15 December 2017

Why Africa must shift from dependence to diversification, now

By Seedwell Hove, Senior Macroeconomist, QGRL | Articles

Sub-Saharan Africa (SSA) has experienced historically high economic growth rates and made some progress on social indicators in the last decade, driven largely by favorable commodity prices, financing conditions and improving macroeconomic management. However, high growth rates have not been sustained for long periods in many countries. The plunge in oil and other commodity prices and their adverse impact on many economies has revealed how dependent African countries are on natural resources.

About 28 SSA countries are resource rich, accounting for over 80% of Gross Domestic Product (GDP), according to the IMF. Many of them depend on a few commodities, which account for the bulk of GDP, exports and fiscal revenues. Many countries have often experienced recurring macroeconomic instabilities because of fluctuations in commodity prices, external demand and extreme weather conditions such as droughts and floods. For instance, the collapse of oil prices tipped the Nigerian economy into a five-quarter recession in 2016, from which it is just now emerging. Angola, Equatorial Guinea, Congo Republic and Gabon also experienced sharp economic slowdowns in 2015-2016 due to the plunge in oil prices. Zambia’s copper-dependent economy (the metal accounts for 60% of exports) was also hard hit by the slump in copper prices, while South Africa slid into a short recession following the decline in prices of key export commodities like platinum and iron ore. This experience underscores the need to diversify economies and build resilience against such large external shocks.

Growth accelerations in most African countries in the last few years have not been driven by expanding manufacturing sectors, which usually signifies structural transformation. In fact, the contribution of the manufacturing sector for SSA has decreased from 15% of GDP in 1981 to about 10% of GDP in 2016, according to World Bank data. Indeed, Africa’s structural transformation has lagged that of other regions.

Africa must diversify its economy to avoid the resource curse. If not managed well, natural resources can impede economic development rather than promote it, perpetrating poverty and inequality.

This can happen through “the Dutch Disease” effects, corruption, rent seeking behavior by political elites and civil conflicts. The Dutch Disease occurs when natural resource booms increase domestic income, appreciation of the real exchange rate and reduction of the competitiveness of other tradable sectors such as manufacturing, potentially leading to deindustrialization. The resource dependence syndrome is also associated with market instability, which raises uncertainty, and hurts investment; financing of recurrent expenditures at the expense of public investments, distortion of incentives to invest in robust and efficient institutions, and public services which support socio-economic development. Commodity prices – which collapsed by over 60% since 2014 – are likely to remain low for some time, highlighting the dawn of a new normal for commodity markets. Clearly, this requires structural adjustments for many commodity-exporting African economies. While adjustments can be painful, this is a window of opportunity for African countries to undertake reforms that embrace economic diversification.

Abundant natural resources can be exploited to increase the range of exports and goods a country produces, especially through beneficiation and value addition for example metal products, refined petroleum products, manufactured, beverage products etc. At the same time, natural resource rents can be leveraged to develop other sectors of the economy such as manufacturing, infrastructure, tourism and services, which can support the broadening of the economic base and sustainable economic growth. This way, jobs could be created for rapidly growing young populations, profit margins and return on investment could be improved, wider economic prosperity can be attained and poverty reduced. Leveraging finite natural resource endowments to develop other sectors of the economy is an opportunity for Africa to finance its own development and secure long-term sustainable growth.

Globalisation also presents a golden opportunity for African countries to integrate into the global economy and connect into global value chains. This allows them to expand their trade into new markets and diversify their markets as well.

As we have seen in the last two years, overdependence on a few markets such as China has exposed a number of African countries to the slowdown and changing structure of the Chinese economy.

Structural economic transformation can be a pathway to sustained, inclusive economic growth. A number of countries that started with similar conditions and resource endowments as most African countries have succeeded in structurally transforming and diversifying their economies, and have managed to sustain higher growth rates for longer periods. For instance, Malaysia, Indonesia and Chile have leveraged on their natural resources to diversify their economies, while Poland and Vietnam have succeeded by integrating into the world economy through global value chains. In these countries, the process of structural transformation has often entailed a shift from low-productivity to high-productivity sectors.

Although economic diversification remains elusive in most African countries, some countries are making commendable progress. For example, Mauritius has made some progress in transforming its economy from a sugar-dependent economy into a major financial services hub, with a vibrant export sector in tourism, textiles, clothing and jewellery. From 98% of exports in the 1970s, sugar now accounts for about 5% of exports in Mauritius. Botswana is striving to diversify its economy along the value chain by developing diamond cutting, polishing and marketing hubs. Kenya’s dynamic private sector is helping to lay a foundation for stronger growth in services, such as financial services, telecoms, and tourism. Rwanda’s efforts to diversify its economy are driven by significant reforms of its business environment and initiatives for economic and regional integration. It has managed to channel significant public resources into programs to boost growth, increase agricultural productivity, expand infrastructure investment, foster wider access to financial services and encourage higher-value economic activities. Indeed, these countries have managed to withstand the commodity price shock of 2014-2016 and maintained solid growth rates. Sectors such as agribusiness, light manufacturing, textiles, energy, tourism, financial services and other service sectors appear to present visible opportunities for diversification and structural transformation of African economies.

Economic diversification will be a game changer for Africa’s future. It will not happen overnight: it is a long-term process that builds on existing endowments, expansion of underlying capabilities and works best with long-term plans and policies. Policies to support diversification should focus on building enabling macroeconomic and business environments, sound institutional structures, human capital development, and conducive infrastructure. This will allow the private sector to expand their activities, exploit new opportunities, and enhance the needed shift from commodity dependence to active economic diversification. And the time to diversify is now!

By Seedwell Hove, Senior Macroeconomist, QGRL

Dr Hove is a Macro-economist with a wealth of experience in African Economies. His strong academic background includes a BSc and a MSc from the University of Zimbabwe, and a PhD in Economics from the University of Cape Town, South Africa, with focus on macroeconomics. Past experiences comprise roles at both the Zimbabwe Development Bank and the Reserve Bank of Zimbabwe. Before joining Quantum Global Research Lab, he was an Economist in the Macroeconomics and Fiscal Management Global Practice at the World Bank.


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