BEYOND THE DEBT TRAP

BEYOND THE DEBT TRAP What Economics Actually Tells Us About Kenya's Escape Routes — If Anyone Is Listening

Part 3 of 3: The Institutional Reckoning | The Daily Pulse

Parts 1 and 2 of this series established the mechanics of Kenya's fiscal bind with some precision. The government is borrowing Sh4 billion a day, crowding out the private sector, spending nearly 80 cents of every tax shilling on debt service, and executing less than 9% of its housing development budget while State House overshoots its annual allocation before February. We know what is happening.

Part 3 asks the harder question: Why does it keep happening? And more specifically: what do the serious schools of economics — not the talking-point versions, but the rigorous analytical traditions — actually tell us about how Kenya gets out?

For this, we turn to two intellectual frameworks that most economic commentary skips in favour of more exciting ideological sparring. Original Institutional Economics (OIE) — the tradition of Thorstein Veblen, John R. Commons, and Wesley Mitchell — argues that economies are not rational machines but evolutionary systems shaped by culture, habit, and the rules societies build for themselves. New Institutional Economics (NIE) — the tradition of Ronald Coase, Douglass North, and Oliver Williamson — asks a more precise question: how do institutions emerge to solve coordination problems, and what happens when transaction costs and property rights are misaligned?

Both frameworks, it turns out, have a great deal to say about Kenya. None of it is entirely comfortable.

Framework One: Original Institutional Economics and the Habits of the State

Thorstein Veblen's great insight — one that remains underappreciated in mainstream policy circles — was that economic behaviour is not driven by rational calculation but by ingrained habits, cultural norms, and what he called "ceremonial" versus "instrumental" institutions. Ceremonial institutions serve status, ritual, and the preservation of existing power arrangements. Instrumental institutions serve actual productive function.

Applied to Kenya's fiscal architecture, this distinction is clarifying to the point of being uncomfortable.

Consider the SGR. Academic analysis published in 2025 concluded that the project was driven more by political interests than developmental needs, with the Kenyatta administration bypassing oversight institutions and keeping loan terms confidential — a non-disclosure agreement that prohibited sharing contract details without Chinese consent. ResearchGate A railway from Mombasa to Naivasha that terminates in a field. A project that the contractor who built it has been operating for eight years, at a cost of Sh1 billion per month in operating expenses, separate from the construction loan repayments.

From an OIE perspective, the SGR is the canonical case study: a ceremonial institution masquerading as an instrumental one. It produces political legitimacy, legacy, and the appearance of development. What it produces in actual economic return is a more contested question, as Chatham House's Fergus Kell observed recently when he noted the SGR's "consistent failure to generate revenue despite government intervention to mandate cargo traffic."

The OIE insight goes further. Veblen argued that habits are sticky — they don't change just because circumstances change. The habit of borrowing for politically visible projects rather than economically sound ones did not begin with the SGR, and it has not ended with it. The institutional culture that kept SGR loan terms confidential, bypassed parliamentary scrutiny, and prioritized a president's legacy over project viability is the same institutional culture that currently allows State House to exhaust its full-year recurrent budget in seven months without consequential accountability.

John R. Commons added a crucial dimension to OIE: the idea that economic activity is governed by "working rules" — the actual practices and precedents that govern behaviour, which often diverge significantly from the formal rules on paper. Kenya's formal rules say the Controller of Budget must approve expenditure overruns. The working rule, as evidenced repeatedly, is that Article 223 of the Constitution can be invoked retroactively to regularize spending that was never a genuine emergency. The formal rule says 30% of county budgets must go to development. The working reality in Nairobi County is 12.2%.

OIE's methodological prescription — case studies, historical analysis, attention to the actual patterns of behaviour rather than the theoretical models — is exactly what Kenya's policy debate needs more of. Less Tokyo comparison, more honest archaeology of why the same fiscal patterns reproduce themselves across different administrations, different party formations, and different economic conditions.

Framework Two: New Institutional Economics and the Transaction Cost of Everything

Where OIE asks why institutions behave as they do, NIE asks how institutions could be designed to produce better outcomes. This is the tradition of Douglass North's insight that institutions are "the rules of the game in a society" — and that economic performance, over the long run, is determined almost entirely by whether a country's institutional rules reward productive activity or predatory extraction.

