Future Capital Kenya

The Jeffersons, the poster family of intergenerational mobility

There are a number of issues, that I feel Kenyans need to have articulated to them in a tangible and understandable manner. It is often the case that a great number of useful articles in economics are in the language of econometrics which is just Greek to most. A language where instead of calling an equation 'simple' they call it 'parsimonious'. I hope to be able to read through these articles and journals and share some of the important findings that they present.

My former econometrics professor Prof Nair once told me that if you can't measure it, you're just guessing, and I totally agree, if public policy is in question. I therefore try not to argue if I don't have the facts. The issue in question is one of intergenerational mobility. What this means is that does your parents education and prestige have an effect on your education and thus prestige?. Does the Kenyan dream exist, where one does what the Jeffersons did in the 70's and 80's, moved from their humble beginnings to the East side?.It is an important question to discuss. In a good society, there should be high levels of intergenerational mobility as people move on up, regardless of their background. So having defined it? how can we analyse it? To this we turn to what I would call Kenya's Chicago School. The University of Gothenburg, the training ground of Kenya's current Central Bank governor. If anyone is in doubt of his abilities and knowledge, I would request them to relax because I don't think there is anyone else in Kenya with such a deep understanding of Kenya's economy.

The Chicago School for Kenyan economists

However, back to the analysis, University of Gothenburg economist Anthony Wambugu, carried out a study in 2000, in which he surveyed 200 Kenyan manufacturing firms from Nairobi, Mombasa, Nakuru and Eldoret and around 800 of their employees. In the study he asked them about how far they went in terms of their schooling, their wage rate, their parents education, proximity to their school (when they were schooling) and years of tenure in that company. His aim was to find out if parents education and therefore by proxy family background had an effect on an individuals wages. Through sound but complex techniques he came up with findings that are against intergenerational mobility.

Firstly he found out that the higher the parents level of education, the more the years of education one is expected to complete. It is worth noting that a fathers level of education had more of an effect than a mothers level of education. Secondly, Mr. Wambugu found that an extra year of education post primary generated a 21% rise in income. To cap this statistics, it was also observed that a person who attended secondary school was likely to have a wage that is 67% higher than a person who did not. The effects of tertiary education are not explicitly stated, however in another paper, Mr. Wambugu finds that attending university had the biggest effect on distorting wage inequality. Therefore it is clear that a parents level of education has a clear effect on the number of years of education that a person completes. It is also clear that there are differences in the number of years of education and the wage rate that one is likely to receive.

Higher education leads to higher wages

The third issue is one directly related to a parents level of education and his/her child's earnings. The study found that when parent's level of education is controlled for i.e. held constant, the returns to education would fall by about 22%. Therefore, a parents level of education is likely to increase your returns to education by about 22%. However, the effect of family background goes beyond education. 40% of the workers sampled were found to have found their jobs through their family contacts. Thus the family effect also plays a hand in terms of contacts and connections.The wage differential due to parents education can be explained in a number of ways. The first reason is that higher education would lead to higher wages and therefore the parents can provide a more suitable environment from which to learn and grow. Secondly, a more prestigious background reduces job search costs, what this means is that a job seeker can have extended periods of unemployment as he has the luxury of waiting for the best job offer. Someone of a worse off background would have to take the first job that comes. The third reason is that the parents can sponsor the child to attain tertiary education and thus improve his/her wage prospects.

In conclusion, the effects of your parents education and by extension their wealth has a material effect on your level of education and by extension your earnings. Higher parents education leads to higher personal education and thus higher earnings. To augment these findings, in a 2002 essay Anthony Wambugu found that education reduced the chances of a persons employment in the agricultural and informal sectors, both notorious for their meager wages. For Kenya, there is thus very little intergenerational mobility as your parents education heavily affects your life prospects. Poverty is therefore a recurring theme across generations and it is very hard to make it out. There are of course, some exceptions but they are just exceptions and not the norm. In terms of public policy, Kenya has already taken a step in terms of free primary education, but as the article suggests the real differences come in terms of post primary and post secondary education. These two tiers are both marred in under enrolment and there is where the most effort needs to be put. Moving on up is therefore more of a dream, the Kenyan dream doesn't exist.

