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Enhancing the Transition from Agrarian to Industrial Development in Ethiopia
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CONFIDENTIAL AND PROPRIETARY Any use of this material without specific permission is strictly prohibited
FEDERAL DEMOCRATIC REPUBLIC
OF ETHIOPIA
Structural Transformation in Ethiopia: Enhancing the Transition from Agrarian to Industrial Development
Economic Policy Analysis Unit (EPAU) Ethiopian Development Research Institute
October 2013
Berihu Assefa Gebrehiwot
2
1 Introduction: Ethiopias Development and Governance Model
2 What is ADLI? Conceptual and Theoretical Underpinnings
3 Why ADLI? Motivation, Rationale and Country Context
4 ADLI as Practiced in Ethiopia: Experience and Evidence
5 Structural Transformation: Theory and Practice
6 What Does it Take to Make the Industrial Sector a Leading Sector?
7 Some Issues that Need Further Discussion and Sensitization
STRUCTURAL TRANSFORMATION: POLICY TRANSITION
FROM ADLI TO INDUSTRIAL DEVELOPMENT
3
Ethiopias Development and Governance Model
Ethiopia officially rejected the Washington Consensus and embraced the Democratic Developmentalism model (DD), which
is a reconfigured version of the East Asian developmental state
model
The DD involves both economic transformation (through economic policies) and the transformation of non-economic
institutions.
The role of the state in the Developmentalism argument:
The state is actively involved in combating rent-seeking and creating value addition
The state and the market complement one another and provide an excellent joint outcome.
4
Developmentalism: The State Assumes Active
Economic Roles
The State Assumes Active Economic Roles
National development planning (key instruments and institutions: central economic agencies, technocrats, High-level Councils or Committees, IPs, 5-year plans)
Deliberate (systematic) resource reallocation towards productive investment (e.g., directed credit and foreign exchange
Model state enterprises development
Nurture value-creation and combat rent-seeking behaviors of economic actors.
5
Developmentalism: Key Conditions for Success
Strong and committed leadership
Policy structure - vision, strategy, actions, monitoring
Severely combat corruption
Efficient bureaucracy
Technocracy-led development planning
Strong tripartite relationship among government, business and bank
National movement for mindset change (i.e., Rallying the public for development)
6
1 Introduction: Ethiopias Development and Governance Model
2 What is ADLI? Conceptual and Theoretical Underpinnings
3 Why ADLI? Motivation, Rationale and Country Context
4 ADLI as Practiced in Ethiopia: Experience and Evidence
5 Structural Transformation: Theory and Practice
6 What Does it Take to Make the Industrial Sector a Leading Sector?
7 Some Issues that Need Further Discussion and Sensitization
STRUCTURAL TRANSFORMATION: POLICY TRANSITION
FROM ADLI TO INDUSTRIAL DEVELOPMENT
7
Agricultural Development Led Industrialization (ADLI):
Definition and Context (1)
ADLI is a development strategy which aims to achieve initial industrialization by transforming agriculture first:
Robust agricultural growth
Productivity breakthrough by small farmers
Improved linkages with industrial sector
ADLIs Vision and Conception
Smallholder farmers can create wealth (but, of course, large-scale commercial farming has been added to the ADLI policy
menu later)
Achieve economic growth and initial industrialization by transforming agriculture first through the use of labor-
intensive and land-augmenting technologies and the
development of agricultural markets
8
Agricultural Development Led Industrialization (ADLI): Definition and Context (2)
ADLIs initial industrialization hypothesis (by focusing on agriculture as the engine of growth) involves:
Transformation from subsistence to market activities (or surplus)
Productivity breakthrough by small farmers
Raise capital (through savings, taxation, export earnings, etc.) for industrial investment
Sustained food supply to enhance sustained industrial growth (or to avoid the Ricardian trap)
9
ADLI Definition and Context: Shaping Resource Allocation and Public Expenditure Priorities
Commit more resources and attention to agriculture (especially, smallholder farmers)
Evidence: Ethiopia devotes about 17 to 18% of its budget to agriculture, which is well above the 10% commitment agreed by
African countries via CAADP
This massive resource is spent on agricultural and rural programs
Extension programs
Agricultural technology
Rural financing (micro-financing)
Productive safety Nets (asset-building)
ADLI guides national resource allocation and shapes public expenditure priorities
10
ADLI: How it Evolved?
