Transformation is a continuous process

By Carlos Lopes, UN Under-Secretary-General and Executive Secretary of the ECA

Distinguished participants,
My brothers Claver Gatete, Minister of Finance and Economic Planning of the Republic of Rwanda, and K.Y. Amoako, President of the African Center for Economic Transformation,

Excellencies,
Ladies and Gentlemen,

My friend Amoako asked me to talk about structural transformation. Like a good student, that’s what I will do.

The issue of structural transformation has been at the core of economic development debates with initial empirical analyses originated with Fisher (1935, 1939) and Clark (1940) who dealt with sectoral shifts in the composition of the labor force.

Poverty reduction has been essentially associated with a profound structural transformation of the economy, a process entailing a reallocation of economic activities from the less productive sectors to the more productive ones. The speed with which this process takes place has been a key factor that differentiates development levels across countries.

The concept of structural transformation has evolved over time. It shifted from a simple reallocation of economic activity across three broad sectors— agriculture, industry and services that accompanies the process of modern economic growth—to encompass issues of sustainability and inclusiveness.

Timmer (2007) defines structural transformation as a process characterized by a decline in the share of agriculture in GDP and employment; a rural-to-urban migration that stimulates the process of urbanization; the rise of a modern industrial and service economy and a demographic transition from high to low rates of births and deaths. The process requires proactive policies and a strong push from state institutions, coupled with strategic capacity.

In 2003, Thomas Theisohn and I wrote a book entitled Ownership, Leadership and Transformation, in which we discussed the role of national agency in relation to structural transformation. We said then that traditionally, the notion of “capacity” came from the engineering world and was understood to involve using particular processes to transfer knowledge, especially technical and scientific skills (Morgan, 2001). Little attention was paid to less sector-specific realms, including policy formulation, social and economic research, systems analysis, or review and feedback mechanisms.

Today we know better: knowledge cannot be transferred; it has to be acquired, learned and reinvented. And it encompasses both the deep pool of local understanding that is the very foundation of learning, and the wealth of global information that can be reconceived to meet local needs. When adaptation fails to happen, however, there is no ownership and lasting capacity development is unlikely.

Structural transformation is perceived by some more in terms of a process by which the relative importance of different sectors and activities of an economy changes over time. In the African context, this implies a relative decline of low-productivity agriculture and low-value-added extractive activities, and a relative increase in manufacturing and high-productivity services.

However, we have learned from past experience that there is a strong historical pattern of worsening income distribution between rural and urban economies during the initial stages of the structural transformation. Even currently rich countries did not escape from this pattern during their early development in the 19th and early 20th centuries. The good news though is that absolute poverty does not necessarily worsen during such episodes. In East Asia, for instance, the evidence reveals that absolute poverty actually fell very rapidly, albeit associated with inequality.

As latecomers to this process, effective structural transformation for African countries means making significant productivity gains in rural areas with vibrant hubs of agri-business and linkages across industrial activity; the translation of Africa’s youth bulge into a demographic dividend; access to social services that meet minimum standards of quality regardless of location; reduced inequality, spatial as well as gender; and progression towards an inclusive green growth trajectory.

In terms of green growth, the knowledge of environmental impacts has become more profound, increasing the the momentum towards a more sustainable and inclusive structural transformation objective. This is likely to be accompanied by a relative decoupling of resource use and environmental impact from the economic growth process.

Africa has experienced unprecedented growth over the past decade and has been remarkably resilient to the global economic crisis. The continent has also made significant strides during this period in all dimensions of human development, comparable with other regions of the world in similar economic trajectories. But such a remarkable economic performance has not created enough jobs. The continent still remains home to the world’s highest proportion of poor people. In addition, African economic growth has proved vulnerable to volatility in commodity prices, and demand and perception fragility.

One of my tasks these days is to keep reminding many that Africa is nevertheless the continent that is growing the most; or that its debt to GDP ratio only increased 2% last year (it is negative in relative terms if reserves are taken into account); or that its macro-economic profile is more affected by internal policy blunders that are fixable than by commodity prices per se.

We know from the experiences of others that they faced a similar difficult time when they were embarking on their industrialization processes—but that challenge only contributed to accelerating, not slowing down, of their transformation ambitions.

Learning from others

Structural transformation has been undertaken across regions and over historical periods, and Africa as a latecomer has the advantage of being able to learn from others’ experience.

For example, between 1950 and 1980 Brazil, like many countries in Latin America, geared economic policy at creating new industrial sectors, changing the prevailing pattern of primary commodity specialization to promoting technology-intensive activities. As a result, Brazil moved successfully into many new industries such as petrochemicals and renewable fuels (especially ethanol), and established the bases for the development of new technologies. In the 80s the government introduced a more liberal New Industrial Policy package to accelerate and intensify the process. In the 2000s Brazil’s Guidelines for Industrial, Technology and Foreign Trade policy (PITCE) targeted specific sectors.

Over the last 30 years Brazil has been among the world’s most active countries in the use of policies designed to expand natural-resource-processing industries and food production. Today, the country is one of the top three producers and exporters of orange juice, sugar, coffee, soybean, beef, pork and chicken in the world. It has also caught up with the traditional big five grain exporters: US, Canada, Australia, Argentina and the European Union.

