By Vanshika Mittal
During the pivotal period spanning from 1985 to 1995, Kenya was at crossroads, torn between the imperative of accountability and the allure of foreign direct investments. As funds poured in, the country faced the ugly truth of corruption and embezzlement, threatening the very foundation of its economy. This era encapsulates Kenya’s unwavering pursuit of progress amidst formidable obstacles, with corruption emerging as the primary driver influencing the country’s economic trajectory.
Post independence in 1963, the government of Kenya adopted a mixed economy model that combined socialist and capitalist ideas. This crucial era was marked by a visionary pursuit of self-sufficiency under President Jomo Kenyatta. The economy’s GDP (constant 2015 US$) grew from 5.63 billion in 1961 to 23.14 billion in 1985, one of the highest rates in Sub-Saharan Africa. The rapid growth of Real GDP (constant 2015 US$) at an average annual rate of 7% was attributed to coordinated efforts in advancing both small and large-scale farming; along with transformation in the country’s infrastructure as large-scale initiatives involving roads, railroads, and telecommunications aimed to connect rural areas with urban areas, thus promoting economic growth.
Consequently, in the 1970s, there was a steady increase in FDIs as Kenya became a popular destination for foreign investors looking to establish a presence in Eastern and Southern Africa. The region’s high level of development, good infrastructure, market size, growth, and openness to FDI contrasted with closed economies in other countries. It contributed to transnational companies (TNCs) selecting Kenya as a regional hub. The FDI’s that started at an annual $10 million, peaked at $80 million in 1979-1980 (“World Investment Report, 1995”).
However, during the same period, Kenya experienced multiple economic difficulties such as high inflation, fiscal deficits, balance of payments issues, and an increasing external debt burden. These challenges necessitated significant policy changes to stabilize the economy and restore growth. Kenya’s external debt had steadily increased, raising concerns about the country’s ability to meet its debt obligations. In the light of these events, International financial institutions, particularly the IMF and the World Bank, put pressure on Kenya to implement economic reforms in exchange for financial assistance and debt relief.
The most notable change made was the introduction of Structural Adjustment Programs in 1981. The aim of SAPs was to restore efficiency in all sectors of the economy and consequently raise economic growth. Some of the major reforms under these programs that were undertaken included price decontrols; foreign trade liberalization; decontrol of domestic marketing of agricultural commodities, customer and producer prices and promulgation of Exchange Control rate.
Restructuring and privatization initiatives led to an increase in unemployment, which widened economic gaps and negatively impacted families. When export-oriented policies were prioritized over domestic food crops in an effort to generate foreign exchange, food security suffered and the economy became more susceptible to swings in the price of commodities globally. Challenges faced by marginalized communities were made worse by inadequate social safety nets. Although the programme was designed to alleviate debt, Kenya was still burdened with a large amount of external debt, and the planned economic diversification did not materialize as anticipated.
While SAPs were intended to stimulate economic growth and attract foreign investment, their implementation in Kenya during the 1980s created challenges and uncertainties. Poor investment environment, high external indebtedness and reduced domestic savings obstructed investments. The direct impact was the reduction in FDI inflows in the short term. The average annual FDI inflows were 21 million dollars between 1983-88, depicted in Table 1. It is particularly interesting to note that from Table 2, the ratio of FDI inflows to gross fixed capital formation and the ratio of gross fixed capital formation to GDP (in %) was 1.1 between 1980-1985 (“World Investment Report, 1995”). From 1986-1990, the annual average was 2.4, and although the averages grew between the two time periods, it is evident that the FDIs were being used for expenditures other than investments.
Table 1 : Foreign direct Investments Inflow
Source: UNCTAD
Table 2 : Ratio of FDI inflows to gross fixed capital formation and the ratio of gross fixed capital formation to GDP (in %)
Source: UNCTAD
Ideally , to support their economy, FDIs could have been diverted for job creation, technology transfer, and export promotion. However, a catch to these diversions was an increased level of corruption met with low economic growth. Drawing from Paolo Mauro’s ‘Corruption and Growth’, corruption is negatively related to investment rate (Mauro).
Table 3 : Business International and ELF Indices
Source : JSTOR
The negative correlation between corruption, investment and growth rate has a high statistical significance. From table 3, If Kenya could control corruption and decrease it by one unit, its bureaucratic efficiency could increase by 4.5 units (Mauro). Paolo’s paper weakly supports the hypothesis that the considerable proportion of effects of corruption on growth works through its effect on investments which is evident in Kenya’s case followed by the lack of capital formation from the FDIs.
