiquitous microchips. It cost $150,000 (about US$ 1.1 million in today’s value). My smartphone cost $1000 dollars and you can get a good one for a quarter of that. One very big difference is that the AGC was crash-proof. That aside, fifty years down the road, the cost of AGC will buy you 5,000 infinitely more powerful handheld computers to do the most frivolous things.

Capital on its own cannot deliver the kind of growth in prosperity that we observe in reality.

It is science, not capital that enables us to waste computing power on selfies and fake news. The reason we can afford to consume knowledge, frivolously or otherwise, is first, not subject to diminishing returns. Secondly, knowledge can be used by many people over and over again at no additional cost.

Suppose Ms Agronomy were to acquire another 50 acres of land. She would with very little capital, simply replicate her knowhow and be producing at peak output in no time. And of course, Ms Agronomy would be continuing with her experiments. So by this time, she would be up to 35 bags per acre, or 40. In fact, every one of Ms Agronomy’s workers could go off and replicate her methods at no extra cost. Mr. Capital’s workers cannot walk into the bank and walk out with a tractor. Mr. Capital would be back to the bankers who would in turn deploy more of society’s savings to equip his operation. More of societies savings would have to be mobilized. New equipment would need to be manufactured. Producing more equipment needs more workers. So instead of producing food, Ms Agronomy’s workers will now be hired to produce the equipment to produce food.

It is science, not capital that enables us to waste computing power on selfies and fake news. The reason we can afford to consume knowledge, frivolously or otherwise, is first, not subject to diminishing returns.

Why then is society, even those countries in which more capital could not possibly appreciably improve standards of living —think Japan— still obsessed with hard work, thrift and accumulation of capital?

Why are Africa’s leaders forever trooping to the West and East, fawning, groveling and whoring for capital?

Bertrand Russell: ‘From the beginning of civilization until the industrial revolution a man could, as a rule, produce by hard work little more than was required for the subsistence of himself and his family, although his wife worked at least as hard and his children added their labour as soon as they were old enough to do so. The small surplus above bare necessaries was not left to those who produced it, but was appropriated by priests and warriors. In times of famine there was no surplus; the warriors and priests, however, still secured as much as at other times, with the result that many of the workers died of hunger. At first sheer force compelled them to produce and part with the surplus. Gradually, however, it was found possible to induce many of them to accept an ethic according to which it was their duty to work hard, although part of their work went to support others in idleness. [But] a system which lasted so long and ended so recently has naturally left a profound impression upon mens thoughts and opinions. Much that we take for granted about the desirability of work is derived from this system and, being pre-industrial, is not adapted to the modern world.

Says Bertrand Russell: “Gradually, however, it was found possible to induce many of them to accept an ethic according to which it was their duty to work hard, although part of their work went to support others in idleness.”

Warriors, priests, chiefs, bureaucrats. And bankers.

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David Ndii

David Ndii is one of Kenya's leading economists and public intellectuals.

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Visas, Africanists and White Privilege

For more than a generation the term ‘Africanist’ has meant an implicit stranglehold by a mostly white and male cadre of academics and Western institutions on the tenor and direction of discourse on African affairs in the global academy and sectors such as conservation. RASNA WARAH argues that authentic African voices and narratives are and will continue to demonstrate the absurdity of this situation and herald the beginning of a substantive change of the old order.

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Visas, Africanists and White Privilege

An article published in Africa is a Country has generated some discussion online on the wisdom of holding conferences on Africa in Western countries – places that are becoming less accessible to African scholars, writers and researchers because of their punitive, African-unfriendly visa requirements. Haythem Guesmi, in the article titled “The gentrification of African studies”, wondered why the African Studies Association’s annual meeting and the annual conference of the African Literature Association are routinely held at North American venues.

Guesmi, a PhD candidate in English Studies at the University of Montreal, was commenting on the absurdity of situations where conferences focusing on African issues are held in Europe or North America and have panellists exclusively from the Western world – people who by virtue of their skin colour or nationality have easy access to these venues, a privilege that citizens of African, Asian or Latin American countries do not have. (A reason why I get so irritated when Kenyans who have acquired US, Canadian or European passports ask me why I am obsessed with citizenship. One so-called Kenyan activist even had the audacity to tell me that if she got into trouble with the Kenyan authorities she would immediately rush to her embassy for protection – a luxury she knows I do not have because of my Kenyan nationality.)

