Resident Fellow  Mauro De Lorenzo

The paradox of Rwanda is that it is making a concerted effort to improve its investment climate, while remaining substantially dependent on foreign aid for its national budget.[1]

Aid dependence tends to reduce the incentive of governments to increase their tax base and make it easier to do business, because it is simpler to increase revenues by competing for aid transfers. In general, aid-dependent governments are not attentive to the needs of the private sector, because they do not depend on it for survival.

Yet, despite these countervailing incentives, over the past few years Rwanda has acquired a reputation as one of the least corrupt, most serious, and most business-friendly governments in Africa. The Rwandan president, Paul Kagame, has declared his intention to move from an aid-based economy to a trade-based economy. Level-headed CEOs swoon when they meet this ostensibly dull leader, and some have engaged themselves in concrete ways to support Rwanda's economic development plans. Rwanda seems like a model for how Africa can go beyond aid.

What is this perception based on? Why is it unexpected? What explains the shift in policy? What challenges does it mask?

The Rwandan Achievement

In the late 1990s, Rwanda began to gain a reputation for its firmness against corruption, and its ability to use aid effectively. Aid commitments increased year on year, with particularly committed support from the UK's department for International development (DfID), then led by Clare Short. The decision to maintain high levels of aid to Rwanda was based as much on the belief that the money could be used effectively as it was on any 'guilt' the West may have felt over its failure to act to prevent or slow the genocide of 1994.

A signal achievement, obtained with intensive collaboration with DfID, was the professionalization of the Rwanda Revenue Authority (RRA). Unlike its counterpart in Uganda or any number of other African countries, the Rwandan tax authority is, if anything, too efficient.[2] Bribery is rare and severely punished, and it is extremely difficult to dodge taxes.

During this period, Rwandan decision-makers also learned that it is possible to say 'no' to donor priorities, or to aggressively push their own priorities, without adverse consequences. So long as aid money was spent well and transparently, so long as growth and welfare statistics increased, the donors would come back with more. Politically, the donors need success stories as much as the recipients need the aid.

From 1994 to 1998, when the insurgency in the north-west was decisively defeated, Rwanda's overriding priority was security. The forces that had committed the genocide had regrouped on the country's doorstep. They seemed positioned to launch attacks inside the country, which would make reconciliation, economic growth, and democratic progress all but impossible. Rwanda had to create a secure space for itself in order to be able to try out innovative policies that the government hoped would, over time, fundamentally change the nature of politics and identity in the country.

As the country's external security situation began to improve after the two wars in Congo (1996-1997 and 1998-2003), it was possible for the Rwandan leadership to devote more strategic attention to issues of economic growth. Indeed, they saw the pursuit of economic growth as an essential component of Rwanda's long-term security strategy.

Rwanda's embrace of the private sector was already formulated in its Vision 2020 strategy document, which was released in 2000 and developed under the leadership of the former finance minister (and current African Development Bank president), Donald Kaberuka. The impetus to implement the economic growth portion of Vision 2020 increased after the elections of 2003, and it has led President Kagame to seek relationships with foreign (and especially United States) business leaders.

Since the election, whenever President Kagame visits the United States, he prioritizes visits with corporate leaders as diverse as Riley Bechtel and Steve Forbes, as well as the leaders of major companies like Starbucks, Burlington Northern Santa Fe, GE Infrastructure, and dozens of others. The content of these meetings is typically informational. CEOs enthuse when they meet this unprepossessing, monotone leader who understands the needs of the private sector, and who exhibits the same qualities of decisive leadership and moral probity that American business leaders admire in themselves. This network has been nurtured and managed by two Chicago commodities traders, Joe Ritchie and Dan Cooper of Fox River Investments. The 'Friends of Rwanda' network, as it has become known, now functions as a sort of high-level consulting service for senior Rwandan government leaders.[3]

A number of these executives have offered their time and expertise on specific Rwandan development initiatives in energy, telecommunications, and railways, effectively making millions of dollars of in-kind contributions. Burlington Northern Santa Fe is helping Rwanda devise a strategy to extend a railway line from Ishaka in Tanzania up to Kigali. Scott Ford, CEO of Alltel, has advised the government on technical and contract issues related to broadband access and the strategy for the national telephone company. All this advice is provided pro bono, and the companies are not themselves investors in Rwanda. Rwanda's challenge now is to transform this network from a source of information into a tool to drive investment into the country. The government is aware that a window has been opened for Rwanda in corporate America, but that it will not remain open for ever. The strategic danger is that if the government's policy choices cannot be put into action--if rhetoric does not match results--then busy, impatient, sceptical corporate leaders could lose interest and move on.

In addition to the above factors, the perception that Rwanda is different from the rest of Africa in some fundamental way is based on a number of elements:

Safety and Stability. Rwanda is one of the most physically safe countries in Africa. It is possible to travel from one end of the country to another at night without any particular worries about security. This is achieved without checkpoints or invasive ID checks. Compared to other parts of the continent, living and travelling in Rwanda feels liberating.

