There will be no economic takeoff in Africa without lots of large (private sector) firms
On why African states’ jobs agenda must focus on catalyzing firm growth (and not disorganized investments in micro-entrepreneurship)
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I: African economies desperately need lots and lots of formal sector jobs
The rate of informal employment in Africa is high, and basically hasn’t budged over the last 20 years. The dearth of formal sector jobs presents an existential crisis for African countries. Over 10m young Africans enter the labor force each year, but the region only creates 3m formal sector jobs. Most workers get absorbed into the informal non-agricultural sector. Fewer every year settle for farming, while many try to migrate outside of the Continent in search of jobs.
One of the drivers of the recent rise in protests is young African’s deep frustration with being jobless or underemployed and trapped in stagnant economies managed by thoroughly complacent elites. If nothing changes, we should expect to see more of the same. Importantly, not all states will withstand the likely higher levels of political instability in the region due to more frequent protests (including rising populism and extra-constitutional changes of government). The claim that youth under/unemployment presents an existential crisis isn’t hyperbole. It’s the one thing that should occupy the minds of African economic policymakers all the time.
How are African policymakers responding to the joblessness crisis? Besides their resignation to generalized informality, in the recent past many have emphasized both a return to agriculture and labor migration as potential fixes to Africa’s jobs problem.
However, there are serious limits to this strategy. Urban areas are simply a much stronger pull for a more educated African labor force than rural farming. Consequently, the average age of African farmers is going up, while the average level of education attainment is declining. At the same time, labor migration can only absorb so many unemployed youth (more on labor migration here). For example, Kenya’s ongoing migrant labor push has only yielded an estimated 243,000 jobs over three years (many of these workers and their families face humiliating horrors). Over one million young Kenyans enter the labor force each year. Plus even if high-income countries accepted the reality of their demographic decline and resulting labor shortages, not everyone can migrate. Therefore, it would be foolish for any African country to rely on migration as their main job creation strategy.
Which is to say that African policymakers must have serious strategies to increase the number of formal sector jobs.
Before proceeding further, I should point out that this post isn’t a mere fetishization of formality as a form. It is about the substantive benefits of modernizing and rationalizing the organization of economic activity, including within firms (and the labor market). I’ve previously argued that the distinction between formal and informal sectors (as well as subsistence vs cash crops) is not good for policymaking as it unnecessarily distorts the idea space. The degree of formality is a continuum. African economies have lots of large informal firms that, for example, have productivity levels not too dissimilar from those of formal firms. This suggests that Africa’s high levels of informality aren’t just a case of small upstarts being unable to meet the costs of formality. These patterns could also partially be fueled by mental models of how economic activities ought to be organized (the idea that pervasive informality may reflect elite tastes or a general absence of habits of accounting to maximize constant improvement is underrated).
My main claim herein is that formal firms are an amazingly efficient way of organizing economic activity. The research on this is compelling (see reviews on labor markets and firms). All else equal, formal firms are typically able to increase productivity over time, expand into new markets, have better access to credit, influence policy or figure out ways to be robust to policy failures, tend to have more employees, and to consistently make a profit. All else equal, informal firms do worse on these metrics and largely remain stunted over time. Regardless of what we choose to call the former types of firms, African policymakers should focus on urgently increasing their number.
II: Why don’t African economies generate more formal sector jobs?
The simple answer is that most firms in Africa are subsistence micro-enterprises that mask unemployment, largely remain small and stunted, and never grow to be able to formalize and hire more workers.
To illustrate this point, let’s examine Ghana’s tomato sector. According to a 2017 survey, tomato made up the biggest share of household vegetable expenditure (11.7%). Ghana produces more than 510,000 metric tons of fresh tomatoes. The country also registers over $200m in fresh tomato imports (mostly from Burkina Faso — about 90% of Burkinabe tomato production) as well as over $100m of imported tomato paste (mostly from Europe and China).
As a crop, tomato occupies the 15th biggest acreage according to the latest available data. During the high season, it’s not uncommon to see lots of tomato vendors along the roadside. Typically, these are small operations involving clusters of (mostly) women-run stands. The image above represents a typical larger-than-average roadside operation. Most of the crop gets sold in large outdoor urban markets and supermarkets. Aggregators and brokers are the main link between tomato farmers and rural vendors and the larger urban markets (famously dominated by women traders).