PASDEP II (GTP I) (2010 2015)
PSNP
IDS
(2003)
11
1 Introduction: Ethiopias Development and Governance Model
2 What is ADLI? Conceptual and Theoretical Underpinnings
3 Why ADLI? Motivation, Rationale and Country Context
4 ADLI as Practiced in Ethiopia: Experience and Evidence
5 Structural Transformation: Theory and Practice
6 What Does it Take to Make the Industrial Sector a Leading Sector?
7 Some Issues that Need Further Discussion and Sensitization
STRUCTURAL TRANSFORMATION: POLICY TRANSITION FROM ADLI TO INDUSTRIAL DEVELOPMENT
12
The Choice of ADLI as a Development Strategy is Explained
by Structural Characteristics of the Economy and
Governments Socio-Economic Objectives
The choice of ADLI (or any development strategy) depends primarily on
1. The structural characteristics of the economy
2. Governments social objectives
Structural characteristics of the economy
Agrarian (agriculture is the largest employer and source of livelihood)
Abundant labor and land, but scarce capital
Overwhelmingly rural households
Governments social objectives
Poverty reduction (pro-poor strategy): What effective pro-poor strategy? Greater impact on poverty reduction by focusing on agriculture, which is the largest employer
Economic justice (inclusive growth strategy): High coverage by agricultural growth
Given these, What Development Strategy?
Given these objectives, What Development Strategy?
13
Theoretical Underpinnings of ADLI: Static Comparative Advantage, Pro-poor and Inclusive Growth Theories
Comparative advantage based on factor endowment (Heckscher-Ohlin and Stolper-Samuelson)
Pro-poor growth theory Inclusive growth theory
Development should
effectively utilize ones Factor Endowment (i.e., abundant
labour and land)
Develop a development strategy based on factor endowment
Economic, social and moral imperative for poverty eradication
Development should address Poverty
Comparative advantage as an economic guide to competitiveness and growth
Development should address Income Inequality (i.e., equitable allocation of resources and opportunities) Economic, social and moral imperative for economic justice (i.e., involve everyone the growth process)
Pro-poor growth strategy
Economic specialization strategy
Inclusive growth strategy
Develop the largest employer and source of livelihood
Develop inclusive and empowering sectors
ADLI
14
Theoretical Underpinnings of ADLI: Static Comparative Advantage, Pro-poor and Inclusive Growth Theories
Growth Employment
Agrarian middle class
Income equality Investment
Foreign exchange earnings
Food supply
Savings
ADLI (Agriculture
as the engine of growth)
15
1 Introduction: Ethiopias Development and Governance Model
2 What is ADLI? Conceptual and Theoretical Underpinnings
3 Why ADLI? Motivation, Rationale and Country Context
4 ADLI as Practiced in Ethiopia: Experience and Evidence
5 Structural Transformation: Theory and Practice
6 What Does it Take to Make the Industrial Sector a Leading Sector?
7 Some Issues that Need Further Discussion and Sensitization
STRUCTURAL TRANSFORMATION: POLICY TRANSITION FROM ADLI TO INDUSTRIAL DEVELOPMENT
16
ADLI as Practiced in Ethiopia: Experience and Evidence
Structural characteristics of the Ethiopian economy
85% ( 7)
Widespread and rampant poverty that necessitate rapid and equitable economic growth
Ethiopias pro-poor and inclusive growth commitment
More than 65% of the public expenditure has been spent on pro-poor sectors such as education, water, health, agriculture, roads and
energy
Agriculture alone: about 18%, much higher than the 10% commitment by African countries via the CAADP
17
ADLI as practiced in Ethiopia: Experience and Evidence
Economic and social opportunities ADLI is expected to deliver
Employment, growth, investment, foreign exchange earnings, savings, income equality and basic needs provision
Creating conditions for the industry to play key role in the economy
Creating an agrarian middle class and a domestic mass market, both of which are necessary for ultimate successful industrialization
18
ADLI as Practiced in Ethiopia: Experience and Evidence
ADLI Economic Outcomes
Source: World Bank Ethiopia Economic Update II (2013)
19
ADLI as Practiced in Ethiopia: Experience and Evidence
ADLI Economic Outcomes
Economic Growth: robust economic growth over the past decade (growth averaged 10.7 percent per year in 2003/04 -
2011/12 compared to the regional average of 5.4 percent (WB
2013)).
