Africa at a fork in the road: Taking off or disappointment once again?

Ernesto Zedillo

26 August 2015

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Not long ago, some called Africa’s growth performance the worst economic disaster of the 20th century. Indeed, by any measure, African countries’ economic record since around the time of the 1973 oil shock was dismal. The secular malaise of Africa’s economy started to abate around the mid-1990s, becoming a new trend of growth revival by the early years of the present century.

By some indicators, the consequences of this shift are quite impressive. Since 2000, Africa’s annual GDP per capita growth has averaged almost 2.5%, with sub-Saharan Africa averaging an even higher 3% and extreme poverty rates fell to 48.5% in 2010. Economic growth has fuelled meaningful progress in tackling a number of the continent’s other key social challenges. Since 2000, under-five and maternal mortality rates have dropped, life expectancy has improved, near universal primary school enrolment has been achieved, and literacy rates have risen faster than in the past.

So what triggered and further fuelled the shift in Africa’s performance? And — more importantly — is it sustainable or, alternatively, what is needed for Africa’s development to take off?

Reasons for Africa’s growth revival

The answer to the first question is clear – improved macroeconomic management, pro-private sector growth policies, population growth and urbanisation, opening up to foreign trade and investment, booming markets for natural resources, strengthened governance and rule of law, and a drastic reduction in conflict and political instability.

Some give special weight to political or geopolitical factors such as the end of the Cold War in explaining Africa’s awakening. At that time, Africa’s authoritarian regimes, feeling the pressure of liberalisation in Eastern Europe, started to ease their grip. More open and competitive political participation led to the emergence of more competent leaders and better policies that boosted macroeconomic management and took into account marginalised groups. Another cause was the rise of a new civil society applying pressure for better governance.

Two important features of Africa’s structural transformation and growth are more orderly rural-to-urban migration and improved agricultural productivity. Because of these trends, Africa’s ongoing transformation is more socially and economically inclusive than in the past.

External factors certainly played a favourable role in Africa’s good economic performance, the most important being the spike in commodity prices that also led to rises in foreign direct investment. Rising commodity prices were bound to relax growth constraints on resource-rich African countries, attracting international investment. The commodity boom that benefitted many African economies cannot be explained without Chinese demand, spurred by that country’s own economic boom.

How sustainable is the upturn in performance?

As reduced demand and lower commodity prices are followed, in all likelihood, by slower African growth, then most African nations will have only two options – either sink back into mediocre economic performance or embark upon more profound reforms to create other engines of economic growth.

Even with the rapid growth of the last 15 years, vast numbers remain unemployed in Africa. This will only get worse as growth slows considering millions of young people will enter the labour market each year. The continent also still confronts extremely high poverty rates. Sub-Saharan Africa is the only region where the number of poor people continues to rise despite GDP growth, and where inequality is still rising.

Persisting structural weaknesses will restrict capacity to grow and some of those weaknesses have become more acute over the recent period of fast growth. The clearest, and most worrisome structural weakness is the dualistic nature of most African economies with informal sectors outside the fiscal system.

In low-income African countries, the informal sector generates half of national output, 80% of total employment, and 90% of new jobs. This is a problem for countries’ economic growth potential, productivity, quality of employment, income distribution, and fiscal revenues.

Those in the informal sector are either self-employed or working in business units with very few people. When marginalisation from the legal system is combined with small size, the results are lack of legal identity, little or no capital, isolation from formal sources of credit and technology, and very limited markets, all resulting in very low productivity. In addition, there is evidence that, until 2005 at least, labour in African countries shifted from high- to low-productivity activities.

When job creation is mostly in the informal sector, the impact on GDP growth is much lower than it could be. It also means lower incomes and if these workers make up the majority of the labour force, this becomes a driver for worsening income inequality.

The fiscal implications are significant because the formal sector shoulders a disproportionate tax burden. It is not uncommon for Africa’s large formal enterprises to provide more than 95% of tax revenue, while the informal sector contributes less than 3%. Increasing taxes and fees on a dwindling formal sector lead some firms to either close or become informal, creating a vicious cycle.

Since formal enterprises are the only source of fiscal revenues in many African countries, they carry a burden that makes them uncompetitive internationally with relatively high wages and unit labour costs despite Africa’s low per capita income. After controlling for firm characteristics and country effects, African firms pay a wage premium of 50%.

In many African countries, trade policy exacerbates the problem. Large disparities in import tariffs and other trade restrictions give rise to massive smuggling, which relies on informal businesses and crowds out formal ones.

Other factors that may explain the duality include overvalued exchange rates raising the cost of wages, poor infrastructure causing high transport prices and an insufficient supply of electricity, barriers to competition that discourage the creation of new formal businesses, and insufficient and inefficient investment in human capital.

Governance

Africa has other structural weaknesses, but the one posing the greatest challenge may be the political one. Despite amazing strides towards democracy achieved across the continent since the 1990s, it is still somewhat fragile in many African countries. Powerful forces are at play that seek to reverse the political reforms that led to improved government policies and the recent economic boom. In many countries where term limits were adopted 20 or 25 years ago, those limits have been removed, or at least there is pressure to extend limits or abolish them completely, and political and civil liberties have weakened.

Overemphasis on the power of the ballot, without mechanisms to effectively distribute power to the people, is at the root of Africa’s recent political volatility. The value of multiparty democracy declines if it encourages corruption, inequality, and societal fragmentation without delivering clean and accountable governments. This concern about the fragility of Africa’s polity and governance should be taken seriously. Also pertinent are analyses showing improved democracy reduces the probability of growth reversals and cushions economies from reversals during economic instability.

