After Diamonds we shall live like Swazis

After Diamonds we shall live like Swazis

 

Virtually every economist who has studied the country, and there are literally hundreds of them,  have told Botswana what every Batswana already knows in their heart of hearts- that despite the marketing slogan, diamonds are not forever. One day the great diamond mines at Jwaneng and Orapa will close and then what will happen  if   the country has not diversified its exports then Botswana will simply become much poorer. But how much poorer and when? If the modelling estimates that have been presented this week by BIDPA and BOCCIM are anywhere near correct then our GDP/ capita will fall by approximately 48%. What does that mean in practical terms? At present Botswana’s GDP/capita which is the standard measure used by economists to measure a country’s income is US$ 7,300 in 2013 according to the World Bank. If our GDP/capita fell by roughly 48% as the modelling estimates suggest we will live slightly better than Swazis who have a GDP per capita of US3,100.

Now what the modellers have done is work out what would happen to Botswana if the diamonds come to an end. Fortunately this is not going to happen any time soon and most of the estimates indicate that we will be producing some diamonds until 2050. While diamond production will continue the estimates are that a very large portion of the diamond revenue will start to fall off after 2027. Much of the effect of the decline in diamond revenue will be felt by Botswana after that date and it is no doubt part of the reason why the government has moved to establish a fund for future generations which will see savings rise substantially in the coming years.

Beware of good news merchants

The first response to telling people bad news (‘you are going to die a long and painful death’, for example) is usually complete denial. The second response, as I know at my peril,  is to ‘shoot the messenger’ if you can.  One senior economist in government has told me that ‘your work is completely wrong - how can GDP per capita fall by 48% if the diamond mining sector  is only responsible for some 20% of Botswana’s GDP’.   The answer is pretty straight forward – diamonds might only add 20% to Botswana’s GDP but they are over 80% of foreign exchange earnings. Without foreign exchange earnings the whole economy will grind to a halt. Another banking economist  told me that these results fly in the face of all the future projections from the international financial institutions which say that Botswana will have future economic growth rates of 4%- no need for a fund for future generations or these projections that simply panic people. All this assumes that the diamonds will be there… but they are not forever. 

In a similar vein one ‘futurologist’ in Pretoria said  at a workshop I attended last week said that African countries do not have to worry about mining i.e. digging holes in the ground because Africa’s economies are now so diversified. Many of these good news merchants peddle the same economics as I got here in Gaborone but the brutal reality in Botswana and throughout Africa is that digging holes in the ground is what underpins everything else in the African economies and those who forget it imperil future generations who have to live with the consequences of those who do not understand the economic consequences of resource depletion.

Export of Die!

Is there really anything that Botswana can do to avert the dramatic declines in income and living standards that are expected with the end of diamonds. The answer is and has always been that the only way to avert this disaster is through diversification- not diversification of GDP but of exports. In other words when the diamonds run out Botswana  needs other sectors that will generate the foreign exchange the country will need to buy imports. But ever since the opening of the Jwaneng diamond mine in 1982 the government has maintained a policy of export diversification but without success. Botswana’s exports are now even  more dependent upon diamonds now than they were 30 years ago in no small part because of the cutting and polishing  of diamonds is now our largest manufacturing sector with exports of P6.8 billion of cut and polished diamonds in 2013.

The reasons that  Botswana has failed to diversify its export sector for over 30 years is complex but it is certainly not for want of trying or throwing money at the problem. The Financial Assistance Policy for over 20 years spent tens of millions of pula subsidizing industry to employ people to almost no sustainable effect until it was finally ended in 2000. The unavoidable fact is that industry in Botswana has been uncompetitive on  a cost basis and there has never  been sufficient attention ever paid to the very un-sexy job of increasing the nation’s productivity and lowering production costs.

