The private sector is supposed to be the engine of economic growth and industrialisation though there are few countries have achieved industrialisation without a successful private sector, the exceptions being the USSR and China (up to 1978). It is therefore imperative that the developmental state nurtures the private sector by creating a productive business environment and encourages them to become competitive in the market place. For instance, in Japan and South Korea, the state developed an indigenous private sector, which played a critical role in the industrialisation of these countries. These indigenous private sectors have since grown into some of the most powerful companies in the global economy. Japan and South Korea used a mixture of protectionism, subsidised credit, and other incentives for their domestic private sectors to develop an indigenous technological base, and then they allowed them to compete in the global market (Chang, 2003a). However, the state should not only provide support (incentives as carrot) but should also challenge to the private sector (as a stick) to perform better and become more competitive in the export markets; and state support should be conditional on the achievement of certain policy objectives. Therefore, the relationship between the state and the private sector should depend on a forward-looking performance directed by a ‘carrot’ and ‘stick’ approach.
A productive private sector is perceived as a major prerequisite for the overall success of the emerging developmental state in countries like Ethiopia. The state could expect to engage in two major ways: at the broader level, the state should develop strong relationships with the private sector and its constituent businesses, and empower domestic firms through incentives such as tax holidays, tax breaks and concessional loans (Kieh, 2015). Public investment in infrastructure expansion and human-resource development will make the private sector more profitable, and will ‘crowd in’ the private sector in the development process. In turn, private sectors (both domestic and foreign) expected to contribute job opportunities and domestic capital formation and transformation by engaging in the manufacturing and commercial farming sectors. The existence of modern infrastructure and effective institutions has expected to encourage the private sector to take investment risks in productive sectors. Therefore, increasing public expenditure on infrastructure and nurturing well-functioning institutions are remaining as a critical homework for the Ethiopian state.
The private sector should intend to promote and encourage industrialisation. To ensure fast and sustained industrial development, the state need to focus on industries that are labour-intensive, industries which have broad linkages with the rest of the economy, use agricultural products as input, that serve as export-oriented and import substituting, and contribute to rapid technological transfer (MoFED, 2002a). The export-oriented development strategy leads to better resource allocation, creating economies of scale (due to larger international markets) and increasing production efficiency through technological development, capital formation and transformation, employment creation and, hence, economic growth. The export sector generates much-needed foreign exchange, which can be used to provide the public funds that required to
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direct investment in growth-enhancing industries. The foreign-exchange earnings from the exports allow the import of intermediate inputs, mainly capital goods for domestic production, to stimulate exports further, thus expanding the economy’s production possibilities.
The Ethiopian state has recognised the private sector as ‘an engine of growth’ and has continued its support to enhance the competitiveness of the sector by providing basic infrastructure, institutional support and other incentives. Since the lack of infrastructure and effective institutions caused high transaction costs for the private sector, the state is expected to be the only institution that can possibly take responsibility for investment in the physical infrastructure, and the provision of direct credit for strategic industries, and the protection of infant industries (UN-Habitant, 2014). However, the quality and capacity of the public sector to provide regulatory support to the infant private sector in the Ethiopian developmental state are practically challenging by the existence of rampant corruption and rent-seeking practices.
It is obvious that, industrial development in general and development of the manufacturing sub-sector in particular, is believed by many (though not all) to be the prime driver of economic transformation and sustain growth (Chnag, 2003a, 2003b; Oqubay, 2015). In the manufacturing sub-sector, the state has been providing substantial incentives for textiles and garments, as well as leather and other agro-processing industries through establishment of industrial zones/parks, privatization of state owned enterprises, capacity building/trainings, bestowing tax holidays and tax relief, provision of basic infrastructure services, preferences in finance/credit provision and foreign currency allocation, and other incentive. Furthermore, the establishment of public institutes like Leather and Leather Product Technology Institute and Textile Industry Development Institute to support the respective manufacturing sub-sectors have tried to provide various trainings that enhanced the skill of the labour force, productivity and competitiveness (Ohno, 2009; MoFED, 2014; Balema, 2014; Oqubay, 2015). These sub-sectors expected to have both direct and indirect linkages with the agriculture sector, employ substantial proportion of skilled and semi-skilled labour forces, and boost export earnings. As equal as supporting the export-promoting sector, the state has been working on promoting import-substitute domestic industries (MoFED, 2006; 2014; Ohno, 2009) to replace imports that ‘drain-off’ the scarce foreign-exchange earnings.
