After independence, most countries in sub-Saharan Africa (SSA) generally choose an import-substitution (IS) industrialization strategy. It seemed to work initially during the 1950s and 1960s, although after years of implementation, IS failed to act as an appropriate trade development strategy. This is due to the fact that the heavy protection and subsidization had resulted in a paralyzed and inefficient industry requiring permanent subsidization with little prospect of achieving international competitiveness which is consistent with a study by (Wade, 1990). Since then the idea of export expansion strategy has gained popularity as a major path to industrialization and instruments that useful in boosting economic growth for developing countries (Krugman & Obstfeld, 2003). In other words, due to increasing pressure to liberalize trade and open up domestic markets to international competition, domestic industries in SSA can no longer be effectively shielded from foreign competition and even resulting inefficiency. Thus, since the 1980s, most countries in Sub-Saharan Africa introduced economic reform programs like structural adjustment programs (SAPs) to address the mounting internal and external economic imbalances under the auspices of the international financial institutions as preconditions for donor funding.
Correspondingly, Ethiopia also adopted this program, including trade liberalization to transform the structure of its economy by making a decisive break with its command economy in many following the fall of the Derg government in 1991. This was accomplished by selectively pursing the SAPs put forward by the IMF and WB with the main theoretical premise that government interventions were inefficient because they distorted market signals. The new reform program declared in 1993 initiated a comprehensive trade reform, and it is committed to several measures that go beyond stabilization and liberalization. The prices of domestic inputs and finished goods were decoupled from arbitrary government regulation and interference. The government has also a strong sense of public sector reform that accorded autonomy to the state-owned enterprises was implemented and some enterprises were privatized. The export tariffs were abolished; export subsidies to domestic and export-oriented firms were eliminated and were replaced by incentives that provided the duty-free importation of raw materials. Last but least, the new reform program involved a large devaluation of the local currency aimed at dismantling quantitative restrictions and gradually reducing the level and dispersion of tariff rates in 1993 (Abegaz, 1999).
In 1998, the government further launched an Export Promotion Strategy in which some manufacturing like textiles, leather, and agro-industry sectors were chosen for preferential treatment. This is justified on the ground that they are labor-intensive and provide strong linkage with the agricultural sector and comparative advantage to compete in the export market. Furthermore, the government has given due attention to the policy emphasis on export-led manufacturing growth and providing a wide range of incentives. Export Trade Duty Incentive Scheme issued in 2001, which includes duty draw?backs, vouchers, and bonded manufacturing warehouses, where exporters are refunded 100% of any duty paid on raw materials. Furthermore, the government issued directives in 2004 to reduce taxes and other costs of salaries paid to foreign experts to further encourage exporters to acquire foreign technology and expertise are part of this measure (Bigsten & Gebreeyesus, 2009). In sum, it is expected that the increased openness to international trade would increase firm-level efficiency and promote economic growth because foreign trade would make it possible for them to exploit economies of scale, access to new technologies and knowledge and thus improve their productivity (Helpman & Krugman, 1985; Melitz, 2003).
The government has already accomplished two programs which are sustainable development and poverty reduction program (SDPRP) from 2002/03 to 2004/05, and plan for accelerated and sustained development to end poverty (PASDEP) from 2005/06 to 2009/10 with different targets. They aimed to strengthen the private sector and bring rapid export growth that includes high-value agricultural products and export oriented manufacturing sectors were the prioritized one. Currently, the Ethiopian government implementing the second five-year growth and transformation plan (GTP) covering the period from 2015/16 to 2019/20 following the first one by giving due emphasis on improving physical infrastructure through public investment projects and promoting the manufacturing sector and export performance. In order to meet the targets, the government has played an important role in improving the investment climate and providing direct support to the selected sectors. This support includes providing economic incentives for exporters/investors by granting cheaper credit, easy access to land at lower lease prices and longer tenure periods, and duty and tax exemptions. The plan also involves promoting export-oriented cluster developments by flourishing industrial zones around major cities with the necessary infrastructures such as roads, power and telecommunications and capacity building in terms of increasing the supply of skilled manpower for the sectors (World Bank, 2016). To exploit this opportunity, a number of foreign companies from China, India, Turkey, and Japan are currently jostling in the country, which has led to a sudden upsurge in FDI inflow in the last four to five years (Hailu & Tanaka, 2015).
Despite the huge potential opportunity for manufacturing industries and the government’s commitment to its development, the sector has not been performing up to expectations. Unlike it has recently been seen in East Asian countries, in Africa, particularly in Ethiopia the sector regrettably plays a rather limited role to bring about the structural change in this regard. In other words, while Ethiopia’s economy continues to register strong and robust growth, which explained by the real GDP grew by more than 10 percent for almost a decade, the contribution of the industrial sector to the Economy is at its infant stage and lagged by far from agricultural and service sectors. Its share, composed of LMMI, small scale industry, construction, mining and quarrying, electricity and water, remains stagnant for a long time at about 14% of the GDP and that of the manufacturing sector is only 4.4% share of total GDP in 2013 (NBE, 2013/14). The sector is limited to simple agro-processing activities (sugar, grain milling, edible oil production, leather tanning) and production of basic consumer goods (beer, footwear, textiles and garment). Industries that might help accumulate technological capabilities and create dynamic inter-industry linkages – such as chemical, electrical and electronics, metal-processing and other engineering industries – are almost non-existent. Besides, most manufacturing exports are agriculture-based, which include clothing, semi-processed hides, footwear, and beverages while the main imports are capital goods and manufactured consumer goods from other countries and are heavily dependent on fuel imports (Hailu & Tanaka, 2015).
1.1.1. Overall macroeconomic performance and sectoral composition
With a population of more than 100 million, Ethiopia is the second and the twelfth most populous country in Africa and world respectively as of 2017. It has a land area of 1.1 million km2 and is the largest landlocked country in Africa. Ethiopia remains a predominantly rural country, with only 20.3% of the population living in urban areas, mainly Addis Ababa. Ethiopia experienced a steady population growth rate of 2.5% between 2009 and 2016. It has the fastest a growing economy and income per capita has tripled from US$270 in 2006/7 to US$800 in 2016 but still substantially lower than the Sub-Saharan average of about US$1600 in 2016. Yet, while extreme poverty is still high which is 27.2% in 2015 (as measured by the international poverty line of less than $1.90 per day), the Ethiopian government aspires to reach lower-middle income status over the next decade (WB, 2015).
Despite strong policy emphasis on agriculture, its contribution to overall growth has been not only limited but also declining recently. The share of agriculture value-added in GDP, as shown in figure 1.1, has shown a decline over the past three decades from 52% in 1990’s to 42% in 2014. On the other hand, the service sector continued to be the main engine of growth of the economy and its share has been increasing and become slightly higher than the share of the agricultural sector in 2014 while the industry sector has remained quite small compared to other developing countries even if it has increased from 10% in 1990’s to 14.7% in 2014. The share of manufacturing in GDP is another indicator of the country’s underdeveloped industry, even declined from 5% in 1990’s to 4.2% in 2014. This is by far the lowest even by the SSA standard where the contribution of the manufacturing sector was not an average lower than 9% of GDP over the past three decades. This indicates that despite the country has shown impressive growth, the manufacturing sector loses momentum.