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The Kingdom of Lesotho is a small, mountainous country that is landlocked by its neighboring nation, South Africa. It has a constitutional monarchy, and its government is currently undergoing economic reforms recommended by the Southern African Development Community. As a result of its proximity, the Lesothian economy relies rather heavily on the economic and political state of its neighbor. Lesotho imports 85% of its goods from South Africa. Economic swings in South Africa are the single largest influence on the Lesothian free-market economy. Additionally, over the past four years, there has been major political instability in South Africa. This unrest has created a prolonged period of slow economic growth in South Africa, and, in turn, negatively impacts Lesotho’s economy as well. The economy of Lesotho grew 1.2% in the third quarter of 2019, but this came after a 2.1% contraction in the second period of 2019. In order to reach its full economic potential, Lesotho will need to attain economic independence from South Africa. The government is currently working on infrastructure improvements to boost its economy, but more actions need to be implemented. Lesotho needs fiscal reforms that will increase its gross domestic product (GDP), decrease unemployment, and increase direct foreign investment in order to stimulate economic growth.
Currently, Lesotho is working on an infrastructure project to boost its economy and promote political stability in itself and South Africa. The Lesotho Highlands Water Project is part of a thirty-year plan to export two billion metric cubes of water from Lesotho to South Africa annually. It will involve the construction of five dams and an intricate series of two hundred kilometers of tunnels between the two nations. This project will increase access to water, usher in royalties from South Africa, and boost the growth of Lesotho’s private sector. In fact, an estimated seven percent of new jobs will be created from this initiative within Lesotho, and it will aid in the facilitation of trade between the two countries. Bilateral trade of any good is beneficial because it allows the nations involved to enjoy a total output and level of consumption far greater than what could have been achieved domestically. In addition, this plan would increase Lesotho’s exports, and subsequently increase Lesotho’s gross domestic product. Four components constitute GDP: personal consumption, business investment, government spending, and net exports. By increasing its GDP, Lesotho’s economy will become better and move forward towards its potential.
Lesotho’s GDP could continue to grow through the implementation of expansionary fiscal policy. The personal income tax rate in Lesotho is currently around 30%. In Canada, the second most economically stable nation, the tax rate is half of Lesotho’s at 15%. If Lesotho wants to boost its economy, it should follow in the steps of Canada and decrease the personal income tax rate to somewhere between 15% and 25%. This reduction in taxes would lead to a substantial increase in the disposable personal income of its residents. Taxes are a major source of revenue for the Lesotho government; however, as disposable income increases, citizens have more money to save or spend, and this naturally leads to an increase in personal consumption. Additionally, this increase in consumption would lead to an increase in aggregate demand (AD). Similarly to GDP, aggregate demand consists of four components: personal consumption, business investment, government spending, and net exports. When aggregate demand increases, GDP increases as well. This is illustrated by the Aggregate Demand Short Run Aggregate Supply (AD/AS) Curve:
AD₁ shifted right to AD₂, moving on the graph towards long run aggregate supply (LRAS). This complements the Lesotho Highlands Water Project because both increase the nation’s GDP. The additional boost in GDP gained from decreasing taxes outweighs the revenue gained by keeping the personal income tax rate around 30%. Additionally, since aggregate demand would shift towards long run aggregate supply, this decision would benefit Lesotho’s economy in the long run. LRAS is where the economy operates at full employment and produces using all of its factors of production. Since Lesotho is currently operating below its full employment equilibrium, it is in a recessionary gap. This further emphasizes the need for a decrease in taxes because expansionary policies encourage economic growth.
An increase in inflation would also following the increase in aggregate demand from a decrease in taxes. Inflation, a sustained increase in the price of goods and services, is usually portrayed as negative. However, when the economy is not operating at its full potential, inflation can lead to increased production. This is because higher prices will lead to the spending of more money which leads to increased AD which leads to an even larger GDP and another increase in inflation. This cycle, the tax multiplier, would repeat continuously, boosting the economy of Lesotho. Furthermore, an increase in inflation would lead to a decrease in unemployment. As stated above, Lesotho is in a recessionary gap, and in a recession unemployment rates are high and inflation is low.There is an short term inverse relationship between inflation and unemployment: if inflation increases unemployment decreases, and if inflation decreases unemployment decreases. This is shown by the Phillips Curve:
In the figure above, the AD/AS model is beside the Phillips Curve to illustrate the relationship between the two when aggregate demand rises. When AD increases, inflation increases and unemployment decreases, represented by the movement of the yellow circle to the position of the red circle. This re-emphasizes the need for a decrease in taxes. Moreover, Lesotho needs to decrease its unemployment rate. The nation’s peak unemployment rate was in 1997 when it reached 37.94%. It has steadily been decreasing since for over twenty years; however, it still remains very high. In 2018, the unemployment rate was 23.60%, and the female unemployment rate was even worse at 32.1%. Compare this to Canada’s unemployment rates of 9.10% in 1997 and 5.92% in 2018. The natural rate of unemployment is between 4% and 6%, and these numbers are seen as the standard to achieve full employment. In order to attain long run equilibrium on the AD/AS and Phillips Curve, Lesotho’s economy would need to operate at full employment and thus decrease its unemployment rate by at least 17.6%. Such a large drop would take any nation a long time to accomplish. This would be especially difficult for Lesotho as its unemployment rate dropped only 0.02% between 2017 and 2018. Additionally, from the years 2014 to 2018, its unemployment rate fell 0.19% on average, a percentage around one hundred times below the task of dropping the unemployment rate a minimum of 17.6% to operate at full employment.
