AFRICAN DEVELOPMENT BANK AFRICAN DEVELOPMENT FUND CAPE VERDE THE ROAD AHEAD Regional–West 2 Department (ORWB) November 2012 Table of Contents Acknowledgements............................................................................................................................6 List of Abbreviations ..........................................................................................................................7 Executive Summary ............................................................................................................................9 The Road Ahead: An Introduction .................................................................................................... 12 1. The Road From Here: Cape Verde’s Transformation Agenda ...................................................... 15 1.1 Introduction ................................................................................................................................ 15 1.2 The Four Main Ingredients of Success ........................................................................................ 15 1.3 Why the Transformation Agenda? .............................................................................................. 20 1.4 The Transformation and Modernization Agenda ....................................................................... 23 1.5 Making the Transformation Agenda a Reality ............................................................................ 25 1.6 Summary ..................................................................................................................................... 30 2. The Road from Here: Examining the Challenges ........................................................................... 32 2.1 Introduction ................................................................................................................................ 32 2.2 Unfavorable Initial Conditions .................................................................................................... 33 2.3 The Major Challenges and Constraints to Development ............................................................ 38 2.3.1 Infrastructure ...................................................................................................................... 39 2.3.2 Telecommunications ........................................................................................................... 43 2.3.3 Water and Energy ............................................................................................................... 44 2.3.4 Transportation .................................................................................................................... 45 2.4 Human Capital Resources ........................................................................................................... 47 2.5 Institutional Capacity .................................................................................................................. 52 2.6 Enabling a Favorable Investment Climate .................................................................................. 53 2.7 Innovation-Promoting Institutions.............................................................................................. 55 2.8 Summary ..................................................................................................................................... 58 3. Exploring the Road Ahead: Alternative Futures for Cape Verde ..................................................... 60 3.1 Introduction ................................................................................................................................ 60 3.2 Macro Variables that will Shape the Future of Cape Verde ....................................................... 61 3.2.1 The Key Factors ................................................................................................................... 61 3.2.2 The Critical Uncertainties .................................................................................................... 64 3.3 Four Futures ................................................................................................................................ 69 3.3.1 Ostrich ................................................................................................................................. 70 3.3.2 Tortoise ............................................................................................................................... 73 3.3.3 Atlantic Fox ......................................................................................................................... 77 3.3.4 Atlantic Tiger ....................................................................................................................... 81 3.4 Implications of the Scenarios ...................................................................................................... 86 3.5 Summary ..................................................................................................................................... 89 4. Exploring the Road Ahead: A Quantitative Assessment ................................................................ 90 4.1 Introduction ................................................................................................................................ 90 4.2 Macroeconomic Policies in Economic Growth, Job Creation and Poverty Reduction ................ 91 4.2.1 Exchange Rate Policy........................................................................................................... 92 4.2.2 Fiscal Policy ......................................................................................................................... 93 4.2.3 Monetary Policy .................................................................................................................. 93 4.3 Model and Data .......................................................................................................................... 95 4.3.1 Overview of the Model ....................................................................................................... 95 4.3.2 Data ..................................................................................................................................... 97 4.4 Assessing Alternative Growth Scenarios ..................................................................................... 98 4.4.1 The Baseline Scenario ......................................................................................................... 