1 Productive Capacity and Economic

2 Growth in Ethiopia.
3 Productive capacity is defined broadly as the natural resource potential, accumulation
4 of human capital and the institutions that facilitate inclusive and sustainable economic
5 growth. This process also encompasses the nurturing modern entrepreneurial skills in
6 the private sector and fostering innovation. The paper starts with an overview of
7 Ethiopia’s economic growth and the change in the domestic economic structure. The
8 manufacturing sector is seen as the success of Ethiopia’s Growth, and its development
9 to a large extent the product of an activist developmental state. The paper then
10 examines growth and diversification of exports and the country’s recent efforts to
11 effectively exploit its natural resources. An analysis of public and private investment
12 and the underlying allocation of financial resources finds that a recent upturn in
13 domestic investment has been financed largely by foreign aid, and that private financing
14 remains too low. Finally, the paper addresses educational attainment, arguing that
15 Ethiopia has some distance to go in its attempts to close the large human capital gap
16 relative to other low-income countries. Productive Capacity and Economic Growth in Ethiopia 1
17 Introduction Ethiopia is one of the largest least developed countries (LDCs) in Sub-Saharan Africa, with a
18 population of about 94 million people in 2012. After suffering economic stagnation for most of the
19 1970s and 1980s, its economy began to grow in the mid-1990s. During the last decade it has become
20 one of the fastest growing economies in the world with an average gross domestic product (GDP)
21 growth rate of about 10% per annum. According to the ambitious fiveyear Growth and Transformation
22 Plan (GTP) that the Ethiopian government rolled out in 2010, Ethiopia aims to attain a lower-middle-
23 income status by 2020. The challenge is hence not about kick-starting growth, as it was the case for
24 most LDCs prior to 2000, but rather about ensuring the sustainability of the current growth momentum.
25 This is a real challenge given the current structure of the Ethiopian economy where rain-fed agriculture
26 continues to play a dominant role, while manufacturing accounts for only 5% of GDP. Rodrik (2014)
27 argues that sustaining rapid growth in African countries is unlikely without a profound structural change
28 in favor of manufacturing. It is therefore very important that policymakers and development partners
29 are clear about the prospect of productive capacity in Ethiopia and related challenges. The latter pertain
30 not only to growth in overall productive capacity but also to the composition and distribution of
31 productive capacity by sector and type of ownership. This paper examines the process of building
32 productive capacity in Ethiopia over the past two decades and the roles played by the government,
33 private sector, foreign firms and development partners. Building productive capacity broadly refers to a
34 nation’s efforts in harnessing natural resource potential, accelerating the accumulation of human capital
35 and designing suitable institutions that facilitate inclusive sustainable economic growth. This process
36 also encompasses nurturing modern entrepreneurial skills in the private sector and fostering innovation.
37 The paper starts with an overview of economic growth and the change in the domestic economic
38 structure. Attention is given to the manufacturing sector as the success of Ethiopia’s Growth and
39 Transformation Plans (I and II) is strongly tied to the performance of this sector. The paper then
40 examines growth and diversification of the exports sector to gauge international competitiveness. In
 1 doing so, the paper examines the country’s recent efforts to effectively exploit its natural resource
2 endowments. The paper also analyzes public and private investment activities and the underlying
3 allocation of financial resources. A key dimension of the analysis is the development of the financial
4 institutions and the allocation of financial resources across economic agents and sectors. Finally, the
5 paper addresses educational attainment as Ethiopia strives to close a large human capital gap as
6 compared to other low-income countries. 2 Political Economy before the 1991 Reforms Similar to most
7 LDCs, Table 1 shows that the Ethiopian economy performed poorly and remained weak throughout the
8 1980s and in the first half of the 1990s. Per capita GDP declined by nearly 1% per annum during the
9 1980s as GDP growth lagged behind population growth. Further decline in per capita income occurred
10 during the first half of the 1990s, by 2.8% per annum, as civil war intensified in the northern part of
11 Ethiopia and the country entered a period of uncertain political and economic transition. The socialist
12 economic system during the 1974-1991 military regime was grossly inefficient 2 CDP BACKGROUND
13 PAPER NO. 34 marked by the outright discouragement of private sector participation and poor
14 performance of StateOwned Enterprises (SOEs). Policy choices including high import tariffs, export
15 taxes, currency overvaluation and the use of marketing boards for agricultural commodities, all played
16 out simultaneously during this period severely undermining economic growth. The violent civil war that
17 culminated in the overthrow of the Derg in mid 1991 was a financial burden on the economy and a
18 human tragedy. The sudden collapse of the military regime was also precipitated by the disintegration of
19 the former communist block toward the end of the 1980s and by a rare alliance between the two
20 insurgent groups in the north, i.e., the Eritrean People Liberation Front (EPLF) and the Tigray People
21 Liberation Front (TPLF), to defeat the Derg. TPLF formed, in coalition with other ethnic based political
22 parties, the current ruling party in Ethiopia, i.e., the Ethiopian People Revolutionary Democratic Front
23 (EPRDF), while EPLF secured the secession of Eritrea in 1993. The Transitional Government of Ethiopia
24 (TGE) was established in 1991 based on a transition period charter in which EPRDF and other ethnic
25 based political parties participated. TheTGE adopted a new constitution in 1994 paving the way for the
26 first democratic national elections in 1995, which EPRDF won by a large margin. However, the country’s
27 democratic process has since stalled with ever diminishing political space for opposition parties and
28 EPRDF wining all subsequent elections. On the other hand, with the exception of the border war with
29 Eritrea during 1998-2000 and other sporadic low-intensity ethnic conflicts in Oromiya and the Somali
30 regional states, there have been no major civil wars in Ethiopia since 1991 making it one of the most
31 stable states in Eastern Africa. 3 Economic Growth and Structural Change after the 1991 Reform The
32 shift in political institutions in 1991 was accompanied by major economic reforms encompassing
33 currency devaluation, trade liberalization, deregulation of markets, removal of restrictions on private
34 sector participation, and modest privatization and reform of SOEs. Most importantly, the government
35 demonstrated unprecedented commitment to public investment in economic infrastructure, education
36 and health services. As shown in Table 1, the Ethiopian economy began to recover during 1995-99 with a
37 4.7% annual average growth and continued to grow at 5.5% per annum during 2000-04. Economic
38 growth greatly intensified since 2005 at slightly above 10% per annum in the ensuing 10 years, allowing
39 per capita GDP to grow at nearly 8% annually. Such performance has made of Ethiopia a symbol of
40 economic turnaround in Africa. Table 1 Growth and Structure of the Ethiopian Economy Sector Share in
41 GDP Growth Rates Agri Indu Manuf Serv Agri Indu Manuf Serv GDP GDP-PC 1980-84 55.8 9.6 4.7 34.6 -
42 0.5 7.1 4.7 5.5 2.1 -0.9 1985-89 52.8 10.7 4.9 36.5 2.6 2.6 2.5 4.2 2.5 -0.8 1990-94 59.5 8.0 4.0 32.5 2.1 -
43 1.8 -2.3 -0.4 0.6 -2.8 1995-99 53.6 11.7 6.1 34.6 3.3 5.4 4.8 7.3 4.7 1.6 2000-04 43.5 13.3 6.1 43.2 3.5 7.4
44 4.1 6.9 5.5 2.5 2005-09 46.6 11.8 4.7 41.6 9.6 9.8 10.2 14.4 10.7 7.8 2010-14 44.9 11.7 4.0 43.4 6.3 18.2
45 11.7 12.0 10.6 7.7 Average 51.0 11.0 4.9 38.1 3.8 6.9 5.1 7.1 5.2 2.2 Source: World Development
46 Indicators (2015) Note: The share of industry in GDP includes that of manufacturing. GDP-PC is GDP per
47 capita. PRODUCTIVE CAPACITY AND ECONOMIC GROWTH IN ETHIOPIA 3 There is broad consensus that
48 the rapid economic growth in Ethiopia since 2000 is largely driven by public investment in infrastructure

1
 1 (World Bank, 2009). The latter include not only expansion of road networks but also construction of
2 hydroelectric power plants and transmission lines, airports, telecommunication systems, health and
3 education facilities, and most recently railways. For instance, a series of Road Sector Development
