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A quarterly magazine of the IMF	June 2007, Volume 44, Number 2

Connecting Africa and Asia
Harry G. Broadman

Improved Asian market access can boost Africa's exports, but Africa needs domestic reforms to fully capture the economic benefits

The recent boom in developing country commerce between Africa and Asia epitomizes the explosion of South-South trade. These trade flows are driven by the burgeoning middle classes in Asia's emerging economic giants—China and India—whose appetite for Africa's commodities is growing, and by rising economic growth in sub-Saharan Africa (SSA), which is increasing the demand for Asian manufactured goods.

These trends are fostering trade that is qualitatively different from Africa's traditional North-South commerce with the European Union (EU) and the United States, in which trade flows have been stimulated largely by preferential arrangements. The strengthening South-South complementarities between the two developing regions suggest that the trade we are observing is likely to be sustainable.

As the global marketplace becomes increasingly integrated, much is at stake for the economic welfare of millions of people in SSA. This article explores the evolution of Africa-Asia trade, as well as its developmental, commercial, and policy implications.

Africa in the global context

Over the past decade, many SSA countries have made significant economic progress. During 1996–2005, 34 percent of the continent's population resided in countries where growth was 4.5 percent or higher—and these were non-oil-producing countries. That there is an emerging class of African economic "success stories," especially outside of the oil producers, is surprisingly little known.

Even so, SSA's trade record remains poor—in no small part because of the continent's numerous small, landlocked countries and high degree of geographic segmentation (see box). World trade accounted for 16 percent of global output in 1991 and 20 percent in 2004. But Africa's export market shares have fallen continuously over the past six decades (Broadman, 2007).

Since 1999, prices for Africa's leading commodity exports have increased noticeably. The price rise was engendered largely by the rapid growth of Asia's developing countries, notably China and India. At the same time, the desire of these Asian countries' middle classes for manufactured goods has been rising. These demand dynamics create important opportunities for Africa's businesses to increase and diversify exports. They also create the potential for African entrepreneurs to extract more value locally by further processing commodities before exporting them.

Asia-Africa trade patterns

Over the past 15 years, trade flows between Africa and Asia have increased rapidly, the hallmark of the recent growth of South-South trade.

Shifting shares. During 1990–95, Africa's exports to Asia grew by 15 percent and, over the past five years, by 20 percent, with Africa's export growth to Asia surpassing that to all other regions (see Chart 1). Asia is now Africa's third most important export destination after the EU and the United States. Africa's imports from Asia have also grown, but less rapidly than exports (see Chart 2).

Emerging complementarities. Manufactured products account for only 20 percent of Africa's total exports, and the pattern of Africa's exports to Asia is consistent with this global pattern. Commodities account for 86 percent of SSA's exports to Asia, and 80 percent of SSA's imports from Asia are manufactured goods. But there are dynamics at work suggesting growing complementarities between the continents. African countries could supply processed materials to Asian countries, linked to industrial and consumer growth. The growing populations in China and India with higher incomes are spurring purchases from Africa. At the same time, Africa is importing Asian manufactured products for consumption by households and for use as capital goods in the manufacturing sector, in which growth is taking off.

The China-India role. China and India, two of the world's most dynamic economies, doubled their annual growth rates of Africa's exports between 1990–94 and 1999–2004 (see Chart 3). These countries'—especially China's—leading role also applies to Africa's imports (see Chart 4).

Africa exports mainly petroleum and raw materials to China and non-oil minerals to India. Its exports of oil and natural gas to China account for more than 62 percent of its total exports to that country, followed by ores and metals (17 percent) and agricultural raw materials (7 percent). Africa's exports to India are also dominated by resource-based products, with ore and metals accounting for 61 percent and agricultural raw materials for 19 percent.

From China and India, Africa imports more value-added commodities—mainly textiles and apparel, electric machinery and equipment, and such consumer products as medicine, cosmetics, and batteries. Manufactured products account for 87 percent of imports from China.

Policies "at the border"

Improved market access for low-income countries has been at the top of the trade agenda in recent years, particularly in the context of the multilateral Doha Round, but also in bilateral and regional forums. The lowering of industrial countries' multilateral tariff and nontariff barriers on Africa's products should increase its exports substantially. But African countries also face such barriers in the South, including in Asia's developing countries. And some African countries also have high tariffs and nontariff barriers that restrict trade flows, in some cases imparting a bias against Africa's exports.

Although Asia's tariffs on African exports are gradually declining, the trend is weak, especially for Africa's least developed countries (LDCs). For some specific product groups, Asian tariff rates are higher for African LDCs than for non-LDCs. Those groups—inedible crude materials and food and live animals—account for two-thirds of African LDCs' total exports to Asia.

Recent evidence suggests that, all other things being equal, high Asian tariff rates on some African products may be discouraging their export to Asian countries. High Indian tariffs on agricultural products are of particular concern because they affect products in which African countries have growth potential. China is a relatively liberalized market, with zero or close to zero tariffs on 45 percent of its imports. It plans to further lower its tariffs and bring about lower dispersion in the structure of tariffs by the end of 2007.

The structure of some of Asia's tariffs is particularly problematic for Africa's export prospects to that region. Higher tariffs are imposed on more processed products to retain higher value-added activities in the domestic market, and lower tariffs are applied to locally available raw materials, creating incentives for the domestic industry to access cheap inputs abroad and process them at home. The cascading pattern of tariff rates along the level of processing is called "tariff escalation," which discourages Africa from processing products exported to Asia. A poignant example is an Indian-owned cashew firm in Tanzania that cannot profitably export roasted nuts to India because India imposes higher tariffs on processed nuts than on raw nuts.