Guesmi, a PhD candidate in English Studies at the University of Montreal, was commenting on the absurdity of situations where conferences focusing on African issues are held in Europe or North America and have panellists exclusively from the Western world – people who by virtue of their skin colour or nationality have easy access to these venues, a privilege that citizens of African, Asian or Latin American countries do not have.

Gone are the days when leading academics from around the world were invited to the University of Dar es Salaam – the incubator of revolutionaries in the 1970s and 80s – to present their research findings; today, African scholars need to be endorsed by a Western institution before their research can be viewed as credible. (Given the declining academic standards at many African universities, this is understandable, but it still doesn’t explain why seminars and conferences also have to take place in the West.)

“This reality,” wrote Guesmi, “has generated numerous difficulties for Africa-based academics and scholars who are now forced to pay exorbitant, non-refundable visa fees in foreign currencies not always available to them and struggle to secure international travel funding. The resulting displacement and exclusion of continent-based Africanists have undermined the true purpose and identity of African studies; a pathological process commonly identified as gentrification.”

The marginalisation, or what Guesmi calls “gentrification”, of African scholars from the field of African studies has led to an absence of Africans from public discussions and intellectual debates. “In the news or in public venues, there is an embarrassing preference to invite white Africanists to comment on every single topic, ranging from women’s oral culture all the way to electoral violence, and anything in between,” noted Guesmi.

Representation and misrepresentation

However, this form of exclusion and marginalisation also exists within the continent. For instance, in a recent article, Mordecai Ogada lamented the near-absence of black Africans in the field of conservation in Kenya. “Wildlife conservation is the one field where highly qualified black Africans are routinely supervised by white practitioners of far lesser technical pedigree or experience,” he wrote.

Those of us who are living and working in Africa are constantly reminded of how little our views or opinions are valued when we attend conferences where all the leading “experts” on a panel are white or foreign. I have witnessed this phenomenon on several occasions, particularly when the topic is about Somalia. I dare not claim to be an expert on Somalia (even though I could claim expertise, having written two books about the country) but I have often been in situations where the so-called Somalia “experts” in panel discussions have only a limited or one-sided view of the war-torn country, yet they are the ones who are flown into Nairobi to speak at such events. Somalis tend to remain mere spectators, and their views on their own country are hardly ever sought. (The fact that these seminars and conferences are taking place in Nairobi, and not in Mogadishu, is a problem in itself.)

Wildlife conservation is the one field where highly qualified black Africans are routinely supervised by white practitioners of far lesser technical pedigree or experience

This means that Somalis are not allowed to be experts even on their own societies. This is the reason why Somali voices have been rendered largely invisible in much of the academic scholarship and literature on Somalia, which imply that Somali scholars as not good enough to be taken seriously – especially on subjects to do with their own country. As one of many examples, an anthology titled Globalizing Somalia published in 2013 has not even one Somali contributor; all except one of the authors is white and either American or European.

Sometimes, for the sake of “diversity” or “representation”, a few Somali scholars or analysts may be included in a collection of essays or in panel discussions. However, in my experience, only those scholars or analysts who do not deviate too far from traditional narrative about Somalia (civil war, terrorism, piracy, pastoralism and the like) are invited to contribute; in other words, they gain visibility through conformity.   Radical thinkers, or those who actively reject racist of distorted representations of Somalis, are rarely invited.

This means that Somalis are not allowed to be experts even on their own societies. This is the reason why Somali voices have been rendered largely invisible in much of the academic scholarship and literature on Somalia, which imply that Somali scholars as not good enough to be taken seriously – especially on subjects to do with their own country. As one of many examples, an anthology titled Globalizing Somalia published in 2013 has not even one Somali contributor; all except one of the authors is white and either American or European.

For example, when a journal called Somaliland Journal of African Studies came out recently, many Somali academics wondered why none of the researchers and academics on the journal’s editorial and advisory boards were ethnic Somalis. Markus Hoehne, a member of the journal’s advisory board, explained the absence of Somalis by arguing that he “did NOT come accross [sic] many younger Somalis who would qualify as serious SCHOLARS – not because they lack access to resources, but because they seem not to value scholarship as such.”

Under the Twitter hashtag #CaddaanStudies (caddaan means “white” in Somali), Somali scholars reacted furiously to his remarks, and released a long list of Somali academics who had done serious research at prestigious institutions and who were recognised as experts in their fields (albeit by a small, but growing group of their peers). Safia Aidid, a historian, said that Hoehne’s comments reflected “a mindset in which the Somali is rendered passionately partisan, while the non-Somali researcher remains worldly and detached in his analysis.”

