Political risk as a deterrent to industrialization of Africa

Many agree that the construction of the African Free Trade Area (AfCFTA) can be an important opportunity for advancing the industrialization of the African continent[1], as the newly established Free Trade Area (FTA) will offer opportunities to both African and foreign investors to establish productive units in one or more African countries from where they can serve the markets in all the continent.

However, some conditions are also needed in order this situation to concretely materialize. First, a clarification is necessary. In order to be traded duty-free among African countries, products must satisfy the rules of origin governing preferential trade between the African Continental Free Trade Area States Parties. This means, for instance, that an investor who establishes a business entity in the continent can benefit from the customs duty exemption (zero import tariffs) when trading with other African nations, only if his products are considered, under the AfCFTA rules of origin, as having their origin in a member of the FTA. For some of such products, this means that they must be entirely grown, harvested or extracted from the soil in the territory of an AfCFTA State Party or have been manufactured exclusively from such products. This usually applies to commodities and related products. For other products that are the result of processing operations conducted in part in third countries (outside the FTA), the origin of the goods will be determined according to the rules specified in the Annex 2 of the Protocol on Trade of Goods of the AfCFTA Agreement and the Appendix IV to such annex, that specifies precisely, product by product, the operation that confers the preferential origin.

The question is: is this situation sufficient to attract investors in Africa?

The reality is that investors do not base their choices to invest only on the size of markets, the availability of raw materials or low labor cost. They consider many others aspects, that combined in a single concept: the country’s reputation.

In this article we will focus on one of the key elements on which a country’s reputation is made up, that is the political stability.

The concept of political stability is defined in negative terms. Political instability, in particular, indicates the propensity of a government to collapse either because of internal conflicts or rampant competition between various political parties[2]. Political instability in reality includes other risks, including those of government expropriation, corruption, unpredictable regulatory changes that can be adverse to investors, and money transfer and convertibility restrictions. All factors that undermine the climate of confidence that investors need, and that in some cases are further aggravated by issues like terrorist threats, economic crises, and developing countries’ desire to control their natural resources and civil societies[3].

A recent article published on Investment Monitor[4] argues that investors have a higher propension to invest in locations having an environment which is similar or more favorable then in their own country, in terms of political stability, while another paper examining the relevance of political stability on Foreign Direct Investments (FDI) concludes that political risks act as a particularly strong deterrent for investments especially in smallest economies, compared to larger ones[5].

Now, if is true that many African states — most of them having structurally weak, vulnerable and small economies — have been able to achieve good levels of political stability and have established an investment-enabling business climate, a number of them are still confronted with security or public order concerns. Although some of these risks can be managed through specific insurance schemes[6], others cannot be controlled through financial mechanisms.

Evaluating the political stability risk has become today a crucial exercise for investors when choosing locations where investments are to be undertaken.

The Index of Economic Freedom developed by the Heritage Foundation is a useful tool that investors usually use in guiding their decision-making processes concerning investments. The Index ranks countries according to the possibility that governments can exert coercitive powers or set limits to the economic freedom of enterprises, by intervening in matters that affect businesses. The Ibrahim Index of African Governance (IIAG) of the Mo Ibrahim Foundation is another tool that measures and monitors governance performance in African countries, with a series of sub-indicators assessing security, rule of law, corruption and the business environment in general. A quick look to these indexes shows that in Africa still many economies suffer from instability and deteriorating economic conditions. In particular, the Index of Economic Freedom shows that among 184 analysed countries, half (9 out of 18) of the most “repressed” economies in the world are in Africa.

Until a condition of political instability will persist in some African States, the AfCFTA project risks to catalyze investments only in those more democratic and politically-stable countries, in detriment of those states that will not be able to offer such guarantees.

More perhaps than ever before in history, these nations will need to develop proper politic stability policies and create better business climates, as this will be vital to attract investment under the AfCFTA and therefore, promote industrialization.

If this will not happen, no surprise then if investors will keep excluding them from their investment plans.

[1] Signé, L., Africa’s industrialization under the Continental Free Trade Area: Local strategies for global competitiveness, Brookings, 4 June 2019, available at : https://www.brookings.edu/blog/africa-in-focus/2019/06/04/africas-industrialization-under-the-continental-free-trade-area-local-strategies-for-global-competitiveness/

[2] Hussain Z., Can political stability hurt economic growth?, on World Bank Blog, 1/06/2014, available on: https://blogs.worldbank.org/endpovertyinsouthasia/can-political-stability-hurt-economic-growth

[3] World Bank, Political Risk: The Missing Link in Understanding Investment Climate Reform?, Investment Climate, N. 20, March 2012, available at: http://documents1.worldbank.org/curated/en/351251468336718273/pdf/682950NEWS0Inv00Box367908B00PUBLIC0.pdf

[4] Caon, V., FDI drivers and political stability, Investment Monitor, 09 Nov 2020, available at: https://investmentmonitor.ai/global/fdi-drivers-and-political-stability

[5] Kurecic P., Kokotovic F., The Relevance of Political Stability on FDI: A VAR Analysis and ARDL Models for Selected Small, Developed, and Instability Threatened Economies, 22 June 2017, available at: https://www.mdpi.com/2227-7099/5/3/22

[6] One of these is the African Trade Insurance Agency, a pan-African institution that provides political risk insurance to companies, investors, and lenders interested in doing business in Africa (https://www.ati-aca.org)