Author: G.C

Sonia Hoque  (Programme & Operations Manager, ODI)

24 August 2017

In the quest for faster industrialisation and economic transformation, governments in Sub-Saharan Africa (SSA) have established a number of special economic zones (SEZs) and industrial parks. At the ACET-ODI Light Manufacturing in Africa Chapter launch on 5 June 2017 (part of the Pan-African Coalition for Transformation, PACT), these zones were a hot topic. Given past stigma around the quality and attractiveness of these zones to foreign investors, participants from around SSA were keen to learn from each other, and in particular from Ethiopia. The ‘immediate success’ of Huajian Shoe Factory in Ethiopia’s Eastern Industrial Park and sustained high growth in foreign direct investment (up 46% to $3.2bn in 2016, despite a fall of 3% in total in Africa in the same year) has caught the attention of peers in the region.

It is easy to see why – when turning a corner in the developing city of Hawassa, the last thing an unknowing visitor would expect to see is a brand-new modern manufacturing fortress. Boasting over 400,000m² of factory floor space, and expected to generate 60,000 jobs and $1bn in exports by the end of 2018, the flagship Hawassa Industrial Park of the Ethiopian Industrial Parks Development Corporation (IPDC) is a shining example of how to do SEZs well. International investors are attracted to Ethiopia, keen to take advantage of its cheap labour costs and modern technological resources which are needed to produce low-cost, high-quality garments and textiles competitively for export. Hawassa Industrial Park, which was up-and-running in just nine months, offers important lessons on how to set up successful SEZs: namely that financial incentives alone are not enough to attract investors – coordination of various aspects on both practical and institutional levels, by a government committed to a broader vision of industrialisation and manufacturing growth, is key.

Getting the conditions right

Two years ago at the Investing in Africa Forum in Addis Ababa, Minister Arkebe Oqubay, Senior Advisor to the Prime Minister of Ethiopia, stated past SEZs in Africa were “missing the ‘basics’ such as power, water and one-stop services, and were not aligned with national development strategies.” Representatives from government and the private sector in African countries agreed on a number of conditions that need to be met to successfully attract investment, create productive jobs and generate positive spillovers into the local economy. These included a clear strategy integrated with national development goals, careful planning, and high-level leadership and coordination. In Ethiopia, the IPDC has visibly strived to meet these and is rewarded in Hawassa Park with full utilisation of its 52 factory sheds by 17 companies including investors from Hong Kong, China, India, Bangladesh, Indonesia, Spain and the USA. After beginning with 37 sheds, 15 additional sheds were built in response to high demand. Prospective new investors are carefully selected by the Ethiopian Investment Commission (EIC). The demonstration effect is undeniable too – the presence of PVH, a producer of iconic American luxury apparel, signals to other investors that this Park is capable of supporting high-quality light manufacturing.

Hawassa Industrial Park is made up of four main elements which are carefully planned and integrated with 50km of underground piping: factories, housing units for expats, a water treatment plant and a textile mill (currently the largest in Ethiopia) which will eventually supply 100% of the textile needs for the Park’s incumbent companies. The latter is a key aspect of the Government’s plans for vertical integration and will benefit the country’s textile industry overall.

Reliable energy supply continues to be a major challenge for African industrialisation – average downtime in African SEZs is reportedly 11 times higher than non-African ones. To meet energy demands, the Hawassa Industrial Park is currently served by a 19-MW mobile substation, but it will eventually be supplied directly to the Park via a dedicated 200-megawatt (MW) substation (in comparison to the power supply for the rest of the city which totals just 75-MW).

However, modern and advanced facilities are not enough to attract manufacturing companies to African SEZs. At the PACT launch event, Pan Li, COO of the Made in Africa initiative, stated that prospective manufacturing investors want clarity on policies, strong commitment from country governments, and dislike uncertainty. To this end, the EIC is solely responsible for selecting investors and drawing up a strategy for all industries in the Park, and works closely with the Prime Minister’s office, which shows commitment at the highest levels to investors considering Ethiopia as their next manufacturing location. “Investors are attracted by strong institutions in Ethiopia, rather than just financial incentives” stated the EIC’s Deputy Commissioner, Belachew Fikre at the PACT event.

It is also well-known that simpler processes for setting up operations are attractive to foreign investors. Mindful of this, Ethiopia has created a one-stop institutional service with the EIC supporting new companies with banking, visa and immigration facilities, import/export licenses, work permits, and customs clearance, all of which helps speed up decision making and can reduce set-up costs.

Location, location, location

At almost 300km south of Addis Ababa, the selection of Hawassa, a relatively remote city, for an industrial park may be surprising to some. An environmentally-concerned observer may be troubled by the potential for contaminating the adjacent Lake Awassa, but the eco-friendly Park operates a zero-liquid discharge facility and strict conservation principles. Rather, the main pull of the city was the availability of the final factor for production that manufacturers need – labour. With 5 million people living within a 50km radius of the city (mostly of working age), manufacturers setting up in the Park can draw on an abundant supply of labour, something that is often challenging outside of capitals in large, sparsely populated African countries. The Park will generate approximately 60,000 jobs in Phase 1 and approximately 80% of those employed in the Park are women, which is significant from a social development impact perspective.

Challenges remain for investors and factory managers

Perhaps unsurprisingly, under the impressive veneer of the Hawassa Industrial Park, teething problems exist. Foreign factory managers have faced on-going issues with power failures and complain of difficulties sourcing essential supplies locally, such as stationery, instead choosing to import them (potentially at a higher cost). The cost of transport to and from the Park is also high, with one factory manager claiming the cost of transporting goods from the port in Djibouti to Hawassa is twice that of shipping across the Indian Ocean. But perhaps most concerning are the reported labour issues: high absenteeism as workers (reportedly) take unreasonable advantage of labour regulations favouring employees (taking bereavement leave for very distant acquaintances, leave for national exams they are not really sitting etc.), high turnover as workers move to other factories once sufficiently skilled, and even issues with ‘work ethic’ of employees who are unfamiliar with formal working practice and etiquette (‘soft skills’). The biggest qualm seems to be the compulsory hiring process – whereby workers sourced through a government job centre in the catchment area are sent to work in factories, and managers have little or no choice in selection beyond filtering workers by the simple skills ‘grade’ assigned at the job centre. If unaddressed, this presents a real risk to the long-term success of Hawassa Industrial Park – cheap labour may be attractive to garment manufacturers, but workers must also be productive and adequately skilled. The commitment shown by the Ethiopian Government so far must continue to ensure the quality and supply of labour meets the new demand by foreign companies.

The fact remains however, that Ethiopia has demonstrated that coordination and the presence of a long-term vision are important ingredients for building high-quality SEZs quickly. These, in turn, can create high numbers of transformational jobs, whilst also generating crucial positive spillover effects to benefit the local economy. To this end, other governments in SSA could already learn much from the Ethiopian experience to date.

Sonia Hoque is the Programme & Operations Manager of the Supporting Economic Transformation programme at ODI.

On 5 June 2017, ODI and ACET convened a meeting on Light Manufacturing in Addis Ababa, Ethiopia. An event report can be viewed online.

Photo credit (all rights reserved): Hawassa Industrial Park, SET Programme, Overseas Development Institute ©

Linda Calabrese (Senior Research Officer, ODI)

30 June 2017

Manufacturing has finally taken a central place in the policy and economic debate in East Africa. This is an exciting change; not so long ago, industrialisation was largely ignored but it is now widely understood that the manufacturing sector is crucial in creating employment and spurring growth in the region.

The second East African Manufacturing Business Summit in Kigali brought together regional institutions, national governments and private sector bodies from East African Community (EAC) countries to discuss the future of East African manufacturing. The summit provided interesting insights on East Africans’ own views and ambitions for their manufacturing sectors, and how to achieve their goals. Here are four important issues to help East African manufacturing that were discussed at the summit, and my views on some of these.

1. East African manufacturing needs more than protection

Many in the private sector would like to protect the domestic industry through trade policy, especially in the form of high tariffs. As the EAC embarks on a revision of its tariff regime, the Common External Tariff (CET), many feel that the current tariff structure has not supported the industrialisation efforts. The upcoming review of the CET is, therefore, necessary, especially to correct those areas that penalise domestic producers. A case in point is the application of high tariff rates to those products that are used as inputs in domestic production, making the domestic industry uncompetitive. But it is very likely that East African producers will also demand higher tariffs, to protect them from international competition.

