The Industrial policy of Ethiopia should move away from predefining priority sectors

This report (PDF) 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.
By Tilman Altenburg, German Development Institute (DIE)

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.

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 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-by case 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.

Source: 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 is Economic Geographer, Deutsches Institut für Entwicklungspolitik (DIE)