The recent push to reform the global financial architecture creates an opportunity to build a more inclusive system that matches Africa’s aspirations, accelerates the green transition, and advances development objectives. Most importantly, such a system must provide equal access to reliable and affordable capital.
CAMBRIDGE – Last June, during French President Emmanuel Macron’s Summit for a New Global Financing Pact in Paris, Kenyan President William Ruto warned that the World Bank and the International Monetary Fund are “hostage” to the world’s wealthiest countries and unable to meet the development challenges facing the Global South. Echoing United Nations Secretary-General António Guterres’s call to reform the “morally bankrupt global financial system” that “perpetuates poverty and inequalities,” Ruto proposed creating a new multilateral institution that is fit for purpose and treats all member countries as equals.
More than any other region, Africa has borne the brunt of the dysfunction embedded in the world’s financial architecture. Despite decades of engagement with the Bretton Woods system, the continent suffers stubbornly high unemployment and poverty rates, even as living standards have improved elsewhere in the developing world.
The latest reform push for the Bretton Woods institutions creates an opportunity to build a more inclusive global financial system that matches Africa’s aspirations, accelerates the transition to a net-zero world, and advances development objectives more broadly. Such a transformation has become essential as the world economy contends with the mounting effects of climate change, and as major geopolitical shifts threaten to accelerate global fragmentation.
ON THE LOSING END
Africa has long been in a vulnerable position within the multilateral system, owing to a constellation of destabilizing forces and policies. The asymmetry of subsidies, which powerful countries with greater fiscal space are more able to deploy, has been a significant constraint on the ability of African countries to diversify sources of growth and competitiveness. The developed world’s recent embrace of industrial policy in response to the escalating climate crisis and volatility of global supply chains is a clear example of this.
Moreover, financial repression, in conjunction with a chronic technological deficit, has further curtailed African countries’ economic development and limited their participation in global value chains to providing raw materials. Given the growing role in global trade of intermediate and manufactured goods with higher technological content, the stickiness of the colonial development model of resource extraction has been very costly for Africa, inexorably shrinking its share of global trade and exacerbating its exposure to global volatility and recurring balance-of-payment crises.
Multilateralism has thus failed to narrow the prosperity gap between Africa and the rest of the world. Africa’s share of world trade has declined steadily over the last few decades, falling from around 5% in the 1970s to less than 3% in 2022. And even though the continent accounts for around 17% of the global population, it is home to more than 60% of the world’s extreme poor – which could rise to 90% by 2030, according to the World Bank. By contrast, countries in Asia have capitalized on labor-intensive, export-led development models to narrow the income gap with advanced economies and lift hundreds of millions of people out of poverty.
As a result of financial repression, the process of structural transformation has continued to elude Africa, and the region is not well integrated into the current two-tiered global financial system, which privileges wealthy countries in the deployment of capital and the issuance of reserve currencies. This is at the root of the “perception premiums,” the overinflated risks perennially assigned to Africa, and the default-driven interest rates that have put many African countries into a debt trap.
In particular, these rates raise the fiscal cost of servicing sovereign debt – more than 50% of government revenues in the most vulnerable countries, such as Ghana. And yet, the external debt stock of African countries accounts for less than 1% of global sovereign debt.
Risk perceptions of Africa have been elevated for decades, with credit-rating agencies assigning sub-investment-grade scores to an overwhelming majority of African countries. With capital scarce, the continent has been unable to invest in other major drivers of economic growth, most notably human resources and physical and digital infrastructure. For example, so acute is the continent’s energy crisis that most African businesses spend a sizable portion of their revenues operating diesel generators, which, aside from exacerbating external imbalances and the climate crisis, inhibits investment and undermines growth.
Africa’s chronically insufficient infrastructure has also widened the global digital divide, which poses a further impediment to development, because technology has overtaken organizational change as the primary driver of economic growth. In the US, for example, the tech sector contributed nearly $2 trillion to GDP in 2022, accounting for 9.3% of total output. By contrast, nearly 70% of Africa’s population does not have broadband internet access, and persistent policy constraints, most notably shrinking fiscal space, make it almost impossible to build more robust infrastructure. As a result, African countries have been unable to reap digital dividends in the form of higher productivity, faster growth, and expanded employment opportunities.
