An analysis of the DFID/EC Strategy for Sierra Leone

By Mohamed Jalloh and Jonathan Rose

January 30, 2007

SALONEDiscussion Group
219 Bristol Downs Drive
Gaithersburg, MD 20877
USA

Robert Watt
Deputy Head
DFID Sierra Leone
Spur Road
Freetown, Sierra Leone
sierraleonejcsp@dfid.gov.uk

An Analysis of the Basis of the DFID/EC Strategy for Sierra Leone’s Development.

On behalf of the members of the Sierra Leonean Diaspora, acting through their networks at home and abroad, we would like to express our appreciation to DFID for inviting us to comment on the 2007-2012 Joint EC/DFID Country Strategy for Sierra Leone.

We are aware of related submissions by other Sierra Leoneans, acting through associated groups, which have specifically answered the questions posed by DFID, and made proposals in regard to infrastructure, law reform, voter education, etc. Accordingly, we do not wish to duplicate those efforts. Instead, this submission limits itself to the fundamental issue which we believe will determine whether the DFID-EU strategy will succeed or fail.

That issue is whether the specific basis upon which DFID-EU’s 2007 strategy for Sierra Leone is justified, given what we know about the nature of the chronic problems of poverty which have defied more than three decades of international assistance efforts.

Our humbly presented answer to that question is contained in the attached document entitled, “An Analysis of the Basis of the DFID/EC Strategy for Sierra Leone’s Development.”

We look forward to continuing the dialogue with DFID for the interest of alleviating poverty and creating a peaceful future for our fellow Sierra Leoneans.

For and on behalf of the participant groups,

Mohamed A. Jalloh

E-mail: MohmJ@aol.com
An Analysis of the Basis of the DFID/EC Strategy for Sierra Leone’s Development

Prepared in association with SALONEDiscussion Group

January 30, 2007

An Analysis of the Basis of the 2007-12 DFID-EU Proposed Strategy for the Development for Sierra Leone

Table of Contents

Introduction

Chapter 1 The Revaluation of Sierra Leone’s Currency

Chapter 2 Is the Sierra Leone Currency Overvalued?

Chapter 3 Why Devaluation Would not Work in Sierra Leone

Appendix About the Authors and SALONEDiscussion Group

Introduction

We start with a fundamental question: Why is Sierra Leone consistently ranked among the poorest countries in the world despite the expenditure of hundreds of millions of dollars on economic aid to the country by the international community over the past three decades?

We do not believe the answer to that question to be that not enough money has been on foreign assistance to SL. If, therefore, enough money has been spent by international agencies to assist SL, the problem must lie not in the amount of money that has been spent, but on what it has been spent on. Which leads to a key question: Have the efforts of international aid entities in Sierra Leone over the past thirty years been directed to the wrong priorities?

The fact that those efforts have not yielded the desired outcome of the alleviation of poverty over the past thirty years suggests that either their focus has been on the wrong priorities and/or that the execution of programs based on those strategies has been flawed. In fact, we believe that both of the above factors lie at the root of the difficulties in transforming hundreds of millions of dollars in foreign aid spent in Sierra Leone in the past three decades into the desired outcome of poverty alleviation for millions of Sierra Leoneans over the same period. However, of the two factors, we believe that it is the emphasis on the wrong priorities that is far more important than the failure to effectively execute programs based on those flawed strategies.

Unfortunately, the DFID-EC strategy proposed for Sierra Leone continues this twin problem. In the joint EC/DFID document, it is stated unequivocally that:

"The root causes of Sierra Leone’s fragility and instability are
political and relate to the poor quality of governance which will remain
key to future development interventions" (p. 20).

We do not believe the above-quoted statement upon which the entire DFID-EC proposed strategy for Sierra Leone is based to be accurate. Therefore, in an effort to avoid the repetition of the experience of the earlier similarly-based efforts to alleviate poverty in Sierra Leone, we would like to suggest an alternative basis upon which the 2007 DFID-EU strategy should be based.

