Why Africa must shift from dependence to diversification, now

Over the last decade, Sub-Saharan Africa (SSA) has experienced historically high economic growth rates. The region has made significant social progress too. These gains have largely been driven by favourable commodity prices, financing conditions and improvement in macroeconomic management.

However, the high growth rates have not been sustained for long periods in many of these African countries. The plunge in prices of commodities like oil, copper and cocoa, with its resultant adverse impact on many economies reveals how dependent African countries are on natural resources. According to the International Monetary Fund, about 28 countries in sub-Saharan Africa are resource-rich, with these resources accounting for over 80% of Gross Domestic Product (GDP). Many of these countries depend on a few commodities, which account for the bulk of GDP, exports and fiscal revenues. Some other countries have often experienced recurring macroeconomic instabilities because of fluctuations in commodity prices, external demand and extreme weather conditions such as droughts and floods.

For instance, the collapse of oil prices tipped the Nigerian economy into a five-quarter recession in 2016, from which it is now just recovering. Angola, Equatorial Guinea, Congo Republic and Gabon also experienced sharp economic slowdowns in 2015-2016 due to low oil prices. Zambia, where copper accounts for 60% of exports, was also hard hit by the slump in copper prices. These experiences underscore the need to diversify economies and build resilience against such large external shocks.

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

This can happen through “the Dutch Disease” effects, corruption, rent seeking behaviour by political elites and conflicts. The Dutch Disease occurs when natural resource booms increase domestic income, real exchange rate appreciates, and there is reduction in competitiveness of other tradable sectors such as manufacturing, potentially leading to deindustrialization. The resource dependence syndrome is also associated with market instability, which raises uncertainty, and hurts investment in the form of financing of recurrent expenditures at the expense of public investments, distortion of incentives to invest in robust and efficient institutions, and public services which support socio-economic development.

Commodity prices – which collapsed by over 60% since 2014 – are likely to remain low for some time, highlighting the dawn of a new normal for commodity markets. Clearly, this requires structural adjustments for many commodity-exporting African economies. While adjustments can be painful, this is a window of opportunity for African countries to undertake reforms that embrace economic diversification.

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

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

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

Although economic diversification remains elusive in most African countries, some countries are making progress. For example, Mauritius has made some progress in transforming its economy from a sugar-dependent economy into a major financial services hub, with a vibrant export sector in tourism, textiles, clothing and jewellery. That is, from 98% of exports in the 1970s, sugar now accounts for about 5% of exports in Mauritius. Botswana is striving to diversify its economy along the value chain by developing diamond cutting, polishing and marketing hubs. For Kenya, its dynamic private sector is helping to lay a foundation for stronger growth in services, such as financial services, telecommunications, and tourism. Rwanda’s efforts to diversify its economy are driven by significant reforms of its business environment and initiatives for economic and regional integration. It has managed to channel significant public resources into programs to boost growth, increase agricultural productivity, expand infrastructure investment, foster wider access to financial services and encourage higher-value economic activities.

Indeed, these countries have managed to withstand the commodity price shock of 2014-2016 and maintained solid growth rates. Productive sectors such as agribusiness, light manufacturing, textiles, energy, tourism, financial services and other service sectors appear to present visible opportunities for diversification and structural transformation of African economies.

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