BIDPA ( a national think tank) and BOCCIM ( the chamber of Commerce)commissioned an international cost study of where our costs are highest by doing a comparison between 9 SADC countries and three Asian countries (India, China and Malaysia). What was found was that the area with the biggest cost disadvantage was in the area of highly skilled labour costs, professionals and management. What was found, much to our surprise, was that at the bottom end of the wage scale amongst those who earn the lowest wages,  that their wages were on average lower than that of India. The conclusion of the work was that if Botswana does not lower salaries at the top end, lower company tax rates for exporters to meet our competitors in Africa and dramatically improve transport costs then export oriented firms will never locate there.

Botswana can compete!

There is absolutely no reason that within the context of the 60 million people in the SACU market  that Botswana cannot be a strong and competitive exporter. There is no doubt that South Africa, in both the case of Botswana’s attempts to export electricity and automobiles, has  acted to undermine our efforts but the nation can diversify  if there is  the recognition and the will to face a  national emergency that is at hand and recognize that living standards will drop massively unless we become competitive. This is an incredibly unpopular message and everything I know about people in denial, tells me that it will be forgotten almost immediately the report is received. But if policy makers do not like this message that those on high salaries need to sacrifice current high living standards to be internationally competitive so that the next generation will be able prosper then just wait 20 years or so and market forces will give you no choice once the diamonds run out … because the diamonds, like our current living standards, are not forever.

These are the Professor Roman Grynberg and not necessarily any institution with which he may be affiliated

Botswana's Diamond Fund for Future Generations

Botswana’s New Fund for Future Generations

 

The amount that will be saved, based on 2014 revenues, would be about P5.3 billion ($600 million) in that year and will increase as diamond prices rise in pula terms and so by 2026 when government revenues from diamond mining fall off, could create a fund for future generations worth approximately P120 billion($13 billion), depending of the drawdown rules and rates of return.

 They say that the best kept secrets are always in plain sight, especially for those who look, but never read. So it is with the most profound change in Botswana’s economic policy for decades. No-one really noticed or perhaps didn’t even read what was contained in the Ministry of Finance and Development Planning Budget Strategy document. The strategy paper in paragraph 26 said that Botswana would set aside and save 40% of mining revenue for future generations. The IMF has long been pushing for precisely this sort of policy for a number of years to help Botswana prepare for a post –diamond future and every once in a while the IMF, despite its best efforts, actually gets it right. Of course if you actually believe that the next generation of Batswana , which will have no diamonds,  will be richer than the present generation then the IMF advice is clearly wrong.  But this is certainly one of those cases where the Fund has got it right. This is an unprecedented change in policy and for those who are deeply concerned with Botswana’s post-diamond future it is welcome news and the only reasonable reaction is that it is a good move that should have been implemented 32 years ago when the Jwaneng diamond mine opened and changed the face of Botswana.

 

The amount that will be saved, based on 2014 revenues, would be about P5.3 billion in that year and will increase as diamond prices rise in pula terms and so by 2026 when government revenues from diamond mining fall off, could create a fund for future generations worth approximately P120 billion, depending of the drawdown rules and rates of return. It is understood that it is the government’s intention is to create an annuity type fund where the country will receive a sustainable dividend that will continue long after the diamonds are gone. This type of sovereign wealth fund is used by the best managed resource rich countries like Norway and Qatar that fully realize that their oil and gas revenues will be gone one day and given the amount of money in question know that they need to give the next generation a chance to benefit. What both Qatar and Norway understood was that if they simply took all the huge amount of revenues derived from their natural resources they would end with unsustainable and irrational investments in infrastructure as has happened in so many countries that have abundant natural resources and have not restrained expenditure.

 

While this is a positive move for all those who realize that a poorer Botswana will be left to our children if this is not done. There should be no illusion, one does not save without sacrifice and so there are many questions that need to be answered by the Ministry of Finance and Development Planning to assure that this is a genuine sovereign wealth fund, beyond the immediate financial and political needs of the country. The key issue is who will run it and under what rules and how can those rules be changed. I have seen a similar fund destroyed in Papua New Guinea by an unscrupulous Prime Minister who simply changed the rules so as to be able to use any amount of money he wanted. Some countries have gone so far as to imbed the fund for future generations into their constitution so that only a constitutional amendment can allow a government to use and abuse these funds.