The other disturbing reality is that African scholars who do not wish to be “Africanists” and who would like to focus their research on countries or regions outside the African continent are even less likely to be taken seriously. If a Ugandan scholar studies the archaeological history of Scotland, for example, he might as well say goodbye to any recognition for his work. No Scottish institution will invite him to present his findings and his work will hardly ever be cited by researchers. This unfortunate reality forces most African academics to focus their work exclusively on Africa – a restriction that is never placed on European or North American “Africanists”, who are presumed to know more about Africa than Africans. The few African voices whose opinions are sought tend to be those who have more access to the Western world, or who are considered the “acceptable faces” of African intelligentsia, which leads to a homogenous view of the continent, a view that in essence reinforces negative stereotypes about Africa and which is unlikely to question the authority (and superiority) of Western scholarship.

White privilege and issue-based activism

The idea that Africans are not qualified to research or write about things non-African is one that the writer Aminatta Forna has grappled with. Forna, who has been described as a Sierra Leonean writer, even though she is half-Scottish and was born in Scotland, wonders where the “orthodox idea” that writers must only set stories within their own country of origin came from. “Writers do not write about places, they write about people who happen to live in those places,” argued Forna in an article published in the UK’s Guardian newspaper. “This is something that the labellers and their labels don’t understand either. [Chinua] Achebe did not ‘write about Africa’, he wrote about people who happen to live in Igboland. Likewise, I do not ‘write about’ Sierra Leone or Croatia; those places are settings for my characters.”

However, what writers such as Forna, who are based in the West and who hold European or North American citizenship, fail to recognise is the imbalance created by “white privilege” (which Forna also benefits from given that she has a white mother and grew up in the United Kingdom) that determines who can say what about where and how. White privilege allows white writers from Europe or North America to become experts on the rest of the world, but people who are not from the bastions of the Anglo-Saxon world are confined to being experts only of their region, their country of origin or their ethnic group – and even then, they are often dismissed as amateurs or not scholarly enough.

It is also important to recognise that Western academics and writers have access to more financial resources and influence than African academics and writers, and so their work has more chances of being published, which could explain the dearth of African contributors in scholarly journals. The lack of credible and respected journals based at African institutions also plays a part in devaluing African scholarship. And those that exist on the continent are almost entirely dependent on Western funding. This allows the Western world to set the agenda on what kind of scholarship on Africa is acceptable and what isn’t. Western institutions that fund research on the continent decide the tone, content and focus of research – and quite often the conclusions.

This also applies to activism, particularly on women’s rights, which tends to be issue-based, rather than taking a more holistic approach to the challenges facing Africans and how these might be overcome. As the Sudanese women’s rights activist Hala Al-Karib noted in a recent article published on the Al Jazeera website, “most Northern institutions reduce women’s rights and violations against women to a one-dimensional fight against FGM [female genital mutilation]…In this context, the rhetoric of gender mainstreaming becomes a box-ticking exercise while minimising the root causes of women’s subordination and the politics behind the subordination. The few publicly-aware activists become the outsiders, bearers of bad news, and are often labelled difficult – too political.”

Issue-based activism also tends to obscure the historical reasons for a problem. When I was in Kabul, Afghanistan, in early 2002 as part of a United Nations mission to assess the country’s developmental needs after President George Bush invaded the country following 9/11 and expelled the woman-unfriendly Taliban from the capital city, the chatter in the UN compound where UN officials and NGO workers were living was all about how the international development community could help Afghani women to abandon their burqas. For them, the light blue veil donned by women in the country symbolised everything that was wrong with Afghanistan; no one asked how the United States contributed to the establishment of the Taliban in the first place through its support of the Mujahideen during the war with the Soviets in the 1980s.

When poverty, underdevelopment or human rights abuses are depoliticised – i.e. taken out of the realm of politics – they become problems that have technical, not political, solutions, which Al-Karib believes is “extremely dangerous for the future of African women”. She says that the depoliticisation of the women’s movement in Africa “has already influenced generations of younger women in our part of the world, causing them to aspire to work for NGOs on women’s rights to claim social and economic privileges rather than making any meaningful change”.

Fortunately, a new group of young African writers and academics are emerging and creating their own spaces. The Kenyan literary journal Kwani? emerged as a response to the fact that few African writers had a space at home or abroad to publish their work. The online magazine The Elephant is another example of a publication that is filling an intellectual and journalistic void that mainstream East African newspapers, which are increasingly being captured by the state or are heavily skewed towards commercial interests, are not filling. Africa-based research institutions, such as The Council for the Development of Social Science Research in Africa (CODESRIA), which has its headquarters in Dakar, Senegal, are also having an impact in global academic circles. Unfortunately, because most of these are funded by Western donors, their long-term sustainability continues to remain precarious.

