Taking advantage of the services sector

Tesfachew Taffere (PhD) is an Ethiopian national who has been leading, as director, the United Nations Conference on Trade and Development (UNCTAD's) Division for Africa, Least Developed Countries and Special Programs since his appointment in October 2011. Prior to that he had held the position of chief of the office of the secretary-general of the United Nations Conference on Trade and Development (UNCTAD). He had also headed the organization's Strategy and Policy Coordination Unit and had served as its spokesperson. He worked as a researcher for the International Labor Office and a teaching Fellow Tesfachew has published  a wide range of research materials, including investment and enterprise development, technology transfer, innovation, industrial policy, and terms of trade. He holds an MPhil and a DPhil in development economics from the Institute of Development Studies, University of Sussex, in UK. Two week ago, Tesfachew was in town launching UNCTAD's Economic Development report 2015: “Unlocking the Potential of Africa’s Services Trade for Growth and Development” where an emerging trend of booming trade in services in African economies was dealt with at length. Asrat Seyoum of The Reporter sat down with the director for an in-depth interview regarding what the report indicated about Ethiopia. Excerpts:

The Reporter: Your report this year focused on one of the budding sectors in African Trade and Services. Apparently, the sector has risen to the level of being the leading sector in terms of its contribution to the GDP in Ethiopia in recent years. What do you think initiated this phenomenon of service in Africa?

Tesfachew Tafere (PhD): Generally services grow as part of the general shift in the country’s demand structure. Just to give you an example, beginning from 2002/03 African economies started to experience strong economic growth as a result of the commodity boom. What happened was that when countries began to export commodities they started earning the vital foreign exchange that helped them to start new economic activities. Usually when that happens, countries would have the resources to lend to businesses; and then business activities would start to boom. And in the process, the critical middle-income group would start to emerge and in relation to that the demand for commodities and services would also rise. This kind of services growth is a natural phenomenon, that is the sector emerges not because of a deliberate policy intervention but propelled by the economic boom. In other words, services grow to serve the economic growth itself. If you take an extreme example, where a country suddenly starts to earn massive foreign exchange as a result of newly-discovered natural resources such as oil, this would mean that the nation can pay higher salary to bureaucrats, have the money to lend to business which, in turn, would initiate construction activities that will employee people. Then people would have jobs, and if they have jobs they would need to borrow to buy commodities. So, you would need financial services, transportations, shops, you name it. This is what you mean by ‘service sector grows to service the growth’. The other side is governments deliberately investing in services to keep the economy growing. A good example here is infrastructure investment such as roads and railways. This kind of investment in the services sector would actually help the economy grow further by facilitating market access to production areas which have not been connected to the market hitherto. The infrastructure investment in turn means better gains to producers, which would also require services in their own locality opening up the door to much more linkages and growth in other services. So, the expansion of the services sector in Africa can be partly explained by these dynamics.

One of the core findings of your research was a visible trend of rising services sector which was matched by the concurrent declining in the countries’ manufacturing base. If I am not mistaken, this trend was observed in 30 out of 45 African countries that were covered by your survey?   

It has to be clear that the decline of the manufacturing sector has been happening anyway. What actually happened was that the manufacturing sector decline happened to continue and coincide with the commodity boom in the 2000s and the subsequent rise of the services sector. We are not saying that manufacturing declined because services were rising or that they have any form of causal relationships. But, unfortunately, in Africa during the commodity boom period the share of manufacturing in the total value added has shown a marked decline. Part of that could be attributed, of course, to the commodities boom encouraging African economies to shift focus to the export of commodities than manufacturing. And the agenda they had in 1960s and 70s of diversifying into import substitution manufacturing was put aside. On the other hand, the opening up of the economies in 1990s and 2000s and the coming to Africa of cheaper manufactured goods exerted pressure on the emerging African manufacturing sector. For instance, the African garment industry, which was in its early stage of development, was in no position to compete with cheaper goods coming from the emerging manufacturing economies. So, the process of the de-industrialization of the African economies did not necessarily happen as a result of the services boom in the continent but followed its own trend. So, we have just observed that the fall of manufacturing and the rise of services happened to coincide.

Regardless, as you have explained it, most of these African economies experienced this services phenomenon before they were able to have a substantial improvement in their manufacturing sectors or to kick-start their industrialization process. So do you say these nations were and are ready for a services boom? Is that a healthy path?