Shortage of skilled labour force obviously constitutes as a key constraint to growth and improved productivity in the manufacturing sector despite the country has made progress in expanding access to education. In the short run, the provision of Technical and Vocational Education Training (TVET) could be used to bridge the gap of skilled labour supply to the manufacturing sector (World Bank, 2016). Even though the state tried to provide different supports and incentives to strengthen the manufacturing sector, the domestic private sector investment is inclined more towards the services sector than to the manufacturing sector. Considerable effort is also channelled into promoting the MSEs42 as the basis for the development of
42 The MSEs development are essential to create a broad-based springboard for the development of competitive
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medium- and large-scale, as well as indigenous private-sector enterprises. It did this by organising, training, providing land, access to loans and markets. Ethiopia’s practice of promoting and supporting MSEs more or less coincides with the experiences of some East Asian developmental states, such as Japan, South Korea, and Taiwan, all of whom created a strong domestic private sector that eventually grew into medium- or large-scale powerful indigenous companies. Although these SMEs face difficulties due to their low levels of entrepreneurial experience, they have relatively played significant role in creating job opportunities and an income for thousands of jobless people in urban areas.
To enhance further the role of the private sector, there is regular top-level dialogue at a national level (on annually basis chaired by the Prime Minister of the country) between high-level of government organs and the representatives of private sector (such as the Ethiopian Chamber of Commerce and Sectoral Associations, or Business Membership Organisations). Working closely with the private sector means, among others, having the means to communicate and cooperate on the reforms required to stimulate the economy further (Balema, 2014; Oqubay, 2015). The government and private sector appreciated from the onset that working together was an imperative to developing the economy, properly managing the existing opportunities and addressing the challenges/constraints. For instance, the government recently increased its effort to develop industrial zones in different parts of the country, and these zones, in turn, intended to play a major role in attracting a substantial amount of FDI and creating a considerable amount of employment opportunities (Balema, 2014; Oqubay, 2015). This systemic state–private-sector dialogue and cooperation helps the state to intensify its efforts to address the constraints related to infrastructure, institutional bureaucracy and credit issues (especially for small and medium-size enterprises) to further promote the role of the private sector in the manufacturing sub-sector. Competitive cheap labour, energy costs, duty and quota free access to the US and EU markets, tax exemptions, holidays, and building consumer markets are key pull factors for FDI in Ethiopia, although there are some challenges in practice (US Department of State, 2014). Regardless of the existing challenges in practice, the private sector is expected to exploit the existing investment opportunities and align its investment projects with the state’s priority areas, which are supposed to have significant social benefits and, thereby, play a greater role in accelerating economic growth and job creation. However, the contribution of FDI to the economy depends on the host country’s strategic vision, as well as how it fits into the overall national development strategy. In this regard, the business environment and the quality of physical and human capital are considered as the key determining factors to attract FDI or the private sector in the productive sectors.
The state looks committed to improving the business climate to enable growth and employment creation from the private sector. Trade and credit policy incentives, massive public investment in key infrastructure (such as road, railways, communication, electricity, water and others), reform in the property rights regime,
On the other hand, medium- and large-scale manufacturing industries create a competitive national economy by ensuring rapid and sustainable technological transfer, an export-oriented economy, an environment conducive for micro and small enterprises, and agricultural development (MoFED, 2013).
