Can African countries skip manufacturing in the journey to achieve economic development?

Chiedza Juru and Boris Houenou

One of the debates among economic development experts is whether the African continent can skip manufacturing and move into the service industry to achieve economic development.

Africa is blessed with abundant land and other natural resources, yet the continent is still grappling with myriad of challenges such as of food security and lack of sufficient energy to power the continent to achieve its potential in manufacturing and by extension industrialization. Agricultural production remains subsistent, and the continent is still relying on food importation. With abundant technology and opportunities for economic leapfrogging, how can African countries achieve economic development?

As part of the series of lectures being organized by Harvard Kennedy School’s Africa Policy Journal (APJ), Africa Caucus, Harvard’s Africa Center and Business and Government, Dr. Hippolyte Fofack, the Chief Economist of the Cairo-based AfreximBank, was invited to speak at the first Africa Lecture Series for the 2022/23 academic session.

After the lecture, he spoke to Chiedza Juru, APJ’s Deputy Editor-in-Chief (Development Policy) and Boris Houenou, APJ’s Lead Development Policy Editor to answer some of these questions and more. Dr. Fofack told the APJ team that in the lead up to the COVID-19 pandemic, African countries imported food worth $49 billion. He suggested ways in which African countries can improve agricultural production, achieve its potential for industrialization and ensure food security. Enjoy:

Africa Policy Journal: In the age of the knowledge economy, should the continent industrialize or embrace the services sector?

Hippolyte Fofack: The trade-off between services and industrialization entered the African development debate a couple of years ago. It even gave birth to a new concept, ‘industries without smokestacks. That notion essentially argues that Africa will not follow the traditional three-step development path of initially a primary sector being dominated by a low-productivity agricultural industry, followed by a secondary sector dominated by industrialization and manufacturing-led growth, and finally a tertiary sector dominated by services. Instead, Africa, according to this concept, will skip the second step, with surplus labor moving directly from agriculture to services.

Across Africa, however, an interesting anomaly in that process of structural transformation has emerged: the rise of services has broadly coincided with the decline of manufacturing output, giving rise to what some might call ‘premature deindustrialization’. In practice, the rise of services has been driven by both entrepôt trade and informal trade. Workers in the ‘informal economy’ have played a large and, indeed, growing role in the distribution of imported manufactured goods across Africa. This has sustained the growth of the services sector, but at tremendous costs in terms of economic development, poverty, and macroeconomic instability.

Unlike other regions where structural transformation and a booming secondary sector have resulted in an increasing share of global trade, an expansion of the tax base, and a decline in poverty rates, Africa’s share of global trade has steadily decreased. Furthermore, it has become the continent with the largest concentration of poor citizens, with 66% of all people living in extreme poverty globally residing in sub-Saharan Africa, despite Africa accounting for just 17% of the world’s population overall.

Manufacturing is a major catalyst for economic transformation and productivity growth. It has accounted for over 35% of productivity growth in the US over the last few decades, sustaining long-run growth and enhancing integration into the global economy, where trade is driven in great part by manufactured goods with increasing technological content. A strong manufacturing sector has also been the most stable and reliable vector out of poverty in Europe and Asia, and it will play a similar, perhaps an even more important role in Africa because its poverty-reducing effects are more pronounced in low-income countries.

The good news is that African manufacturing is enjoying a revival in its fortunes. The long decline in manufacturing’s share of regional GDP—triggered by the World Bank and International Monetary Fund (IMF) structural adjustment programs—has bottomed out. Manufacturing output now stands at more than 12% of GDP, up from 10% a decade ago. Moreover, since 2000 manufacturing output has increased by more than 91% in real terms. The African Continental Free Trade Area (AfCFTA), which is set to fast-track the diversification of sources of growth and trade, will accelerate this trend. The expected boom in intra-African trade, which manufactured goods dominate, will accelerate structural transformation and lead to more sophisticated exports.

Africa Policy Journal: Overall, the trade openness of the continent has been widening but we have not seen much diversification in exports. How will AfCFTA, beyond intra-African trade volume, enable both diversified and complex goods and services exchange?

Hippolyte Fofack: Trade openness has been the law of the land. Most African countries have abided by the rules of the World Trade Organization (WTO), emerging as some of the globe’s most extroverted economies. For instance, members of CEMAC, the Central African regional economic bloc, still trade more with Europe than with one another. Trade with Europe accounted for more than 36% of the bloc’s total trade in 2021, while intra-bloc trade accounted for just 5.5%.

