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

2
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

3
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.

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

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
 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

8
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)

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

12
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?

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 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

14
Theoretical Underpinnings of ADLI: Static Comparative
Advantage, Pro-poor and Inclusive Growth Theories
Growth Employment
Agrarian middle
class
Income equalityInvestment
Foreign
exchange
earnings
Food supply
Savings
ADLI
(Agriculture
as the engine
of growth)

15

16
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

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 Economic Outcomes
Source: World Bank Ethiopia Economic Update II (2013)

19
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

21
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

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
 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?

23
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?

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 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?

25
3 Why ADLI? Motivation and Rationale

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)
 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

27
 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
 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 country’s policy choice matter more than endowments.

31
3 Why ADLI? Motivation and Rationale

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

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