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«Tilman Altenburg Bonn 2010 Discussion Paper / Deutsches Institut für Entwicklungspolitik ISSN 1860-0441 Altenburg, Tilman: Industrial policy in ...»

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Industrial policy in Ethiopia

Tilman Altenburg

Bonn 2010

Discussion Paper / Deutsches Institut für Entwicklungspolitik

ISSN 1860-0441

Altenburg, Tilman: Industrial policy in Ethiopia / Tilman Altenburg. – Bonn : DIE, 2010. − (Discussion

Paper / Deutsches Institut für Entwicklungspolitik ; 2/2010)

ISBN 978-3-88985-477-3

Tilman Altenburg, Economic Geographer, Deutsches Institut für Entwicklungspolitik (DIE)

E-Mail: tilman.altenburg@die-gdi.de

© Deutsches Institut für Entwicklungspolitik gGmbH Tulpenfeld 6, 53113 Bonn ℡ +49 (0)228 94927-0 +49 (0)228 94927-130 E-Mail: die@die-gdi.de http://www.die-gdi.de Contents Abbreviations Summary 1 Introduction 3 1 Initial conditions and challenges for industrial policy 5

1.1 Socio-economic situation 5

1.2 Historical and political background 6

1.3 Enterprise structure 9

1.4 State-business relations 12 2 Industrial policy: Ideology and practice 14

2.1 The Ethiopian government’s overall development perspective 14

2.2 Ethiopia’s industrial development strategy: A critical review 17

2.3 Policy formulation and implementation in practice 20 3 Case studies 22

3.1 The leather and leather products industry 22

3.2 The emerging cut flower industry 24

3.3 Lessons from the case studies 27 4 Conclusions 29 Bibliography 33 Abbreviations ADLI Agricultural Demand-Led Industrialisation BMZ Bundesministerium für wirtschaftliche Zusammenarbeit und Entwicklung (Federal Ministry for Economic Cooperation and Development) EFFORT Endowment Fund for Rehabilitation of Tigray EHPEA Ethiopian Horticulture Producers and Exporters Association ELIA Ethiopian Leather Industries Association EPRDF Ethiopian Peoples’ Revolutionary Democratic Front EU European Union FDI Foreign Direct Investment FeMSEDA Federal Micro and Small Enterprises Development Agency GDP Gross Domestic Product GNI Gross National Income GTZ Gesellschaft für Technische Zusammenarbeit ISO International Organization for Standardization LLPTI Leather and Leather Products Technology Institute PASDEP Plan for Accelerated and Sustained Development to End Poverty PPP Purchasing Power Parities ReMSEDA Regional State Micro & Small Enterprises Development Agency SMEs Small and Medium Enterprises SOE state-owned enterprise TAMPA Tigray Agricultural Marketing and Promotion Agency TVET Technical and Vocational Education and Training UNIDO United Nations Industrial Development Organization UNU-MERIT United Nations University - Maastricht Economic Research Institute on Innovation and Technology VAT Value Added Tax WTO World Trade Organization Industrial policy in Ethiopia Summary Industrial policy is a contested issue, especially for low-income countries. On one hand, it is widely accepted that these countries need proactive policies to master the transition from low-productivity resourced-based societies with large informal sectors to more productive, knowledge-based and formalised patterns of productive organisation. On the other hand, deliberate interventions aimed to channel resources into preferential activities may well end up reducing allocative efficiency and creating perverse incentives for investors and bureaucrats alike. This is especially true for low-income countries, where political checks and balances tend to be weak.

This report assesses industrial policy in Ethiopia. It is part of a research project on Industrial policy in low- and lower-middle-income countries covering nine states in SubSaharan Africa, the MENA region and Southeast Asia.

The Ethiopian government has demonstrated impressive dedication and ability to create the preconditions for a market-based and socially inclusive industrial transformation. It is strongly committed to investing in technological learning in order to build new competitive advantages. This becomes evident in ambitious programmes to strengthen the Technical and Vocational Education System and to set up new universities as well as supporting institutions for specific sectors, e.g. for textile, leather and horticultural products. The government has defined priorities for diversification and industrial development. Agricultural demand-led industrialisation and export promotion play a key role in its strategy.

From 2004 onwards, the Ethiopian economy has grown at 11% annually. This growth, however, has mainly been due to favourable agro-climatic conditions, high coffee prices, considerable inflows of aid and remittances, and a boom in construction; it does not reflect increased competitiveness, and it has not yet prompted significant changes in the economic structure. The share of manufacturing in GDP stagnates at 5%, and still virtually all exports are unprocessed or at best semi-processed.

This study takes a closer look at the policymaking process in the leather/leather products and the cut flower industries. The two case studies exemplify different government approaches. In the cut flower industry, the dominant players are quite strong medium-sized and large firms. Their success depends on the ability to choose the right variety of flowers, to adapt available technology packages to local agro-climatic conditions, and to sell a perishable high-value product on the international market. This requires much tacit knowledge which only large specialised firms are able to accumulate. Here the government plays no role in intervening at the company level – the technology being far too complex, and the product too heterogeneous. Instead, the government opted for a more responsive stance, easing regulations and removing obstacles in infrastructure, and leaving the strategic decisions to firms and their highly professional organisation. In the leather and leather products industry, the challenge is different. The sector is stuck in a “low-quality trap” in which problems at all levels of the value chain are mutually reinforcing. The sector can thrive only if all these aspects are tackled simultaneously. As no large private corporations exist in this industry, active public engagement is necessary to overcome the existing coordination failure. Conse

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quently the government implements a comprehensive package of activities to nurture companies along the whole value chain, with a leather technology institute as the focal point.