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HOW TO RE-INVENT MONEY: Notes for cryptocurrency techno-warriors

Ultimately money is a social contract DAVID NDII argues. And though Bitcoin and cryptocurrencies may yet emerge as transformative disrupters of human and economic relations, certain fundamentals need to be in place if they are not to go the way of other fads past. History teaches us that ultimately monetary delinquency is one of the more reliable harbingers of revolution. If government makes a mess of our money, we can always behead the King.

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HOW TO RE-INVENT MONEY: Notes for Kenya’s cryptocurrency techno-warriors

Ten years ago, an anonymous person or people known as Satoshi Nakamoto published a paper announcing a monetary innovation described as a peer-to-peer electronic cash system. “Peer-to-peer” means a system of exchange that does not require intermediaries, such as banks, to function. When we use a card to buy something at the supermarket, the holder’s account is debited and the account of the merchant is credited. There are at least three intermediaries to this transaction namely, the card-holder’s bank, the supermarket’s bank and the card issuer all who make some money from it, and there is of course the governments which are the ultimate guarantors of the payment systems we use.

The system devised by Satoshi Nakamoto known as Bitcoin became the progenitor of cryptocurrencies. Instead of the accounting systems of banks and other intermediaries, the cryptocurrency systems use a digital public register, known as a blockchain. When people transact, the transaction appears on the public register. The transaction’s security and validation services that we rely on: banks, card issuers, central banks and lately telcos and “fintechs” in the case of mobile phone payments platforms, is done by techies called “miners” who compete to verify transactions by solving puzzles. The miner who completes the verification first earns some bitcoins. So in effect, the claim that there is no third party intermediary is not quite accurate. What they have done is to replace centralized systems and authorities with a decentralized free-for-all system.

Bitcoin appeared have settled at around $1000 up until January 2017, when it began what was to become an unprecedented rise. In December 2017 it peaked at a little over $19,400. A year later it is down to under $4000. Bitcoin is now billed as the most spectacular financial bubble on record.

At the height of the cryptocurrency boom, enthusiasts were declaring fiat currencies history. Fiat money is a currency decreed by governments to be the “legal tender” in its jurisdiction and is one of three types of money that have existed in history. The other two are commodity and credit money. Commodity money is something of intrinsic value such as precious metals that is generally accepted for payment. Credit money arises when debt instruments typically issued by a reputable party such as a bank, wealthy enterprise or government becomes accepted for payment. The word “banknote” originates from the “free banking era” in the US, when promissory notes issued by banks were generally accepted as means of payment. Today’s prominent fiat currencies such as the US dollar began life as promissory notes issued by governments mostly to finance wars.

Bitcoin appeared have settled at around $1000 up until January 2017, when it began what was to become an unprecedented rise. In December 2017 it peaked at a little over $19,400. A year later it is down to under $4000. Bitcoin is now billed as the most spectacular financial bubble on record.

As Bitcoin soared, Initial Coin Offerings (ICOs) began to look uncannily like the prospectuses of South Sea Bubble companies (such as my personal favourite: “For carrying out an undertaking of great advantage; but nobody to know what it is”). Economists, who pointed this out, including this columnist, were dismissed as luddites who were stuck in old school thinking. Cryptocurrency and blockchain were the ultimate technological disrupter. We were on the cusp of a new economic architecture where the old rules would no longer apply.

Today’s prominent fiat currencies such as the US dollar began life as promissory notes issued by governments mostly to finance wars.

The cryptocurrency techno-warriors may yet have the last laugh. But to do that they would do well to learn a thing or two about the competition.

Up until they were colonized a century ago, my Agikuyu forebears were moneyless. In Elspeth Huxley’s irreverent parody of the Agikuyu’s early encounters with Europeans Red Strangers, this is what ensues when Muthengi is offered a job that pays five rupees a month: 

“I do not want these metal objects,” Muthengi answered. “What can I do with them? Why does he not give me goats?”

It is the same as if he gave you goats” the interpreter said. “You can exchange rupees for goats.”

“How many are needed to obtain a goat?”

One rupee will buy one goat?”

