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DIVERSIFICATION OF TRADE AND INVESTMENT IN THE SADC REGION

Paper Prepared for the Committee of the Central Bank Governors in SADC by Bank of Mauritius

ABSTRACTThe SADC integration initiative did not provide the expected impetus to trade and investment diversification. There is concern that, although Member States have a fairly heterogeneous trade structure, they nonetheless display sufficient homogeneity in terms of their common exposure to trading partners outside the region. This could easily stymie any attempt to accelerate trade and investment diversification in the region, in view of mixed evidence regarding the capacity of the region to embrace newly created sectors. This paper explores three questions: Do SADC countries have the potential to diversify? Have they diversified so far? Should they diversify further?

Our main finding is that, given its current state, it is desirable for the SADC region, as a whole, to accelerate its diversification process, both, at the production level and at the market level, to reap welfare benefits. Most importantly, SADC countries must break away from trading outside the region and trade more among themselves to reap benefits from regional integration. Since most SADC countries have already explored their respective comparative advantages, we propose exploration of new possibilities to achieve both objectives. One option could be vertical specialization opportunities at a regional level, with each participating Member State playing a part of the supply chain for high value added products. This would spur faster intra-regional trade and enhance welfare across the region. The Central Banks of the region would have a key role in fostering trade and investment diversification in SADC through more effective policies aimed at maintaining macroeconomic and financial stability and in creating an enabling environment for deeper financial integration in the region.

DISCLAIMER

We are thankful to the members of the CCBG Research Review Panel and Macroeconomic Subcommittee for their comments and suggestions on earlier drafts of the paper. The views expressed, however, are those of the authors and do not necessarily represent those of the members of the Committee of Central Bank Governors (CCBG) in the Southern African Development Community (SADC) and the Bank of Mauritius. While every precaution is taken to ensure the accuracy of information, the CCBG shall not be liable to any person for inaccurate information or opinions contained herein. For any information concerning this paper please contact the following persons:

Dr Ashwin Moheeput, Chief, Financial Stability Division, Supervision Department, Bank of Mauritius, [email protected]

Mr. Neetyanand Kowlessur, Chief, Research and Economic Analysis Department, Bank of Mauritius, [email protected]

Mr. Dooneshsingh Audit, Chief, Research and Economic Analysis Department, Bank of Mauritius, [email protected]

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Document 9 14/09/2017

mailto:[email protected]




Table of Contents

1. INTRODUCTION 3

1.1 Background 3

1.2 Statement of the Problem 3

1.3 Objectives of the Paper 4

1.4 Organization of the Paper 5

2. SADC INTEGRATION AGENDA 6

3. AN OVERVIEW OF THE LITERATURE ON TRADE AND INVESTMENT PARADIGMS 8

4 WHY IS DIVERSIFICATION IMPORTANT AND WHAT ARE THE PREREQUISITES FOR DIVERSIFICATION TO WORK? 10

5. THE CASE OF SADC - DATA ANALYSIS 12

5.1 Structural Transformation in SADC 13

5.2 Analysis of Trade in SADC Region 14

5.3 Analysis of Investment in SADC Region 15

5.4 Trade and investment flows with China 16

6. QUALITATIVE ASSESSMENT OF THE DEGREE OF HETEROGENEITY OF SADC GROUP 17

6.1. Degree of Economic Integration in SADC 17

6.2 Macroeconomic Structure 18

6.3 Macroeconomic Convergence progress and implications 19

6.4 Development Indicators – Can SADC countries diversify further? 19

6.5 Financial Inclusion 20

6.6 SADC Governance 21

6.7 Overall Qualitative Assessment 21

6.8 Igniting dynamic comparative advantage and building competitive advantage 22

7. KEY LESSONS AND POLICY MEASURES 23

7.1 Key Lessons 23

7.2 Economic Analysis of Policy Options in SADC 25

7.3 SADC Industrialization Strategy and Roadmap 2015 -2063 27

8. ROLE OF CENTRAL BANKS TO PROMOTE ECONOMIC DIVERSIFICATION IN SADC 27

9. CONCLUSION 30

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1. INTRODUCTION

1.1 Background

SADC member countries vary in terms of their natural resource endowments. With the exception of Mauritius and Seychelles, most members possess large reserves of natural resources, including mining, mineral deposits and, to a more limited extent, petroleum. Zambia, for instance, possesses 6 percent of the world’s reserves of cobalt. Together, six SADC members produce over 50 percent of world’s diamonds. South Africa now ranks among the top 10 gold producing nations on earth and was, before 2006, the premier gold producing nation in the world.

A close look at the historical sectorial shares of GDP across SADC countries clearly shows the process of structural transformation that many countries have gone through over time. In the 1980s, agriculture was an important part of the economy of many countries such as Malawi, Mozambique, Madagascar, Mauritius, and Democratic Republic of Congo (DRC). The share of agriculture in GDP has declined in nearly all SADC countries over time. Manufacturing displays a different story. While manufacturing has assumed relatively greater importance in Swaziland over time, most other countries have experienced episodic fluctuations in their manufacturing sector’s share of GDP over time. What is clear from the data is that, barring Swaziland, there is a tendency for SADC members’ share of manufacturing sector in GDP to converge to an average of 10 percent across time.

SADC endeavored to create a free trade area by removing market boundaries between Southern African states, and creating an expanded market that ought to encourage more investment in the region. It has been recognized right at the outset that newly liberalized economies, especially smaller and weaker ones, should benefit from higher investment flows to offset some of the negative consequences associated with the re-direction of trade, or trade diversion.

It is debatable whether SADC liberalization and integration initiatives have yielded expected results in terms of social and economic development, in particular with regard to creation of jobs for the large pool of unemployed and poverty alleviation. Intra-SADC trade remains modest and trade imbalances have accentuated, which is a source of political tensions among states. SADC did not attract the volume and quality of foreign direct investment that could boost the competitiveness of its products. Similarly, attempts to move up the quality ladder through the introduction of higher value-added products, not only in manufacturing but also in agriculture, have only been met with limited success. As the global economic environment remains fragile, it is imperative for SADC countries to strengthen their economic structures through the implementation of targeted reforms.

1.2 Statement of the Problem

Diversification of trade and investment are closely linked to each other and can be considered to be the outcome of structural transformation process, i.e., the dynamic reallocation of resources from the less productive to the more productive sectors. In many instances, they are often the end result of a regional trade liberalization program initiated through the aegis of a trading block, with the aim of fostering intra-regional trade, and promoting flows of resources and capital across Member States. While a liberalization program may help economies better exploit their comparative advantages in trade, economies will only benefit if they buttress their trade openness with greater investment openness, and if they have a proper industrial policy in place. Under these circumstances, some key stakeholders of the economy will stand to gain, while others will lose. Having a well-designed plan to

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assist those who are more likely to lose1 from a reform program, forms part of the efforts to harness the benefits from liberalization.

The success of trading blocs partially hinges on significant fixed investment inflows into some of the member countries, especially the smaller ones, so as to offset some of the negative consequences associated with the re-direction of trade, or ‘trade diversion’. Economic theory vindicates the existence of strong linkages between trade policy, investment policy and industrialization, and it is imperative to understand that any desired level of industrialization is derived from investment inflows that are facilitated by the existence of trade.

Almost 15 years after the launch of the SADC Free Trade Area, it would appear that the intra-SADC trade and investment levels are relatively low compared to other regional economic blocs in Europe and Asia. The impediments to SADC’s trade and investment have been well documented – low product complementarities which limits the potential for expansion of intraregional trade, distorted trade regimes and poor infrastructure. Regional integration efforts have also been marked by a lack of political commitment, policy reversals in implementing harmonization provisions, multiple and conflicting objectives of overlapping regional arrangements and limited administrative resources.

Moreover, there are strong concerns that benefits from liberalization and integration in SADC are accruing to the larger and more diversified countries in the region. In the worst case scenarios, some Southern African countries such as Zambia have suffered from trade diversion, in the form of de-industrialization. In particular, its trade liberalization policies were not complemented by sufficient investment openness and therefore, greater trade openness was associated with the wholesale import of goods and services that could have otherwise been produced locally. Such trade imbalances as well as the persistence of high customs duties and non-tariff barriers which restrict market access to products from the region are a source of tensions among some Member States.

At the highest political level, SADC leaders have recognized that trade liberalization on its own cannot provide an effective instrument to boost the social and economic development of SADC and meet the aspirations of the SADC people. SADC Summit has accordingly given top priority to the implementation of the SADC Industrialization Strategy and Roadmap, which is anchored on three pillars, namely, industrialization, competitiveness and regional integration. The Industrialization Strategy is aligned to the Continental Vision, Agenda 2063, a global strategy aimed at optimizing the use of Africa’s resources for the benefit of all Africans.

The growth outlook for several countries in SADC remains muted in the short to medium term and is subject to downside risks, including among others, geopolitical tensions, tighter global financial conditions and a sharper than expected slowdown of the Chinese economy. Several countries are facing exchange rate pressures, amid deteriorating external deficits and low foreign reserves while fiscal deficits have increased. In these circumstances, SADC countries should urgently implement policy reforms to diversify their production and trade structures. Productivity gains and innovations, sound macroeconomic policies, infrastructural development, a more conducive business climate and the elimination of trade and non-trade barriers, are pre-requisites for sustained growth and enhanced resilience against shocks.

1.3 Objectives of the Paper

The aim of this paper is to take stock of progress made in the SADC region regarding diversification of trade and investment. Three main avenues are explored: Do SADC countries have the potential to diversify? Have they diversified so far? Should they diversify further? The last two questions will also help shed light on the most appropriate forms of diversification going forward, taking into account the

1 Other potential losses from trading blocs include revenue losses for the government, the possibility of trade diversion, and the displacement of traditional import substitute competitors. If structural transformation is embraced, then losses may also encompass those who will lose as a result of the decline of traditional industries.

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region’s natural and socio-economic specificities. At a more granular level, this paper more explicitly aims to:

Analyze how economic structures in SADC Member States have evolved; Assess the extent of trade and investment diversification in SADC; Identify the underlying causes for lack of diversification; Propose policy measures to enhance trade and investment diversification in SADC; and Identify areas where central banks can most effectively contribute to the process of trade and

investment diversification.

Since most countries are already exploring their respective comparative advantages, it holds the view that SADC countries must accelerate their diversification agenda by tapping into vertical and diagonal diversification, going forward. Given current conditions in the region, South Africa’s distribution network and industrial clusters can prove to be useful in tapping into vertical specialization winds crossing the world. Appropriate institutional and social structures must be developed to this end, and safeguards must be enacted to translate this objective into reality. Most importantly, SADC countries must catalyze intra-regional trade if these diversification efforts are going to produce any benefits at all to the trading bloc.