4 Programs (at a cost of more than $7bn during 1997-2010) have significantly improved road accessibility.
5 Table 2 indicates that the proportion of roads in good conditions increased from 22% to 57% between
6 1997 and 2011 while road density doubled from 24km to 49km per thousand square kilometers.
7 Although evidence remains scant, Shiferaw et al., 2015 find that improvements in road infrastructure
8 have allowed a growing number of new firms to locate outside the historical centers of manufacturing
9 including the capital city Addis Ababa and increased average size of startup firms. Figure 1 shows that
10 the investment rate in Ethiopia doubled from about 20% of GDP in the second half of the 1990s to about
11 40% of GDP in 2014. This represents nearly a percentage point increase in domestic investment rate
12 annually since the mid 1990s. Most of this increase is attributed to a steady increase in public
13 investment from about 5% of GDP in 1992-93 to 16% of GDP in 2014. Private investment, on the other
14 hand, has been very volatile and declining in recent years. It increased to about 15% of GDP right after
15 the 1991-92 economic reforms but declined sharply in the second half of the 1990s. Although private
16 investment bounced back to 18% of GDP during 2002-2004, it steadily declined to about 14% of GDP in
17 2011. It is only in 2012, half way into the first GTP, that private investment for the first time rose above
18 20% of GDP. While some of the reasons behind the unimpressive and volatile private investment will be
19 discussed shortly, it is clear that the steady increase in public investment has not yet attracted
20 commensurate private investment. The unsteady and limited expansion of productive capacity in the
21 private sector is an important concern for sustained economic growth of Ethiopia. Before the launch of
22 the GTP in 2010, the Government of Ethiopia adhered to a development strategy dubbed Agricultural
23 Development Led Industrialization (ADLI) that emphasized improving agricultural productivity. Major
24 interventions under ADLI included provision of fertilizers, improved seeds and extension services to
25 smallholder farmers. These Investment Gross Domestic Saving Private Investment Public Investment
26 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 45
27 40 35 30 25 20 15 10 5 0 Source: World Development Indicators (2015). Figure 1 Trends in Gross
28 Domestic Savings and Investment 4 CDP BACKGROUND PAPER NO. 34 interventions coupled with better
29 road connectivity and favorable rainfall for most of the post-reform period facilitated faster growth in
30 agriculture, especially after 2003 (See Figure 2 and Table 1). Other interventions that are believed to
31 have contributed to better agricultural performance include the donor supported Public Safety Nets
32 Program (PSNP) which aimed at building farmers’ productive assets in drought prone areas. Given that
33 agriculture accounts for about 80% of employment, growth in agriculture (about 6% per annum) is
34 believed to have greatly benefited rural households in Ethiopia. While ADLI is credited for improved
35 agricultural productivity and poverty reduction in rural areas, it did not lead to agricultural based
36 industrialization as initially anticipated. As shown in Table 1, industry value added stagnated at about
37 12% of GDP since the mid 1990s. The share of agricultural value added declined from 56% during 1980-
38 84 to 45% during 2010-14. With no change in the share of industry value added, the 10 percentage point
39 reduction in agriculture’s share reflects rapid expansion in the services sector which increased from 34%
40 of GDP during 1980-84 to about 44% in 2010-14. Since the mid 1990s, the service sector’s growth was
41 about 3 percentage points faster than growth in the industrial sector. Faster growth in services is
42 attributed to growing public and private spending on education and health sectors, expansion of
43 financial services as well as growth in distributive services such as transportation and domestic trade.