Muthengi could conceal his incredulity no longer. It was impossible to believe that the world held anyone so foolish as a man who would surrender a goat for a useless piece of metal possessed, it seemed, of no magical powers. But the thought of five goats a month burrowed like a mole underneath Muthengi’s mind. It seemed incredible, yet what if it could be true? Five goats a month, thirty goats a season, two hundred and ten goats in four seasons with the increase of one to each female in a season…it was impossible to encompass so many goats with the mind’s eye.

Muthengi accepts, dutifully converts his five rupees pay into goats every month, and becomes very rich.

In economics, we tend to look at money like Muthengi. Since money is not of itself productive people ought not hold on it longer than necessary, they would convert it to goats as soon as they are able. Money would be constantly changing hands, lubricating commerce. Why then, is money such a big deal?

To study questions like these, economists sometimes resort to reverse engineering to see whether we can build a model in which the thing in question arises “endogenously.” By “endogenous” we mean that it is not introduced by an outside agent, such as the mysterious Satoshi Nakamoto.

As Bitcoin soared, Initial Coin Offerings (ICOs) began to look uncannily like the prospectuses of South Sea Bubble companies. Economists who pointed this out were dismissed as luddites who were stuck in old school thinking. Cryptocurrency and blockchain were the ultimate technological disrupter. We were on the cusp of a new economic architecture where the old rules would no longer apply… The cryptocurrency techno-warriors may yet have the last laugh. But to do that they would do well to learn a thing or two about the competition.

Students of economics know that money serves three functions: a medium of exchange, a unit of account and a store of value. Our earliest ancestors were hunter-gatherers. We do not know for sure whether hunter-gatherers invented money. It is not evident that small bands of hunter-gatherers would find need to invent a medium of exchange, or units of account.

But one thing we are sure of is that hunter-gatherers grew old. They would have had to figure out some means of surviving in old age. One of these is to cultivate social bonds which obligate progeny to provide for the elderly. This is quite evidently true, but it is not entirely sufficient since not everyone will have children, and it is far from certain that children will survive to support their parents in old age. Thus, kinship-based old age security will result in some old people enjoying good care from their progeny, and others dying of destitution, quite an unsatisfactory situation.

Trading seems to be one of the things that we do naturally. Two hunter-gatherers, one who has caught an antelope and the other has harvested wild honey bump into each other on the way home. Can I have some of that, for some of this? Markets enable strangers to meet each other’s needs. Can the market find a solution for the old age security problem?

Table 1

Table 1

Now, imagine a small hunter-gatherer community with a population of two hundred people. Each person lives for two periods, youth and old age, and is endowed with three units of a consumption good, manna from heaven if you like, when young and one unit when old. As per the law of diminishing returns, consuming the first unit yields 20 units of happiness, the second yields 15 and the third yields 5 units. As shown in the table, if each person consumes only their endowment, they enjoy 60 units of happiness. If they can trade so that each person consumes two units in each stage, each person would enjoy 70 units of happiness in their lifetime.

In economics, we tend to look at money like Muthengi. Since money is not of itself productive people ought not hold on it longer than necessary, they would convert it to goats as soon as they are able. Money would be constantly changing hands, lubricating commerce. Why then, is money such a big deal?

This set up is called an overlapping generations model and is one of two devices that economists use to study long run economic dynamics (the other one is called an infinite horizon model). It was formulated by French economist Maurice Allais and refined by Paul Samuelson in a seminal 1958 paper titled A Consumption Loans Model of Interest with or without the Social Contrivance of Money. My set-up here conveys the gist of Samuelson’s model but the formulation and parameters are my own.

If the community can find a way to trade, everyone will enjoy 10 more units of happiness.  One way of thinking about this is as an increase in life expectancy from 60 to 70 years. The problem with this trade is that it cannot be conducted bilaterally, peer-to-peer if you like.  The young can support the old today, who will then die. For their own old age security, they will need the support of the next young generation which is as yet unborn. However, if society were to device a voucher, a receipt if you like, that is given to each prime-age adult in exchange for giving up one consumption good unit to support an old person, they can trade vouchers with the subsequent generation.

Be it a strip of buffalo hide, or a string of cowrie shells, a social security card or a promissory note, it stands to reason that once it’s invented each successive generation will value them, since everyone will also need to secure their old age with the successor generation. Individuals need no longer fear old age destitution on account of not having family support in their old age. In fact, this market system could have the unintended consequence of undermining the kinship system, as Alessandro Cigno observes in his book Economics of the Family:

“the growth of the financial sector (including in that the social security system, as well as banks, private insurance and the stock exchange) tends to coincide, in the development of an economy, with a sharp fall in fertility, the break up of extended family networks and a widespread reluctance on the part of the middle aged to accept responsibility of elderly relatives.”