Preserving and strengthening governance continues to be crucial for Africa, particularly regarding corruption. Any discussion of African development must include corruption, which continues to impede the rule of law, good governance, and state building. Any democratic reversal that reduces political alternation makes the pursuit of development more difficult.

Another aspect of governance that is crucial for the development of more than a few African countries is natural resource governance. Most resource-rich countries have substantial deficits in governance that result in poor resource management, causing not only their deviation from development purposes but also making the poor to be excluded from the benefits of that wealth. On present trends, the proportion of poor people living in resource-rich countries will increase to 50% by 2030 from 20% in 1990. Corruption is at the root of this trend, but corruption is itself the symptom of a broader institutional weakness and governance failure. This must be tackled and a good place to do so is in natural resource management.

It is worrying that a significant proportion of natural resources are misused in Africa, but this can be an opportunity for Africa’s future development as revenues from natural resources properly managed could reach $400 billion a year, by some estimates eight times development aid receipts. Better governance and management of those resources can lead to new economic activities, including downstream industries, resulting in higher GDP growth and generating better quality jobs on top of the fiscal revenues.

Agriculture

Africa is also home to 60% of the world’s uncultivated arable land, so agriculture has a huge potential role in sustaining Africa’s good overall performance of the last 15 years. Agriculture is also crucial considering around 70% of the poor are still rural.

Most African countries need to raise agricultural productivity significantly to achieve widely distributed economic gains. It will not be enough to increase yields per hectare, but rather, a multiplicity of other policy interventions are needed, including lowering transport costs, expanding credit in rural areas, and making reliable energy available to agricultural producers.

The goal must be to have sustainable and substantial productivity gains to have high economic growth rates, become more economically inclusive, create jobs for youth, and reduce poverty. The right strategy must focus on smallholder farmers, key geographies, staple crops and livestock, the adoption of key technologies and practices, and developing comprehensive regional food systems.

The entire agri-food system is important, not just supply of production. A holistic approach requires actions comprising natural resources, social networks, and diversity in genetic resources and farming techniques in addition to effective governance.

There are pitfalls in following rigidly general prescriptions when pursuing higher yields and productivity in the African agricultural sector. Successful interventions must take into account heterogeneity on the ground and should be tested before being widely applied. Large-scale programmes introduced from above and purely state-led are likely to fail.

Participating in global supply chains

While agriculture is crucial to keep African economies moving forward, a dynamic manufacturing sector is also a must.

Workers leaving the rural sector traditionally have moved into the informal sector, not the formal manufacturing sector. There are estimates that Africa’s working age population will increase by 70% over the next 15 years – therefore, it is crucial to advocate active policies to foster African industrialisation. While Latin America’s import-substitution model and Asia’s export-oriented one may no longer be options for Africa, this is not an insurmountable obstacle given the changes that have taken place in global production, trade, and division of labour.

It is important to note the view best articulated by Richard Baldwin (2013) on the development implications of an essential feature of contemporary globalisation – the economic feasibility of unbundling complex production processes. As computing and telecommunication capabilities became cheaper, production dispersion in internationalised supply chains has become cost effective and, in many cases, the only way to be competitive.

By assimilating off-shored links of the supply chain, developing countries can industrialise more rapidly without waiting to build the deep industrial base formerly required.  Nations can industrialise by joining a supply chain rather than building an entire industry, which gives Africa a real opportunity to industrialise despite being a latecomer. The new industrial model, by virtue of decomposing production into a multitude of tasks, offers Africa the potential also to develop a formal service economy linked to modern manufacturing.

For this opportunity to materialise, much more must first be done to improve Africa’s human capital. Despite the sizable resources spent on health and education, results are disappointing. There is a valid concern of whether human capital deficiencies are a chief obstacle for further development.

There is also the challenge of insufficient infrastructure. It is hard to see how African economies can move up the value chain without better infrastructure. African exporters pay some of the highest transport prices in the world. However, this will not be fixed just by building new infrastructure, but will require dismantling entry and other competition barriers and regulations. For African firms to have a serious chance, governments must also lower trade barriers and strive for African economic integration.

Conclusion

There are reasons to be both optimistic and troubled about Africa’s development prospects.

African economies have come a long way and although nobody dismisses the role of favourable external conditions, much credit is also due to domestic conditions and decisions of Africans themselves.

However, recent setbacks illustrate how uncertain the African take-off still is. Now with headwinds from a more difficult external environment, like declining commodity prices and slower growth in key trading partners, most countries will need to reinforce or even redesign a number of their strategies and policies to foster employment and productivity while reducing their economic duality. The challenge is not just to restore the basic macroeconomic fundamentals, but also to embark on a structural transformation that goes well beyond the efforts applied over the last 20 years.

The most significant transformation needed consists of strengthening, and in some cases building, practically from scratch, the institutions required for lasting development. On this, foreign aid could be used actively to promote such institution building. Among all the necessary institutional reforms, the most urgent and important are those pertaining to the rule of law. To make African growth inclusive, the playing field must be levelled and this requires a system that provides justice and security for all Africans. This ambitious but necessary step would lead to more accountable and responsible governments and would help further unleash Africa’s immense development potential.

References

Baldwin, R (2013), “Trade and Industrialization after Globalization’s Second Unbundling”, in R C Feenstra and A M Taylor, Globalization in an Age of Crisis: Multilateral Economic Cooperation in the Twenty-First Century, Cambridge, MA: NBER Books, National Bureau of Economic Research.

Zedillo, E, O Cattaneo, H Wheeler (eds.) (2015), Africa at a Fork in the Road: Taking Off or Disappointment Once Again?, New Haven, CT: Yale Center for the Study of Globalization.

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Topics:  Development

Tags:  Africa

Director of the Yale Center for the Study of Globalization, ex-President of Mexico

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