It is important that the tariff structure is appropriate. This can be achieved by ensuring that inputs are not taxed excessively; and that industries that have no chances to succeed will not be protected. However, the industrial sector cannot develop and become competitive by relying solely on high tariffs. This was reflected at the summit in the words of the EAC Director of Customs, Mr Kenneth Bagamuhunda, who warned that the East African manufacturing sector should not rely on customs tariffs and regulations to thrive. Instead, countries wishing to promote their manufacturing need to focus on the appropriate policy mix, and to build infrastructure, develop skills and provide proper support to investment.

2. Manufacturing needs to move from an inward orientation to an export focus

A striking feature of the East African manufacturing sector is that it seems to be very inward-focussed. East Africans seem to aim to produce only what they consume, with almost no focus on exports. Yet the East African market is limited in size and most people have limited purchasing power. To achieve economies of scale and make production viable, East African countries need to focus on exporting.

This lack of focus on export is even more surprising given the country models that the EAC seeks to imitate. Vietnam has pursued an export-oriented industrialisation and even China, with a domestic market of one billion individuals, relied on exports to develop. A similar story can be told of South Korea, and other late industrialisers.

In pursuing an export-oriented industrialisation, efforts to promote East African products (such as the ‘Made in Rwanda’ campaign) should focus on promoting products domestically as well as outside of the region. As Minister Kanimba of Rwanda pointed out, ‘Made in Rwanda’ is not about narrowly protecting Rwanda’s industry, it is about making it thrive in a competitive global environment.

Producing for the export market may be more difficult for the East African countries. International markets are tough, and there is competition with producers in more established regions like South East Asia. However, exporting remains the best way to achieve the right scale of production, and to procure the foreign exchange that East African countries need.

3. Ambitious plans require gradual implementation

The East African public and private sectors are very ambitious in their manufacturing goals – they would like to produce many things, and they want to do it now. This level of ambition is commendable and necessary to mobilise resources across the region. However, EAC countries also need to be realistic about what can be achieved, and how quickly.

Take one example: the automotive industry, a sector that East African countries are keen to develop. Some plants are already operating in the region, for example in Kenya, and companies have plans for further expansion; while the region also has some experience of assembling motorcycles. But not all East African countries can produce all types of cars at the same time.

At the summit, car manufacturing experts were clear that some organisation of the production process will naturally take place in the region, with the industry taking off earlier in some countries compared to others. Specialisation is also likely to take place, with different EAC countries assembling different types of vehicles, or producing different components. This model exists in other regions – for example, in Latin America, Brazil and Argentina trade cars, as each country is specialised in producing different models.

Sector experts highlighted the different stages in the production of goods too. At this stage, it is unrealistic for the East African manufacturing sector to enter the market through complex production, or host research and development operations. East African countries wishing to enter this sector typically start with simple assembly, and with time they may move up the value chain as they take on more complex production tasks.

4. Manufacturing investors need to tap new sources of finance

How to mobilise finance for investment in the manufacturing sector was central to discussions at the summit, that included some interesting points on involving the East African diaspora. Yet other important issues such as domestic lending and foreign direct investment (FDI) were barely mentioned.

Our recent study on Rwanda shows how banks are reluctant to lend to the manufacturing sectors, and conversely how FDI into the manufacturing sector is growing. The main question for Rwanda and the wider region is how to channel these funds into manufacturing activities that can promote economic transformation.

Other countries have shown that FDI can be a useful source of finance for industrialisation – again, Vietnam is a good example. Though the benefits from FDI are not a given, it is up to the recipient countries to set up terms and conditions in ways that benefit the domestic economy in terms of employment, exports, learning opportunities and linkages.

What is the future for manufacturing in East Africa?

It is important that East African countries are turning their attention towards industrialisation. However, some of the key elements are missing from the main discussion, or are not quite targeted in the right direction. To remain sustainable in economic terms, it is essential that East African industries become competitive at the international level.

This blog has been released alongside a study on financing manufacturing in Africa which can be found here.

Photo credit: UNIDO via Flickr

Linda Calabrese (Senior Research Officer, ODI) & Stephen Gelb (Principal Research Fellow – Team Leader, private sector development, ODI)

27 June 2017

Recently The New York Times published an article by Christopher Blattman (Columbia University) and Stefan Dercon (Oxford University and DFID) questioning the poverty-reduction effect of sweatshop work in developing countries. They carried out a randomised experiment, which ended in 2013, with almost 1,000 Ethiopian jobseekers, placing some in factory jobs in one of five factories, providing a second group with some entrepreneurship training and a modest grant, and leaving the rest to find an income however they could. One year down the line, two thirds of the first group had left their manufacturing jobs, while those who remained were working longer hours, earning less and facing more work-related health hazards compared with those in the second group.

Blattman and Dercon conclude that their study shows factory work is not an ‘escalator out of poverty’, saying ‘everything we believed [before the study] would turn out to be wrong’. They argue that the study has shaped their views of factory work: ‘In the short run, workers seem to share few of the benefits but a heavy burden of the risks’ from industry. This is hardly surprising for those who know the industrial sector in developing countries today (remember the Rana Plaza fire in Bangladesh 2013?) or indeed the history of manufacturing in now-industrialised countries (remember Dickens?).

Apart from the well-known methodological problems of Randomised Control Trials (RCTs), as experimental studies are known, we do not think that one study of 1,000 people and five factories in one country can or does tell us nearly enough about the costs and benefits of industrialisation as a development path. And as Blattman and Dercon themselves acknowledge, ‘we simply do not know of any alternative to industrialisation. The sooner that happens, the sooner the world will end extreme poverty.’ They suggest that the difficulties faced by the factory workers in their study resulted from deficiencies in the businesses – bad, or at least very inexperienced, managers – and the absence of policies providing social protection.

Blattman and Dercon’s findings are echoed in our recently published paper on foreign direct investment in Myanmar from China and elsewhere, which examined the clothing and shoe industries amongst others. Myanmar’s income per capita is around double that of Ethiopia. We did not do any experiments, but we conducted several dozen interviews of firm managers, local representatives of clothes buyers such as large European retailers, and NGOs working with management and workers to upgrade business performance.

The clothing industry has expanded rapidly since EU sanctions on imports from Myanmar were lifted in 2012, and further expansion is expected because US sanctions were lifted last September. The industry employs close to 200,000 workers in about 340 firms, of which about 180 are foreign-owned, though many that are officially locally owned have silent or hidden foreign partners.

One of the attractions of Myanmar for the garment industry is that wages are low while productivity is relatively high – not as high as in China, but above most African countries, according to the managers we spoke to. Managers complained to us that high worker turnover was one of their biggest challenges, along with unreliable electricity, bad roads and the difficulty of finding skilled workers. A study conducted on a sample of less than 200 firms showed that in one year, the average firm lost around 40% of its workers – with peaks of 57% in the garment sector.[1] Many workers live in slums outside the industrial areas, with no access to water or electricity.[2] Rural–urban migration flows push many rural dwellers into urban centres.[3]

There are factories with unpleasant working conditions for the predominately female and young workforce – very hot factories, often poor or no drinking water or sanitation facilities, long working hours. But the story is mixed – we also visited a Hong Kong-owned factory supplying garments to the UK and Europe, where workers enjoyed a good working environment including a canteen and on-site medical staff. Since it opened, this factory has experienced very low turnover.

Learning how to manage

Blattman and Dercon point out that their own intervention in the hiring process of the five factories they studied introduced a degree of organisation unknown to the managers. This again is unsurprising – new industries, new factories, so also new managers. In Myanmar, we found the same: foreign factories employ foreign managers almost exclusively, and domestic managerial skills are lacking. Interestingly, in one Asian-owned factory we visited, the managers and technicians were mostly from Madagascar and Mauritius, African countries that have developed successful garment industries and are now exporting their skills.

Scarce management capabilities are undoubtedly one of the major constraints facing development. We recommend in our report that Myanmar prioritise developing technical and managerial skills by setting up tertiary training institutes specifically for the garment industry, as was done in Bangladesh. Foreign managers provide a short-term solution, but in the long run Myanmar and Ethiopia need to develop their own talent pools.

