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Climate crisis highlights urgency of diversifying Africa’s economies

Dr. Zainab Usman
By Dr. Zainab Usman

Director of the Africa Program at the Carnegie Endowment for International Peace

Posted on Monday, 5 July 2021 09:57

Residents gather near a washed-out bridge after flooding on the the River Hululu, which joins the Rver Lubiriha, near Beni, eastern Congo Thursday 21 May 2020. (AP Photo/Al-hadji Kudra Maliro)

America's return to the Paris Climate Accord in January 2021 was a milestone in the global push for climate action.

But when Donald Trump announced his intention to withdraw from the Accord in 2017, the world did not stand still waiting for the US to rediscover the gravity of climate change.

During these five years of US absence, advanced economies from the EU to Japan unveiled ambitious carbon neutrality strategies. China expanded its dominance in the industry of solar panels, wind turbines, batteries, and other clean energy hardware. Ruinous floods in African countries, apocalyptic wildfires in Australia, and other extreme weather events showed the devastating impact of climate change on vulnerable populations around the world.

With America’s return to the global stage on climate action, the weight of the world’s largest economy is now energizing the fight against climate change. This momentum is also highlighting the intensifying urgency for the African continent to diversify its economies.

Global climate action will affect Africa’s resource-rich countries

Climate change will affect African countries, with the heaviest toll on the poor and most vulnerable. Extreme weather fluctuations severely disrupt the rainfed agriculture on which the incomes of 60- 80% of African workers depend. Droughts and desertification in West Africa are also forcing the migration of nomadic herders further south, increasing the likelihood of violent conflict with farming communities.

The accelerating momentum of climate action by the global powers has implications, not all of them positive, for African economies.

Back in 2017, the World Bank announced plans to stop financing upstream oil and gas projects in developing countries. Project teams I worked with at the World Bank Extractives Group found it difficult to secure internal approvals for technical assistance on minerals and hydrocarbons in developing countries.

Similarly, NGOs are forcing commercial banks in Europe to reconsider investments in oil and gas projects.  The $3.5bn East African Crude Oil Pipeline running through Uganda and Tanzania is still struggling to find financiers, for example.

Well-meaning but abrupt ends to investments in oil and gas by global powers and financiers could inadvertently devastate petroleum resource-exporting African economies.

Take, for instance, the more than ten African countries that generate at least 25% of their exports from oil and gas. A sudden retrenchment of public and private financing in new projects – coupled with a steady decline in international demand – could reduce government oil and gas revenues by up to 50% in some African countries by 2040, according to Carbon Tracker projections.

While hydrocarbons industries have enclave characteristics, are not labour-intensive, and often make up only a small share of a producer’s economy, they also generate the government revenues that fund public services, pay civil servant salaries, and support small businesses. In Africa, that matters because these critical funds cannot be easily replaced in around 25 African countries where tax revenues make up less than 15% of GDP.

This is not to say that broad and sudden climate action will wholly disadvantage African economies. Of Africa’s 19 mineral-rich countries, new forms of clean energy technologies could prompt an opposite effect: increasing financial flows in mining projects and causing rising demand for the critical raw materials or “climate minerals” needed for the batteries in electric vehicles, solar panels, and wind turbines.

These minerals include Guinea’s graphite and manganese, the Democratic Republic of Congo’s cobalt and nickel, Zambia’s copper, South Africa’s platinum group of metals, and the Sahel’s lithium deposits.

In fact, a new commodities supercycle of rising demand in climate minerals could soon be underway. But risks loom large of reproducing the pathologies of previous commodities booms, in which the environmental devastation associated with climate mineral extraction in poor countries fuels the clean energy technologies that power wealthy economies.

The urgency of economic diversification in Africa

To avoid these unintended impacts of global climate action, African countries must prioritise economic diversification. However, there remains little clarity about what economic diversification actually entails and how this definition affects the menu of policy options available to policymakers.

In a recent Carnegie Africa paper, we attempt to bridge this knowledge gap in defining and contextualising the challenge of diversifying African economies. Economic diversification involves transitioning away from dependence on a few commodities or activities such as crude oil, minerals, and agriculture production in an economy.

Closely associated with the process of structural transformation from lower to higher productivity sectors, economic diversification has three evident dimensions:

  1. The expansion of economic sectors that contribute to employment and production, or gross domestic product (GDP) diversification.
  2. Exports diversification – relates to an increase in the range of goods and services an economy exports to the rest of the world as well as to destination markets.
  3. Fiscal diversification as identified by our paper refers to an increase in the number of economic sectors that contribute meaningfully to government revenues and are targeted by government expenditures. With a re-contextualised definition, it becomes clear that the policy interventions to support the diversification of an Angolan economy reliant on oil extraction and exports are very different from those required for the tourism-heavy economy of Seychelles.

Fiscal diversification as part of fiscal policy more broadly can play a central role in helping to catalyse the expansion of activity in specific industries.

During economic crises, fiscal policy provides emergency liquidity into an economy – as we have seen with the trillions of dollars of stimulus injected into economies worldwide to weather the Covid-19 economic shock.

As part of ambitious plans to reorient economies towards a net-zero carbon future, wealthy countries are using fiscal instruments as industrial policies through investments in EV charging stations and carbon taxes, subsidies, tax breaks, and research grants for clean energy industries.

Bottom line

One of the five pillars of the recently unveiled industrial strategy by the US government is the commitment to target nearly $300bn of investments towards technologies, innovations, and infrastructure to position the American economy for a low-carbon future and to compete with China.

African economies should follow the United States’ lead, leveraging fiscal tools wisely as part of broader industrial strategies to target investments in burgeoning clean energy industries and their supply chains.

African countries have a closing window of opportunity within this decade to diversify their economies to build resilience to the shock of a steep decline in demand for hydrocarbons (for oil and gas exporting countries) and the pathologies of climate minerals extraction (for mineral-rich countries).

To seize the moment of climate action, policymakers must first define what a diversified economy means within their country’s specific circumstances and then employ fiscal policies towards achieving this objective.

With strong and diversified economies, African countries can realistically hope to avoid recreating the dependencies and pathologies of the fossil fuel era by creating new economic opportunities and insulation from the vagaries of international markets.

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