1.4 Organization of the Paper

The rest of the paper is organized as follows. Section 2 provides an overview of the SADC integration agenda. Section 3 provides a succinct overview of the literature and various paradigms on trade and investment diversification. Section 4 describes the importance of diversification and highlights the conditions for diversification to work. Section 5 focuses on data analysis and appraises the status of trade and investment in the region, while also considering constraints to trade and investment diversification. Section 6 provides a qualitative discussion of the case for or against diversification in the SADC region through the prism of a number of economic and structural / institutional factors and a quantitative assessment of the degree of integration in SADC region. Since the SADC bloc is a fairly heterogeneous region with commonality of external trading partners, the section purports that diversification makes sense for the entire bloc, although at the country level, there is mixed evidence as to whether individual countries are capable of diversifying further. Section 7 provides an array of key lessons to retain from the SADC experience and of policy measures that could be implemented by members to promote trade and investment diversification. The main responses, following a survey questionnaire designed by the Bank of Mauritius and sent to central Banks in the region, have been summarized in Box A2 in the Appendix. This section also sheds light on the most appropriate policy options to consider for the region. A policy framework, built on well-grounded hypothesis, is provided. The role central banks could play to promote economic diversification in SADC is discussed in Section 8. Finally, Section 9 concludes the paper. Table 1 provides a synopsis of the key approaches we take, the questions we want to address, and overviews how we address those.

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2. SADC INTEGRATION AGENDA

The SADC Treaty is the anchor that provides the legal basis for SADC as a regional community. The Protocol on Finance and Investment (FIP) is one of the protocols entered into by the Southern African Development Community (SADC) Member States to give legal and practical basis to their commitments under the SADC Treaty. It sets out commitments made by Member States to achieve two goals: a) an improvement in the investment climate in each member state and the attraction of more investment to the region and b) co-operation, co-ordination and harmonization in the financial sector. The SADC Regional Indicative Strategic Development Plan (RISDP) sets out the broader level goals that underpin the FIP - full regional financial integration, formation of a monetary union and adoption of a single currency. The RISDP considers trade and economic liberalization for deeper integration and poverty eradication as one of its key catalytic intervention areas. In the trade, economic liberalization and development areas, the objectives of the RISDP are to establish a Free Trade Area (FTA) by 2008, Customs Union by 2010, Common Market by 2015, Monetary Union by 2016, and Regional Currency by 2018.

The FIP was signed in August 2006 by all SADC Member States and was ratified by the required two-thirds majority of Member States during 2010. Consequently, the FIP came into force on 16 April 2010. As of June 2015, 11 Member States have ratified the Protocol.

A report reflecting the state of progress of implementation of the Protocol on Finance and Investment in SADC, by Genesis Analytics in February 2012, noted that ‘While progress has been made at the levels of country preparation and regional co-operation, the research shows that the FIP as a whole is still some way from achieving full regional financial integration’. While there has been good progress implementing the FIP commitments relating to the preparation and co-operation phases, with respect to the harder-to-achieve regional level commitments, there has been little progress.

The Integration Milestones outlined in the RISDP have not been achieved, except for the establishment of the FTA in 2008. The SADC customs union, planned by 2010, has yet to be established, implying delays in the achievement of the other milestones. With a view to promoting objectives of the FIP, under its purview, the CCBG has worked to achieve greater regional coordination on exchange control issues and convergence within SADC legal and operational frameworks. It has drafted a model central bank law and launched the SADC Integrated Regional Electronic Settlement System (SIRESS). It should also be noted that at the continental level, the Association of African Central Banks (AACB) has approved a Strategy for the Creation of the African Central Bank. The strategy is based on a gradual, step-by-step approach which conforms to the traditional and holistic stages leading to economic and monetary union, with the Regional Economic Communities (REC) as the building blocks. The Southern Africa sub-region and the CCBG have,

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however, expressed their reservations on the implementation of the Strategy. With regards to monetary union in SADC, the position of the CCBG is that it is not feasible to create a SADC Central Bank until certain pre-conditions are met, in particular, substantial integration of SADC economies, harmonization of the fiscal and monetary policies and greater convergence of SADC banking systems.

The formation of the FTA did not generate the expected outcome in terms of trade and investment flows within SADC. Industrialization in SADC has lagged behind and the process of trade liberalization has resulted in skewed trade patterns in favor of the more industrialized countries, giving rise to tensions among some SADC Member States. SADC leaders have recognized that trade liberalization has not delivered the level of social and economic development in line with the aspirations of the SADC people.

After a review process, a revised RISDP Plan 2015 to 2020 was endorsed by the Summit in its extraordinary meeting held in Harare, Republic of Zimbabwe, in April 2015. The revised plan identifies four major priority areas, namely, Industrial Development and Market Integration; Infrastructure in Support of Regional Integration; Peace and Security Cooperation as a prerequisite or regional integration and Special Programs of regional dimension. SADC Summit has also approved the SADC Industrialization Strategy and Roadmap, which is anchored on three pillars, namely, industrialization, competitiveness and regional integration. It has been decided to front load the aspect of industrialization into the RISDP, ahead of the Market Integration Program.

Most countries in eastern and southern Africa are members of more than one of the various regional arrangements. For example, seven countries are members of both COMESA and SADC. Such overlapping memberships adversely affect negotiating resources and capacity, raises administrative costs related to complex rules of origin and, more importantly, conflicting objectives among rival arrangements have contributed to a lack of progress in many areas.

The Tripartite Framework is currently under negotiation with the aim of widening and consolidating existing cross-cutting regional integration processes. Successful completion of these discussions will bring together COMESA, SADC and the EAC with the aim of creating a free market consisting of 26 countries with a population of about 632 million, which is 57 percent of Africa’s population and a combined GDP of 1.3 trillion US dollars, 58 percent of Africa’s GDP. The launch of the COMESA-EAC-SADC Tripartite Free Trade Area in Egypt in June 2015 by the Heads of State and Government of the three RECs is no doubt a positive development which could serve as a platform for boosting trade and investment flows in the region.

Macroeconomic stability and convergence are essential prerequisites for economic integration and development. The FIP provides for the establishment of the Peer Review Panel (PRP), which is mandated for the surveillance and monitoring of macroeconomic convergence in the region. The SADC Macroeconomic Convergence Peer Review Mechanism was launched in Maputo in May 2013, where Malawi and Lesotho volunteered to be reviewed as pilot. An effective surveillance system, through a rigorous monitoring of policies that the reviewed country is expected to implement as per the agreed implementation matrix, is key for perceptible progress on the macroeconomic convergence front. The surveillance mechanism should be supported by strengthening the statistical capacities both at regional and national levels.

Against the backdrop of a challenging global environment, characterized by subdued economic recovery and muted global commodity prices, strengthening US dollar and climate change factors, macroeconomic conditions in SADC have weakened sharply in recent years, undermining performance with respect to key macroeconomic convergence criteria. Inflation has surged from 6.4 percent in 2015 to 10 percent in 2016 while the average budget deficit and public debt have increased to 4.5 percent and 51.5 per cent, respectively, in 2016. Real GDP growth in SADC has sharply

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slowed down from 5.6 percent in 2013 to 3.3 percent in 2015 and further to 2.6 percent in 2016, much lower than levels required to attain the Millennium Development Goals (MDGs). Depreciating currencies, high current account deficits (nearly 7.0 percent in 2016) and relatively low foreign reserves point to serious external vulnerabilities which need to be urgently addressed through an overhaul of the economic strategy.

Looking forward, it is difficult to envisage a much deeper level of integration within SADC without the unflinching commitment of its political class to accelerate regional integration by allocating necessary resources and by adopting regional frameworks. The process would gain momentum as politicians and people become increasingly convinced about the economic benefits from integration.

3. AN OVERVIEW OF THE LITERATURE ON TRADE AND INVESTMENT PARADIGMS

Before World War 2 (WW2), the patterns of trade could easily be explained by the international trade paradigms (Smith, Ricardo and later Heckscher-Ohlin) which advocated free trade as the efficient solution to ensure higher growth and enhanced living standards. While these trade theories essentially advocated specialization based on comparative advantage2, they were put to test after WW2 as countries broke away from ‘comparative advantage’-based free trade in the 1960-70s to embrace restrictive trade policies through the adoption of import substitution strategies. Prominent contributions by Prebisch and Singer in the 1950s played a key role in facilitating this shift as they painted a dismal picture for those nations which were involved in exporting commodities such as agriculture. The Prebisch-Singer hypothesis purported that commodity exporters would face declining terms-of-trade as world incomes grew since these commodities were viewed as having low / negative income elasticities of demand. As a result, a growing number of countries - as evidenced in East Asia – began to open their economies in the 1980s while diversifying their production and exports base away from agriculture. While different areas of the world have progressed in their diversification efforts, the case of Sub-Saharan Africa (SSA) paints a mixed picture.

2 The Heckscher-Ohlin theory was perhaps an exception to this rule since it did advocate ‘zones of diversification’, while not completely ruling out complete specialization.

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Diversification is an all-embracing concept that includes product diversification (number of different products), market diversification (number of partner countries), and upgrade of product quality (i.e., the move towards high value-added products up the quality chain). Measures to capture

diversification3 – such as the Theil Index – further distinguish between the concepts of ‘extensive margin’ and of ‘intensive margin’. The extensive margin tracks changes in the former two, i.e., number of products and / or trade partners. The intensive margin refers to changes in trade that take place within surviving trade relationships (i.e., trading more or less of the same product to the same country)4. The literature also distinguishes between various concepts of diversification, e.g. horizontal diversification (within same sector and involves adjustment in export mix by adding new products), vertical diversification (shift from primary to higher value-added secondary) and diagonal diversification (mixture of horizontal and vertical). Box 1 (see appendix) qualitatively assess the features of economies having progressed at different speeds in transforming their production and exports base.

Diversification of the production base and of the exports base are closely related concepts, although they may differ in scope. Studies by the IMF (2012) show that Less Industrialized Countries (LICs) with a more diversified export base experienced a larger reduction in agricultural shares. Faster movement out of low-productivity sectors such as agriculture was also observed for economies that have enjoyed relatively faster quality upgrading of their export products (e.g., Mauritius). Given that not all products are tradable, it may be worthwhile to note that the difference between the pace of diversification of the production and of export base, may be attributable to the relative growth in importance of sectors such as construction, wholesale trade, utilities and transportation.

An IMF Staff Discussion Note on Economic Diversification in the Gulf Cooperation Council countries published in December 2014 underscored that, based on international experience, it is very difficult to diversify away from oil. Countries that have been successful, such as Malaysia, Indonesia and Mexico, have, in addition to creating a favorable economic and business environment, focused on export diversification and quality upgrading, by encouraging firms to develop export markets and by supporting workers in acquiring the relevant skills and education to boost productivity.

3 The text chart is from an IMF study (2014). 4 Put differently, the extensive margin refers to the breadth of international trade capturing the number of trade partners and number of products a country has. The intensive margin refers to the depth of international trade capturing exports of a more balanced mix of existing products.

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Extensive margin

Across products

Intensive margin

Export diversification

Extensive margin

Across partners

Intensive margin

Diversification Output

diversificationAcross sectors

Quality upgrading

On existing products

Source: IMF (2014)


In recent years, the CCBG has examined papers on intra-SADC trade and Foreign Direct Investment in SADC. A paper released in August 2014 by the Bank of Tanzania noted that ‘intra-regional trade in SADC countries has remained low’ …. and that ‘improvement of intra-regional trade of goods and services may well be the stepping-stone not only to create potential for production chains and value addition, but also product diversification, and hence improving economic growth within the SADC region.’ Using the gravity model, the author found that variables such as GDP, per capita income, the value of manufacturing, foreign direct investment, financial development and infrastructure development, stable exchange rate, and low inflation rate impact on intra-regional trade flows in most SADC Member States.