44 The reason why growth in services outstripped that of industry is a critical question which has
45 implications on the sustainability of Ethiopia’s rapid economic growth. The nature of structural change
46 in Ethiopia also differs from the experiences of most East Asian countries where rapid economic growth
47 has been accompanied by sharp increases in the share of manufacturing. Given the capital intensity of
48 manufacturing industries relative to rain-fed agriculture and services, it is very important to explore why

2
 1 productive capacity in manufacturing is lagging behind and some of the actions that can be taken to
2 strengthen it. 4 Productive capacity in manufacturing The performance of manufacturing remains a
3 cause for concern as its contribution to GDP not only remained low but also contracted slightly from
4 about 6% of GDP during 2000-04 to about 4% during the first GTP. A goal of the second GTP is to
5 increase 23 22 21 20 19 1980 1985 1990 1995 2000 2005 2010 2015 log (Real Value Added) Agriculture
6 Industry Manufacturing Services Source: World Development Indicators (2015). Figure 2 Trends in Real
7 Value Added by Sector (Log Scale) PRODUCTIVE CAPACITY AND ECONOMIC GROWTH IN ETHIOPIA 5 the
8 share of manufacturing to 15% of GDP. Despite the attention given to manufacturing in these fiveyear
9 plans, it is quite clear that the sector’s productive capacity is not expanding as expected. The
10 Government of Ethiopia has prioritized a few industries to lead its ambitious industrialization agenda,
11 namely, sugar, textile and garments, and leather products industries. These sectors are prioritized
12 because of their expected linkages with the agricultural sector and the desire to exploit the country’s
13 potential comparative advantage in labor-intensive products. These priority industries are expected to
14 be exported-oriented in order to generate the financial resources needed for capacity expansion in
15 other manufacturing industries. This strategy sounds consistent with the country’s natural resource
16 endowments and may allow the country to take advantage of preferential trade arrangements such as
17 The African Growth and Opportunity Act (AGOA). However, evidence from firm-level studies uncovers a
18 number of challenges that may restrain the rate of industrial expansion in Ethiopia. These challenges
19 pertain to firm-level investment activities, the rate of adjustment of the product basket, and the rate of
20 job creation in the manufacturing sector. The next section addresses these challenges followed by a
21 discussion on industrial zones designed primarily for FDI firms and the direct involvement of the state in
22 the production and export of sugar. 4.1 Private Investment in Manufacturing: Given the historically low
23 manufacturing base in Ethiopia, the intensity of firm-level investment will undoubtedly play a critical
24 role in industrial expansion. Unfortunately, private investment in Ethiopian manufacturing remains
25 relatively weak. Shiferaw (2015) finds that about 50% of Ethiopian manufacturing firms have a zero
26 investment rate at any point during the period 1996-2007. This proportion rises to 70% among small
27 firms that employ less than 50 workers. Among firms with a positive investment rate, the majority has
28 investment rates that are far below the frequently used 10 % depreciation rate. The average firm-level
29 investment rate is about 12% of the capital stock. Such limited private investment in manufacturing is
30 inconsistent with the emphasis placed on this sector by the GTPs. Previous studies lamented that the
31 size and investment rates of African firms are restrained by a weak aggregate demand and poor
32 infrastructure (Collier, 2000). While this might explain conditions in most African countries during the
33 1980s and 1990s, it stands at odds with recent experiences of rapid GDP growth and improved
34 infrastructure in countries like Ethiopia. To better understand current investment patterns, Shiferaw
35 (2015) compares the investment responses of private enterprises in Ethiopia, with and without access to
36 credit, using initial relationship with banks as a proxy for potential credit constraints. This is based on
37 the assumption that borrower-lender relationships tend to be sticky (Chodorow-Reise, 2014)1.
38 According to this proxy, about 60% of private manufacturing firms do not have ties with commercial
39 banks implying that they are potentially credit constrained. Interestingly, the average investment rate
40 among firms with initial bank ties (14%) is twice that of firms without bank ties (See Table 3).
41 Unsurprisingly, investment rate among large firms (16.4%) is higher than that of small firms (9.3%). The
42 former are also significantly less likely than the latter to have zero investment episodes. Shiferaw (2015)
43 also finds that although access to credit increases with firm size, small firms with bank ties are at least as
44 responsive to investment opportunities as large firms are, who enjoy better access to credit. Most
45 importantly, having a relationship with banks seems to allow firms to implement large (lumpy)
46 investment projects that exceed 20% of initial capital stock.2 1 Chodorow-Reise (2014) finds that US
47 firms who borrowed from less financially healthy banks before the 2008 financial crisis experienced
48 stronger contraction of employment during the 2008-09 recession than firms who borrowed from

3
 1 healthier banks. 2 In the Ethiopian case, firms with such lumpy investment account for about 70% of
2 total private investment in manufacturing although they account for less than 15% of the number of
3 firms. 6 CDP BACKGROUND PAPER NO. 34 Shiferaw (2015) shows no significant difference in investment
4 opportunities among firms with and without bank ties, suggesting that the difference in actual
5 investment rate lies in the ability to capture investment opportunities, which at least in part depends on
6 access to credit. The key message is that private investment in manufacturing and its contribution to
7 GDP seems to be constrained substantially by limited access to credit for private enterprises, particularly
8 small firms. This observation is consistent with a recent study by the World Bank which finds that 56% of
9 small medium enterprises in Ethiopia, (not just in manufacturing), are credit constrained far above the
10 African average (World Bank, 2015). This study also finds extremely high collateral requirements as well
11 as stringent financial regulations on private commercial banks. This situation has led to a steady decline
12 in private sector borrowing from the banking sector as percentage of GDP. Details on financial sector
13 developments will be provided in section six. 4.2 Diversification of manufacturing firms There is growing
14 evidence that economic prosperity is strongly associated with the pace at which new products are
15 added to an economy and its exports basket (Imbs and Wacziarg, 2003). Most importantly, the higher
16 the technological content of the newly added products, the faster the expected rate of growth in
17 income per capita (Hausmann et al., 2012). At the micro level, evidence shows that multi-product firms
18 are larger, more productive and export-oriented than single-product firms (Bernard et al, 2010;
19 Goldberg et al. 2010). In the Ethiopian context, Shiferaw (2010) shows that multi-product firms account
20 for about 34% of manufacturing firms and 42% of manufacturing sales. Interestingly, the rate of
21 transition from single- to multi-product firm is strongly associated with the incidence of lumpy
22 investment (Shiferaw, 2010). In other words, adding a new product at the firm level is associated with a
23 major increase in investment spending. Unfortunately, only 13% of firms exhibit lumpy-investment rate
24 (often defined as investment rate exceeding 20% of capital stock). The process of adjusting the product
25 basket at the firms’ level also accounts for 30% of growth in manufacturing output which is greater than
26 the contribution of net firm entry. The lackluster investment activity highlighted above not only
27 undermines industrial expansion through the intensive margin but also through the extensive margin.