Now that we have a theory of money, we can examine what attributes sound money should have. First, it needs to be trusted. Every voucher must be a legitimate store of value. It is not difficult to see that people entrusted with its production may be tempted to game the system by producing more vouchers than needed, and some people will find themselves with vouchers that command less than what they put it. Second, it should be possible to increase the number of vouchers in tandem with the population growth To see this, let us suppose the next generation increase to 110 people, an additional ten vouchers will be needed otherwise some of its members will be locked out of the intergenerational trade.

What then, are the lessons to be learned by people seized with the idea of re-inventing money?

One of the key requirements of sound money is a credible supply rule. In our simple model, the anchor is population growth. But it so happens that in our model population growth and economic expansion are identical, therefore it is the same as a money supply rule that is anchored on the size of the economy. Satoshi Nakamoto decreed that the bitcoin algorithm would cease after 21 million of them were mined. Why 21 million? Nobody seems to know. In effect, as a currency, bitcoin had the same flaw that undermined gold and silver, namely arbitrary supply that is unrelated to demand.

A second flaw is the tech-hype the cryptocurrency as the ultimate disruptive technology that would liberate society from the state-financial capitalist stranglehold. Because the value of technology innovations is highly uncertain, the value of bitcoin became entwined with people’s subjective guesses and predictions of what that value might turn out to be, as opposed to the economic fundamentals. We call this a sunspot equilibrium. For an asset purporting to be money, it is a highly undesirable attribute. It is this particular flaw that fueled the speculative bubble. This eventuality could have been mitigated by creating two assets: one that would profit from the innovation and one that reflected the economic fundamentals.

One of the key requirements of sound money is a credible supply rule. In our simple model, the anchor is population growth. But it so happens that in our model population growth and economic expansion are identical, therefore it is the same as a money supply rule that is anchored on the size of the economy. Satoshi Nakamoto decreed that the bitcoin algorithm would cease after 21 million of them were mined. Why 21 million? Nobody seems to know.

The third and perhaps fatal flaw is that cryptocurrency inventors failure to appreciate that fundamentally, money is a social contract. Social acceptance is what makes cowrie shells, beaver pelt, silver, gold or pieces of paper issued by government a currency. Of all our social contrivances, the one that money shares most attributes with is the state. It should not surprise then, that money has evolved into government-issued fiat currencies. But just like in governing, it does not mean that governments will excel in monetary affairs. In fact, the quality of a country’s money and governance tend to be closely correlated. Robert Mugabe’s ZANU-PF regime is but the latest to make a mess of both.

Monetary delinquency is one of the surer harbingers of revolution. If government makes a mess of our money, we can always behead the King. Which is just as well that Satoshi Nakamoto had the foresight to be anonymous. Could be he/she/they knew something that their starry-eyed cryptocurrency enthusiasts did not.

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Shopping Mall Economics: A note on the value of the Kenya shilling

What does a recent spat between the IMF and the Central Bank’s Prof Patrick Njoroge, himself a veteran of the Fund, tell us about the state of the Kenya shilling? By DAVID NDII.

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Shopping Mall Economics: A note on the value of the Kenya shilling

Is the Kenya shilling overvalued or not? According to the IMF it is currently overvalued by 17 percent. In an unusually combative response to his former employer the Central Bank governor says that is only off-kilter by 5 percent and accuses the IMF of making Kenya a “guinea pig in its new approach.” The offensive claim, contained in the IMF’s latest report on the country dated October 2018, states as follows:

“The EBA-lite methodology for the exchange rate suggests that the external position is weaker than fundamentals. The current account approach shows that the current account deficit (both actual and cyclically adjusted) are above the norm (the CA gap is -2.5 percent), suggesting an overvaluation of about 17.5 percent of the real exchange rate. This can only marginally be explained by the policy gap. The REER approach also shows a similar-size of overvaluation, equivalent to about 18.0 percent. Again, the policy gap is marginal. Given the continued appreciation of the real exchange rate, the external position is assessed to be weaker than fundamentals. Regarding the last approach, the external sustainability approach, it was not possible to use it as the international investment position data is not yet produced by the authorities.”

This needs a fair amount of disambiguation. EBA is a needless acronym that stands for external balance approach for exchange rate assessment. The methodology is described in an IMF paper published in 2013 as an update of a previous methodology known as CGER. CGER is another needless acronym for consultative group for exchange rate assessment. This EBA thing appears to be what the CBK governor is referring to as a new approach.