Another paper by the Reserve Bank of Zimbabwe on Foreign Direct Investment in SADC countries reviews the experiences of SADC countries in attracting foreign direct investment (FDI) and explores the major determinants of FDI in the SADC region. Using a cross-country panel regression analysis, the paper indicated that agglomeration, credit to private sector, urban population share, trade openness, market size and infrastructural development have a positive significant relationship with FDI inflows in the region. The authors underlined the need to improve both institutional and governance indicators to create a conducive business environment for FDI. They also recommended exploring ‘diversification through developing new investment niches in dynamic sectors, beyond natural resources sector, by tapping into other areas such as engineering, software development and computing.’

4. WHY IS DIVERSIFICATION IMPORTANT AND WHAT ARE THE PREREQUISITES FOR DIVERSIFICATION TO WORK?

There is both a growth payoff and a stability payoff to diversification, underscoring the case for paying close attention to policies that facilitate diversification and structural transformation. Cross-country evidence by Cabral et al (2010) shows that countries that are more likely to diversify, are also more likely to experience faster rates of growth and enhanced living standards. IMF studies have also shown that heavy concentration in a few sectors undermine prospects for strong, balanced and inclusive growth and heightens the exposure of the country to external shocks. In a study on diversification in Mauritius, Sannassee et al (2013) show that a 1 percent increase in diversification leads to a 0.11 percent increase in GDP in the long run. The authors argue that trade openness, FDI, and human capital all play a significant part in explaining this link. In the short run, GDP grows by 0.09 percent following the same increase.

Empirical evidence on the relationship between diversification and growth shows that countries that embark on the diversification journey seem to be characterized by the ‘U-curve phenomenon’. Imbs and Wacziarg (2003) show that at an early stage of their developmental process, countries exhibit specialization / heavily concentrated production and export structure. As they move to a more advanced developmental status, they have the inclination to diversify their production and export base. But as they reach advanced country status, they exhibit concentrated structures back again, although they now aim for quality upgrades. These results are corroborated by Cadot et al (2011) who purport the existence of nonlinearities / non-monotone relationship between diversification and growth. Broadening the diversification base and shrinking it back again has non-negligible distributional impact on declining sectors and their workers. As a result, compensatory mechanisms are needed to compensate those who are most affected by changing structure of economic base such as traditional industries and those that cannot face competition from imports.

Trade diversification acts as a shock absorber against external disturbances. For instance, fluctuating terms-of-trade due to changes in world price of commodities entail volatility in export revenues, and

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subsequently in government revenues as commodity exporters are state-owned enterprises. Empirical studies show that, for diversification to be successful, a number of pre-requisites must hold:

Trade liberalization is an important pre-requisite for diversification. In many LICs with a relatively important share of agriculture in their GDP, opening up the economy to trade by abolishing industry-level tariffs, has helped provide access to imported intermediate inputs, and has led to more export variety through enhanced quality of downstream supply chains5.

Trade openness must be accompanied by liberalization of investment flows. In addition to trade liberalization, investment liberalization also matters to promote production and trade diversification. Opening up an economy to foreign direct investment acts as a major catalyst to help diffuse technological developments and technical know-hows - all of which have positive spillover effects on other sectors – more broadly to the rest of the economy. Exporting firms, in particular, serve as a conduit for technological transfers that generate backward and forward spillover linkages throughout the domestic economy. In countries such as Vietnam, liberalization of investment in 1980s was key to ensuring success of its diversification strategy. Initially, FDI was concentrated in the oil sector but then, moved to lateral sectors in 1990s. FDI helped Vietnam integrate into global value chains and to diversify output and exports away from textiles to electronics.

Financial deepening and financial development both matter. Deeper financial systems (measured by the private credit to GDP ratio) are also associated with higher export diversification in developing countries.

Human resource development and capacity. Cabral et al (2010) show that the level of education positively affects export diversification and sophistication in SSA, by promoting horizontal diversification through product differentiation. Callen et al (2014) show that the creation of high-paying jobs for highly-skilled professionals in the private sector, would act as a bulwark facilitating diversification as efforts endeavor to build up capacity to support new export clusters. Evidence also shows that in countries that have tried to diversify their production base without beefing up their secondary and tertiary education system, there has been increasing tendency for these economies to rely on foreign brain power to work in newly-created economic sectors. Where these new sectors have had a heavy urban presence, this has also contributed to waves of labor migration from rural to urban areas in anticipation of higher paid jobs in urban areas – thereby contributing to urban unemployment and rural under-employment (Harris-Todaro Effect).

Macroeconomic stabilization (e.g., low and stable inflation, favorable business climate, expansion of education etc.)

Market-friendly reforms (e.g., liberalization of trade, FDI flows, Competition Commission, etc.)

International negotiations at the bilateral, regional and multilateral levels help reduce market access constraints and help open up new opportunities to tap into global value production and distribution chains.

5 This is most evident in transition economies such as Vietnam where collectivization was reversed and a diverse agricultural sector emerged, but also in Rwanda and Tanzania, where the large divestment of SOEs in the former and the dismantling of the state distribution system in the latter has led to the mushrooming of the private sector. In Bangladesh, the removal of bureaucratic red tape has triggered large investments in export processing zones.

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Malaysia, Indonesia, Mexico and Chile are countries well known to have been successful in diversifying their economies from oil, thus escaping the straightjacket of the Resource Curse Paradox. In addition to their business-friendly macroeconomic environment, these economies have chosen the pathway of quality upgrades by encouraging their firms to develop new products (e.g., electronics) by adapting advanced countries’ methods and learning and to develop new export markets. In addition, national development policies have been enacted to help workers acquire new skills that will help them adapt in these new environments.

5. THE CASE OF SADC - DATA ANALYSIS6

This section provides a succinct overview of the economic structures of SADC member countries, through the prism of trade and investment patterns. Some of the insights for this part of the paper have been drawn from a questionnaire designed by BOM staff and addressed to each SADC member state.

Many SADC countries have historically been richer than the average of SSA. This pattern has hardly changed over the past two decades. Based on the 4-quadrant categorization discussed in an earlier section of the paper, SADC member countries have been classified accordingly in order to identify more clearly the course of action that may be undertaken in the respective member countries to catalyze the diversification process (Table 2).

Table 2: Classification of SADC Member CountriesProductionDiversification

Low

High

Exports DiversificationLow HighQuadrant I

DRC, Madagascar, Malawi,Swaziland, Mozambique and Tanzania

Quadrant III

Seychelles, Mauritius

Quadrant II

Angola, Botswana, Lesotho,Namibia, Zambia and Zimbabwe

Quadrant IV

South Africa

Depending on their factor endowments and accessibility to particular technology and markets, some countries may be more inclined to diversify their export base than their production base. Natural-resource poor countries like Mauritius and Seychelles have been able to diversify their markets and quality of their exports, but their production bases have been constrained by lack of resources. In contrast, natural-resource rich countries like Botswana and Namibia have been able to expand their production base through better exploitation of non-tradables since their exports bases have been constrained by exports of natural resources. A cross-country comparison of the relative shares of different sectors of SADC member countries also tentatively indicates the intended direction of 6 The authors wish to warmly thank colleagues from SADC Central Banks submitting their replies to the questionnaire and for filling in the accompanying spreadsheet (see Appendix for model of questionnaire and spreadsheet). Due to paucity of data, many entries in the spreadsheets remained unfilled. As a result, the authors opted for a more qualitative assessment of issues at hand.

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expansion. For instance, countries generating windfall gains from rapid improvements in terms of trade, have more leeway to invest in good infrastructure and human development skills that have positive economy-wide externalities. These attributes, by ricochet, may help facilitate the diversification process.

5.1 Structural Transformation in SADC

A close look at the historical sectorial shares of GDP across SADC countries shows the process of structural transformation that many countries have gone through over time. In the 1980s, agriculture was an important part of the economy of many countries such as Malawi, Mozambique, Madagascar, Mauritius, and DRC. As chart 1 shows, the share of agriculture in GDP has declined in nearly all SADC countries over time. Manufacturing illustrates a different story. While manufacturing has become relatively more important in Swaziland over time, most other countries have experienced episodic fluctuations in their manufacturing sector’s share of GDP over time. What is clear from the data is that, barring Swaziland, there is a tendency for SADC members’ share of manufacturing sector in GDP to converge to an average of 10 percent across time.

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0

10

20

30

40

50

60

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

Chart 1: SADC Countries, Agriculture percentage Share of GDP, 1980-2014

Angola Botswana D.R Congo Lesotho

Madagascar Malawi Mauritius

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Chart 1 (cont'd): SADC Countries, Agriculture percentage Share of GDP, 1980-2014

Mozambique Namibia Seychelles South Africa

Swaziland Zambia Zimbabwe


In many SADC countries such as Mauritius, employment share in agriculture and industry has clearly declined over time while the employment share in services has risen. This mirrors the structural transformation process that Mauritius has experienced over time, from a purely agrarian based economy in the 1970s towards a financial services-based economy in the 2000s. South Africa’s case is similar for agricultural employment, although the shares of employment accounted for by its industry and its services sector has remained more or less stable over time. For other SADC countries, employment data for key sectors were not available. However, since many of these economies are endowed with natural resources whose production and exploitation are capital-intensive, it is possible that the share of employment accounted for by traditional sectors, such as agriculture and manufacturing / industry, has remained high. A natural feature of these resource-rich countries is that, while their natural resources industries are a powerful magnet for attracting foreign direct investment, they do not generally constitute the largest employer of the country, despite accounting for a significant proportion of the country’s foreign exchange earnings. To take the case of Zambia, mining generates 70 percent of foreign exchange reserves. But over 50 percent of labor force is employed in agriculture and manufacturing sectors combined. Thus, for many SADC countries, their structural transformation story may not be adequately captured by employment shares figures.

5.2 Analysis of Trade in SADC Region

While export patterns in the SADC region generally follow principles of comparative advantage of the Hecksher-Ohlin relative factor endowments type, intra-SADC trade is relatively low, despite some countries having other SADC members in the top-tier of their exports destination / imports source. Countries with colonial ties with Europe, continue to have Europe as dominant trading partner (e.g., Mauritius, Seychelles, Madagascar, and Mozambique). For other countries, EU and South Africa represent their main markets. Not much market diversification has taken place for cultural, historical, geographical and product availability reasons.

Moreover, the share of SADC exports in world exports has remained at around 1 percent while its share in African exports in 2015 was at 37.7 percent, less than in the 1990’s. These statistics illustrate the extent to which SADC has not delivered on its regional agenda with regards to trade and competitiveness. Table 3 provides the significance of intra-group trade in SADC, Africa, Europe and Asia in 1995, 2005 and 2015. While Europe and Asia registered shares of intra-group trade above 60 percent, intra-SADC trade was estimated at 20.9 percent in 2015. Intra-Africa trade was much lower at 17.7 percent. A key objective of a regional block is to make member countries increasingly customers and suppliers of each other and by so doing raise growth and per capita income. This was not achieved in SADC mainly because of a lack of industrialization and low absorption of global technological improvements. While being the source of many raw materials, many of the derivative products are produced elsewhere. Product and market diversification is thus an imperative for member countries, in particular, given the opportunities that intra-SADC trade offers with enhanced visibility of their products within SADC.

