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The trade and industrialisation nexus: A pathway for development

There is no single country that has managed to reach a high-income level without first undergoing an industrialisation process. Even the few exceptions of rich countries with a large natural resource base, such as Canada and Australia, built a strong and relatively diversified industrial park. Perhaps the main question is what kind of industrialisation process the current low-income countries will have to pull together in order to develop? I argue for a close trade and industrialisation nexus. Trade, embedded in global and regional value chains (GVCs and RVCs), is a powerful, however, tricky tool to leverage industrialisation, increasing growth and creating the conditions for sustained growth.

The main reason for the importance of industrialisation is that manufacturing is arguably an engine of growth (Szirmai 2009). This means that it has a unique condition to create jobs, promote and diffuse technology upgrading and learning by doing, and bring tax revenues, thus generating rapid and sustained economic growth in the long run. This is the basic model that has lifted the current developed countries from poverty to success on international markets and which holds the promise to do the same in Africa. It is against this backdrop that the African Union celebrates yearly the “Industrialisation Day”, which is usually complemented by a series of meetings and special events dedicated to draft policy recommendations and roadmaps guiding the industrialisation effort of the continent.

Structural transformation in African economies

Despite the lofty statements and unimplemented development plans, Africa still lacks a central necessary condition to industrialise: the large majority of its countries still have not undergone structural transformation. This is a developmental stage whereby less productive labour is shifted from the agricultural sector to more productive activities i.e. industry (in particular manufacturing) and modern services, thus boosting aggregate labour productivity and economic growth in the endline. Many African countries have seen a persistent negative pattern of structural transformation, dubbed the ‘boda boda economy’[1], which is shifting agricultural labour directly to unproductive, low-technology, and low skills-intensive urban services (Ellis et al. 2018)

Consequently, Africa is still largely a low productivity agrarian economy with agricultural based commodities accounting for a large share of national income, employment, government revenue, and foreign exchange earnings. Foreign trade also heavily relies on the unprocessed produce from the rural areas. The continent has a booming young population and, thus, affordable labour costs. One could even say that human capital will soon replace natural resources as Africa’s dominant comparative advantage. If these masses do not find gainful employment when they leave the rural areas, it could create significant political and economic distress. A strong industrialisation process would diversify the economy and reduce negative spillovers stemming from negative shocks on commodity prices and terms of trade, reducing the overreliance on too few products.

GVCs have changed industrialisation

It is important to state that not only the context, but also the conditions that the current developed countries benefitted from are very different nowadays. The developing world needs a faster convergence because of political and demographic pressures and increasingly faster changes in the technological frontier. Consequently, it is now harder for low-income countries to industrialise and capture international markets in the same way that East Asian countries have done in the past three decades. There is solid empirical evidence showing that manufacturing has assumed a lower share of GDP at all levels of per capita income than it had decades ago when measured as a share of employment or value added (Newfarmer et al. 2018). This means that the traditional smooth pathway to industrialisation and development is now a long and winding road.

The main culprit are the so called GVCs, which are the dominant contemporary mode of production. Firstly, Value addition is the amount by which the value of goods and services is increased in value by each stage in the production process. Secondly, The GVCs do a thorough unbundling that breaks production and manufacturing down to the individual component level and then strategically chooses the location where these economic activities will take place, based on potential for cutting costs and reaping higher efficiency gains. While a country can now specialise in producing a single component of a final product, it must apply cutting-edge technology and surpass stringent quality control to be competitively inserted into the GVCs. Capital and technology are scarce resources that are quite expensive in developing countries, since they tend to be further away from the frontier of production and lack a skilled work force.

Even in an era of retreating globalisation (Stiglitz 2017), GVCs continue to play a major role in reducing information, communication, and transportation (ICT) costs. It is vital to get the fundamentals right: adequate infrastructure, educated workers, access to energy, deeper financial markets, etc. Coupled with the relative cheap labour force of the continent, the GVCs represent an opportunity for industrialisation provided that these countries are able not only to “do their homework”, but also attract enough foreign direct investment (FDIs) that could plug their gap of capital. Then, they would be able to further specialise and capture portions of the GVCs. In this scenario, it has become virtually impossible for any country to industrialise without connecting its economy to the GVCs. While the old and protectionist Latin American model of industrialisation via import substitution might have worked back in the 1960s, it is impractical and counterproductive to replicate it in the 2010s.