After this tumultuous period from the early 1980s to 1989, Kenya introduced market reforms in 1990. The economic reforms included trade liberalization, deregulation and privatization. The adjustments aimed to reduce barriers to entry and enhanced market competitiveness. Following the political instability, for the first time in 1992, Kenya held multi-party elections that reduced uncertainty for investors. It was so because risk mitigation played an important role in a multi-party system. The likelihood of abrupt political changes or radical shift in government priorities lowered, and the system improved Kenya’s reputation and credibility abroad since the elections were regarded as a sign of democratic governance and political pluralism. It inspired confidence in foreign investors and development partners.
Alongside this, Kenya worked to improve the ease of doing business in the nation, cut corruption, and simplify bureaucratic procedures. Establishing and running businesses in Kenya had become easier for foreign investors thanks to streamlined licensing, permit, and company registration processes. Kenya created specialized anti-corruption organizations to look into and prosecute corruption cases on their own. Organizations like the Ethics and Anti-Corruption Commission (EACC) and the Kenya Anti-Corruption Commission (KACC) gave rise to institutional bodies whose main goals were to combat corruption and advance integrity in public service.
Therefore, Kenya became more welcoming to foreign investment as the government actively pursued FDI to augment domestic savings and promote economic development programmes. Higher levels of FDI inflows to Kenya were attracted by an improved investment climate in conjunction with focused investment promotion initiatives. In 1993, the FDI inflows increased to 9 million dollars from an all time low of 2 million dollars in 1992. However, the FDI inflows to gross fixed capital formation and the ratio of gross fixed capital formation to GDP decreased to 0.2% in 1993 from 0.5% in 1992 (“World Investment Report, 1995”). This still meant that the FDIs were not being used for capital formation.
Figure 1 :GDP Growth Rate (in%)
Source : World Bank
Generally, based on the growth accounting framework of the Solow model, an increase in investments should lead to an increase in the GDP growth in the short run. The model also tells us that capital poor countries have a higher GDP growth rate in the short run. In Kenya’s case, for the majority of the period between 1985 and 1995, first, it did not receive enough investments that could lead to an increase in the GDP growth rate. But secondly, for this period, the FDIs attracted by Kenya did not encapsulate into the capital augmenting investment rate of the Solow model because there was practically no investment in capital formation. The increase in GDP growth rate (figure 1) from 1992 to 1995 from -0.8% to 4.4% was not effectively promoted by investments but by exogenous factors.
Such exogenous factors that are not accounted for in the model include policy reforms that can directly or indirectly affect the parameters or the variables of the model. These variables can also be impacted by shifts in the state of the world economy such as the end of the Cold War in 1991, changes in commodity prices, or developments in geopolitics. A stronger global economy or a rise in the market for Kenya’s exports might have led to a greater GDP growth rate during the time period under review.
To conclude, In Kenya’s case, it was high degrees of corruption and political instability that led to an unfavorable environment for investments. The introduction of some policies such as the SAPs negatively impacted capital formation in the country. For the residual FDIs that Kenya received in the period 1985-1995, the country did not allocate these resources to capital formation, but used them for their short-term needs. We speculate that a large part of these FDIs were pocketed by inefficient bureaucracies. Thus suggesting that the little investments that Kenya received from abroad did not capture the Solow model’s emphasis in determining long-term growth paths by influencing capital accumulation.
References –
“World Investment Report, 1995.” unctad.org, 1995, unctad.org/system/files/official-document/wir1995_en.pdf.
Mauro, P. “Corruption and Growth.” The Quarterly Journal of Economics, vol. 110, no. 3, Oxford UP (OUP), Aug. 1995, pp. 681–712. Crossref, https://doi.org/10.2307/2946696.
“World Bank Open Data.” World Bank Open Data, data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?end=1995&locations=KE&start=1961.
“Kenya: Selected Issues.” IMF eLibrary, 17 Oct. 2008, https://doi.org/10.5089/9781451821192.002.A001.
Editors. “JSTOR – a History.” eLucidate, vol. 7, no. 1, University of Alberta Libraries, Jan. 2010. Crossref, https://doi.org/10.29173/elucidate576.
Economists in Transition 