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Chart 2: SADC Countries, Manufacturing percentage Share of GDP, 1980-2014

Angola Botswana D.R Congo Lesotho

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Chart 2 (cont'd): SADC Countries, Manufacturing percentage Share of GDP, 1980-2014

Mozambique Namibia Seychelles South Africa

Swaziland Zambia Zimbabwe


As pointed out at various points of the paper, intra-SADC trade can act as a strong stimulus for trade and investment diversification in SADC. There is much scope to boost intra-regional trade and make more SADC member countries buyers and sellers of the SADC goods and services. If the individual trade directions are considered, some countries like Swaziland and Zimbabwe have a very high share of their exports to SADC, in particular towards South Africa. Much of these directions of trade are the result of historical, geographical, cultural and the process of “self-discovery”. South Africa, the largest economy in the region, sources only some 6 percent of its imports from the region. An increase in this figure could generate positive spillovers to other economies in the region.

5.2.1 Constraints to Trade in SADC

As described in the literature review part, it is not hard to understand why most SADC countries have difficulties in diversifying their trade, despite having open current accounts. Economic theories, rooted in the Resource Curse Paradox and in the Dutch Disease Effect, may shed useful light in this regard. Most respondents to the BOM questionnaire have identified structural factors as main hindrance to their diversification efforts. In particular, they flagged their country’s poor performance in ‘Ease of Doing Business’ as the main stumbling block impeding their attempts to diversify their production (and hence trade). Prominent among other factors include infrastructure bottlenecks, lack of access to finance, and poor transport and communications facilities. As a result of these factors, these countries have not been able to attract foreign investment into alternative (and potentially new) production sectors, resulting in compromised attempt to diversify.

5.3 Analysis of Investment in SADC Region

The presence of various bilateral and multilateral agreements enjoyed by several member countries, in addition to the existence of mining and mineral deposits / natural resources, have traditionally been one of the few incentives for attracting foreign investment to the region. For instance, under the Sugar Protocol Agreement (Lome Convention) and under the Multi-fiber Agreement, the sugar sector and textile industry in Mauritius thrived in the 1980s and were a powerful magnet for foreign investment. Despite its natural advantages, the SADC region, barring South Africa, has performed relatively below-par in general with regards to attracting FDI and this is cause for concern among Member States. South Africa accounts for a significant proportion of inflows received by the SADC bloc. The share of SADC in World FDI inflows has ranged between 0.7 percent and 2 percent between 1980

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1995 2005 2015

Intra-SADC 15.0 10.5 20.9

Intra-Africa 12.4 9.2 17.7

Intra-Europe 73.3 74.2 66.6

Intra-Asia 52.9 55.8 60.1

Table 3: Share of Intra-Group Trade in Group Total Trade

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Share of Intra-SADC trade in total SADC trade

Share of SADC exports in World exports

Share of SADC exports in African exports

EAC IOC COMESA SACU

Tanzania Madagascar DRC BostwanaMauritius madagascar LesothoSeychelles Malawi Namibia

Mauritius SwazilandSeychelles South AfricaSwazilandZambiaZimbabwe

Source: InternetEAC - Eastern African CommunityIOC - Indian Ocean CommunityCOMESA - Common Market for Eastern and Southern AfricaSACU - Southern Africa Customs Union

Table 4: SADC Countries Membership of Other Blocs


and 2015. Moreover, the distribution among SADC member countries is uneven, with South Africa accounting for a major share of over 50 percent of all FDI flowing into SADC regional bloc. Various reasons have been attributed to this disappointing investment performance of most SADC states.

5.3.1 Constraints to Investment in SADC

An important barrier to investment diversification in the region includes restrictions on capital account. Apart from Mauritius and Seychelles, all countries in the region had some form of restrictions on capital account movements, despite having opened up their current accounts. Other factors, most of which characterize SSA countries in general, can be summarized as follows: small size of domestic market(s); high distance to main markets; scarcity of reliable infrastructure; inadequate governance structures; political instability; high relative costs of doing business; and inadequate property rights. These constraints have been well documented in several papers.

SADC is not the only regional integration initiative in which its member countries are adhering to. As table 4 shows, several countries are also members of the Community of Eastern and Southern Africa (COMESA); others are involved in the Cross-Border Initiative (CBI); while a smaller subset of members are participating in the long standing Southern Africa Customs Union (SACU) and in the Common Monetary Area (CMA). According to Moradzikwa (2002), trade and investment diversification have not taken off as anticipated in many African trading blocs, in part because of overlapping trading bloc memberships, lack of authority and bureaucratic sophistication to deal with bigger powers, and political turmoil in some countries.

A broad comparison of Africa and Asia reveals the extent to which Asia has outpaced Africa, in the global race to attract FDI inflows, despite having many countries with similar characteristics to those in SSA. The key issue in Asia is the much larger size of its markets, closer connectivity, existence of better infrastructure networks, fewer occurrences of social / political turmoil, and better infrastructure.

Market size is a key driver of investment and trade diversification, and it can grow on the strength of competitiveness, size of population, distance or more precisely, visibility, to markets. Within SADC, there is considerable disparity in the size of domestic market due to the size of population and level of per capita income. While not much can be done about the size of population, per capita income can be raised through increases in productivity levels and a fairer distribution of income and economic opportunities.

5.4 Trade and investment flows with China

In recent years, trade and investment flows with China have increased multi-fold. The increase in SADC exports to China has, however, been mainly driven by commodity exports while imports from China represented mainly manufactured goods. Concurrently, China’s investment in SADC has been on the rise and directed principally to the extractive sectors. These include, for instance, uranium mining in Namibia, diamond mining in Zimbabwe, and cobalt and other rare minerals extraction in DRC. Chinese investments have also flown into the construction sector in many countries of the

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region, principally as a result of major infrastructure projects being implemented in the region to close infrastructural gaps. Despite the Chinese renaissance in the region investment-wise, as epitomized by the significant increase between 2000 and 2016, these remain outweighed by those from the UK which continues to retain its position as the most important provider of FDI in the region. A study by Chen, Dollar, and Tang (2015) finds that China’s attraction to resource-rich countries is no different from Western investment except that China’s investments are uncorrelated with a measure of property rights and rule of law, whereas Western investments tend to favor better governance environments. Although SADC’s GDP growth benefits trade and investment flows, the potential value addition that could have been generated had those raw materials been semi-processed in the SADC region would have been considerably higher.

6. QUALITATIVE ASSESSMENT OF THE DEGREE OF HETEROGENEITY OF SADC GROUP

The purpose of this section is to qualitatively assess the degree of heterogeneity of SADC countries with regards to a number of parameters and indicators in an attempt to address the issue of whether SADC countries should diversify further. A heterogeneous block leads to potential trading opportunities between member countries, albeit no light is shed on the degree of diversification within a country. The results will also enable us assess the level of synchronicity of the bloc to external shocks, which, could potentially justify the case for diversification within member countries so as to act a bulwark against these aggregate shocks.

6.1. Degree of Economic Integration in SADC

SADC members have fairly dissimilar trade structures, and can be categorized into common groupings (e.g., resource-rich, low-income countries, small island economies etc.). We now turn to an analysis of the degree of concentration of export structure of each SADC member. Table 5 shows that there is evidence of extremely slow evolution in the degree of concentration of export commodities of all SADC countries, despite some evidence of structural transformation taking place in these economies (see section 5 of this paper). Countries which have traditionally retained a relatively heavily concentrated structure (e.g., Angola, Botswana, and Zambia) in the 1990s, still maintain the same structure in 2010-14. The evidence shows that Angola, Botswana, Seychelles, Zambia and Malawi, all have a relatively high index of concentration in 2010-14 with respect to their external trade patterns. As the region’s largest economy, South Africa had the lowest degree of concentration in 2014. The relative diversification of the South African economy may be rationalized on grounds that it is well integrated in the world’s trade and financial systems. Most other countries, including Mauritius, have a relatively well diversified trade structure, with an average index of below 0.5. While there is evidence or relative stability in the degree of concentration, one fact that also stands out is that, for many countries, especially resource-rich countries like Angola and Botswana, the degree of concentration has mildly increased in year 2010-14, hinting at the possibility of the Dutch Disease Effect or the Resource Curse Paradox at work.

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1995-2000 2000-2005 2005-10 2010-14 Angola 0.9 0.9 0.9 1.0 Botswana 0.7 0.7 0.6 0.7 Dem. Rep. of the Congo 0.6 0.6 0.4 0.4 Lesotho 0.4 0.4 0.4 0.3 Madagascar 0.2 0.3 0.2 0.2 Malawi 0.6 0.6 0.6 0.5 Mauritius 0.4 0.3 0.3 0.2 Mozambique 0.3 0.5 0.4 0.3 Namibia 0.3 0.3 0.3 0.2 Seychelles 0.5 0.6 0.5 0.5 South Africa 0.1 0.1 0.1 0.1 Swaziland 0.3 0.3 0.2 0.2 United Republic of Tanzania 0.2 0.2 0.2 0.2 Zambia 0.6 0.5 0.6 0.6 Zimbabwe 0.3 0.3 0.2 0.3

Source: UNCTAD and BOM staff

Table 5: SADC Countries. Concentration Index of Exports and Imports, 1995-2014


6.2 Macroeconomic Structure Growth performances – As we have seen in the last section, the production and exports base of SADC members, widely differ. Furthermore, there is a great degree of economic reliance of bloc members on Europe, US and China, as main trading partners. This particular aspect of the production and export structure of SADC members makes them highly dependent on the materialization of external events, but also prone to highly localized events. An analysis of real GDP growth rates of SADC members over the 1990-2015 period, provides a clear-cut case for heterogeneity, as economic growth is driven by highly localized one-off events. Angola recorded episodes of negative growth performances in 1990s due to civil war. The Democratic Republic of Congo (DRC) experienced negative growth rate in late 1990s due to the unfolding of political unrests and war. Madagascar and Zimbabwe similarly recorded negative growth performances during the last decade due to episodes of social and political unrests. Seychelles underwent a period of acute economic crisis in 2008 that saw its growth rate plummet into negative territories.

Inflation – While the growth picture hints at idiosyncratic factors as being dominant in driving growth performances of individual member countries, inflation in the trading block seems to rest more on a common footing. Apart from DRC and Zimbabwe7 which both experienced acute hyperinflation in the past, it is conspicuous that inflation experienced by SADC members, has followed a similar pattern across time, albeit with different magnitude and persistence. Since the SADC region as a whole is a net importer, it follows that an important factor driving inflation across SADC member countries is imported inflation. For instance, with the exception of Angola, most SADC member countries are oil importers and are thus subject to developments of unfolding events in the global oil industry. This common driver is also rationalized on grounds that the non-tradable sector is still at ‘catching up’ phase in the region as utility and transport prices are still regulated and housing still occupies a relatively low rank in the consumption basket weights of member countries. As a result, some degree of synchronization is observed regarding inflation across member countries.