28 4.3 Job creation The other major challenge for Ethiopian manufacturing is the ability to create jobs. The
29 employment share of manufacturing remains below its 5% contribution to GDP. One contributing factor
30 for this outcome is the extremely low graduation rate of small enterprises into medium and large size
31 categories. Shiferaw and Bedi (2013) find that among small Table 3 Investment Patterns in Ethiopian
32 Manufacturing Firms (1996-2007) All Firms Bank Ties Firm Size No Yes Small Large Investment Rate (IR)
33 0.114 0.076 0.136 0.093 0.164 Percent of firms with zero investment (IR=0) 0.496 0.684 0.381 0.629
34 0.245 Percent of firms with lumpy investment (IR>20per cent) 0.161 0.103 0.197 0.112 0.238 Cash Flow
35 (π) 1.010 1.289 0.835 1.420 0.952 Firm Size (No. of workers) 105.33 33.22 163.32 20.22 294.83 Percent
36 of Small Firms 0.690 0.897 0.524 Percent Without Bank Ties 0.580 0.149 Source: Central Statistical
37 Agency (CSA) of Ethiopia, 1996-2007. PRODUCTIVE CAPACITY AND ECONOMIC GROWTH IN ETHIOPIA 7
38 firms that employ less than 30 workers, only 7 percent managed to employ more than 50 workers after
39 10 years. This suggests that small firms contribute to job creation primarily at the time of entry but
40 much less through post-entry expansion. Most of the job creation in Ethiopian manufacturing actually
41 occurs among large firms. This underscores the need to increase the average size of manufacturing
42 startup firms and/or to create a business environment that allows small entrants to grow faster. The
43 authors also show that the major problem for expansion of manufacturing employment is not
44 inadequate gross job creation rate. Net employment growth is actually undermined by a simultaneous
45 process of gross job destruction. Net employment growth has gained some momentum since 2003
46 mainly because of a significant reduction in job destruction rate among large firms and an improvement
47 in gross job creation. Even during periods of strong growth in manufacturing employment, data show
48 substantial rates of job destruction among small firms due to high rates of firm closure. In 2011, the

4
 1 Ethiopian government passed a new pension law mandating pension benefits to private sector
2 employees for the first time. This was a privilege that so far was available only for civil servants, the
3 police and armed forces. The new pension law requires all formal sector firms, regardless of size, to
4 contribute 11% of salary for pension contributions and to withhold 7% in employee contributions. Since
5 some large firms have been providing pension benefits to their employees on a voluntary basis before
6 the reform, the pension reform is less likely to affect their profit margins and labor demand. However,
7 for small firms without pre-existing pension schemes, the sudden increase in labor cost might reduce
8 their labor demand, unless they are able to adjust other cost/utilization of other inputs. Using industry-
9 level data from 72 counties Shiferaw and Hailu (2016) find that developing countries need to achieve
10 exceptionally high growth in manufacturing value added (about 10% per annum) to achieve modest
11 growth in employment (about 4%). This suggests that even if the share of manufacturing value added
12 may increase by 10 percentage points as per GTP II, the employment share of manufacturing may not
13 increase by the same proportion. This will have important implications not only on welfare but also on
14 long-term competitiveness and export orientation of the manufacturing sector. Currently, policymakers
15 in Ethiopia seem to be focused primarily on increasing manufacturing output and exports without
16 explicitly addressing the employment challenge. However, given the high rate of urban unemployment
17 (25%) which is even higher among the youth, policy makers cannot afford to overlook job creation in
18 manufacturing. 4.4 Industrial zones and foreign direct investment in manufacturing While privately
19 owned local firms do not seem to feature prominently in Ethiopia’s industrialization process, the
20 government continues to take some bold initiatives to accelerate growth in manufacturing and achieve
21 the GTP targets. One such initiative is the establishment of major industrial zones around Addis Ababa,
22 such as Bole Lemi industrial park funded in part by the World Bank Group. These facilities are intended
23 to provide investors with readymade factory sites, basic utility services, and are particularly attractive
24 for foreign firms who may not be familiar with the local bureaucracy and business practices. One of the
25 largest foreign firms in Bole Lemi industrial park is the Taiwanese Shoe factory George Shoe PLC,
26 established at a cost of around $120 million. In addition to attracting more foreign direct investment
27 (FDI), the government also uses industrial zones to create clusters of related industrial activities. The
28 Bole-Lemi industrial zone hosts firms in the textile, garments and leather industries. Similarly, the Kilito
29 industrial zone will host firms in the agro-processing, food, beverage and pharmaceutical industries.
30 Such clusters may facilitate the flow of information and technology across firms in closely related
31 industries that may in turn increase collective efficiency beyond intra-firm productivity gains. This would
32 be particularly likely if the industrial 8 CDP BACKGROUND PAPER NO. 34 parks could accommodate both
33 local and FDI firms, which unfortunately is not the case at the moment. Apart from state-owned
34 industrial zones, private companies are also allowed to lease land at a reduced rate for establishing
35 industrial zones. Examples include the Eastern Industrial Zone that hosts Chinese manufacturing firms,
36 and the Ethio-Turkish industrial zone, which will be hosting several Turkish firms. Some of the largest
37 foreign firms are also building their own industrial zones taking into account their size and future plans
38 for expansion. For instance, the Ayka-Addis complex is established by the export-oriented Turkish textile
39 firm Ayka that started operations in 2010 with 7,000 workers. Textile exports from Ethiopia are expected
40 to increase substantially in the near future as Ayka-Addis and other FDI firms become fully operational.
41 Similarly, the Chinese shoe producer Huajian Group has acquired a large plot of land to build its own
42 industrial zone that would host about 45 Chinese firms affiliated with the Huajian Group. Together with
43 the Taiwanese shoe factory (George Shoe PLC), Ethiopia is expected to become a major hub for shoe
44 exports. Major attractions for multinational companies (MNCs) in Ethiopia are low costs of labor and
45 energy. MNCs in the above-mentioned industrial zones pay $40-$60 per month for factory workers as
46 compared to a $600 average monthly wage in China. Although labor productivity in Ethiopia is also
47 lower than that of Chinese workers, the wage gap is much larger than the productivity gap thus
48 suggesting that labor cost will still be lower in Ethiopia. Public investment in hydroelectric power plants

5
 1 has kept cost of electricity very low, although both local and foreign investors complain about frequent
2 power interruptions. The government attributes this problem to power transmission problems. In
3 addition to low energy and labor costs, the government provides tax holidays and duty free import of
4 capital goods for most investment activities and a duty drawback scheme for export-oriented firms.
5 Other attractions to FDI include the relative stability of the country, Ethiopia’s preferential access to
6 export markets in developed countries and also the growing domestic market. The growing number of
7 foreign-owned manufacturing firms in the industrial zones indicates a potential avenue by which
8 productive resources in LDCs can be aligned with the interests and capabilities of MNCs to fuel economic
9 growth. Although Ethiopia has nine major river systems, most of them are non-navigable because of
10 topography reasons and are rarely used for irrigation and power generation due to high fixed costs. This
11 has begun to change in the last decade with major investments in new hydroelectric power plants
12 contributing to Ethiopia’s competitiveness as a low cost destination for export-oriented manufacturing.