Poverty headcount: people living below the poverty line has declined from 45.5 % in 1995/96 to 27.8 in 2011/12 (GTP-
APR MoFED, 2011/12)
Income inequality: low Gini-index (about 0.3, WB)
20
1 Introduction: Ethiopias Development and Governance Model
2 What is ADLI? Conceptual and Theoretical Underpinnings
3 Why ADLI? Motivation, Rationale and Country Context
4 ADLI as Practiced in Ethiopia: Experience and Evidence
5 Structural Transformation: Theory and Practice
6 What Does it Take to Make the Industrial Sector a Leading Sector?
7 Some Issues that Need Further Discussion and Sensitization
STRUCTURAL TRANSFORMATION: POLICY TRANSITION FROM ADLI TO INDUSTRIAL DEVELOPMENT
21
Theories and Patterns of Structural Transformation (1)
Petty-Clark Law, Lewis Theory of Development and Chenerys Patterns of Development
The center of gravity in economic activities shifts from the primary to secondary sector, and further to the tertiary sector as income continues to rise.
Put differently, Agriculture cedes its place to manufacturing; and manufacturing cedes its place to services.
Intersectoral migration (e.g., agricultural labor becomes factory worker)
Change in consumer demands
Demographic transition
22
Theories and Patterns of Structural Transformation (2)
1. Market-led Inter-sectoral Resource Allocation
Structural change through market-led changes and resource reallocations
Economic growth/rising level of income
Changes in the composition of internal demand (greater demand for non-agricultural goods)
Rising level of Skills and Competencies
International Shifts in comparative advantage
This is relatively a slow structural change process
2. Correct-policy-mix
Even if the comparative advantage theory tells countries to focus on their factor endowments, some countries
Push the limits of their static comparative advantage and diversify into new activities
Dont rely only on factor endowments (or static comparative advantages)
Discover new economic activities and create new comparative advantage
Learn that comparative advantage can be created (i.e., the dynamic comparative advantage theory)
This is a policy response to expedite structural transformation
What drives structural transformation?
23
Structural Transformation: East Asian Experience
East Asias Dynamic Growth Experience
Pushed the limits of their static comparative advantage and were able to quickly diversify into more sophisticated activities (i.e., breaking a conventional development thinking)
For example, Joseph Stieglitz wrote: The theory of comparative advantage told South Korea, as it emerged from the Korean War, that it should specialize in rice. But Korea believed that even if it were successful in increasing the productivity of its rice farmers, it would never become a middle or higher income country if it followed its static comparative advantage. It had to change its comparative advantage, by acquiring technology and skills . It had to focus not on its comparative today, but on its dynamic comparative advantage.
During their early stage of industrialization, their factor endowments were similar to Ethiopias abundant in labor and scarce in human and capital endowment.
Were bold enough and embarked on light and heavy manufacturing at their very early stage of development
Question: how did they solve their savings gap and capital constraint?
24
Structural Transformation: East Asian Experience
Because of the dominance of the agricultural sector in poor countries, capital required to finance industrial expansion (at least in the early stages of development) would have to be largely raised from agriculture by taxation, voluntary transfer (savings), or even by forced savings.
For example, agriculture provided resources for industrialization through taxation and foreign exchange earnings in countries below
Silk and tea exports (Japan 19th c) Rice and sugar (Taiwan up to 1960s) Rice export (Thailand up to 1980s) Fish and shrimp (south east Asia) Grapes and salmon (Chile)
How about Ethiopias experience? Low agricultural saving (lack of innovative financial institutions in rural
areas)??
Agriculture is largely untaxed?? No belt-tightening (or forced saving) policies??
What is the role of agriculture in early development?