A need to protect the people

Clearly a fund so large needs to be managed by a combination of outside independent financial advisers and relevant officials from the MFDP and the Bank of Botswana. Botswana already has what some people commonly call a sovereign wealth fund – the Pula Fund, administered by the Bank of Botswana. During the ‘Great Recession’ which began in 2008 the Pula Fund was heavily drawn down so as to prop up the nation’s foreign exchange reserves. The Pula Fund, despite the hype, is not a real sovereign wealth fund, it is merely a buffer fund and while this is useful it does not assure that wealth is transferred from this generation to the next.. If there is to be a fund for future generations then it cannot be used in such a manner or it will simply collapse in the face of the economic crisis that will occur in the period after 2026 when the diamond revenues go into serious decline.

The billions that will go into the fund for future generations will need independent people to manage it and it must report to government and parliament directly so as to assure that some future government, that may be less committed to sustainability and sound economic management, does not raid the fund as is regrettably common practice.

The Old Botswana Model has stopped working

What seems entirely missing is the economic question of why the government is doing this at this point in the country’s economic history, rather than 32 years ago when it would have had much bigger and better results. The economic model of Botswana since the opening of Jwaneng has always been that the government takes that diamond revenue and invests it in infrastructure and human resources. This creates an educated workforce operating in a modern environment which can adapt to what the world throws at Botswana. The need for a pool of inter-generational financial resources was never seen as necessary as long as the export sector diversified and there were prospects for Batswana other than diamonds. This unfortunately has never eventuated.

The simple fact is that much of the new government investments in infrastructure and education at the beginning of Jwaneng made a good deal of sense, but as time went on the high yielding investments in infrastructure and in education disappeared and there was progressively more investment in projects that were, to be polite, economically marginal, e.g., giant but empty police stations, standards bodies with buildings big enough to house 2 jumbo jets and investments in yet more tertiary education institutions, while thousands of graduates remain effectively unemployed as interns.

  Who will pay for this fund?

The really important question is where will the billions come from to pay for this fund? It is fine to save money, but someone always pays. Here the government is about as up-front as any government can be with what is a very sensitive matter. The resources will come out of a more prudent policy on wages and salaries in the public service. The Budget Strategy Paper states ‘The implementation of the fiscal rule will therefore require measures to control and manage expenditure, especially the wage bill’. Those who welcome this unambiguously also emphasize that some of the government’s less effective pet projects will have to be abandoned and there will now have to be a more rigorous project evaluation. This is extraordinarily naive. One can only hope that this view is right; but in the real world it is usually the deeply political projects and not necessarily the sensible economic ones that will go ahead- fund or no fund.

The ones who will pay will in part be the public servants who will receive lower real wages and the public at large. The hardest thing to imagine is that you are overpaid. But the simple reality of Botswana’s economy is that salaries of professionals and managers are simply too high for any export-oriented diversification to occur. It is one of the big ticket items explaining why Botswana has never diversified. This is an incredibly unpopular thing to say, but its unpopularity does not make it less true. Professional salaries are the part of what makes Botswana so highly uncompetitive. Restraint in the public sector salaries is an important part of addressing this issue, but also breaking up the ‘professional cartels’ that limit competition from foreign lawyers, accountants, architects and engineers needs to occur in order for Botswana to become internationally competitive. It is not the wages at the bottom of the pay scale, which are lower than that of India, that are the problem, but the salaries at the top are amongst the highest in the region.

The only negative thing that can be said of the government’s proposed fund for future generations is that it is simply too little and too late in Botswana’s economic history to stave off a major fiscal crisis that will surely come around 2026, when diamond revenues fall drastically. But it will provide the country with some cover.

 

BIDPA, together with BOCCIM, will be organizing a conference on November 13th which will be discussing Botswana’s future after diamonds. Some of these issues will be addressed at this meeting.

 These are the views of the author and not necessarily those of any institution with which he may be affiliated.