Traditionally, we come to understand that the process of economic development in countries that are based on agriculture starts at the agrarian level which will gradually move to manufacturing and then to services. The point we are trying to make in the report is that this is not the nature of things that is happening at the moment. Now, it is possible to go to services without even going into manufacturing. What countries are finding out these days is that even for the manufacturing sector to be dynamic, the complementary services sector is very important. How are you going to transport your manufactured goods if you don’t have an efficient transportation services sector, or without efficient logistics services? Apart from that, you can also see critical services such packaging, marketing activities, accounting and business consultancy services are all vital to the development of the manufacturing sector. So, what we are saying is that this thinking of focusing on manufacturing and the production of goods saying that service comes afterwards is a wrong strategy at this stage. Both should develop concurrently because they are complementary to one another.

But not all service activities are complementary to manufacturing. There are the non-tradable, less productive services which, instead of augmenting the growth of manufacturing, tend to compete for vital economic resources. What about the effect of those services?

Well that is what industrial policy is here for. Industrial policy should shift resources to the most productive economic activities, that is manufacturing. I think that is what is happening with the Growth and Transformation Plan (GTP) of Ethiopia. In this policy document, the government had a clear industrial strategy with the type of vertical and horizontal policies to make sure that resources like labor and skill are directed to these sectors which are identified as a priority. This channeling of resources is what we are referring to when we talk about structural transformation.  This is a process of identifying sectors which are more dynamic than the ones you have right now, and pouring resources to these sectors. This hopefully would shift resources from low productivity activities to more productive ones. But, if you have non-tradable services sector dominated by the informal economic activities, that would be problematic. By definition, the informal sector operates outside the legal framework of the country and could be very difficult to monitor. So, one of the issues we have tried to address in our report was these informal activities and how governments can formalize them. However, the approach is very important; you can’t just force operators of this informal sector to register, pay taxes and have permanent business addresses at once without helping them to be more dynamic. The issue is how you help them access technologies they need to produce quality products. It is how you help them upgrade their products and link them with the formal sector and the supply chains. You need what you call ‘enterprise support measures’ which will ensure that these enterprises are supported in terms of special credit and loans and the needed production technologies. Of course, all these policies are not new; they are all being tried. But these policies do need resources and the question here is whether these resources are available.

One of the issues that you have raised in your report is that the services sector in general does not appear to be well integrated into the national growth plans of most of African countries. You said the boom came without a proper, deliberate policy intervention from African governments. Do you think services have been given the right emphasis in Ethiopia?

What we did was to look at the national development plans of 38 countries in Africa including Ethiopia. We found out that in terms of being mentioned, it is there in most (about 30) of the national economic plans. For instance, if you take a look at the Growth and Transformation Plan, you see that tourism, logistics, transport, railways and similar service subsectors and the associated development plans and the spending are all mentioned. In fact, most of these plans tend to mention services activities in their national plans. However, some are more articulated than the others. In some nations, we found that they barely appeared in the national economic plans, and when they do appear they are expressed more in the form of a general vision for the sector. In that regard, we saw that the GTP is better than other national documents as it is more of a plan than a simple expression of vision for the sector. One issue we have noticed in these national development plans is that they don’t articulate what they want to do at a regional level. This is a bit strange since most of these countries are parts of these regional groupings [regional blocks]. In fact, most of the regional blocks in Africa do mention services as part of their overall plans as regional blocks but it is conspicuously absent in the national development plans of the individual member countries. So, we noticed a great disconnect between the regional blocks and individual member countries with regard to services. But, in general, we do not see the services sector being guided by a deliberate and articulated policy framework in many of these African countries although this did not stop the sector from thriving anyway. On the other hand, you do find a few countries which have targeted certain service sectors; Mauritius is one example here. Kenya is also another one with a serious attempt going on there to boost the information technology sector [a services sector] and a lot of young Kenyans joining this emerging sector. The government there has placed  an assortments of incentives to encourage the young people to come to this sector and work on their innovative ideas. There are also other nations who targeted a particular service sector; in fact the smaller the countries the greater the drive to target one or few a particular services because the option of manufacturing is not that encouraging in such smaller nations.