The path to better wages and working conditions: pressure from below and from above

Myanmar also shows how the industrialisation path itself can lead to improved wages and working conditions, as political dynamics play out within the garment sector. On the one hand, the large workforce enables organisation and collective action, which presses governments to regulate labour markets better and raise standards. Trade unions were made legal in Myanmar in 2012,[4] and union pressure and workers’ strikes contributed to the introduction of a minimum wage in 2015.[5] At 3,600 kyat (less than $3/£2) per day, the minimum wage level is among the lowest in the region, which is significant for firms’ international competitiveness.[6] Before the introduction of the minimum wage, many – probably most – factories paid their workers much less, and the low wages forced them to work long hours to top up meagre incomes with overtime.[7]

Pressure from workers’ organisation – ‘below’ – is complemented by pressure from ‘above’. The garment sector globally is dominated by large retailers and clothing brands, and many of these buy clothes produced in Myanmar: H&M, Primark, Marks & Spencer and The Gap, for example.[8] In fact, we found that these large buying corporations are often significant in influencing existing suppliers in China or elsewhere in Asia to start up a production operation in Myanmar, so they are contributing to the country’s industrialisation. And the buyers are also very important in influencing supplier factories’ behaviour. The buyers face consumer (and NGO) pressure from their customers in rich countries, who do not want goods made by exploited, unsafe or insecure workers or produced by child labour. Retailers and brands demand in turn that their suppliers maintain good labour standards – and they have the power and influence to monitor and enforce such standards. For example, global retailers supported the introduction of the minimum wage.[9]

Little surprise, then, that a large systematic survey of garment firms (Tanaka, 2017) showed that employment and safety conditions, wages, union recognition, fire safety and health care were better in exporting firms (almost all with official or hidden foreign ownership) than in non-exporters.[10] Turnover rates were also lower in exporting factories, possibly because they offer better labour conditions.

Of course, not all firms are exporters, but exporters show the way by creating an upward pull that, together with worker demands, places pressure on non-exporters, at least those in the same industry. Eventually, as current circumstances in China illustrate, and as Blattman and Dercon acknowledge, these upward pressures force firms to adopt new strategies – to introduce new technology with improved productivity and higher incomes, or indeed to shift to lower-wage locations and start the cycle of improvement there.

Blattman and Dercon do not discuss the broader industrial and political context in which ‘their’ five factories operate in Ethiopia. But we would surmise that Ethiopia is at an even earlier stage on the path than Myanmar, so that some of the dynamics already strongly in play in Myanmar are only just emerging in Ethiopia.

Entrepreneurs out of necessity, or factory workers?

Of course, we recognise that this upward path is not inevitably followed, and neither is progress along it smooth and linear. There are setbacks for workers even in rich countries, as we see with the recent spread of the ‘gig economy’ and zero-hours contracts. And the industrialisation path excludes many people, at least from its direct benefits: the 200,000 employed in Myanmar garments is a large number but not nearly enough to absorb the 56% still working in agriculture[11] or the millions doing informal work in the cities.

Such ‘necessity entrepreneurship’ by people aiming to survive is – realistically – the only option for many, even most, people in developing countries, and will remain so for a long time yet. Blattman and Dercon found that the people in their study who were given a short business training and a small grant had a slightly higher average income at the end of the one-year study than those in the factories. This is positive, but is it enough for a ‘solution’, enough for either poverty reduction or sustained income growth? Industrialisation drives strong growth in incomes and productivity, and we would argue that these benefits are essential to lift informal incomes as well. The need for social protection systems that are adequate in both their levels and their coverage is crucial, as Blattman and Dercon insist. But, to reiterate their conclusion, the sooner industrialisation happens, the better for ending extreme poverty. It is not a choice: the response to the challenges of industrialisation is not to forego it but to do it faster and better.

This blog has been released alongside a briefing and longer study on foreign direct investment and economic transformation in Myanmar which can be found here.

Media coverage

Torino World Affairs Institute, 2 August

Myanmar Times, 9 August

Fibre2fashion, 10 August

Myanmar Times, 18 August

References:

[1] Bernhardt, T., Kanay De, S. and Thida, M.W. (2017) Myanmar labour issues from the perspective of enterprises: Findings from a survey of food processing and garment manufacturing enterprises, ILO, CESD, GIZ.
[2] Theuws, M. et al. (2017) The Myanmar Dilemma: Can the garment industry deliver decent jobs for workers in Myanmar? SOMO, ALR, LRDP.
[3] See, for example, Qualitative Social and Economic Monitoring (2016) A country on the move: domestic migration in two regions of Myanmar. World Bank Group.
[4] Zajak, S. (2017). ‘Trade union building in Myanmar’, Open Democracy, 17 February (https://www.opendemocracy.net/sabrina-zajak/trade-union-building-in-myanmar).
[5] Reuters (2015) ‘Myanmar sets $2.8 daily minimum wage in bid to boost investment’ (http://www.reuters.com/article/us-myanmar-economy-wages-idUSKCN0QY0A620150829).
[6] Bernhardt, T., Kanay De, S., Thida, M.W. and Min, A.M. (2016) ‘Myanmar’s new minimum wage: What’s next? Policy considerations for the way forward’. CESD Labor Market Reform Working Paper No. 1/2016.
[7] Bernhardt T., Kanay De, S. and Thida, M.W. (2017) Myanmar labour issues from the perspective of enterprises: Findings from a survey among food processing and garment manufacturing enterprises, ILO, CESD, GIZ.
[8] Oxfam (2015) ‘Made in Myanmar: Entrenched poverty or decent jobs for garment workers?’. Oxfam Briefing paper no. 209.
[9] Tudor, O. (2015) ‘Burma: Unions, global brands and NGOs back minimum wage for all’. Stronger Unions, 16 July (http://strongerunions.org/2015/07/16/burma-unions-global-brands-ngos-back-minimum-wage-for-all/).
[10] Tanaka, M. (2017) ‘Exporting Sweatshops? Evidence from Myanmar’ (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2938903).
[11] Raitzer et al. (2015) Myanmar’s Agriculture Sector: Unlocking the Potential for Inclusive Growth. ADB Economics Working Paper Series, No. 470.

Photo credit: NYU Stern BHR via Flickr

Phyllis Papadavid (Senior Research Fellow – Team Leader of International Macroeconomics, ODI) 

19 June 2017

Further US dollar weakness

The US dollar rose by 5% in trade-weighted terms following the US election of President Trump in November 2016.[1] Since its peak at the end of December 2016, the dollar has reversed all of its post-election rise (see Figure 1).

The continued erosion of expected growth-enhancing policy reforms means that many financial forecasters now expect the dollar to decline further.[2] This could negatively impact US growth while also dampen US dollar prospects – a financial environment exacerbated if President Trump, or members of his administration, continue to argue that the dollar is ‘too strong’.[3]

Implications for Africa’s growth prospects

Dollar weakness could have multiple impacts on economic transformation in sub-Saharan Africa (SSA). Some impacts are negative: for example, the value of dollar-denominated reserves held by SSA economies has declined; and SSA’s exports may become relatively more expensive as the dollar depreciates. However, dollar weakness also lowers the value of dollar-denominated debt, which would alleviate some fiscal constraints for highly indebted economies.

Importantly, US dollar weakness is emblematic of a fundamental shift in US growth expectations. This shift could be catalytic for growth and economic transformation in developing countries: if investors’ risk appetite stay resilient, external investment could flow to emerging and developing economies at a time of reduced willingness to hold dollar-denominated investments.

The Overseas Development Institute’s March 2017 Shockwatch Bulletin highlighted the multiple spillover effects already seen in SSA domestic economies, a result of the dollar’s 28% trade-weighted appreciation from 2011 to 2016. These included record SSA currency depreciations against the dollar (including in Ghana, Mozambique, Tanzania and Zambia) and investment outflows, particularly from economies with ‘twin’ deficits in their external current and fiscal accounts (such as in Mozambique and Ghana).

Pathways to catalyse economic transformation

Dollar weakness could catalyse and improve the prospects for economic transformation. First, SSA inflation could moderate and stabilise in certain economies if SSA exchange rates strengthen against the dollar. Lower inflation would also reduce the need for SSA policy rate rises, which could lower firms’ borrowing costs. Ultimately, lower inflation could result in reducing countries’ real effective exchange rates (REERs)[4] – a key measure for facilitating manufacturing export competitiveness in aid of successful economic transformation.