While this differentiated and pragmatic approach is convincing, the study also identifies major risks of industrial policymaking. The government deliberately employs a carrot-and-stick approach that differentiates between economic activities and firms, up to the point where targets for individual firms are sometimes negotiated on a case-bycase basis in exchange for public support. At the same time, resource allocation for industrial policy is not fully transparent, e.g. it is not clear when firms are eligible to get preferential treatment in term of access to licenses, land, credit and foreign exchange, on what condition ailing firms will be bailed out, and whether these conditions vary between state-owned enterprises, firms affiliated with the ruling political parties, and independent private firms. Moreover, business and politics are still strongly entwined in Ethiopia. State-owned enterprises still dominate many manufacturing industries and service sectors, and party-affiliated endowments have taken many of the business opportunities left for private engagement. Discretionary allocation of public resources lends itself to political capture by interest groups.

To date Ethiopia is clearly anything but a predatory state whose government pillages the economy. There is no hard evidence of systematic abuses of political regulation and support programmes for illicit personal enrichment of political elites. Relying fully on the wisdom and integrity of an enlightened leadership, however, is not without risks. Power constellations may change, those who have vested interests in SOEs and endowment-owned enterprises may gain political influence, and political power shifts may force political leaders to compromise on their development agenda.

Against this background, the main challenge is to make policy decisions more transparent and ensure the accountability of policymakers. Deepening of the Civil Service Reform Programme, reducing the privileges of state-owned and endowment-owned enterprises, and exposing them fully to fair competition will help to draw a clear line between business interests and public policy. Policymakers should acknowledge that private entrepreneurs are better equipped to recognise market trends and take advantage of new opportunities than government agencies. Thus industrial policy should move away from predefining priority sectors and instead focus on skills development and on creating incentives for entrepreneurs in order to develop innovations and disseminate new business models throughout the country. The prospects for such a policy shift are good, as the Ethiopian government has a clear development agenda and increasingly recognises the need to combine a market-friendly policy environment with determined supply-side policies for technological learning.

German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) Industrial policy in Ethiopia Introduction Productivity growth is a precondition for increasing people’s living standards and maintaining competitiveness in the globalised economy. Low total factor productivity is the key reason for persistent poverty in developing countries. The productivity gap separating poor and rich countries has never been as deep as it is today. Poor countries in particular thus need to emphasise productivity growth to alleviate poverty. The challenge is not only to develop more productive ways of doing business in already established activities but also to accelerate the structural transformation from low-productivity activities in agriculture, petty trade and skill-extensive services to new activities that are knowledge-intensive and exploit the advantages of inter-firm specialisation.

Undoubtedly the main driver of structural change is the private sector. Still, governments have an important role to play in setting policy frameworks that allow for competition and encourage innovation and technological change as well as in correcting market failures. It may be important to encourage new activities that do not emerge spontaneously, e.g. because several interrelated investments need to be made simultaneously that exceed the possibilities of individual entrepreneurs, or to support activities that while unlikely to pay off right away for an individual investor, are still likely to produce manifold linkages and spillovers in the future. Governments may in this way accelerate structural change towards more competitive and higher value activities. This is what industrial policy is about.

While the theoretical case for industrial policy is not in doubt, there is no consensus about the right degree of intervention. The controversy is mainly about selective interventions that favour some sectors over others and thus interfere with the price mechanism, the main signalling device of market economies. Critics argue that governments are usually not very good at identifying coordination failures or anticipating future knowledge spillovers, and their decisions may well end up reducing allocative efficiency and creating perverse incentives for investors and bureaucrats alike.

It is now widely accepted that industrial policy may work well in countries with strong merit-based public services and political checks and balances. Opinions, however, diverge widely with regard to the role of industrial policies in low- and lower-middle-income countries where financial resources are often severely limited and some core institutions still need to develop administrative capacities and better incentive systems. According to all available governance indicators, most low- and lower-middle-income countries lag far behind with regard to government effectiveness, transparency, and accountability. Hence, even if it is clear that these countries face particularly severe market failures, there is a big question mark as to the ability of governments to intervene in markets in a way that increases public welfare.

In any case, the appropriate policy mix is unlikely to be the same as in rich countries, because both the requirements and the capacity for public intervention are substantially different. Yet most empirical case studies of industrial policy focus on the old industrialised countries or the famous success stories of technological catching up (such as Korea, Taiwan, Singapore, Malaysia, Brazil, and Chile). Much less is known about the quality and the outcomes of industrial policies in low- and lower-middle-income countries.

German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 3 Tilman Altenburg The aim of this report on industrial policy in Ethiopia is to help fill this gap. It is part of a comparative research project on “Industrial policy in low- and lower-middle-income countries” funded by the German Ministry for Economic Cooperation and Development (BMZ) and supported by GTZ. Besides Ethiopia, the comparative research included Cambodia, Egypt, Mozambique, Namibia, Nigeria, Syrian Arab Republic, Tunisia, and Vietnam.

For the purpose of the project we define industrial policy as any government measure, or set of measures, to promote or prevent structural change in ways that the government views as desirable. Two implications of this definition need to be highlighted. First, industrial policy has a normative perspective. Most policy documents address a range of goals, including productivity growth, employment creation, social inclusion, and environmental sustainability. Second, policies may target not only the manufacturing sector but also promising activities in agriculture or services.

As part of this project, a background report has been written that takes stock of the industrial policy debate and discusses the peculiar challenges of such policies in less developed countries.1 For a comprehensive discussion of the pros and cons of industrial policy, the reader may refer to that report. This country case study therefore concentrates on the Ethiopian experiences only.



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