By the time Ghanaian tomatoes make it to markets like the one above their shelf life is usually less than a fortnight. This forces vendors to sell their produce at throwaway prices the more they have to wait, and explains much of the seasonal fluctuations in prices shown above. Produce that’s not sold simply gets discarded. About 30% of Ghanaian tomatoes get lost after harvest. The other ledger of this reality is that Ghana runs a deficit of tomatoes. During the dry season, well above 80% of the fresh tomato supply comes from Burkina Faso.
To the point about not over-indexing on the distinctions between formal and informal economic activity, this system is quite impressive and effectively does the job of satisfying Ghana’s tomato-rich diet.
But it could be made more efficient. How does one begin to do this? The answer may lie in better organization and rationalization, with a view of helping rural farmers retain as much value from their produce as possible. While it’s politically infeasible to increase efficiency through scale, one way to deal with the small acreages of tomato farms might be through cooperatives. These organizations may then serve as platforms for skilling, dissemination of improved varieties and better farming methods, as well as access to inputs and financing. The same cooperatives may even be able to own storage facilities and processing plants.
While I have a developmentalist preference for organizationally empowering farmers, one could also take an approach that consolidated the operations of aggregators. They could then be the ones owning logistical networks for collection and distribution to markets, the processing plants, and helping their contract farmers improve productivity and reduce post harvest losses. Notice that either approach could easily be integrated with foreign producers of fresh produce or suppliers of tomato paste. They’d simply plug into the existing value chain and collaborate with local agents.
To be clear, the problem shouldn’t be viewed simply as one of reducing tomato imports. Exposure to international competition is good; and the coddling a low-productivity sector is a waste of scarce resources. There’s nothing wrong with Burkinabe farmers outcompeting their Ghanaian counterparts.
The biggest policy challenges throughout the tomato value chain that need policy attention include low productivity (a function of farming skills, inputs, infrastructure, access to finance, and land management); inability to extend the shelf-life of tomatoes post harvest (market aggregation, transportation, storage, processing); rationalization of the regional tomato market by smoothing out the growing cycle (green houses, new varieties); and better organization of different players for efficient market operations and policy influence (reasonably big formal firms).
Infusing formality (i.e., rationalization and modernization) into the supply chain would not necessarily kill jobs. This is especially if such a change doesn’t seem to displace all existing processes. There are lessons to be learned from the spectacular failure of many African startups that tried to displace critical bits of agricultural supply chains. Successful policy interventions will likely come from a layering of formality onto the existing supply chains, and not an introduction of completely alien processes and players.
So what exactly is Ghana doing about this? First off, there is very little that the line ministry can do on its $265m annual budget. The tomato sector isn’t top of the list. Overall, most official interventions tend to not pay much attention to the issues of modernization and rationalization. For instance, the new NDC government’s reform agenda includes making agriculture appealing to the youth (good luck!), diversification, and deepening value addition. The government’s strategy for implementing the latter two priorities amount to the usual “attracting investors.” In other words, the policy posture will remain individualized and focused on micro-interventions.
This is also true of many donor interventions in the agricultural sector. Take the Mastercard Foundation’s $61m Harnessing Agricultural Productivity & Prosperity for Youth (HAPPY) project, which seeks to “[e]quip 326,000 young people, especially young women, with skills and tools to unlock work opportunities.” Among other things, this will involve training 100 youth in the use of digital technologies, support for 500 trainers of trainers to be HAPPY ambassadors, create digital agriculture content and online training modules, and integrate IT tools (including machine learning) in modeling crop yields, disease/best outbreaks, and optimize farm conditions. None of these interventions directly address the big issue of how to modernize and rationalize the agricultural sector in Ghana. At best, the interventions will encourage terribly inefficient informal micro-entrepreneurship in the sector (I should note that the World Bank’s new jobs agenda has similar defects).
This is no way to, for example, compete with tomato paste manufacturers in China and Europe (Ghana’s paste factories have historically operated only intermittently). For Ghanaian processors to have a chance, there will have to be an elongation of the production cycle (not just during the rainy seasons plus imports from Burkina), adoption of the right tomato varieties, and more sophisticated management of the logistics from the farm gate, to the factory, to retailers. The best way to organize these improvements is within large (private sector) firms, not individual micro-entrepreneurs.