In much of the world, the private sector is expected to play a central role in driving innovation-led growth. But Africa faces a shortage of entrepreneurs, owing largely to the difficulty of accessing finance. And, faced with massive debt-service costs – projected to have risen 35% in 2023, to $62 billion, owing to rapid tightening of global financial conditions – African governments lack the capacity to expand productivity-enhancing public investment, crowd in private capital, and attract foreign direct investment. According to the United Nations Conference on Trade and Development, FDI flows to Africa were a paltry $48 billion in 2023, whereas Asia received $584 billion.
At the same time, a series of procyclical downgrades by credit-rating agencies pushed more African countries into junk status and further curtailed their access to global finance. In 2022, only three African countries (Angola, Nigeria, and South Africa) were able to tap capital markets, raising a total of $6 billion, down from $19.6 billion in 2021, at default-driven borrowing rates. This led Zainab Shamsuna Ahmed, Nigeria’s then-finance minister, to announce in December 2022 that her country would not issue Eurobonds in 2023 unless market conditions improved.
INDUSTRIALIZATION, INTERRUPTED
The Bretton Woods institutions further limited Africa’s development options by implementing structural adjustment policies during the post-1990s era of hyper-globalization. The Washington Consensus – the pro-market policy cocktail of trade liberalization, deregulation, and privatization espoused by the IMF and the World Bank – gave rise to costly austerity measures, with public investment being among the first casualties.
For starters, these structural adjustment policies contributed to the dismantling of Africa’s nascent manufacturing base, which consisted mainly of state-led enterprises that had been established after achieving independence. This put the continent on the path toward premature deindustrialization, with African countries running out of industrialization opportunities sooner and at much lower levels of income compared to early industrializers.
The Washington Consensus also undermined investment in human capital. For example, African countries continue to suffer from a serious shortage of skilled engineers and scientists, with a ratio of 198 scientists per million inhabitants, compared to the world average of 1,150 per million. The chronic lack of technical capacity has hindered African governments’ ability to develop the infrastructure needed to attract private capital and expand Africa’s industrial base, and, crucially, to capitalize fully on the continent’s abundant natural resources to develop robust regional value chains and unlock endogenous growth potential.
Consider that Africa is home to 60% of the best solar resources globally, but only 1% of installed solar generating capacity. Without the human capital and financial resources to harness its energy resources (renewable or non-renewable), Africa has become the world’s most energy-poor continent. Sub-Saharan Africa (excluding South Africa) uses less electricity than Spain, and 600 million people on the continent – nearly 43% of the total population – lack access to power.
Given that industrialization is energy-intensive, Africa’s energy poverty has left the continent increasingly dependent on imported manufactured goods. Over the long term, this has undermined the growth of intracontinental trade, which remains dismally low, accounting for around 15% of total African trade, compared to 60% in Asia and 70% in the European Union. Thus, the imported cars clogging city streets in many African countries represent a massive hole in the balance of payments – even though the continent possesses all the raw materials to manufacture automobiles domestically.
The enduring colonial development model of resource extraction has only perpetuated the unhealthy correlation between growth and commodity-price cycles, resulting in increased exposure to adverse global shocks and the amplified perception premiums that are behind Africa’s default-driven borrowing rates. This, in turn, constrains refinancing options, turning liquidity challenges into solvency problems and raising the risk of sovereign-debt crises.
So far, the only four countries that have applied to the G20’s Common Framework for Debt Treatment are African, even though the continent has the lowest share of global public debt. Spreads on Eurobonds issued by these countries (Chad, Ethiopia, Ghana, and Zambia) were in the double digits, putting them on the path toward failure from the outset and making the perceived high risk of default a self-fulfilling prophecy.
In addition to fueling the risk of debt default and undermining the expansion of growth-enhancing public investment, the vicious cycle of recurrent balance-of-payments crises is also keenly felt at the household level. The unemployment rate is at Great Depression-levels – above 30% in Nigeria and South Africa, two of the continent’s largest economies. This fuels migration pressures, as more and more young Africans seek opportunities elsewhere, and exacerbates intergenerational poverty.
BRETTON WOODS TO BLAME?
While no single entity is solely responsible for Africa’s dire situation, it is fair to say that the continent’s sustained engagement with the Bretton Woods institutions has narrowed African countries’ economic policymaking capacity to the management of balance-of-payments crises. Africa’s international partners have done nothing to promote industrialization on the continent. Worse, many wealthy countries have made use of subsidies to bolster their domestic industries and competitiveness, adding to the burden on African entrepreneurs and business leaders, who are already contending with the high costs of financial repression and a chronic infrastructure deficit. This misalignment of development priorities became even more important after the World Bank, at the height of the Washington Consensus, shifted to offering balance-of-payments support.