The analogy of a house of cards to me is very appropriate in discussing the recent economic growth circa 2003-2007 and pre-Kibaki growth in Kenya. Economic growth is an ideal every country strives for and is usually the intrinsic mandate of all government efforts. Growth leads to jobs, higher standards of living, higher life expectancies, higher education and even less suffering and misery. However in our case, we have to be very careful as to what factors drive this growth. Here I would like to present a very simple growth model, first posited by an eminent MIT economist called Robert Solow. His model was simple:
Y = f(At Kt Lt)

In this simplified model, he stated that growth in output Y was dependent on At which is a measure of productivity at a given time, Kt a measure of the amount of capital (Buildings, machines, cars, trains) at a given time and Labour at a given time.

From the model, it is the At that we should be interested in. In economic terms, it is referred to as Total Factor Productivity (TFP) and basically shows how much we are getting per worker or machine. If TFP is low in relation to other countries, then our workers and our stock of capital produce less than the same workers and the same stock of capital in other countries. The IMF in a recent study show that Kenya's growth and that of other Sub-Saharan countries has been due to an accumulation of factors rather than an increase in TFP. To better discuss this, I feel an analogy is appropriate. Imagine the economy as a lush field of grass and growth is reflected in how much grass we can cut and harvest off the field. We harvest grass by hiring people armed with sickles to cut the grass. Our growth then in this regard has been as a result of hiring more and more people armed with more and more sickles to cut the grass. The worrying fact is that according to the law of diminishing returns this method of growth is not sustainable.

The law of diminishing returns states that as more and more variable factors of production are added to a fixed factor, production will at first increase at high rate then increase at a decreasing rate before eventually dropping. In the grass case, then production of grass will first increase because of more workers then as workers start jostling for space and arguing over whom gets which sickle, the production will start increasing at a decreasing rate before eventually dropping. TFP in our case would be solved by maybe fertilising the grass so that it grows longer thus justifying the number of workers, buying lawnmowers so as to increase the speed of collection and other such measures.

Clearly then TFP is an important and I would dare say the most important factor in creating economic growth. According to the World Development Report of 2005, between 1960-2000 45-90% of cross country differences in GDP growth were attributable to TFP growth. Added to this, TFP growth in Kenya according to the World Bank grew at an average rate of -1.0 between 1990-2000. Slowing TFP in Kenya has then been the main cause of the massive difference between Kenya's growth and the growth of the East Asian economies. Of the cumulative GDP per capita of Malaysia, Singapore, Korea and Kenya in 1964, Kenya's GDP per capita was 10%. In 2006 this had reduced to 1%.

A study of the factors that affect TFP growth is therefore vital. The IMF in a study conducted in June this year show that good governance, education, good health and inflation are amongst the main causes of differences in TFP.

In terms of governance, it is no secret that the governance in Kenya for the last 40 years has been miserable. Corruption, inefficiency, lack of transparency have been some of the main adjectives used to describe the successive regimes that have ruled the country. Good governance is important as through working institutions and regulations, people can invest in the country and technological and financial innovation can thrive. The poor governance has lead to foreign direct investment flows to Kenya being much lower than those of other countries. FDI as a percentage of GDP in Kenya was approximately 5% in 2006 compared to approximately 18% in Ghana, 28% in Uganda, 30% in South Africa and amazingly 158% in Singapore.