25
1 Introduction: Ethiopias Development and Governance Model
2 What is ADLI? Conceptual and Theoretical Underpinnings
3 Why ADLI? Motivation and Rationale
4 ADLI as Practiced in Ethiopia: Experience and Evidence
5 Structural Transformation: Theory and Practice
6 What Does it Take to Make the Industrial Sector a Leading Sector?
7 Some Issues that Need Further Discussion and Sensitization
STRUCTURAL TRANSFORMATION: POLICY TRANSITION FROM ADLI TO INDUSTRIAL DEVELOPMENT
26
Making the Industrial Sector a leading Sector: From ADLI to Industrial Development Led Growth
In terms of structural change, Ethiopia fared little i.e., the share of the industrial sector has remained stagnant at about 13%,
which is low even compared to the SSA, which is about 25%
However, initial conditions for structural transformation have been created
Since Ethiopia did very well in terms of economic growth (a double digit growth for the last 10 years)
Peoples income has grown , which means people would demand more non-agricultural goods (i.e., Engles Law)
So, income growth means high demand for industrial goods
27
Making the Industrial Sector a leading Sector: From ADLI to Industrial Development Led Growth
So, what is the rationale for a policy transition from ADLI to Industrial development led growth? What are the economic
and social opportunities? Sustained economic growth (per capita income growth) market for
industrial goods is created
Sufficient infrastructure has been laid out for industrialization to take-off
Capital (e.g., saving and FDI) and skill accumulation has reasonably grown (e.g., saving rate is 17.7%)
Education policy twinning (70% to join science and technology )
Industrialization drive industry as a sustainable source of prosperity and employment
Enhanced foreign-technology learning From China, Japan, German, USA
Mind-set change (can-do thinking, improvements in working culture, time management, etc.)
28
Making the Industrial Sector a leading Sector: From ADLI to Industrial Development Led Growth
Additional Opportunities for Industrial Development
Cheap labor (much lower than the sub-Saharan average)
Young population
Publicly-owned land (readily available for investment and infrastructure development)
Large domestic market size
29
Expected outcomes of a policy shift to Industrial Development-Led Growth
The industrial sector is expected to exhibit a
much faster growth. Why?
Expected outcome: Enhanced industrial growth
a) The growing industrial sector and urban population will create a huge demand for agricultural products (i.e., demand for food and inputs)
b) Better adoption of agricultural technology - as many rural labour become factory worker (as a result of industrial growth), those who remain farming will have larger agricultural land. And owning large agricultural land would lead to better technology and modern variety adoption because of scale economies.
Despite diminished public resources (because some of the resources are going to be allocated to the industrial sector), the agricultural sector is also expected to grow . Why?
Because, the industrial sector is expected to a) benefit from increased public resources b) Benefit from the internal and external
demands created c) benefit from the economic and social
opportunities created (see previous slide)
Expected outcome: continued agricultural modernization and growth
Question: If the industrial sector starts to enjoy high policy support and public resources in an attempt to make the industrial sector an engine of growth, then what happens to agriculture, industry and the overall economy?
Overall economy growth and transformation (ceteris paribus)
30
Putting the transition to Industrial Development-Led Growth into Context
Note that it does not mean that the industrial sector has taken the lead in terms of contribution to GDP
It is rather a policy metamorphosis to make more resources available to the industrial sector to stir industrialization
Or it is a transition from the static comparative advantage to the dynamic comparative advantage thinking
Dynamic comparative advantage means that a country can create new comparative advantages through smart industrial policy
Discovery process Nurture new economic activities (economic diversification) A countrys policy choice matter more than endowments.
31
1 Introduction: Ethiopias Development and Governance Model
2 What is ADLI? Conceptual and Theoretical Underpinnings
3 Why ADLI? Motivation and Rationale
4 ADLI as Practiced in Ethiopia: Experience and Evidence
5 Structural Transformation: Theory and Practice
6 What Does it Take to Make the Industrial Sector a Leading Sector?
7 Some Issues that Need Further Discussion and Sensitization
STRUCTURAL TRANSFORMATION: POLICY TRANSITION FROM ADLI TO INDUSTRIAL DEVELOPMENT
32
Some Policy Issues for Discussion and Sensitization
Expand the current industrial policy (IP) in terms of scope. Instead of focusing on a few priority areas, try to discover or create new comparative advantages
Both export promotion and import substitution strategies but export promotion should be the pillar policy for import substitution does not enjoy economies of scale.
Only a few strategic industries need to be substituted
Enhance the role of private sector in industrial development
Industrial sector - Industrial Policy
Defining Sectoral Roles and Priority Areas
Less massive but innovative support for smallholders food self-sufficiency versus surplus production??
Tapping the huge commercial farming opportunities Ethiopia has
Public support should aim for narrower but higher-impact agricultural projects
Encourage private sector investment in agriculture (e.g., seed development, fertilizer production and distribution, rural finance)
Agriculture Agricultural Policy