13 With the foreseen completion of the Grand Renaissance Dam on the Nile River in the next few years,
14 electricity generation is expected to rise above domestic demand allowing exports to neighboring
15 countries. Together with its large, relatively young and increasingly better-educated workforce, Ethiopia
16 has a great potential to become a major player in the export of light consumer goods. Moreover,
17 Ethiopia is known for having the largest livestock population in Africa, and the inflow of FDI in the shoe
18 sector reflects its huge potential for exports of leather products. The recent increase in foreign and
19 domestic investment in the leather and footwear industry for export purposes represents a major shift
20 from previous practices where Ethiopia used to export primarily raw hides and skins. Further investment
21 in manufacturing is needed to take advantage of trade opportunities such as the African Growth and
22 Opportunity Act, mentioned earlier. According to some estimates, about 40% of Ethiopian textile
23 exports are destined to the US market while the remaining 60% goes to European countries. The Wall
24 Street Journal reported how global buyers such as H&M and Calvin Klein are exploring possibilities to
25 source garments from outside their current suppliers in Asia (including China and Bangladesh) among
26 which Ethiopia seems to be a major contender. In fact, H&M has already started to place test orders
27 that may lead to importing more than a million pieces of garment per month. These possibilities will
28 allow Ethiopia to join the global value chain in garments, which is currently PRODUCTIVE CAPACITY AND
29 ECONOMIC GROWTH IN ETHIOPIA 9 dominated by Asian countries. Further integration in global value
30 chains would allow Ethiopian firms to not only increase their access to foreign markets but also to
31 acquire much needed technological capabilities. However, this process is at an incipient stage and a lot
32 needs to be done to secure a stable and profitable position in value chains in its low-technology
33 industries. 4.5 The Sugar Sector Mega Projects While industrial parks are established primarily to attract
34 more FDI in manufacturing, the government is also heavily investing in sugar production. Until recently,
35 Ethiopia has been a net importer of sugar as the two old sugar factories (Wonji and Metehara) have
36 limited capacity to meet domestic demand. However, one of the targets of the first Growth and
37 Transformation Program (GTP I) is to expand the sugar sector with the ambition for Ethiopia to become
38 one of the top ten sugar exporters in the world. This plan involves the construction of ten large sugar
39 plantations and factories in different parts of the countryto be implemented by the state-owned
40 Ethiopian Sugar Corporation (ESC). The assumption is that the domestic private sector does not have the
41 managerial and investment capabilities to undertake such a large project and hence a decision was
42 made to create a number of state-owned enterprises under the Sugar Corporation. According to a press
43 conference issued by the director of the Ethiopian Sugar Corporation in 2014, seven out of the ten new
44 sugar projects will become operational in 2015 with a production capacity of 1.5 million tons. The press
45 release also reveals that the country has already stopped importing sugar for the first time in 2014-15
46 reducing the import bill by about $130 million a year. With domestic demand currently amounting to 0.5
47 million tons, the country may be able to export nearly 2 million tons of sugar when all ten factories
48 become operational. Work on the other three sugar factories is delayed mainly because of financial

6
 1 constraints and lack of infrastructure in the planned sites. Financing for the new sugar factories are
2 secured partly through loans provided by emerging economies with a requirement that contracts to
3 build the factories are awarded to firms from the lending countries. For instance, the Indian Import-
4 Export Bank has given about $650 million in loan for one of the sugar factories and an Indian firm has
5 been awarded the contract to build the project. Similar arrangements have been made with Chinese and
6 Israeli firms. The ambitious expansion of the sugar sector involves not only building the new factories
7 but also constructing several irrigation dams and sugar cane plantations to supply the factories. It also
8 involves investment in road infrastructure and residential units to host factory and plantation workers,
9 as well as the provision of health and education services for their families. Moreover, there are
10 resettlement programs for farm households who will be displaced by the irrigated plantations. The
11 expansion of the sugar sector is another example of a development program that harnesses natural
12 resource endowments, primarily land and water, as well as the country’s growing and youthful labor
13 force. Although the financing of some of the projects involves a form of tied-aid, which is known for
14 being inefficient, the loans in this particular case seem to be used for the intended purposes. Moreover,
15 the huge potential for sugar exports in the near future implies that the loans may not increase the
16 country’s external debt burden while on the other hand may help reduce it. 5 Growths and
17 Diversification of Exports 5.1 Overall growth We now turn to the performance of the exports’ sector
18 both in terms of growth and composition of the exports’ basket. Figure 3 shows a dramatic increase in
19 export earnings in Ethiopia since 2005 against a backdrop of nearly zero growth for the preceding ten
20 years. In five years export earnings doubled from $1bn in 2005 to $2bn in 2010, and doubled again in
21 the four following years. This shows a 20% annual growth in exports since 2005, which is twice the rate 1
22 0 CDP BACKGROUND PAPER NO. 34 GDP growth. This trend suggests strong improvements in the
23 competitiveness of the economy and the reallocation of resources toward tradable sectors. 5.2 Export
24 performance by commodity Like most LDCs, Ethiopia relies heavily on a few primary export commodities
25 exposing its economy to volatility of international markets and declining terms of trade. During the
26 1970s and 1980s, coffee and oilseeds accounted for nearly 85% of exports in which the coffee’s share
27 was 65%. While coffee remained the dominant source of export earnings until 2000, this started to
28 change in subsequent years as the share of non-coffee agricultural exports surged. Figure 4a shows this
29 clearly with a secular decline in the share of coffee from about 65% in 1995 to about 20% in 2014. In the
30 meantime, the share of non-coffee agricultural exports increased to 60% in 2014 from only 15% share in
31 1995. Figures 4a and 4b reveal remarkable shifts in the composition of the export basket within the
32 agricultural sector. Although the share of agriculture in GDP is declining over time as shown earlier, its
33 contribution to export earnings seems to be rising. Further research will be needed on how much of this
34 outcome is the result productivity gains in agriculture, favorable commodity prices in international
35 markets and reallocation of resources to high value crops. On the other hand, export earnings from
36 leather and food processing industries declined over the last decade from a 15% share each in 2002 and
37 2005, respectively. The vast majority of non-agricultural export items in Figure 4b have less than 2%
38 share in export earnings and show no noticeable increase over time except for a modest rise in garment
39 exports in recent years. Therefore, it is evident that the strong growth in export earnings in Ethiopia
40 since 2005 is a result of non-traditional agricultural exports. Key among the latter are cut-flowers which
41 have experienced a 49% annual growth during 1995-2014 followed by a 29% growth in dairy products
42 and eggs. The remainder of the increase in non-coffee agricultural exports comes from traditional items