Ronald Coase's foundational contribution was the observation that markets don't function without institutions — that every transaction has costs (information costs, enforcement costs, negotiation costs) and that the role of institutions is to reduce those costs to levels where productive exchange can occur. Oliver Williamson extended this to show how organizations and contracts evolve to manage uncertainty and prevent opportunistic behaviour.

Applying NIE to Kenya's five available exit pathways produces a rigorous, and occasionally sobering, assessment.

Pathway 1: Liability Management — The Art of the Swap

In October 2025, Kenya completed a landmark conversion of three dollar-denominated SGR loans into Chinese yuan. The restructuring is expected to reduce annual debt-servicing costs by around Sh27.8 billion ($215 million), cutting the interest rate from over 6% to approximately 3%. Sharp Daily This is the single largest interest saving Kenya has secured through debt management in recent years, and it deserves credit as a genuine fiscal achievement.

The NIE analysis, however, complicates the celebration. From a Coasian perspective, the question is: what are the transaction costs of this arrangement, and who bears them? The SGR had accumulated arrears of Sh413.4 billion by June 2025, partly because escrow account terms required Kenya Railways Corporation to maintain a Sh25 billion minimum balance — effectively locking out loan repayments despite continued SGR operations. Business Daily The currency conversion reduces the interest rate. It does not resolve the institutional design failure that allowed arrears to accumulate in the first place.

Douglass North would add a longer-run concern: path dependence. The yuan conversion makes Kenya more integrated into China's monetary ecosystem — it will need yuan reserves, Chinese banking relationships, and trade flows denominated in renminbi. As one Beijing-based analyst observed, African countries that pay or trade in renminbi become integrated into China's monetary ecosystem, needing RMB reserves and often hiring firms paid in RMB. Indonesia Finance Market Whether this new institutional dependency is better or worse than dollar dependency is a genuine analytical question, not a settled one.

From an OIE perspective, the ceremonial dimension is equally visible: the yuan conversion was announced during President Ruto's state visit to Beijing, with the geopolitical optics of a China pivot layered over what is, at its core, an interest rate negotiation. The IMF has already flagged that while the conversion reduces near-term costs, it introduces new currency risk exposure if Kenya cannot generate sufficient yuan revenues.

NIE Verdict: Useful short-term relief, high path-dependency risk. Swaps buy time but do not redesign the institutional incentives that created the debt.

Pathway 2: Asset Recycling and the National Infrastructure Fund

The NIE framework is arguably most illuminating when applied to the National Infrastructure Fund. The government's model — sell state assets, ring-fence proceeds, invest in new infrastructure without new borrowing — is institutionally elegant in theory. The sale of a 15% Safaricom stake to Vodacom Group for Sh204.3 billion, and the broader privatization pipeline, are meant to capitalize the fund.

Williamson's transaction cost economics asks the decisive question: what governance structures exist to prevent opportunistic behaviour? In plain language: what stops the proceeds from being redirected to recurrent expenditure? The Controller of Budget has already flagged that the NIF could bypass parliamentary scrutiny. The IMF has warned that innovative financing schemes must not circumvent oversight institutions.

Kenya's institutional history on this question is, to use the diplomatic framing, mixed. Previous privatizations have been characterized by opacity and allegations of political patronage. The absence of an NSE listing for the Safaricom stake — which would have allowed Kenyan retail investors to participate — is precisely the kind of institutional design choice that NIE would flag as increasing transaction costs for ordinary citizens while reducing accountability.

North's framework on institutions and economic performance suggests that the NIF's success depends entirely on whether Kenya can create credible commitment mechanisms — rules that bind future governments to using proceeds for their stated purpose, enforced by oversight institutions with genuine authority. Without this, asset recycling becomes, as the OIE tradition would predict, a ceremonial act: the appearance of fiscal discipline without its substance.

NIE Verdict: Potentially transformative, institutionally fragile. The gap between the model and the implementation depends on oversight institutions that Kenya is simultaneously struggling to strengthen.