Recreation of a Political and Moral Order after the Genocide. No analyst imagined that Rwanda would be able to restore order and achieve a modicum of justice after so cataclysmic an event as the genocide of 1994. This new order is more consensual than analysts conferring with exiles typically credit, and, if sustained for a generation, could permanently transform the nature of politics in the country.

Macroeconomic Stability. The former finance minister (and current African Development Bank president), Donald Kaberuka, put the country on a sound macroeconomic footing, and the Rwandan National Bank is managed professionally.

Effective Tax Collection. The Rwanda Revenue Authority, which was built with significant support from the UK Department of International development (DfID), is widely recognized as a success.

Low Corruption. Foreign business leaders most often talk about Rwanda's intolerance of corruption as one of the country's most attractive features. Public officials--even well-connected ones--are frequently investigated for corruption, and sometimes convicted.

Openness to the Private Sector. Through public pronouncements and, increasingly, through legislative action, Rwanda is showing its commitment to improve the conditions for the private sector. The Business Law Reform Cell, based in the Ministry of Justice under the leadership of Richard Mugisha, has rewritten all of Rwanda's commercial laws to bring them up to international standards. Hong Kong and Mauritius laws were studied for inspiration. Once these laws are passed by the Rwandan legislature in 2007 or 2008, Rwanda's position in the World Bank's Doing Business indicators should increase substantially.

This constellation of choices is not suggested by the ideological history of the Rwandan Patriotic Front, the dominant party. Its politico-military training curriculum was borrowed from the National Resistance Movement in Uganda (in which most senior RPA officers had fought). The NRM had in turn taken its cues from Samora Machel's Front for the Liberation of Mozambique (FRELIMO), where Yoweri Museveni and Fred Rwigema, the late first leader of the RPF/RPA, received early training in the late 1970s. In other words, its orientation was anti-capitalist and anti-imperialist.

The Countervailing Incentives: Obstacles to Moving Beyond Aid

Rwanda's policy innovations are also a paradox, because the country is so aid-dependent. Countries that are aid dependent have incentive to do the kinds of things that get you more aid from the West, not to undertake the reforms that will make it easier to do business. They tend to be more oriented to donor priorities and processes than to developing their own economic policy vision.

They also tend to have a low tax effort, because extracting revenue domestically is difficult and politically painful, and governments are happy to avoid it if they can. For the same reason, aid-dependent countries have no incentive to make conditions better for their own private sector, because they do not depend on it for tax revenue.
 
An important example of this trend is Kenya, which in 2008 was the reform leader in Africa in ease of doing business. According to Simeon Djankov, the creator of the Doing Business series, Kenya did not reform to please donors, but because it had no choice but to reform during the years when it was in the aid wilderness.

Countries in this position also tend to have little 'ownership' of their own policy space, which is dictated by the political needs of donors. Yet, as President Kagame has written, Rwanda seeks to 'replace donor conditionality with internal policy clarity'. While remaining heavily dependent on aid, Rwanda has increased its tax effort and taken important steps to improve the investment climate.

Above all, politics in such countries tends to be distorted because accountability is oriented outwards, towards donors, and not inwards, to domestic constituencies and business interests.

Where Did the Internal Impetus for a Trade-Based Economy Come From?

Why has Rwanda been self-consciously trying to transcend the donor-led model of development? If the incentives in Rwanda's path push it away from a trade-based economy and towards an aid-based one, what accounts for the apparent shift?

The first impetus is political. Good policy innovations almost never come from externally imposed conditionality. Even good policies, when imposed, tend to be resisted. The reason President Kagame and his advisors have embraced the trade and investment agenda is not because they thought it would please donors, but because they thought it would make them more independent of donors. They also believe that real growth is the most fundamental component of Rwanda's security strategy--the one sure-fire way of permanently eliminating the threat of a resurgence of a genocidal ideology.

Rwanda is convinced that donors do not understand, or do not care about, Rwandan national priorities. Particularly on reconciliation and security matters, donors tend to resist Rwandan solutions, because these solutions sometimes fail to align with Western liberal norms. If Rwanda had not taken action in Congo in the 1990s over the strong objections of donors, or if it had left its security in the hands of the United nations, as many urged it to do, the country could very well have descended into violence, becoming a blight on the prospects of the entire region.

In order to take the sort of action that Rwanda deemed essential to its national security, it needed to be able to fund its security and defense establishment no matter what punishments the donors decided to impose. The need to have that freedom to maneuver, combined with the belief that foreigners do not take Rwanda's security needs seriously, impel the leadership to seek as much financial and political independence as possible from the institutions of the international community. At the same time, they are aware that they cannot easily progress without some support from those same institutions.

The second factor is cultural. Traits of independence and self-reliance, which were inherited from the political circumstances and livelihoods of the pre-colonial period, were enhanced by the experience of the exile generation of 1959-1990. When they launched their rebellion in Rwanda in 1990, they did so with the tacit approval of President Museveni of Uganda, but with very little material support from him. They sustained their guerrilla activities without any substantial external support. Instead the RPF devised its own covert, effective, and accountable fundraising program, managed by Aloisea Inyumba (now a senator), which had tentacles throughout Africa, Europe, and the Middle East. When donors and UN officials attempted to cajole or sanction Rwanda for one reason or another in the 1990s, they were surprised by the sometimes haughty disdain they received from Rwandan officials. They had little understanding of what the Rwandans had already been through, and how unimpressive the threats seemed. The Rwandans had already survived worse, and prevailed.

