Bridging Africa’s Transformation Gap: Could Natural Resources do Good after all?

Last year’s edition of the African Economic Outlook (AEO) on Promoting Youth Employment showed that, despite steady growth, Africa’s capacity to offer economic and social opportunities to its younger generation has been falling short of its demographic dynamism: African economies today are facing no less than the formidable challenge of creating more and better jobs, not just by sustaining the pace of growth, but by making it more inclusive.

Africa’s structural transformation gap

Emerging economies, such as China, Brazil, India and others have been more successful than most African countries in that endeavour, achieving impressive reduction in poverty on a sustained basis for over two decades. How are they different from Africa? They have undergone a more rapid structural transformation, i.e. the process by which new, more productive activities are created and resources move from traditional activities to these newer ones. A higher proportion of labour thus moved from low to high productivity sectors. In Africa, evidence suggests that structural transformation is still at its formative stage in most countries and has not yet taken a deep root (McMillan and Rodrik, 2011). As a result, the pace of poverty reduction has not been commensurate with the relatively rapid growth attained in many countries.

Fresh evidence is casting light on the magnitude of the shortfall: the African Development Bank’s Research Department recently analysed changes in poverty for selected African countries, using successive household surveys in the 2000s: results -- to be published in the forthcoming AEO 2013 -- suggest that the bulk of the change in poverty was due to a rise in productivity -- per capita income or output per worker -- within each sector, while the movement of labour across sectors, a proxy for structural transformation, made negligible contributions. In fact, changes in employment across sectors were associated with a rise in poverty on average. 

The figure below goes one step further and sketches what poverty reduction would have been like, had labour moved from low productivity to the most productive sectors of the economy: the pace of poverty reduction would have been much faster under such positive structural transformation. 

Are natural resources to blame?

A lot of the growth achieved by Africa in the last decade originated from the same, primary sectors, such as agriculture, mining and energy: many African economies continue to depend heavily on exports of unprocessed raw material, with little additional value or employment created on African soil. The abundant literature on the ‘resource curse’ has conceptualised the vicious circle of bad governance and lack of economic diversification that seems to beset those economies.

How can African economies break that vicious circle? How can its economies break away from the resource curse and bridge the transformation gap? Should they prepare to seize the new opportunities open by rising labour costs in China, and adopt East-Asian types of manufacturing, export-led strategies, like Mauritius successfully did 30 years ago? Should they invest massively in the processing of raw materials extracted from African soil, so as to climb up the global value chains and retain a larger share of their own wealth? Or should they look into an alternative “Indian model” centred around services?

Africa is not Asia: natural resources –energy, minerals, and agriculture -- will undoubtedly remain the continent’s comparative advantage for the foreseeable future. Former DFID Chief Economist Adrian Wood’s diagnosis holds: “Although there are important lessons for Africa from the experience of East Asia, the sectoral and spatial structures of an increasingly prosperous Africa will be more like those of the Americas. Because it is land-abundant, as is America, Africa will always have a larger primary sector and a smaller manufacturing sector than the land-scarce regions of Asia and Europe” (Wood, 2002).

Yet most young African nations failed to build on those natural resources to accelerate their development in the decades following independence. The primary sector has often been seen as contributing little to economic development. Agriculture was branded as backwards or traditional and extractive industries as ‘enclave’ activities that offer few opportunities for employment and for the generation of important expertise for higher value added activities. Focusing on industrialisation was seen as the high path to development. Many African countries pursued policies aimed at fast industrialisation, defying their comparative advantage (see Lin’s New Structural Economics for an explanation of the concept) in natural resources. Often these policies were actively biased against the primary sector, especially against agriculture. The result has been a sub-par performance of the primary sector and little industrialisation to show for. The share of manufacturing value added products in Africa’s export has remained at the same level for the last 20 years. Agricultural productivity in Africa is lower than elsewhere: 24% of global agricultural land is in Africa, but only 9% of global agricultural production. As a consequence of rising commodity prices, Africa’s production of mining and petroleum products has increased over the last decade, but it remains the most underexplored continent. Expenditure on mining exploration activity in Africa has remained below US$ 5 per square kilometre relative to an average of US$ 65 per square metre in Canada, Australia and Latin America (Ncube, 2012).

What can we learn from the experience of African economies? The original desire to build a diversified economy that provides employment and protects the economy from the risks of overdependence on a single product was a good one. The mistake was to look at the primary sector as a single entity, standing in the way of diversification. Indeed, several developing countries have successfully grown by actively basing their strategy on their resource endowment. They have shown that the primary sector itself can be an important source of diversification. Chile used its proceeds from copper to invest into new agricultural commodities, such as salmon, a product that had not been part of the countries export products before. Malaysia invested its oil revenues into forestry and palm oil, building very successful industries. Indonesia used its oil rents to supply fertilizer to farmers and develop new crops, building the basis for the country’s green revolution.