Pathway 3: Expenditure Rationalization — The Performance Budgeting Puzzle

Kenya has been implementing Performance-Based Budgeting (PBB) reforms since 2012. A 2024 academic study of their effectiveness produced findings that perfectly illustrate the NIE prediction: PBB shows significant positive effects on budget performance in the short run — one to two quarters — but no statistically significant long-run relationship exists between PBB reforms and sustained budget performance. And crucially, PBB's effectiveness is constrained by rising debt burdens and depends on complementary reforms: participatory budgeting, medium-term expenditure frameworks, and transparency mechanisms.

This is precisely what North meant when he argued that "institutions are the rules of the game" — but rules only work when enforcement mechanisms exist and when the players face real consequences for breaking them. An end-to-end e-procurement system is an excellent institutional tool. It becomes a performative one when the officials responsible for procurement face no meaningful accountability for the outcomes it was designed to prevent.

The OIE tradition adds a further layer: the problem is not that Kenyan officials lack knowledge of better procurement processes. The problem is that the existing habits, working rules, and incentive structures — what Commons called the "going concern" of institutional life — reward the current behaviours. Until those underlying patterns shift, technical fixes operate at the surface while the deeper logic continues undisturbed.

NIE Verdict: Necessary but insufficient in isolation. Technical reforms require complementary institutional changes in enforcement, accountability, and political incentives to produce durable results.

Pathway 4: The IMF Programme — Credibility by Proxy

Kenya is negotiating a new IMF programme after the previous $3.12 billion arrangement expired in April 2025, with the IMF projecting Kenya's debt at 68.3% of GDP in 2025 — above the 55% sustainability threshold.

NIE provides the most analytically useful framing of what IMF programmes actually do. They are not primarily financing mechanisms. They are credibility-transfer mechanisms — the IMF's institutional reputation substituting temporarily for the domestic institutional credibility that Kenya has not yet fully built. When a government can say "the IMF made us do this," it can implement reforms that would be politically impossible under domestic framing alone. This is the "scapegoat mechanism" in action, and it is not cynical — it is how institutional change often actually happens.

The Controller of Budget's caution — "We should not take IMF programmes wholesale. We need to speak up" — is institutionally sophisticated advice. Front-loaded fiscal tightening, as the OIE tradition would predict, tends to fall hardest on the portions of the budget with the least political protection: development spending, social services, county transfers. The rigid recurrent costs — the wage bill, debt service, executive overheads — are institutionally entrenched and politically protected. Austerity that targets the wrong line items doesn't reduce the debt trap; it just makes it more expensive for ordinary Kenyans.

Kenya abandoned the ninth review of its previous IMF programme amid the 2024 protest disruptions — a reminder that institutional change imposed from outside, without adequate domestic ownership, faces the resistance that Commons described as inherent to any challenge to established working rules.

NIE Verdict: IMF programmes provide political cover, not solutions. Used intelligently — with Kenya negotiating the conditionalities rather than receiving them passively — they can enable reforms. Used as a substitute for domestic institutional change, they extend the problem.

Pathway 5: The Growth Imperative — But Whose Growth?

The ultimate exit from debt is growth. Kenya is projected to grow at 4.5–4.9% over 2025–27. Faster growth expands the tax base and reduces debt-to-GDP ratios without austerity, which is why every Treasury press release leads with GDP projections.

But this is where OIE's most fundamental contribution becomes indispensable. Thorstein Veblen's distinction between business and industry — between the financial claims on productive activity and the productive activity itself — maps almost perfectly onto Kenya's current situation. GDP growth is a measure of business in Veblen's sense: monetary transactions, financial flows, recorded economic activity. What Kenya needs is growth in industry: actual productive capacity, employment, manufacturing output, agricultural value addition.

These are not the same thing, and Kenya's recent growth trajectory illustrates the gap. GDP grew at 4.7% in 2024. Private sector credit contracted by 1.4%. Non-performing loans hit 17.2%. The economy is growing in the aggregate measure while the credit conditions for productive enterprise deteriorate. This is what happens when government borrowing absorbs 78% of available financing — the monetary aggregates move upward while the institutional foundations of productive enterprise erode beneath them.

NIE's Douglass North spent his later career arguing that the key variable in long-run economic performance is not policy — it is the quality of institutions that allow individuals and organizations to engage in productive specialization and exchange. Property rights, contract enforcement, and constraints on executive discretion are not abstract governance indicators. They are the preconditions for the private sector credit growth, entrepreneurial activity, and job creation that translate GDP growth into lived experience for ordinary Kenyans.