In this regard, GVCs are driven by international trade, which poses threats and opportunities to the African industrialisation push. Whereas trade is a powerful tool to leverage gains from industrial development, it can also expose nascent African industries to intense Asian competition, thus blocking their pathway to development. On the other hand, trade can promote valuable technology exchanges, wider market access via economies of scale and labour skills upgrading. With regards to trade, Africa needs to go regional, before it goes global.

Towards a regional trade strategy

Low-income countries cannot industrialise based only on domestic markets for one of two main reasons:

  1. They have small populations, thus not gaining enough economies of scale to reduce production costs
  2. They have large and poor populations, thus not having enough purchasing power.

Therefore, it is imperative that they expand their markets by plugging local economies to regional and then global economies.

GVCs can be seen as an aggregation of RVCs, which are finally being established in Africa. RVCs are a strategic mechanism to reorganise production and accrue gains from economies of scale and division of labour, thus building joint competitive manufacturing capacity. They could also serve as a springboard for countries to put their competitiveness edge to the test before widening the scale, thereby integrating African economies to the global economy.

The importance of the African Continental Free Trade Agreement

The opportunities of furthering regional integration presented by the African Continental Free Trade Agreement (AfCFTA) are significant due to an estimated market size of 1.2 billion people with a combined GDP of $2.5 trillion. Notwithstanding the large potential, real world politics are yet to be tested because it will need to strike a balance between national vs. regional priorities, as well as decide how much sovereignty each country is willing to forego.

It is important to mainstream RVCs concerns across all government economic policies and adopt targeted policies to identify low hanging fruits with the potential to drive industrialisation in Africa. However, it is equally important to emphasise the need to actually implement the approved policies i.e. make things happen. For instance, in the East African Community, all member countries have “national development plans” emphasising the importance to foster the textiles industry. However, little has actually been done and the region still relies on the import of second-hand clothing.

For this reason, African countries could gain a lot by becoming strong and effective developmental states that can actively support and plan projects. This type of State is also important not only for improvements to the macroeconomic scenario, but also to supply elementary infrastructure (e.g. energy, water & sanitation, transportation networks) – the backbone of any industrialisation push (Lin and Monga 2017).

Three examples discussed in the Africa Industrialisation Week 2018 were the cassava, cotton & textiles, and the leather sectors, which could leverage natural resources into valuable RVCs. Developing these and other sectors, and furthering the process of regional integration could boost industrialisation in the continent. Two main characteristics of intra-regional trade stand out:

  1. It is more concentrated on manufactured goods and higher value added products than trade with the rest of the world, thereby providing an opportunity for African countries to use regional integration as a platform for industrialisation.
  2. Competition inside each RVC is crucial to drive out the less productive fringe of firms, allowing for the emergence of more robust and resilient larger firms.

A continent full of potential

In conclusion, old models of industrialisation need to be rethought by African countries if they want to tread the same path towards development. The continent has a huge untapped potential that, even though surrounded by a number of binding constraints, still can be realised if supported by effectively implemented and targeted policies. The biggest challenge looming ahead is how to transform comparative advantages – a large natural resource base – into competitive advantages i.e. how to move up the GVCs and produce finished products with higher value added. Africa has been labelled as a continent full of potential, but it is now time to finally unleash and harness the forces that will finally realise this potential.

References

Lin, J, C Monga (2017), Beating the odds: Jump-Starting developing countries, Princeton, NJ: Princeton University Press.

Newfarmer, R, J Page, F Tarp (2018), “Industries without smokestacks and structural transformation in Africa: Overview”, In: Industries Without Smokestacks: Industrialisation in Africa Reconsidered. Oxford, UK: Oxford University Press.

Ellis, M, M McMillan, J Silver (2018), “Employment and productivity growth in Tanzania’s services sector”, In: Industries Without Smokestacks: Industrialisation in Africa Reconsidered. Oxford, UK: Oxford University Press.

Stiglitz, J (2017), Globalisation and its discontents revisited: Anti-Globalisation in the era of Trump, New York, NY: W.W. Norton.

Szirmai, A (2009), “Industrialisation as an engine of growth in developing countries, 1950-2009”, Maastricht: UNU-Merit Working Papers ISSN 1871-9872.

[1] ‘Boda bodas’ are the omnipresent motorbike taxis in East Africa.

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