The methodological spat is a red herring. Economic models are tools, not oracles. What we have here is workmen quarrelling over tools. Our top three economic mandarins are former IMF staffers. Surely, as former colleagues, they can sit together with their colleagues and their models and converge on an assessment as to whether the shilling is overvalued or not?

The IMF refers to three methodologies: the Real Effective Exchange Rate (REER), the current account and external sustainability approach. Of the three, the REER is the most intuitively understandable and also the one for which we have data. But what is this animal the REER?

The methodological spat is a red herring. Economic models are tools, not oracles. What we have here is workmen quarrelling over tools. Our top three economic mandarins are former IMF staffers. Surely, they can sit together with their colleagues and their models and converge on an assessment as to whether the shilling is overvalued or not?

Suppose bananas are retailing at KSh 100 shillings a bunch in Kenya. The Kenya/Uganda shilling exchange rate is one to ten. At this exchange rate and banana price, 20 percent of bananas are coming from Uganda. Suppose price of Kenyan bananas goes up to KSh 125 a bunch (e.g. because of increase in taxes), and exchange rate remains the same. Ugandans can continue to sell bananas in Kenya profitably at KSh 100 while many Kenyan producers cannot. In fact, Ugandans are likely to hike their price to let us say KSh.110 making Kenya an even more profitable market than their home market. Uganda bananas will flood the market and put Kenyan producers who are not profitable at Ksh. 110 out of the banana business. For the market to remain at the old equilibrium (i.e. 20/80 Uganda/Kenya market share) requires Kenya shilling to fetch USh. 8.00 so that to get USh. 1000 as before, the Ugandans will also have to sell their bananas at KSh125.

Its readily apparent that if our domestic prices go up faster than those of our trading partners, then foreign goods will keep becoming cheaper. But you cannot tell by just looking at the dollar shilling exchange rate. We need to factor in the price movements with every trading partner. The REER is an index that combines the relative exchange rate and price movements of all our trading partners.

If the REER is rising, our goods are becoming more expensive. We can expect to import more and export less. If this happens our trade deficit will widen. If the trade deficit continues to widen, we run the risk of defaulting on our international obligations in particular debt service and repatriation of profits and capital. This is where the IMF comes in. The IMF’s mandate is to maintain international financial stability. The IMF is a financial cooperative whose job it is to ensure members do not run into external payments difficulties, and to bail them out when they do, in order to keep global finance and commerce going.

The spat between the IMF and the CBK is therefore about our external creditworthiness. The key indicator for this is the current account balance. The current account balance has two components: trade and income. The trade account I have already mentioned. The income account consists of payments for “factor services” such as interest (use of capital), labour (e.g. for services of Kenyan troops abroad) and another component we call unrequited transfers (meaning money we have not earned) such as diaspora remittances, grant aid and such like. The external account in turn, has a third component, the capital account where, as the name suggest, we record investment transactions.

The spat between the IMF and the CBK is…about our external creditworthiness. The key indicator for this is the current account balance.

This is how it works. Kenya Airways buys an aircraft using a foreign loan. The aircraft is entered in the trade account as an import and simultaneously in the capital account as a capital inflow. The following day it ferries passengers from Lagos to Dubai. The income is recorded in the trade account as a service export. At the end of the month it remits repayment on the loan. The interest is recorded in the income account as a factor service payment and the principal is in the capital account as a capital outflow.

The net of the current account and the capital account are added together to give the overall balance. An increasing overall deficit depletes foreign reserves, while a surplus leads to a build up of reserves. Current account surpluses mean that a country’s savings exceed its investment; it can, therefore, export capital, like China. A current account deficit means that a country is investing more than its savings, in other words, it is importing capital (either debt, FDI, remittances, grants etc).

Chart 1

The country’s creditworthiness thus depends not just on trade but also on other financial flows, that are determined by factors other than trade competitiveness, both economic and non-economic. Complicated stuff.

Both the IMF and CBK agree that the shilling has appreciated, but they disagree on the magnitude. The IMF also implies that the appreciation is a reflection of policy action while the CBK maintains that it is a reflection of market forces. The IMF view translates to accusing the CBK of misleading the public by espousing a monetary policy that claims to target inflation, while in practice it is actually targeting the exchange rate. The IMF’s “smoking gun” is the fact that the NEER has flatlined for the past six years (see Chart).