98 4.4.2 Alternative Scenarios .......................................................................................................... 99 4.4.3 Findings ............................................................................................................................. 100 4.5 Summary ................................................................................................................................... 102 5. Getting There: Key Recommendations ........................................................................................ 103 5.1 Introduction .............................................................................................................................. 103 5.2 Elements for a Strategic Agenda ............................................................................................... 104 5.2.1 Implementing a New Approach for Development Management ..................................... 105 5.2.2 Extending and Deepening Reforms ................................................................................... 106 5.2.3 Building Human Resources and Skills................................................................................ 108 5.2.4 Promoting Innovation and Entrepreneurship ................................................................... 109 5.2.5 Expanding Infrastructure and Improving the Quality ....................................................... 111 5.2.6 Mobilizing Financing and Facilitating Access to Finance .................................................. 113 5.2.7 Ensuring Social Cohesion .................................................................................................. 114 5.3 Summary ................................................................................................................................... 115 References ..................................................................................................................................... 117 Appendix 1: A Social Accounting Matrix for Cape Verde – 2002 ....................................................... 120 A1.1 Introduction ......................................................................................................................... 120 A1.2 Background .......................................................................................................................... 120 A1.3 A Macro SAM for 2001 ........................................................................................................ 121 A1.4 A Micro SAM for 2002 ......................................................................................................... 124 Appendix 2: Simulation Results ..................................................................................................... 125 Table A2.1: Sectoral Production ......................................................................................................... 125 Table A2.2: Sectoral Investment ........................................................................................................... 126 Table A2.3: Sectoral Exports ................................................................................................................. 127 Table A2.4: Sectoral Imports ................................................................................................................. 128 Acknowledgements This research project was sponsored and managed by the African Development Bank’s Regional Department West II (ORWB) under the direction of Franck Perrault, Regional Director. The study was prepared by Olugbenga Adesida, Mohamed Chemingui and João Resende Santos (AfDB consultants) under the supervision of Mohamed Hedi Bchir, Principal Country Economist, ORWB, Mamadou Diagne, Principal Country Economist, ORWB, and Adalbert Nshimyumuremyi, Chief Country Economist, ORWB, respectively. Research assistance was provided by Cassandro Mendes. The useful feedback from Desiree Nadege Yameogo, Senior Research Economist, EDRE, and Kim Harnack, Economist, International Consultant, who served as peer reviewers, and CLSD for English editing support and translation into French, as well as the insights of many Cape Verdean officials and experts are all gratefully acknowledged. List of Abbreviations ADEI Agency for the Development of Enterprise and Innovation AfDB African Development Bank AGOA Africa Growth Opportunity Act AJEC Association of Young Cape Verdean Entrepreneurs ANAC Agencia Nacional de Comunicações ARE Agencia de Regulação Económica BAU Business-as-usual BCV Banco de Cabo Verde (Central Bank) CET Constant Elasticity of Transformation CES Constant Elasticity of Substitution CGE Computable General Equilibrium CI Cape Verde Investment ECOWAS Economic community of West African States ECV Escudos Caboverdianos (Cape verdean escudos) EEZ Exclusive Economic Zone ELES Extended Linear Expenditure System EPA Economic Partnership agreement EU European Union FDI Foreign Direct Investment GDP Gross Domestic Production GNI Gross National Income GPRSP Growth and Poverty Reduction Strategy Papers ICF Investment Climate Facility for Africa INE Instituto Nacional de Estatística IMF International Monetary Fund ITC Instituto Tecnológico de Canarias ITC Information Technology and Communication LES Linear Expenditure Demand System LDCs Least Developed Countries MDGs Millennium Development Goals NIS National Innovation System ODA Overseas Development Assistance SAM Social Accounting Matrix SET Science, Engineering, Technology SDE Sociedade de Desenvolvimento Empresarial SIGOF Integrated System for Budget and Financial Management SPA Special Partnership Agreement TFP Total Factor Productivity UCRE Unidade de Coordenação da Reforma do Estado USD United States Dollars UNESCO United Nations Education, Scientific and Cultural Organization WTO World Trade Organization Executive Summary “Cape Verde—The Road Ahead”, is a study commissioned by the African Development Bank (AfDB). It provides a critical examination of the development experience of Cape Verde, a small island country off the coast of Senegal. The study complements the companion Bank report, “Cape Verde: A Success Story”, an in-depth work analyzing the factors behind the country’s development success. As the companion volume looks at the country’s past trajectory, the present work looks at the road ahead. It offers a critical examination of the key issues and challenges facing Cape Verde as it attempts to make the transition to upper middle income country. The study surveys the key challenges and opportunities, and sets out four alternative futures up to the year 2025. The