As a result, Africa has been confronting crises with increasing frequency. In addition to security, energy, debt, and migration crises, the continent is currently experiencing the devastating effects of climate change: water stress, food insecurity, extreme weather events, and violent conflict, all of which ultimately lead to lower economic growth. And yet, Africa’s share of global climate financing is currently just 5.5%.
It was not supposed to be this way. The continent’s outlook following the wave of decolonization of the 1960s was bright. In his 1968 book Asian Drama: An Inquiry into the Poverty of Nations, Nobel laureate economist Gunnar Myrdal predicted that Africa would enjoy better growth prospects than Asia.
The opposite happened. Asia, unlike Africa, benefited from access to affordable and patient capital, which helped it close its yawning gaps in human and physical capital and led to economic diversification and successful demographic transitions. This has yielded significant dividends in knowledge production, for example, with Asia accounting for 66.8% of the world’s patent applications in 2018 (only 0.5% came from Africa). Bolstered by sustained investment catalyzing export diversification and effective integration into the global economy, Asia entered a long and virtuous cycle of robust economic growth, whereas more than four-fifths of African countries remain dependent on commodity exports and therefore highly vulnerable to global volatility and terms-of-trade deterioration.
In their rush to promote free markets and trade liberalization, the Bretton Woods institutions failed to consider African countries’ individual circumstances and their positions on the economic-development ladder when prescribing austerity measures. Speaking at a news conference after the opening of the African Union Summit in Addis Ababa in February 2023, Guterres remarked that realizing Africa’s potential requires overcoming a series of challenges. Chief among them, he stressed, is the “dysfunctional and unfair global financial system that denies many African countries the debt relief and concessional financing they need.”
But to the extent that Africa faces the perpetual threat of debt overhang, owing to the twin problems of financial repression and a chronic technological deficit, reforming this “dysfunctional and unfair” system requires channeling affordable and patient capital toward the continent. Similar to the postwar Marshall Plan for rebuilding Europe, this financing would accelerate the structural transformation of African countries and the implementation of the African Continental Free Trade Area (AfCFTA). Such an approach could reduce the unhealthy correlation between growth and commodity-price cycles and, eventually, mitigate correlation risks (one of the main drivers of perception premiums), which would help to leverage more private capital.
In other parts of the world, trade integration has spurred structural transformation and the development of new products, suggesting that, under the right conditions, the AfCFTA would accelerate the diversification of the sources of growth required to boost both extra- and intra-African trade and sustain robust economic growth. Preliminary estimates show that intra-African exports would increase by 109%, led by manufactured goods, especially if the implementation of the AfCFTA is accompanied by robust trade facilitation measures. This is important in a region where the consequences of non-tariff barriers, equivalent to an import tariff of 18%, have been just as costly for trade and endogenous growth as market fragmentation has been. Corporations could take advantage of economies of scale and the gains in productivity and competitiveness associated with investing in smaller markets.
The rules of origin underpinning the AfCFTA would stimulate industrialization, as championed by African leaders, in a region where industrialization and intra-African trade are mutually reinforcing. Most importantly, trade integration would increase the supply of patient capital and technology transfer to expand manufacturing output and boost resilience to negative global shocks, putting African countries on a path toward fiscal and debt sustainability and reducing the frequency of balance-of-payments crises.
FIT FOR AFRICA
How can we ensure that any reforms to the existing global financial architecture are more than just a facelift of octogenarian institutions? How can we create a new system that has Africa’s best interests at heart and realizes the tremendous growth and development potential that Myrdal recognized nearly six decades ago?
Some important proposals have already been advanced. In its “evolution roadmap” released last year, the World Bank outlined a wide range of options to revamp its business model and boost its lending capacity to help its member countries deal with climate change and other global challenges. These include an injection of new capital, changes in the Bank’s capital structure, a higher statutory lending limit, lower equity-to-loan requirements, and deployment of callable capital. They also include innovative financial instruments such as guarantees for private-sector loans, and a new concessional lending trust fund to attract financing from bilateral shareholders and private foundations in support of growth and the green transition in middle-income countries. But for low-income African countries, which have remained highly vulnerable to global volatility and recurrent adverse commodity terms-of-trade shocks, the scale of development challenges calls for a massive injection of patient and affordable capital.
