Economic Report on Africa 2015: Industrializing Through Trade

Africa Programme Meeting Summary Economic Report on Africa 2015: Industrializing Through Trade Speaker: Dr Abdalla Hamdok Deputy Executive Secretary and Chief Economist, UN Economic Commission for Africa Discussant: Professor Machiko Nissanke Department of Economics, School of Oriental and African Studies Chair: Dr Gita Honwana Welch Associate Fellow, Africa Programme, Chatham House 5 October 2015 The views expressed in this document are the sole responsibility of the speaker(s) and participants, and do not necessarily reflect the view of Chatham House, its staff, associates or Council. Chatham House is independent and owes no allegiance to any government or to any political body. It does not take institutional positions on policy issues. This document is issued on the understanding that if any extract is used, the author(s)/speaker(s) and Chatham House should be credited, preferably with the date of the publication or details of the event. Where this document refers to or reports statements made by speakers at an event, every effort has been made to provide a fair representation of their views and opinions. The published text of speeches and presentations may differ from delivery. 10 St James s Square, London SW1Y 4LE T +44 (0)20 7957 5700 F +44 (0)20 7957 5710 www.chathamhouse.org Patron: Her Majesty The Queen Chairman: Stuart Popham QC Director: Dr Robin Niblett Charity Registration Number: 208223

2 Economic Report on Africa 2015: Industrializing Through Trade Introduction On 5 October 2015 the Africa Programme at Chatham House hosted a meeting to assess trends, challenges and opportunities in Africa s economic and social development. Africa s economic growth has remained robust, despite the global economic downturn in commodity prices. However, the continent s social development lags behind, with high poverty and unemployment rates still prevalent. Although trade will continue to play an important role in the continent s growth, economies need to be diversified to address inequality. The event launched the 2015 UN Economic Commission for Africa (UNECA) report, Industrializing through Trade, which examines policies necessary for inclusive growth, productivity and structural transformation. The meeting was held on the record. The following summary is intended to serve as an aide-memoire for those who took part, and to provide a general summary of discussions for those who did not. For more information including recordings, transcripts, summaries, and further resources on this and other related topics visit www.chathamhouse.org/research/africa. Dr Abdalla Hamdok The central theme of Industrializing through Trade is the need for Africa to industrialize to sustain and cement its economic transformation. To understand this proposition, aspects of the global and regional context must be highlighted. There has been a shift in the balance of power, largely from West to East, but also including the rise of the global South and the shift from the G8 to G20. This change presents both challenges and opportunities, but a multipolar world provides a greater range of choices for African economies. Global demographics are also changing, with an ageing population in the global North contrasting with a youth bulge in Africa and the global South. These trends have coincided with increasing inequality, rising unemployment, regional conflict, terrorism and competition for resources. This last issue is particularly significant on the African continent, where outdated modes of business are all too common such as mining companies that work next to villages without running water. A report headed by Thabo Mbeki which revealed the annual loss of $450 billion from the continent through illicit financial flows, around 60 per cent of which was through the commercial activities of multinational mining companies, demonstrates Africa s need for companies to do business that adds value. There has been a move towards global public goods, as shown by the global health response to Ebola. The disease that might otherwise have spread across the continent was contained and overcome. Additionally, Africa is experiencing an information and communications technology (ICT) revolution. The continent should play a larger role in shaping the global fight against climate change, especially as African countries are often the first to suffer its detrimental effects in the form of droughts and famine. Despite the high cost, Africa should leapfrog other technological stages and immediately adopt green technologies. Finally, increased migration from Africa to the wealthier countries of the global North is a concern. Whether one agrees with the Africa Rising narrative or not, many countries have experienced significant rates of economic growth, sometimes reaching double digits. Ethiopia, for example, has had double-digit growth for a number of years. This has occurred for a number of reasons. A significant determinant has been improved macroeconomic policy, which has checked inflation and the public deficit. This has paralleled an improving business environment, high rates of urbanization and a growing middle class

