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Unlocking the potential of Africa’s services for structural transformation

Unlocking the potential of Africa’s services for structural transformation
Photo credit: ICTSD

19 May 2016

If Africa is to fully realise the benefits of development, services must play an enhanced role in its structural transformation and economic growth processes. This will require addressing some of the pitfalls underlying the regulation of Africa’s infrastructure services sector.

Services have a vital role to play in the context of Africa’s transformational development strategy, whether it is based on the exploitation of its natural resource base or on labour-intensive light industry and manufacturing. For either approach to succeed, however, knowing how to exploit further the services potential of Africa will be critical.

The continent is already tapping into some of the opportunities the services sector has to offer. For example, some African economies have been developing their services industries with relative success and are supplying services across Africa. Known examples of emerging regional services are the financial and banking services industries of Mauritius and Nigeria, the commercial and cargo air transport industry in Ethiopia and South Africa, the educational services industries of Uganda and Ghana, the telecommunication services of Egypt and the port services industries of Djibouti and Kenya. Major challenges persist, however, especially as Africa seeks to move away from consumption-based growth to more durable sources of growth through structural transformation.

One such challenge lies in enhancing the trade potential of Africa’s services sector. In 2012, Africa accounted for only 2.2 percent of the world’s total exports of services, compared to 3.6 percent for developing America and 24.3 percent for developing Asia. Africa accounted for 4.0 percent of total world services imports, compared to 5.2 percent for developing America and 27.9 percent for developing Asia. Only 11 African countries have consistently been net services exporters since 2005 (Cabo Verde, Djibouti, Egypt, Eritrea, Kenya, Mauritius, Morocco, Namibia, Seychelles, Tunisia and Tanzania). With the exception of Djibouti and Kenya, these countries are mainly dependent on exports of travel services. The services sector in Africa remains by and large mostly non-tradable and with limited domestic value-added.

Another challenge lies in informality. Informality is a noticeable feature of the services sector in Africa and of African economies in general. The informal sector in Africa ranges from 50 to 80 percent of GDP and 60 to 80 percent of total employment and accounts for 90 percent of new jobs. Some of the fastest growing services sectors of West African economies (wholesale and retail trade, restaurants and transportation) are dominated by informal firms. African services are predominantly informal and small in scale.

Despite these challenges, the services sector in Africa has of late experienced vibrant growth. During the period 2009-2012, the services sector grew rapidly in real terms in Africa (a rate of 4.6 percent), at more than twice the world average rate. Growth was particularly strong in Eastern and Western Africa. However, the continent needs to shift away from relying on subsistence and non-tradable services to services which generate greater value addition and can act as a catalyst for Africa’s structural transformation. Therefore, a key policy question is how to translate this services-led growth into structural transformation, sustainable employment and inclusive development for Africa.

Services as an enabler of structural transformation and sustainable development in Africa

As the most dominant sector in many African economies, services need to support the process of structural transformation, characterised by a shift from low to high-productivity activities, and a declining share of low value-added agriculture in output and employment, as well as an increasing share of manufacturing and modern services. There are some dynamic emerging subsectors within the services sector with the potential to support structural transformation, which have yet to be tapped. For instance, logistics and distribution could greatly benefit Africa’s agriculture (including agribusiness and food trade) and manufacturing sectors. African policymakers thus need to place greater emphasis on how to move towards the provision of more sophisticated services, where there is greater value addition and which offer opportunities for technology transfer and linkage development with other sectors of the economy. Such an approach should be part of an overall strategy intent on fostering the structural transformation of African economies.

So far, progress in that direction has remained limited on the continent. Many African countries have undergone a process of shifting from agriculture to mainly non-tradable services, without undergoing a process of manufacturing development marked by significant productivity improvements, formal job creation, exports of sophisticated goods and the application of technology to the wider economy. During the periods 2001–2004 and 2009–2012, of the 45 countries where the share of services in output rose, 30 experienced a contraction in manufacturing. This suggests that the complementary elements between the two sectors have yet to be fully developed in some countries. Building complementarity, that is, strengthening input–output and demand linkages between services, manufacturing and agriculture, thus remains a necessary continental goal. The services sector has a critical role to play in the industrial and manufacturing development of African countries, as well as in boosting agricultural productivity.

