Klasen, A. 2015. Export promotion and private sector development in Africa. GREAT Insights Magazine, Volume 4, Issue 5. August/September 2015.
Export credit agencies play an important role in providing access to capital. Traditionally mostly supporting public African buyers, there is a growing number of transactions with private businesses. But to support private sector development, a comprehensive policy framework is crucial.
Africa is experiencing unprecedented economic growth, exceeding the global average in past years with the expectation to further accelerate. Thousands of African companies create jobs by developing the potential of many different sectors. It is African businesses that train and use local talent and a growing number of small and medium-sized enterprises (SMEs) in Africa act in a sustainable manner by considerably using natural resources. There is a fundamental change of Africans’ thinking in recent years: The future of economic growth, particularly in sub-Saharan Africa, is closely associated with the private sector. Governments outside and on the continent understand the crucial role of private companies in generating more business.
Entrepreneurship is a key driver for prosperity and economic growth. Increasing the market value of goods and services creates jobs, and balanced economic development diminishes poverty and boosts state revenues. While multinational companies are often global leaders only in selected industries, innovative small and medium-sized enterprises are an important success factor in both industrialised and developing economies. SMEs often represent the vast majority of businesses and produce substantial taxable turnover. Producing modern technologies such as renewable energies, electrical engineering or precision engineered components, SMEs are main drivers for successful economies. In many countries, innovative small and medium-sized companies engaged in the export economy have a higher growth rate or are even at the heart of the social market economy’s growth model.
In a globalised world, entrepreneur-ship is also driven by foreign trade activity. Opening up to trade impacts long-run growth through several channels, in particular, by affecting the return to capital accumulation, and through its effects on the incentive to innovate as well as the institutional framework. Models that analyse the interaction between international trade and economic growth show that a small open economy can sustain extensive periods of growth with capital accumulation only. What matters is the effect of trade on market size, competition and knowledge spillovers. In addition, trade liberalisation often goes hand in hand with the adoption of external commitments. Many countries have prospered by establishing competitive export industries, and GDP growth helped to generate economic resources needed to improve people’s living conditions such as access to healthcare, education and housing.
International trade is strongly connected with a well-developed and functioning financial environment. The dynamic growth of world trade over the past decades was only made possible by a rapid expansion in trade finance. The latter is crucial for trading partners in order to bridge the time lag between export order and payment for goods and services produced. Factors such as transaction volume and credit period can considerably increase costs of financing or even make it difficult to obtain funding at all. Disruptions in trade finance lead to a severe decline in companies’ output on a micro level as well as a contraction in trade on a macro level. Companies willing to export therefore often need credit insurance to access credit facilities and manage their receivables risk. This applies, in particular, for large transactions with longer maturities. Typically, risks arise from non-payment for political or commercial reasons. Political causes of loss can be the lack of hard currency in the buyer’s country or, for example, wars, civil unrest or a payment moratorium imposed by a government. Commercial risks include payment defaults by the customer or insolvency leading to temporarily uncollectible receivables or full write-offs.
Export transactions with risky markets can often only be realised on the basis of governmental support. Government export credit agencies (ECAs) are regarded as an insurer of last resort and only step into the breach when private insurers do not offer sufficient cover. They are official or quasi-official branches of their governments and as such form an integral part of national governments’ industry, trade promotion and foreign aid strategies. There is a causal link between export credits and merchandise. ECAs pursue their aims by providing export credit insurance facilities of privately financed transactions through direct lending or pure cover support. Collectively, ECAs account for the world’s largest source of government financing for private sector industries.
The ECAs’ impact is mainly associated with the promotion of national exports, and the general objective is to stimulate growth through foreign trade. The underlying export credit is usually commercially motivated and has no explicit objective of promoting economic development and welfare in host economies. However, by mitigating risks for investors and enabling production and large infrastructure or energy projects, these flows play an important role in providing access to capital in developing countries. Export credit agencies are therefore also meant to give importers in emerging markets access to finance in situations and on terms not available in private markets. A large portion of exports from industrialised to emerging and developing countries is insured. For example, in 2014 developing and emerging economies accounted for approximately 84% of all insured transactions in Germany.
