Introduction. industrialization (ISI) to export-oriented growth was due to numerous supply side

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1 Lindberg 1 Constraints of ISI in the Kenyan Economy Introduction I argue that Kenya s inability to naturally transition from import substitute industrialization (ISI) to export-oriented growth was due to numerous supply side constraints exacerbated by reliance on foreign capital. At independence in 1963, Kenya had inherited a policy of import substitution from the colonial state, which it continued to pursue for the next two decades. The idea behind this policy was for the government to take a protectionist approach to import-substituting industries through bans on competitive imported goods and concessions on sales tax, as well as custom duties on inputs. In theory, this would increase government revenue, allowing for a trickle down effect, while allowing industries to grow until they were eventually productive enough to enter the international competitive market. In Kenya, this was appealing since the colonial legacy of an economy centered around the export of mostly agricultural primary commodities had left the economy vulnerable and less profitable than those of industrialized countries. Unfortunately, ISI success was limited by a reliance on foreign capital, which manifested in the form of multinational corporations (MNCs) creating industrial monopolies and stunting growth. These MNCs created supply-side constraints by focusing on the best interest of their parent companies rather than the efficiency of these companies and their linkages to the Kenyan economy as a whole. This approach was manifested in limited re-investment of profits, large reliance on imported inputs that worsened balance of payments and resulted in products catering to the rich, and employment patterns that created vast socio-economic cleavages.

2 Lindberg 2 Investment and Monopoly Status Following Independence and capital divestment that lead to the outflow of foreign capital, the Kenyan government was eager to pursue foreign investors 1. In 1964, the Foreign Investment Protection Act was put into place as a part of the government s open door policy to foreign firms. This act guaranteed foreign investors the right to transfer profits, dividends and capital out of the country, in hopes that this would attract new foreign direct investment (FDI). 2 The act was successful and MNCs such as Firestone, Schweppes, and Lonrho began producing in Kenya 3. Despite small decreases in overall ownership, which can be attributed to selling of minority shares and joint ventures with the government, the increase in volume of foreign capital throughout the decades of ISI policies is illustrated by the data provided in Table 1. 4 During the 1960s and 1970s, much of this FDI was involved in import-substituting industries. 5 Since MNCs tended to dominate the transfer of technology to less developed countries, such companies were expected to generate economic development in Kenya. 6 A large issue with the policies meant to attract FDI was that they allowed for minimal reinvestment of profits in subsidiary firms and the Kenyan economy. A major part of profits was being remitted abroad in transfer payments. Between outflow of investment 1 Gertz, Geoffrey. "Kenya s Trade Liberalization of the 1980s and 1990s: Policies, Impacts, and Implications1." Carnegie Endowment for International Peace, 2008, 2. 2 Gachino, Geoffrey. "Industrial Policy, Institutions and Foreign Direct Investment: The Kenyan Context." African Journal of Marketing Management 1, no. 6 (2009): Gertz, 2. 4 See Tables 5 Gachino, Langdon, Steven. "Multinational Corporations, Taste Transfer and Underdevelopment: A Case Study from Kenya." Review of African Political Economy 2, no. 2 (1975): 12.

3 Lindberg 3 income nearly equaled inflow of capital leading to a cyclical reliance on foreign funds. In a 1975 study, it was found that subsidiaries in Kenya tended to re-invest only 44.2 percent of their profits, compared to the 65 percent profits re-invested by parent companies. Monopolies and a Concentration of Wealth Instead of investing in the Kenyan economy, these companies focused on attaining monopolies and maximizing global capital. This is linked to the high level of expatriates in executive roles in Kenyan subsidiary MNCs. Though the government attempted to curb this trend, by 1971 only twenty-three executive or managerial positions in Unites States MNCs were held by indigenous Kenyans. 7 The overall spread of indigenous Kenyan employment over different sectors, with non-citizens dominating the formal industrial sector, can be seen in Table 2. Even in the most Africanized companies, at least two or three principal operations managers tended to be expatriates. 8 The very limited participation of Africans in manufacturing was exacerbated by how uncommon it was for foreign owners to allow local management to determine the use of company profits in the long term 9 The monopoly status of MNCs in the industrial sector, in addition to tariff protections, allowed for companies to charge high prices and earn high profits. This meant that MNCs drove out considerable local competition and, since this led to higher wages for employees of monopoly firms, contributed to a greater concentration of wealth in the Kenyan economy. Wages in the formal industrial sector were far superior to those in the 7 Leys, Colin. Underdevelopment in Kenya: The Political Economy of Neo-colonialism, Berkeley: University of California Press, Ibid. 9 Leys, 124.