External imbalances – The SADC region, as a whole, has run a current account deficit in the 1990-2015 period. Countries that were caught in the complication of civil wars, social unrests, political turmoil, and economic crisis, were also those that had experienced the sharpest current account deficit as a percentage of GDP, as exports were hindered in the midst of checked production. Despite having bands of agricultural lands designed to provide partial self-sufficiency in specific agricultural commodities, SADC member countries have depended on imports of many commodity items that their population usually consumes. While this may be vindicated on economic developmental grounds as transformation of their economies would undoubtedly be associated with mounting imports, the current account deficits experienced by most SADC member countries may also be explained by the low level of savings, as opposed to profitable investment opportunities available locally.

Savings-Investment Nexus –Most SADC countries have had relatively low savings rate as a percentage of GDP in the 1990-2015 period, with average investment hovering in the 10-30 percent range. These are below average benchmark levels for middle-income countries. The negative savings gap for the block is reflected in the current account deficit for the region, and bears testimony to the region’s dependence on foreign capital to fund domestic investment projects. In parallel, this translates into the region’s vulnerability to economic events taking place elsewhere, and points to the possibility of correlated macroeconomic risks in the region.

Debt-Revenue Nexus –Those SADC countries that had experienced some form of economic and / or political crisis in the 1990-2015 period, also recorded lower government revenue as a percentage of GDP. In parallel, these countries were also those that had experienced the highest proportion of debt as a percentage of GDP. With the exceptions of these crisis-stricken countries (DRC, Madagascar, Seychelles and Zimbabwe), many SADC countries have, over the last decade, adopted appropriate 7 The figures shown for Zimbabwe are not accurate.

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debt management strategies aligned with enhanced public financial management reforms following the Heavily Indebted Poor Countries (HIPC) Initiative that siphoned off a substantial amount of their debt. These countries had a reasonable mix of revenue-debt proportions.

6.3 Macroeconomic Convergence progress and implications

As aforementioned, several countries in SADC have been characterized by macroeconomic instability which, in turn, had stymied trade and diversification processes. However since the signing of the Memorandum of Understanding on Macroeconomic Convergence (MEC) in 2002, SADC countries have made some progress, although much still needs to be done. The positive impact of the MoU on Macroeconomic Convergence was that it helped recast investors’ confidence in the region away from the stigma of the past.

What do macroeconomic conditions suggest on diversification possibilities within SADC? The differing production and export structures of member countries point to a considerable amount of heterogeneity across members. However, as mentioned in the last section, commonality of members’ trading partners underscore common vulnerability of SADC member countries to external risks. This is reflected by synchronization of inflation patterns across the regional bloc. Furthermore, this external vulnerability is reflected by the member countries’ external imbalances, as mirrored by current account deficits and, by their negative savings gap. While these structures add a few extra layers of support to the vulnerability argument, they have nonetheless been stymied by good debt-revenue prospects as a result of public management reforms in the last decade. Overall, the idiosyncratic nature of their economies overlaid on a platform of common vulnerabilities, points to interesting prospects for accentuating trade diversification within member countries, as a mechanism to contain vulnerability shocks. But now, we turn to the fundamental capacity question as to whether they can diversify further, at all?

6.4 Development Indicators – Can SADC countries diversify further?

Do SADC member countries have the appropriate institutional setup to support trade and investment diversification, should they choose to embrace it at all? A number of prerequisites must hold to ensure the success of a diversification strategy. This section reviews these prerequisites from the prism of historical data covering education, financial deepening, ease-of-doing business, infrastructure access, and transport availability8.

Education – A well-educated population is crucial to ensure that all the various streams of diversification, (i.e., diversification of the production base and of the export base, as well as enhancing product quality and targeting new markets.) As structural transformation holds sway, trained manpower will ostensibly be needed in new sectors, and workers in declining (traditional) industries may need training in order to occupationally migrate to new sectors. Most SADC countries have good enrolment rates at primary and secondary school levels, although the situation with tertiary education enrolment paints a gloomier picture. The scarcity of data in some countries and the lack of reliability in others suggest that this interpretation should be exercised with caution.

Financial deepening – This metric, encapsulated by the ratio of domestic credit to GDP, shows that SADC countries in general have a more encouraging result than that of the entire SSA region. Financial deepening is a crucial indicator for ensuring success of potential diversification strategies

8 Due to hindrances, some countries did not report their data.19


since access to finance and broadening the range of financial services, go hand-in-hand with facilitating the diversification process. This issue will be covered in more details in the next section.

Ease of Doing Business – With the exception of Mauritius, South Africa and Seychelles, the ‘ease of doing business’ indicator, compiled by the World Bank, for the period 2008-2015 points to a disappointing performance for other SADC countries. Since this measure is often assessed by investors before deciding whether to invest in the region, it could also turn out to be a major hindrance on diversification prospects at the production level since without transfer of funds, technical know-how and of appropriate technology, chances of creating new highly-valued sectors are rather slim.

Infrastructure Access –Infrastructure coverage in most SADC countries looks rather unpromising. Two words of caution here: given lack of data, information is not available for many members. Furthermore, within member countries, a given figure for infrastructure access masks important disparities across various regions as urban dwellers have proportionately more ready access to infrastructure facilities than rural dwellers. It is conspicuous that wired broadband penetration has taken place at a slower pace in the SADC region than electricity access. Wireless internet access however looks more promising in the region, as evidenced by growing usage of mobile phones in the region. Lack of infrastructure access is an important stumbling block to the goal of achieving diversification. For instance, blockages to accessing electricity can easily check the establishment of manufacturing industries. Impediments to broadband access may stymie prospects for setting up a financial services industry.

Transport – Transport infrastructure and networks are good in SADC, compared to other parts of Africa, although more needs to be done in promoting reliability and access, before embracing diversification. The current transport network spans good availability of rail networks, good ports, airports and sea-land communication facilities. A word of caution here: while exports in the region tend to be transport-intensive, the costs of transport facilities have to be appropriately assessed so as not to hinder developmental prospects of new export-orienting sectors.

To arrive at a balanced conclusion regarding whether SADC countries are currently well-equipped to strengthen any potential diversification efforts, data constraints must be addressed and meaningful benchmarks must be developed so as to facilitate understanding of the current state of development in SADC. Policy measures covering each of the above indicators must be enacted in a timely fashion, if the authorities decide to push ahead with the diversification agenda.

6.5 Financial Inclusion

While financial deepening has been described as an important element that could act as a catalyst to diversification efforts, it turns out high deepening could conceal important underlying inequalities in access to bank facilities. If this is so, then efforts to diversify may be compromised. A number of granular metrics will be overviewed here9.

Legal rights-credit depth nexus – On a scale of 0-10 (0 being worst case and 10 being best), those countries in SADC which produced data on the strength of legal right and on the credit depth of information, achieved average scores. With data being unavailable for most countries, this metric, while important, does not shed much light on access conditions in the SADC region.

Bank facilities access – With the exception of Lesotho, Namibia, and Swaziland, for whom data could not be collected, most other countries had a disappointingly low proportion of adults owning a

9 Again, a word of caution should be issued as data was not available for many countries.

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credit card. Furthermore, the population access to commercial bank branches was above SSA average for Angola, Mauritius, Namibia, South Africa and Botswana. For the other countries in the region (barring Seychelles), the widely disperse cities with low population densities resulted in extremely low number of bank branches per 100000 inhabitants. In a similar fashion, the number of ATMs per 100000 inhabitants was above SSA average for the aforementioned countries in addition to Swaziland but below average for the rest. Lack of access to bank facilities may impede any attempts to diversify as foreign investors prefer to keep away from those countries in which their money is unsafe and in which they cannot readily access their money.

6.6 SADC Governance

The quality of governance in a country and the strength of its institutional setup, including social capital, are important determinants of its capacity to attract investment from abroad and of the speed at which new sectors can be created. A succinct scrutiny of the Mo-Ibrahim Index (Table A1 in the Appendix), which broadly measures the quality of governance through the prism of a number of legal and developmental factors, shows that, SADC members have, on average, traditionally fared better than the average country in Africa, and better than the average country in Sub-Saharan Africa (SSA). A more granular analysis showing the decomposition of each country’s 2015 overall score into separate components, reveals two facts. Firstly, countries that have relative abundance of natural resources tend to perform weakly. Not coincidentally, some of the worst performing countries are also those that have experienced episodes of economic turmoil and relatively poor human rights records. Secondly, these countries are also those that have greatest inequities in terms of their population’s access to infrastructure facilities.

6.7 Overall Qualitative Assessment

In the light of arguments developed in the last two sections of this paper, Box 1 below provides a synopsis of factors that may either promote or impede trade and investment diversification in SADC. Since both types of factors are very present in many member countries and vary in different intensities across the region, we present them as ‘stylized factors’ here. Note that a careful assessment with appropriate weightings should be done on a time series basis, before getting some quantitative sense as to whether diversification has increased or not. As Box 1 shows, there is mixed evidence as to whether SADC countries should diversify further. In some SADC countries, the level of institutional development, social capital and political fabric, all conjure together to speed up their readiness to embrace diversification process, more than in other countries.

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Factors in favor of Diversification Factors against Diversification

Governance

Lack of institutional accountability and bottlenecks in access to network infrastructure. Inadequate property rights in many countries

Structural Factors Different production and export structures of member countries

Commonality of trading partners

Macroeconomic Factors Improved fiscal spaceExternal vulnerabilities (exchange rate arrangements, reserves, and BOP)

EducationRelatively good enrolment at primary and secondary levels (all countries)

Low enrolment rate at tertiary level. Absence of skill-specific human resource development

Financial DeepeningGood ratio of credit-to-GDP, relative to SSA standards (all countries)

Financial inclusion in many countries is still an issue (lack of access and high cost of access)

Ease of Doing Business

Poor 'ease of doing business' indicators, despite tax and non-tax incentives given to foreign investors. Most FDI remain targeted to mining sector though. Inadequate infrastructural coverage (water, power, telecommunication and transport)

Infrastructure AccessAccess to electricity in many member countries has improved

Connection to wired internet is still disappointing

TransportFor inland SADC - Improved road network (e.g., Maputo corridor)

Relatively high cost of transport and communications

Bank facilities AccessMobile banking progress and improved payments system (e.g., SIRESS)

Relatively few bank branches per 100,000 inhabitants. Relatively few ATMs per 100, 000 inhabitants

InnovationTraditional product commercialization. SADC Tourism initiative.