Second, with an uncertain US policy outlook, a reduced willingness to hold US assets could increase investments abroad, particularly in emerging and developing economies offering a higher return. This would benefit SSA economies that have streamlined and transparent investment processes (such as in Rwanda) or resource-related investment prospects targeted to manufacturing growth. Both financial and foreign direct investment inflows could alleviate financing constraints and help to support SSA countries’ economic transformation agendas.

Policy response matters

The impact of a weaker dollar, and potentially weaker US growth prospects, depends on governments’ responses.

In some SSA economies where competitiveness has been problematic – such as in Kenya and Rwanda – cost and price reductions would help facilitate a lower REER. This can be achieved in part through deregulation and ending price subsidies in certain sectors. Undervalued currencies, aided in part by central bank intervention, have typically helped growth.[5] In Ethiopia and Tanzania, there is evidence that a weaker REER boosts exports and diversification.[6] By contrast, currencies that are fixed, or managed at an unsustainable rate by central banks – such as in Nigeria – act as a tax on exports exacerbating progress on economic transformation and reducing countries’ foreign exchange reserves.

Equally, when it comes to inward investment into SSA, investment authorities and ministries of finance could play a greater role in channelling financial inflows to support manufacturing in SSA. Financial liberalisation could lead to lower lending rates for firms amid increased competition. It could also result in more favourable financing rates for SSA economies issuing government and corporate debt supporting strategic sectors in the economy to transform growth. Similarly, domestic incentives could be put in place too by investment authorities for foreign direct investment to flow to new industries. This enables diversification, which is particularly important in economies where growth has been largely linked with extractive industry rather than economic transformation.

[1] The broad dollar index is a weighted average of the foreign exchange values of the US dollar against the currencies of the US’s largest trading partners. See: https://www.federalreserve.gov/releases/h10/weights/default.htm.

[2] https://www.bloomberg.com/news/articles/2017-05-18/citigroup-says-it-s-time-to-sell-the-dollar-for-the-summer

[3] https://www.wsj.com/articles/trump-says-dollar-getting-too-strong-wont-label-china-currency-manipulator-1492024312

[4] We define the REER as the nominal effective exchange rate multiplied by the ratio of domestic to foreign prices. The nominal effective exchange rate is the country’s trade weighted exchange rate relative to its major trading partners.

[5]Habib, M.M., Mileva, E. and Stracca, L. (2016) ‘The real exchange rate and economic growth: Revisiting the case using external instruments’. Working Paper 1921. Frankfurt: European Central Bank.

[6] Wondemu, K. and Potts, D. (2016) ‘The impact of the real exchange rate changes on export performance in Tanzania and Ethiopia’. Working Paper 240. Tunis: African Development Bank.

First published on www.odi.org.

Phyllis Papadavid (Senior Research Fellow – Team Leader of International Macroeconomics, ODI) 

15 May 2017

Dirk Willem te Velde (Director of SET Programme, Head of IEDG and Principal Research Fellow, ODI)

24 April 2017 (based on a presentation at Chatham House 20 April 2017)

An examination of UK–Africa economic relations is timely. Africa’s needs (which vary from country to country) are changing, the UK’s international position is changing and the interaction between foreign powers (such as China, the US and Japan) and Africa is fast changing too. Further, the EU will publish an Africa strategy in early May in the run-up to the EU–Africa summit in November 2017, and the G20 has suggested a compact with Africa.

This note argues that the UK can offer an appropriate support package using smart aid, targeted development finance, free trade and foreign direct investment (FDI) promotion and temporary (legal) migration policies to help with economic transformation and job creation in Africa.

It is crucial to start by focusing on what Africa wants and needs:  

First and foremost, nearly all African countries want and need more and better jobs. In the past decade, job creation efforts have lagged behind working-age population growth by a third. In the coming decade, some 13 million new jobs need to be created each year in Sub-Saharan Africa to address the relatively large increase in the number of young people entering the labour market. With agriculture producing low-quality jobs (or, in the case of natural resources, very few jobs), industrialisation and quality services production is required to sustain job creation into the future. This is what many countries state they want. It is also part of the AU 2063 strategy.

The main challenge for most countries is lack of quality growth, job creation and economic transformation. Africa achieved relatively fast growth over 2000–2014, but, despite some good examples in East Africa (IMF forecast in 2017/18 for Ethiopia (7.5/7.5%), Tanzania (6.8/6.9%), Rwanda (6.1/6.8%), Kenya (5.3/5.8%) and Uganda (5.0/5.8%)), average African growth overall has slowed down considerably owing to commodity dependence in, for example, South Africa and Nigeria.

ODI’s SET programme, which includes current work in close to 10 African countries, examines the what, why, where next and how of economic transformation. It finds that there is little evidence of significant transformation, both within sectors and in terms of movements between sectors; that a general enabling environment needs to be complemented by targeted interventions (such as market-friendly industrial policy using Special Economic Zones) to make things move; and that political economy considerations are really important. Active coordination and leadership around industrialisation are often lacking, beyond public statements (with Ethiopia and Rwanda being exceptions).

How can the UK help?

African countries are in the driving seat, but a targeted UK approach consisting of four pillars can be helpful: (i) smart aid; (ii) targeted development finance; (iii) free trade and FDI promotion; and (iv) temporary migration.

Smart aid. UK bilateral aid to Africa was £2.8 billion in 2015, and a similar amount of UK aid is provided to Africa through other routes (total UK aid was £12.1 billion). The UK could provide politically smart and technically sound analytical capacity and bring together new actors. One example relates to targeted support for trade logistics across borders, along corridors and linked to production capacity (e.g. the sort of aid provided by TradeMark EastAfrica). Our research shows such aid is highly effective in terms of reducing trade costs, promoting exports and diversification. It ultimately pays for itself; it is mutually beneficial (e.g. through cheap imports). In other research we show that UK bilateral aid of £5.1 billion in 2014 led to £1.1 billion in 2014 and the creation of 12,000 jobs in the UK.

Targeted development finance. The portfolio of investments by European Development Finance Institutions (EDFIs) in Sub-Saharan Africa quadrupled between 2005 and 2014 and amounted to €9 billion in 2014. From near obscurity in 2000, the value of DFI investment (including EDFI and IFC) in the region has risen to the equivalent of 16% of FDI and 22% of aid in 2014. Recent announcements around the CDC will increase DFI exposure further. This is good news for Africa: our econometric research shows that, if the DFI/gross domestic product ratio increases by 1% (or by some €10 billion), per capita incomes increase by around a quarter of a percent. DFI finance can be used to fund targeted infrastructure and transformational investments. Increased transfers to DFIs (building up a portfolio) should not come at the cost of other valuable aid (a financial flow).

Free trade and FDI promotion. Annual average UK imports from Africa over 2013–2015 were at £12.8 billion. Annual UK exports to Africa were at £7.6 billion (less than 3% of total UK exports). The stock of UK FDI in Africa averaged £40 billion over 2012–2015 (3.7% of total UK OFDI); the rate of earnings in 2012–2015 was 10.9% (twice that in Europe, for example), although the commodity price slump has taken a toll. Post-Brexit, the UK should offer continued and better preferential access to Africa. New research shows UK–Africa preferences are worth £300 million in reduced duties (taking into account both ad valorem and other tariffs), with all preferences worth £1.6 billion in avoided duties (but this can have significant knock-on economic effects). The UK could go further by offering relaxed rules of origin (either raise the de minimis significantly above 15% or allow full cumulation for least developed countries (LDCs), many of which are based in Africa). It could seek a waiver for Africa wide cumulation, or simply allow full cumulation for all LDCs. This benefits UK consumers and it will not be very costly for UK producers anyway (100,000 garments workers in the UK, probably catering for the high end, compared with 1.7 million (5.7%) EU garment workers – rules can therefore be more liberal than in the EU). Further attention should go to making links between UK companies, especially those in finance, and African ones. Interesting partnerships have emerged, such as that between Standard Chartered and CDC to support fragile countries such as Sierra Leone.

Business travel cards. The UK can use mode 4 – services negotiations to offer two types of benefits: control of migration and use of labour where it is most effective. Such mode 4 agreements (e.g. an ACP business travel card) allow for temporary movement based on economic needs tests, which can be controlled and implemented by and with key stakeholders. (Managed) brain circulation is a win-win.

Photo credit: Russell Watkins / Department for International Development

Phyllis Papadavid (Senior Research Fellow – Team Leader of International Macroeconomics, ODI) 

20 April 2017

First published on www.odi.org.