The third relates to security and defense. Rwanda faced a number of external threats which it knew the international community would not act to protect it from. Rwanda knew that it would have organize its own defense, and fund it mostly from internal sources.

A fourth element seems to relate to the fact that the Rwandan government is in a sense a minority government. Though the RPF has made efforts to expand its membership well beyond the core group that took power in 1994, it is not clear that it has true majority support. The leadership is aware of this political danger, and it is one of the most important factors that provide a sense of urgency to 'deliver' on growth, education, and health. Because the legitimacy of the RPF is not 'natural' or inevitable--that is, they are not automatically legitimate just by being there, as the previous government was--they can only achieve legitimacy by delivering results. A comparison to other high-performing governments with legitimacy problems, such as China's, would not be totally inapt.

The final element, impossible to quantify, is leadership, particularly as embodied in the person of Paul Kagame.

Remaining Obstacles

The idea of Rwanda as a model masks a number of serious problems, some of which donors can help with, and some of which Rwanda must grapple with on its own.

The main obstacles to Rwanda's economic success are the high cost of doing business, and the inability of government to execute economic, industrial, and agricultural policy.

Ability to Implement Policy. Good policy can only have its full effect if government has the capacity to put it into practice. The record of Rwanda in this regard is probably superior to the performance of most other African governments, but not at all sufficient to increase Rwanda's competitiveness to offset its inherent geographical limitations. Currently, Rwanda has the right policies and vision, but the Rwandan leadership is increasingly frustrated by the slow pace of implementation.
 
Inability to Prioritize Action That Is Most Crucial to Economic Growth. Entrepreneurs appreciate the bureaucratic reforms, but there is little evidence, either anecdotal or statistical, that they are taking advantage of them, or that these reforms are changing how people make investment decisions. The same could be said of the much-heralded one-stop shop. The reason seems to be that these were not the real constraints preventing them from investing.

Overconfidence and Overpromising. Some Rwandan officials imagine that the hard work has already been done, and that when American CEOs sing a country's praises, a future of milk and honey is close at hand. The attention of these CEOs is, of course, just an indicator of promise, not the reward of a completed project. Other officials, less sanguine, have a different worry: that Rwanda's brand is being built up by sympathetic media too fast, too aggressively. These officials know that Rwanda has a long path to travel before the current policy constellation results in substantial growth and investment. They worry that disillusionment could set in as results take longer to materialize than people expected. They feel the time is right to start actually dampening expectations.

Failed Privatizations, Inability to Vet Foreign Partners. Rwanda was sometimes too eager to privatize and enter into deals with foreign partners. A number of these deals have gone bad, ending in mutual recrimination between government and foreign firm. The most recent examples are the failed Rwandatel-Terracom deal, and the failed Dane Associates deal on a methane gas project on Lake Kivu. This sort of controversy, if mismanaged, can send bad signals to the market and deter future investors. It seems, though, that key decision makers in Rwanda have recognized the importance of doing due diligence on foreign bidders--and of hiring professional firms to conduct the investigations where Rwanda does not have the capacity to do so. One positive sign is that the government knew how carefully it had to tread as it attempted to extricate itself from these bad deals. It consulted extensively with executives from the United States-based Friends of Rwanda network, in order to better understand and manage the market signals that would result from pulling out. As a result, the government acted more slowly and carefully than it might have a few years ago.

'Philanthropic Investors'. A number of the new investors in Rwanda are in fact not 'real' investors. They have not come to Rwanda because they saw unique business opportunities. If they had made their calculations on a purely commercial basis, they would have invested elsewhere. The attraction to Rwanda was often a personal connection to the president, being impressed by his vision for the country, and wanting to be a part of the experiment. We will know that Rwanda has turned a corner when investors who have never met President Kagame come based on purely commercial calculations.

Cost of Doing Business. No development challenge is more urgent than the high cost of utilities and transportation. These are the real binding constraints on growth. These are the factors that every investor, domestic and foreign, must build its business plans around. most projects that are in principle good ideas--such as adding value to Congolese natural resources in Rwanda--are not feasible because of high energy and transport costs. Until these are brought down, most of the other reform initiatives of the Doing Business variety are unlikely to bear much fruit.
 
Rwanda's laurels are deserved, but if it rests on them, or comes to imagine that the hard work of reform and consensus-building has already been done, the country may yet sink back into the development traps out of which it has only begun to crawl. Alternatively, if it persists on its current path, and finds creative solutions to its key geographical challenges and binding economic constraints, Rwanda could well become the best case study for how a country with few natural advantages can effectively use aid to transcend its limitations.

Notes

1. In 2008, about 44 per cent of the Rwandan budget will come from donor budget support.
2. This can in fact be a problem for businesses in cases where the tax code itself is in need of reform.
3. See Mauro De Lorenzo, 'Rwanda Redux', The American, November 2006.