Lack of support to 'self-discovery' process for encouraging innovation

Source: BOM Staff

Box 1. SADC Region - Qualitative Assessment

6.8 Igniting dynamic comparative advantage and building competitive advantage

The analysis so far has found that many SADC member countries are already exploiting existing their comparative advantage. One of the main policy recommendations is to frontload dynamic comparative advantage and build sustainable competitive advantage by putting in place the prerequisites to attract FDI and increase knowledge transfer in the region. As noted by Kiyoshi and Terutomo (1998), both the Ricardian and Heckscher-Ohlin models of trade are incomplete because they ignore the possibility of knowledge and entrepreneurial transfer. In the policy recommendations we propose in the next section, we focus on: the development of human skills; creation of an attractive investment climate; and the establishment of an industrial policy so as to better leverage on those value-drivers behind aligning dynamic comparative advantage with competitive edge. The proposed development of a value chain in the region is to spread the risk of investments among various countries as well as to create an enabling environment that allows Member States to harness, both, economies of scale and learning-by-doing effects. The proposed industrial policy will be flexible enough to adapt to factor endowments and available resources of SADC Member States. The paper thus endorses recommendations of the SADC industrial roadmap that is subsumed in section 7.3.

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7. KEY LESSONS AND POLICY MEASURES

In this section, we harness our findings from the last couple of sections and provide a synopsis of the key lessons to be retained for the SADC region. We then rationalize the case for policy measures in SADC. Doing so enables us design policy measures to expediently troubleshoot the most pressing impediments to diversification. A policy framework is finally proposed to turbocharge the diversification process and catalyze intra-regional trade.

7.1 Key Lessons

What are the key lessons for the SADC region in general and what prevents attempts to enhance diversification among member countries? As the analysis has shown so far, although SADC members have experienced enhanced volume of trade over recent years, the diversification of their production and exports base has remained limited. A deeper analysis of underlying economic structures and institutional frameworks, provides mixed evidence as to SADC economies’ readiness to embrace further diversification. As a result, a number of key lessons must be retained for the SADC zone, given its heterogeneity:

Economic geography matters – Proximity to markets is an important factor underpinning successful diversification process. Landlocked countries, for instance, are found to be relatively less diversified. Trade and transport costs contribute to the ‘Border Effect’ puzzle. The absence of appropriately linked rail networks in some member countries, for instance, poses a hurdle to those landlocked countries which find it hard to exploit new export clusters that require ‘Just-In-Time’ (JIT) manufacturing.

Size of country – The larger the size of the country, the greater the scope for physical attributes such as wide expanses of productive lands for agriculture, enhanced possibility of discovering natural resources deposits, etc. Climate and sparsely distributed population may nonetheless act as a constraint on broadening production and scope for exports. Although, agriculture’s contribution to GDP has been declining in the SADC zone, this argument is nonetheless relevant for some member countries which continue to depend on agriculture.

Resource Curse Paradox – This is relevant for resource-rich countries in the region and contributes to the explanation of heavily-concentrated export structures in these economies (e.g., mining and minerals). Although this is true at the production level, employment figures do not seem to be skewed towards these natural resource industries.

Lack of financial deepening and development – This factor is crucial in explaining the failed attempt of the region to design, develop, engineer and implement new export clusters. Although the SADC region as a whole fares better than many other parts in SSA in financial deepening terms, lack of access to credit in some member countries, especially in their rural parts, continues to act as a major constraint that strangulates production and export prospects for small medium enterprises, thereby stymying attempts at a national level to diversify.

Paucity of human capital – Most countries in SADC are endowed in land and natural resources which traditionally favor agrarian-based or natural-resource based economies. New export sectors that represent departures from these traditional export sectors cannot emerge without the availability of trained personnel, especially if these new products are skill-intensive and technology-intensive. Although, educational attainments are good in SADC region as per SSA standards, there is disparity among member countries in the availability of highly-trained

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manpower to support potentially new sectors. The scarcity of highly-skilled labor in selected areas of high technology also poses an immaculate challenge for SADC countries to engage in vertical specialization in certain sectors while maintaining the horizontal structure of their trade patterns. Investment in people is crucial especially for moving up the quality ladder. A better-educated workforce is also more likely to spawn successful entrepreneurs seeking to branch out into new activities and improve existing products. Two countries – one outside Africa - which have both been successful diversification stories, Vietnam and Rwanda, had stepped into this bandwagon. Vietnam managed to increase its average years of education by about 50 percent in just two decades, while Rwanda has expanded education through ninth grade for all students.

Lack of appropriate governance and legal structures - As empirical studies have shown, a major contributor to diversification is the widening of technological capacity thanks to spillover effects from FDI which have positive repercussions throughout the rest of the economy. While FDI flows to the SADC region has been increasing over years, in part thanks to South Africa, the increase is modest when benchmarked against EMEs. Major institutional hurdles include the lack of appropriate governance structures, high corruption and absence of adequate property rights in the region.

Infrastructure gap issues need to be addressed - Alleviating bottlenecks in infrastructure is an important ingredient to ease the diversification process since it lowers business costs. For services industries, liberalization of network industries (e.g., telecommunications and power industries) are pivotal elements of the reform package supporting structural transformation from agrarian-based economy to more diversified economy with both, manufacturing and service industry bases.

Government policy may be useful to assist countries in the diversification process - The government’s role is to address any market failures that may continue hindering the diversification process. Since diversification accompanied by the right package of measures, entails a number of positive externalities that may not be adequately factored in by market forces, certain types of industrial policies may become useful to help endogeneize these social benefits. The establishment of spatial agglomeration zones (e.g., industrial zones and export processing zones as illustrated by the cases of Mauritius and Vietnam) have proved to be effective in encouraging entrepreneurial activities by harnessing economies of scale, skills and knowledge spillovers, and backward and forward linkages associated with local markets. Furthermore, in small markets in which competition is not always feasible, the state has a significant role to play in supporting the diversification process through the appropriate regulation of infrastructure facilities.

Political economy considerations – Diversification entails the rapid disappearance of some traditional sectors, such as agriculture. Given the rural importance of agriculture in many SADC countries and the powerful electoral bases that the rural population represents, intense lobbies from the sector may jeopardize any efforts to diversify the economy further. Natural resource-rich economies have historically been prone to civil wars and political unrest. Weak governance structures and rife corruption have left control of resources in the hands of a few individuals close to power.

Macroeconomic stabilization - Some country cases (e.g., Mauritius, Rwanda and Tanzania) show that successful diversification has coincided (no causation claimed) with improved macroeconomic performance and a greater degree of political stability.

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7.2 Economic Analysis of Policy Options in SADC

The main onus of policy option should be on diversification of the production base and of the market as depicted in the flow chart below. With regards to the former (i.e., production base diversification), one has to bear in mind that many SADC countries have already explored their comparative advantages and that, due to macroeconomic and institutional constraints of the types considered under sections 5 and 6, many of these countries do not have sufficient capacity to harness resources to move to exploitation of new profitable production possibilities. With regards to the diversification of the market base, a number of challenges still exist, as evidenced by weak connectivity within the region, language differences, and different tax and incentives regimes. Increasing intra-SADC trade, through the implementation of a well-devised industrialization strategy, can unlock potential of member countries.

Notwithstanding the constraints to trade and investment diversification, there is nonetheless scope for these countries to develop new avenues of collaboration and to widen their production and export base. This can be done through the exploitation of the new world economic order in trade, i.e. to engage in ‘vertical specialization’. The term vertical specialization entails the process of supply chain processes of goods whose components are produced and assembled in different countries, i.e., vertically differentiated goods. South Africa, for instance, could specialize in high value-added manufacturing production due to its big market size and wide availability of opportunities for scale and scope economies, while importing spare parts and various components from regional partners. In this respect, each SADC member could specialize in the production of a separate component, given its resource constraints, institutional fabric and social capital. It could then trade with other members until the components reach assembly point and, the resulting product, is then sold by the region’s largest economy outside the region. Crucial in the attempt to realize this regional ambition is the need for SADC members to have a policy of mutual recognition of educational and vocational qualifications, a well-designed financial deepening and inclusion strategy, stronger institutions aligned with robust governance frameworks, as well as a common strategy to facilitate doing business. With the materialization and harmonization of these policy measures, it will be easier for the region as a whole to attract more FDI inflows which are crucial to finance the establishment of new production clusters. At the same time, a policy for allowing labor and capital to move in a flexible way in the region, unhindered by restrictions and / or visa considerations, should be envisaged. This would facilitate the circulation of labor resources across member countries and enable the region to better leverage on its own manpower skills to man high value-added production clusters. Several studies suggest that the development of intra-industry trade and vertical integration of supply chains within the region would benefit the regional integration process.

While SADC member countries vary in terms of their natural resources endowments, there is also scope for these countries to complement each other’s industrialization strategies while promoting the regional integration agenda. For instance, Angola, which is endowed with oil resources could

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collaborate with South Africa which has manufacturing capacity, to develop high value-added products that are oil-intensive, such as plastics. Chart 4 provides an overview of a framework that could be adopted throughout the SADC region to boost the diversification process and stimulate intra-regional trade. The main thrust is to put in place the prerequisites to attract FDI and expand the production base and grow markets through high intra-SADC trade. A common strategy for the region will enhance its possibility to embrace wider production and export base which, by ricochet, will percolate through and benefit each individual member country in the region.

↑

↑ ↑ ↑ ↑

→ →

Source: BOM Staff

Chart 4: Framework for Facilitating Diversification in SADC and for boosting Intra-Regional Trade

Attract FDI in the Region

Facilitate labor movements

within the bloc

Industrialization strategy in each member country with information sharing at the regional level to encourage intra-SADC FDI and encouraging vertical home integration

Countries increase trade and investments between themselves as a result of being part of a proposed value chain in the SADC region

Each member country specializes in a separate horizontal or vertical component. Development of domestic and regional market to achieve rising per capita income, innovations and commercialization of indigeneous products

More robust institutions and appropriate governance structures

Review of tax structures and of incentives to support the industrial agenda

Strong legal system

Political Stability

Common financial deepening and inclusion strategyReview of education policy and Peer review process

Relaxation of non-tradable constraints (e.g., customs clearance, port tariffs etc).

Even though regional integration might be seen as a tool for member countries to leverage on the power of joint negotiation on key economic and diplomatic issues vis-à-vis other trading blocs, it is important that SADC countries give weight to their national industrial development strategy which can be complementary to the regional initiative. Indeed, regional trade integration by itself is not a catalyst to economic development. In this respect, infrastructure improvement and a well-developed industrialization policy may be a prerequisite for successful trade integration and growth.

Economic theory vindicates the existence of strong linkages between trade policy, investment policy and industrialization, and it is imperative to understand that any desired level of industrialization is derived from investment that is facilitated by the existence of trade. In the worst case scenarios trade liberalization without a well-implemented industrialization policy could end-up making a country worse off. Zambia, for instance, have suffered from trade diversion in the form of de-industrialization as a result of trade liberalization not being complemented by sufficient investment in building manufacturing infrastructure and therefore leading to the wholesale import of goods and services that could have otherwise been produced locally.

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7.3 SADC Industrialization Strategy and Roadmap 2015 -2063

The current paper’s observations and policy prescriptions are in line with SADC Industrialization Strategy and Roadmap 2015 -2063. At the release of this strategic document in April 2015, the SADC Chairperson noted that “despite persistent efforts to boost trade within the region through the SADC Free Trade Area, the value of intra-SADC trade has remained very low, at only 17 percent of total SADC trade. Exports from the region are dominated by unprocessed or minimally processed products mainly from the agricultural and mineral sectors, thus providing very low value returns”. It was estimated that in agriculture, SADC countries’ exports earned approximately 10 percent of the potential value of the products.