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along with the commitment to maintain macroeconomic stability have been extensive (Teshome, 2012; Fantini, 2013) . Furthermore, the state established some public specialised institutes such as Leather Industry Development Institute, Textile Industry Development Institute and others to support the private sector to engage in the manufacturing sector (Balema, 2014; Oqubay, 2015). The government also tried to provide different incentives and support programmes to build the capacity of the private sector (as ‘carrots’) while it also introduced several disciplinary measures (as ‘sticks’), though there are multiple of limitations in execution of the se carrot and stick instruments in practice. These all efforts tried to provide by the government have expected to contribute positively for economic growth and increase the inflow of FDI into the economy (Balema, 2014; MoFED, 2013; 2014; Oqubay, 2015). These ‘carrot’ and ‘stick’ instruments were practised widely in the East Asian developmental states to nurture their domestic private sectors. As UNCTAD (2009:34) explains:
The incentives and resources provided by Government included the creation of rents. That is, policies were devised to ensure that private companies would secure profits above normal market conditions. Such rents were particularly important for inducing new investments and innovative activity. The management of rent- seeking was thus an essential part of governance in successful developmental States. In this model, rent- seeking was not in itself bad. But the key governance issue was to ensure that rents were derived through activities that had social as well as private returns and that the rents, when earned as profits, were reused in a way that supported national development.
The incentives and disincentives are based on the private sector’s development performance and are commonly related to production and export objectives, and the incentives provided by the state are aimed at boosting competition among private firms. To ensure this, the private sector needs to reduce the misuse of resources and shield them against capture by interest groups; the incentives are gradually subject to the discipline of competition.
Box 4.2: Examples of ‘carrot’ and ‘stick’ instruments in the leather industry
The strategy in which a strong state mobilizes incentives and disincentives to induce economic agents to create value are most vivid in the leather and leather-product industry. The goal of this industry, as set by the government, is to supply finished leather or finished-leather products for export and domestic markets by acquiring management and technology capabilities to process what had previously been sold as raw or semi-finished leather. The carrots, are a series of policies have been offered to the industry, including:
‘Establishment of the Leather and Leather Product Technology Institute (LLPTI) to provide training, quality tests and some production processes;’
‘Donor assistance, foreign advisors and twinning with a British institute for LLPTI;’ ‘Preferences in finance and foreign currency allocation;’
‘Business matching between domestic shoe producers and European firms;’ and
Monthly government business meetings to promote the industry and remove its barriers’ (Ohno, 2009)
The sticks included a ban on raw leather (crust leather) export and high tax of about 150% on exports of crust or semi-finished leather, which represented about 40% of Ethiopian leather exports in 2011, to protect the domestic market (World Bank, 2014c).
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However, there are critics who claimed that the ‘carrot’ and ‘stick’ instruments are not transparent, and the policy-makers and implementers tend to patronise the private sector instead of encouraging competition and innovation (World Bank, 2013b). Despite tremendous efforts exerted by government to support private- sector development,the policy mixes have the unintended consequences of ‘crowding-out’ the private sector in access to land, credit and foreign-exchange markets. The public investment rate of the country is the third highest in the world and this has had probably a negative impact on the distribution of credit, land and foreign exchange (World Bank, 2013b). The private sector in Ethiopia, however, has obviously not yet reached the stage of playing a visible and dominant role in the economy although there are several policy incentives and support mechanisms. The private sector is dominated by risk-averse behaviour and it does not eager much to engage in productive economic sectors though there are different policy packages provided by the government in order to engage into the productive sub-sectors (Teshome, 2012; Balema, 2014; MoFED, 2014). At the same time, the state bureaucracy and institutions are not yet reached at a level where they can administer the policy direction put in place to support the private sector. The issue of competent bureaucracy and well-functioning institutions are considered as the main challenges for the state apparatus and these need to be improved (Balema, 2014). It is common that private sector in low-income countries, like Ethiopia, faces huge challenges in competing in the global economy, and more effective industrial policies and instruments that facilitating economic growth and structural transformation need to be designed and executed in a proper manner (Oqubay, 2015). Therefore, the government needs to put further efforts into addressing these constraints that create obstacles in the private sector through continuous state––private sector dialogue and different policy amendments, and by boosting public investment in the critical infrastructure to smooth the business environment.
