Njuguna Ndung'u: East African integration as a solution to economic
growth and employment generation
Remarks by Prof Njuguna Ndung'u, Governor of the Central Bank of Kenya, on the occasion
of a public lecture, Kenyatta University, Nairobi, 16 March 2010.
* * *
The Chairman of Council;
The Vice-Chancellor;
Deputy Vice-Chancellors;
Members of the entire University Community;
Distinguished Guests;
Ladies and Gentlemen:
It is a pleasure and honour for me to address this distinguished audience on a very topical
and timely issue of EAC integration as a solution to economic growth and employment
generation for Kenya and the EAC region. I wish to focus my talk on domestic and regional
policy initiatives and how they impact on growth, and more specifically on the employment
situation in Kenya.
May I start by pointing out that unemployment reflects the inability of economic activity to
absorb labour or human resource at different levels. When we talk of economic activity, we
mean growth. It allows economic opportunities to emerge. The most important one;
investment opportunities that increase the demand for human capital. So employment is a
derived demand, from the demands on economic activity and increased investment.
But how does regional integration improve economic activity (growth) for member countries
and so increase labour absorption - employment? This is the question we need to focus our
attention on. Let me try some quick avenues:
1. EAC will provide a wider market - this will induce firms' production expansion in size
and product lines - to satisfy a wider market.
2. A larger market requires a larger investment outlay.
3. A larger market diversifies the sources of income flows.
4. Financial services to cover the region will have to adjust to a higher platform: for
instance, Kenyan banks are currently expanding to the region in a significant way.
The same applies to a number of other sectors such as retail services as evident
with the expansion of Nakumatt and Uchumi retail shops to the region.
5. Larger demands for regional infrastructure to facilitate trade and production.
The list can be long and depends on where one starts, but at the end, labour demand is
derived demand from all of these economic activities.
To develop this topic on Kenya, I wish to develop three arguments on Kenya's case:
First, the policy solutions, their evolution and shocks; It is often good to start from a
perspective that policies, once implemented, will work and even when shocks hit the
economy, the economy will return to its potential. How long it takes to return to its potential is
determined by how pervasive and persistent shocks were. Having said that, the blue print of
growth and employment creation was laid out by the NARC Government - "Economic
Recovery Strategy for Wealth and Employment Creation" which covered the period
2003-2007. This bore fruit and the economy picked up from a low of 0.5 percent annual
growth in 2002 to 6.3 percent in 2006 to 7.1 percent in 2007. This saw the number of new
jobs created reaching 506.5 thousand, 488.4 thousand, 485.5 thousand, 467.3 thousand in
2004, 2005, 2006 and 2007 respectively.
The results of this blue print of policy paradigm show that success will always generate
success. Once policies are followed to the paper, they will generate the desired results.
But then external and internal shocks hit the economy in 2008 stepped in. However, the
economy is on the recovery path and it was expected to grow by about 2.1 percent in 2009
and at between 3 and 4.5 percent in 2010 and by over 5 percent in subsequent years. It is
important perhaps to explain why in times of shocks, growth, investment and even economic
decisions are affected and even affect other outcomes like consumption and employment.
Three examples include:
1. At the individual level optimizing welfare under uncertainty.
2. Irreversibility of fixed investment decisions.
3. Informal sector expansion as a disequilibrium queuing model of employment.
These are short-run and should not condemn us to a low equilibrium trap.
Second, the EAC Common Market and its potential for employment.

In general, most countries in Africa are forming regional economic integration
arrangements in order to; secure access to larger markets and enhance trade flows
and in the process attract the much needed foreign direct investments; lower trade
costs among neighbours; leverage or lock in domestic reforms; create a framework
for regional cooperation and resource pooling; increase their bargaining power and
political cohesion.

Economic integration has the potential for economic growth; to create wealth;
improve labour and social conditions and result in a better division of labour
between countries based on comparative advantage. Exploiting relative comparative
advantage of each integrating member country enhances the region's efficiency in
production, increasing output and boosting economic growth of each member
country.

Regional integration, uniformity of policy and common goals will act as an agency of
restraint and cushion the external shocks in some cases.

The EAC brings together nationals of five countries namely, Kenya, Tanzania,
Uganda, Rwanda and Burundi. In 2008, the five countries had a combined
population of 126.6 million people and a nominal GDP of USD73 billion (based on
EAC Facts and Figures Report, 2009). In the same year, Kenya's GDP stood at
USD26.9 billion, that is 37 percent of the EAC total. It is the dominant economy in
the bloc. This enlarged market means potential for increased free trade among
members. Free trade is expected to lead to rapid expansion of trade and output,
which in turn is expected to lead to demand for further investment, employment and
GDP growth. These gains result from the dynamic effects of a Common Market,
which have been shown to overshadow the static effects, that is, trade creation,
trade diversion and terms of trade effects. The dynamic effects, which are
cumulative in nature lead to growth. Indeed, the dynamic effects of a Common
Market are often described as the long-run consequences for the economic growth
of member countries as a consequence of increased market size and exploitation of
economies of scale, increased competition, learning by doing and increased
investment. Also, the stronger the potential economies of scale are, and the more
rapid the autonomous productivity advantages, the more likely the economic
integration will lead to growth. Thus, the contribution of the EAC Common Market to
economic growth and employment will be greater if the economies of scale are
possible by increased market size, takes place pari passu with learning by doing.