Jun Hou (Senior Research Officer,ODI) 

01 March 2017

Rising wages for unskilled workers in China signals that low-cost manufacturing may start to lose its competitive limit. [1] Our own ongoing background work suggests that from 2009 to 2014, China’s real manufacturing wages increased by an annual average of 11.4%, even though this was in the aftermath of the worst financial crisis since the Second World War. Both foreign multinationals located in China and Chinese manufacturers that are engaged in labour-intensive production in China are therefore actively seeking to relocate to new low-cost destinations. Apart from generating substantial employment opportunities in these destinations, the presence of labour-intensive manufacturing is also expected to foster the inflow of technological and financial resources which will eventually help the host country’s industrial transformation and economic take-off.

To seize the manufacturing relocation opportunity, Ethiopia has taken a proactive approach in recent years, making tremendous effort to attract foreign investors across the world, especially from China, including in the manufacturing sector. For example, the former prime minister ‘head-hunted’ one of the largest Chinese Original Equipment Manufacturers (OEMs, manufacturers who resell another company’s product under their own name and branding) in shoe manufacturing industry, Huajian Group, whilst attending the Shenzhen Universiade in 2011. The company’s representatives travelled to Ethiopia in August of the same year and met with the former prime minister, and a formal investment plan was announced soon after. In less than half a year, production lines opened up for operation near Addis Ababa employing 600 people. Now, five years later, the Huajian International Ethiopia employs over 4200 locals in six production lines and produces nearly 7500 pairs of shoes per day for well-known brands, all of which are exported to European and US markets. [2] Generating USD3 million export value, and making up to more than 50% share of the shoe exporting in the Ethiopia, Huajian International has become the largest exporter in Ethiopia. [3]

Huajian’s success in writing the ‘Sino-Africa’ cooperation story is by no means an accidental opportunity. Transforming ‘Made in China’ to ‘Made in Africa’ requires multiple supporting factors, including the inputs supply and capability of the company, as well as the commitment from both investors and host government.

“Labour costs normally makes up 30% of the total cost in shoe manufacturing. As the second most populous country in Africa, Ethiopia has abundance of cheap labour force, approximately one tenth comparing to the cost of China. Meanwhile, the country is rich in high-quality leather, which provides us adequate supply of raw materials. In addition, economic development and social environment are relatively stable. Government is also committed to accommodate investment-friendly environment. These are the factors attracting us to come and settle down”, Mr. Zhang said.

Unlike other shoe manufacturing FDI, Huajian group puts great effort in training local staff. New workers without experience in manufacturing industries need to participate in a pre-work training programme, and regular on-the-job training sessions are provided to employees. In addition, the company also regularly selects a group of young Ethiopian university graduates (normally several hundred) and sends them to the headquarter in Southern China for training. Back in Ethiopia, some of them will also have the opportunity to take on managerial positions in the company. It is believed that such forms of on-the-job training are vital in removing culture barriers, conveying corporate culture, as well as upgrading local technological and managerial capabilities.

In response to the continuous rising land and labour costs in China, Huajian Group had already started its internationalisation activities back in 2004. The company’s first attempt was to take advantage of the low cost labour in Vietnam. However, it ended unsuccessfully. Due to the lack of skilled workforce and formal training, the quality of the shoes failed to meet the clients’ standards. In addition, the industry chain was incomplete at the time and domestic suppliers were absent. Many raw materials and components needed to be shipped from China, which took extra time and incurred additional transaction costs. “Inadequate ‘going out’ talent, lack of communication with host government, unfamiliar with the local laws and regulations, and several incidences of labour disputes led to our decision to withdraw the investment from Vietnam”, said Mr. Liu, the deputy general manager. [3]

Learning from past experiences, Huajian International Ethiopia has now become the largest shoemaker in Africa. It appears support from Chinese and the host country government, as well as financial institutions were indispensable for the company’s growth and success in a foreign land. [3] In 2015, Huajian Group received a 138-hectare plot from the local government to boost its investment in Ethiopia. Mr Zhang Huarong, the general director of Huajian group, soon announced the Lebu industrial zone plan in the South Western outskirts of Addis Ababa. The project will inject USD 2.2 billion, supported by CAD (China-Africa Development) fund, to develop the shoe manufacturing industry chain (infrastructure, fabrics, leather, chemical, carton manufacturing etc.) in the region, as well as to attract more Chinese investors to support the industrial cluster development across light manufacturing industries including garment, shoemaking, and electronics. [4] By its completion in 2020, the industrial park is expected to create about 50,000 local job opportunities.

Using industrial parks to bring international investors has become a popular strategy adopted by international donors (i.e. DFID) to help low-income countries move away from aid-dependency towards becoming modern middle-income trading nations. Priti Patel, the UK Secretary of State for International Development states ‘creating factories where international investors would create jobs was fundamentally in Britain’s interest and creating jobs is the best way to alleviate poverty’ [5]. With two operational industrial parks and another eight to come, Ethiopia is planning to achieve this goal within the next decade. [6]

China’s outward investment has expanded in an unprecedented speed during the past decades, which also brought nearly 100 Chinese overseas industrial parks across different continents. Yet, only few have been abloom and fruitful. Huajian international Ethiopia is often cited as one of the most well-known stories. [4] Following the ‘The belt, the road’ initiative, Huajian Group is now preparing their next overseas attempt to Bangladesh, another popular low-cost investment destination.

References:

[1]: McKinsey (2013) ‘A new era for manufacturing in China’http://www.mckinsey.com/business-functions/operations/our-insights/a-new-era-for-manufacturing-in-china
[2]: http://english.cntv.cn/2015/11/12/VIDE1447304531970203.shtml
[3]: http://ceis.xinhua08.com/a/20160418/1630334.shtml
[4]: http://www.atbclub.com/Article.aspx?id=8026
[5]: http://www.itv.com/news/2017-01-31/priti-patel-creating-jobs-is-the-best-way-to-alleviate-poverty-in-ethiopia/
[6]: http://www.investethiopia.gov.et/investment-opportunities/strategic-sectors/industry-zone-development

Photo credit: Huajian International Ethiopia, www.acfic.org.cn

Phyllis Papadavid (Senior Research Fellow – Team Leader of International Macroeconomics, ODI) 

27 February 2017

Economic transformation often denotes a move away from low-productivity to high-productivity growth. Promoting economic transformation in the aftermath of shocks is one strategy for developing economies to build resilience to further shocks. This is particularly true for resource dependent economies, given that they are more vulnerable to shocks. Many of these countries are still managing the fallout from multiple economic shocks, including the continued effects of the commodity price downturn. Fuel exporters saw GDP growth fall from 5.7% in 2014 to -1.6% in 2016 and these countries now face the risk of external debt distress.

Devaluation has long been considered a successful part of industrial policy. It has stimulated growth in both China and India, as well as in Uganda and Tanzania, making them more competitive economies in the long term. A competitive economy engaging in foreign trade can transform the structure of its domestic production. Knowledge transfer is an important element in this transformation. A more inward-looking economy with a large domestic market can hinder or delay this transformation because it can lead to an over-reliance on consumption at the expense of investment and exports.

The real effective exchange rate (REER) is an important metric for a country’s competitiveness. It can determine the degree to which a resource-dependent economy can use its resource rents to achieve transformation through growth in non-extractive sectors. Here, we look at the recent REER experience of Nigeria and compare it with that of Indonesia. Where Indonesia’s currency policy was an important precursor to its transformation, Nigeria has remained largely resource dependent.

Nigeria’s transformation deficit

Nigeria has a ‘transformation deficit’. Growth in its gross domestic product (GDP) per capita and the share of manufacturing have lagged owing, in part, to a low level of investment. At 9%, Nigeria’s share of manufacturing is well below China’s 30% and Indonesia’s 25%. Nigeria’s trade share of GDP has also declined over the past decade to roughly 20%. In comparison, Rwanda and Ethiopia’s almost 40% trade share has been steadily increasing. Additionally, Nigeria has an export basket that remains largely undiversified and continues to be dominated by crude oil and gas-related products.