That alternative strategy is outlined in chapter 1 of this documents.. We address in chapter 2 the conclusion in the DFID_EU document that the Sierra Leone currency is overvalued. In chapter 3, we lay out the case why we believe that devaluation, apotent cure for balance of trade problems in industrialized countries, would not work to cure Sierra Leone’s balance of trade problem.

In preparing this document, we conducted a careful review of the DFID document and benefited from forum discussions, mailing lists, essay responses to questions placed and web polls. The consensus is that, while the EC/DFID strategy strives to give greater priority to the delivery of basic services and the promotion of economic growth, better governance and security, nevertheless, it leaves room for improvement. Our proposals aimed at such improvement are described below.

Finally, we recognize that, at this initial stage, this document contains only an outline of our proposals in response to DFID’s proposed strategy. We are hopeful that, in the near future, we would be accorded an opportunity to present in much greater detail the ideas outlined in this document. Accordingly, all the collaborating authors have agreed to provide, upon request, complete documents related to the proposals outlined in this document. We hope to do so within the context of a continuation of this nascent dialogue with DFID, pursuant to the interest of all parties concerned with improving the welfare of the millions of our fellow Sierra Leoneans who now live in poverty.

Chapter 1: The Revaluation of Sierra Leone’s Currency

By Mohamed A. Jalloh and Jonathan M. Rose

Why a Change in Strategy is Needed in Foreign Aid to Sierra Leone

The best guarantee against pervasive poverty in Sierra Leone (SL) is a sound economy. Foreign aid is beneficial to Sierra Leoneans only if it can advance the goal of achieving a sound economy. We suggest a fundamental change in the strategy underlying foreign aid efforts as a way to overcome the past difficulties in achieving that goal.

The Case for Revaluation of the Sierra Leonean Currency

As the example of pre-World War II Germany attests, it is a truism that a country with a worthless currency will become, sooner or later, a country with a worthless economy. With a currency that has depreciated by more than 375,000 % since it was first devalued in 1979, and a people frequently ranked as the poorest in the world, SL’s economy is in dire crisis.

We believe that the single greatest contributor to SL’s economic crisis is the same one as that identified by one of the greatest economists of the 20th century, Lord John Maynard Keynes of Great Britain under similar circumstances. In his seminal 1919 treatise, "The Economic Consequences of the Peace," Lord Keynes accurately predicted that the destruction of the value of the German currency would precipitate a second world war, because, as he put it: "There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

For largely similar reasons, we believe SL’s economic crisis to be rooted in the debauchery of the country’s currency. Accordingly, we propose a never-before-tried measure in SL — the revaluation of Sierra Leone’s currency — as the cornerstone of an economic recovery program for our country. This proposal is aimed at reversing the unprecedented inflation and other distortions in SL’s economy in the wake of the 1979 devaluation and subsequent depreciation of the Leone that have made it virtually impossible to sustain economic growth or alleviate poverty.

Whereas devaluation is a potent cure for balance of trade problems in industrialized countries, in Sierra Leone it has spawned perverse consequences. In particular, devaluation has induced a condition of fundamental disequilibrium by creating a self-perpetuating vicious cycle of poverty - lowered real incomes leading to low demand that leads to low production which leads to still lower incomes. Infrastructure has been depleted and the ability to maintain viability as a sovereign nation has rapidly decreased. The interruption of this cycle requires either massive external intervention, in general, or a controlled reversal of the currency devaluation, in particular. Our proposal to revalue the Leone is specifically intended to break that vicious cycle of poverty in which millions of Sierra Leoneans have long been trapped by reversing the currency devaluation.

How to Implement a Revaluation of the Sierra Leonean Currency

The revaluation of the Leone requires meticulous and diligent planning for it to succeed. At a minimum, the process should be transparent and equitable enough to afford each and every Sierra Leonean a reasonable opportunity to adjust their business, educational, social and/or bureaucratic activities to the expected realities prescribed by the intended new exchange rate.