However, higher levels of economic integration that would ensure such benefits are
realized require heavy infrastructural investments in the region. With this realization,
the EAC Development Strategy sets out the priority programmes for the region
focusing on among others, cooperation in infrastructure development. An efficient
infrastructure development mainly for EAC in terms of roads and railway
interconnectivity has the potential to increase from 3.7 million tonnes in 2007 to over
16 million tonnes by 2030, at an annual rate of growth of 6.7 percent, according to a
study on the EAC Railways Master Plan. Current EAC efforts to develop regional
infrastructures are complemented at the continental level by such initiatives as the
Infrastructure Consortium for Africa (ICA), established in 2005 and mandated to
support and promote increased investment in infrastructure in Africa from both
public and private sources. In addition, with the implementation of the EAC Common
Market Protocol, regional infrastructural projects will be well defined.

Ladies and Gentlemen, it is worth noting that the overriding rationale for regional
integration is development, with all the benefits that come with it. Theoretically,
integration fosters growth through different channels such as increasing innovation
through economies of scale and through technological spillovers and elimination of
replication in research and development. Empirically, integration gives access to a
larger market, more stock of technology and knowledge and therefore, more
innovations and growth. Furthermore, expanded markets and increased productivity
following integration, triggers increasing returns in the research and development
sectors due to the implied scale effects. All these channels have important
implications on employment generation and economic growth for the integrating
economies.

The overriding objective of the EAC Common Market is to widen and deepen
cooperation among partner states in both economic and social fields for the benefit
of the citizens of the member states. This is beyond what literature terms as "beg thy
neighbour" effects. The Common Market Protocol provides for the free movement of
goods, persons, labour, services and capital within the region as well as the right of
establishment and the right of residence.

The Common Market will unlock many other benefits among East African citizens.
Currently, efforts are underway to move to the next level of economic integration,
after the completion of a Study by the European Central Bank consultants on the
East African Monetary Union (EAMU). The study has explored among other things
the current preparedness for a Monetary Union, institutional frameworks and
structure for an EAMU, design of a protocol on the EAMU to be negotiated by
partner states, and proposals for monitoring and enforcing macroeconomic
convergence in the region.

Ladies and Gentlemen, all these integration endeavours will create employment
opportunities. I will emphasize on employment opportunities because it is a dynamic
concept that focuses on gainful employment and space to utilize your own relative
comparative advantage. It is upon you to position yourselves to take advantage of
these new opportunities. Our higher institutions of learning have the responsibility of
training an internationally competitive labour force to enable Kenya take full
advantage of these regional initiatives. The investment opportunities that come with
it will allow the appropriate signals of skill requirement.
Finally, the Vision 2030 and unemployment in Kenya: The Vision 2030 aims at transforming
Kenya into a newly-industrialised, middle income country: what does it mean to solve the
unemployment problem of Kenya?
To solve unemployment, we need a long-run vision for growth and investment supported by
short-run policies like macroeconomic policies, specifically: fiscal and monetary policy and
also trade policies.
a) Fiscal policy and fiscal stimulus
The economy is just emerging from the devastating consequence of drought and the global
financial crisis. The pervasiveness and persistence of these shocks required that the
government develops a fiscal stimulus. It is important to understand how fiscal stimulus
works in an economy like ours:
1. Recognizes support and protection for the wage good through targeted public
investment and public works - Kazi Kwa Vijana.
2. A shilling spent in rural Kenya has a higher multiplier effect in the economy.
3. Support local industries - via government expenditure and higher domestic
consumption - preserve jobs - prevent layoffs.
4. Increase public investments that are complementary to private investments - in that
they enhance profitability of private investments.
5. Finally, in this way the government crowds-in private sector but not crowd-out.
b) Monetary policy
But perhaps one may ask how has the monetary policy reacted to the crisis and how does it
work to support economic activity? Monetary policy works to control the level of money
supply consistent with economic activity.
Several instruments:

Central Bank Rate (CBR) - as a signalling rate of the stance of monetary policy. It
has been progressively reduced from a high of 9 percent in August 2008 to the
current level of 7 percent. Lowering of the CBR signalled the intention of the Central
Bank for a low interest rate regime to encourage credit extension to the private
sector and so investment to support growth.

Cash Ratio Requirement (CRR) - in order to avail liquidity to commercial banks
and release more resources for financial intermediation, the Bank has lowered the
CRR from 6 percent to 5 percent in December 2008 and further to 4.5 percent in
June 2009.

Liquidity management tools: To further enhance liquidity management in the
banking system, the Bank has instituted several reforms to introduce new
instruments like horizontal repo, vertical repo with fixed tenors.

Financial development: In general an efficient and developed financial system is
important to collect and collate savings from micro-savers to investors. Second, an
effective monetary policy will depend on an efficient and developed financial system.
In concluding my remarks, let me emphasize that employment is a function of economic
activity. Sustained economic growth is good for employment. One major solution for
sustained growth is a wider market for trade and investment. EAC provides just that. But
public investment infusion required to support the private sector investment is immense.
Public investment especially in infrastructure will reduce transaction costs for the private
sector and allow profitable regional trade. To date 43% of the total Kenyan exports of goods
and services go to the EAC region. These exports are mostly manufactured exports. There is
scope for more within the EAC and locational advantages. This is what we want to strive for
in EAC and these are the positive development agenda EAC presents to Kenya and East
African countries.
Thank you for your attention.