Playing the long game: how DFIs can drive sustainable industrialisation in Africa

Franziska Hollmann, Director Corporate Finance, DEG

The UN General Assembly has declared 2016-2025 the Third Industrial Development Decade for Africa. Yet, Africa’s manufacturing value added accounted for only 1.6% of the global total in 2014. The continent continues to lag behind other regions and adds value to only 14% of its exports, compared to 27% for emerging Asian economies and 31% for developed economies.

Promises of Africa’s industrial take-off have been made before, but, this time, there are signs that cautious optimism may be called for. The recently ratified African Continental Free Trade Agreement is a significant step towards breaking down barriers in the way of intra-African trade. Ultimately, with its booming population, Africa may have no choice but to rapidly expand its industrial base if it is to grow sustainably.

We spoke to Franziska Hollmann, Director of Corporate Finance at the German Development Finance Institution, DEG, about how sustainable industrialisation can be achieved in Africa and crucial role that patient capital plays in this process.

Why is it so important for Africa to industrialise?

Recent and the not-so-recent history provide enough evidence that that industrialisation plays an important role in economic development. Think not only of the Industrial Revolution in the UK but also the experience of the Asian Tigers like Korea or the economic “miracle” that happened in China. Such rapid economic growth would not have been possible without sustained industrialisation and successive integration into the world economy. Now, it is crucial that all stakeholders – particularly governments and the private sector – work together to make it happen in Africa.

How can industrialisation drive sustainable development in Africa?

There are several important advantages to industrialisation that are especially relevant in the African context.

The first is job creation. Manufacturing can provide a huge number of jobs and this is especially relevant in the context of the rapid demographic change experienced by African countries. For instance, Côte d’Ivoire will double its population over the next 30 years.

‘The population of the Côte d’Ivoire will double in the next 30 years.’

Manufacturing does not just create new jobs but also improves their quality. Industrialisation creates many “unskilled” jobs but then enables the constant “upgrading” of skills. Think about someone who starts out working on an assembly line but then has the possibility to gain more product and management knowledge and move, with time, to other roles within the company (or move to other companies to more skilled roles).

This is all part of a structural transformation of the economy. Many African countries have developed from ‘frontier’ to ‘emerging’ markets and are in the process of transitioning into ‘developed’ economies. Generally, this transformation has involved human capital shifting from the traditional agricultural sector to the manufacturing sector where productivity – and in the end also wages – are higher. As such, industrialisation plays an integral role in sustainable development on the continent and DEG seeks to support this through a variety of initiatives. We work with African agricultural companies to increase “local value added” through higher local processing and up-grading of industrial capacity. Through our Business Support Services we assist clients in analysing and reducing their skills gaps and, for those on our DeveloPPP, we support vocational training centres.

You’ve touched on the ways in which DEG supports high-quality job-creation and bolster value-added though investing in manufacturing. With their ability to provide long-term capital, what role do DFIs have to play in sustainable macro-economic development, particularly in relation to Africa?

‘Access to long term and risk adequate finance is especially difficult for African companies.’

In theory, deep and liquid capital markets provide companies with the necessary financial means to invest into new machines and equipment and to take advantage of profitable projects, thus driving the industrialisation process. In reality, empirical evidence and our own experience show that access to long term and risk adequate finance is especially difficult for Africa companies. While financial markets are evolving on the African continent, the local banking sector still struggles to provide enough capital – especially with the required maturity – for African companies. DFIs play a crucial role in addressing this market failure by complementing the markets with financial products and services that do not exist locally. Hence we do not crowd-out local investors. Furthermore, DFIs – and DEG – do play the long-game. Our interest is to grow together with our clients and develop a long-term relationship, as opposed to other investors that have more a short-term horizon. In times of volatile capital markets, DEG provides stability.

With this focus on facilitating long-term growth, how does DEG ensure that its investments are sustainable?

First, we work with professional and successful entrepreneurs and support our clients to be economically sustainable. We do so by being in close and frequent contact with our clients and where we discuss the implementation of current or future measures to improve their business and increase the positive impact of the company. Furthermore, and more formally, we have a yearly update of our sustainability rating that tracks the progress. What makes us very happy is that many clients are enthusiastic about sharing their positive development milestones with us. On our homepage, we provide several evaluation studies that illustrate our development effectiveness rating and the process behind it with actual clients.

An awareness of sustainability is, as you have suggested, essential to ensuring that Africa achieves the macro-economic transformation needed to support future growth and prosperity. How do you measure your impact and how do you strike a balance between positive development impacts and profitable investments?

‘Companies that focus on increasing their development impact also increase their financial returns.’

We assess all our investments with regard to their development impact. We strongly believe that economically viable projects can – and should – have a positive development impact. This view is also implemented in DEG’s strategic goals. Our main focus is exploring how, by working successfully together, we can jointly increase the development impact of the company. Which measures would be helpful and could be implemented? From our experience, companies that focus on increasing their development impact also increase their financial returns. The two goals are not opposed to each other but complimentary. Take the classical case of implementing international norms: while many see only the cost at first sight, they realise that complying to international norms opens up new markets and business opportunities that in the end more justify the costs. It is very important to us that our clients share this view and see the value-added here.