4 Lindberg 4 informal and agricultural sector, as demonstrated in Table 3 and Table Most often, Kenyan executives were given wages in parallel to their Western counterparts, rather than along the lines of Kenyan average wages. 11 For example, in 1972, wages were higher in foreign-owned soap subsidiaries -- with an average salary of 73 pounds per month -- than in their locally-owned counterparts, which averaged a salary of 36 pounds per month. 12 The above factors resulted in a domestic industrial commodity that catered to the small rich bourgeoisie, while further alienating the rest of the population. This has resulted in a gini coefficient of.60 throughout the mid 1970s. 13 This coefficient measures income inequality, in which the greater level of inequality exists the closer the gini is to 1, meaning that Kenya was considered extremely unequal. 14 In 1969, the poorest 50 percent of the population earned only 14 percent of total income, where as 56 percent went to the richest 10 percent. 15 This only worsened throughout the period of ISI, as foreign firms paid rapidly rising wages to a small labor force that grew at a much slower rate than the 3 percent population growth rate. 16 Capital-Intense Production The above socio-economic cleavage was again exacerbated by the capital-intense nature of these firms. Since machinery could be imported nearly duty-free, the 10 R, Kaplinsky. Employment Effects of Multinational Enterprises: A Case Study in Kenya Kaplinsky, Ibid 13 Meilink, Herik A. "The Effects of Import-Substitution: The Case of Kenya's Manufacturing Sector." Institute for Development Studies, University of Nairobi, 1982, Todaro, Michael P., and Stephen C. Smith. Economic Development. 9th ed. Boston: Pearson Addison Wesley, Meilink, Leys, 128.

5 Lindberg 5 manufacturing sector became so capital-intense that opportunities for employment were seriously limited. Between , output growth in the industrial sector averaged 8 percent per year 17 whereas growth in employment averaged under 4 per cent per annum. By 1970, 8 years after independence and ISI, there were still only about 645,000 people receiving modern sector wages out of a total population of about 11 million. Five years later, in 1975, only 15 percent of the total population involved in the Kenyan economy were earning wages in the industrial sector, less than one million people. 18 This proves the validity of unemployment fears expressed in the revised Lewis model, when a growing manufacturing sector reinvesting their profits in capital rather than labor. 19 MNC subsidiary managers were often pressured by their parent companies to comply with centralizing machinery purchases, often incongruent with the needs of consumers of the underdeveloped Kenyan economy. 20 While local firms tended to focus on less sophisticated products, such as simple laundry soap, MNCs had a propensity towards high-income products, like brand-name toilet soap. 21 The standardization and quality control involved with the production of international brand-name toilet soap required capital-intensive techniques. On the other hand, simple laundry soap can be made effectively by labor-intensive methods. 22 Though it is proven that subsidiaries attempted to be more labor-intensive than their parent companies, the above factors required MNCs to 17 Meilink, Kenya Bureau of Statistics. "Economic Survey." Todarro and Smith, Kaplinsky, Langdon, Ibid

6 Lindberg 6 be more capital-intense than their local counterparts. 23 This is especially detrimental for a country naturally endowed with labor versus capital, as shown in Table Inputs Instead of taking advantage of a large labor pool in order to domestically produce inputs, MNCs reveled in the protection afforded by ISI and pro foreign investment policies. Due to low import duties and an overvalued fixed exchange rate 25, it was attractive for companies to import their inputs rather than obtain them from local suppliers. 26 Furthermore, since most of these firms were subsidiaries of larger parent companies, they were encouraged to import their inputs from other foreign subsidiaries of the same parent company. 27 In 1963, 42.5 percent of all inputs used in the industrial sector came from abroad. Many industries imported nearly all basic material, for example, in 1963 the rubber products industry imported 95 percent of its inputs. 28 Between 1964 and 1971 total imports rose from 76.5 million pounds to million pounds. By 1975, 97.9 percent of industrial firms imported more than 70 percent of their machinery and 79.2 percent imported more than 95 percent of their machinery 29. In addition, the nature of the goods being produced by MNCs affected the nature of desired inputs. MNCs tend to focus on sophisticated, branded products that are popular in 23 Todaro and Smith, Kaplinsky, Mwega, Francis. "Trade Liberalization, Credibility and Impacts: A Case-Study of Kenya, " Journal of African Economies 2, no. 3 (1992): Meilink, Kaplinsky, Kaplinsky, Kaplinsky, 31.

