Ethiopia Why has the industrial sector stagnated for long? Policy explanations

1. EthiopiaWhy has the industrial sector stagnated for long? Policy explanations Berihu Assefa DOC09010 Ethiopian Development Research Institute (EDRI) July 2010

2. In this presentation…. Preview of the Ethiopian economy Status of the industrial sector Policy evolution, dynamics and key players Analysis of 3 policy problems Conclusions/suggestions

3. Preview of Ethiopian economy However, due to 1) lack of industrial dynamism / weak private sector 2) dependency on narrow range of exports and sectors many ask if growth can be sustained?”

4. Status of industrial sector Value added (% of annual growth) Stagnant for nearly two decades (about 12% to GDP Manufacturing alone about 3% to GDP

5. Status of industrial sector (cont.) Average productivity (VA per worker) Source: Results of Ethiopia Investment Climate Survey, Africa Financial and Private Sector Development, the World Bank, June 2007 • First, much lower average productivity (peak value) in Ethiopia • Second, productivity distribution among enterprises in Ethiopia is so wide - coexistence of relatively low & high productivity firms (i.e. absence of competition)

6. Status of industrial sector (cont.) Gross fixed capital formation, private sector (% GDP) Source: Results of Ethiopia Investment Climate Survey, Africa Financial and Private Sector Development, the World Bank, June 2007. For Kenya, figures are for private investment • Based on this figure, Ethiopia has the lowest gross capital formation as % of GDP (i.e. weak private sector)

7. Status of industrial sector (cont.) • Ethiopia commands relatively lower TFP than all the other countries indicated

8. Policy Evolution

9. Key players and policy dynamics External advice/coercion

10. Why stagnant for so long? Despite recent reforms in government service delivery (speedy and less corrupt) Better tax administration Some consultations with investors (hearing complaints, though not continuous discussion) Basic infrastructure, industrial zonation And business environment improvements, the private sector has not responded sufficiently, especially the manufacturing sector remains stagnant The question is why? Next, policy explanations are provided

11. Policy explanations 3 policy problems are visible to me Rural obsession (‘traditional-trap’) Policy bias in favor of exports Egalitarian growth as an objective

12. Policy problems (cont.) a) Skewed policy (“traditional-trap”) Rural obsession - state resources have been reallocated to rural sector for long (extension packages) Agriculture is almost untaxed (only negligible rent) About 97% of inland tax revenue comes from the urban area. This pro-rural orientation is stated in ADLI ADLI stipulates that smallholder farmers can create wealth and are the starting point of industrialization – is it feasible? ADLI makes more sense from equity and political support point of view Theory & empirics predict that modern sector is engine of growth – but ADLI challenges this thought

13. Resource flows between agriculture and industry • Because of the dominance of the agricultural sector in poor countries, it is evident that the capital required to finance industrial expansion (at least in the early stages of dev’t) would have to be largely raised from agriculture by taxation, voluntary transfer (savings), or even by forced savings

14. Policy problems (cont.) Labor productivity in agriculture a) Skewed policy (‘traditional-trap’) (cont.) Despite huge supports, agricultural productivity remains very low: land policy, rain-fed, fragmented Gov’t learned importance of urban sector only recently IP drafted in 2002/3identifying priority sectors with clear focus on export industries – the need to generate Forex. Source: Magdi M. Amin, World Bank, 2007

15. Policy explanations 3 policy problems are visible to me Rural obsession (‘traditional-trap’) Policy bias in favor of exports Egalitarian growth as an objective

16. Policy problems (cont.) b) Policy bias in favor of exports IDS clearly focuses on export industries – that’s why support is based on export performance. In line with the need to generate foreign exchange Sectoral priority is necessary but cost is higher when mistakes are committed (reward upgrades, new excl.) A fair example is garment industry – on the list but continuously on the decline. Adding ‘product wise support’ may solve above two problems: lowers mistakes & captures new ones

17. Policy bias in favor of exports My own: support ‘tradable standard products’ rather than exports

18. Policy problems Rural obsession (‘traditional-trap’) Policy bias in favor of exports Egalitarian growth as an objective

19. Policy problems (cont.) c) Egalitarian growth as an objective The EPRDF is strongly committed to egalitarian policies. Common statement from government officials: ensuring egalitarian economic growth Also found written in policy documents Practical evidences include: ADLI (focus on rural)policy, control of land ownership About 64% of the government’s total budget is spent on pro-poor sectors such as agriculture, education, health, water, and roads (European Union 2009). Not bad, if it were possible; however, there is trade off between efficiency and equity In the process of rapid industrialization, some portion of the population may be left behind Growth tends to produce income inequality (historically true in many cases)

20. Policy problems (cont.) c) Egalitarian growth as an objective (cont.) Caring too much for equality from the beginning leads to distortion Growth may stagnate as one discourages growth propelling entrepreneurs by income distribution Thus, the result may be low equilibrium – i.e. too equal and stagnant society Korea in the 1980s, Japan in the 1950s faced income inequality (rural lagged behind). They devised mechanisms to tackle – movements So, income inequality need to be treated as one of the adverse effects of growth, same way we treat congestion, crime, etc

21. Getting out of the “traditional-trap” (indications for policy review) It seems that government has learned that the idea that small farmers should spearhead economic development and structural transformation is proving difficult . How do we know that? Indicators for policy reviews and adjustments (by PM Meles) Aggressive promotion in the area of Expansion of large scale farms by private investors Rapid and aggressive efforts in the industrial sector – policy scope widening, introducing toolkits such as benchmarks, BPR, Kaizen, etc Invitation of foreign experts to help policy formulation and articulation (e.g. Prf. Ohno’s team) and others informally PM announced after landslide election victory last month – he will make policy reviews soon & unveil next September

22. Conclusions The last 5/6 years witnessed high growth (but with little structural transformation Also, encouraging policy learning among authorities Confusion in the role of agriculture still remains; ADLI stipulates agriculture staffed by small farmers can be engine of growth ADLI (equity & political support) However, theoretical & empirical evidence show that manufacturing is the engine of growth Conduct export promotion in a way that lowers mistakes and incorporates dynamism (abandon losers & embrace new ones) To do so, introduce methods such as ‘product-wise’ support in addition to ‘sector-wise’ support The future seems bright (commitment + quick learning + etc)