43 that experienced faster growth since 2005: 29% growth in live-animals exports, 22% growth in
44 vegetables, 18% growth in meat and fish, 18% growth in oilseeds, and a 10% growth in fruits. Coffee
45 exports grew by 6% explaining the secular decline in its share during the period. Ethiopia has not yet
46 tapped into its competitive advantage in textile and garments, which at the moment are contributing
47 very little to total exports. As shown in Figure 5, some of the fastest growing export commodities are
48 currently contributing the Figure 3 Ethiopian Export Earnings Source: UN COMTRADE Database (2014). 0

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 1 1000 2000 3000 4000 5000 6000 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Millions
2 (USD) Total Non-Coffee Agriculture Coffee PRODUCTIVE CAPACITY AND ECONOMIC GROWTH IN
3 ETHIOPIA 11 Coffee Food Processing Leather and Leather Products Non-Metal 1995 2000 2005 2010
4 2015 1995 2000 2005 2010 2015 1995 2000 2005 2010 2015 Graphs by export-category Graphs by
5 export-category Share in Total Export (%) Agriculture Excluding Coffee Gas & Oil .8 .6 .4 .2 0 .8 .6 .4 .2
6 0 .6 .4 .2 0 .6 .4 .2 0 .6 .4 .2 0 Beverage 1995 2000 2005 2010 2015 1995 2000 2005 2010 2015 Share in
7 Total Export (%) Chemical & Plastic Printing & Paper Textile Apparel Metal Machinery & Locomotives
8 Furniture & Toys 1995 2000 2005 2010 2015 Figure 4a Performance of Export Commodities (with at
9 least 2% share) Figure 4b Performance of Export Commodities (with at least 2% share) Source: UN
10 COMTRADE Database (2014). 1 2 CDP BACKGROUND PAPER NO. 34 least to total export earnings. These
11 manufactured exports could benefit from an aggressive capacity expansion. 5.3 Growth in the Extensive
12 Margin Based on UN-COMTRADE data, Figure 6 indicates that the number of 6-digit Harmonised System
13 (HS) export items in Ethiopia doubled from about 45 in the late 1990s to about 90 products in 2009. This
14 suggests that the rapid growth in total export earnings has also been accompanied by expansion of the
15 extensive margin. This is consistent with Imbs and Wacziarg (2003) who show that the process of
16 economic development involves building productive capacity in a growing number of products, rather
17 than specializing in a narrow range of products as implied by traditional trade theory. Source: UN
18 COMTRADE Database (2014). 0 0.2 0.4 0.6 0.8 1 1.2 Food Processing Coffee Metal Agriculture Chemical
19 & Plastic Leather & Leather Products Beverages NoMetal Printing & Paper Apparel Others Textile
20 Furniture & Toys Machinery & Locomotives Gas & Oil Average Growth Rate (%) Figure 5 Annual Average
21 Growth Rate of Export Earnings in USD by Major Categories (1995-2014) Source: UN COMTRADE
22 Database (2014). 40 50 60 70 80 90 100 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Number
23 of Commodities Figure 6 Number of Six-Digit (HS) Export Commodities PRODUCTIVE CAPACITY AND
24 ECONOMIC GROWTH IN ETHIOPIA 1 3 6 Financing domestic investment 6.1 Credit to the Private Sector
25 LDCs are often characterized by low domestic savings and underdeveloped financial institutions. As
26 shown earlier in Figure 1, the domestic savings rate in Ethiopia declined from 15% of GDP during the
27 1980s to about 12% during the 1990s. Savings increased above 15% of GDP only after 2010. It is evident
28 from Figure 1 that movements in aggregate investment were closely correlated with the savings rate up
29 until the late 1990s, suggesting a binding constraint on investment imposed by low domestic savings.
30 Since the year 2000, however, the gap between domestic investment and savings widened substantially.
31 While domestic investment doubled from 20% of GDP in the early 2000s to 40% of GDP in 2014, the
32 increase in domestic savings was rather muted. It is clear that foreign aid (including concessional loans)
33 has been playing an increasingly important role in domestic investment finance. Recent studies have
34 examined developments in the Ethiopian financial sector and the private sector’s access to credit (IMF,
35 2013; Zewdu, 2014; World Bank, 2015). These studies highlight the fact that the Ethiopian financial
36 sector remains closed to foreign banks and that the quality of its services compare poorly with respect
37 to other African countries. There are about 16 privately owned commercial banks as of now, accounting
38 for less than 30% of the sector’s financial assets. The state-owned Commercial Bank of Ethiopia (CBE)
39 overwhelmingly dominates the market. Private banks function under stringent financial regulations that
40 restrain financial intermediation. The government justifies strict regulations on the grounds of financial
41 stability. The market dominating CBE has dedicated almost all of its lending efforts, as a matter of policy,
42 to a growing number of public infrastructure projects and expansion of state-owned enterprises.3
43 State3 This pattern of financial resource allocation is quite similar to the Chinese experience except that
44 domestic savings rates and private investment rates are much higher in China owned banks thus have
45 limited financial resources for lending to the private sector. While individual investors can borrow from
46 private banks, the latter are constrained by high liquidity and reserve requirements as well as single-
47 borrow limits. According to Zewdu (2014), private banks contributed to 34% of total credit supply in
48 2011-12, down from a 49% share in 2004-05. Since 2011, a new directive of the National Bank of

8
 1 Ethiopia (NBE) requires private banks to set aside 27% of any loan provided to private borrows for
2 purchasing NBE bonds. The idea is that funds raised in this manner will be allocated to the Development
3 Bank of Ethiopia (DBE) for on-lending to priority sectors. In addition to government interventions that
4 reduce credit supply to the private sector, the latter’s demand for credit is also curtailed by collateral
5 requirements and relationship lending practiced by private banks. Private banks impose high collateral
6 requirements (as high as 230% of the loan) making access to credit very difficult, if not impossible,
7 particularly for SMEs (World Bank 2015). Private banks also rely on relationship lending in screening loan
8 applications instead of using a credit rating system. It is assumed that the practice of relationship
9 lending has become more prevalent as the size of loanable funds declines due to the above mentioned
10 policy conditions. The combined effect of excessive regulation on private banks and the preoccupation
11 of state-owned banks in lending to the public sector has resulted in a continuous reduction of domestic
12 credit to the private sector from 19% of GDP in 2004 to about 11% in 2011 (World Bank, 2015). Ethiopia
13 seems to be unique in this regard as no other African country exhibits a declining trend in credit to the
14 private sector. The African average for outstanding credit to the private sector in 2011 is about 23 of
15 GDP (World Bank, 2015). The trend in credit supply to the private sector is entirely consistent with the
16 decline in private investment to GDP ratio since the early 2000s, which however showed some recovery
17 in 2013 and 2014. 1 4 CDP BACKGROUND PAPER NO. 34 5.2 Foreign Aid Flows While Ethiopia, like most
18 other developing countries, experienced a decline in official development assistance (ODA) during the
19 late 1990s, it has been one of the largest recipients of aid since 2000. Real net ODA quadrupled to $4bn
20 in 2014 relative to aid flows in 2001. In the meantime, the country’s aid-dependence has come down
21 slightly from about 25% of GDP during the late 1980s and early 1990s to about 18.5% during 2000-2009,
22 and to 15% of GDP during 2010-2014. Table 4 also reveals that domestic investment in Ethiopia has
23 been increasing faster than aid flows to the country, as a result of which the percentage of domestic
24 investment financed by foreign aid declined from 50% during 2000-04 to about 29% during 2010-14.
