How Is Africa's Infrastructure Deficit Harming Development?

In the context of weak growth in major economies, Sub Saharan Africa (SSA)'s attractive macroeconomic profile - underpinned by a low base, natural resource wealth, a burgeoning consumer market and a broadly improving business environment - has seen the region become increasingly prominent on investors' and multinationals companies' radar screens over recent years. From private equity firm Helios Investment Partners' raising of US$900mn in 2011 for investment into the region, to Walmart's acquisition of South African retailer Massmart (also in 2011), the growing interest in SSA is palpable. But even the most euphoric Africa optimist will admit that economies in the region still face significant challenges. Although undoubtedly diminished over recent years, political risk - mainly in the form of lack of policy continuity and social instability - cannot be discounted completely. Additionally, the underdevelopment of the region's capital markets means that it is difficult and expensive for firms to access finance.

However, we believe that one of the biggest constraints to economic development, which is cited by almost all who have an interest in the continent, is the inadequacy of physical infrastructure, in the power and transport sectors in particular. According to BMI's proprietary ratings system, which quantifies political and business environment risk and components thereof by assigning each with a numerical value (a higher value implying lower risk), the SSA average for the infrastructure component of the business environment rating lags the global average by more than any other component or aggregate rating.

Infrastructure Is Where SSA Most Lags The Rest Of The World
BMI Ratings - Short & Long Term Political Risk And Business Environment Total & Infrastructure Subcomponent

In light of this, BMI has put together a series of articles which seek to: (1) identify the macroeconomic implications of the physical infrastructure deficit; (2) provide a progress report by looking at case studies of ongoing infrastructure projects; and (3) assess how likely it is that meaningful progress at addressing the deficit will be made in the future given the different financing options available. In this first article in the series, we will start by looking at the macroeconomic and political implications of the physical infrastructure deficit.

Headline Growth Constrained: Perhaps most obviously, poor physical infrastructure decreases headline real GDP growth by negatively impacting productivity and raising costs of production. The African Development Bank (AfDB) estimates that if African countries were to catch up to South Korea in terms of infrastructure, productivity gains would increase annual growth rates by 2.6 percentage points on average.

Diversification Impeded: Many African countries rely disproportionately on a particular natural resource for export and fiscal revenues and as a source of economic growth (eg Botswana: diamonds; Gabon, Angola, Equatorial Guinea: oil; DRC, Zambia: copper). Inadequate infrastructure is one of the major stumbling blocks to the broadening of the economic base in these countries which means that their economies remain susceptible to unpredictable commodity demand and prices.

Keeping The Reins On Manufacturing Sector Growth: Nowhere is the effect that poor infrastructure is having on diversification more pronounced than in the manufacturing sector. Based on figures from the AfDB, BMI's analysis suggests that SSA is less industrialised than it was at the turn of the 21 st century as growth in the manufacturing sector has failed to keep pace with resource and consumer-fuelled headline economic expansion. Although the region benefits from a large pool of cheap labour, the competitive advantage this offers is more than offset by higher production costs associated with inadequate electricity and water supplies and transport links.

Stuck In Second Gear?
SSA - Manufacturing Value Added (% of GDP)

Consumer Market Fragmentation: Much of the recent excitement about Africa has centred on the continent's burgeoning consumer market with sound bites, such as one about SSA having a larger middle class than India, bandied about as a rallying cry for the potential of the African consumer. The fact though is that SSA is comprised of a patchwork of about 50 economies which are, for the most part, relatively small. Poor transport links connecting them mean that gaining access to the SSA consumer pool in its entirety is difficult and expensive. Improved transport links would bolster the attractiveness of the consumer market as a whole and would lure in more competition to drive down prices and improve services.

Inter-Regional Trade (Dis)Integration: The negative impact of poor regional transport infrastructure and the pressing need to improve inter-regional connectivity is starkly borne out by the fact that SSA is the least trade integrated region in the world. Only 12.5% of total SSA imports come from other countries in the region, compared to almost 20.0% in Developing Asia and Latin America and the Caribbean. This has a great deal to do with the fact that inland shipping costs are prohibitively high. According to data from the World Bank, of the $4,990 it costs to import a container to Rwanda, $4,000 goes towards inland transportation costs.

Trade With Thy Neighbour
Regional Trade - % Of Total Regional Imports Coming From Home Region

The expense and consequent low amount of inter-regional trade is another reason that the African manufacturing sector has not flourished. Indeed, high regional transportation costs mean that it is cheaper for African countries to import finished products from abroad rather than importing inputs and raw materials from neighbouring countries and manufacturing products themselves.

Inflation Magnification: Most economies in SSA have had to deal with periods of high inflation over recent years. Deficient infrastructure has played a part in many instances as it tends to exacerbate supply side shocks. The most recent example is East Africa where a regional drought severely impacted a power sector that is overburdened and heavily reliant on hydroelectric power. The consequent surge in demand for oil for use in diesel-powered generators caused a massive widening of the current account deficit and a collapse in regional currencies which in turn stoked imported inflationary pressures.

Inadequate Power Infrastructure Exacerbated Drought-Induced Price Growth In 2011
East Africa - Inflation, % y-o-y

Food has the largest weighting in consumer price baskets in every country in the region (except South Africa), often making up more than 50% of the total. Poor transport infrastructure means that it is often not efficient to move food from well-supplied regions to those facing shortages, leading to market distortions and driving food prices higher than they might otherwise have been.

Raising Political Risk: Links can also be made between poor physical infrastructure and political risk. Episodes of high inflation, and high food price inflation in particular, have been at the heart of popular discontent and demonstrations over recent years in countries across the region including Uganda, Mozambique, Tanzania and Cameroon. Inadequate infrastructure will continue to exacerbate supply-side shocks, leading to elevated inflation and increasing the possibility of social instability until meaningful progress is made at addressing the shortfall.

Unemployment is a major issue for many countries across the region. The relative stasis of the labour-intensive manufacturing industry has meant that little progress has been made at addressing the problem. In fact, strong headline economic growth driven largely by the capital-intensive resource sector has arguably seen the disparity between the haves and the have-nots grow further in recent years. As the events of the last 18 months in the Middle East and North Africa have shown, this is a recipe for social upheaval.

Finally, deficient infrastructure also makes it difficult for central governments to exert control over remoter parts of the territories they govern. For example, the government's ability to respond to turmoil in eastern Democratic Republic of Congo has been severely restricted by the lack of connectivity between Kinshasa and the rest of the country. Poor quality roads, which become impassable after heavy rain, have slowed the progress of Kenyan forces which are helping the Somali government to re-exert control over the country in a fight against Islamist insurgents.

These are but a few examples of the ways in which poor physical infrastructure is constraining economic, social and political development in many SSA countries. The good news is that, although challenges are huge, there is some progress being made. We look at this progress in the next article in this series where we provide case studies of several of the planned or ongoing physical infrastructure projects and analyse the extent to which we believe that these will mitigate the problems outlined above.

This article is tagged to:
Sector: Country Risk, Infrastructure
Geography: Africa

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