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Cabo Verde at a threshold: Changing growth paradigm

Wednesday, March 15, 2017

In 2010, the African Development Bank’s President applauded Cabo Verde for having achieved a “policy induced graduation” into the middle-income country group against all odds, as opposed to reaching it through a drive by natural resources. From 1995 to 2007, Cabo Verde’s real GDP growth rate averaged 7.2%, while the GDP per capita grew 5.1% a year over the same period. Good governance, political stability and sound economic policies have been the key ingredients to the country’s success.

In achieving such success, a 2012 report by the AfDB entitled “Cabo Verde: the Road Ahead” identified four key ingredients: the country’s unwavering commitment to investment in human development, good governance and sound management of the State and economy, underlying social-political stability, and the generosity of the international community as well as the strong ties that its global diaspora retains to the homeland.

Over the years however Cabo Verde’s economy became increasingly linked to Europe. Its dependence on European foreign direct investment (FDI), as well as tourism from the Old Continent proved to be a good anchor up until the global financial crisis and the European debt crisis hit. As a consequence the country saw a sharp fall in FDI flows, remittances and a slowdown in tourism. Between 2008 and 2009, FDI inflows fell from 11.8% to 7.4% of GDP. Remittances also showed a drop from USD 155 million in 2008 to USD 131 in 2010 before recovering. As such, the country experienced a year of recession in 2009 (-1.5%) before returning to a 1.8% average growth between 2010 and 2014. In 2016 a recovery begins with an estimated rate of 3.2%.

With such a situation at hand, the authorities engaged into a counter-cyclical policy spell with high investment spending, yet the country only managed to grow by an average of 1.3% over the 2010-2015 period. To some extent, the country’s small market (and its low level of regional integration with Economic Community of West African States partners) as well as its high propensity to import led to a low spending multiplier that did not convert the spending into growth. Still it maintained the economy afloat. On a positive note, important investment infrastructure has been rolled-out which can in theory yield dividends down the line. On the negative side, as a consequence of the high investment spending the debt level increased drastically, from 71.9% of GDP in 2010 to 125.8% in 2015.

While debt issues can be the focus of a subsequent blog post, an important issue that the situation raises is that the public sector can no longer afford to be an engine for growth. Considering the debt level as well as the budgetary efforts required to keep it sustainable, the government is seeking to change the underlying growth paradigm and placing the private sector at the center. The challenge in doing so is that the private sector is still at a relative infancy.

In the past decade, Cabo Verdean authorities have made important strides in order to improve the business environment, and in particular the regulation affecting entry, exit and competition. In 2011, Cabo Verde made firm start-ups easier by eliminating the need for a municipal inspection before a business begins operations. They also worked on computerizing the system for delivering the municipal licenses.

But placing the private sector as a growth engine at this stages requires more than focusing on climbing the Doing Business ladder. First, it requires a strong and coherent public policy discourse. One recent example relates to the new presence of a private airline to operate inter-island routes. Not discarding the fact that territorial continuity in Cabo Verde is a fundamental requirements, it remains that the private operator is competing against a State-owned subsidized airline. The challenge is thus to reconcile an investment-friendly policy with exigencies of territorial continuity and level the playing field between operators.

Second, the country should endeavor to turn towards the West Coast of Africa in order to seek market opportunities. Regional integration is a major challenge for this small island country. As a member of ECOWAS, Cabo Verde is also the only island country in the sub-region. Trade volume between Cabo Verde and the other ECOWAS countries is insignificant (about 0.1% of all trade in Cabo Verde). According to the ECOWAS trade complementarity index presented, Cabo Verde scores 23 out of 100 (where a score of 100 indicates perfect complementarity between partners). Although high in relation to some partners, this index highlights both the need for economic diversification in order to align with regional demand and take advantage of the economic zone, as an opportunity to strengthen its economy.

Third, diversification of the economy is an indispensable condition for long-term growth. In the absence of natural resources and economies of scale to support a significant base in the manufacturing sector, the Cabo Verdean economy is concentrated in the service sector. In 2012, the tertiary sector accounted for about 70% of GDP and was dominated by tourism and FDI flows in the tourism sector. Structural reforms such as the improvement of the organization of local production of goods and services, the creation of a system of certification of the quality of local products and the improvement of transport systems between islands are key. Due to the poor natural conditions, agriculture is underdeveloped yet remains a crucial sector for poverty reduction, the promotion of green growth and climate resilience.

Towards the end of 2016 the economy showed some positive signs of recovery. Albeit still at overall low levels, credit to the private sector has increased as opposed to past years, and a trend inversion is noted in economic confidence indicators. While these are positive short-term developments, Cabo Verde should not lose sight of the long-term. The decades of experience of good policy choices will now need to be leveraged in order to achieve the intended change of growth paradigm.

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