The diffusion of Africa’s ‘productivity islands’

Inclusive Economy11 Aug 2014Alan Gelb, Christian Meyer, Vijaya Ramachandran

Although Sub-Saharan Africa is increasingly attractive to investors, structural transformation and formal job growth remain slow. Industrial surveys in many countries show that some highly productive firms co-exist with many low-productivity businesses. Why do these “productivity islands” not diffuse more rapidly to create the “missing middle”? Our research (pdf) suggests three important factors.

Shortcomings in business climates

Shortcomings are poor power supply, roads and ports, high security costs, corruption and unpredictable regulatory changes that especially affect medium-size “transactions-intensive” firms requiring power, finance, transport and the ability to enforce contracts. High costs and risks squeeze out such firms, eroding the middle of the productivity spectrum. The limits of the economy are polarized between subsistence business and the few large firms with the capacity and bargaining power to “deal” and influence their own business climate.

Complex relations between government and business

Only eight African states make it into the top 100 of 173 countries when combining measures of GDP and business climate. Not surprisingly, market competition is limited. Sub-sectors are usually dominated by a handful of firms. “Influential” firms are prone to lobby governments to preserve market power and have rents to share between owners, employees and officials. Many countries are locked into a low-level business climate equilibrium that changes only slowly.

The ownership of larger-scale business

Although there are differences between countries, foreign investors and ethnic minorities of European, Asian, or Middle Eastern descent often dominate the leading firms, a pattern with longstanding historical origins. Ethnic networks are prominent in many countries, including emerging industrial powers in Asia. Like foreign investors they bring skills, financial resources, networking and knowledge of products and markets. Their trust-based relationships compensate for shortcomings in the business climate, helping to access finance and substituting for weak contract enforcement. Like multinationals, they can diversify against country risk more easily than indigenous, African investors. On the other hand, beyond a certain point foreign and minority ownership can have negative side-effects. Dominance by a few industrial-trading groups can further reduce competition in small markets and stir populist policies that increase country risk and deter investment and entry. The absence of a natural political constituency for these investors also makes it more difficult for secure broad-based business coalitions to emerge.

The picture is changing – slowly

Africa’s geography and its distinctive history have sustained a high-cost business climate, which has both constrained the productivity of firms and slowed productivity convergence. But both history and geography are evolving in response to demographic, technological, and regulatory changes. Rapid population growth and urbanization are putting pressure on governments to accelerate job creation. ICT is breaking down distance barriers, at least in some dimensions. Trade reform and progress on regional economic integration are helping to break down market barriers. The political economy of the private sector is also evolving, with growth in larger-scale African business, including some emerging trans-Africa firms, which will help to strengthen domestic business constituencies. Growth alone is not enough; durable structural change will need to open up opportunities for indigenous businesses.