The SADC Industrialization Strategy and Roadmap 2015 -2063 is a collective effort as a region to increase manufacturing capabilities of SADC member countries in order to increase value addition with emphasis on developing key infrastructure and technology. The strategy is based on three pillars:

Industrialization as champion of economic and technological transformation; Competitiveness as an active process to move from comparative advantage to competitive

advantage; and Regional integration and geography as the context for industrial development and economic

prosperity.

The Strategy’s long term vision is aligned to the African Union Agenda 2063, covering the period 2015-2063. SADC member countries are expected to progressively move from factor-driven to investment-driven, then to efficiency-driven and ultimately to high growth trajectory based on knowledge, innovation and business sophistication, very much in line with the policy recommendations of this paper. The quantitative goals of the SADC Industrialization Strategy and Roadmap 2015 -2063 are very instructive of the huge task ahead. They include the following:

To lift the regional growth rate of real GDP from the 4 percent annually (since 2000) to a minimum of 7 percent a year;

To double the share of manufacturing value added (MVA) in GDP to 30 percent by 2030 and to 40 percent by 2050, including the share of industry-related services;

To increase the share of medium-and-high-technology production in total MVA from less than 15 percent to 30 percent by 2030 and 50 percent by 2050;

To increase manufactured exports to at least 50 percent of total exports by 2030 from less than 20 percent in 2015;

To increase share of industrial employment to 40 percent of total employment by 2030.

The most important role of central banks within this transformational roadmap will be to ensure macroeconomic and financial stability to sustain progress, and to provide an enabling environment that makes finance available to stakeholders of the roadmap for timely implementation of the development programs. Central banks will thus have to strive at maintaining stable exchange rates, in line with economic fundamentals, price and financial stability.

8. ROLE OF CENTRAL BANKS TO PROMOTE ECONOMIC DIVERSIFICATION IN SADC

In maintaining low and stable inflation rate, stable exchange rates, adequate foreign reserves and a sound and well-capitalized banking system, central banks help create a strong foundation for sustained economic growth and development. Central banks also need to ensure that the financial

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intermediation process in the economy is efficient, safe, sound and adequate to meet the needs of a growing economy.

Most SADC economies have weakened noticeably against the backdrop of weak commodity prices, a stronger US dollar and climatic change. For instance, Angola, which is heavily dependent on oil exports, recorded a 30 percent depreciation of its currency in 2015, which led to double-digit inflation and shortages of foreign currency. In 2016, the Democratic Republic of the Congo had to deal with a 24 per depreciation of the local currency which pushed year-on-year inflation to a high of 11 per cent. In South Africa, GDP is projected by the IMF to edge up slightly from 0.3 percent in 2016 to 0.8 percent in 2017. Strengthening the economic structures of SADC economies through the implementation of a coherent diversification strategy should be on top of the economic agenda in each Member State. The CCBG’s new strategic approach to promoting economic integration, focusing on five Strategic Focus Areas (SFA) would contribute to more effective interventions and strategies in areas falling under their purview of SADC central banks.

(a) Price Stability and Financial Stability In the wake of the global financial crisis, the mandate of many central banks globally has been extended to include financial stability, in addition to their primary objective of price stability. The global economy is still subject to significant downside risks pertaining mainly to rising protectionism, a sharper than expected tightening in global financial conditions and a severe slowdown in China, which could pose serious challenges for SADC central banks to deliver on their core functions. Exchange rate stability is another key goal that central banks need to achieve to reduce business risks in the SADC regions. When exchange rates are artificially overvalued or undervalued, the seeds of instability are sown. So central banks must continuously be on their guards to ensure that the exchange rate in their respective economies, is as far as possible, market determined and move in line with the economic fundamentals, which is key for macroeconomic and financial stability. It is also noteworthy that different exchange rate regime have different macroeconomic outcomes. The IMF in its October 2016 Regional Outlook of sub-Saharan Africa, found that since around 2000, countries with more flexible exchange rate arrangements in sub-Saharan Africa have enjoyed 1–2 percentage points higher annual output per capita growth rates than countries with exchange rate pegs.

SADC central banks therefore need to monitor closely these risks and implement appropriate policies aimed at minimizing such risks. Putting in place an appropriate framework of coordination between the central bank and fiscal authorities with explicit appreciation of the limits of the tools available to each side helps minimize policy errors and contribute to better outcomes in terms of macroeconomic and financial stability. Clearly defined mandates for central banks as well as operational independence in terms of resources and tools to implement effective monetary policy and financial policies are key in this regard.

(b) Attaining monetary union

It has been decided that the establishment of the monetary union should be a long -term objective of SADC. Macroeconomic convergence, a key condition for monetary union, has been impacted negatively as adverse global economic and financial developments have weakened the economic structures of SADC Member States. In 2016, the inflation has increased to a level well beyond the primary convergence criterion while the fiscal deficit and public debt have increased noticeably. Although within targets, the inflation and fiscal deficit have reached levels very close to the target. The level of foreign reserves and real growth rate registered so far are inadequate to drive the region on the path of rapid economic and social transformation. Recent macroeconomic conditions call for enhanced vigilance and corrective policies to avert further deterioration of key convergence indicators. The SADC Peer Review Process is no doubt a positive development which can contribute to regional macroeconomic convergence if backed by an effective surveillance system and robust national and regional data frameworks. Central banks have a key role to ensure that monetary and

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balance of payments data they compile and publish are comprehensive and as per international benchmarks.

(c) Financial Inclusion

Financial inclusion can provide a boost to the financial sector, in particular, with respect to the domestic market and contribute to inclusive economic growth. In SADC, the level of financial exclusion is high with significant variances across Member States, ranging from 6 percent in Seychelles to 60 percent in Mozambique. Overall, it is estimated that 34 percent of the adult population in SADC are financially excluded, that is they do not use any financial products – neither formal nor informal.

While in the past, cost has been the principal bottleneck in many financial inclusion initiatives, technological improvements have morphed financial inclusion into a commercially viable option. Thus, if appropriate technology is harnessed and the requisite policies are applied, assisting the financially-excluded groups, in particular the Small and Medium Enterprises (SMEs) and agriculture, can allow them to save, invest and grow, with positive spillover effects in their respective economies. SADC central banks can thus actively participate in national financial inclusion strategies so as to reap these benefits by providing an enabling environment for such developments to take place.

(d) Financial Markets Development

Financial markets development is an important area of focus for central banks. A deep and more developed financial market contributes to sustained growth and facilitates the transmission of monetary policy impulses to the productive sectors of the economy. There is scope for financial markets, including primary and secondary market for Government/central bank securities and stock markets, to be developed and deepened in SADC by making a greater range of options available for both foreign and domestic investors. It is encouraging that SADC countries are increasingly tapping global capital markets. Eurobonds have been issued by Zambia, Namibia and Angola. Developing the capacity to effectively manage the issuance process and handle ensuing debt management and investor relations issues are very important. The maintenance of positive real interest rates, through reduction of inflation to low and stable rates, is key in promoting domestic savings and thus, reduce vulnerability to abrupt capital withdrawals and exchange rate depreciation.

(e) Promoting Financial Integration in SADC

Central banks in the region could also pursue efforts aimed at enhancing financial integration in SADC. In their role as custodians of the payments and settlement system, they can promote a broader set of transactions, including ATMs, e-banking, and mobile-banking, so as to enhance financial deepening. In parallel, initiatives pursued by central banks globally to establish deposit insurance schemes to protect small depositors, extend the payments systems to rural regions, and develop credit information sharing mechanisms such as credit bureaus, contribute towards enhanced financial access and greater inclusion. A study by Moody’s Analytics in 2013 indicated that a one percent increase in the use of credit cards would increase consumption by 0.056 percent and GDP by 0.032 percent, respectively. While the role of technology in boosting financial deepening and financial inclusion is key, cybersecurity issues should be on top of the agenda of regulators and policy makers.

A regional payment system has several benefits including reduced cost and execution time of transactions and lower reliance on US dollar as a trading currency. In terms of cross-border payment systems there has been continued expansion in the operations of the SADC Integrated Regional Electronic Settlement System (SIRESS). Going forward, the challenge is to extend SIRESS by rendering it multicurrency while ensuring it is competitive relative to correspondent banking charges. Trade and investment diversification in SADC would also be supported as Member States pursue efforts to remove remaining capital controls, while proceeding in a prudent manner to preserve financial stability.

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Some SADC countries have more sophisticated and deeper financial markets than others. Harmonization of financial market practices across countries, the harmonization of banking regulations and supervision and the development of a regional crisis management mechanism could foster greater financial integration in the region. It is also very important to promote financial integrity in transactions by ensuring adherence to agreed international principles and standards, including ESAAMLG initiatives, in the transactions undertaken by SADC financial institutions.

9. CONCLUSIONThis paper explores three questions: Do SADC countries have the potential to diversify? Have they diversified so far? Should they diversify further? With regards to the first question, a qualitative assessment of the economic structures and various institutional and social indicators in various Member States, provides mixed evidence as to their readiness and capacity to diversify. With regards to the second question, we find that SADC countries have not diversified so far, based on concentration measures gauging diversification. Regarding the third question, we find that the main constraints to further trade and investment diversification in the SADC region are common.

It is also observed that most SADC countries have already explored their existing respective comparative advantages. We argue that SADC countries must accelerate their diversification agenda by tapping into vertical and diagonal diversification going forward by adopting an industrial policy that is suited to their resource endowments and by building new dynamic comparative and competitive advantages. While loosely based on the East Asian paradigm, this could mean enhanced economic and business activities in the SADC region which will enable it harness scale economies, learning-by-doing effects and knowledge transfer. This would create the right conditions to catalyze trade and investment diversification in the region. Appropriate institutional and social structures must be developed in this realm, and safeguards must be established so as to translate this objective into reality. The principal role of the central bank in this process is to maintain macroeconomic and financial stability and to create an enabling environment for deeper regional financial integration.

