Why LDCs must be wary of consumption-based growth

Rwanda’s consumption expenditure has been growing since 2000, indicating an increase in the contribution of consumption expenditure to the country’s Gross Domestic Product (GDP). The country’s value for household final consumption expenditure per capita (constant 2005 US dollars) was recorded at 343.39 in 2014. Over the past 54 years, the value for this indicator has fluctuated between 343.39 in 2014 and 150.72 in 1964. Neo-classical growth theories emphasised the importance of investment as one of indicators of long-run economic growth. Besides, most developed countries attained high levels of development through investment-led growth strategy, which has a multiplier effect on income growth of a country. Investment in capital and heavy industries provides base for long-run sustainable growth. Over past decades, there has been growth in consumption expenditure in most developed countries. High consumption expenditure accompanied with high income shows maturity in the level of economic development. Such growth in consumption expenditure in developed countries shows change in nature of economic activities directing growth of economy. Countries with highest household final consumption expenditure in world are United Arab Emirates, the USA, Hong Kong, Switzerland and Luxemburg. However, consumption expenditure is also increasing in developing countries in post globalisation period. This growth is result of increasing foreign direct investment in developing countries, especially in services and consumption-based industries, which is driving consumption-based growth. This is noticeable in form of growth of service sector activities, like banking, insurance, hotels and restaurants, and information technology. High consumption and its contribution to GDP is a new phenomenon that is giving rise to a consumption-based growth strategy in developing countries. In African countries, investments are still low and there is heavy reliance on the consumption-based growth strategy. However, such strategy is not sustainable in long-run and will not lead to sub-optimal use of resources. Rwanda is one of the fastest growing economies in Africa. It has made a significant progress in recent years, maintaining stable growth rate of around 7-8 per cent between 2000 and 2015. Rwanda is a market of over 11.8 million people with a rapidly growing middle-class that is driving up consumption expenditure. Some of the other factors contributing to the growing consumption expenditure in Rwanda are growth of FDIs, urbanisation, and growth of middle class. The rise in foreign private investment is fueling the expansion of the service sector and driven up consumption expenditure in the country. Most of the investments in Rwanda are from the European Union countries like Germany and the United Kingdom, East African Community (EAC), South Africa, and Kenya. In 2015, 23.8 per cent of total foreign private capital was invested in the financial sector, energy received 18.7 per cent, and ICT 16.8 per cent, while tourism 14.7 per cent and manufacturing got 6.6 per cent. Contribution of urbanisation In past few years, growth of urbanisation and urban population in Rwanda has increased consumption expenditure. Urban population increased from 4.6 per cent in 1978 to 16.5 per cent in 2012. Urbanisation accompanied by growth of financial sector has also led do increase in mortgage based consumption. Growth of middle class due to urbanisation has increased consumption expenditure in Rwanda. This is due to demonstration effect making people to copy western lifestyle. High demonstration effect has negative effect on savings which will affect investment. Strategy review needed The consumption-based growth strategy is not an ideal strategy for developing countries as they are still at initial stages of growth. So, such a strategy caters for the short-term and not sustainable. Long-term sustainable growth comes from investment and exports. In developing countries, consumption-based growth strategy is causing balance of payments crisis which tends to have strong negative impact on growth and employment. In this regard, developing countries should have a growth strategy that balances the relative contributions of consumption and investment in the growth of economy. According to a 2014 report by United Nations Conference on Trade and Development (UNCTAD), a consumption-based growth strategy often results in overdependence on imported consumer goods, which affects the development and survival of local industries, the building of productive capacities and job-creation. Countries, like Rwanda, are in initial stages of development and should, therefore, adopt investment-based growth strategies to ensure sustainable development. Import substitution approaches and promotion of locally-made products should central for solutions to bear fruits. In addition, there is need for developing countries to be selective on type foreign direct investments (FDIs) they attract. FDIs in infrastructure, utilities and heavy capital-based industries should be prioritised. Rwanda should also continue to promote a savings culture among the populace through incentives and awareness programmes. The writer is a senior lecturer at Jomo Kenyatta University of Agriculture and Technology Kigali Campus js.jayashukla@gmail.com

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Why LDCs must be wary of consumption-based growth