Another example of transformation is China, which transformed its economic structure through agro-based industrialization to accelerate growth and development. Between 1978 and 1983 China concentrated on agricultural productivity. In its 1981–1985 Five Year Plan it emphasized foreign trade and foreign direct investment in order to facilitate the importation of advanced technology. Strategic industries identified in the Five Year Plan were given targeted support, such as protection from foreign competition and subsidized loans from state-owned “policy banks”. Through a deliberate strategy China has combined a variety of policies to develop both its agricultural and industrial sectors as well as services. In just two decades China became the largest exporter of manufactured goods.

Another example of successful transformation is the United Arab Emirates (UAE). This oil-rich emirate carried out a structural transformation strategy to diversify its economy, which depended on the export of crude oil for about two thirds of its GDP. UAE developed an industrial base and invested its oil wealth in industry-related infrastructures.

Furthermore, Jebel-Ali, the first free zone in Dubai, was created in 1985 with a host of incentives designed to appeal to foreign investors. These included 100% foreign ownership, no customs duties, unlimited repatriation of funds and exemptions from certain labor laws. The UAE government also promoted a number of manufacturing activities through its industrial policy, including oil refining and the production of fertilizer and cement. As of 2010 manufacturing in the UAE accounted for around 10% of GDP, a significant jump from the 0.9% share in 1975.

Between 1957 and early 1990 Malaysia achieved substantial economic transformation with the share of manufacturing in GDP rising from 14% in 1971 to 30% in 1993. Malaysia’s export-to-GDP ratio increased from 46% in 1970 to 95% in 1995, and the share of manufactures in total exports rose from 12% to 71% between 1970 and 1993. There were three distinct phases of industrial expansion over this period: import substitution between 1957 and 1970; the New Economic Policy (1970–1985); and the New Development Policy of 1986, which moved the country’s industrial policy closer to the type practiced by the East Asian Newly Industrialized Economies.

Carlos Lopes, UN Economic Commission for Africa

Carlos Lopes, UN Economic Commission for Africa

A continuous process

These successful stories are not perfect though. Structural transformation is a continuous process which very often encounters challenges. A country’s capacity to design and implement a successful transformation agenda can be undermined by internal and external factors. Gains can be reversed if there is inconsistent policy implementation or poor perception of new threats.

Negative internal factors include: poor economic management typified by macro-economic instability, poor planning, and poor design and implementation capacities; weak institutional and individual capacities; limited investments in social and economic infrastructure; limited investment in technology and R&D; and political instability.

On the other hand, negative external factors can include: limited policy space; barriers to trade that undermine export revenues and constrain exports of manufactured goods; disproportionate concentration on dealing with ODA-defined areas rather than handling its real macro dimension; and the concentration of FDI in extractive mineral and gas sectors of the economy with limited investments in value addition. In recent years climate change has also emerged as a threat to development through its destructive impacts.

The role of the state

To address these challenges and promote a sustainable and inclusive structural transformation, the roles of institutions and the state are paramount. The emerging consensus is that a developmental state is central to the process of accelerated economic growth and transformation of any country.

The role that the state played in bailing out the flagging economies of Western countries following the 2008–2009 global economic crisis reaffirms is importance in sustaining the transformation process and has revalidated Keynesian theories about the primacy of the state in stabilizing economies.

A developmental state is defined as: “a state that puts economic development as the top priority of government policy, and is able to design effective instruments to promote such a goal” (UNECA, 2011).

More specifically, a developmental nation-state entails the following:

  • Scaling up public investment and public goods provision. Africa at its stage of development requires a big push in public investment—at national, region and continental levels—in the coming decades. Without committed public investment, sustained private investment will not be forthcoming, causing overall productive investment to fall below the level needed to keep the growth momentum going.
  • Maintaining macro stability to attract and sustain private investment. In fact, macroeconomic stability is essential as high uncertainty and risks deter private agents from making forward-looking productive investments. At the same time, harsh fiscal retrenchment and overly restrictive monetary policies aimed at attaining the stabilization objective only cannot take the transformation agenda forward.
  • Coordinating investment and other development policies. Public investment using scarce resources should be made selectively, sequenced and directed to achieving the highest development dividends in the long run. This requires public and private investment to be well coordinated across sectors so that aggregate demand spillovers can facilitate “a move from a bad to a good equilibrium” (Murphy et al., 1989), especially given the market’s well- failure at coordination.
  • Mobilizing domestic resources and reducing aid dependency over time. This requires a solid framework to develop financial institutions (banking and non-banking) and deepen financial markets.
  • Securing fiscal sustainability by establishing fiscal legitimacy. This calls for urgent prudent and efficient public finance management. But this must be the bedrock of a relationship between the government and domestic actors, for fiscal sustainability can only be secured in the medium to long run on such a foundation.
  • Other development policies critical for structural transformation include: trade, technology, financial development, oversight regulation and competition, education and health, and sector-specific policies such as those for industry and agriculture.

 

Why is the current Africa growth not to our liking?

We said it. Africa’s current growth has not generated sufficient jobs and has not been inclusive enough to significantly curb poverty. A third of it has been driven by a commodities price boom and government-related spending. Fluctuations in commodities prices have made such growth vulnerable.

This reminds us that the imperative for structural transformation, in our case, should focus on the potential offered by industrialization, be it through the expansion of commodities value chains, be it through agro-business to pull agricultural out of the doldrums, or be it through attracting low-value manufacturing from Asia where labor costs are rising.

This is not out of reach.

Real structural transformation has been experienced by many countries in different regions of the world. It will not happen spontaneously but rather as a result of deliberate policies entrenched into a coherent development strategy, enlightened by a transformational leadership.

This is what we expect from leaders.

 

Ends

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