Friday, November 28, 2014

Africa’s Structural Transformation Challenge

PRINCETON – Long viewed as an economic basket case, Sub-Saharan Africa is experiencing its best growth performance since the immediate post-independence years. Natural-resource windfalls have helped, but the good news extends beyond resource-rich countries. Countries such as Ethiopia, Rwanda, and Uganda, among others, have grown at East Asian rates since the mid-1990’s. And Africa’s business and political leaders are teeming with optimism about the continent’s future.

The question is whether this performance can be sustained. So far, growth has been driven by a combination of external resources (aid, debt relief, or commodity windfalls) and the removal of some of the worst policy distortions of the past. Domestic productivity has been given a boost by an increase in demand for domestic goods and services (mostly the latter) and more efficient use of resources. The trouble is that it is not clear from whence future productivity gains will come.

The underlying problem is the weakness of these economies’ structural transformation. East Asian countries grew rapidly by replicating, in a much shorter time frame, what today’s advanced countries did following the Industrial Revolution. They turned their farmers into manufacturing workers, diversified their economies, and exported a range of increasingly sophisticated goods.

Little of this process is taking place in Africa. As researchers at the African Center for Economic Transformation in Accra, Ghana, put it, the continent is “growing rapidly, transforming slowly.”

In principle, the region’s potential for labor-intensive industrialization is great. A Chinese shoe manufacturer, for example, pays its Ethiopian workers one-tenth what it pays its workers back home. It can raise Ethiopian workers’ productivity to half or more of Chinese levels through in-house training. The savings in labor costs more than offset other incremental costs of doing business in an African environment, such as poor infrastructure and bureaucratic red tape.

But the aggregate numbers tell a worrying story. Fewer than 10% of African workers find jobs in manufacturing, and among those only a tiny fraction – as low as one-tenth – are employed in modern, formal firms with adequate technology. Distressingly, there has been very little improvement in this regard, despite high growth rates. In fact, Sub-Saharan Africa is less industrialized today than it was in the 1980’s. Private investment in modern industries, especially non-resource tradables, has not increased, and remains too low to sustain structural transformation.

As in all developing countries, farmers in Africa are flocking to the cities. And yet, as a recent study from the Groningen Growth and Development Center shows, rural migrants do not end up in modern manufacturing industries, as they did in East Asia, but in services such as retail trade and distribution. Though such services have higher productivity than much of agriculture, they are not technologically dynamic in Africa and have been falling behind the world frontier.

Consider Rwanda, a much-heralded success story where GDP has increased by a whopping 9.6% per year, on average, since 1995 (with per capita incomes rising at an annual rate of 5.2%). Xinshen Diao of the International Food Policy Research Institute has shown that this growth was led by non-tradable services, in particular construction, transport, and hotels and restaurants. The public sector dominates investment, and the bulk of public investment is financed by foreign grants. Foreign aid has caused the real exchange rate to appreciate, compounding the difficulties faced by manufacturing and other tradables.

None of this is to dismiss Rwanda’s progress in reducing poverty, which reflects reforms in health, education, and the general policy environment. Without question, these improvements have raised the country’s potential income. But improved governance and human capital do not necessarily translate into economic dynamism. What Rwanda and other African countries lack are the modern, tradable industries that can turn the potential into reality by acting as the domestic engine of productivity growth.

The African economic landscape’s dominant feature – an informal sector comprising microenterprises, household production, and unofficial activities – is absorbing the growing urban labor force and acting as a social safety net. But the evidence suggests that it cannot provide the missing productive dynamism. Studies show that very few microenterprises grow beyond informality, just as the bulk of successful established firms do not start out as small, informal enterprises.

Optimists say that the good news about African structural transformation has not yet shown up in macroeconomic data. They may well be right. But if they are wrong, Africa may confront some serious difficulties in the decades ahead.

Half of Sub-Saharan Africa’s population is under 25 years of age. According to the World Bank, each year an additional five million turn 15, “crossing the threshold from childhood to adulthood.” Given the slow pace of positive structural transformation, the Bank projects that over the next decade only one in four African youth will find regular employment as a salaried worker, and that only a small fraction of those will be in the formal sector of modern enterprises.

Two decades of economic expansion in Sub-Saharan Africa have raised a young population’s expectations of good jobs without greatly expanding the capacity to deliver them. These are the conditions that make social protest and political instability likely. Economic planning based on simple extrapolations of recent growth will exacerbate the discrepancy. Instead, African political leaders may have to manage expectations downward, while working to increase the rate of structural transformation and social inclusion.

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    1. CommentedPatrick Lietz

      Given that the Western economic system shows evermore growing signs of being on the verge of disintegration, due to extremely high oil prices, absent growth and rising debt burdens, the lack of industrialization may become Sub-Saharan Africa's greatest asset.

      The palpable desperation coming off in waves from Western central banks and financial institutions such as the IMF suggest that the next financial crisis is not too far around the corner. As Western governments have been saddled with so much debt in the last one, they are unlikely to be able to be the lender of last resort once more.

      Depending on the severity of the next financial disruptions, the issuance of letters of credit (LoC) for oil deliveries, as well as the financing of new oil drilling projects may become very challenging.

      The more the oil production and delivery is reduced, the more our whole mode of living comes unglued. It is no exaggeration to state that our whole society is built on the uninterrupted flow of oil.

      Sub-Saharan Africa is, with the exception of south Africa, much less dependent on oil, and much less integrated into the global interdependence of finance and commerce.

      Therefore, the more dramatic the following downturn is likely to become for the Western nations, with its concomitant effects on Asia, the comparably better sub-Saharan Africa will likely fare.

      Quite counter-intuitive, but highly likely.

    2. CommentedRad Economics

      This analysis is out of touch with environmental realities. You are ignoring the fact that industrialization, while providing a more materially wealthy life for many people, is also responsible for natural resource depletion, environmental destruction, and climate change. More industrialization means more energy use, higher rates of consumption of natural resources, more pollution, more waste. The economy does not exist separately from nature but as an embedded system within it. Please, stop ignoring the destructive elements of industrialization and acting as if there are no limits to what this one planet of ours can handle.

    3. Commentedsteve from virginia

      Economist don't understand how countries 'develop' and industrialize in the first place. It isn't resources, workforce or importation of factory equipment, rather it is some counties and not others possessing organic credit.

      England had organic credit in the 18th century: banks and customers, a central bank, a Treasury and its own currency. Kenya in the 19th century possessed fertile lands, ample labor and resources, sea ports, navigable rivers and an elite-intelligent manager class. It did not have its own source of credit and was required to borrow from the British as a consequence ... to use other countries' money. Kenyans became slaves to British and European creditors, unable to manage money-capital flows. in or out of their own country.

      Africa looks to be a slave to the Chinese now that they control so much forex and can use it as their own ...

      Can anyone else see anything wrong with this picture?

    4. Commentedtemesgen abate

      a sobering is high time to tamper the hoopla on recent growth rates in Africa .the euphoric cacophony is laced with sequestering undertones for any doubt .critical aspersions are becoming as politically incorrect .but my experiential take on the economy here in Ethiopia belies most of the recent hypes.