25 Given that most of the increase in domestic investment is driven by public investment in infrastructure,
26 it is not surprising that the government also resorted to borrowing from the domestic banking sector in
27 addition to using aid for investment purposes. This is reflected in the sharp increase in domestic credit
28 to government as percentage of GDP, while the GDP share of lending to the private sector shrank. These
29 developments suggest that credit constraints for the private sector in Ethiopia go beyond the
30 conventional information asymmetry problem. The preceding discussion underscores that while
31 Ethiopia’s productive capacity is growing at a faster pace, it is largely driven by the ability of the public
32 sector to invest in a wide range of programs and projects simultaneously. On the other hand, the private
33 sector is experiencing formidable financial constraints, created directly and indirectly by public
34 investment programs, to capture and benefit from investment opportunities. Assessments of growth
35 prospects by the World Bank and the IMF also underscore that the rapid economic growth over the last
36 decade may prove harder to sustain if the private sector continues to be starved of bank credit. A
37 challenge for the Ethiopian government is striking a balance between the much needed public
38 investments in infrastructure and the ability of the private sector to effectively utilize the infrastructural
39 services. Currently, the aggressive public investment has not attracted yet private investment primarily
40 due to credit constraints. Obviously, increased aid flows to the public sector may ease the state’s
41 demand for domestic credit. The other option is for donors to find ways to increase credit for the private
42 sector. Another interesting development in investment finance is the government’s effort to raise funds
43 from international financial markets. In 2014, the Ethiopian government issued 10 year bonds for the
44 first time and raised about 1$billion. This development set a new trend as the investment in
45 infrastructure and growing export orientation boosted investors’ confidence on the creditworthiness of
46 the Ethiopian economy. Table 4 Net Flow of ODA to Ethiopia Year Net Flow of ODA (Million USD) Current
47 Prices Constant Prices ODA/GDP ODA/Investment ODA per capita 1980-84 285.0 777.5 13.0 18.3 7.5
48 1985-89 734.0 1520.0 24.6 34.3 16.8 1990-94 1100.0 1640.0 25.2 62.2 21.0 1995-99 716.0 1024.0 12.7

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 1 44.3 11.9 2000-04 1298.0 1820.0 18.2 50.1 18.6 2005-09 2720.0 2940.0 18.9 44.3 33.7 2010-14 3525.0
2 3575.0 14.9 28.6 39.1 Source: World Development Indicators (2015) PRODUCTIVE CAPACITY AND
3 ECONOMIC GROWTH IN ETHIOPIA 1 5 7 Investment in human capital 7.1 Primary and secondary
4 education The most important among the productive resources in any country is its workforce and the
5 level of its human capital. In this regard, Ethiopia has a long way to go, even by the standards of other
6 low-income countries. According to the 2014 Human Development Report, the adult population in
7 Ethiopia has only 2.4 years of schooling, which is 50% lower than the average for Sub-Saharan Africa
8 (SSA), and nearly 2 years less than the average for low-income countries. However, the expected years
9 of schooling for children of school-entry age, the second measure of access to knowledge in the HDI,
10 shows significant improvements from 2000 to 2013. According to this index, children of school-entry age
11 in 2013 are expected to attain 8.5 years of schooling as adults, showing a 100% increase since 2000. The
12 expected attainment is based on the assumption that the prevailing age-specific enrolment rates would
13 remain unchanged throughout a child’s life. Improvement in expected years of schooling reflect the
14 rapid increase in primary school enrollment in recent years. This trend may allow Ethiopia to nearly
15 eliminate the gap in the educational attainment of its younger generation with respect to other SSA and
16 low-income countries. The expected years of schooling for children of school-entry age in SSA and low-
17 income countries in 2013 were 9.7 and 9.0 years, respectively. Using data from several issues of the
18 Education Statistics Annual Abstract prepared by the Federal Ministry of Education, Figure 8 shows rapid
19 expansion of access to primary education over the last decade. In fact, gross primary enrolment rate
20 increased from about 33% in 1995 to 100% in 2014. Most of the increase occurred between 1995-2005
21 with enrolment staying above 95% since 2005. Figure 8 also shows that the gender gap in primary
22 education has declined significantly. In the meantime, secondary school enrolment rate increased from
23 less than 10% in 1995 to about 25% in 2014. Howver, improvement in secondary education has slowed
24 down since 2006, which is a cause for concern given the low enrolment rate at the secondary level.
25 Secondary school enrolment rate in Sub-Saharan Africa is estimated to be 41.2% in 2012, according to
26 the World Bank. 5 10 15 20 25 30 35 40 45 0 1000 2000 3000 4000 5000 1980 1990 2000 2010 2020
27 Percent of GDP MillionUSD(Constantprices) Net-ODA Net-ODA/GDP Figure 7 Net ODA to Ethiopia 1 6
28 CDP BACKGROUND PAPER NO. 34 Better prospects of educational attainment for the youth are
29 extremely important for sustainability of the recent growth momentum. Actions taken by the
30 government and its development partners are broadly consistent with this recognition. Government
31 spending on education increased from 14% of total government budget in 1995-96 to about 24% in
32 2011-12. The GDP share of the government’s education budget also increased from 2.5% in 1995-96 to
33 4.5% in 2000, and remained at about 4% until 2012. Given the decline in total government expenditure
34 from 27% of GDP in 2007 to 17% of GDP in 2012, there appears to be strong commitment to investment
35 in human capital. 7.2 Higher education In terms of higher education, enrolment numbers remained very
36 low and relatively stable during 1995-2005 while enrolment in primary and secondary schools increased
37 sharply. It was only after 2005 that enrolment in tertiary education started to rise. Figure 9 shows that
38 enrolment in undergraduate programs was far below 100,000 students per annum until 2003, climbed
39 to 300,000 in 2008 and reached 600,000 in 2014. Similarly, less than 10,000 students were enrolled in
40 graduate programs (mainly master’s degrees) until 2007, with a slight contraction in the late 1990s.