3 Economic Report on Africa 2015: Industrializing Through Trade coming together to produce more dynamic economies. Another important factor has been the long and sustained peace prevailing in some regions, especially unprecedented stability in Southern and West Africa, although notable challenges remain such as the wars in Sudan and South Sudan. Improved governance and democracy has also contributed to growth. Comparing the continent with the situation 30 years ago, when 50 per cent of African countries were under military dictatorships, there is reason for optimism about the spread of electoral politics. Despite some reservations, governance is moving in the right direction to sustain economic development, especially with recent moves towards increased infrastructural spending. The commodity boom was an important factor in Africa s recent growth, despite the current downward shift in prices. However this positive picture of Africa s economic trajectory must also be nuanced by the serious challenges that still face the continent. Impressive growth has not resulted in job creation and has had little impact on poverty, instead becoming commensurate with rising inequality. In this context, two key questions will define Africa s economic future. First, how can Africa maintain its current rates of growth? Second, how can this growth be inclusive and poverty-reducing, and have a positive social and environmental impact? Industrialization is the essential answer to both questions. It is the element that could break the underdevelopment cycle as it creates direct and indirect employment, as well as forward and backward linkages with other sectors in the economy. Industrialization and trade facilitate each other, and so it is essential to understand how trade might encourage industrialization and structural transformation in Africa. This provoked three main questions for the 2015 report: When and how do trade policies benefit or harm prospects for industrialization? What are the prospects for Africa to industrialize by tapping into global value chains? What is the current state of national and regional trade policy, and how does it compare to African aspirations to industrialize? A positive sign in tackling these questions is the report s finding that African economies should continue to experience growth, perhaps up to 4 per cent, despite the global downturn. This growth should be converted into a structural transformation of African economies. Global value chains are an important feature of today s global trade, especially with regard to trade in intermediaries. The production of goods and services is no longer occurring in one place and in one direction, which complicates the economic situation for African countries. Currently, the African continent is on the lowest rung of the global value chain. Intermediate exports have increased, but they remain dominated by mining and other material resources. African exports as a whole have increased fourfold over the last 15 to 20 years, but consist largely of primary commodities. There is therefore an opportunity to move up the value chain. For example, Africa exports $500 million in raw cotton each year, but it also imports processed cotton to the value of $4 billion. Nigeria alone exports $5 billion in crude oil, only to import an equivalent amount of refined oil. For Africa to effectively tap into the global value chain, it must first rise up the regional value chain and foster training in appropriate skills. The expansion of financial services, design, logistics and other services sectors will also play a key role. Preferential schemes, such as the African Growth and Opportunity Act (AGOA) in the United States, have supported African trade while doing little for

4 Economic Report on Africa 2015: Industrializing Through Trade structural transformation. This is illustrated by the fact that 80 per cent of exports under this agreement are of oil, while the remainder are primary materials. Regional integration is a key factor to enable industrialization. The African Union s (AU) planned Continental Free Trade Area (CFTA) might prove a crucial step to transform commerce and move Africa up the value chain, as long as reforms are gradual and well sequenced. This will also allow Africa to keep abreast of the global trend towards mega-regional trade agreements. Despite its ambition, the CFTA could be negotiated by 2017. In the event of such a breakthrough African markets should be reopened progressively, only after regional economic integration has been achieved. After the establishment of a free trade area will be the most opportune time to implement economic trade agreements with other regions, such as the European Union (EU). The report makes several policy recommendations: Trade policy should be used to promote efficiency, protect nascent industries, avoid negative policy externalities and effectively engage all stakeholders to enhance industrial development. Trade agreements should be oriented towards the crucial task of industrialization. This should be underpinned by an Africa-wide negotiating template that helps coordinate and harmonize policy towards a continental free trade area. The development of regional value chains will be vital to moving up the global value chain. The CFTA can do this by removing tariffs on goods within Africa in a sequenced series of policy reforms. There is a need to design trade policy to move up the value chain. This would require serious political commitment, but the moment is right for this. If Africa achieves these goals, it will have the basis on which to become an industrialized continent, and to undergo a full economic transformation. Prof. Machiko Nissanke Since the turn of the century, growth has spread from resource-rich African countries to their continental neighbours. Africa includes many heterogeneous economies, but there are nevertheless continent-wide phenomena, including an ongoing surge in investment fuelled in part by foreign direct investment (FDI) from new partners in the global South. The acceleration of private capital growth and a burgeoning middle class in Africa has sparked a shift in investors perceptions of the continent, away from its image as being aid-dependent. Remittance growth has been very significant, with remittances now exceeding both FDI and foreign aid. The increase in investment in agriculture and infrastructure is particularly promising, as infrastructure has been a key bottleneck throughout Africa s economic history. While there are a number of positive trends, African economies are still fragile and vulnerable in many ways. Despite a 10 per cent reduction in poverty in the last decade, the decrease in poverty has been minimal over a longer timeline. The detrimental impacts of economic policies in the 1980s and 1990s have barely been balanced by recent growth. The continent remains one of the most inequitable regions in the world, with six of the 10 most unequal countries being in sub-saharan Africa. Notwithstanding the clear potential for a demographic dividend and the rise of a middle class, 80 per cent of Africans continue to live on less than $2 a day.