To supplement a decrease in taxes and decrease in unemployment, Lesotho’s government should also implement another expansionary fiscal policy: an increase in government spending. If the Lesotho government increased government spending on education, it would not only benefit the citizens and government, but also the economy of Lesotho as a whole. Currently, the education sector of Lesotho is allocated an average of 23.3% of the government’s recurrent budget on average, a number that is equivalent to 9.2% of the kingdom’s GDP. In spite of almost a quarter of the budget being spent on education, Lesotho’s literacy rates are quite low: 84.93% of females aged fifteen and older are literate, but only 67.75% of men fifteen or older are literate. Compare this to Canada’s adult literacy rate of 99%. Currently, some of the major issues the education sector faces are high inefficiency in the system, graduates with inadequate skills for the job market, and low student achievements. By investing more money into education of Lesotho’s youth, preferably at least 30% of Lesotho’s GDP, the nation will be able to overcome the challenges within the current education system and gain a more employable and productive workforce. This should also aid in decreasing the unemployment rate. If the improved education system that is currently being put into place is refined, Lesotho’s workforce will gain laborers that will be able to compete locally and regionally.
An increase in government spending on education would have additional benefits for Lesotho’s economy. Aggregate demand would increase because government spending is one of the four constituent pillars of AD. This once again would increase GDP, reinforcing the benefits previously shown on both the AD/AS and Phillips Curves. Moreover, there will be a multiplying effect from increasing government spending. This money spent by the Lesotho government will be used by residents to consume more and more. A continual cycle of consumption will occur, further increasing AD and GDP. This cycle would be the result of increased amount of money spent by the government, continuously boosting Lesotho’s economy. This cyclical transaction of money, the spending multiplier, has a greater effect than the tax multiplier. All of the money from government spending will be recycled into the market and increase AD; however, with the tax multiplier a only portion of the disposable income will enter the money cycle. Mathematically, the spending multiplier is always 1/(1-MPC), and the tax multiplier is (-MPC)/(1-MPC) or K-1. The tax multiplier will always be one less than the spending multiplier, so it has a smaller multiplied effect. Furthermore, an increase in government spending would increase the demand for loanable funds. An increase in the demand for loanable funds would also accompany a decrease in the unemployment rate. An increase in inflation benefits borrowers because inflation causes the value of money to decrease over time. So, inflation allows for debtors to repay lenders back with money that is worth less than it was when they first borrowed it. Furthermore, an increase in the demand for loanable funds leads to an increase in the real interest rate. This is portrayed by the Loanable Funds Curve (LFC):
The demand for loanable funds, D₁ and D₂, represents borrowers on the LFC. When the demand for loanable funds shifts right from D₁ to D₂, the real interest rate increases from r₁ to r₂. When the real interest rate increases, direct foreign investment also increases. Financial capital inflows enter countries with high interest rates because they can expect a higher return. This, however, can lead to crowding out. However, the inflow of foreign investment in a country such as Lesotho can balance the loss of private investment. There are many benefits to nations who would choose to invest in Lesotho: free market economic system, stable political environment, large labor force, decreasing water and electricity tariffs, low corporate tax rate of 15%, and a sales tax exemption on capital equipment. Foreign investment would be very beneficial for the kingdom because it would stimulate Lesotho’s economic development, increase productivity, create new jobs, and raise the national income. These benefits coincide with the aforementioned effects of implementing expansionary fiscal policy, and they would help Lesotho achieve a few goals including decreasing the unemployment rate, increasing AD, increasing GDP, boosting the economy, and attaining economic independence.
There are four main issues Lesotho will have to tackle on its way towards economic prosperity: debt, poverty, economic diversity, and health challenges. In 2018, Lesotho’s debt reached 44.53% of its GDP, an incredulous 7.42% in a single year. Hopefully, by significantly increasing Lesotho’s GDP, the debt percentage of GDP will decrease immensely. Secondly, the economic growth Lesotho has incurred over the past two decades has decreased poverty, but almost half of the population lives beneath the poverty line. From 2002 to 2017, the national poverty decreased from 56.6% to 49.7%, food poverty decreased from 34.1% to 24.1%, and the poverty gap decreased from 29% to 21.9%. Poverty negatively impacts economic growth because impoverished children generally do not contribute as much to educational environments and human capital, poverty is linked with social unrest and high crime rates, and regions with high poverty rates generate less per capita income growth. Third, Lesotho will need to diversify its exports. There have been attempts in the past to diversify its economic base including the encouragement of textile manufacturing and tourism, but it has not been enough. 86% of the labor force works in the agricultural field. Economic diversification leads to economic growth and development, and with direct foreign investment this can occur. And finally, disease. 25% of the kingdom’s adult population has human immunodeficiency virus (HIV) or acquired immune deficiency syndrome (AIDS), and Lesotho has the second highest number of cases of tuberculosis (TB) of all countries in the world. This co-epidemic results in high health costs, further pushing the population into poverty. To overcome these diseases, more education and money must be circulated in Lesotho’s economy so that the people are aware of how to prevent and deal with HIV, AIDS, and TB and so they have the funds to treat themselves and their loved ones. The path to economic prosperity will not be short or simple or easy; however, Lesotho has the determination and motivation to achieve its economic goals.
In conclusion, Lesotho is currently beginning to take the correct steps to gain economic independence from South Africa. The initiatives, such as the Lesotho Highlands Water Project and reforming the education system, are a step down the proper path, but in order to truly boost the economy quickly and efficiently, expansionary fiscal policies will need to be implemented. By enacting a reduction in taxes and increased government spending, gross domestic product will increase and unemployment will decrease. If Lesotho is able to decrease its unemployment rate, increase its aggregate demand, increase its gross domestic product, boost its economy, and attain economic independence from South Africa, it will be able to move forward and develop itself further. Thus, by implementing expansionary fiscal policies, Lesotho will be able to achieve sustainable and continuous economic growth in the future.
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