41 Although graduate enrolment is still very low, it increased to about 33,000 students in 2014,
42 representing more than threefold increase compared to 2008. Women account for about 30% of
43 enrolment in higher education with very little change over time. The strong expansion of tertiary
44 education since 2005 is a result of deliberate education reform measures in 2003 (Saint, 2004). These
45 reforms addressed not only the supply but also the management of higher education and the
46 composition of academic programs. There were only two public universities and seven colleges in
47 Ethiopia in 2000. The number of public universities increased to 8 in 2003 and to 32 in 2014, showing
48 dramatic and unprecedented increases in higher education. The government plans to add 10 more

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 1 universities by the end of the 2nd GTP. There are also several colleges offering twoyear diploma
2 programs as well as teachers’ training Source: Ministry of Education, Federal Government of Ethiopia. 5
3 10 15 20 25 20 40 60 80 100 1995 2000 2005 2010 2015 Secondary Education Primary Education Primary
4 Male Primary Female Primary Secondary Figure 8 Gross Enrolment Rate in Primary and Secondary
5 Education in Ethiopia PRODUCTIVE CAPACITY AND ECONOMIC GROWTH IN ETHIOPIA 1 7 institutions.
6 Since the late 1990s, the government has also allowed private sector participation in higher education,
7 which in recent years accounts for 30% of total enrolment. Private higher education institutions provide
8 training programs that are high in demand such as accounting, business administration, information
9 technology and nursing, mostly at the diploma level. Some of these training programs are
10 predominantly offered by private colleges making significant contribution to the government’s objective
11 of expanding higher education. The sharp increase in the number of public universities in a short period
12 of time and the opening of private colleges has important implications on the quality of higher
13 education. Most of the new universities have very few instructors at the Ph.D. level and lack the
14 requisite teaching materials and inputs. To ensure that the rapid expansion of higher education does not
15 compromise the quality of education, the government established the Higher Education Relevance and
16 Quality Agency (HERQA) in 2003. Higher education institutions have also been given greater autonomy
17 under the recent education reform program, allowing them to choose their leaders and respond to
18 market demand in designing academic programs. This is extremely important to increase hiring and
19 retention rates of qualified faculty staff, expecially considering the experience under the Derg regime in
20 the 1980s, during which hostile interventions in university matters and censorship led to a massive
21 brain-drain, depriving universities of their highly trained and experienced scholars. As compared to
22 primary and secondary education, access to tertiary education raises important equity concerns (Saint,
23 2004). A large majority of students enrolled in public universities come from urban areas whose parents
24 are relatively more educated. Before the 2003 education reforms, public universities did not charge
25 tuition fees and provided students with free food and accommodation. Government subsidy for higher
26 education was thus strongly biased in favor of urban dwellers who account for less than 20% of the total
27 population. Since 2003, the government has introduced a graduate tax to recover the cost of food and
28 housing and in an effort toto expand higher education while addressing equity concerns. Since the new
29 universities are mainly located in regional states, they are expected to improve accessibility of higher
30 education to broader sections of society. Figure 9 Enrolment in Tertiary Education (‘000) Source: 0 10 20
31 30 40 0 100 200 300 400 500 600 1995 2000 2005 2010 2015 Graduate Undergraduate Undergraduate
32 Graduate 1 8 CDP BACKGROUND PAPER NO. 34 As Ethiopia moves toward export-oriented
33 manufacturing, the demand for educated labor force is expected to rise. In this regard, the rise in
34 educational attainment at various levels is encouraging and the government’s budgetary commitment to
35 education may facilitate the economic transition toward increasingly advanced manufacturing
36 industries. Currently the country relies on natural resource endowments (land, water, livestock and
37 cheap labor) and better infrastructure would both attract FDI and foster industrial progress. 8
38 Conclusions The Ethiopian economy has been growing rapidly since 2000 and long-term plans are under
39 way that may lift the country to a lower middle-income status by 2020. A major driving force behind this
40 remarkable achievement is the developmental state, which mobilized resources for investment in
41 economic infrastructure and human capital while harnessing some of the country’s natural resources.
42 The paper highlights some of the weaknesses that need to be addressed to sustain the strong growth
43 momentum. Perhaps the most important of these concerns is the relatively weak private investment
44 rate, which in theory is supposed to rise rapidly with improvements in infrastructural services and strong
45 aggregate demand. In addition to critical problems with access to credit, the private sector faces several
46 challenges including access to land, high and at times arbitrary taxes on small firms, and inefficient legal
47 systems for contract enforcement. An improvement in the transparency and efficiency of these
48 institutions is crucial for market competitiveness and sustainable growth. The second concern, also

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 1 related to private investment, is the rate of expansion of the manufacturing sector. The share of
2 manufacturing in GDP is far below the African average and there is apprehension about the viability of
3 the current strategy to achieve the GTP objectives. Currently the focus seems to be on large FDI and
4 state-owned firms without commensurate attention to the role of the domestic private sector in
5 manufacturing. While FDI flows to the manufacturing sector is growing, owing that partly to the
6 establishment of industrial parks, its total magnitude remains small. Moreover, it is yet to be seen if
7 multinational companies will have a positive spillover effect on the productivity of local firms as they
8 tend to be confined to industrial zones where only a few domestic firms are located. Similarly, the
9 expansion of the sugar sector is left to the Sugar Corporation and the recurring concern about the
10 inefficiency of state-owned companies may arise. As of now there is no indication whether nor when the
11 government intends to privatize the sugar factories or incorporate private ownership. The third major
12 concern is the structure and development of the financial sector as an instrument for building
13 productive capacity. The limited number of private banks, the stringent rules and regulations under
14 which they operate, and the high collateral requirements they require, are undermining the allocation of
15 credit to domestic investors while the market dominating state-owned banks credit primarily to the
16 state and state-owned enterprises. Studies show that better access to credit may increase private
17 investment in manufacturing and speed up the attainment of the objectives set in the GTPs. Financial
18 sector reforms, as well as efforts that reduce the government’s competition with the private sector for
19 loanable funds, including more foreign aid as well as borrowing from international financial markets,
20 may relax credit constraints of the private sector. Fourthly, the export of manufactured products has yet
21 to show meaningful contributions to Ethiopia’s export earnings. While important changes in the
22 composition of the export basket have occurred recently, most of this change pertains to the
23 restructuring of agricultural exports. Connecting local firms with foreign buyers, providing them with
24 tailor-made business support and inserting them properly in global value chains, may help improve the
25 export orientation of the manufacturing sector. Finally, while access to tertiary education has expanded
26 rapidly in recent years, it does not seem to PRODUCTIVE CAPACITY AND ECONOMIC GROWTH IN
27 ETHIOPIA 1 9 have generated highly trained instructors at the Ph.D. level Currently, this gap is being
28 filled through collaborations with foreign universities who loan their faculty members to teach block-
29 courses. While this might be a viable short-term solution, more aggressive efforts are needed to improve
30 the hu
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