Bad governance has also affected Kenya's exports as a lack of improvement in infrastructure and the tax system has lead to domestic demand exceeding domestic production due to high domestic production costs. This leads to Kenya being a net importer of goods and thus creating a current account deficit. This flies in the face of the mid-term strategy of being a net exporter by 2012. The World Bank usually grade a country's government through six measures namely; voice and accountability, government effectiveness, political stability, regulatory quality, rule of law and control of corruption. Kenya did poorly with voice and accountability scoring approximately 36%, Political stability 15%, government effectiveness 24%, Regulatory quality 45%, rule of law 13% and control of corruption 16%.

If this was your report card after the end of the year, your parents would hang their heads in shame especially for rule of law which should be the cornerstone of any economy that is based on capitalism and allocative efficency.

However as a bright spot, I feel that the current Prime Minister Raila Odinga, has shown commendable leadership taking a strong and often politically unpopular stand on many issues such as the Mau evictions, environmental control and his commitment to improving infrastructure.

In terms of education, it is no secret that our education system needs a lot of work and prayers even. Sound educational policy has been lacking and is reflected in the enrolment statistics and the cost of education in the country. Good education often leads to a higher stock of human capital and thus improved labour productivity. Our education system in my humble view is one that is still based on the colonial role of educating a native population the basics of reading and writing so as to serve in clerical roles for the British. The lack of technological innovation has been a big deterrent to improved TFP. The government has clearly forgotten that early childhood education and technical education are an important part of the educational infrastructure.

My mother who has worked in education all her life always stresses that early childhood education both at home and at school is a make or break time for the child in terms of his/hers approach to learning and knowledge. Between fiscal year 02/03 and 07/08, early childhood education got on average 0.17% of total expenditure on education and technical education got on average 2% of total expenditure on education. Free primary school on the other hand got 52.67%. To make matters worse, of the total expenditure recurrent expenditure was about 92% of the total. Added to this the unit costs of education as a percentage of GDP per capita are high compared to other countries. This means that due to inefficiencies, it is more expensive to educate a Kenyan than it is to educate a South African, Indian or Chinese child at each level of education.

The last factor is inflation. Inflation in terms of TFP usually means that high inflation usually leads to lower investments and savings which are major drivers in TFP growth due to lower real earnings. Kenya has seen high inflation usually due to exogenous (external) shocks that have rendered most wages and salaries useless. According to the Kenya Institute of Public Policy Research and Analysis (KIPPRA), food and beverages contribute approximately 80% of inflation and are subject to extreme shocks such as drought and gross mismanagement of food reserves in the country. Sound policy needs to be enacted to deal with the food issue and consequently inflation so as to improve TFP.

Clearly our economy has been a house of cards, growth has taken it higher and higher but one day when the wind blows or someone bumps into the table, the house will come crumbling down. Governance has to improve through a new proper constitution, improved political good will and leadership and zero-tolerance to corruption. Our education system needs to be ridden of the inefficiency and slack reflected in the high unit costs and high recurrent expenditure on education. Furthermore, the bureaucrats in government need to focus more attention to early childhood education and technical education. Finally the government must realise that monetary policy alone will not fight inflation rather a focus on removing the shocks that affect inflation. Through all these measures, Kenya's growth will finally be sound and stop looking like a house of cards.

Due to difficulties in posting tables and graphs I can email the comprehensive article to anyone interested just express your request to my email address at samora365@gmail.com

Walking round the Nairobi Central Business District (C.B.D) the other day, I was bemused by just how so many businesses are similar. One is bombarded by cyber cafes, mobile phone shops and clothes retailers. To me it is very amusing that within one bazaar, from out of 12 shops, 7 of them sell mobile phones while the other 5 sell clothes. It is representative of the insatiable entrepreneurial spirit that Kenyans possess as well as maybe a lack of innovation and imagination within society. It could be that low levels of tertiary education and rigid rules concerning small enterprises in Kenya warrant this over indulgence in the aforementioned businesses. They could be thought of as the trinity of businesses amongst I would dare say people who lack a specific personal skill acquired through tertiary education.