It can be done by a SL government decree to re-establish a par value for the currency against a major world currency such as the US dollar or the British pound. While government intervention is critical, simply decreeing the par value of the currency is not sufficient. Issues such as the use of old currency and corruption of the re-evaluation process could derail the effort. It also could potentially create a greatly destabilizing situation. Alternatively, value in the Leone can be re-established through open market interventions, including, but not limited to, actions by the Sierra Leone government and private Sierra Leoneans pursuing their legitimate business and other interests, in buying and selling foreign currency. While this would require far more time than a decree, it would inspire greater market confidence, create lesser disturbance of social strata, and distribute the wealth being injected into the country more evenly than by simple government fiat.

The Critical Role of Foreign Aid

Whichever mechanism is chosen, the infusion of foreign exchange into the banking system at levels sufficient to sustain the exchange rate of the Leone at par with the benchmark foreign currency will be critical to the success of the revaluation. This is where foreign aid can play a critical role — by providing the foreign exchange required to sustain the exchange rate through the transition period until market stability is achieved without the need for such support.

The benefits will be significant: The harmful parallel market for foreign currency would disappear, thereby restoring all foreign exchange transactions within the official banking system. This will decrease the need for foreign exchange support by aid donors. The removal of the distortions in SL’s economy would engender growth by removing the purchasing power disadvantage imposed upon indigenous Sierra Leoneans. At that point, the remaining focus of efforts to alleviate poverty would be SL government action to correct income disparities that would otherwise prevent the widespread dispersal of the benefits of the economic growth resulting from the revaluation of the currency.

Chapter 2: Is The Sierra Leonean Currency Overvalued?

The basis of the conclusion in the DFID-EU document that the Sierra Leone currency is overvalued is contained in the following statement:

“One issue of concern is whether the Leone is overvalued in relation to the equilibrium real exchange rate (ERER), or the real exchange rate that would prevail if all the variables determining that rate were at their long-run equilibrium."

Based upon that standard, the DFID-EU proceeded to conclude that the Leone is indeed overvalued, viz.

“In addition, Sierra Leone is heavily dependent on mineral exports, especially of diamonds, and now reinforced with the reopening of bauxite and rutile mines. This result in an [Real Exchange Rate] which is overvalued relative to the exchange rate that would prevail if those diamond exports did not exist."

With due respect to the authors of the above statements, we are obliged to point out, in the interest of accuracy, what we believe to be a fundamental error in the above conclusion. Essentially, the entire basis for the conclusion that the Leone is overvalued rests on the speculation about the future composition of Sierra Leone’s exports. In particular, it projects that Sierra Leone’s exports in the future not include the diamonds that are currently being exported.

Whereas that may turn out to be true, depending on the reserves of diamonds available for export, and the length of the period over which the Leone is considered overvalued, that alone does not lead to the conclusion that the Leone is overvalued. In order to proceed to that final conclusion, an assumption is required to be made that any diamond exports that would cease at an undetermined future date, such exports would not be replaced in value by other non-mineral exports, such as oil, fish, shrimp, coffee, cocoa, lumber, etc

Since the DFID-EU report doe not provide requisite evidence that diamonds would not be exported by Sierra Leone at some undetermined future date and that the loss of the export revenue from the speculated cessation of diamond exports would not be made up by other exports from Sierra Leone, the conclusion is inescapable that the case that the Leone is overvalued rest on tenuous assumptions.

Therefore, we do not believe that such shaky assumptions warrant the certainty that has been accorded them in the DFID-EC document, and upon which the conclusion that the Leone is overvalued is based.

Chapter 3: Why Devaluation Would not Work in Sierra Leone

The first devaluation of the Sierra Leone currency was executed by the Sierra Leone government in 1979, at the behest of the IMF. It was intended to solve Sierra Leone’s balance of trade problem (not enough exports to pay for imports) by increasing the country’s exports while reducing its imports — the classic case for devaluation as a cure for balance of trade problems in industrialized countries. Specifically, by cheapening its currency in relation to others, the devaluing country makes imports more expensive for its own citizens (thereby reducing demand for them) while making its exports less expensive to foreigners (thereby increasing demand for them).