ingredients behind the success of the past thirty six years may not be sufficient or relevant for its next phase of development. Cape Verde must now make the transition to the upper-middle income category, requiring new bases of growth and a much higher level of economic and institutional capacity to compete successfully. Which future scenario materializes for Cape Verde will depend greatly on the country’s ability to weather and traverse the present world crisis, particularly in the Eurozone. As the study points out, Cape Verde’s continued success is not guaranteed, since its ability to consolidate its past development gains will be strongly conditioned by the current global crisis. Yet, Cape Verde’s future will be of its own making. Whether or not it can successfully make the transition to a competitive, upper middle income country will be conditioned primarily by the alacrity and efficacy with which the country addresses the many policy and institutional challenges it will face on the road ahead. Cape Verde today is a different country from what it was in 1975. Little of it resembles the country that emerged from 500 years of colonial rule in 1975. It is a lower-middle-income country, having graduated from the United Nations list of Least Developed Countries (LCDs) in 2008. For over a decade, Cape Verde has been among the fastest growing economies in the world. It ranks among the top high growth economies in Africa, ranking sixth in the top 17 growth performers in Sub-Saharan Africa during the 1995-2007 regional “great take-off with a real GDP growth rate of 7.2 percent and real GDP per capita growth of 5.1 percent for the period.”1 In fact, Cape Verde’s economic growth has mirrored the pre- global crisis strong regional and global performance. But, it is Cape Verde’s unique attributes, and the characteristics of its growth, that make its performance noteworthy. Its strong performance has been well-rounded. Its strong growth has resulted in improved living standards for the population, putting the country on track to meet or surpass all the targets of the Millennium Development Goals (MGDs).2 It has among the best social indicators on the continent. Its economic performance has been accompanied and indeed driven by an equally remarkable political performance. Cape Verde ranks among the world’s most stable democracies, receiving high marks for good governance, political stability, civil liberties, and its democracy index. This broad-based performance has been propelled by nearly two decades of continuous structural and institutional reforms. 1 International Monetary Fund (IMF), Regional Economic Outlook: Sub-Saharan Africa (Washington DC: October 2008), 26. 2 Ministry of Finance (2009); Government of Cape Verde, (2011). Cape Verde is a country in transformation. However, as this study makes clear, the future is uncertain. On the one hand, the country has a window of opportunity to insert itself in a number of niche markets in the world economy, taking advantage of its strategic location in the mid-Atlantic, its vast maritime resources, its endless renewable energy resources, its tourist-friendly climate and its durable social peace and political stability. On the other hand, the country is confronted by an array of current and emerging challenges. As this study demonstrates, the country can no longer rely on cheap external financing such as official development assistance and remittances, which fueled much of the intense capital investments over the last decade. Further, the country’s own development strategy moving forward, its “Agenda for Transformation,” lays out the vision and strategy for achieving upper middle- income status. This agenda however, demands a number of profound reforms. Will the country take the necessary steps, and do so in time? Can it continue its hitherto proven ability to manage its structural vulnerability successfully as a small island economy amidst worsening external conditions? In a generation, will Cape Verde be counted among the very few countries that have successfully made the difficult transition from lower to upper middle income country? Four alternative futures are presented as possible options for the road ahead. Each of the four the futures: The Ostrich, the Tortoise, the Atlantic Fox or the Atlantic Tiger are all plausible. The Ostrich Scenario results from a combination of doing nothing internally and an ongoing global economic downturn. The emerging issues and key constraints that Cape Verde must address are neglected because of inaction. This worst-case scenario is plausible, either because of political paralysis, deteriorating governance capacity, lack of political will, or prolonged domestic and international economic distress. The Tortoise scenario is a future where the country’s leadership chooses to rely on past successes and fails to make the bold reforms necessary. Cape Verde simply becomes too slow and unresponsive to competitive challenges, coasting along, losing ground and flirting with a fall into the Ostrich scenario. The Atlantic Fox is a future in which the global economy is sluggish and moving from one recession to another. In this future, however, Cape Verde reacts like a fox and does what it takes to constantly create and seize opportunities. The result is a nation better able to weather global challenges by building its capacity and capability to innovate and compete in niche opportunity areas. The fourth scenario, the Atlantic Tiger, presents a future of foresight with emphasis placed on building high quality education, good infrastructure, a strong work ethic, a business friendly environment and high savings. In this future, Cape Verde has successfully positioned itself as an export-oriented global player in knowledge driven services. Which of these four future scenarios becomes reality will largely depend on two critical sets of factors. The first critical set of factors—naturally for a small, open, insular, vulnerable economy—relates to trends in the international environment. The present global crisis poses significant challenges for Cape Verde. More worrisome is the evolution of the present crisis in the Eurozone, which has been Cape Verde’s biggest source of trade, monetary stability, ODA, foreign investments, remittances, and tourism. Prolonged crisis in the Eurozone could spell disaster for Cape Verde, a potential body blow to its efforts to make a steady and sustainable transition to upper middle income. These external factors are in fact beyond Cape Verde’s control and any policy adjustments it can make. The second group of factors is in