In some products, African producers cannot capture the benefit of low tariffs in Asian markets because they lack production capacity. One example is cocoa beans. China is slightly reducing its imports of raw cocoa beans and increasingly importing processed cocoa bean products, such as cocoa powder, cocoa paste, and chocolate. But Africa's exports of cocoa beans to China are overtaking those of cocoa powder and chocolate. China imposes a tariff of only 9 percent on finished chocolate, not very different from its 8 percent duty on cocoa beans. But even with a relatively low tariff on chocolate, Africa has little opportunity to penetrate the Chinese chocolate market because it does not have the supply capacity to produce high-quality chocolate.

Policies "behind the border"

A compelling case can be made for removing escalating (and other) tariff barriers to enable African exporters to access Asia's markets, but such reforms are not substitutes for reforms in Africa's domestic markets. These reforms include reducing domestic barriers to entry and exit and establishing institutions that foster vigorous domestic competition between companies; putting in place effective incentives and discipline to bring about sound governance; and pursuing policies that make domestic labor and capital markets more flexible. Moreover, the removal of tariff barriers will not enhance trade unless African countries are able to produce goods cost-effectively and identify where demand exists.

Although Africa's exports to Asia as a whole do not exhibit significant product diversification, its factor endowments complement those of China and India. Africa, with its rich resources, has a natural comparative advantage in producing raw materials, including energy resources. China and India, with their rich supply of skilled labor, have a comparative advantage in manufactured products.

But there are three signs that show positive shifts in these complementarities—shifts that can be reinforced by domestic reforms in Africa. The first is the prospect for resource-based value-added manufacturing exports, which China and India are importing. African countries could increase their manufactured exports to China and India based on their existing exports of raw materials. However, growth is always limited by horizontal diversification. African countries do not want to remain a "resource basket" for other economies but instead hope to realize dynamic efficiency gains by extracting values from their endowed resources. Natural resources should allow African countries to launch value-added activities. Although still limited to a few countries, such as Nigeria and South Africa, resource-based manufactured products such as aluminum, iron, and steel figure among Africa's leading exports to China and India.

The second sign is the prospect for broader participation in global value chains. New evidence shows that vertical complementarities along value chains between Africa and China and India are growing. For example, among Africa's top 20 exports and imports with China and India, clear complementarities exist in the cotton-textile-garment value chain. West African countries supply raw material (cotton) to China and India, which supply intermediate materials (fabrics) to apparel producers in Mauritius, Nigeria, South Africa, and other SSA countries. New business case studies show that African producers could participate in global network trade in the apparel sector.

The third sign is the diversity among African countries and potential benefits from regional integration. South Africa has evolved as a regional hub of industrial and commercial development in SSA and beyond. The technological complementarities between South Africa and China and India provide scope for more intra-industry trade. Through regional integration, the emerging intrasectoral complementarities between Africa's industrial leaders and China and India could lead to wider benefits in the subregional markets through further forward and backward linkages.

Africa can benefit from the rapidly growing markets in China and India to achieve broad-based economic development. To do so, it must determine how to create an enabling environment for engaging more extensively in value-added production in the natural resource and other sectors and how to participate effectively in global supply chains. A key to entering supply chains is attracting foreign direct investment (FDI).

Asian-African FDI patterns

A large proportion of FDI inflows to SSA goes to the oil sector. For the past 15 years, 70 percent of FDI has been invested in five of Africa's seven oil-exporting countries and in South Africa, which has attracted the most dynamic FDI among African countries, including in the financial sector after its mid-1990s liberalization. Still, although 50–80 percent of FDI in most African countries goes to natural resource exploitation, some countries are increasingly able to attract FDI into the telecom, food processing, tourism, construction, electricity, retail trade, light manufacturing, and transportation equipment sectors. This is a recent phenomenon, for which Asian investors, especially the Chinese and Indians, are in the vanguard.

Chinese FDI to Africa represents a small proportion of China's total FDI portfolio, although Africa is second to Asia as the major destination of Chinese FDI. China has had economic and political ties with the region since the cold war era, with an active role in investing in infrastructure projects. Globally, 75 percent of China's FDI is in the tertiary sector, including construction and business activities, although a large proportion has recently gone to oil-rich countries. In 2002, the Chinese authorities allowed 585 Chinese enterprises to invest in Africa, accounting for 8 percent of total approvals. In terms of numbers of investment approvals, South Africa had 98, valued at $119 million. Today, about 700 Chinese enterprises are operating in Africa.

India has been present in Africa for decades, with its FDI mostly in the services and manufacturing sectors but also in Africa's natural resources, including the oil sector (for example, Sudan). During 1995–2004, Africa accounted for 16 percent of India's FDI, or $2.6 billion. Like China, India seeks primarily to secure energy sources and other natural resources from Africa to support its dynamic economic growth. In eastern and southern Africa, Indian immigrants, with business ties to India and a good knowledge of Africa, have played a significant role in attracting new investment to the continent. This is especially true in recent years because India is flush with foreign reserves and the government has lifted regulations and controls, allowing firms to go abroad and removing the $100 million cap on foreign investment by Indian firms.

An African game plan

Africa's exports to Asia have not yet significantly contributed to sustained, widespread SSA export diversification, of either trading partners or products, including with respect to greater value added through further processing. Even though the boom in natural resource exports to China and India is providing short-term benefits, African countries need strategies to leverage the current export explosion to create opportunities for long-term economic benefits.

Further reforms in at-the-border trade policies—such as reducing Asia's escalating tariffs or harmonizing or consolidating Africa's overlapping regional trade agreements—will surely help facilitate Africa's exports to Asia and elsewhere. But dealing head-on with domestic constraints in Africa is likely to be every bit as, if not more, critical. Indeed, if African countries are to enhance their global economic performance in Asia and beyond, it will take far more than simply liberalizing trade policies to reach that objective.