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REFERENCESAcemoglu. D. and F.Zilibotti (1997), “Was Prometheus bound by chance? Risk, Diversification and Growth”, Journal of Political Economy, 105(4): 709-751Binti. F.F. (2011), “Pattern and Determinants of Export Diversification in East Asian Economies”, International Conference on Social Sciences and Humanity, Singapore Cabral, M.H., P. Vega (2010), “Determinants of Export Diversification and Sophistication in SSA”Cadot, Carrere and V. Strauss-Kahn (2007), “Export diversification: what’s behind the hump?” Centre for Economic Policy Research Discussion Paper, No. 6590.Cadot, O., C. Carrère and V. Strauss-Kahn (2011), “Export diversification: What’s behind the hump?”, The Review of Economics and Statistics 93(2): 590-605.Callen, T., R. Cherif, F. Hasanov (2014), “Economic Diversification in the GCC: The Past, the Present and the Future”, IMF Staff Discussion Note SDN 14/12Chauvin, S. and G. Gaulier (2002), “Prospects for increasing trade among SADC countries”, CEPII Annual ForumRodrik, D. (2004), “Industrial Policy for the Twenty-First Century”, CEPR Discussion Papers 4767, C.E.P.R.Foreign Direct Investment in SADC Countries, Paper Prepared for the CCBG by Reserve Bank of ZimbabweGenesis Analytics (2012), "Protocol on Finance and Investment Baseline Study: Regional Report"ILO Working Paper No. 175 (2015) Role of the Central Bank in supporting economic diversification and productive employment in Cambodia Imbs and Wacziarg (2003), "Stages of diversification," American Economic Review, 93(1): 63-86IMF Policy Paper (2014), “Long Run Growth and Macroeconomic Stability in Low-Income Countries”IMF October 2016 Regional Outlook of sub-Saharan Africa IMF Staff Discussion Note (2014), “Economic Diversification in the Gulf Cooperation Countries”Intra-SADC Trade in Goods and Services, Paper prepared for the CCBG by Bank of TanzaniaKrugman, P. and M. Obstfeld (2008), “International Economics: Theory and Policy”, Addison Wesley PublicationsKojima Kiyoshi and Ozawa Terutomo (1998), “Toward a theory of industrial restructuring and dynamic comparative advantage”, Hitotsubashi Juournal of EconomicsLove, J. (1979): “Model of Trade Diversification Based on the Markowitz Model of Portfolio Analysis”, Journal of Development Studies, Vol. 15, No. 2, 233-241Markusen et al. (2005), “International Trade Theory and Evidence”, McGraw-Hill PublicationsMatthe, M. and W. Naude (2008), “Export diversity and regional growth in a developing country context: empirical evidence, Paper submitted to the Regional Studies Association International Conference: “Regions: The dilemmas of integration and competition”, Prague, 27–29 May 2008.Moradzikwa, S. (2002), “Foreign Investment in SADC”, Development Policy Research Unit Working Paper 02/027Papageorgiou.C. and N. Spatafora (2012), “Economic Diversification in LICs: Stylized Facts and Macroeconomic Implications”, IMF Staff Discussion Note SDN 12/ 13SADC Industrialization strategy and roadmap 2015-2063, 29 April 2015 Sannassee, R.V., B.Seetanah and M. Lamport (2014), “Export Diversification and Economic Growth – The Case of Mauritius” In: Jansen, M., Jallab, M.S. and Smeets, M., Eds., Connecting to Global Markets—Challenges and Opportunities: Case Studies, Chapter 1, WTO, Geneva, 11-23.W. Chen, D. Dollar, and H. Tang (2015), “Why is China investing in Africa?” Evidence from the firm level.

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APPENDIX

Box A1: Exploring the Theoretical Nexus Between Production and Exports Diversification

The first quadrant (low exports diversification, low product diversification) is an extreme case that characterizes many LICs in SSA that display the following features: (1) an extremely narrow production base; (2) heavy dependence on one of very few partner countries; (3) export sector dominated by a poorly-performing state-owned enterprise (SOE); (4) serious infrastructure gap problems; occupationally and geographically immobile labor, and (5) presence of natural (non-renewable) resources. These five features result in little role for diversification as any natural resource price booms crowd out any scope for other tradable sectors to develop (Dutch-Disease Effect). Since infrastructure facilities are deficient, this also thwarts the development of non-tradable sector. The second quadrant (high production diversification, low export diversification) is characterized by economies which have made strides to address infrastructural gap issues and horizontal reforms (e.g., education) but whose export sector tends to remain under the dominion of a natural-resources SOE. Commodity price booms will, in this case, raise price of non-tradables and result in a shift in labor into the non-tradable sector (Balassa-Samuelson Effect). The third quadrant (low product diversification, high exports diversification) is characterized by economies whose exports diversification process has embraced quality upgrades and / or diversification into new markets, although the production base has remained unchanged. The fourth quadrant (high product diversification, high exports diversification) is characterized by economies at a relatively advanced stage of development, with a highly educated and mobile labor force, and with relatively little or no infrastructural deficiency. The diversification process features new products, new markets and quality upgrades for existing products, with sectorial re-allocations of labor supporting the overall diversification process.

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LOW HIGH

LOW

Non-Tradables play an insignificant role+Natural Resources Economies => Diversification plays no role (Dutch-Disease effect / Resource Curse Paradox)

Non-Tradables sector play an insignificant role + Non Natural Resource Economies => Diversification takes form of quality upgrades and / or new markets

HIGH

Non-Tradables play a relativelyimportant role + Natural Resources Economies => Diversification takes place in non-tradable sector (Balassa-Samuelson Effect)

Non-Tradables play a relativelyimportant role + Export-oriented production structure with labor mobility across sectors => Diversification may take form of new products, new markets and of quality upgrades

Production Diversification

Exports Diversification

Source: BOM staff interpretation


(Contd…)

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Natural ResourcesMain Export

PartnersMain Import

PartnersMain FDI Partners

Main Exports Constraints to DiversificationCapital / Exchange

ControlsPolicy Measures

Angola

Minerals (Crude Oil, Uranium, copper, gold, zinc, coal); diamond; fisheries; forestry

China (45%); USA (13 %); India (11%); S. Africa (4%); Other (31%)

China (20%); Portugal(19%); USA (7%); Brazil(6%); Other(48 %)

N/A Crude Oil,petroleum products, coffee, cotton, fish,diamond

Poor Ease of Doing Business; lack of national diversification strategy

Exchange Control Under IMF program to stabilise the preconditions for stable economy

Botswana

Diamond, copper, nickel, soda ash

Europe (86%); S. Africa (9%); Zimbabwe(3%); Other (2 %)

Europe(24%); India (23%); China (15%); SADC(7%); Other(31 %)

N/A Diamond Landlocked and population size

MadagascarMining (titanium, nickel, cobalt); Gold and Precious Stones

Europe(32%); Other (49%); USA(8.4%); SADC(6%); China (4.5%)

Other(61%); China(15.5%); Europe(11.5%); SADC(8.6%); USA (3.2%)

n.a (FDI flows into mining sector, telecom, and EPZ)

Political instability; high cost of doing business; poor access to infrastructure; lack of confidence

None on current account; however, capital account is still subject to controls

National Development Plan adopted by the authorities aims to tackle impediments to trade and investment diversification. The main objectives include: increasing the share of agriculture in exports; improving the institutional/legal system for natural resource management; promote good governance and promote access to finance.

Mozambique

Natural and mineral resources (gas, titanium, gemstone, bauxite, coal); water and energy resources; forestry

Europe (44%); SADC (29%); Other (20%); China (5.2 %); USA (1.4 %)

SADC (39%); Other (29%); Europe (23%); China(8.5 %); USA (2%)

USA (36%); Other (39%); Europe (14%); SADC (13%); China (0.9%)

Paucity of credit and market access; high government tax levels; high cost of transportation and communication; high cost of doing business

None on current account; capital account is subject to restrictions

Policy measures by the authorities currently aim at improving the business climate; a wide variety of tax benefits and other non-tax incentives are provided; a free trade area and a private sector association aimed at improving the country's competitiveness, have been established.

Box A2: Preliminary Assessment of Trading Structure of SADC Member Countries


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Mauritius

None Europe (50%); Other (25%); SADC(15%); USA (10 %)

Europe(24%); India (23%); China (15%); SADC(7%); Other(31 %)

Europe (53%); Africa(25%); Other (22%)

Textile, Tourism, Seafood and Sugar

Market size, geography and limted naturalresources

Exchange Control Suspended in 1994

Development of new sectors, recently with increasing emphasis of taking adavantage of Ocean resources.

Namibia

Minerals (Uranium, gold, copper, zinc, coal); diamond; fisheries; forestry

SADC (especially South Africa)

SADC (mostly South Africa); UK; USA; Germany

Crude materials (except fuel); Manufactured goods

Ease of Doing Business; investment climate; focus on sectors that are not labor-intensive (e.g., minerals); EPZs focusing on labor-intensive manufacturing, will be phased out

None on Current Account; Restrictions apply to capital account

Various tax rebates and non-tax incentives are provided by the government; access to netwrok industries (e.g., railways, telecommunications, port, power etc) has greatly improved recently.

Seychelles Fisheries

Europe (France, Germany, Italy, UK), SADC, China

SADC, China, Europe

FDI flows essentially in tourism-related projects

Tourism, Fisheries

Poor Ease of Doing Business; lack of national diversification strategy

None The Seychellois government has taken a number of initiatives, through the Seychelles Investment Board, to facilitate doing business; a number of Double Taxation Avoidance Agreements (DTAA) will be signed to faciliatte routing of foreign investment via Seychelles.

Tanzania

Zambia

Copper (6 % of world reserves); arable land and 40 % of SADC fresh water; deposits of gold, zinc, coal and gemstones

SADC (22%); China (19%); Other (59%); Europe (1.4 %); USA (0.1 %)

SADC (52 %); China (9%); Other (30%); Europe (5%); USA (1.8 %)

Europe (52%); Other (16 %); China (16%); SADC (15 %); USA (0.4 %)

Mining (70 % of foreign currency reserves); Agriculture; Tourism; Energy

Ease of Doing Business

None

Zambia Development Act 2006 provides tax and non-tax incentives to foreign investors wishing to invest over $500,000. Investors in priority areas are exmpt from taxes; Zambia's new investment framework enables identification of priority sector areas for foreign investment

Zimbabwe

Source: Country Authorities (Compiled by BOM staff)


Box 4: Mo-Ibrahim Index Table for 2015

Overall Rank*

Overall Score

Safety and Rule

of LawAccountability

Participation and Human

Rights

Sustainable Economic

OpportunityInfrastructure

Human Development

Mauritius 1 79.9 80.8 65.6 76.0 79.0 92.3 83.7Botswana 2 73.7 81.9 72.1 69.3 65.2 64.0 78.5Seychelles 4 72.6 74.1 55.9 67.1 64.8 85.5 84.2Namibia 5 69.8 76.1 60.4 76.1 62.2 69.9 64.7South Africa 6 69.4 67.1 61.5 71.4 68.4 65.0 70.6Zambia 13 58.8 66.5 42.5 61.4 46.4 38.0 61.0Lesotho 15 57.8 67.1 59.8 64.6 45.6 37.5 53.8SADC 57.7 61.7 43.7 58.8 49.8 46.6 60.3Malawi 17 56.6 62.2 29.4 65.8 44.1 38.3 54.3Tanzania 18 56.5 60.4 36.9 63.5 46.8 31.9 55.5Mozambique 21 52.3 54.0 28.4 58.3 47.3 34.2 49.5Swaziland 29 49.7 60.8 40.5 27.6 49.7 53.0 60.7Madagascar 33 48.5 55.0 36.3 64.7 33.1 16.6 41.1Zimbabwe 39 44.3 43.8 24.2 45.1 34.6 34.1 53.8Angola 45 39.2 44.3 16.0 35.5 30.4 24.4 46.7DRC 46 35.8 31.0 26.2 36.2 29.0 15.0 47.0

Source: Mo-Ibrahim Foundation Website*Overall Rank on 54 African countries.

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Documents

Docum… · Web viewThe SADC integration initiative did not provide the expected impetus to trade and investment diversification. There is concern that, although Member States have