5 Economic Report on Africa 2015: Industrializing Through Trade There are few established avenues for transforming current growth into broad-based development. Compared with other developing regions, growth in Africa has not had a sufficient impact in addressing poverty, nor has it facilitated a transformation away from the dependence on primary commodity exports that leaves African economies especially vulnerable. The fall in commodity prices and the slackening of key global drivers of economic growth also have a negative impact. Both rural and urban poor have been absorbed into informal economic activity, which constitutes between 70 and 90 per cent of activity in African economies. There is also little spillover between sectors, no culture of learning by doing, and a restricted diffusion of knowledge. For African economies, structural transformation is more than just a shift between sectors. It must also be accompanied by a distribution of resources from low-productivity activities to high-productivity activities, both within and between sectors. So far, however, the movement of labour from rural to informal services on the urban fringe has actually coincided in a reduction of productivity, despite a notable structural transformation. Since the mid-2000s there has also been a shift away from agriculture, and it is questionable whether this has been a deep or shallow transformation, as there has been little in the way of economy-wide spillover and linkages. Rather than emphasizing structural transformation, there is a need to focus instead on raising productivity. Structural transformation can be a purposeful and concerted societal effort to create a very articulated economy where different sectors cross each other in a coordinated and dynamic manner. Diversification to encourage higher productivity is essential if structural transformation is to achieve inclusive growth from the beginning. Intra-African trade should be prioritized over deals with external stakeholders. Enhancing regional and continental integration will also raise effective demand as per-capita consumption goes up. Another important factor that will ease structural transformation will be whether countries capitalize on the demographic dividend as an important productive asset. Regional integration needs to take advantage of the dynamic effects of economic scales, and must enhance positive externalities through cross-border production clustering, dense production and supply networks, and consumption spillovers. In this way, higher productivity could spark a process of cumulative causation in which FDI will become market-seeking, rather than driven by resources or the low cost of labour. Such a change will encourage FDI that promotes the transfer of technology and knowledge to enhance the African skills base. This should be complemented by the negotiation of investor deals with transnational corporations for the benefit of all stakeholders, in order to allow coordination and information-sharing. In addition, this could stimulate the accumulation of financial and physical assets, knowledge and skills. It is also crucial for African countries to develop comparative advantages within the global economy. Trade policy will play an important role, but it is not the only component necessary for achieving this goal. Social, technological, agricultural and other sectorial polices will be equally essential, as will building productive human assets through health and education policies. A comparative advantage requires Africa s participation in technology-driven globalization, primarily through the use of green technology; however, integration into the global economy does not guarantee a productivity-enhancing transformation. Continued passive participation at the lowest rung in the global value chain does not in itself engender the structural transformation that Africa needs. Comparative advantage should not be based on impoverished wage labour and under-consumption. Instead, an expansion in domestic demand will allow for greater inter-sectoral articulation, and will liberate private capital for meaningful public - private partnerships.