Yet the anticipated benefits of that openness have not materialized. Africa’s contribution to global trade has fallen by more than 47% since 1970. The region as a whole now accounts for less than 3% of global trade—that is lower than the Netherlands (3.5%), a country the size of Zambia. Primary commodities and natural resources still dominate Africa’s exports, accounting for more than 85% of the region’s total exports.

The AfCFTA will help change these circumstances by facilitating an increase in foreign direct investment and shifting the composition of those inflows more towards manufacturing which offers opportunities for capital accumulation and effective integration into the global economy. Beyond giving a spur to technology transfers and enhancing the linkages and spillover effects, the revival of manufacturing and development of competitive regional value chains will enable countries across Africa to better integrate into global value chains through value-adding backward activities as corporations take advantage of economies of scale to inject patient capital and expand industrial output.

Preliminary estimates are encouraging and point to an acceleration in the diversification of sources of growth and trade during the implementation of the continental trade integration reform. According to the World Bank, the AfCFTA will raise Africa’s exports by US$560bn, mostly in manufacturing. Intra-African trade, which is expected to see the biggest boost during the AfCFTA’s implementation, will drive the production of manufactured and complex goods, acting as a catalyst for industrialization. Intra-African trade and industrialization are mutually reinforcing because manufactured goods dominate trade within the region. By disproportionately stimulating manufacturing exports, the trade integration reform will gradually narrow Africa’s industrial output gap with the rest of the world and, in the process, accelerate global convergence.

Africa Policy Journal: The share of trade tax revenues of GDP has trended downward overall on the continent. Knowing that the largest share of trade tax revenues does not come from intra-African trade, is the fiscal adjustment overemphasized to the brink of getting us into the trap of preparation or a concern that requires formal mechanisms of compensation to trade shocks?

Hippolyte Fofack: One of the key concerns with the AfCFTA is that the sharp tariff reduction envisaged under the reform could lead to revenue losses and heighten macroeconomic management challenges in a region where fiscal deficits remain very high. In addition to exacerbating the fiscal incidence of sovereign debt, the tariff reduction could undermine the AfCFTA’s early-phase implementation by weakening the more vulnerable countries’ commitment to participating fully in trade under the trade reform.

The good news is that, except in a few cases, customs revenues in Africa are relatively low, averaging 2.5% of GDP and around 16% of total tax revenue. Furthermore, only a small proportion of such revenue depends on regional trade. This is because intra-African trade revenues are very low (contributing only around 15% of total African trade) or because of zero-rated imports within the various regional economic communities, which of course predate the AfCFTA in any case.

However, for countries that are leaders of intra-African trade and that source a large share of their imports from the continent and beyond their own regional economic community, the AfCFTA could result in large revenue losses. These include countries such as the Democratic Republic of Congo, Cote d’Ivoire, Cabo Verde, Liberia, and Zimbabwe, where revenue from customs and other duties expressed as a share of GDP largely exceeds the regional average.

For these countries, the African Export-Import Bank (Afreximbank), in collaboration with the AfCFTA Secretariat, is arranging an adjustment facility worth US$8bn to provide short-term financial incentives to governments and private sector operators in the most vulnerable countries. This facility will enable these economies to adjust in an orderly manner to sudden tariff revenue losses and broaden the support base to enhance the participation of the maximum number of countries and augment the growth opportunities associated with greater economies of scale.

Africa Policy Journal: Russia has halted participation in the Ukraine grain agreement. What does it mean for food security in Africa?

Hippolyte Fofack: The supply-chain bottlenecks triggered by the Covid-19 pandemic have been exacerbated by the Ukraine crisis, leading to further increases in commodity prices. The price of wheat reached a record-high of US$14.25 per bushel on 7 March on the Chicago international benchmark, almost double the price from end-December 2021. Fertilizer prices increased sharply as well following Russia’s invasion of Ukraine, with average prices for major components (including diammonium phosphate, triple superphosphate, urea, and potassium chloride) more than doubling in Q2 compared to same period in 2021. Overall, the WTO’s fertilizer price index increased by more than 100% between Q1 2021 and Q1 2022.

Although Russia and Ukraine account for less than 3% of world trade and about 1.7% of total African trade, that portion of Eastern Europe has been the world’s breadbasket in terms of wheat production and the supply of fertilizers. African countries that depend on these two countries for wheat and fertilizers have been particularly affected by the crisis. According to WTO estimates, Russia and Ukraine were the source of more than 70% of all wheat imported by African countries in 2021, at an estimated value of US$12.9bn.

