Exchange rate misalignment, state fragility, and economic growth in sub-Saharan Africa

Abstract

The sluggish and sometimes negative growth in sub-Saharan Africa has defined the objectives of most studies seeking to explain the sources of its slow growth. I contribute to this inquiry by estimating how state fragility influences the effect of exchange rate misalignment on economic growth. Since exchange rate misalignment captures the distortionary effects of inappropriate macroeconomic policies in the main, my hypothesis is that resilient and less fragile states cope better with macroeconomic imbalances making misaligned exchange rates less likely to have serious effects on growth in such countries. In testing this hypothesis, I first measure misalignment as deviations of the actual exchange rate from an estimated equilibrium level using the dynamic ordinary least squares method. I then insert this variable and its interaction with state fragility in a growth specification. In line with my hypothesis, results from the system generalised method of moments and data on 13 sub-Saharan countries observed between 2009 and 2018 show a significantly negative effect of exchange rate misalignment on growth that increases with state fragility. Based on this evidence, I urge countries in this region to improve state resilience as an effort to reduce the negative effect of exchange rate misalignment on economic growth.

Keywords:

• Exchange rate misalignment
• state fragility
• economic growth
• sub-Saharan Africa

PUBLIC INTEREST STATEMENT

Generating sustained growth in sub-Saharan Africa remains a developmental challenge and a necessity for alleviating extreme poverty in the region. This policy challenge has occupied the hearts and minds of academic researchers interested in growth and development in Africa. Much of the research attention in sub-Saharan Africa has however gone to factors such as limited investment, terms of trade volatility, external debt, and inappropriate economic policies. In this paper, I focus primarily on the effect of real exchange rate misalignment on economic growth in this region and proceed to test how state fragility influences this relationship. Fragile states are generally marred by weak governance, conflict, weak institutions, and lack of effective public service delivery by the state. I provide evidence that real exchange rate misalignment is likely to have a more severe effect in countries exhibiting these features.

Notes

1. The presence of an initial income coefficient (the convergence term) also raises concerns of the Nickell bias (Nickell, 1981).

Additional information

Funding

The author received no direct funding for this research.

Notes on contributors

Brian Tavonga Mazorodze

Brian Tavonga Mazorodze is an economist and a current research fellow with the University of Zululand whose research covers trade, development and industrial economics.