18 September 2018

East Africa: Arrested Development - a Comparison of East Africa and South Korean Growth Paths

The year is 2018 and the average East African - let us call her Kazuri - is richer than her Chinese and Russian counterparts.

A citizen of an industrialised region, earning $12,723 per annum and owes much of her wealth to manufactured goods produced in her country, from cellular phones and refrigerators to merchant vessels and warships, aircraft and luxury vehicles, you name it, East Africa makes it.

East Africa is of course not large enough a market to absorb all these expensive and sophisticated goods that the region produces. But that is not a problem.

The global market is large enough and in fact cannot have enough of East Africa's goods.

There are more than enough buyers for the industrial goods that German, Korean and the East African manufacturers are producing.

An insightful East African reader suspects by now that we have played an awful trick on his mind.

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If his perceptions and insights suggest that he is not that wealthy, he is right. The average income for East Africans is $700 per annum.

And the reason for this low level of income is that the region has remained largely agricultural, with most jobs and incomes coming from agricultural activities.

Viewed in another way, East Africa is a low manufacturing and industrial region.

Industrialisation is the process by which a nation changes its major source of income from agriculture-based activities to manufacturing.

Industrialisation has an unmatched record of lifting large numbers of people out of poverty, raising national incomes and increase employment rates.

A comparison of East Africa's and South Korea's industrialisation history, by focusing on its effects on incomes, employment creation and economic activities, illustrates how the region was left behind.

Disparities

In 1960, the average South Korean earned $158.24 whereas the average Kenyan (Kenyans have the highest average income in the region) earned $97.62.

By 2017, the average income per Kenyan had grown to $1,507 while the equivalent for a South Korean had reached $29,742.84.

This means that in 1960, a South Korean's wealth was only about twice that of a Kenyan. In 2017, the average South Korean citizen had become 20 times wealthier.

Even more astonishing is the fact that since 1960, South Korea's total annual income has grown by about 188 times, whereas Kenya's has only grown 15.45 times.

Had Kenya's economic wealth grown by the same factor as South Korea's, a Kenyan would be earning an income of $18,348 today.

The level of growth seen in South Korea has also been observed in Taiwan, Hong Kong and China, all of which raised their incomes on the back of the manufacturing industry.

China's story is particularly remarkable as it lifted 400 million of its citizens out of poverty within 30 years.

What explains the disparity in incomes between a developing country in Asia and those in East Africa?

In 1960, the manufacturing sectors of South Korea, Uganda and Kenya were comparable.

Then, South Korea's manufacturing sector made up 11.23 per cent of the economy, whereas Kenya and Uganda's made up 8.71 per cent and 8.15 per cent respectively.

By 2017, the contribution of manufacturing to South Korea's economy had more than doubled to 27.57 per cent, while for Kenya and Uganda, it has hovered around eight per cent.

This disparity suggests that South Korea's faster growth and greater incomes are linked to the successful expansion of its manufacturing sector, unlike Kenya, Uganda and rest of East Africa.

Changes to the agriculture sector's share of gross domestic product, however, places in relief the changes observed in the other sectors.

In 1960, Korea's agricultural sector made up 36.23 per cent of that nation's economy while Kenya and Tanzania's agricultural sectors comprised 35.35 per cent and 29.88 per cent respectively.

As the years passed, the difference between the evolutions of the two nations' agricultural sectors becomes stark.

Where South Korea's agriculture sector comprises a relatively insignificant 1.96 per cent of Korea's GDP in 2017, Kenya's and Uganda's agricultural sectors are up to 15 times larger, and yet the income levels of citizens of the latter two is much lower.

Clearly, East Africa's low incomes are a factor in its failure to restructure economies and shift the centre of growth and income towards manufacturing and away from agriculture.

Put another way, South Korea's manufacturing sector growth and the subsequent decline in its agricultural sector seems to explain the large difference in incomes between it and East Africa.

Manufacturing as a source of employment.

Most East Africans work in the agriculture sector, where incomes are still very low, despite being the largest and most lucrative sector of the economy.

This leads to the question: How does industrialisation affect availability of jobs?

Industrialisation, because it involves adding value to basic material and producing sophisticated products, requires many levels of skilled workers.

This can create a big base for employment, especially in developing nations with low costs of labour.

Industrialisation creates both direct and indirect employment.

The increase in employment in the manufacturing sector is a sign of industrialisation and confirmation that the composition of the economy is changing.

An analysis of the evolution of sectoral shares of employment rounds out the analysis on the economic changes of East Africa as compared with South Korea.

Sectoral employment is a reflection of the economic structure of a nation.

Where a sector is a veritable source of higher incomes, the region's average incomes should be reflected in that sector's contribution to employment.

In the 26 years from 1991 to date, Ethiopia's manufacturing sector employment rose from 2.184 per cent to 9.375 per cent of all employment in that country.

The dramatic changes in employment in Rwanda's and Ethiopia's manufacturing sector employment can be partly explained by both nations' emergence from civil war and the stabilising economic reforms that followed.