Following its de-pegging in mid-2016, Nigeria’s naira nominal effective exchange rate is around 77% below its peak in October 2014. Intermittent US dollar selling by the Central Bank of Nigeria (CBN) has led to uncertainty over the timing and extent to which the CBN plans to let the naira fully float. This uncertainty is important. Currently, it is not affecting the ability to tap into markets because of the recent launch of $1 billion Eurobonds that was eight times oversubscribed. However, the continuing lack of clarity regarding Nigeria’s foreign exchange policy could trigger an unexpected reversal in inflows.

Exhibiting ‘Dutch disease’ type symptoms, Nigeria’s economy has been buoyed by oil-related inflows during the oil price boom. Subsequent naira strength has coincided with a stagnant non-oil sector, which has been at the expense of a largely undiversified manufacturing sector. Looking ahead, CBN naira support at the current rate is consistent with overvaluation, further evidence of which can be seen in the approximate 40% gap with the parallel market naira rate.

The naira’s overvaluation functions as a tax on exports and will limit prospects for Nigeria’s manufacturing capacity. This capacity continues to decline due to foreign exchange shortages. Overvaluation will continue to present a challenge to Nigeria’s economic transformation.

Lessons from Indonesia

As an oil producer, Indonesia has faced many of the same shocks as Nigeria. Between 1974 and 1978, amid higher oil prices, the Indonesian rupiah’s appreciation was as pronounced as the naira’s. However, during that period, using the windfall from higher oil prices, Indonesia actively diversified its economy. Following multiple devaluations from as early as the 1970s, rupiah management was aimed at limiting speculation, thus using the REER to support exports.

Indonesia’s foreign reserve position was stronger than Nigeria’s is currently, and such differences create clear points of divergence for Indonesia and Nigeria’s experiences. However, Indonesia’s experience remains relevant for Nigeria. Most importantly, the Indonesian experience shows that extra wealth can be used to invest in capital-intensive industrial projects. This includes agricultural development and manufacturing, with the latter attracting significant foreign direct investment (FDI). In Indonesia, this manufacturing FDI was followed by instrumental FDI into services, which would be a transformative outcome for Nigeria too.

With oil prices expected to recover moderately in the year ahead, Nigeria could pursue a similar policy. Combined with freely floating the naira, which would allow adjustment in its REER, it would aid diversification and export growth (rather than consumption-based growth). This, in turn, would increase Nigeria’s resilience to future shocks in a world where oil prices are unlikely to reach previous highs.

Photo credit: Arne Hoel/World Bank

First published on www.odi.org.

Gerrishon K. Ikiara (University of Nairobi, former- Permanent Secretary, Ministry of Transport, Kenya)

03 February 2017

Industrialisation of the Kenyan economy has remained an important goal for Kenyan policy-makers since independence and especially since the mid-1970s. This was when the country started facing more socioeconomic challenges, partly associated with a slowdown in the country’s economic performance following the global oil crisis. It has become clear over the years, however, that, for the country’s industrialisation process to experience a truly transformative phase, there is a need for a conducive institutional framework that encompasses the following areas: industrial policy-making; trade facilitation; clustering; investment promotion; building local capability; infrastructure modernisation; a more focused public–private sector dialogue and coordination; and building financing capability.

This discussion focuses on what is required in three key areas: 1) the provision and regulation of special economic zones (SEZs) and industrial clusters/hubs; 2) investment facilitation, with a focus on economic processing zones (EPZs) and KenInvest; and 3) supportive infrastructure planning.

Provision and regulation of special economic zones and industrial clusters/hubs

For more than two decades, Kenya’s industrialisation programme has attempted to support Kenya Industrial Estates (KIE) and Kenyan EPZs with facilities in various parts of the country. KIE was aimed at encouraging industrial enterprises and entrepreneurs across the country to participate more effectively, through state provision of essential facilities in government-built industrial estates. These mainly targeted small-scale enterprises, which were expected to grow gradually and graduate into domestically owned medium- and large-scale industrial enterprises.

To date, the KIE strategy has had limited success. A limited number of enterprises have grown into medium-sized entities that operate outside the KIE sheds. But the scheme has not had the expected impact of a major explosion of locally owned enterprises that play a highly significant role in the Kenyan economy in terms of employment and export earnings.

The more organised EPZ programme, managed under the government’s Kenya Export Processing Zones Authority (KEPZA), has also achieved only moderate success in terms of increasing the country’s exports of manufactured products and generating employment opportunities. This has been in part because the country has not been able over the years to attract a large number of foreign and domestic investors to the programme, unlike many countries in other parts of the world. One of the causes of Kenya’s low competitiveness in this area has been the existence of relatively militant trade unions pushing for higher wages and improved working conditions in the country’s EPZ structures, which has had the effect of making the country less attractive for most of the period to date.

In addition, policy restrictions on EPZ firms have reduced the attractiveness of Kenya’s EPZ programme to foreign investments. In particular, the requirement that EPZ firms not sell more than 20% of their products within the markets of the East African Community (EAC) has made it difficult for EPZ investors to take advantage of this market of about 130 million people.

One of the recent successes of Kenya’s EPZ programme has been its relatively effectively use of the Africa Growth and Opportunity Act (AGOA) to substantially increase Kenyan exports to the US. This has led the country to emerge as one of the leading AGOA-eligible countries in Africa with regard to exports of manufactured products to the US within the AGOA framework.

One lessons learnt is that advanced countries in Europe, North America and Asia could use properly targeted trade support programmes and policies to help push forward Africa’s industrialisation. The aim here would be to enable the continent to reduce its trade deficit with the rest of the world, diversify its economic structure and reduce its over-reliance on agricultural and other primary exports.

Special economic zones

The newly introduced SEZ programme in Kenya aims to sidestep the limitations of the EPZ programme in terms of incentives to investors. It is also expected to use the experiences of other countries, such as Singapore and China, which have used SEZ programmes effectively to implement their agenda of rapid industrialisation using private sector investments, public–private partnership programmes and government-to-government initiatives.

One of the highly innovative measures of Kenya’s SEZ programme is the government’s deliberate effort to identify priority areas through its Transformative Industrialisation Programme in order to bring in the focus needed to facilitate implementation of the programme. Many observers of Kenya’s industrialisation and economic development programme are largely supportive of the priorities identified, which currently include development of the leather, textiles and agro-processing industries.

The SEZ framework has introduced a number of incentives in the hope of attracting a high volume of diverse foreign direct investments as well as high-quality international, regional and domestic investment. This package of incentives is expected to provide a large dose of energy and resources into the country’s efforts to establish an industrial sector that will represent a visible transformative element in Kenya’s industrialisation and overall development agenda.

The package of incentives includes a concessional annual corporate tax of 10% for the initial 10 years of an investors operations, upped to 15% for the subsequent 10 years (Kenya’s current corporate tax is pegged at 30%). In addition to this concessional corporate tax rate, SEZ investors are allowed to import equipment and raw materials duty- and VAT-free, as well as to bring up to 20% of their overseas employees into the country where skilled personnel are not available domestically. To allow participation of local private sector investors, the programme extends the same incentives to those whose projects meet the minimum SEZ requirements in terms of size and scope. There are also ongoing discussions around allowing SEZ firms to sell a larger proportion of their products within the East African Community (EAC) markets than is allowed to EPZ investors.

Effective investment facilitation

While significant steps have been taken in the past 15 years to improve Kenya’s ranking on the ease of doing business index, the country still lies behind Mauritius and Rwanda, among many others, in this regard. There is a need to make the necessary adjustments to address this situation. One of the measures needed is to empower the institutions whose mandate it is to facilitate foreign investment and to provide essential aftercare, in terms of sorting out teething problems and improving investor confidence in interactions with key relevant government institutions to help deal with issues that could cause delay in the implementation of the SEZ or EPZ programmes. A number of countries, such as Ethiopia, Rwanda and Uganda, have handled such issues by placing facilitating institutions such as investment authorities under the office of the president or other power ministries or institutions. This gives such institutions more influence and clout and reduces the delays and bureaucracies that often frustrate providers of the foreign direct investment needed in various industrialisation programmes.

Supportive infrastructure planning

During former-President Moi’s 24-year regime that covered the period 1978–2002, Kenya’s key infrastructural facilities, including energy, roads, railways and ports and airports, were largely neglected. This had heavy consequences in terms of reduced competitiveness for Kenyan products in global markets and stunted many parts of the country in terms of attracting investment, given their inadequate and disruptive power supply and other related shortcomings.

