When economists refer to ‘structural transformation’, they usually mean the shift in factors of production – such as labour and capital – from low-productivity sectors (typically agriculture) to high-productivity ones (such as manufacturing and high-quality services).

Few African and Middle Eastern economies have had success transforming structurally and many appear stuck in low-productivity mode. Indeed, while there is substantial heterogeneity in the level of income, geography, resource endowments and legal traditions, parts of eastern and southern Africa and select parts of the Middle East (Kenya, Mauritius and Dubai) have had some success in diversifying their economies.

The mega-trends in automation and digitalisation have tested the premise that developing countries like those in Africa and the Middle East can follow the traditional path of industrialisation that advanced economies and China have followed. Digitalisation removes the compartmentalisation between different sectors, making it difficult to rely on old distinctions. For example, mining and agriculture sectors are subject to a wave of technological innovation in big data and high-tech services, which blur the traditional distinction between primary and tertiary sectors.

The Covid-19 pandemic is likely to exacerbate the move away from globalisation that began early this century and promote regionalisation around big economic blocs – led by the United States, the European Union and China. Regionalisation provides an opportunity for African and Middle Eastern countries to deepen regional integration and create their own value chains.

In addition to structural change, ‘transformation’ can also refer to physical processing, which adds value to the raw materials that Africa and the Middle East have in abundance. Such a transformation entails a move up the value chain, which can help the region mitigate the vagaries of commodity price fluctuations.

Whether it is cocoa, oil, metals or wood, the lack of physical transformation is widespread, and it has frustrated the ability of Africa and the Middle East to create good jobs. Indeed, waves of mineral and hydrocarbon discoveries and an abundance of fertile land, especially in Africa, make the region a prime source of natural resources for the rest of the world. But there are too few jobs in the primary sector and many are low paid. Moreover, despite the abundance of its resources, Africa and the Middle East import billions of dollars of processed food and refined products annually.

Attracting foreign or domestic investment in the processing of raw materials will create good jobs with decent wages and result in a bigger share of the ultimate value of the raw materials staying in the region. Pro-active policies to foster local content include using tax policy design to provide incentives for value addition and limiting exports of raw products. Gabon has had some success in wood processing, Botswana in diamond cutting and Nigeria in oil extraction – all of which show that it is possible to move up that value chain and localise jobs.

Value added tax (VAT), when well designed, can be an important tool for formalisation. Informality suffers from both chronically low productivity and profitability but can be given incentives to move up the value chain. For example, adjusting the VAT threshold liability – the level at which a firm is subjected to VAT – can encourage small agriculture farmers to get rebates on their investments and hence move up the value chain.

Commodity producers have tried other approaches to maximising the value of their natural resource endowments. An important one is the cartel. In response to the unfair shake they believed they received from the exploitation of natural resources, developing countries have set up producer cartels, such as the Organization of the Petroleum Exporting Countries (OPEC).

While these cartels may get higher prices for the primary commodity and add revenue to government coffers, in practice advanced economies eventually find alternative suppliers (for example, non-OPEC producers) or develop alternative products (such as synthetic palm oil or shale oil). Moreover, cartels do not resolve either a producer’s exposure to the boom-bust price cycle in raw commodities or the need to create a large number of good jobs. Transformation appears indispensable for getting out of the development trap.

Why has it been so difficult to transform raw products in the region? Trade theory helps explains why, when transport costs are low, transformation activities cluster in advanced economies and developing countries are relegated to supplying raw materials. During the colonial era, that structure of interdependence was imposed through coercion and military might. At the onset of independence, many developing countries tried to escape that trap by adopting import substitution policies.

But policies to encourage domestic production of goods that used to be imported largely failed, in part because of lack of comparative advantage and ineffective state-owned enterprises. The paradigm has since shifted from import substitution to export promotion, which has also met with little success despite government efforts – such as establishing special zones with tax and other advantages for exporting firms.

Fostering a vibrant private sector to promote good jobs while ensuring regulation to fight anti-competitive practices is the best approach. In addition to the appropriate design of tax and trade policies, the region needs an antitrust moment like the late 19th century Sherman Act in the United States – the first federal legislation that outlawed monopolistic business practices – to leverage collectively the rise in pent-up domestic demand to facilitate the development of domestic productive systems.

As the population of Africa and the Middle East is set to double by 2050, efforts to ‘demonopolise’ economies of the region are vital to achieve economic transformation. Too often the blurry relationship between business and politics, whether it is linked to the presence of state-owned or private monopolies (or oligopolies), comes in the way of economic transformation. Indeed, fair competition through private sector development will drive innovation and investment in ways that the public sector cannot outside sectors where there are natural monopolies or in presence of externalities.

Africa has embarked on an ambitious African Continental Free Trade Area (AfCFTA) to stimulate trade in the continent. To promote a deep agreement that fosters investment in transformation, the agreement will have to coordinate trade, competition and tax policies to ensure that there are no loopholes. The agreement should leverage the rising demand from the African consumer to stimulate investment in the continent to serve that demand.

Yet the experience of the European Union, which started with a coal and steel community to promote narrow and deep agreement and eventually blossomed into a full-throated confederation, demonstrates the importance of avoiding shallow and broad agreements. Deepening the AfCFTA by focusing on transformation of agriculture products is the best way to start. Indeed, agribusiness could be as pivotal for Africa as coal and steel for Europe because of the benefits of food security and jobs for the continent.

Similarly, it is high time for countries in the Middle East to deepen their regionalisation efforts, including in regionally traded services such as electricity and telecoms, by relying on the rising power of their collective domestic demand. That should be done through strengthening their competition apparatus to support the development of a more genuine domestic private sector, in turn creating decent jobs. Opportunities for the Middle East and Africa to deepen their economic ties through trade and investment is a no-brainer provided the walls of vested interest can be torn down.