6 Economic Report on Africa 2015: Industrializing Through Trade Strong institutional configuration is another important factor that is required to influence the quality of policy-making. The effective provision of public goods, commensurate with a broadened tax base and effective social contract, is central. Forging productive coalitions through fiscal dialogue, legitimacy and sustainability is essential to sustainable development, in order to allow states to negotiate better deals centred on domestic stakeholder interest, and to build a stakeholder-centred development process. Summary of Questions and Answers Questions Why have governments not yet facilitated trade agreements to open up investment opportunities? What lessons have been learned from the rush to industrialization in the 1960s and the subsequent deindustrialization under Structural Adjustment Programmes (SAPs)? What role do you envisage for government intervention in industrialization, and how might this fit with the World Trade Organization s strict and complicated rules on intervention? Abdalla Hamdok Encouraging governments to facilitate trade is an issue that stems from a wider problem of implementation across Africa. The AU has limited mechanisms to secure implementation, but the change from the Organization of African Unity to the AU signified a shift towards a more serious continent in this regard. This was equally evident in the creation of a tripartite free trade area, incorporating the Southern African Development Community (SADC), the East African Community (EAC) and the Common Market for Eastern and Southern Africa (COMESA), involving 26 nations and nearly half-a-billion people. The Economic Community of West African States (ECOWAS) has also done an exemplary job in stimulating regional movement of goods and services. Such processes are always gradual, but there is incremental movement in the right direction. There has been minimal understanding of what constituted good industrial policy in the 1960s, as demonstrated by the institutional requirement for consultation and the failure to address unvaried economies. A lost decade did follow the 1960s, and SAPs were crucial to deindustrialization. Many lessons were learned from this experience, yet it is still clear that states must lead the way in industrial policy, though not through central planning in the Soviet style. Historically in both the West and East, under capitalist modes of production, socialist economies and in Communist China, industrialization has been led by the government. In this systematic process, the government must play a role. It cannot be left to the invisible hand of the market alone. It is equally clear from previous experiences of democratic development projects that African countries must have a vision that transcends individuals and orientates society for this effort to succeed. Questions Can you comment on the failure to reach the target of $93 billion for investment in infrastructure, as well as on the Ethiopian experience in the last two decades? How can African development be made beneficial for other developing nations and the developed world, without the continent becoming a one-stop shop for resources?

7 Economic Report on Africa 2015: Industrializing Through Trade Which regions, and what type of intra-regional value chains, offer the most potential for industrialization? Abdalla Hamdok The challenges of infrastructure do pose a major obstacle to industrialization. Without improvements to road, rail and air networks, regional integration will remain wishful thinking. The New Partnership for Africa s Development s (NEPAD) recent privatization of infrastructure projects on the continent is a sign that Africa is trying to define its priorities in this area. The Ethiopian experience is an example of visionary commitment and is a step in the right direction. If the country continues on its positive trajectory, it may leave the rest of Africa behind. Countries such as Rwanda and Ethiopia may form models of home-grown development for the rest of the continent to follow. In the current global climate, with production dispersed across regions, there is ample opportunity for Africa to move up the value chain, though entry will be difficult as such a process remains under the control of multinational firms. But Africa still has much to offer in terms of investment. One infrastructure-related example is that of the Inga dam project in the Democratic Republic of the Congo (DRC). If this is constructed, then the DRC could export energy not just across Africa, but also to Europe. East Africa appears to be the most promising region with regard to regional value chains. For example, 60 per cent of trade between Kenya and Uganda is in manufactured goods. The EAC is the most integrated regional community, and is likely to see the complete removal of tariff barriers. Southern Africa, under the leadership of South Africa, is also seeing progress in the development of soft and hard infrastructure. Questions As stability and good governance are key to encouraging FDI, how can investment be balanced with the goal of reducing conflict across Africa? There is frequent discussion of growth in joblessness, but can you comment on lacking entrepreneurial skills? As capital-intensive modes of production increase, what impact does this have on the potential for manufacture in Africa? Abdalla Hamdok In theory FDI always goes to places with good governance and stability, but at the moment investors are ready to take risks. Money has been made in high-risk contexts such as Angola, the DRC and the Central African Republic. This type of FDI flow will always continue, but development-oriented FDI would be more desirable. The latter form requires rule of law, democracy, transparency and accountability, and Africa is seeing some advances in this. This is a result of lessons learned from the early experience of industrialization. At that time, many African countries did not address the skills mix, and entrepreneurial skills in particular were neglected. To counter this, there is a need for investment in research, development and education, though this should be context-specific to promote issues of development and innovation in skills that will attract investors.

8 Economic Report on Africa 2015: Industrializing Through Trade Although technology is being developed in an environment of labour shortage, Africa s unique context means that it will be affected by this differently to other regions. Current research on learning by doing suggests that although core activities are becoming capital-intensive, there are still forward and backward linkages that would create learning-by-doing environments in the context of an articulated economy. Africans themselves can become innovators by appropriating their own resources, so countries on the continent can be more than just passive players adapting rather than adopting. Machiko Nissanke There is no going back to previous industrial policies in Africa. Instead, there should be more open-door industrialization, with room for private counterparts who must play an active role in formulating policy so that governments cannot monopolize knowledge. This should be combined with a vision of the future that allows all stakeholders to work towards a shared goal.