Recently the IMF re-classified the Kenya shilling from a “floating” (meaning market determined) to “other managed arrangement.” This means the IMF is convinced that the Central Bank is propping up the shilling. What reason would the Central Bank prop up the shilling especially if it undermines the country’s competitiveness and solvency?

Foreign currency debt exposure is one reason. The interest payments on the first Eurobonds issued in 2015 ($185 million a year) has increased by KSh 3 billion, KSh 16 billion to KSh 19 billion on account of the depreciation of the shilling. Translate that to the total interest payments this year which are in the order of $1.4 billion dollars. The shilling has weakened by about three shillings to the dollar since the beginning of the financial year. The total interest payments this year which are in the order of $1.4 billion. This translates to a KSh 4 billion squeeze on a government that is already living way beyond its means. The last thing the Treasury wants to hear is that the shilling should be trading at about 120 to the dollar.

Recently the IMF re-classified the Kenya shilling from a “floating” (meaning market determined) to “other managed arrangement.” This means the IMF is convinced that the Central Bank is propping up the shilling. What reason would the Central Bank prop up the shilling especially if it undermines the country’s competitiveness and solvency?

Another reason is pressure to keep low interest rates. Interest rate is the policy instrument in an inflation-targeting monetary policy regime such as we claim to have. Central Banks are given statutory independence over the conduct of monetary policy to insulate them from such pressure so that they can raise interest rates when they need to, even when it is politically costly for the government of the dayParliament’s capping of interest rates two years ago is ample demonstration that political pressure on Central Banks is real.

Keeping interest rates artificially low puts pressure on the exchange rate. A weakening currency creates inflationary pressures, which is what the Central Banks are mandated to control in the first place. The Central Banks end up trying to meet incompatible objectives, low interest rates, low inflation and a stable currency.

This is precisely what happened from mid-2009 to September 2011. The Central Bank bent over backwards to accommodate the government’s economic stimulus meant to respond to both the post-election violence and the global financial crisis. Interests rate were driven to the floor. From mid-2010 to mid-2011 the benchmark 90-day Treasury bill rate was kept below 3 percent. The IMF’s charts show how this ended— with a very hard landing. The shilling which had been propped up at about 80 to the dollar, started unravelling in April peaking at KSh100 to the dollar in September. The Central Bank was forced to jack up interest rates in a hurry. By the end of 2011, the T-bill rate was heading to 20 percent.

The IMF seems to believe that, left to market forces, the shilling will depreciate in real terms. The IMF’s REER chart covers eight years, from 2010 to 2017. A longer timespan does not necessarily support this contention (see Chart). My chart goes back to the beginning of the liberalized regime in 1994. What do we see? The shilling has been appreciating in real terms since it was liberalized. Overall it has appreciated 157 percent, by 9 percent per year on average. This could mean that the Government has been propping up the shilling all these years, or that market forces are not working the way the IMF expects.

Chart 2

Many Kenyans have observed that we have become an importing country. One also hears policymakers lamenting that we are losing our markets in the region and blaming all manner of things. There is no mystery to it.

My [assessment is that] the shilling has been appreciating in real terms since it was liberalized. Overall it has appreciated 157 percent – by 9 percent per year on average. This could mean that the Government has been propping up the shilling all these years, or that market forces are not working the way the IMF expects.

But is the Central Bank propping up the shilling? That we cannot be able to tell that easily. There are lots of moving parts. It can also be on account of some trading partners manipulating their currencies: China, for example, is regularly accused of maintaining an artificially weak currency. China has a big weight in our REER and it’s been growing over time.

The ultimate question is whether it is sustainable. There are two parts to this, financial and economic. The widening trade deficit has been plugged by remittances and portfolio inflows (money flowing into the stock exchange and government securities), not all of it honest money, and lately, government commercial borrowing, the ubiquitous eurobonds and syndicated loans. As long as these keep flowing, the show can go on.

Why are we told the economy is growing and yet we cannot feel it? This is the shopping mall economy. How long can we keep that going?

The economics is a different story. This is the shopping mall economy. It is not good for employment and equity. It is not good for employment, or equity, or sustainable growth. It is part of the answer to the question that Kenyans keep asking: why they are told the economy is growing and they are not feeling it. This is the shopping mall economy. How long can we keep that going? Your guess is as good as mine. Governments are known to manipulate currencies and to distort financial markets generally. The IMF is known to (a) have more faith in market forces than warranted and (b) get the workings of those market forces wrong. What to do?

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