Both nations were starting from a relatively low manufacturing base.

Kenya's manufacturing share of employment grew from 15.9 per cent in 1991 to 25.73 per cent in 2017.

This partly reflects the primacy of Kenyan manufacturing sector in the region, albeit small when compared with South Korea's.

In the rest of East Africa, the manufacturing sector share of employment remained stagnant.

Sectoral changes

On the other hand, South Korea's employment share in manufacturing shrank from a peak of 36 per cent in 1991 to 24.78 per cent in 2017. This calls for a closer look at other sectoral changes.

In East Africa, Kenya's services sector employs more people than happens in other regional countries.

But it is obvious that South Korea's and Kenya's services sectors are made up of very different ingredients because the average services sector worker in South Korea earns more than the services sector worker in East Africa.

This can be down to the sophistication of products produced by each sector.

A robust manufacturing sector offers higher wages that attract workers from low paying agricultural jobs.

This is because the sector has a higher productivity and creates goods of higher value.

Higher incomes then promote demand for more domestic goods and services. This in turn leads to improving the living standards of the people and an increase in the overall productivity of the economy.

So, where Korea's manufacturing sector's share of total employment has shrunk in favour of its services sector, East Africa maintains a large agricultural sector, employing a large proportion of the workforce but has an unsophisticated services sector.

In Korea, only about five per cent of citizens today work in the agriculture sector. This put together suggests that Korea's manufacturing industries drove economic growth, raised average incomes and added to total employment.

The opposite is true of East Africa. The agriculture sector is dominant, the manufacturing sector is stunted and produces basic goods and the service sector is not so sophisticated either. This explains the difference in the incomes and welfare of the people of East Africa and South Korea.

Coming back to the reality in East Africa, Kazuri probably works on a farm but desires a job in the manufacturing sector.

The case of a Korean of the same age as Kazuri is different. Most probably the Korean's grandparents were farm labourers and her parents toiled in factories that produced clothing and other textiles, but she is likely to be a lawyer, an accountant or a banker.

Value addition

Her employer owes the existence of the firm to the large local manufacturers to whom it offers services. This is the reality for many Koreans today.

An industry adds value to a basic good. Let's assume Kazuri owns forestland inherited from her family.

Ideally, forests are considered a factor of production for the agro-forestry sector. Kazuri can opt to either sell the land, or harvest the trees and sell timber, or use the timber herself to produce furniture or music instruments.

It is evident that if she was a wood worker, she could reap greater economic benefits from her forest.

The wood worker who transforms Kazuri's timber into music instruments or furniture will earn more from the "added" value to the wood.

The said wood worker will invariably earn more out of the forest than Kazuri, the lumberjack and everyone down the chain offering intermediary services.

But over time, everyone along the production chain of agro-forestry can earn more if the value of the final product is higher than raw timber.

At the very core, it is the prospect of adding value to this basic product (wood) that generates profit that serves to motivate all workers in the sector.

Furthermore, they will seek "innovations" and make investments that will contribute to the process of value addition.

This in essence, is how the process of industrialisation grows out of agriculture and raw natural resources.

If she was interested in earning more from her forest, Kazuri would do well to educate herself in the work of transforming on wood into high value goods. What is true for Kazuri also applies to the economy.

Japan, South Korea and the United States sell products that demand innovation and investment in research and development.

It takes valuable technical skill to build the Boeing 787 Dreamliners that Tanzanian, Kenyan and Ethiopian airlines fly.

Sectoral effects

The historical background we have explained here, illustrates how economic sectors are interlinked. Evolutions in the agricultural and manufacturing sectors have the effect throughout the economy.

Countries raise their incomes by producing goods of ever increasing sophistication and value.

South Korea owes its growing wealth to the Hyundai and Samsung products, that are so ubiquitous in the global market.

Hyundai Motor Group, Korea's largest car manufacturer, reported revenues of $221.91 billion ($12.24 billion in net profits) in 2016 and represents a part of Korea's automotive industry that is itself a wing of that nation's greater manufacturing industry.

More dramatic, perhaps, is Samsung's history as a noodles and groceries trader.

Both are emblematic of South Korea's sensational rise to an industrial giant starting from an economy dominated by farming families to a modern one dominated by industrial firms.

The value of South Korean manufacturing was $379 billion in 2016, exceeding the entire annual output of the greater East African economy of 300 million people.

By 2017, South Korea's GDP stood at $1.53 trillion to Ethiopia's $80.5 billion and Kenya's $75 billion.

It is clear from this historical accounting of growth and development that East Africa cannot count on natural resource revenues to drive the growth of national income and standards of living.

South Korea represents a model of economic growth for East Africa because the nation's profile as a resource-poor nation resonates with countries in East Africa.

In our next part of this series, we will examine what economic promise manufacturing sector growth holds.

The Institute of Economic Affairs is a Nairobi-based think tank.

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