Non-governmental organisations have mentioned potential adverse effects of export credit insurance on developing countries, for example due to negative environmental impacts and human rights infringements associated with commercial activities supported by ECAs. In answer to this criticism, multilateral organisations like the Organisation for Economic Co-operation and Development (OECD) and the Berne Union have been immensely beneficial. Agreements such as the ‘OECD Consensus’ and the ‘Common Approaches’ guarantee minimum standards for a sustainable application of officially supported export credits. Today, environmental, social and developmental impacts play an important role for the decision whether an export transaction is eligible. There are three major success factors of the OECD export credit work: Transparency, comprehensive rules and an ongoing evolution of the rules. These comprehensive rules include minimum advanced payments and maximum credit periods, also to ensure adequate financial debt for developing countries.
There are two examples for effectively combining private sector development and government support through export credit agencies. Traditionally supporting mostly public buyers in African economies, there now is a growing number of insured transactions with private buyers, in particular in sub-Saharan Africa. Exporters and importers benefit from export credit insurance as ECAs are able to relieve balance sheets by transferring risk, effectively open African markets and provide acceptable finance conditions for local companies. In many cases, African businesses are able to place orders only because of export credit insurance, as exporters from many different industries are able to manage potential bad debt losses. This again supports economic diversification, being at the heart of many African economies for decades.
ECAs are also important for private sector development because of another fundamental challenge for Africa: Energy supply and climate finance. African companies suffer from the lack of access to reliable electricity supply. They regularly experience power shortages and service interruptions resulting in lost sales or damaged equipment. On the other hand, Africa is becoming the ‘go-to destination’ for renewable energy solutions. The private sector occupies a substantial portion of the renewable energy finance space and ECAs (often together with international financial institutions) fill existing gaps. As part of the UN’s Energy for All (SE4All) initiative, several ECAs support renewable energy projects in Africa with specific reference to climate finance. This applies, for example, to the US or Danish export credit insurance programmes, but also for the multilateral African export credit agency ATI. Supported with a grant from the European Investment Bank, ATI enhances its underwriting capabilities for renewable energy transactions in order to boost private sector investment.
To further and successfully support private sector development in Africa by the use of export promotion instruments, a comprehensive policy framework is crucial. Different institutional setups for development support show different levels of resilience and effectiveness in coping with the economic conditions they are exposed to. However, there is strong evidence that managing the interplay of three fundamental building blocks – public policy, key and critical success factors as well as institutions, is the key to crafting sustainable and responsive economies. Together with my colleague Henning Meyer from the London School of Economics (LSE), I have labelled this approach to the development of such a supportive economic environment in a Global Policy special issue on economic policy, governance and institutions a ‘strategic econsystem’. The aim is to create a strategic fit, ensuring an effective alignment or specific objectives with internal and external factors influencing their chances of realisation.
In the context of this comprehensive policy framework for private sector development in Africa and officially supported export credits, this includes the following aspects: For highly industrialised countries, export plays a significant role in the national economy and innovative and integrated government financing instruments have to successfully support the competitiveness of national companies in the global economy. In addition, the objective of ECAs must be to give importers in developing countries access to finance. Using commercially motivated export credits insured by ECAs and governed by global standards ensures coherence between job impact and environmental as well as social protection. Financing and supporting foreign trade with private businesses in Africa occupies a pivotal role, impacting from new product development and job creation in developed countries through economic growth and human development in African countries.
About the author
Andreas Klasen is Professor of International Business at Offenburg University. As a Partner with ATRx, he also advises governments on trade policy and economic development.
This article was published in GREAT Insights Volume 4, Issue 5 (August/September 2015).