This situation has changed radically since 2003, with infrastructural development emerging as a leading budgetary item, often second only to education. Former-President Mwai Kibaki, Kenya’s third president, is credited with leading the country’s focus towards infrastructure as the gateway to its transformation. Another innovation Mwai Kibaki brought about was the introduction of performance contracting in the country’s public sector. Since 2005, Kenya’s public sector officials at all levels have been expected to sign a negotiated contract indicating targets to be achieved in each government institution and by senior officials. These contracts are evaluated and announced in public each year.

By means of collaboration with new development partners such as China and Japan, Kenya has embarked on ambitious infrastructural development programmes that have been or are in the process of being undertaken. Such programmes are especially evident in road infrastructure, covering most of Kenya’s counties; port modernisation and expansion, with Mombasa Port elevated to fifth position in Africa in a recent global ranking of container ports[1]; railway transport, in the form of the Chinese Exim Bank-supported Standard Gauge Railway line from Mombasa to Malaba (whose first phase Mombasa–Nairobi is expected to be operational by mid-2017); airport expansion and modernisation; irrigation schemes; an information and communication technology-facilitated national security system; and energy expansion.

The impact of the country’s massive infrastructural development programme is already visible in terms of the inflow of foreign direct investment into many sectors of the Kenyan economy, such as energy exploration and production, real estate, wholesale and retail trade facilities, tourism and hospitality, agriculture and others. Investment in Mombasa Port and the Northern Corridor transport network has reduced the time it takes to transport a container from Mombasa Port to Kampala in Uganda from 22 days to five or six, lowering the regional cost of exporting and importing significantly. The past three years have also seen the country emerge from a deficit in energy supply to a surplus, which is expected to stabilise the electric power supply system and enable the country to support more industries in the coming years.

[1] Container Management magazine (2016) Global Ranking of the World’s Top Container Ports.

Photo credit: USAID/Riccardo Gangale

Dr. Neil McCulloch (Director, McCulloch Consulting Ltd.) @neilmcculloch64

15 November 2016

‘I am giving preference to those who are “Made in Nigeria,”’ announced the moderator at the Nigerian Economic Summit, which took place from 10 to 12 October in Abuja. His bias, echoing the theme of the summit, perfectly encapsulated Nigeria’s response to its current economic malaise… and the muddled economic thinking that is making it hard for the country to emerge from its current economic crisis.

As Africa’s largest economy, and with its largest population, of 170 million people, Nigeria should dominate the continent. But the country has long been one of the world’s prime examples of the resource curse: 60 years after discovering oil Nigeria still relies on it for over 90% of export revenue, and the government depends on it for 62% of its revenues. Overreliance on oil has caused Dutch Disease – overvaluation of the currency – which has made exports expensive and imports cheap, stifling diversification into other sectors. The collapse of the oil price has left a gaping hole in government finances, with a budget deficit of N3.5 trillion in 2015 (3.7% of GDP), while the drying-up of foreign exchange from oil has left a ballooning current account deficit.

Of course, the president and the government are facing other major challenges too: the military campaign in the north-east of the country against Boko Haram is absorbing significant resources and revealing an immense humanitarian crisis, with millions of people displaced and livelihoods destroyed. And a resurgence of militant activity in the Delta has blown up oil and gas pipelines, crippling revenues and power supplies. But the government’s response to the economic challenges it is facing has been slow and incoherent. President Buhari, who was inaugurated in May 2015, spent several months appointing a cabinet and many months more before taking action to address the collapsing currency and slowing growth. The delays in key decisions, as well as the strongly adverse external environment, have resulted in a dramatic shift from 6.3% growth in 2014 to a deep recession today, with rising inflation and widespread unemployment.

Faced with such a crisis, the Nigerian Economic Summit Group (NESG) – the country’s largest association of large private sector players that hosted the Summit – has been urging the government to use low oil prices as an opportunity to finally diversify the economy. And the government is trying. The economic team, led by the vice-president, spent two days at the Summit along with various ministers explaining the myriad initiatives that are being planned: investment in infrastructure, a new secretariat to ease doing business, a new set of Intervention Funds established within newly capitalised development banks and much more.

The audience of MDs and CEOs from Nigeria’s largest firms across all sectors were polite but clearly frustrated. Top among their concerns is the difficulty involved in obtaining foreign exchange. The president’s response to dwindling foreign reserves was to attempt to save forex by banning access to foreign exchange from the Central Bank for 41 items. The result was the decline, not only of the sectors affected but also of activities that relied on the outputs of those sectors. Indeed, the government’s exchange rate policy has been focused on doing all it can to avoid a slide in the currency – pushing against the one change most likely to stem the outflow of foreign exchange. As Doyin Salami, Professor at Lagos Business School, said, ‘A strong currency subsidises the middle class at the expense of everyone else.’

Yet the business community is also pushing in opposing directions. While a handful of speakers called for Nigeria to focus on becoming globally competitive, the Summit’s theme of ‘Made in Nigeria’ concentrated less on encouraging exports and more on discouraging the purchase of foreign goods. One of the final recommendations from the NESG at the end of the Summit was that the government require its departments to buy Nigerian – regardless of cost or quality. The language of self-sufficiency has returned; as President Buhari himself stated, ‘We should produce most of the things that we use.’ The idea is that Nigeria needs to import only what it does not produce, and so boosting production for domestic consumption can save foreign exchange.

Yet a shift inwards is the opposite of what Nigeria needs, as SET’s recent report shows. Devoting resources to high-cost production for domestic needs draws resources away from building globally competitive export businesses. It focuses energy on older, less productive and less diversified activities. When these activities struggle, the pressure for protection will grow, either through tariffs or, worse, through bans and quantitative restrictions that earn hefty rents for the institutions that administer them.

What Nigeria needs is to do the opposite. Not to stem the demand for foreign exchange but to stimulate the supply by welcoming investment from all over the world. But few foreign investors without privileged access to the echelons of power would invest in Nigeria today. With crumbling infrastructure, unreliable power, insecurity and endemic corruption, it is not surprising that Nigeria languishes at no. 169 on the World Bank’s Doing Business ranking. More than anything else, Nigeria needs a signal from the top – that foreign capital is welcome, that monopolised sectors will be liberalised, that the government is serious about slashing the thicket of rent-seeking regulations that, in the words of one businesswoman, makes every government department a ‘one more stop shop’.

Sadly, none of this is likely. In part, this is because it directly contradicts the interests of the political elite, whose machinery these rents oil. But, unusually for Nigeria, that is not the main problem today, as President Buhari’s key strength has been his courage in tackling corruption. Rather, the failure lies in a mindset that is against the idea that openness to the rest of the world would also benefit Nigeria and help it achieve the structural change that it seeks.

Can the business community help change this mindset? Perhaps. The NESG represents a national, cross-sectoral and non-partisan voice of the private sector. Its Policy Commissions – covering every sector of the economy – engage in dialogue with the government throughout the year in an attempt to fashion policies that will promote diversification and growth. It represents a relatively transparent and evidence-driven mechanism through which the government and the private sector can jointly search for effective solutions. Unfortunately, it is not clear whether this is the form of state–business relations that drives policy at the highest level, or whether Nigeria’s long tradition of non-transparent deals between politically connected actors will ultimately determine the future direction of structural change.

Photo credit: Flickr/Jeremy Weate

David Primack (Executive Director, ILEAP*) @DavidPrimack

11 November 2016

Despite improvements in the collection of services trade data over the past 15 years, in many low-income and least- developed countries (LICs) the macro- and micro- level services data needed for meaningful economic analysis simply do not exist. This acts as a fundamental roadblock to having informed services trade negotiations and to using services trade policy to leverage services for inclusive growth and structural transformation.

The relative paucity of services and services trade data has contributed to obscuring the role that services have increasingly been playing, alongside agriculture and manufacturing, in the process of structural transformation. While emerging research such as ODI’s Supporting Economic Transformation initiative and WIDER’s Industries Without Smokestacks project is helping to advance a more analytically rigorous understanding of the interactions different service sectors have in the transformation process, such efforts continue to be hampered by a number of services-specific data limitations.

Unlike trade in goods, where a single document provides an internationally recognised product code and an indication of the country of origin and destination, as well as a transaction value, collecting service trade statistics is a highly subjective undertaking, prone to inaccuracies and a general dearth of availability. This is particularly the case for LICs, though the challenges prevail in other developing and even developed countries. These challenges are directly related to the nature of services trade and the absence of a physical item (and/or sometimes a payment) crossing a border where national authorities can track, count and record it.

