Industrial policy and late industrialisation in Ethiopia: The structure and performance of the manufacturing sector
The AfDB’s Vice-Presidency for Economic Governance and Knowledge Management has posted a series of new Working Papers and Economic Briefs. The following analyses have been prepared by Dr Arkebe Oqubay.
The structure and performance of the Ethiopian manufacturing sector
Although Ethiopia has emerged as one of Africa’s fastest-growing economies, its manufacturing sector is still far from being an engine of growth and economic transformation. It currently plays a marginal role in employment creation, exports, and output, and falls short on stimulating domestic linkages.
The sector is dominated by small firms and resource-based industries, low-value and low-technology products, and weak inter-sectoral and intra-sectoral linkages. The manufacturing sector’s export orientation has been low and stagnant.
Based on data and evidence from the past 25 years, the paper provides an in-depth analysis of the structure and performance of the Ethiopian manufacturing sector and further explores the reasons behind the ‘paradox’ of the slow growth of industrial outputs and structural shifts.
Since the mid-2010s, however, there are some promising signals that the manufacturing sector might be coming out of its doldrums and showing positive dynamics. The paper summarizes the growing challenges of building an industrial workforce and domestic capability, together with export capacity. The findings from this study show a bias for hope, as well as a potential structural transformation.
A bias for hope: Late industrialization in the early 21st century
Achieving Vision 2025, a plan to make Ethiopia the leading manufacturing hub in Africa, requires an annual manufacturing growth rate of 25 percent and an increase in manufacturing’s share of GDP to 20 percent by 2025.
The evidence above suggests the economy may fall short of this ambitious target. And as discussed, there are plenty of reasons to be sceptical about the prospects for success. Nonetheless, the evidence also suggests that Ethiopia’s commitment to structural transformation in recent years may be starting to bear fruit. The government has also developed the beginnings of a sharper policy focus. First, it encouraged investment in new productive capacity, especially in priority manufacturing activities (in light manufacturing, basic wage goods and import substitution, and strategic new industries such as new energy). Light manufacturing industries are acknowledged to be export oriented, labor intensive, linked to agriculture, and involve tradable goods.
Second, a new approach to hub development, agglomeration, and clustering was deemed essential, with the focus on building sustainable, specialized parks that apply a plug-and-play model. The major departure occurred during GTP II when the government decided on a comprehensive industrial hubs strategy, with the aim of developing 25 industrial parks, of which some were operational by December 2018. Ethiopia’s unique model of hub development and industrial parks has been based on systematic learning (from South Korea, Singapore, China, Vietnam, Mauritius, Nigeria, and a review of the brief experience in Ethiopia). Learning by doing was supported through piloting and experimenting at Hawassa Industrial Park.
There are positive indications of the effect of this new strategic approach. The quality and volume of FDI inflow has shown very rapid growth and change. FDI almost quadrupled to US$4.2 billion in 2016/17 from US$1.1 billion in 2011/12. Manufacturing drew in more than 80 percent of FDI during this period. McKinsey’s survey (2017) shows that about two-thirds of all Chinese firms in Ethiopia were engaged in the manufacturing sector, which is twice the average of Chinese firms’ engagement in Africa. In the export-oriented apparel and textiles sector, the contribution of FDI firms has grown in recent years and accounts for about 70 and 60 percent of exports and employment respectively.
Conclusion: enduring constraints
By early 2018, there was inadequate evidence to fully assess the effectiveness of these policy responses. The three strategic issues below required comprehensive and long-term attention. First, as Ethiopia embarks on late industrialization, building an industrial workforce has become a strategic issue of concern. Firms and industrial associations have developed joint initiatives to develop and upgrade workers’ skills in collaboration with government agencies and development partners, which has led to some positive results. High absenteeism and labor turnover eroded attempts to develop labor force skills in order to increase productivity. Labor sourcing and supply has been constrained by lack of well-developed labor market institutions to recruit and train workers, low wages, weak industrial relations, rapidly increasing living costs, and lack of affordable housing in host cities. Moreover, human resource issues related to personnel management and communication have also been cited as potential constraints in firms observed. Oya highlights that building an industrial workforce is uneven, protracted, and requires wider state intervention. Based on the historical account of the UK and continental Europe, Thompson (1967: 90) underlines that it may take several generations to perpetuate and ‘institutionalize’ industrial work discipline.
Second, an equally important strategic issue for Ethiopia’s industrialization is the development of domestic industrialists and linkages. There has been little participation by domestic firms in highly competitive export-oriented manufacturing for a number of reasons. There has also been a lack of access to long-term industrial financing for domestic firms due to the limited capacity of public banks and the lack of interest by private banks in such financing. The political economy constraints favored investment in more profitable sectors and speculative activities rather than in export-oriented manufacturing. Despite an industrial policy that has in some respects been prepared to ‘get prices wrong’ in order to encourage accelerated manufacturing activity, relative prices in the Ethiopian economy clearly still deflect investors away from manufacturing.