Services are indeed enablers of many production and sales processes. There are important input–output linkages between manufacturing and services. With regard to South Africa, one study estimates that 25.3 percent of the intermediate inputs into manufacturing come from services (of which the bulk comes from trade and finance) and 24.7 percent of the intermediate inputs into services come from manufacturing (Tregenna, 2007). If imported intermediates are excluded, 31.4 percent of all domestically produced intermediates into manufacturing are purchased from the services sector and 18.6 percent of all domestically sourced intermediate inputs into services come from manufacturing. While African countries should aim to develop their manufacturing sectors, increasing the competitiveness of their domestic services sectors should be a concurrent objective.

Some services sectors are considered to be the backbone of economic activity and have a direct bearing on drivers of structural transformation. In particular, infrastructure services – encompassing transport, telecommunications, water, energy and financial services – are of critical importance to economic development through structural transformation. They could contribute to addressing Africa’s physical infrastructure deficit and low manufacturing development in order to foster inclusive growth. Infrastructure services also provide and support basic services (i.e. electricity, gas and potable water), which will be critical to the achievement of the sustainable development goals (SDGs) by 2030. Lastly, infrastructure services are essential to the development of other services sectors, including tourism, distribution (wholesale, retail), information and communications technology (ICT) services, and business process outsourcing services. For infrastructure services to contribute successfully to the structural transformation, economic and social development of Africa, the institutional and regulatory environment must be supportive.

This article initially posed the following question: how to translate this services-led growth into structural transformation, sustainable employment and inclusive development for Africa? One part of the answer lies in improving the effective provision of infrastructure services in Africa through more effective regulation of the sector. Infrastructure services provision is suboptimal in Africa and entails high costs. Many of the market failures and inefficiencies afflicting the sector may be addressed through regulation and regulatory reform in African countries.

The important role of infrastructure services in Africa’s structural transformation process

Inadequate infrastructure services remain a major obstacle to achieving full transformative economic growth potential in Africa. The continent needs to raise investment in infrastructure, encompassing a range of services subsectors, in order to achieve its development goals of structural transformation and economic diversification. Addressing Africa’s infrastructure gap will require a substantial programme of investment, estimated at $93 billion per year. Improved infrastructure and the enhanced provision of services, such as financial services, could contribute to growth in the manufacturing sector in Africa, a sector where the competitiveness of African firms is weak. The cost structure of firms, and particularly the difference between the direct and indirect costs of production, have a bearing on the weak competitiveness of African manufacturing. One study shows that the overall level of profitability of African firms, which is much lower than elsewhere, results from high indirect costs (Eifert et al., 2008). Firms in developing regions with a stronger performance have indirect costs amounting to less than 15 percent of total costs, whereas indirect costs in poor African countries account for 20 to 30 percent of total costs, often exceeding labour costs. It may be seen that a considerable share of African firms’ indirect costs comprises costs related to infrastructure and public services such as energy, transport, communications, water and security, which constitute significant barriers to the international competitiveness of African manufacturers.

A critical constraint to realising transformative economic growth potential in Africa thus lies in the state of infrastructure services. As infrastructure services industries are typically dependent on monopolistic networks (whether public or privately owned, local and/or national), economic regulation of the sector matters and needs to address concerns related to competition (asymmetries of information and abuse of dominance) and consumer interests (universal access, affordability and quality). In addition, with the increasing integration of infrastructure systems across Africa through pan-territorial initiatives (e.g. the Programme for Infrastructure Development in Africa) and common electricity markets, potentially significant benefits from economies of scale and shared resources will require effective regional regulation.

As indicated, infrastructure services regulation is also critical as a guarantor of access, affordability and quality control, which are interconnected. The type of regulation matters; simply regulating inputs or processes rather than outputs or outcomes may reduce a utility or firm’s incentive to improve quality, access and efficiency. If a country decides to open up the sector, the sequencing of privatisation and development of regulatory institutions are also important, as establishing an institutional framework conducive to promoting competition and governing access, affordability and quality control before privatising infrastructure services is correlated with improved investment and wider services provision.