Although prices declined following the negotiation of the Russia-Ukraine grain deal in July, some are concerned that Russia’s response to Ukraine’s attack on its Black Sea fleet in late October will disrupt supply chains again and lead to a new cycle of commodity price increases. However, a few days after Moscow’s response and following mediation by Turkey, Russia opted to continue participating in the deal after receiving written guarantees from Kyiv that the ‘safe passage’ corridor in the Black Sea would no longer be targeted militarily. The market welcomed the decision, with Chicago wheat futures falling by 6.7%, the most since March.

Nonetheless, heightening geopolitical tensions, which have become a major drag to global growth and trade, could metastasize into a permanent tail risk to international supply chains. To mitigate this risk a growing number of nations, including the US and countries in Europe, are advocating the return of industrial and import-substituting policies to increase domestic food production. For instance, the US government is actively promoting policies to “reshore” production of automobiles, semiconductors, and other manufactured goods to boost American output and expand manufacturing jobs.

Economies of scale and expected productivity gains associated with the AfCFTA offer Africa the opportunity to draw on its excess arable land to boost domestic production and reduce its vulnerability to external shocks, whether triggered by geopolitical considerations or business cycles. These shocks are set to become increasingly frequent during the new race for global hegemony between the US and China, which has turned trade, technology, and currencies into weapons to advance superpowers’ geopolitical interests. Food and other agricultural commodities could soon join their arsenals.

Several African countries are implementing policies to achieve self-sufficiency in food production. Egypt—which in 2021 accounted for more than 23% of Russia’s wheat exports and 17% of Ukraine’s—is one case in point. Its government has provided fiscal incentives, including raising procurement prices by 15%, to increase local production of wheat to meet at least 70% of domestic consumption. Preliminary estimates assessing the impact of these and similar policies in the region are encouraging, with forecasts showing that Africa is set to produce 30.5m metric tons of wheat in 2021-22, an increase of more than 18% from the same period across 2020-21.

Many countries were also affected by disruption in the fertilizer space—particularly Ghana, Cote d’Ivoire, and Mauritania, which purchased between 20%-50% of their fertilizer supply from Russia pre-crisis. As with wheat supplies, steps are being taken to expand domestic production. In Nigeria, for instance, the Dangote Group has raised its production of urea, a low-cost, nitrogen-based fertilizer. Morocco’s state-owned OCP Group is partnering with governments and financial institutions to build fertilizer plants across Africa. It plans to construct a US$2.4bn fertilizer facility that will employ Ethiopian natural gas next year. Afreximbank is also supporting these efforts.

The success of these import-substituting policies will have significant implications for the region beyond short-term crisis management. Besides strengthening the food security and national security nexus in a challenging geopolitical environment of recurrent crises, these policies will also close a major hole in most countries’ balance of payments, strengthening the foundation of macroeconomic stability and setting Africa on the path towards fiscal and debt sustainability.

Africa Policy Journal: Food security through more agriculture, more exports, or more inventories? What do you see as a long-term strategy for the continent?

Hippolyte Fofack: For decades Africa, which contains 60% of the world’s remaining arable land, has been a net importer of food. According to most recent estimates, the food import bill has become one of the largest items on the balance of payments of countries across Africa and is undermining their pursuit of macroeconomic stability and debt sustainability.

In the lead-up to the Covid-19 pandemic, the continent spent around US$49bn on food imports, according to 2019 estimates from the Brookings Institution. Amid surging food price inflation and the appreciation of the US dollar in recent months, the food import bill is even higher now, depleting hard-earned foreign exchange reserves and heightening the risk of debt crisis in the most vulnerable countries.

Simultaneously, the supply-chain disruption that emerged at the height of the Covid-19 pandemic and which the Ukraine crisis has exacerbated revealed the risks of excessive reliance on food imports for both food security and national security. There is no national security without food security—the region has learned that the hard way over the last two and a half years.

But in the light of projected population growth, agriculture and agribusiness, more than any other sectors across the region, are major growth industries with tremendous potential for job creation and structural transformation. The growth of agribusinesses will reduce post-harvest losses and sustain output growth in the agricultural sector, which is set to enjoy a boost in productivity, with increased domestic production of fertilizer reducing the gap in fertilizer usage with the rest of the world. While global fertilizer use averaged 137 kilograms per hectare in 2018, the average across Africa was less than 20 kilograms per hectare. Raising the yields of African farmers and boosting agricultural productivity should be central to the continent’s strategy for achieving self-sufficiency in food production and strengthening national security.

Africa Policy Journal: Afreximbank has rolled out the Pan-African Payment and Settlement System (PAPPS) to facilitate trade. How is it doing and what do you see as the way forward for fast, secure and cost-effective ways for payments across the continent?