To reiterate, the problem as I see it isn’t the idea of informality as an idealized form per se, but the failure to cultivate conduits of overall economic improvements on the intensive margin at scale (that is, big firms). Again, informality is a continuum. And formalization is not an end in itself. It is the means to continually improving productivity, expanding markets, and absorbing ever more productive labor. It shouldn’t be controversial to accept that modern and rationalized modes of organizing economic activity within (private sector) firms do a lot better than subsistence micro-entrepreneurship.
I accept that making bets on firms may seem riskier than the micro-entrepreneurship approach; has potential impacts that are harder to quantify in the short-term (not to mention a built in high failure rate that may give beancounters pause); may not appeal to grant managers who are ideologically squeamish about big for-profit agri-businesses; and doesn’t appeal to politicians whose primary KPI is the total number of people who can directly attribute outcomes to their specific policy interventions. But it’s definitely worth trying. This is as true for the agricultural sector as much as it is for the manufacturing and services sectors.
III: It’s very hard to create good jobs without large (private sector) firms
I cannot stress this enough. It’s really hard to create good jobs without large private firms. The same goes for intensifying productivity growth. Firm size matters:
American firms follow a life cycle. Firms enter, on average, at a smaller scale and with lower productivity. Many exit shortly after entering, while the survivors quickly converge to the industry average size and productivity level. Exit from the industry by mature firms is generally preceded by a period of declining size and productivity. In Africa, however, the largest and most productive firms also display the highest growth rates and contribute disproportionately to aggregate growth. This leads to divergence between firms at the top and bottom of the distribution. Small firms rarely reach the top of the size and productivity distribution.
Given these empirical regularities, it’s not surprising that higher-income countries exhibit relatively lower rates of labor informality. Yes, this is partially a question of better enforcement of labor regulations. But more importantly, it’s a story of having lots of highly productive large firms. In other words, it makes little sense to pursue lowering rates of formality simply through enforcement of regulations. Deliberately shepherding the process of increasing firm sizes and the number of employees per firm has to be part of the mix. And yes, part of this shift has to involve changing elite tastes and mental models about how modern economies ought to work (the Continent’s progress movement should take on this challenge).
Large firms also come with important political economy effects. They can at once discipline and increase the effectiveness of policymaking — for example, by channeling elite owners’ interests in the direction of higher productivity, lobbying, and policy transmission (including via the phenomenon of “private governance,” which isn’t always a bad thing). Large firms also make it easier to collect both corporate and payroll taxes, thereby boosting state capacity (see here). And most importantly, large firms are best placed to be robust to the uncertainties of doing business in low-income countries with patchy infrastructure, volatile regulatory environments, and fairly shallow markets.
Finally, another reason for doubling down on helping grow the size of African firms is the AfCFTA. Achieving meaningful regional integration will be impossible without interlocking supply chains built on networks of relatively big formal firms. A response to this point might be that informality powers a great deal of intra-Africa trade (which never gets recorded). I’d say that’s part of the problem. There is reason to believe that bigger firms would do a better job of fostering regional economic integration. For instance, notice the relatively small figure of agricultural commodities (an important part of cross-border informal trade) in the figure below.
IV: Conclusion
Since the degree of informality is a continuum, policy should always focus on how to derive the substantive benefits of formality and not merely fixating on the forms of either mode of organizing economic activity. Formalization as performative checking of boxes doesn’t work. What matters is the substance. Policy interventions that might work include lowering the cost of doing business and getting big, active government support of young domestic firms, cultivating financial systems that provides longer runways for young firms, and an ideational commitment to modernization and rationalization as critical to organizing economic activities. Basically, doing stuff that makes it easy for firms to become bigger, more profitable, and to employ more people (and make them more productive).
Why the focus on firms? Because the path to job creation — an existential necessity in many African countries — must pass through big domestic firms. This is a message that must be internalized by policymakers throughout the Continent. The decades-long fixation with informal micro-entrepreneurship must stop; and all jobs programs in the region should be evaluated on the basis of how much they foster the growth in firm sizes and the overall share of formal sector employment. While appreciating the necessity of informality as a source of resilience in low-income economies, it’s important to resist being trapped in a mindset that views it as the only feasible mode of organizing economic activity. There’s a different and better way.