Accelerating learning within the global economy is as critical as relaxing constraints on the balance of payments. The hope was that industrial parks would facilitate this, by promoting production linkages and learning from the interaction between domestic and foreign firms. But these learning outcomes did not instantly materialize. Moreover, additional support schemes and incentives (such as government cost sharing and loans) designed to promote skills and productivity were not entirely translated into action.
Third, Ethiopian manufacturing needed a breakthrough in export performance. Export-led industrialization and import substitution should be seen as complementary rather than mutually exclusive. In addition to an overvalued exchange rate and inadequate institutional support for exporters, the lack of internationally competitive export logistics and trade facilitation, especially important given that Ethiopia is landlocked, became key binding constraints on export-led industrialization. The construction and operationalization of the new national railway network and construction of the Grand Ethiopian Renaissance Dam are part of the strategic responses that will ultimately determine the success of Ethiopia’s late industrialization. So too are the recent investments by Ethiopian Airlines to expand its freight terminal and to foster integration into global logistics networks.
Industrial Policy and Late Industrialisation in Ethiopia
Industrial Policy in Ethiopia: An Introduction
More than fifteen years into a period of sustained and rapid economic growth, Ethiopia has continued to attract international attention for its achievements and for pursuing a home-grown development strategy, with an active industrial policy at its center. Some have been sceptical about Ethiopia’s development model. While a 2017 BBC documentary asked: “Can Ethiopia be Africa’s leading manufacturing hub?,” the Financial Times was dismissive, arguing in an article entitled "Ethiopia’s mythical manufacturing boom” that the Ethiopian government had waged a successful PR campaign by selling “a story that does not really exist.” The Ethiopian People’s Revolutionary Democratic Front (EPRDF) had initially targeted agriculture as the key driver of post-war economic take-off (1995-2015) but increasingly pursued the development of the manufacturing sector as the prime driver of sustained economic growth and structural transformation post 2010. Nonetheless by 2018, per capita income remained very low and it was services that had come to dominate the economy rather than manufacturing. Despite being able to feed its growing population, Ethiopia – Africa’s second and the world’s twelfth most populous country – faced intense structural constraints.
Industrial policy and structural transformation
An industrial policy can be a vehicle for catch-up and structural transformation, and increasingly such a policy must focus on how an economy is integrated into global trade and production networks. Industrial policy may be defined as “a strategy that includes a range of implicit or explicit policy instruments selectively focused on specific industrial sectors for the purpose of structural change in line with a broader national vision and strategy” (Oqubay 2015: 18).6 Structural transformation involves the shift (of an irreversible and permanent nature) of people and economic activities between sectors, and from less to more productive activities. It involves diversification (both vertical and horizontal) into new more dynamic activities, fostering domestic linkages and building technological capabilities, and developing the stock of technical knowledge that constitutes wealth. There continues to be convincing evidence that manufacturing is the engine of structural change and sustained growth. This is because of the greater scope in manufacturing (broadly defined to include high-productivity agricultural production) for economies of scale, learning by doing, technological development, and productivity gains, together with the strong links between manufacturing and other sectors. Manufacturing also has powerful direct and, perhaps even more important, indirect employment effects. Another central – and often neglected – component in structural transformation is the strategic role of exports. First, exports drive international learning, and hence catching up. Second, exports expand demand and increase productivity gains. Third, exports relax the balance of payments constraint, while enhancing the viability of import substitution. For a late latecomer such as Ethiopia, the key challenge is to be able to catch up by learning from forerunners, and to mobilize abundant, scattered, and underutilized forces for the purpose of development.
Against this background, this paper examines the Ethiopian experience of industrialization and industrial policy in the early twenty-first century. The paper reviews the origins of Ethiopia’s industrialization and industrial policymaking process in the 20th century. The Ethiopian government has pursued developmentalism and practiced an active industrial policy since the early 2000s. However, a review of industrial policies in various priority sectors shows that the outcome has been uneven across sectors, indicating the importance of the strong interaction between industrial structure, linkage dynamics, and politics/political economy for the evolution and effectiveness of an industrial policy.
After examining the fundamental weakness in Ethiopia’s economic structure, this paper will illustrate why and how industrial policy must focus on manufacturing and exports to generate structural transformation and accelerate catch-up. The Ethiopian experience shows that an activist industrial policy goes hand in hand with an activist state.
Dr. Arkebe Oqubay is a Minister and Special Advisor to the Prime Minister of Ethiopia, Dr Abiy Ahmed. The above papers are forthcoming in The Oxford Handbook of the Ethiopian Economy, a volume edited by Chris Cramer, Fantu Cheru, and Arkebe Oqubay, to published by Oxford University Press in 2019.