7 Lindberg 7 the developed market of their parent company. 30 This made it difficult for firms to create the important forward-backward linkages that would have allowed industrialization to stimulate the entire Kenyan economy. While the agricultural sector provided certain inputs to the industrial sector, the reverse supply linkages between industry and the agricultural sector were only developed to a limited extent. 31 Sophisticated products required sophisticated inputs and these were often unavailable in the domestic economy. 32 For example, sugar was imported since local sugar was not as highly refined, leading to a slightly discolored final product. Other products required inputs from industries that altogether did not exist in Kenya, such as a large-scale chemical industries required to produce the phosphates used in detergent. 33 The subsequent absence of linkages undermined the rationale of ISI generating further industrialization. 34 Results By the end of the 1970s it became clear that ISI was not successful. The Kenyan economy was faced with industrial growth along the same inefficient and unproductive lines that existed at Independence. Transition into a successful export economy was not going to happen naturally, it would require a large change in policy. The result of the supply side constraints of ISI led to an industrial sector dominated by inefficient production, lack of indigenous Kenyan entrepreneurship, and a continued reliance on foreign funds. The vulnerable agricultural sector was not able to offset a balance of payments issue only worsened by mass imports of inputs. Furthermore, the industrial 30 Meilink, Meilink, Meilink, Langdon, Kaplinsky, 29.

8 Lindberg 8 sector never progressed out of the infant stage due to large foreign-owned monopolies that remained comfortable behind government protections which did not adequately emphasize cost reduction, productivity improvement, or quality and inventory control. 35 The near complete exclusion of locally-owned firms, as well as indigenous employees, in the industrial sector prevented the growth of entrepreneurship. This, again, was exacerbated by socio-economic cleavages leading to a lack of skilled workers in the economy. All of the above statements support my argument that Kenya s inability to naturally transition from import substitute industrialization (ISI) to export-oriented growth was due to the consequences of reliance on foreign capital. 35 Gachino, 153

9 Lindberg 9 Tables Table 1. Kenya Bureau of Statistics: Economic Survey 1977

10 Table 2. Kenya Bureau of Statistics: Economic Survey 1975 Lindberg 10

11 Lindberg 11 Table 3. Kenya (annual). Statistical abstract. Republic of Kenya, Central Bureau of Statistics. Table 4. International Labor Office: Working Paper 1979

12 Table 5. Factor Endowment: World Bank 2005 Lindberg 12

13 Lindberg 13 Works Cited Gachino, Geoffrey. "Industrial Policy, Institutions and Foreign Direct Investment: The Kenyan Context." African Journal of Marketing Management 1, no. 6 (2009). Gertz, Geoffrey. "Kenya s Trade Liberalization of the 1980s and 1990s: Policies, Impacts, and Implications1." Carnegie Endowment for International Peace, 2008, Kenya Bureau of Statistics. "Economic Survey." Langdon, Steven. "Multinational Corporations, Taste Transfer and Underdevelopment: A Case Study from Kenya." Review of African Political Economy 2, no. 2 (1975). Leys, Colin. Underdevelopment in Kenya: The Political Economy of Neo-colonialism, Berkeley: University of California Press, Meilink, Herik A. "The Effects of Import-Substitution: The Case of Kenya's Manufacturing Sector." Institute for Development Studies, University of Nairobi, Mwega, Francis. "Trade Liberalization, Credibility and Impacts: A Case-Study of Kenya, " Journal of African Economies 2, no. 3 (1992). R., Kaplinsky. Employment Effects of Multinational Enterprises: A Case Study in Kenya Todaro, Michael P., and Stephen C. Smith. Economic Development. 9th ed. Boston: Pearson Addison Wesley, 2006.

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