In the short term, Guterres has called on the IMF to redirect $100 billion a year in special drawing rights (SDRs, the Fund’s reserve asset), to pay for investments in sustainable development and climate action. Meanwhile, the Bridgetown Initiative, championed by Barbadian Prime Minister Mia Amor Mottley, has proposed measures to channel more credit and investment into strengthening climate resilience. That includes providing debt relief and restructuring to climate-vulnerable countries, increasing official-development assistance to $500 billion annually, and making international financial institutions more representative, equitable, and inclusive.
But any meaningful reform should address the entrenched inequalities that are largely responsible for recurrent debt crises in low-income countries. Policymakers must devise a new and improved credit-rating system to account for countries’ growth prospects and long-term debt sustainability, while remaining consistent with the IMF’s assessment of macroeconomic stability. This would ensure that any improvements in macroeconomic fundamentals are credit positive and would provide equal access to reliable and affordable capital. At the same time, this system should be underpinned by an inter-temporal approach to fiscal deficits that enables countries to mobilize funds for structural transformation – measures that increase deficits in the short and medium term may be necessary to put countries on the road toward long-term fiscal and debt sustainability.
It will also be necessary to support the development of Africa’s digital infrastructure, as this would accelerate the transition to a multipolar monetary system and the use of local-currency settlement (LCS) arrangements. In addition to cutting transaction costs and boosting efficiency, the use of LCS for cross-border trade would boost intra-African trade, help ease the balance-of-payments constraints associated with dollar funding, and deepen regional integration.
Considering that more than 85% of intraregional trade payments in Africa are rerouted offshore for clearing and settlements, adding an estimated $5 billion per year to transaction costs, the increased use of LCS would yield significant benefits for the continent. The Pan-African Payment and Settlement System, launched in 2022 as a complement to the AfCFTA, could be essential to achieving this goal.
At the same time, a multipolar world requires a more democratic system for reserve-currency issuance, drawing on advances in digitalization. This would make the international monetary system more stable and mitigate the perennial shortage of safe assets, which drives capital outflows from the Global South, often at inopportune times, with significant consequences for macroeconomic stability and growth.
Many African countries have recently experienced currency gyrations because of these outflows, with an index combining depreciation against the US dollar and reserve depletion showing that exchange-rate pressures were at a six-year peak in Africa in 2022. To help drive the transition toward a multipolar monetary system, a reformed IMF could strengthen the global financial safety net, which would promote the growth of reserve-sharing arrangements and facilitate the multilateralization of LCS arrangements.
Lastly, the new international financial system must support the development of liquid secondary markets for sovereign and corporate bonds, which would provide investors with flexibility, security, and a steady stream of income. Given that African countries’ external debt is largely denominated in dollars or euros (the “original sin” of sovereign-debt markets), such markets could mitigate foreign-exchange risk and help prevent the sudden stops in capital flows that have pushed African countries experiencing liquidity problems into debt distress, which imposes huge welfare costs. According to the World Bank, poverty levels increase by 30%, on average, after a country defaults on its external obligations and remain elevated for a decade.
But debt need not be a path to default, persistent inequality, and intergenerational poverty. It can be a blessing, as evidenced by the key role it has played in the reconstruction and development of economies around the world. An oft-cited example is the perpetual bond that the United Kingdom issued in 1932, when the government realized that debt-service payments were reducing fiscal space and undermining post-World War I reconstruction. The debt was finally redeemed in 2015.
To be afforded the same opportunity, African sovereigns and corporate entities must be able to borrow reliably on reasonable terms, leaving behind the costly default-driven interest rates to which they have long been subjected. Any reform of the international financial system that does not provide equal access to capital, especially affordable and patient capital to invest in human resources, infrastructure, and the green transition, would be a facelift unacceptable to Africans.
The good news is that Guterres’s call to reform the global financial system is being well received, even by one-time apostles of the Washington Consensus. In fact, many of these former proponents now acknowledge that one-size-fits-all austerity measures are not appropriate if they ever were. In a much-praised Foreign Affairs article, IMF Managing Director Kristalina Georgieva deplored the fact that “many countries lack the technology, financial resources, and capacity to successfully contend with economic shocks on their own.”
Ongoing efforts by the World Bank to boost its lending, together with the recent decision to increase IMF quotas by 50% are steps in the right direction. But more must be done to create an inclusive global financial system that works for all countries and builds climate resilience. Such a system must address the twin problems that prevent Africa, and the Global South more generally, from devising solutions to new development challenges: financial repression and a chronic technological deficit. In today’s “polycrisis” world, ensuring that all countries have access to green technology and affordable financing will be essential to combating climate change and providing hope to all who aspire to a fair share of global prosperity.