 Deficiencies in the measurement and availability of services trade data were flagged by negotiators during the WTO’s Uruguay Round GATS negotiations and continue to hinder services negotiations the world over (e.g. Lipsey, 2006; Magdeleine and Maurer, 2008; WTO, 2010). However significant improvements in services trade data collection have been achieved since 1994. This includes the UN Statistical Commission’s publication of the Manual on Statistics of International Trade in Services (MSITS) (in 2002, revised in 2010), which provides guidelines and recommendations for best practice on how to use and develop sources to measure international trade in services. Four international sources now provide services trade data: the UN Services Database (UNSD); the WTO/UN Conference on Trade and Development (UNCTAD)/International Trade Centre (ITC) Services Database (WTOSD); the OECD Trade in Services by Partner Database (TISP); and the World Bank Trade in Services Database (WBTSD).

 While these improvements have enabled better analysis, including in LICs, they have yet to fundamentally address a number of core deficiencies that impede more informed services trade negotiations and policy-making.

 The first relates to the source of services trade data and the mismatch with how services trade negotiations are organised. In GATS-based negotiations, services are delineated by the different ways in which they are traded – e.g. online (mode 1 or ‘cross-border’), by consumers visiting the ‘exporting’ country (mode 2 or ‘consumption abroad’), by investment flows establishing an operation that provides services outside the home country (mode 3 or ‘commercial presence’) or by individuals operating outside their home country on a temporary basis (mode 4 or ‘presence of natural persons’). However, services trade data are sourced largely from the balance of payments (BoP), which records transfers of money across borders.

 This results in a number of shortcomings. First, in instances where a local consumer pays funds to a locally established foreign affiliate services provider, these payments do not cross a border and are not captured. Investment-related services trade is effectively left out of BoP-based statistics.^[1] In that the WTO has estimated such flows to comprise over 50% of global services trade (though surely less so in LICs), services negotiators and policy-makers start with (at best) only half the picture.

 Second, when it comes to movement of persons, international services trade statistics utilise proxies in the form of labour-related flows (i.e. compensation of employees, workers remittances and/or migrant transfers). While these provide rough estimates, these data include the activities of permanent migrants and workers outside the services sector, whose work may also not be temporary in nature. This is likely to result in overestimations (offset, however, by the prevalence of the informal sector; see below).

 Third, for cross-border services, while available statistics include elements of transportation services, communications, insurance and banking, as well as royalties and licence fees, they generally omit e-commerce transactions (notably where the product is both procured and delivered online).^[2] In that e-commerce represents a growing potential delivery channel for LIC service providers (Frost & Sullivan [2014] for example estimate the African e-commerce market will grow by 40% annually over the coming decade), this leaves another key dimension of developing country services trade profiles out of the view of negotiators.

 Lastly, with tourism being a major source of LIC services exports, the shortcomings in measuring services consumed abroad can have significant distortionary effects on policy-making and negotiations. For example, trade statistics on tourism generally rely on the travel account under the BoP, which includes not only services but also the purchase of goods by tourists. It also excludes international airfares, which are counted under transport services.^[3]

 While problematic in their own right, such shortcomings do not even begin to take into account more recent international trade patterns, notably in terms of indirect services trade (i.e. services embodied in goods) in the context of regional and global value chains. Here, trade in value-added statistics based on national input/output tables, are increasingly being deployed, such as those found in the OECD-WTO Trade in Value-Added (TiVA) database, the World Input-Output Database (WIOD), or the Eora multi-region input-output table (MRIO) database. Unfortunately outside of MRIO, few LICs are included in the country coverage, and where available in MRIO, the underlying data tends to be dated and of questionable quality. The SET data portal highlights a number of such services-related indicators of relevance for analysing economic transformation.

 Other core deficiencies that preclude the use of existing services trade data to support services negotiations and policy-making relate to the absence of information on bilateral flows (i.e. what partner is the trade happening with?) and sectoral disaggregation (i.e. exactly which services are being traded?).

 In recent Department for International Development (DFID)-supported research, Shingal (2015) reaffirms that the coverage of services trade, both aggregate and at the sector level, remains a challenge for least developed countries (LDCs) and LICs, especially vis-à-vis their bilateral trade flows. The latter is particularly so because, in the absence of LICs & LDCs reporting their bilateral flows, partner ‘mirror flows’ are used as a substitute. For example, when UNSD reports Tanzania’s commercial services exports to the UK, these figures are in fact what the UK reports as commercial services imports from Tanzania. While such standard techniques are helpful in filling some gaps, they do not address the gap in South–South services trade flows (as there are no mirror data to use). This has particularly adverse implications for South–South regional services integration: policy-makers and negotiators have virtually no data about the services that flow between the parties to the negotiation. It is perhaps unsurprising then that the private sector is hard-pressed to identify negotiated services outcomes that have a meaningful impact on their business.

 Another important phenomenon affecting the availability of services trade data in LICs is the prevalence of the informal economy. To the extent that significant cross-border transactions happen outside the formal sector (e.g. distribution services, personal and professional services), these go unrecorded in the BoP.  Similarly, where services operators tend to be micro and small enterprises, a tendency has been observed for successful services firms to export ‘under the radar’, often to avoid paying taxes (e.g. VAT) (Primack and Kanyangoga, 2014).

 The low levels of data reliability add additional texture to these challenges. In comparing LIC & LDC services trade data in UNSD, Shingal (2015) identifies high variability in the recorded sectoral coverage across years, as well as at times significant year-on-year variation. These, he suggests, may point to weaknesses in the quality of data collection and transcription/coding. One commonly cited example is the improper handling of exchange rates, where in the context of relatively low overall volumes a few mis-recorded transactions can significantly distort an entire year of data.

 LIC services policy-makers and trade negotiators have thus been left to operate in relative darkness. More often than not, the determination of offensive and defensive negotiating interests is left to the realm of anecdote, intuition and, at best, the input of a few (hopefully representative) stakeholders on the barriers they may be facing in external markets they are contesting (or would like to contest). The same goes for identifying binding constraints in the domestic market that may undermine firm competitiveness and limit productive and exporting capacities. While case studies in specific sectors and countries can help, and indeed remain essential even in the best of data scenarios, alone they cannot substitute for reliable, adequately disaggregated services trade statistics for informing services policy-making and negotiations (at both the macro country level and the micro firm level).

Improving the state of services trade data in LICs is a time- and resource-intensive endeavour, but one very much in the realm of the possible. Of note, securing results here need not require operating at the frontier of international best practice. Building on the aforementioned DFID-supported research, Holmes et al. (2016) suggest a sequenced process for improving the collection of services trade data based on the practices of other developing countries that have performed well in this realm. Such practices include, inter alia, undertaking a needs/capabilities assessment, implementing enabling legislative and institutional provisions (including strict confidentiality for reporting firms), use of multiple data sources – in particular targeted firm-level surveys – and securing external technical assistance and capacity-building. Finally, ensuring any such efforts are properly embedded in national planning and budget processes will help promote sustained improvements over the longer term.

[1] While Foreign Affiliates Trade in Services (FATS) statistics track such investment flows, this is a still-novel and complex methodology, and as such remains largely the purview of advanced economies. BoP data do capture some mode 3 data related to constructions services.

[2] The use of thresholds under which items need not be declared can exacerbate under-reporting.

[3] Tourism under the Tourism Satellite Account represents an alternative framework.

References

Holmes, P., J. Rollo and A. Shingal. (2016). ‘Toolkit: Improving services data collection in LDCs & LICs’, ILEAP, CUTS International Geneva and CARIS: Toronto, Geneva and Brighton.

Primack D. and J.B. Kanyangoga. (2014). Operationalizing the LDC Services Wavier: Rwanda Country Assessment. Mimeo

Shingal, A. (2015). ‘Identifying good practices in services trade data collection in LDCs/LICs’, ILEAP, CUTS International Geneva and CARIS: Toronto, Geneva and Brighton.

* A number of the studies cited emanate from the DFID-funded Trade Advocacy Fund (TAF) project Support to Enhance Development of Trade in Services Negotiations, led by the author. A host of project publications and services-related resources, including on services trade data, are available at www.tradeinservices.net. The author would also like to acknowledge the comments and support from Dirk Willem te Velde and Neil Balchin.

Photo credit: Jonathan Ernst/World Bank