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Ethiopia Why has the industrial sector stagnated for long? Policy explanations Berihu Assefa DOC09010 Ethiopian Development Research Institute (EDRI) July 2010 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 Preview of Ethiopian economy Status of industrial sector Value added (% of annual growth) -20 -10 0 10 20 30 Lowess smoother: Industry Value Added (% annual growth) 1980 1990 2000 2010 year bandwidth = .8 Source: WDI (2009) -40 -20 0 20 40 60 Lowess smoother: Manufacturing Value Added (% annual growth) 1980 1990 2000 2010 Year bandwidth = .8 Source: WDI (2009) • • Stagnant for nearly two decades (about 12% to GDP Manufacturing alone about 3% to GDP 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) 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) Status of industrial sector (cont.) • Ethiopia commands relatively lower TFP than all the other countries indicated Policy Evolution Rural-centered Development policy (1991~) (Farmers can produce surplus and start small cottage industries) SDPRP (a small section to industry and trade (No urban economic policy) Agricultural Development Led Industrialization (ADLI) (1995~)(start linking with SMEs) SDPRP Food security strategy (3 years) Industrial Developm ent strategy (end of 2002) PASDEP I (2005/6~2009/10) Master plans PASDEP II (2010~2015) Key players and policy dynamics External advice/coercion Policy advice from the West (scholars, IMF, WB, …) Usually one shot policy advice ; and such policy advice tend to be common to all LDCs (with the exception of J.Stiglitz & D. Rodrik) Policy advice from the East (mainly Japan) – GRIPS team (led by Prof. Ohno) Policy dialogue with key government officials with the aim of developing policy making skill and dynamic capacity. Supported by concrete projects such as factory productivity improvement (Kaizen). 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 Policy explanations 3 policy problems are visible to me a) Rural obsession (‘traditional-trap’) b) Policy bias in favor of exports c) Egalitarian growth as an objective 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 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 Policy problems (cont.) a) Skewed policy (‘traditional-trap’) (cont.) Labor productivity in agriculture Source: Magdi M. Amin, World Bank, 2007 • • • 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 2002/3 identifying priority sectors with clear focus on export industries – the need to generate Forex. Policy explanations 3 policy problems are visible to me a) Rural obsession (‘traditional-trap’) b) Policy bias in favor of exports c) Egalitarian growth as an objective 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 Policy bias in favor of exports Industrial policy orientation Export promotion Current system: support based on export performance Prof. Rodrki’s recommendati on: Support new activities rather than exports Prof. Ohno’s team: select a few priorities but make sure to learn to expand policy as you develop policy capability My own: support ‘tradable standard products’ rather than exports Import substitution industries In the pipe line: supported by Ohno’s team, J. Stiglitz, D. Rodrik Policy problems a) Rural obsession (‘traditional-trap’) b) Policy bias in favor of exports c) Egalitarian growth as an objective 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) 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 Getting out of the “traditional-trap” (indications for policy review) Indicators for policy reviews and adjustments (by PM Meles) 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? 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 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)