Another mistake made was fixating on the enclave nature of extractive industries as a reason for their inability to generate technological advancement and inclusive growth. The key is to look beyond the core business of extraction, and consider all the “lateral” opportunities, such as supplying food for miners or engineering services. As lead resource firms increasingly concentrate on their core activities, they strive to outsource those other functions. In many cases, technology requirements for those inputs pose a lower threshold, so developing countries can more easily participate in this part of resource value chains.

The fact that every resource deposit has specific characteristics poses further opportunities for local value addition. This route has previously been taken by South Africa and Australia, both of which now have internationally competitive industry’s for mining supply (see One thing leads to another by Morris, Kaplinsky and Kaplan). More recently, Chile has successfully developed local know-how on adapting mining technology to local conditions, and Nigeria has also started to build up a supplier industry for its resource sectors. A range of low- to high-tech activities such as food supply chains or engineering and chemical analysis services for the setting up of mining operations offer opportunities to generate employment and build capabilities through learning-by-doing that can be the basis for expanding the economies production possibility frontier.

Furthermore, the pursuit of processing and beneficiation of raw materials has proven challenging in Africa and elsewhere for a number of reasons. First, the distance between the necessary technology and local know-how was often too large to generate meaningful learning opportunities for enough people to create new capabilities. Second, the search for value addition does not always make economic sense. Consider for example distance to markets: the higher the manufacturing value added of a product, the higher are transport costs and the more important is proximity to the customer. Chile decided against a copper processing industry because the additional transport costs for copper products like wire and sheets from Chile to consumer markets in Europe and the US would have been higher than the price difference between these products and simple copper concentrate. In fact, most of the recent increase in prices has accrued to miners, not processors. Refining charges accounted for 30% of the price of refined copper in the 1990s but are down to less than 10% today. Third, the raw material input, for example in the form of ore, is evidently essential, but only one of many inputs into the processed product. Energy is another one. In the USA aluminum smelting alone consumes 5% of total electricity production (Nature’s Building Blocks by John Emsley), which is equivalent to a third of Africa’s electricity production. In most of Africa, however, electricity is a scarce good. At about 28 megawatts the energy capacity required to refine 10,000 tons of copper, roughly 2% of Zambia’s annual production, for example, would be equivalent to two times Benin’s current electricity generating capacity (see World Bank Open Data for electricity data).

The good news is that having a large natural resource sector is not at odds with industrial capacity. Recent analysis of the determinants of comparative advantage by the OECD Development Centre – to be published in the forthcoming AEO 2013 — demonstrates the close link between a strong resource sector and strong manufacturing sector. Balassa defined a country’s revealed comparative advantage (RCA) as the number of products which the country exports relatively more of than these products’ share in world trade. Applying this concept separately to raw commodities and higher value added products we find that countries’ RCAs in both categories are closely related. Countries that have comparative advantages in a large range of raw commodities also tend to have comparative advantages in a wide range of higher value added products. Thus, instead of holding a country back, a strong primary sector is an important step towards a diversified economy that creates productive jobs. What’s been holding back Africa was not the large share of its primary sector per se, but the poor performance of this sector. Investing in the right conditions for agricultural productivity and mineral exploration and assuring the domestic economy build capabilities in the process will pay off.

This is where the double dividend of extractive industries comes to play. Beyond the creation of jobs and capabilities, arguably the greatest benefit offered by extractive industries in the short- to medium-term is revenue collection. Invested wisely, the proceedings from mining and petroleum production can be used to fund many of the crucial inputs for structural transformation such as education and health, as well as infrastructure and strong public services.

Charting an economic transformation agenda 

Instead of putting the primary sector aside, African countries should look at it for its strengths and the opportunities it offers to create a diversified economy. Can policy beat the odds? It can, but to be successful in promoting structural transformation, it must be done differently than in the past. The fact that the African Union and Economic Commission for Africa are dedicating their Sixth Joint Annual Meetings later this month to the theme Industrialization for an Emerging Africa is a strong signal: as sources of development finance continue to rise and diversify, and their policy space broadens --underpinned by sustained macroeconomic stability--, a growing number of African governments are exploring options for actively promoting the transformation of their economies; industrial policy and economic planning “2.0” are back on the agenda. The forthcoming African Economic Outlook 2013, out in May, aims to help policy makers get it right.

Abebe Shimeles is the Manager of the Development Research Division of the African Development Bank. Jan Rieländer and Henri-Bernard Solignac-Lecomte are respectively Economist and Head of Unit in the Africa Desk of the OECD Development Centre. Together with the UN Economic Commission for Africa and the UNDP, they publish jointly in the annual African Economic Outlook report.

This article was published in Great Insights Volume 2, Issue 2 (February-March 2013)