Is the situation any different amongst workers who have attained a university degree or beyond? Probably not, most young Kenyan workers educated both home and abroad mostly engage in similar enterprise. A marketing consulting firm, an accounting firm, a corporate communications firm or a media firm are the usual suspects. The breadth of business ideas is very narrow. This is not to say that the businesses mentioned are not profitable. Among the Top 100 Small and Medium Enterprises (SME's), rated by Business Daily and KPMG 12 of them operate within the fields I have just mentioned. Therefore when run well, they can be very profitable enterprises. In the short run, they can be an investor's best dream as they generate good cash flows and have a high Return on Assets (ROA); this is a measure of the profit gained per shilling of assets. Since the value of the asset is the denominator, it is a measure of how well you use your assets to generate income.

The question then is why is this of any significance to someone who is concerned about our economy? My response is based on an analysis of a perfectly competitive industry.

Perfect competition occurs when there are many buyers and sellers of the same product, selling a homogenous (similar product), within a system that has perfect or near perfect information (where buyers and sellers know everything about each other's prices and output) all leading to a situation where firms make zero economic profits adjusted for risk. An example can be given of the wheat industry in our imaginary province Ungaland. In Ungaland, there is an abundance of land where wheat can be grown. In the province, the population has split itself into two groups; wheat growers and wheat buyers. If one farmer were to start growing wheat and everyone else was buying from him, he would make supernormal profits since he determines his output and therefore price. When other Ungaland citizens take cognisance of this, they will all rush to become farmers so as to also make economic profits. This will happen up to the point where they are no longer making profits as they increased supply will see them sell at a point where the price of the bushel of wheat sold at the market is equal to the cost incurred by the farmer to produce that bushel of wheat.

Here the distinction of economic profits is made because in economics, one has to take into consideration of the opportunity cost. This is the cost of the best alternative activity foregone due to undertaking the farming. The farmer could have become a fisherman or maybe would have put the funds he used to start the farm into an interest bearing account. The benefits that would have accrued from these activities are the opportunity cost. Accounting profit on the other hand just reflects explicit (stated) costs and benefits. From this, the implication is that after adjusting for opportunity costs, the farmers are not being compensated for their foregone opportunities.

If one now applies this to the situation with both "skilled" and "unskilled" workers and I call them that with extreme caution since some of the "unskilled" workers are very skilled at a particular vocation, one observes that the markets for their goods and services are either saturated (especially in the case of the former business trinity) or are going to be saturated in the near future (the case of the firms). They sell a similar product, to many buyers and sellers who are well informed about the demand and supply situations of these firms.

Why then is this an issue if the resulting condition is good for the consumer who will benefit from low prices and bad for the seller who will have to make do with zero profits? It is obviously a good thing for the consumer as he will have cheap stuff. He/she will be able to buy cheap clothes, get a cheap phone, access cheap internet and even have someone do his books for him at a low price. The concern in this article is not for the consumer, it is for the firm and the economy at large.

Low profits will add little value to the economy as in the long run, firms will have no incentives to hire new workers and expand their activities. They will pay less in taxes and therefore add little revenue to the taxpayer. There will then be little income for the government to achieve infrastructure expansion and carry out their mandate.

Furthermore, for me it reflects a failure of our educational system. The clear lack of a stimulating and empowering educational system has two effects. A narrow skill base from which more diverse business ideas can emerge and a monkey see monkey do business climate. The country's business environment needs clear innovation or otherwise many of the existing businesses will have to make do with penny pinching from meagre earnings adding no enterprise value to the economy. Imagine one wanted to buy the businesses; the small earnings will lead to low valuations from potential investors as future earnings are limited. Most business valuations are contingent upon valuing future cash flows so as to get a present value of the business. The businessmen in the businesses and firms therefore lose in their investments from both an earnings perspective as well as an asset growth perspective.

We need more innovation through I suggest better education so that we can have a robust business climate within the country.