However, in order for devaluation to work successfully, the devaluing country must have the capacity to replace suddenly expensive imported goods with local substitutes — otherwise its citizens would either have to keep buying more expensive imports, if they can still afford to do so, or, forgo consuming imports, with a resulting drop in their standard of living, if they can not afford the now more expensive imports. In addition, the devaluing country must be able to supply the increased demand by foreigners for its suddenly cheaper exports. An industrialized country typically would experience little problem meeting both of those conditions because of the presence of adequate local industries. Moreover, because the prices of the exports of industrialized countries are set competitively by market forces, a devaluation that makes a country’s currency cheaper directly translates into cheaper exports. That, in turn, results in greater demand for those exports by foreigners. The resulting combination of higher exports and lower imports then brings the devaluing country’s balance of trade disequilibrium into equilibrium.

Yet, because Sierra Leone has never been an industrialized country (being instead a mainly agricultural country exporting primary crops like cocoa and coffee, and raw minerals such as diamonds and gold), it has never had the capacity to replace (mostly manufactured) imported goods with local substitutes. Moreover, it does not have the capacity to instantly increase the supply of its mainly agricultural exports. Furthermore, the producer prices of SL’s major exports are set non-competitively primarily by consuming countries, those prices are not directly affected by a devaluation of the Leone. Therefore, the demand for Sierra Leone’s mineral exports is not necessarily increased by devaluing the Leone, unlike the exports of a devaluing industrialized country. All of the above factors clearly make devaluation inappropriate as a cure for Sierra Leone’s balance of trade problems.

Therefore, instead of reducing Sierra Leone’s demand for imports and increasing its supply of exports — as devaluation is supposed to do (and as it has done in industrialized countries, including Great Britain in the early 1970s) — the devaluation in Sierra Leone in 1979, as well as the floatation of the Leone in 1986, and the resultant deterioration of the Leone to its present cumulative decline of 375,000%, merely produced astronomical inflation, particularly in the cost of imported goods. Thereby, it severely reduced the standard of living of millions of Sierra Leoneans, due to their inability to afford the highly-inflated prices of imported items and other goods and services. It also failed to increase the country’s exports. The result has been a total failure of devaluation to cure Sierra Leone’s balance of trade problems. Worse still, the stratospheric inflation it unleashed has left millions of Sierra Leoneans no longer able to afford the basic necessities of life — propelling them into searing poverty that, according to the United Nations, it is unmatched anywhere in the world.

There are obviously other factors — corruption and other acts of mismanagement — which contributed to the impoverishment of millions of Sierra Leoneans. However, none of them comes close to matching in virulence what the great 20th century British economist, Lord John Maynard Keynes, described as the debauchery of the currency in his seminal 1919 treatise, "The Economic Consequences of the Peace," as noted above.

Appendix

About the Authors and SALONEDiscussion Group

Mohamed A. Jalloh is the founding Managing Director of a financial services company based in suburban Washington, D.C., USA, that manages investments for corporations, partnerships and high net worth individuals. His internationally published writings on the effects of foreign aid and devaluation on Sierra Leone’s development span the last twenty-eight years. MohmJ@aol.com

Jonathan M. Rose is a research and development engineer and organizational management specialist based in Saint Paul, Minnesota, USA. He has been studying currency economics for the past twenty years jrose1@mmm.com
SALONEDiscussion Group is a non-partisan, group of Sierra Leoneans formed in 2005 as a serious Internet forum dedicated exclusively to discussing issues relating to Sierra Leone, with the goal of advancing the development of the country. Its more than 320 members are Sierra Leoneans resident in Africa, Australia, Europe, and North America.

APPENDIX - About the Authors and the SALONEDiscussion Group

Photo: Mohamed Jalloh, one of the authors.