structural transformation in Ethiopia: Enhancing the transition from Agrarian to Industrial Development

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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

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1 Introduction: Ethiopia‘s 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

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Ethiopia’s ‘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.

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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.

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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)

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STRUCTURAL TRANSFORMATION: POLICY TRANSITION

FROM ADLI TO INDUSTRIAL DEVELOPMENT

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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

ADLI’s 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

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Agricultural Development Led Industrialization (ADLI): Definition and Context (2)

ADLI’s 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)

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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

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ADLI: How it Evolved?

PASDEP II (GTP I) (2010 – 2015)

PSNP

IDS

(2003)

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STRUCTURAL TRANSFORMATION: POLICY TRANSITION FROM ADLI TO INDUSTRIAL DEVELOPMENT

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The Choice of ADLI as a Development Strategy is Explained

by Structural Characteristics of the Economy and

Government’s 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?

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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 one’s 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

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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)

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ADLI as Practiced in Ethiopia: Experience and Evidence

Structural characteristics of the Ethiopian economy

ከአገራችን ህዝብ ውስጥ ከ85% በላይ የሚኖረው በገጠር ነው። አብዛኛው መሬት ያለውም በገጠር

ነው። ጉልበትንና መሬትን በሰፊውና በላቀ ደረጃ መጠቀም የሚቻለው በግብርና ዘርፍ ህዝቡና

መሬቱ ባለበት በገጠር ላይ ያነጣጠረ የልማት ስትራተጅ የተከተልን እንደሆነ ነው (የገጠር ልማት

ፖሊሲ፤ ገፅ 7)።

Widespread and rampant poverty that necessitate rapid and equitable

economic growth

Ethiopia’s 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

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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

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ADLI Economic Outcomes

Source: World Bank Ethiopia Economic Update II (2013)

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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)

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Theories and Patterns of Structural Transformation (1)

Petty-Clark Law, Lewis Theory of Development and Chenery’s 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

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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

Don’t 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?

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Structural Transformation: East Asian Experience

East Asia’s 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 Ethiopia’s – 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?

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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 Ethiopia’s 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?

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3 Why ADLI? Motivation and Rationale






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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)

People’s income has grown , which means people would demand

more non-agricultural goods (i.e., Engle’s Law)

So, income growth means – high demand for industrial goods

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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.)

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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

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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)

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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 country’s policy choice matter more than endowments.

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3 Why ADLI? Motivation and Rationale






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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

Economy & Finance

structural transformation in Ethiopia: Enhancing the transition from Agrarian to Industrial Development