There is growing consensus on the key design features of a modern regulatory framework and ancillary agency. The main features of effective regulation of privatised utilities are coherence, independence, accountability, predictability, transparency and capacity, along with accessibility, affordability, ownership and quality control. Coherence implies that the laws underpinning regulation are consistent, with clear divisions of responsibility between municipal and national regulators. Predictability relates to overall decision-making stability in the regulatory framework, as confidence in the decision-making processes of a regulatory body is important for long-term investors in network industries. Capacity relates to the quality of human resources available to the authority and appropriate levels of staffing. Regulatory bodies should be strengthened, allowed to operate independently and adapted to fit the specific needs of national economies. Minimal state interference in regulatory decisions is also important.

Africa ranks low in regulatory independence

Most African states rank low in regulatory independence across all sectors, and standard international models of infrastructure regulation are not regularly employed in Africa. Most African regulatory bodies are at an early stage of development, have modest budgets (ranging from less than $300,000 to about $3,000,000 for electricity) and often lack qualified staff. Staff numbers also vary widely, ranging from one or two to over 30. This reinforces the need for independent regulatory authorities that are autonomous but also have some political backing to fulfil their roles. In some instances, national bodies need to be bolstered through partnerships and collaboration with regional and pan-territorial regulatory bodies, as they emerge. This could help national bodies, as they may use regional regulatory bodies as a counterweight to domestic political pressures on regulatory governance. There may also be a need to separate supervisory functions (e.g. with regard to competition) from regulatory functions (e.g. price and universal service regulation) to ensure that there is no conflict of interest.

To enhance performance, African countries also need to improve the capacity-building efforts of regulatory bodies with regard to human resources, which may be supported regionally through shared training programmes, twinning arrangements and information sharing arrangements to more effectively disseminate best practices and benchmark regulatory performance.

Cross-country regulation, at the regional economic community level or more broadly, is of particular importance. A key issue in such regulation is the harmonisation of national standards and systems, to enable the linking and coordination of national infrastructure networks. This is crucial for international trade in infrastructure services at regional and global levels. Commitments made through regional trade agreements can also facilitate a process of domestic regulatory reform through the following: widening the scope of competition in services markets to include foreign operators, which could lead to higher output and employment across the sector (as in telecommunications); undertaking commitments to open up services, which may enhance the credibility of domestic policy reforms, as regional commitments can indemnify investors against the risk of possible future policy reversals; and allowing countries to tap into the regulatory expertise of their trading partners, thereby bolstering domestic regulatory capacity and harmonisation. Examples of pan-territorial cooperation already in place among regulators include the mechanism for central bankers in Africa, Southern African Development Community (SADC) payment systems, power pools and civil aviation authorities.

Policy messages

In order to fully capitalise on their services sector and turn services as an effective enabler of their transformational development strategies, African countries need to pay greater attention to the state and regulation of their infrastructure services sector. Africa’s services provision remains suboptimal and is delivered at a high cost. There are regulatory and policy shortcomings that explain these inefficiencies. Regulatory reforms aimed at increasing the autonomy of national regulatory authorities in the services sector, as well as promoting the adoption of international models of regulation and boosting regional harmonisation of regulatory standards, could benefit the continent’s development agenda.

Bineswaree Bolaky is an Economic Affairs Officer, Division for Africa, United Nations Conference on Trade and Development (UNCTAD).

This article is based on UNCTAD Economic Development in Africa Report (EDAR 2015): “Unlocking the potential of Africa’s services trade for Growth and Development”. References are available in the report and can be downloaded here. The report is prepared by the Africa Section of UNCTAD and is headed by Mr. Junior Roy Davis, supported by Ms. Laura Paez and Ms. Bolaky.

This article is published under Bridges Africa, Volume 5 - Number 4, by the ICTSD.

Author Bineswaree Bolaky
Source Bridges Africa | ICTSD
Website Visit website
Date 19 May 2016
 
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