There is a significant amount of capital flooding into public-sector projects, which will have expected a positive spill-over effect for private-sector development and create conducive business environments in general (US Department of State, 2014). The existence of conducive business environment accompanied by macroeconomic stability is obviously indispensable for attracting investment (both domestic and foreign), which is expected to contribute for employment creation and poverty reduction. For instance, the amendment of Ethiopia’s investment proclamation No.769/2012 introduced provisions for the establishment of industrial zones, both state and private run, with favourable investment, tax and infrastructure incentives for key priority investment areas. The government established the Ethiopian Industrial Zone Corporation under the Ministry of Industry43 to oversee the construction and regulation of industrial zones. The key priority areas in the industrial sector are textiles and garments, leather, sugar, cement, metals and engineering, chemicals, pharmaceuticals and agro-processing (FDRE, 2012).
43 In addition, under the Ministry of Industry there are different sectoral supporting institutions, such as: Textile
Industry Development Institute; Leather Industry Development Institute; Metal Industry Development Institute; Chemical and Construction Input Industry Development Institute; Meat and Dairy Industry Development Institute; Food Beverage and Pharmaceutical Industry Development Institute; and National Kaizen Institute, all of which provide support to the private sectors.
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Box 4.3: The development of industrial zones in Ethiopia
Aware of the problem of land supply, the government has invested in the development of industrial parks/zones for private investments. In 2012/13, demand-based industrial zones were developed in different regional states and city administrations with a configuration of the entire necessary infrastructure. A total of 3537hectares of land was prepared for the establishment of industrial zones in Addis Ababa, Kombolcha, Dire-Dawa, Mekelle, and Hawassa. Of the five industrial sites, construction was started in the Bole Lemi industry zone site in Addis Ababa, which is known as the Addis Industrial Village. Privately owned industrial zones are also under development around Dukem and Finfine areas of Oromia region. These include Eastern Industrial Zone around Dukem, which is owned by a Chinese investor, and Sendafa Industry Zone, which is owned by Turkish investors. Furthermore, a company called Huijan International Shoe City has requested 320hectares of land to establish an industrial zone. All these initiatives are expected to result in the expansion of private investment, particularly in manufacturing (MoFED, 2014). The industrial zones are created to enable competitive conditions, to integrate the manufacturing sectors based on value creation, as well as to attract and expand investment. Furthermore, the first phase of Mekelle, Hawassa, and Kombelcha industrial parks was completed recently, the Hawassa industrial park is officially started its operation, and the remaining are already ready for operation.
The operational framework for planning and implementing industrial zone development projects will be through a consultative process with the appropriate stakeholders at the project-site level. The benefits of the industrial zone development will expect to promote extensively to attract investors (both foreigner and domestic) to the zones. The aim is to provide capacity-building, linkage services to management, technology transfer, factory setup, boost level of export, create employment opportunities, and similar matters so that industries clustered within industrial zones operate with the spirit of sound competition. The main responsibility for initiating and carrying out these activities will be the responsibility of the Industrial Zone Development Corporation.
The industrial zones are expected to provide a high potential for growth and value addition, as well as for strengthening both the forward and backward linkages among economic sectors and creating considerable employment opportunities. The industrialisation packages and the development of the industrial zones have in effect created another enclave for international capital in the form of FDI to boost the national economy. The establishment of industrial zones in Ethiopia is in line with the experiences of the East Asian developmental states and Mauritius who built export-processing zones (EPZs) or special economic zones (SEZs). For instance, Singapore, Taiwan, and South Korea built EPZs in the 1960s and 1970s to attract labour-intensive and export-based manufactured FDI. Furthermore, the EPZs or SEZs have created the second-tier of NICs, including China, where foreign firms were granted various preferential treatments, and this led to the rise of numerous export-oriented enclaves. The Chinese EPZs and low-wage labour attracted FDI to produce at low cost and develop the export-driven manufacturing sector, i.e. EPZs emerging as effective locations for FDI in the 1990s. The second-tier NICs, such as China, also rapidly liberalised their FDI regulations to attract labour-intensive manufacturing sectors. Consequently, competition for FDI has become fierce (Kimura, 2006).Such FDI-led ‘take-off’ at the beginning stage of catch up has been effective