What about the quality of services in Africa…

In fact, one of the reasons why we felt we had to emphasize the regulation aspect of services in Africa is precisely this [quality of the services]. We believed that if there are stronger regulations the type of services that should be provided will surely be specified there. For instance, if you take the hospitality business, and if you have regulations as to what type of services should be offered by the services institutions [three, four or five star hotels for example], then the operators would be forced to maintain that quality. Of course, regulation would also be critical for accessibility and affordability of services in addition to the quality. On the other hand, a strong regulation would also help in terms of addressing the raging debate regarding the service sector liberalization in Africa by ensuring efficient services provision regardless of its being provided by the public or the private sector. As far as we are concerned, public vs private or foreign vs domestic is a false dichotomy. I think the most important thing is to know where you want to go in terms of goals and make sure that the services you provide are efficient enough to allow you to get there. It is my understanding that the government of Ethiopia is wary of opening up one of the services sector [financial sector] at this stage, where the private financial institutions are not strong to withstand pressure of consolidation from the foreign firms. This would in turn give the foreign firms the power to decide to whom they lend. In fact, our finding in this regard shows that, with the exception of a few, African countries are as open as they could be at this stage. And the other is that, now, foreign ownership or foreign assets in Africa’s financial sector has reached 52 percent. However, if you see the lending activities of most of these banks, they predominantly lend to big multinational companies, mergers and acquisitions or invest in treasury bills. This is reasonable because they are not going to incur a huge overhead cost by lending small amounts to small businesses. Looking at it from that perspective one can see that the concern of the Ethiopian government is well-founded. So, that is why we emphasized a strict regulation for the services sector in Africa.

With the coming to an end of the GTP I, one thing that is clear is that the manufacturing sector is not where it was supposed to be both in terms of production and export earnings. What is your assessment of this sector of the period?

Essentially the GTP I was an extension of the agricultural led-industrialization strategy that was pursued for many years in Ethiopia. So, a lot of it was about using agriculture as a base to encourage manufacturing growth. Having that link between agriculture and manufacturing was a very intricate task without having services playing an important role. This was what we were talking about; but I am not saying that this was the only reason why manufacturing is not where it is supposed to be but it must have contributed its fair share. For example, the marketing aspect is very important for farmers and agriculture not only in terms of getting the agricultural produce get to the market but also for the farmers to get better price for their products. Now, to transform agricultural production into manufacturing and sell the products competitively, it needs a lot of support structure which will determine the market competitiveness. I guess this was lacking here. This includes research and development to help you with quality. If you take leather and leather products, one of the priority manufacturing subsectors in Ethiopia, we are finding out now that 60 percent of the raw leather is rejected at tannery level because of the quality. We also have anecdotal stories where small firms in this sector are getting huge orders from abroad which they could not meet at the current level of production capacity. Consequently, the goods trade has not also expanded as much as the government would have liked in the past five or six years. Interestingly enough, the services sector is the one sector that is keeping the economy going; had it not been for the services sector, especially the aviation sector, the balance of payment would have been even worse. I think the government recognizes these issues and now it is coming together a bit. The establishment of the economic processing zones is one good example in this regard. We are now doing a study at UNCTAD to help with the industrial policy of Ethiopia, and the one thing we have noticed is that the internal supply chain is very important for such sectors like leather and leather products. A proper industrial policy links the whole value chain from the bottom to the end process. For instance, Ethiopia is supposed to be one of the top countries in the world in terms of its livestock population but a lot of this livestock is not for slaughter. Furthermore, when we get up the value chain we see that much of the hides and skins is rejected because of poor quality. With regard to textile we also saw that some of the Turkish companies in Ethiopia have started to grow their own cotton. So, the whole value chain has to be there in addition to the complementary services for manufacturing to work. This is why we wanted to talk about services in this report, because partly we want to create awareness.

As you may well know, currently GTP II is in its drafting stages and one of the issues that are under discussion is what type of manufacturing sector the country should aspire to adopt. Mostly, the debate is between FDI-led or domestic firms-dominated manufacturing growth. What is your take on the matter?

I think attracting FDI is very important for industrialization since FDI companies are expected to come with knowledge, capital and important market link. Ethiopia, like many other LDCs, has duty-free and quota-free access to many developed markets. This would be useful to attract FDI since investors would come to take advantage of this market access. If you look at the structure of the manufacturing firms in many African countries, they are dominated by micro and small enterprises and very few large ones. In fact, the middle is missing. There are not a lot of medium enterprises. Hence, it is difficult to see export strategy which is purely based on small enterprises; scale matters a lot. Unless, they are integrated into the overall value chain of the production of export products, it is very difficult to imagine export strategy solely based on small enterprises. By the way, what we call small enterprises in the context of Africa are firms which employ not more 10 to 20 people. So it is quite difficult to see these firms, as drivers of export in manufacturing. I think that is why the government is going for FDI. But, these smaller firms can supply inputs to the larger firms, possibly FDI firms. Even the market itself is structured in such a way that products have to be exported in bulk to return a reasonable amount of profit. In UNCTAD also we have struggled with this question of how countries can design their export oriented manufacturing sector purely based on small enterprises. It is very difficult, unless, of course, one goes about it by creating these cooperative-type clusterings of the small enterprises.