NIE Verdict: Growth is the only sustainable exit. But the growth that matters — productive, employment-generating, credit-accessible — requires institutional reforms that reduce the state's privileged claim on credit and strengthen the rules of the game for private actors.

The Synthesis: What Both Schools Tell Us

What OIE and NIE together reveal — their convergent diagnosis, despite different methodologies — is that Kenya's fiscal crisis is not primarily a technical problem. It is an institutional one.

OIE shows us the habits: the ceremonial preference for visible projects over functional ones, the working rules that allow executive overspend while development budgets languish, the cultural patterns that have reproduced themselves across Kenyatta and Ruto administrations alike. Habits, Veblen argued, change slowly and resist external pressure. The SGR was not an anomaly. It was an expression of a deeply embedded institutional logic.

NIE shows us the incentive structures: the transaction costs that reward lending to government over private enterprise, the absence of credible commitment mechanisms that would ring-fence NIF proceeds, the governance gaps that allow Article 223 to become a routine workaround rather than an emergency provision. North's framework predicts precisely what Kenya's budget data shows: when rules reward extraction over production, extraction is what you get.

The intersection of these frameworks points to a coherent reform agenda — not a technical checklist, but an institutional one:

Parliamentary oversight must have real enforcement power, not just the authority to ask questions after the money has been spent. The Controller of Budget's warnings are analytically excellent. Their impact on actual spending behaviour has been, to date, limited.

The single obligor exemption for government borrowing — the institutional rule that allows banks to shovel unlimited funds into Treasury securities while facing caps on private sector lending — is a transaction cost that falls entirely on the private sector. Reforming it, or at minimum subjecting it to regular review, would change the incentives that currently drive credit allocation away from productive enterprise.

Privatization and asset recycling must be conducted through transparent, publicly accountable processes that allow Kenyan citizens — not just Vodacom — to participate. The institutional design of who benefits from state asset sales is not a secondary consideration.

The IMF programme should be used as Commons described effective institutional reform: a set of "working rules" negotiated between parties, not imposed unilaterally. Kenya has more negotiating leverage than it typically exercises.

The Uncomfortable Conclusion

Kenya's debt crisis is not a story about bad luck, hostile global financial conditions, or the malevolence of external creditors — though all of these have played a role. It is a story about institutional design: the rules that have been built, the habits that have been normalized, and the incentives that continue to reward the behaviours producing the outcomes everyone agrees are unsustainable.

The OIE tradition would remind us that these patterns are not immutable. Institutions evolve. Habits change — slowly, through persistent pressure, through the accumulation of consequences that can no longer be deferred or borrowed against. The 2024 protests were, among other things, an institutional signal: that the working rules no longer had sufficient legitimacy to sustain the existing arrangements.

The NIE tradition would add that institutional change requires deliberate design — that better rules don't emerge spontaneously but must be constructed, with attention to enforcement mechanisms, accountability structures, and the transaction costs that determine whether formal rules translate into actual behavioural change.

Is Kenya doomed? The frameworks say no. But they also say that debt swaps, infrastructure funds, IMF programmes, and budget reforms are necessary conditions, not sufficient ones. The sufficient condition is something more fundamental: political will to redesign the institutional rules of the game in ways that genuinely constrain the state's claim on resources and genuinely expand the space for productive private activity.

The real wealth of Kenya is not in government securities. It is in the entrepreneur in Gikomba who cannot access a bank loan because the government offered a better return. It is in the road that was allocated Sh76 billion and spent Sh24 billion of it. It is in the institution that has not yet been built — the credible, enforceable, transparent oversight structure that turns borrowed money into lasting assets.

That institution is the one Kenya most urgently needs to construct. And unlike the SGR, its returns would be compounding, durable, and genuinely national.

This concludes The Great Debt Deception, a three-part series by The Daily Pulse on Kenya's fiscal crossroads.

Part 1 examined the borrowing paradox — why Kenya pays 17% when the IMF charges 3%, and how Sh4 billion a day is crowding out the private sector.

Part 2 followed the money — how consumption is eating Kenya's development budget, and what the collapse in development execution reveals about institutional priorities.

Part 3 asked what economics actually tells us about the way out — and found that the answer has always been less about policy than about institutions.

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