Executive summary

With its “Compact with Africa”, the German G20 Presidency intends to encourage private institutional and corporate investment, together with the African partners. The objective is to boost growth and jobs, promote inclusion and give people economic perspectives at home so that they do not have to leave their home country to seek subsistence elsewhere. Stimulating private sustainable investment in Africa has been a longstanding G20 policy target.

Both institutional investments, for example through pension funds and life insurers, as well as corporate investments in the form of foreign direct investment (FDI) can benefit Africa. Institutional investors enjoy long-term liabilities in their balance sheets, which is essential to fund Africa’s infrastructure, a central growth prerequisite for the continent. FDI, in turn, requires modern infrastructure, especially energy and connectivity, to fully deploy its external benefits. FDI can entail benefits for the modernisation of production capacity; knowledge transfer; integration into global value chains and regional value chains; as well as employment for the jobless. Corporate FDI reflects a long-term commitment and is hard to reverse, thus providing stability.

Total assets managed by long-term institutional investors are projected to reach $100 trillion by 2020, up from $62 trillion just eight years earlier. To fill Africa’s annual infrastructure funding gap of $50 billion, one percent of new institutional investment by pension funds, life insurance companies and sovereign wealth funds would need to be invested in Africa’s infrastructure every year. Yet, despite the longstanding policy focus of G7/G20 leaders, private long-term investment in Africa’s infrastructure has remained deficient. Private finance still plays a minority role in funding Africa’s infrastructure. Since 2010, Africa’s infrastructure deployment has become uneven and, on average, has not progressed further. Why has the decade-long G7/G20 push for private investment in Africa’s infrastructure failed to produce better results so far? Regulatory supply-side barriers for investors and low-income Africa host barriers have been identified as root causes. To help improve the situation, appropriate dialogue partners not envisaged so far are identified, especially prudential regulators.

FDI inflows produce important effects which go beyond spillovers to domestic firms. They contribute to structural change, but the effects of different FDI inflows vary (FDI in resource-driven countries vs. consumer-oriented industries). The shift of FDI to consumer sectors has created jobs, mainly low-skilled ones. Some middle-income African countries have managed to enter global value chains. Generally, a stronger integration of African countries into global value chains may foster the absorption of technology, build skills and promote inclusive growth. The paper shows that the transfers of technology and spillover effects are still limited; a systematic trend can hardly be identified.

In order to drive structural transformation in Africa, some policy prerequisites are seen as key: apart from political and macroeconomic stability, improved transport systems and energy access to generate agglomeration benefits and industrial clusters. Job creation in small and medium-sized enterprises (SMEs) requires that barriers be removed. Regional economic integration is essential for Africa to realise its full growth potential, to participate in the global economy and to share the benefits of an increasingly connected global marketplace. Many African economies are still resource-intensive and FDI inflows mainly resource-driven. Dominance of resources, low levels of manufacturing and widespread informal economic activities do not appear to be the appropriate foundations for long-term, sustainable and jobs-driven growth.

The main 10 policy recommendations:

1. Initiation of a structured dialogue between prudential regulators of savings institutions and development partners to remove prudential barriers to institutional investment in Africa.

2. Identification of viable components of infrastructure projects and revenue streams in cooperation between institutional investors and development finance institutions.

3. Handling of contingent liabilities for weak African public budgets that may arise from public-private partnerships from the start of jointly financed projects.

4. Provision of local currency finance to unhedged and vulnerable borrowers by multilateral development banks to avoid currency mismatches.

5. Provision of various forms of credit enhancement, structured finance and hedging solutions by multilateral development banks to increase the attractiveness of local-currency bond offerings.

6. Promotion of a favourable investment climate (such as access to finance and imported inputs, enforcement of contracts, reliable regulatory standards, improved infrastructure) for local firms and foreign investors.

7. Promotion of a change in industrial policy to develop national industries to raise the potential of upgrading in global value chains through tax incentives and local content requirements.

8. Facilitation of the formation of industrial clusters through business development services, better transport systems, qualified labour, cooperation with research institutions and access to electricity.

9. Promotion of regional economic integration, stronger intraregional cooperation, connectivity, regional market expansion and intraregional investment in infrastructure (roads, electricity, internet networks, ports and railways).

10. Transforming the SME sector to become a more sustainable employer with backward and forward linkages to large domestic firms and foreign companies.

The “Compact with Africa” has suggested a great number of “policy commitments” for African partner countries that are deemed necessary to facilitate private infrastructure and corporate foreign direct investment. These commitments have not been subject to the reality test of the difficult political and institutional environments in many poor countries. Such a “laundry list” approach to reform has proven ineffective, as it assumed that all developing countries suffer from the same problems, and that all of the problems were equally important. However, an unweighted check-off of selected governance elements has led to an undifferentiated reform programme that fails to target an economy’s most severe bottlenecks under the constraint of scarce political and administrative (human) capital.

---

» Download the DIE discussion paper: Compact with Africa: fostering private long-term investment in Africa (PDF, 1.3 MB)