Hippolyte Fofack: Over the years, one of the major constraints binding African trade and economic development has been access to international liquidity. The costs of liquidity constraints have been particularly high in the trade arena, given that more than 90% of African trade is invoiced in foreign currency, primarily the US dollar. The exodus of multinational financial institutions in the face of increasing costs of compliance and stringent regulatory environment over the last decade has further exacerbated these constraints, worsening Africa’s already-very-large trade financing gap. PAPSS—which is jointly supported by leading African institutions on the frontline of economic transformation, including Afreximbank, the AfCFTA Secretariat, African Union Commission, and African central banks—aims to alleviate these constraints by facilitating payments for cross-border trade in African currencies, thereby reducing the foreign currency content and overall costs of intraregional trade.

After the pilot phase, which involved members of the West African Economic and Monetary Union, PAPSS became operational earlier this year and has expanded its coverage to include countries in Eastern and Southern Africa. At the time of writing, 47 commercial banks have already joined the PAPSS network, and commercial transactions have been completed among eight banks, with that number expected to increase significantly in the coming months as the lower cost of trade associated with participating in the network broadens support across the region.

Advances in digitalization are enabling new financial technologies that have created improved conditions for financial inclusion—with the groundbreaking Kenyan-led M-Pesa being one of the most celebrated innovations—to be expanded to cross-border payments and settlement. These technologies are mitigating frictions in international payments and boosting cross-border trade in the digital era. The PAPSS, which the IMF has described as an important step in operationalizing the AfCFTA, will maximize the efficiency gains and cost reduction associated with financial innovation in Africa.

Africa Policy Journal: Do you see an African trade policy on the global stage? And when can we expect that?

Hippolyte Fofack: The fragmentation of Africa has been costly in the global trade arena, which has been dominated by the emergence of large trading blocs, such as the European Union, and powerful continental nation states such as China, the US, and India. In the challenging global environment of weakening multilateral trading arrangements, these behemoths have leveraged their political and economies of scale to project a comprehensive trade policy that has enabled them to systematically trounce smaller economies in bilateral trade negotiations. For African countries, which have been at the short end of the international trade negotiation stick, this imbalanced arrangement has confined their contribution to global trade to less than 3%.

The AfCFTA has the potential to reverse that trend and significantly boost both extra- and intra-African trade if African governments are able to speak with one voice and project a unified continental trade policy that strengthens their bargaining power in international trade negotiations. The rules of origin that underpin the AfCFTA, and which have been touted as an industrialization accelerator, could further enhance that process. By mitigating supply-side constraints to expand the growth of manufactured output and reclaim the African trading space, the AfCFTA will set the stage for a globally competitive continent that is ready to project a Pan-African trade policy that sustainably raises the region’s share of global trade for the benefit of all countries.

The AfCFTA provides the institutional framework for a united African trade policy. The expected diversification of sources of growth under the agreement will operationalize that policy, using Africa’s share of global trade as a benchmark for monitoring progress over time.

Africa Policy Journal: COP27 has just been concluded in Sharm El Sheikh. Africa is already paying the highest cost for climate change and clearly mitigation and adaptation strategies are poorly financed as shown by the failure of the recent Africa Adaptation Summit in Rotterdam. What is the path to energy transition in the context of energy poverty for Africa?

Hippolyte Fofack: COP27, which has been touted as the ‘Africa COP’, has been organized at a time when the continent—which has contributed the least to the global climate crisis, accounting for less than 4% of cumulative greenhouse gas emissions—is paying a terrible price.

Most African countries are on the frontline of this crisis, with households facing the quadruple burden of climate change, disease outbreaks, food insecurity, and conflicts. This is the case despite the fact that regional economic development, and therefore emissions, has been undermined by a chronic energy deficit. According to the International Energy Agency, more than 600m Africans (more than half the continent’s population) do not have access to electricity. The shortages are even worse in rural areas, where 70% of people lack access.

The disproportionate impact of climate change across the region is, in part, the consequence of energy poverty, which has long undermined the process of economic diversification that is required to broaden sources of growth and expand both economic opportunities and the tax base. While countries in the Global North—as well as a growing number of successful emerging market economies in the Global South—have polluted their way out of poverty as the biggest emitters of greenhouse gases, energy poverty has sustained high poverty rates across Africa.

The path to energy transition for the region is one that powers the transformation of African economies and puts countries on an irreversible path towards poverty reduction for global convergence. In order words, a just transition towards net zero will not be possible without a just energy transition. An intermediate path that relies on both fossil fuels and cleaner sources of energy in the short and medium term, while simultaneously fostering synchronized access to clean energy at the global level, is perhaps the most realistic path for Africa.